23 rd September. CASS Seminar, London. Issues arising out of CP13/5 a legal perspective. Ash Saluja 23 September 2013.

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1 Issues arising out of CP13/5 a legal perspective Ash Saluja 23 September 2013 Scope and timing Revisions to rules on client assets for investment businesses i.e.: CASS 6 (custody assets) CASS 7 (client money) CASS 8 (mandates) Multiple client money pools for EMIR implementation purposes Client distribution rules (CASS 7A) speeding up pay outs Comments due on bulk of proposals p by 11 October 2013 a number of points worth lobbying on Mosty changes due to be implemented after 6 month transition period, once final rules published by FCA in H

2 Remember the policy objective Main goal of CASS regime is to ensure that on insolvency or failure of the firm (a primary pooling event), client assets are easily identifiable and can be returned to clients rather than being claimed for the benefit of all creditors of the firm Risks arise due to: unresolved deficits due to errors or debts (e.g. failure to recognise client assets as such and so comply with CASS) uncertainty over records intra-day/transfer risk (e.g. on the alternative approach/dvp exemptions as not all client money will be in a client account when firm fails) Main objectives of this review are to improve the speed and size of return of client assets following the failure of a firm holding client assets (e.g. by making sure firms records identify all relevant client money) Client money scope of CASS 7 Money received or held by a firm for or on behalf of a client in the course of or in connection the firm s MiFID business or designated investment business FCA is expecting firms to know the basis on which money is held and so when the statutory trust applies Banking exemption: FCA wants banks to be clearer with clients when they rely on this exemption banks must genuinely treat the money as a deposit (e.g. if they do not hold the deposit on their balance sheet and hold the money with a third party bank it will be client money) Trustee firms (e.g. SIPP trustees who are also SIPP operator/administrator): currently subject to limited application of certain CASS 7 rules - FCA allowing firms to opt-in to full application of some these (e.g. segregation, records & reconciliations, acknowledgment of trust) clarification that on a primary pooling event, CASS 7A does not apply to monies held under separate trust deed (effectively they are outside the client money pool) 2

3 CASS 7 changes receipt and segregation Immediate (rather than prompt) segregation of client money into client accounts for firms not operating the alternative approach (i.e. direct to client account) Must allocate unidentified receipts of client money to specific client(s) within 5 business days Physical receipts (cash, cheques, payment orders) recorded immediately and paid within 1 business day into client money bank account firms may not use to conduct business until cleared Prudent over-segregation (or buffers) to be formalised basis on which money placed in client money bank account has to be clear (i.e. it will be client money rather than firm money) and firms are not permitted to use without clear reason (i.e. specific liability or risk) Use of alternative approach to segregation (where client money is mingled with firm s house money, and transfers are made between house accounts and client accounts on reconciliation) limited to certain multi-currency, multiproduct firms who must justify use and put in place appropriate protections (including buffers) CASS 7 changes client money banks Greater onus on appropriate p diversification specific factors to be considered enhanced due diligence (financial soundness, deposit protection) Acknowledgement of trust letters FCA now proposes template wording following discussions with the banks to be on firm s letterhead, although arguably better to be on bank letterhead to avoid verification and potential fraud issues counter-signature required from bank to the letter and firm must take reasonable steps to ensure signatory is authorised firms must obtain the acknowledgment BEFORE placing client money in the account (rather than within a 20 business day grace period post account opening) requirements cover client money bank accounts with overseas banks also initial repapering exercise expected within 6 month transition period of rules coming into force firms also expected to review letters annually 3

4 CASS 7 changes use of fixed term deposits (1) Client money is placed by firms with banks on a fixed term deposit or in notice accounts in order to get a better interest rate either for an individual client (designated account) or clients generally (pooled account) FCA is concerned: that firms will be unable to take action to move client money if they consider the bank is no longer suitable (e.g. change on credit rating, adverse announcement, high potential to fail etc.) if bank fails then a secondary pooling event will occur - clients with a designated account at that bank or clients generally if a pooled account is held with that bank, will suffer as a result If primary pooling event occurs (i.e. firm itself fails) then there will be a material delay in returning money to clients CASS 7 changes use of fixed term deposits (2) FSA raised concerns (questionnaire in August 2012 on term deposits and Dear CF10a letter on unbreakable deposits) and asked firms to (i) review policies and procedures in this area and (ii) confirm to the FSA the details of any unbreakable client money term deposits CP proposes to prohibit term deposits and/or notice accounts where the principal cannot be recovered within 1 business day of a withdrawal request FCA considers that clients cannot agree to client money being held in an unbreakable deposit, as a primary pooling event affects all clients with entitlements to the client money pool need to open the account/put the deposit in the client s name so avoiding CASS 7 but falling under CASS 8 Lobby FCA for a practical solution banks need stable funding, large firms will consistently hold a balance of unused client money long term, clients want better interest rates. How can all parties benefit from this arrangement without posing undue risks to clients? Is there an alternative to keeping the deposit in the client s own name which brings operational challenges? 4

5 CASS 7 changes DVP exemption for CIS Operators of regulated funds do not need to treat subscription/redemption monies as client money under CASS 7 exemption FCA now proposes to remove the DVP exemption: what happens if DVP transaction fails to settle in time? what happens if firm becomes insolvent before transaction has settled? Practical implications how to switch to receiving subscription monies in a client money bank account - many operators use bank accounts that co-mingle DVP money with their own money would they be able to convert those into client money bank accounts or need to set up new accounts and inform investors? How do they cover intra-day positions? would operators seek to act as agents for the CIS (i.e. operate mandates over CIS bank accounts only in accordance with CASS 8 rather than comply with CASS 7?) CASS 7 changes miscellaneous Interest: FCA has admitted the draft rules are incorrect (they implied a firm either had to pay all interest on client money balances to a client and treat it as client money, or not pay interest at all on such client money balances) firms can agree contractually the scope and timing of payments of interest to clients (may differ from scope and timing of payments from underlying banks) Transfers of business: FCA now proposing simplified approach for firms seeking to transfer client money to a transferee of their business, rather than needing individual consents/waivers from FCA and having doubts over discharge of fiduciary duty must have an an assignment clause in the relevant contract with the client covering prescribed issues likely most firms will adopt to give flexibility Allocated but unclaimed client money: cannot reclaim for firm s benefit, but can pay to charity subject to formalities for amounts over 10 must give undertaking to make good valid claims 5

6 CASS 6 proposals Written custody agreements explicit requirement to document arrangements with third parties holding safe custody assets for clients even in an intra-group context further FCA clarification on terms within that agreement New requirements on custody assets reconciliations Unclaimed custody assets: cannot liquidate for firm s benefit, but can pay proceeds to charity subject to formalities for amounts over 10 must again give or procure undertaking to make good valid claims CASS 8 changes mandates Applies when firms control rather than hold client money (e.g. bank account is in the name of client, but the firm has authority to give the bank instructions on making payments and transfers) risk of misappropriation CASS 8 already sets out high level rules that requires a firm to establish and maintain adequate records and internal controls in respect of its use of the mandates Proposal now to include non-written mandates within the scope of these rules covering anything that gives the firm the ability to control the client s assets or liabilities (e.g. telephone instructions passing credit card details etc.) 6

7 CASS 9 client reporting and information COBS already covers periodic reporting and information on client assets protection to be provided to clients FCA believes there is a lack of understanding amongst clients on client assets issues, as demonstrated by recent insolvencies New proposal for a Client Assets Disclosure Document standalone document does not supersede contractual documentation but acts a single source of the relevant provisions on client assets which impact a client s rights to or interests in such assets provide to clients at least annually if not more frequently if changes occur Multiple Client Money Pools Key proposals to give effect to EMIR: exclude client money that is held by a clearing member firm in a client transaction account at a CCP from a primary pooling event allow the porting of excluded money to a back-up clearing member firm To make porting feasible clearing member firms will be allowed to operate legally and operationally separate client money sub-pools (i.e. the margin held in a particular net omnibus client transaction account at a CCP and the client money the clearing member holds in relation to the relevant transactions) Insolvency practitioners will be able to make the separate client money pool available to the back-up clearing member as necessary FSA had been looking to extend the proposal to permit firms to create multiple client money sub-pools in relation to any investment business but now deemed by the FCA as too difficult for firms to manage operationally 7

8 Client distribution rules current rules CASS rules aimed at achieving the FCA s statutory objectives: maintaining market confidence financial stability consumer protection CASS 7A governs distributions on a firm s insolvency Failure of the firm results in a primary pooling event (PPE) where all client money (anywhere) held is notionally pooled into a single client money pool (CMP) CMP then distributed to clients on a pro-rata basis in accordance with their entitlements (regardless of whether their money actually in CMP) In practice, pay outs can take months or years to effect as the insolvency practitioner (IP) works out the available CMP and the relevant entitlements Client distribution rules the speed proposal Speed is driving the proposed changes New two-stage client money distribution process proposed with two notional CMPs CMP1 and CMP2 Initial distribution of client money held in client accounts within weeks of insolvency from CMP1 (based on reconciliation of failing firm s records as at PPE) appropriate where IP believes that the records reasonably allow determination of entitlements to be made Second (later) distribution comprised of any surplus left in CMP1 & any identifiable client money held in the firm s house account (CMP2) If two-stage distribution not possible (e.g. more than 10% discrepancy, no accurate record of entitlements etc.), IP may form single combined CMP and then make one distribution, which is similar to current process Huge reliance on firms records FCA likely to be even less tolerant of breaches larger clients also likely to want oversight of firms records 8

9 Client distribution rules codification proposal Alternative to the speed proposal, refine existing rules based on recent insolvency experiences clarification of what money constitutes the CMP corrected reconciliation carried out at the PPE procedure set out for determining each client s CMP entitlement Arguably fairer as client entitlements and full scope of available CMP are calculated before any distribution, but still likely to take a substantial amount of time Client distribution rules other proposed changes Remove current prohibition on the whole of the CMP being transferred to a purchaser, provided decision made within 14 business days of the PPE and notifications made to clients Hindsight used to value client s open position when determining entitlement to the CMP (for margined transactions through CCP/3 rd party broker, use the liquidation valuation after PPE rather than the valuation at the PPE) Unclaimed client money may be used to make up shortfall in CMP (notify clients and make attempts to contact them) 9

10 Any questions? 10