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Will Financial Conduct Authority (FCA) proposals add to the administrative and operational burden for firms holding client money? James Smethurst of Freshfields Bruckhaus Deringer says firms need to consider the impact on their client money and assets operations carefully.
Where are we now?
Proposals from the FCA on material changes to the rules in relation to client money, custody assets and mandates could see the introduction of multiple client money pools and an extension to the scope of the mandate rules. Changes are proposed to the client assets rules which are applicable to firms subject to the client assets sourcebook with the aim of enhancing the client assets regime to provide improved results for customers. The consultation (Review of the client assets regime for investment business--CP13/5) closed on 12 August 2013 for indirect client clearing proposals and will close on 11 October 2013 for all others.
Is a review of client asset handling regime necessary?
The principal reason for the FSA/FCA undertaking a review of the client assets regime was the difficulties with the operation of the current regime, highlighted by the collapse of Lehman Brothers and, to a lesser extent, MF Global. The current proposals include some changes to bring the client money rules into line with certain requirements in the European Markets Infrastructure Regulation (EMIR) relating to margin segregation and porting for indirect clients. These build on changes that have already been made to reflect EMIR.
What are the key proposals from the consultation?
The consultation contains a substantial number of proposals. Probably the most significant change proposed is to the client money regime. The FCA is proposing to change the distribution rules to use a firm's own records to establish the initial client money distribution, rather than a distribution based on clients' claims. There would then be a subsequent distribution based on clients' claims to client money. The money distributed at this stage would comprise any client money left over from the initial distribution plus any identifiable client money that was not segregated but should have been.
The purpose of the change is an attempt to speed-up the initial return of client money, but this could be at the expense of clients' entitlements as poor records will mean clients are unlikely to get their full client money entitlement--at least not during the initial distribution.
To ensure that firms' records are adequate there will be a greater emphasis in the new rules on the accuracy of firms' record-keeping and reconciliation arrangements. These apply to both client money and client assets.
What are the implications for firms should the FCA implement the proposals?
The proposed changes are likely to add to the administrative and operational burden for firms holding client money. They are also likely to make it more difficult for some firms to rely on what is known as the 'alternative approach'. Firms wanting to use this approach will have to justify to the FCA why they should be permitted to continue to do so for each business line.
The proposals also include some additional disclosure requirements in relation to client assets which will inevitably impose a compliance cost.
Finally, the changes to the rules will require firms to review their client agreements and sub-custody agreements to check whether any amendments are required in order to ensure they comply with the new rules.
How can firms prepare?
At this stage, firms should review the consultation paper carefully and consider the likely effect on their client money and assets operations. To the extent that the proposals are unclear or are likely to prove difficult to operate in practice, firms should consider responding to the consultation.
This was first published as a New Analysis update in LexisPSL Financial Services.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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