Putting clients first

The FCA has changed the rules of its client assets regime to help protect customers 

Following the meltdown of American investment bank Lehman Brothers in 2008, some British customers endured a wait of several years before they recovered assets or cash - far longer than peers on the other side of the Atlantic.

In 2012, the FCA promised a "radical" shake-up of its rules governing client assets. Yet the package of changes the regulator published in June this year was not quite the revolution the watchdog had told the industry to expect.

In the meantime, however, there are plenty of steps financial institutions that handle client money need to take. These include giving clarity to customers over the terms in which their assets are being held, explains Christopher Bond, Chartered MCSI, Senior Adviser at the CISI.

He says: "Clients must be provided with much more information whenever a financial institution accepts cash or assets from them. For example, it needs to be spelt out more clearly when clients actually give up title to certain assets when they post collateral. The evil this is intended to address is that customers were sometimes not aware that they risked losing collateral when a financial institution collapses."
"The FCA has found numerous instances of poor record-keeping practices" The pace of change may be slow, but there is plenty in the reforms being introduced by the FCA to keep wealth managers, custodians and other financial institutions busy. A raft of new rules and guidelines came into force on 1 July this year and others will follow this December and in June 2015.

Part of the original goal of the overhaul was to improve the speed with which client assets were paid back in the event of a financial institution collapsing.

The initial plan was to speed this up by paying out the bulk of money almost immediately based on the firm's own records, leaving a smaller portion for later claims. To do this, it was important to make changes to ensure the information kept by firms is spot on.

"A key focus of the updated rules is to ensure that firms' records are complete and accurate," says Amanda Sherwood MCSI, an independent business consultant and Client Asset Sourcebook (CASS) specialist. "Firms will face tougher rules on protection of client assets and client money, and clients will be entitled to greater clarity about where and how their assets are being held. But there is nothing here yet to dramatically accelerate how quickly they will get their cash and assets back."

New legislationChanges may be made later to accelerate the process, experts point out. "Work is being done by the Treasury so it seemed sensible to hold fire," says Hannah Meakin, a partner at Norton Rose Fulbright. "If there is new legislation on the way, any FCA rule changes on speed may have been superseded and would have had to be revised anyway."

This point is underlined by Meakin. "There is a far clearer requirement that clients be kept up to date with exactly how their cash and securities are being held, and whether it is in custody or held as client money or not," she says. "This right to disclosure will be applied to all clients, including the big institutions."

To reinforce this new transparency, communication with clients will be more regular and frequent. "Previously, clients would often get this information only upfront and in the event of a significant change," Meakin explains. "Now they will be reminded about the exact details of the situation every time they receive a statement of assets from their financial institution."

Reliable records For many firms, the real meat of the change relates to ensuring that records of client assets are completely reliable and up to date. "The FCA has found numerous instances of poor record-keeping practices, and it is taking action to tighten the rules on reconciliations in particular so that firms regularly check their records to ensure they are complete and accurate," says Sherwood. "The new rules carefully define a standard approach to reconciliations; firms may use a different method but their auditors must confirm that the method is suitable."

A key part of the process is making sure financial institutions conduct an internal reconciliation on the client assets they are responsible for. "Where companies only keep a single set of records, they must confirm that systems and controls are in place to guarantee the accuracy of their files," emphasises Sherwood. External reconciliation - making sure a firm's records are in line with external bodies, such as custodians - is also required.

Some provisions are likely to affect only the smaller financial institutions that until now have relied on outside systems to keep their records. "Under the more rigorous system being brought into force, such businesses will now have to maintain their own internal records," says Sherwood.

There are requirements, too, for firms to leave a clear trail of actions taken to keep their affairs in order. "Institutions will need to record the dates on which they conducted internal and external reconciliations or due diligence when depositing cash with another bank," says Meakin. "So it is not just about what you hold, but the reasons why and all of the actions you have performed. The result is a much longer audit trail."

Third parties The FCA is also insisting on more thorough due diligence on third parties that wealth managers or brokers use to hold cash or assets for their clients. To further reduce the risk of losing client money, the Authority is encouraging greater diversification. "The idea is that a broker should consider whether it is appropriate to put all the clients' money and assets with a single institution," Meakin explains.

Of course, many firms that were already following best practice will be little affected. "For these businesses, there is nothing terribly onerous in this aspect of the changes," says Meakin. "For others, it may require new IT systems and a deep overhaul of procedures."

Finally, firms will need to consider a shift in the system for over-the-counter derivatives. As of 1 July 2014, client collateral can be placed either in individual accounts, omnibus accounts of all clients or a smaller sub-pool. "As a result, there is a lot more information that clients need to receive about these options," says Bond.

Although these changes seem bureaucratic and incremental, they should increase the safety of client assets. They also lay the foundations for greater speed. If records are more reliable, it should ultimately be easier for clients to be repaid faster when institutions go bust.

The original version of this article, written by Chris Alkan, was published in the September 2014 print edition of the Review.
Published: 04 Nov 2014
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