FCA consultation paper 13/5

Review of the client assets regime for investment business July 2013

Extended Assurance Assurance beyond financial statements

1Review of the client assets regime for investment business

Overview and time line

This paper advises on material changes to the rules to client money, custody assets and mandates. Individually, each proposal is intended to address a particular risk identified in firms or clarify an existing requirement, to enhance the client assets regime to achieve better results for consumers and increase confidence in financial markets.

Comments received by 12 Aug 2013 for European Market Infrastructure Regulation (EMIR) proposals

Final rules published on EMIR Regulatory Technical Standards(RTS)

Comments received by 11 Oct 2013 for other proposals

Final rules published in December 2013 on all other proposals

Rules come in effect first half of 2014

CP 13/5 published

2013

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

2014

Consultation closes (EMIR)

Consultation closes

Final rules published (EMIR)

Expected final rules published

Rules come into effect

2 Review of the client assets regime for investment business 3Review of the client assets regime for investment business

Client money distribution rules: prioritizing speed Multiple client money pools

The key proposed changes to the rules are: ► Introduce a staged approach to distribution of client money following the failure of a firm by establishing:

► Stage 1: an “initial” client money pool requiring distribution of client money based on firm’s books and records. This will require a repeat of the firm’s reconciliation calculation in accordance with the firm’s existing methodology, to effectively update the firm’s records and distribute promptly on the basis of these recorded entitlements.

► Stage 2: a “residual” client money pool distribution of client money constituting any client money not in the client bank accounts or client transaction accounts. The firm would be required to establish a claims process.

► The alternative (combined) approach in which the firm may not be able to follow the “initial” or “residual” approach. The insolvency practitioner will be required to perform a client money reconciliation (i.e., in this context, the reconciliation would not be a repeat of any calculation previously carried out by the firm but a new calculation on the basis that the insolvency practitioner thinks is correct.

► Client’s margined transactions that are open at primary pooling event are valued at the amount at which they are liquidated.

► Provisions to allow an insolvency practitioner to use unclaimed money to make good shortfall in client money pool if reasonable steps are taken to trace clients concerned.

► Interest earned on client money pool will be used to reduce shortfalls after a primary pooling event.

The proposed changes aim to improve the speed of return of client assets and reduce market impact of an insolvency.

If implemented, the rules would come into effect six months after the policy statement publication in first half of 2014.

However, subject to consultation responses and extent that the changes are dependent on client money and custody rules, rules may come in effect immediately following publication of policy statement.

The proposed changes will lead to: ► Emphasis on firms to maintain accurate and timely books and records as there will be likely an increased Financial Conduct Authority (FCA) supervisory

focus in this area. ► Pressure on firms to update current processes, systems, documentation and controls surrounding the firm’s methodology to calculate and reconcile client assets. ► Increased investment around reconciliation engines functionality and documentation of rules engines.

The proposed changes are likely to impact firms in many ways including: ► Increased operational demands and costs relating to reconciliation requirement and disclosures. ► Additional training and education to firm’s employees and clients on operating multiple pools. ► Increased reporting requirement and documentation. ► Related investment required to upgrade current CASS reporting tools and reconciliation engines to cope with data requirements.

The FCA has reflected on industry feedback and firms’ concerns to the operational complexity of the proposals in CP12/22 and has proposed changes to the client money pool rules with anticipated effective date being first half of 2014.

Key proposed changes are: ► Only those firms that are clearing member firms to offer net omnibus client transaction accounts that can be

used for porting.

► Each client pool to have its own client money bank accounts, and client money belonging to one pool cannot be placed in client money bank account belong to another client money pool.

► Firms will be required to perform separate internal and external reconciliations on each subpool.

► Firms will be required to keep records in Client Asset Sourcebook (CASS) Resolution Packs relating to client money bank accounts and transactions used for each subpool.

► Firms required to create subpool terms and maintain a subpool disclosure document that identifies omnibus client account beneficiaries and explains distribution.

► Notification requirement to the FCA of their intention to establish a client money subpool, and client consent is required before operating a client money pool.

4 Review of the client assets regime for investment business 5Review of the client assets regime for investment business

Client money rules

The proposed changes to client money rules aim to clarify and enhance the regime to ensure the best protection of client money held. If these proposals are implemented, they will come into effect six months after the policy statement is published (in the first half of 2014).

Key proposed changes are:

CASS 7

Alternative approach method

► Firms would be required to justify using the alternative approach and consider maintaining buffers, having appropriate systems as well as notifying the FCA no less than three months before adopting this method.

► Document the use of the alternative approach in writing as well as providing an auditor report to the FCA covering the adequacy of the firm’s systems and controls to effectively operate the alternative approach and the appropriateness of the firm’s calculation of its buffer before commencing use of the alternative approach.

Client money reconciliations

► Internal client money reconciliation to be performed on a daily basis.

► External client reconciliation to be performed as regularly as necessary

► Evaluate on a regular basis the frequency of external reconciliations with the likelihood of carrying out external reconciliations on a daily basis.

► Converting many of the provisions set out currently in CASS7 Annex 1 into requirements, including additional guidance in this area.

Banking exemption

► Where firms are able to use the Banking exemption, that the default is that money relating to investment business is held by the firm under Banking exemption.

► Comply with the requirements in COBS 6.1.1R relating to making available to the clients details of the relevant compensation regime and requirement to the proposed Client Asset Disclosure Document.

Title transfer collateral arrangements (TTCA)

► Introduce rules to document TTCA and a mechanism that must be followed should client request client money protection (switching out of TTCA and back into CASS protection).

► On agreeing to a request for protection, firms must notify the client of its agreement including, notification of when the protection would come into effect. This would be on the business day following the agreement.

Unbreakable term deposits

► Introduce rules to prohibit placing client money in unbreakable term deposits or notice accounts

► Time deposits subject to penalty clauses will be allowed provided money can be withdrawn within one business day of giving notice.

Acknowledgement letters

► The proposed changes require firms to use a standard template in relation to acknowledgement letters and re-paper existing ones using the standard template.

► Obtain acknowledgement letters for all client bank accounts (including those located outside the UK) and remove the 20-business day grace period.

Delivery versus payment

► The proposed changes to provide clarity regarding the use of the “delivery versus payment” (DvP) window and Definition of a “commercial settlement system.”

► Remove the DvP window so that authorized fund managers should treat client money relating to units in regulated collective investments schemes as client money and all redemption proceeds in the same way.

6 Review of the client assets regime for investment business 7Review of the client assets regime for investment business

Client money rules (contd)

Changes to the rules will have significant impact on firms as they will result in:

► Increased operational demands and costs due to the proposed requirements (auditor sign-offs, immediate segregation, enhanced due diligence, re-papering of existing trust letters, notification requirements and daily client money reconciliations).

► Review and assessment of existing client money reporting tools, systems and documentation as result of the proposed changes (e.g., firms required to evaluate on a regular basis the frequency of external reconciliations in light of the number and value of transactions which they undertake for clients together with the risks to which client money is exposed with likelihood of carrying out external reconciliations on a daily basis.

► Where alternative approach is considered inappropriate, there will be significant impact as a result of a requirement to re-paper clients for settlement instructions, trust letters and re-configuring treasury arrangements.

► Revisiting of existing controls and applications to ensure these would have desired capabilities following the proposed changes.

► Assessment of legal, contractual and similar arrangements and related operational applications.

► Significant impact on asset managers as they will need to create client money infrastructure.

► New processes required for TTCA and buffers.

► Impact on liquidity for firms that are relying on alternative approach where no buffers are maintained.

Other proposed changes to the client money rules:

Unclaimed client money ► Allow firms to pay unclaimed balances of £10 or less to charity as well as requirement for the firm’s governing bodies to review and approve payment of

unclaimed money to charity.

Trustee firms ► Changes to the rules to make it clear that the client money distribution rules do not apply to client money held by a trustee firm and in event of failure of a

trustee firm that money is dealt with in accordance with the terms of the trustee deed under which it is held or in accordance with the general trust law.

Interest ► Changes to the rules to provide clarity on application of the rules regarding setting out segregation and allocation when firms receive interest or contractually

agree to pay interest to clients.

Transfer of business ► FCA proposes to put rules around the content of an assignment clause pending client consent to the transfer of client money so that if firms wish to transfer

client money along with the transfer of business, they have obtained consent in advance.

Immediate segregation ► Immediate segregation where the firm does not use the alternative approach and does not segregate money promptly, the proposed rules will require that all

client money is received directly in client account.

Qualifying money market funds (QMMFs) ► Units in QMMFs should be treated as safe custody assets and held in accordance with custody rules.

8 Review of the client assets regime for investment business 9Review of the client assets regime for investment business

The proposed changes intend to clarify and enhance the regime to ensure the best protection of custody assets held in relation to investment business. If these proposals are implemented they will come into effect six months after the policy statement (in the first half of 2014).

Custody rules

► Requirement for firms to have in place a written agreement whenever they place custody assets with a third-party and group entities.

► The FCA intends to provide further clarification on the terms and details that a firm might include in such an agreement.

► TTCA to be in form of written agreements. ► Firms to follow a mechanism should clients request that their assets be subject to

custody rules for assets under TTCA.

► ►The proposals intend to require firms to consider clients’ best interest when agreeing right of use arrangements with clients.

► ►The considerations above would have to be reflected in the Client Asset Disclosure Document requirements proposed in the reporting chapter (CASS 9).

Key proposed changes are:

► Introduction of provisions to deal with unclaimed custody assets. ► Firms governing bodies to review and approve the payment

of money resulting from the liquidation of safe custody assets to charity and make an undertaking to make good any valid future claim.

► Setting up of frequencies for the different types of custody reconciliations subject to the minimum requirements.

► Firms should carry out three types of reconciliations; reconciliation of internal records, reconciliation of physical custody assets that are held and reconciliation of firms records against third-party records where custody assets are held.

► Where firms use integrated custody recording systems, the FCA proposes that firms should carry out internal custody reconciliations in the form of “internal custody records checks.”

► Firms will be required to send to the FCA a written report from an auditor before using the internal evaluation of custody records system method.

► Removal of the firms’ ability to register their own assets in the same name as safe custody assets they hold.

► Registering of the safe custody assets will continue to be permitted in specified circumstances, e.g., where local law, client agreements or market practice outside the UK allows it.

Unclaimed

Written agreements

Switching out

Registration of

Reco

ncli iat

ions

cu

stody assets

of TTCA

Right of usecustody assets

CASS 6

10 Review of the client assets regime for investment business 11Review of the client assets regime for investment business

The changes to the rules will require firms to:

► Consider additional reporting and documentation requirements as a result of proposed changes to the frequency of reconciliations, requirements of the Client Assets Disclosure Document, changes to right of use arrangements and TTCA arrangements

► Revisit their current client asset reconciliations methodologies and reporting tools to ensure these would meet the requirements

► Assess existing information technology systems and applications to ensure they are sufficient for the proposed changes

► New process required (e.g., TTCA)

► Potential increase in resource required to police client assets compliance

Custody rules (contd)

Other proposed changes to the custody rules:

Delivery versus payment (DvP) ► Amend the rules to clarify the meaning of a “commercial settlement system”, including setting out exactly when the DvP window begins and ends so firms are

aware they should comply with CASS 6 and CASS 7 should a transaction fail to settle within the DvP window, with a possibility of closing the window should firms not use it correctly.

Discrepancies ► Where there is a shortfall in safe custody assets held by firm following reconciliation, the firm must resolve the shortfall and if unable to do so immediately it

must then ensure client protection by segregating an equivalent amount of the firm’s own assets or segregating client money to the value of and in respect of the shortfall.

Physical share certificates ► Where a firm is safekeeping a physical share certificate, it falls within the scope of “safeguarding” part of the activity of safeguarding and administering

investments under Article 40 of Regulated Activity Order (RAO).

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The FCA proposes changes to the rules to cover mandates that are not in written form and minimal changes to the client money rules to comply with EMIR Regulatory Technical Standards (RTS).

Client reporting and information Mandates and indirect client clearing (EMIR)

Key proposed changes are: ► Reports to clients should clearly show when assets or monies the firm reports as holding for the

client are or are not protected under either or both custody rules (CASS 6) and the client money rules (CASS 7).

► A requirement for all firms subject to the custody rules (CASS 6) or client money rules (CASS 7) to highlight to their clients in form of a standalone disclosure document a summary of key provisions within their client agreements which modify rights or protections that would otherwise be available to the client under the custody rules or client money rules.

► The Client Asset Disclosure Document to include likely consequences of the arrangements (liens, right of set-off, right to use, TTCA, money opt in/out) for the treatment of a client’ custody assets and client money.

► Create transparency to clients by requiring the firms to review their Client Assets Disclosure Document and provide a copy to their clients before the provision of services and on at least an annual basis.

Key proposed changes are: ► Extend the definition of mandates to include all mandates that a firm receives which are not in

written form.

► Amend CASS 7A (client money distribution rules) so that:

► Clearing member in accordance with RTS may remit any client money relating to indirect clearing directly in event of failure of the client.

► The money so remitted will cease to be client money in the hands of the client.

► The clients’ entitlement to the client money pool be reduced by any sum so remitted.

Firms would have to assess impact and:

► Ensure they have systems and procedures to effectively capture and record mandates that are not in written form.

► Assess their control environment, documentation and operational processes and ensure these are fit for purpose.

Firms should consider the implications of the proposed changes, including:

► Additional reporting and documentation requirement specific to “Client Asset Disclosure Document.”

► Review and assessment of current contractual and legal arrangements to capture requirements of proposed changes e.g., summary of key provisions within client agreements which modify rights or protections should be highlighted in Client Asset Disclosure Document.

► Existing reporting systems and controls will need to be assessed to ensure capability of the proposed changes e.g., annual review of the Client Asset Disclosure Document or in circumstances where there is a change in a relationship or services they offer to client.

► Impact on systems as client statements should clearly identify CASS6 and CASS7 separately from assets under TTCA or right of use.

The FCA has issued a series of clarifications on firm reporting obligations relating to client assets.

The proposals aim to increase market transparency and improve market awareness in relation to client money protection.

14 Review of the client assets regime for investment business 15Review of the client assets regime for investment business

Value propositions

EY has delivered the services offerings noted below across a wide spectrum of clients in the banking, capital markets, insurance and asset management sectors.

# Service offering Value delivered

1 Client money processes and controls Agreed Upon Procedure (AUP)type reviews

Reports issued on specific procedures agreed with management, including specific procedures on remediation of CASS deficiencies

2 s166 Report on client money systems and controls

Skilled persons report on adequacy of systems and controls relating to client money and custody assets commissioned by the Financial Conduct Authority (FCA)

3 Shadow s166 Report on client money systems and controls

Full scope skilled persons review but not commissioned by the FCA

4 ISAE 3402 Type reviews Report and assurance opinion issued on the design of CASS systems and controls

5 CASS Audits CASS audits as required by FCA regulations

6 Client money and assets reporting (CMAR) Review of the client money and assets returns submitted to the FCA for completeness, accuracy and compliance with the FCA requirements

7 CASS Resolution Pack reviews Review firms are in compliance with the CASS Resolution Pack requirements effective from 1 October 2012 and practical assessment of the effectiveness of CASS Resolution Packs led by Insolvency practitioner

8 Internal Audit support Support firms in delivering CASS Internal audit reviews

9 CASS Training and support Support compliance and operations to deliver industry focused key issues

10 On call advisory CASS insights and support

EY credentials

► EY has a proven track record of delivering client money and assets compliance assurance projects, including skilled persons reviews, and CASS audits for a range of financial services firms in the UK.

► We have performed client money and assets root and branch reviews for top global investment banks and investment firms covering all businesses and product lines within the regulated entities.

► We have supported top tier global investment banks and investment firms in the client money and assets returns (CMAR) and CASS Resolution Pack (RP) initiatives and helped firms evidence compliance with the FCA requirements.

► We have also provided assurance opinions (ISAE 3000 Type reports) on the design of CASS systems and controls

16 17Review of the client assets regime for investment business

Extended Assurance

Our Extended Assurance offering provides regulators, management and directors assurance over the governance and controls around processes not directly impacting the financial statements but nevertheless considered to be of vital importance.

► Addressing business risks: working with management and internal audit departments we help satisfy audit committees that significant risk areas within the business have been adequately addressed and suitable controls exist to mitigate and reduce these risks from both the financial and non-financial perspectives.

► Changes to processes: current turbulent markets are driving significant changes to all firms’ internal processes through increased regulatory requirements and demands for better/new management information.

► Reinforcing trust: we combine advisory and assurance skills to deliver assurance and instill credibility and trust in an organization’s reporting in areas, such as capital, liquidity, sustainability, data and management reporting. We can help develop and provide assurance over new processes, such as risk convergence, Solvency II, Basel III, FATCA and Dodd–Frank.

Benefits to you:

► Sustainable solutions to improve trust and confidence

► Reasonable and limited assurance opinions and change solutions that stand up to external audit scrutiny

► Enhanced reputation

► Opinions and insights around processes and governance

Extended Assurance Assurance beyond financial statements

Our Extended Assurance practice continues to support our clients across a wide variety of needs

Regulat

ory

agen

da

Fina

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trol

age

nda

Operational agenda

FATCASafe

guarding the Trading

Floor

Accuracy of business reports

LIBOR &other

Benchmarks

Compliance with client

moneyrules

Regulatory returns

Prudential returns

Financial controls

assurance

Accuracy of management information

ExtendedAssurance

Information technology

Governance

Information technology

Governance

Contact details

Andrew WooseyPartner, Financial Services

T: + 44 20 7951 8117M: + 44 7766 498 328E: awoosey@uk.ey.com

Amarjit SinghPartner, Asset Management and Insurance

T: + 44 20 7951 4419M: + 44 7787 152 946 E: asingh@uk.ey.com

Mduduzi MswabukiExecutive Director, Banking and Capital Markets

T: + 44 20 7951 5052M: + 44 7824 402 672E: mmswabuki@uk.ey.com

Lara TaraziSenior Manager, Banking and Capital Markets

T: + 44 20 7951 7346M: + 44 7920 236 225E: ltarazi@uk.ey.com

Review of the client assets regime for investment business

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