Barely a week goes by without news of another enforcement action by regulators against a firm for breaches of client money and asset rules.
The sanctions are significant, the breaches often technical, and the discovery of the breach usually incidental to other activities, such as year-end audits.
Actual loss to clients is rare but it is no wonder compliance officers and executives alike have sleepless nights at the very thought of a client asset audit or regulatory visit.
The problem for advisory firms or platforms that hold client monies and assets are that the rules are often complex and can be open to interpretation.
Regulators have taken a tougher stance on matters that would once have been seen as technical or minor.
Breaches can result in eye-watering fines (£33m was one example from the FCA) and companies can be compelled to appoint an expert to oversee rectification exercises.
The regulatory focus has been sharpened by the financial crisis and well-publicised cross-jurisdictional financial catastrophes, with clients often waiting a long time for resolution and return of their assets and, in extreme cases, investors have been left out-of-pocket.
Sorting out ownership of client assets raises questions about the efficiency of the regulatory tools available to manage the crisis and procedures if records are inadequate and client agreements unclear.
Principled approach
This has led to consultation on changes designed to enhance investor protection.
Firms holding client money and assets must ask themselves if they are prepared for the risks inherent in this complex area.
The principles of client money are well established:
• Client money and assets must be segregated from a firm’s own money/assets.
• Accounts set up to hold client money/assets must clearly identify that the money/ assets belong to a client, ie state ‘client money/asset account’ in the title.
• Firms must perform due diligence on third parties such as banks and custodians they use to hold money/assets.
• Letters must be in place with banks/custodians that acknowledge the money/assets belong to a client and not the firm.
• Firms should consider diversification when placing client money with a bank, ie not all client money should be held with one bank to spread insolvency risk.
• Some regulators will have rules that restrict the amount of client money that can be held with group entities.
• Reconciliations must be performed both for internal books and records and externally with banks and custodians that hold client money/assets.
These principles contain a myriad of detailed rules relating to the naming of accounts, contents of custodians/banks confirmation that accounts are client in nature, type and frequency of reconciliations, and accuracy of books and records.
Proposed changes
Both the UK and Ireland have been consulting for the past two years on changes to the rules. The FCA issued CP13/5 in July 2013, and released the related policy statement PS14/9 containing the new rules on 10 June.
The Central Bank of Ireland released consultation paper CP71 in August 2013.
The FCA’s objectives for what it expects the new rules to achieve are to improve the speed of return of client assets following the insolvency of a firm, achieve a greater return of client assets to clients following the insolvency of an investment firm and to clarify points on existing rules.
The central bank consultation discussed fundamental questions around all aspects of client assets. Whatever the jurisdiction, the rules are complex, constantly evolving and require resources and investment to interpret and implement.
The Central Bank of Ireland will follow the FCA’s latest changes and Jersey is believed to be considering a review of its client assets regime. Other crown dependencies may do the same.
Change is inevitable and will continue. While we await the final outcomes, advisory firms must carefully consider how they hold client assets.
Key considerations
- Do I hold client assets and am I authorised to do so?
- Do my client agreements make it clear how I hold client money/assets and how these will be treated?
- Am I holding client assets in accordance with my applicable regime, complying with all of the relevant principles?
- Is my regulator proposing changes to their client assets regime?
- Have I considered these changes and given my feedback?
- Am I adequately resourced with expert staff to manage the risks of holding client assets or is this something I need to outsource?
- What is the risk and the potential impact of a breach to my business and my clients?
