Handling client cash

* A two-stage client money distribution process would be introduced: (1) the formation and distribution of an ‘initial’ client money pool (CMP1); and (2) the formation and distribution of a ‘residual’ client money pool (CMP2).

* A process for transferring the whole client money pool, which may operate in parallel with the preparation stages of the distribution process, would be introduced.

* The failure of an investment firm would trigger a primary pooling event. On the occurrence of a primary pooling event, the firm (or its insolvency practioner) will be required to notionally pool all the money held in client bank accounts or client transaction accounts of the failed firm forming the initial client money pool (known as client money pool one). The firm (or its insolenveny firm) would be required to repeat the firm’s reconciliation calculation – in accordance with the firm’s existing methodology (whether or not it is fully compliant with the Client Assets sourcebook rules) – as at primary pooling event to effectively update the firm’s records to the point of the firm’s failure.

* The firm would then use those updated records to determine each client’s entitlement to client money pool one. The new rules would then require (making it a term of the statutory trust) the firm to distribute on the basis of these recorded entitlements. Clients not appearing in the firm’s updated records as having an entitlement would not be eligible for a distribution from client money pool one (even though they would have been under the current regime). Under this proposal, the FCA stated it would expect that within a couple of weeks of a primary pooling event there will be a prompt interim distribution of client money entitlements from client money pool one.

* A second, residual client money pool (CMP2) constituting any client money not in client bank accounts or client transaction accounts (for example, ‘identifiable’ client money in house accounts) and any surplus client money from client money pool one would also be formed. The firm would be required to establish a claims process to allow clients who believe they should have had a claim on the client money held by the firm to establish an entitlement to CMP2. The firm must then distribute CMP2 rateably on the basis of the agreed client entitlements. There could be situations where CMP2 may not arise – namely where all client entitlements have been met by CMP1 or where there is no identifiable client money in house accounts of surplus from CMP1.

* In certain circumstances a firm may not be able to follow the distribution process set out in the stages above. If the firm cannot repeat the firm’s reconciliation calculation due to systems failure, or there is a difference of more than 10 per cent between the amount the firm should have been holding according to its last reconciliation and the amount it had actually segregated in client bank accounts immediately prior to the occurrence of the PPE, or the firm cannot reasonably determine the eligible clients’ entitlements to CMP1 as described in stage 1, the insolvency firm will be required to form a single, notional combined CMP made up of all the client money from CMP1 and CMP2. The firm would then be required to perform a client money reconciliation.

* A firm will be required to notify the FCA of its intention to establish a client money sub-pool not less than two months before the date on which it establishes the subpool. This is because the FCA would like to be aware of which firms are operating multiple client money sub- pools and two months will provide the FCA with an opportunity to ask any questions it may have on the systems and controls that the firm has put in place in order to support the operation of such a pool.

* In the event of a firm failure, an initial client money pool would be formed in relation to each client money sub-pool. The reconciliation that the firm had carried out before failure in relation to that sub-pool would be repeated at PPE and the sub-pool would be distributed on the basis of the clients’ entitlements to the initial pool as set out in those records.

* Guidance to the application provisions will be added to remind 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.

* If money relating to investment business is not held by the firm (as client money) the firm must assess whether it is providing appropriate protection for clients’ money, for example by complying with the mandate rules.

* Rules requiring firms to document their transfer collateral arrangement agreements are set to be brought in. In addition, the FCA is proposing a mechanism, which must be followed should the client request client money protection as to how money previously subject to transfer collateral arrangements may be protected. On agreeing to a request for protection the firm must notify the client of its agreement including notification of when the protection would come into effect.

* Due to the potential risks of the use of the delivery versus payment (known as DvP) window to take money out of the client money protections, the FCA is proposing to amend the rules to clarify the meaning of ‘commercial settlement system’ and to set out exactly when the DvP window begins and ends to ensure that firms are aware that they must be able to comply with the CASS 6 and 7 rules should a transaction fail to settle within the DvP window.

* The FCA will define ‘commercial settlement system’ as a system that is commercially available to firms that are qualified to act as participants, the purpose of which is to facilitate the settlement of transactions using money or assets held on a settlement account.

* The FCA is looking at removing the DvP window so that authorised fund managers should treat money from clients in relation to transactions in units in regulated collective investment schemes as client money and all redemption proceeds in the same way. This should, according to the FCA, ensure that clients remain protected when their money is held by authorised fund managers.

* The FCA is proposing to put rules in place around the contents 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. This may remove a significant hurdle for the transfer of business, while retaining protection for clients. Firms will however still need to ensure that the client money will be protected on receipt by the transferee firm and comply with the requirements set out in the assignment clause.

* Firms would be allowed to transfer amounts of client money of less than £10 per client without having to obtain consent from the client as part of a transfer of business.

* Firms should conduct enhanced due diligence over the banks with which they deposit client money. Factors that must be considered include those set out in CASS but also, for example, the financial soundness of the bank, the percentage of the firm’s overall client money held by that institution and the protection provided by the relevant deposit protection scheme (this would be the FSCS for deposit takers authorised by the UK regulators).

* The FCA is also reiterating that the counterparty to the bank must be the firm in relation to client bank accounts. Any bank account in which a firm deposits client money must be in the name of the firm.

* Firms who receive physical payments of client money such as cash, cheques and payment orders must record their receipt immediately and deposit the client money in a client bank account promptly but no later than one business day following receipt. According to the FCA, this should ensure that all client money received by a firm is protected, however it is received.