Compliance with the rules in the client assets sourcebook (CASS) has never been more important, and has been a regulatory priority since the financial crisis and the collapse of Lehman Brothers in 2008. Over the course of a 12 month period a series of new requirements are coming into force, the first of which took effect on 1 July 2014, with a second set on 1 December, and a final implementation deadline of 1 June 2015. This articles looks at the evolving client asset regime and considers examples of the latest rule changes.
In general terms, all firms carrying on investment-related business are covered by CASS, although EEA passported firms (providing services or through branches) are regulated by home Member State supervisors.
CASS comprises a number of chapters, each dealing with a different area. CASS 7 lies at the heart of the regime. Firms must segregate monies received from, or held for, clients in the course of investment business by paying it into a client money account segregated from the firm’s own money. It imposes a statutory trust to protect client funds from a firm’s creditors in the event of its insolvency. The aim is to return client money with minimum delay, an objective which, in practice, has not been achieved as was demonstrated in the administrations of Lehman Brothers International (Europe) Limited and MF Global UK. In the 2012 Lehman Brothers money case, the UK Supreme Court held that the statutory trust under CASS 7 arises on receipt by a firm of client money and applies to all identifiable client money, whether or not actually segregated.
Prior to the financial crisis, client money supervision was low key and, generally, low priority. Since then, matters have changed dramatically.
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Apart from facilitating the prompt return of client assets, other rule changes motivated by the collapse of Lehman Brothers include requiring prime brokers to report to clients on a daily basis on cash values, the placing of restrictions on the liens that can be exercised by firms over clients’ assets and on the amount of intra-group deposits.
A prohibition on the use of title transfer collateral arrangements (TTCA) has now been extended for retail clients when transacting in certain rolling spot forex contracts. This will prevent firms using client money and assets to fund their trading activities.
In 2012, CASS Resolution Packs were introduced. These are the equivalent of “living ills” for banks and require firms to prepare and maintain packs to be used in the event of their insolvency in order to facilitate the return of client money and assets.
There have also been amendments to align CASS with the European Markets and Infrastructure Directive (EMIR).
In 2010, the then FSA set up a Client Asset Unit, bringing together in one place specialist risk, supervision and policy functions. The unit works alongside supervisory teams, providing specialist assessments and analysis. In common with other aspects of FCA supervision, firms may expect a judgment led, intensive and intrusive approach.
The FCA sends reminders to firms and compliance officers about their regulatory responsibilities, for example, through Dear Compliance Officer and Dear CEO letters. The purpose is to leave firms in no doubt as to the FCA’s expectations. Inadequate senior management oversight and control often give rise to the most serious CASS contraventions.
Compliance with CASS is independently verified through annual reports prepared by firms’ auditors. Given their importance, the FCA has sought to improve their quality by clarifying the rules, working with the Financial Reporting Council (which oversees auditors), and seeking to increase awareness by auditors of their responsibilities.
The Client Money and Assets Return (CMAR) was reintroduced with large and medium sized firms having to submit these to the FCA monthly through the GABRIEL online system. CMARs, together with other key data sources, help the Client Asset Unit to prioritise its risk-based supervisory approach.
A new Client Assets Oversight function (CF10a) was created to improve governance and oversight in large and medium CASS firms and, in particular, to increase senior management focus on the issue. An individual holding this role has ownership of CASS policies, reports to the firm’s board and submits the CMAR. A new office holder in a larger firm can expect to be interviewed by supervisors; as a corollary they should insist on having sufficient authority and resources given the responsibility placed on them. In small CASS firms operational responsibility will lie with the holder of the compliance oversight function.
Enforcement & common errors
Since 2008, there has been a steady flow of enforcement cases. The most common contraventions concern failures in firm’s governance, especially over having adequate systems and controls in place and following up deficiencies once identified. Typical examples are:
- a failure to locate trust acknowledgement letters from banks or other third parties for their client money accounts, and check whether they contain the required details to ensure client money would be held on trust in the event of the firm’s default;
- client money and assets reconciliations being incorrectly performed, delayed or completely overlooked; and
- Permitting the inter-mingling of client and own monies and, therefore, paying business expenses out of client money and creating a shortfall.
Review of the client asset regime
In July 2013, the FCA published proposals in Consultation Paper CP13/5, and after carefully considering industry feedback, a Policy Statement PS14/9 was finally published in June 2014 setting out conclusions and final rules. The rule changes are extensive. Their principal theme is to improve clarity around the rules and the provision of information to clients.
Those changes coming into force from 1 December 2014 include rules around written custody agreements, acknowledgment of trust letters, TTCA – written agreements, “delivery versus payment” commercial settlement systems and the information to be given to clients about client asset arrangements prior to providing investment services. In respect of the banking exemption, banks will have to provide more information to customers, including notification of the basis on which monies are held and the applicable protections.
Improvements in firms’ compliance with CASS has been a key regulatory priority since 2008 and will remain so for the foreseeable future. The FCA is not just concerned with the risk that client assets or funds may be at risk of loss were a firm to become insolvent, but that CASS failings will delay and/or impede their prompt return. Firms should remember that most enforcement cases arise from a failure to fulfil basic requirements.
David Heffron, partner, head of financial regulation group at Addleshaw Goddard LLP
“David advises on regulatory and commercial matters in the financial services sector, including all aspects of the Financial Services & Markets Act 2000 and FCA Handbook His clients include banks, building societies, insurers, brokers and other financial services providers.“