The Financial Conduct Authority's overhaul of client assets regime

18 June 2014

Around 1500 firms regulated by the Financial Conduct Authority (FCA) (collectively holding more than £10 trillion of custody assets and more than £100 billion of client money) are subject to the client assets regime and must now come to grips with substantial changes coming into effect under the FCA's Client Assets rules (CASS).

Last week the FCA released its long awaited final policy and rules, namely PS 14/9 Review of the Client Assets Regime for Investment Business(PS14/9). Its provisions come into effect in stages from next month and through to June 2015.

Three goals

This review considered a complete overhaul of the FCA's rules on client money and client assets in order to arrive at a package of changes that would achieve three outcomes:

  • Faster return of money and assets to clients
  • Lower shortfalls of client money and client assets returned to clients
  • Greater market stability in event of firm failure

The final changes made under PS14/9 are expected to improve the protection of client money and custody assets held by investment firms.

Some of the more controversial aspects of the initial proposals under the consultation paper CP13/5 (e.g. CASS 7A distribution proposals, and a standalone client disclosure document) have been put aside - but just for the time being. Distribution will be consulted on again later this year.

Despite the decision not to proceed with the CASS 7A distribution proposals, the FCA believes that firms' operations, organisational requirements, records and practices will improve due to the changes made in the areas of segregation, reconciliations and record keeping obligations.

These are expected to make it quicker and easier for insolvency practitioner to determine client money and the client assets estate of a failed firm, and thereby facilitate a faster return of assets and lower shortfalls than under the current regime.

Changes or just clarifications?

Instead of creating an entirely new sourcebook, the FCA has opted to change the structure of CASS following feedback on CP13/5. Structural changes will be made in the following areas:

  • A new chapter CASS 6.6: Records, accounts, reconciliations (replaces CASS 6.5)
  • A new chapter CASS 7.17 (replaces Annex 1 under CASS 7 on methods of internal client money reconciliations)
  • A new chapter 7.19 Acknowledgement letters (renaming CASS 7.8)
  • Introduction of a new chapter 7.20 Multiple pools
  • Four new Annexes under CASS 7
  • Renaming and expanding CASS 9: Prime brokerage section to "Information to clients"

These changes are intended to make the rules simple and easier to follow.

In many instances throughout PS14/9 the FCA has sought to emphasise that a new provision is simply a clarification rather than a change. For example, a theme throughout is the insertion of new guidance in order to highlight other rules or guidance (under CASS or COBS) that firms simultaneously need to be aware of when their activities are caught by the client money or client custody rules.

It might be argued that some 'clarifications' in reality amount to a change on some level. Either way, as a consequence of meeting new CASS requirements or 'clarifications', changes will take place in firms' operations, organisational requirements, records and in their practices.

As always, the real devil is in detail when it comes to applying the rules or guidance in practice.

Will the new FCA rules increase costs for firms?

The FCA believes that the new and revised rules dealing with faster return of client money, lower shortfalls and greater market stability are still in line with the earlier cost benefit analysis under CP13/5.

A key theme under the new regime is the creation and retention of detailed records.

It will not, however, simply be a case of going through the process of creating a record at a particular point in the handling of client assets. Firms must ensure the substantive content of the record contains the required details, and that those details are kept accurate. For example, in relation to title transfer collateral arrangements (TTCA), the record must set out details of how a firm responds to a client's request to terminate. A lack of clarity could amount to a failure to meet the required standard. All of this will force firms to spend more time and resource getting the details right.

The FCA typically downplays the costs involved for firms in working out how to meet new regulatory requirements, so it is worth noting some of the areas where the FCA admits that the final form of the rules may involve higher costs than estimated under CP13/5:

  • Resolving custody shortfalls with the firm's own assets
  • Delivery versus Payment (DvP) window (commercial settlement systems)
  • Due Diligence on third parties (holding custody assets or client money)
  • Diversification of client money
  • Prudent segregation
  • Alternative approach mandatory prudent segregation
  • Clearing arrangement mandatory prudent segregation
  • Internal client money reconciliations and approved collateral
  • Frequency of external client money reconciliations

Firms must maintain records for five years under the new CASS regime.

Will client documentation need replacing?

The FCA does not believe that many firms will need to review and repaper their existing client documentation for all the changes being introduced. In an attempt to minimise this type of cost impact, the FCA distinguishes between mandatory and optional requirements.

For certain mandatory requirements, it concedes (in the small print of PS14/9) that some firms "may" incur costs to repaper client documentation to meet new notification, consent or information requirements which are mandatory in specific circumstances. For example:

  • Making use of the TTCA exemptions under client money and custody rules
  • Making use of DvP window for commercial settlement systems
  • Making use of DvP for regulated collective investment schemes
  • Taking client money on deposit as banker (banking exceptions)
  • Firms with non-retail clients may also incur costs from the additional information which they will now be obliged to provide those clients before the provision of investment services (CASS 9.4).

Other firms, the FCA states, might only incur additional costs if they have "chosen" to use optional mechanisms for handling client money and assets in specific circumstances, such as:

  • Handling unclaimed client money and custody assets
  • Carrying out a transfer of business
  • Choosing to operate multiple client money pools (e.g. the sub-pool disclosure document)
  • Handling shortfalls in custody assets (certain credit institutions operating under the banking exemption may need to revise their client documentation in order to be able to segregate their own money as client money to cover a shortfall in custody assets instead of otherwise immediately making good that shortfall).

The FCA considers that much of the repapering will simply be done as part of firms' business as usual processes and this reduces the likely costs that these new CASS requirements will impose on them.

Deadlines on firms

The rules come into effect in stages, starting from next month and on 1 December 2014 and the most time-consuming changes become effective in June 2015.

Preparing for the new FCA Client Assets rules

Although some of the more controversial aspects of the initial proposals have been put on hold (just for the time being), firms are still faced with a challenging workload ahead to ensure they are compliant by the time the rules come into effect.

All investment firms to which the CASS sourcebook applies should have already conducted gap analysis based on CP13/5. Firms that did not will need to conduct a gap analysis now and on an urgent basis.

To get ready, firms will need to comb through the details of the new CASS regime and establish how the overhaul to the rules and guidance affects their business so that they can take steps to ensure their records and processes will be fully compliant. With all the 'clarifications' inserted into the regime following industry feedback, firms will have less scope to explain away a CASS breach.


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