Looking After the Pennies: Wealth Manager CASS Challenges

Karen-BondThe old adage says that looking after the pennies means the pounds look after themselves – but will this still be true if the new client money and assets proposals are adopted? We look at some of the key challenges for wealth managers raised by the proposed rule changes in this area.

Business As Usual?

A surprising number of the proposed ‘changes’ in the recent FCA consultation paper on CASS are simply restatements or clarification of existing rules. This may be indicative of the need for education in the industry, but it could be argued that a more effective remedy would be stringent enforcement measures against those that have failed to apply the current requirements. It is worrying for example, that the FCA has felt it necessary to clarify to firms that “when their activities are caught by the client money rules they should ensure that the money is held in accordance with the client money rules.” Hopefully this is not a pointer to current levels of compliance with the rules, as it would suggest there are some fundamental problems with firms’ behaviour and with auditors’ and the FCA’s policing of the rules than can be solved by restatements of this kind.

However some of the clarifications still leave uncertainties to be resolved. One such area is the DvP exemption, which allows for the exclusion of CREST and similar transactions from the requirements during a defined settlement period. The new clarification does not specify whether it is applicable only to CREST or to other centralised settlements and whether it applies to members or also applies to their clients in turn. For a wealth manager that has outsourced dealing, the latter point could have a significant impact on these arrangements, particularly if money held by third parties must be included in reconciliations from now on. While it is understandable that the rules cannot cover every scenario, this does mean that wealth managers need to consider how both auditors and the FCA may interpret them in addition to re-examining their own understanding of their application.

Calculating the Costs

One of the greatest impacts for some firms will be in the restrictions applied to the placement and investment of clients’ cash. On the one hand, firms are still permitted to retain interest on clients’ money, provided clear disclosures and transparency are in place. On the other hand, the requirement to consider diversification across multiple banking groups – and to justify a decision not to diversify – will place wealth managers’ systems and administrative costs under pressure while at the same time having a detrimental effect on the interest rates that can be commanded by a smaller pool of cash. This may affect the firm’s profitability, where these margins are retained, but may also impact on performance at a time when return on cash is a material part of the portfolio’s profitability.

Added to this pressure on margins, the prohibition on unbreakable term deposits, while consistent with a desire for speedier return of assets post-insolvency, will be a further blow to the commerciality of cash holdings. With over £100bn in client money accounts as at April 2013, a loss of margin of even a few basis points on this sum would equate to a cost in the region of £5m per bp per annum as insurance against the risk of insolvency. Is this too high a price to pay?

Increasing Standardisation

Given that no two firms are the same, a whole range of different approaches and methodologies have built up over the years in the receipt, processing and reconciliation of client money. The consultation paper proposes to close down many of these options except in narrowly defined circumstances. So, the alternative approach whereby money is received initially into corporate, rather than client money accounts, will be restricted to only large investment banks. The calculation methodology which allows firms to calculate requirements by adding back negative balances to the total in client money accounts will be restricted to asset managers. There are also other more detailed requirements around the use of non-standard reconciliation methodologies.

On the plus side, these measures may well tighten up the protections offered to clients and also support auditors and the FCA in reducing the subjectivity applicable to the assessment of whether a non-standard approach is sufficiently robust. It may have commercial advantages as well, if these protections can be promoted as advantageous to advisers and their clients. However, we have worked with very few firms which had no alternative or non-standard approaches in operation anywhere in their business – and where these exist they are often unrecognised by them or by their auditors. A particular corner in which such anomalies lie is inherited legacy business, where balances are perhaps left unanalysed and the application of standard methodologies is not supported by the available systems. Wealth managers often have certain types of infrequent receipt that flow initially into corporate accounts, such as property insurance rebates which might be shared between the firm and its clients or underwriting commissions. Where such processes exist but have not been identified or signed off, this is a current issue with CASS compliance, but it is one which is now under greater scrutiny. Wealth managers would be well advised to check for these non-standard processes and address such issues before their next audit, regardless of the outcome of the consultation paper. Beyond that, of course, assessing the practicalities and cost of applying standardisation should be a focus for consultation responses.

What Next?

The scale and breadth of the potential impacts of these wide ranging proposals needs detailed analysis and assessment. Wealth managers would be well advised to invest time in the consideration of:

  1. The likely practical and administrative impacts of the proposals, and their costs
  2. The commercial impacts to the firm, both positive and negative
  3. Potential client impacts and costs; and
  4. Any unintended consequences

While the FCA’s aims are laudable, they will need detailed and reasoned responses to support their further analysis of what changes should be made. Nobody wants clients to lose out in the event of a firm’s insolvency, but it is in their interests as well as the industry’s to ensure that the measures taken to protect these assets is proportionate to the risks.

About Walbrook Partners

Karen Bond is a Director of Walbrook Partners, a specialist consultancy to the Investment Management and Wealth sectors, offering support and subject matter expertise covering relevant and current topics where changes are taking place, such as client money and asset regulation, post RDR developments and changes, Platforms and Outsourcing.

 

 

 

 

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