Client Money is a hot topic at the moment, with Aberdeen Asset Managers Ltd becoming the latest addition to the FCA roll of dishonour for a breach of the rules (contributing 13 per cent of the client money fines since 2010).
With the staggering fines being levied, all carefully worked out based on duration and amount of money exposed, one could be forgiven for thinking adherence to the rules was only an issue for the largest of our investment management organisations. Looking beyond the seven figure fines, though, reveals some smaller organisations that have been called out by the regulator.
A couple are trading services, such as ActivTrades and Xcap Securities, but there are advisory firms in the list too. These are typically investment-oriented firms and, while the Cass rule book does apply to insurance intermediation, the nature of investment business is such that application here is inherently more complex.
For most advisers and wealth managers, the definition of client money is relatively simple: it’s the money a client has to live on, what they have available for investment, and what they have placed in existing investments. The adviser’s job is to help the client make the most of it (within their own particular risk appetite and goals).
It is common knowledge that the challenges and differences between this view of client money and the regulatory definition affects those advisers that hold discretionary permissions with a client far more than the majority who do not get involved in that part of a financial transaction. But the impact will also be felt for those advisers who are part of ‘alternative business structures’ formed out of changes in the Legal Services Act (2007).
One of the features changed in the way the legal industry was regulated was the creation of ‘alternative business structures’ for legal services firms to allow a combination of services within an organisation. With the advent of the RDR, the industry has seen some tie-ins between solicitors, accountants and financial advisers. A memorandum of understanding between the Ministry of Justice and the financial services regulator sets out how to avoid dual regulation for such firms, but also highlights how certain common elements of each business stream are treated differently. For the purposes of client money, the document talks in terms of “adequate protection”, but prevails on a firm to ensure a separation of firm money from client money, and a further separation of ‘legal services client money’ from ‘financial services client money’. It is the identification and separation of client money that has caused many of the issues for those firms fined to date.
Of the advisory firms who have received fines, they are common in holding and using discretionary permissions for managing a client’s account – and it’s the nature of the services offered here that will cause most of the compliance risk for advisers. Offering a ‘fully managed service’, where the adviser handles the transactional aspects without troubling the customer’s bank, opens up the full range of responsibility for client money in ensuring that client money is properly identified, reconciled and accounted for at every stage – from the initial receipt of investment money from the customer through the resulting purchase, trading and sale lifecycle.
While this type of service has its merit and is valued by many clients, it presents a degree of risk due to the regulatory rigour required. There are technology solutions available in the market to support delivery of client money models, from virtual bank account systems through to reconciliation systems. However, these all carry a cost that needs to be measured against the risks they mitigate and the revenue generated by the activity.
Delivering a discretionary service for clients through a platform is a useful way to offset some of this risk. A customer can make initial investment contributions direct to the platform cash account, and subsequent execution decisions are made by the adviser through the platform – placing identification, reconciliation and accounting for client money during the investment lifecycle with the platform provider. For those investments where going ‘off platform’ is the best outcome for the client, then how this is handled changes the adviser’s risk exposure. Enabling the customer to pay direct to the product provider removes the client money requirement, but needs to be balanced against the service expectations of the relationship.
The FCA is currently consulting on a review of the client assets regime for investment business (CP13/5) and making some good proposals for changing the way client money is handled in the event of a firm insolvency, moving to a more logical TCF consistent approach – essentially returning identifiable client money more quickly based on the records the firm keeps with a secondary pool used for subsequent claims.
These proposals place even more emphasis on the frequency and accuracy of reconciliations, which will mean an even greater regulatory focus on this from the FCA. Some argue that as the financial services industry moves from the giant historically ‘safe’ institutions to smaller niche and specialist participants, such as Sipp operators and platforms, there is an adjustment in regulatory tolerance from “can’t be allowed to fail” (hence solvency limits and recovery/assurance schemes) to “allowed to fail, but protect customers” (hence recordkeeping and reconciliations). Other changes proposed are around clarification of rules regarding payment of interest on client money balances. Historically low interest rates mean that the value in holding client money for an adviser firm is somewhat diminished, especially when the costs of Cass compliance are considered from an advisory perspective.
Regardless of structure, permissions and services offered, all advisers have a responsibility for due diligence on the product providers and platforms that they use. Just because your chosen vendor is a known market name is no guarantee, as the £3.5m levied against Integrated Financial Arrangements Plc (aka Transact) attests. Part of this due diligence should consider an organisation’s approach to client money, and observation of the Cass rules, asking questions about the reconciliation approach used and having sight of the Cass Resolution Pack are good roads into this.
The Cass Resolution Pack needs to contain sufficient information, at different levels of detail, to enable external overseers to manage the business. It is at once a disaster recovery plan, operating model and client holdings report designed to be wheeled out within 48 hours of an insolvency event. There are outsource arrangements to consider, functions delivered by different parts of a parent group, different IT systems and a whole host of contractual and legal arrangements in place. It might sound a little arcane, but the FCA is keen on transparency and appropriateness, and articulating all these different aspects to a wide audience quickly, concisely and easily is no mean feat. Taking a step back to get sight of the business such that Cass impacts and obligations are understood and visible as part of a wider, end-to-end view, gives context and meaning to the activities and operations that present a compliance risk in that area.
Chris McCullam is a senior consultant of consultancy firm Altus
Key Points
Client Money is a hot topic at the moment with Aberdeen becoming the latest addition to the FCA roll of dishonour for a breach of the rules
The FCA is currently consulting on a review of the client assets regime for investment business (CP13/5) and makes some good proposals for changing the way client money is handled in the event of a firm insolvency
All advisers have a responsibility for due diligence on the product providers and platforms that they use
Box out
Outside of the due diligence question, the impact on a firm of understanding and adhering to the Cass rules and regulations around client money varies according to the services it offers clients and how they are structured. For instance, Cass 8 covering mandates for controlling client assets through to Cass 5, 6 or 7 for holding those assets.
The Cass rules apply to individual regulated legal entities and these are often organisationally and operationally different to the businesses that deliver service to customers. Keeping a clear view of how your firm is structured (operationally and legally), what services you offer to clients, and how these are delivered is key to not only running a compliant business, but also beneficial in operating efficiently. There is no quick and easy route to client money compliance, short of not holding any, and having robust and structured views of the organisation can only be of help when the regulator or a skilled person comes to call and asks: “What would you do if…”
