The Financial Services Authority (FSA) has issued a combined Consultation Paper (CP) and Discussion Paper (DP) that proposes a number of changes to the client money and custody assets (collectively “client assets”) regime for firms that undertake investment business.
In addition to some changes required by the European Markets Infrastructure Regulation (EMIR), the FSA proposes changes that could lead to a radical shift in how firms protect client money. The FSA also seeks comment on some wider issues in relation to its fundamental review of the client assets regime with the aim of producing better results in the insolvency of an investment firm.
Today’s proposals fall under three different headings:
Part I: Changes required by EMIR
One of the measures introduced by EMIR will require central counterparties (CCPs), or clearing houses, in the event of the default of a clearing member, to try to ‘port’ (i.e. transfer) the positions and certain associated margin of the failed clearing member’s clients to a back-up clearing member or return any balance. This will allow clients to either carry on trading or see their positions closed and money returned.
These changes mean that when a firm fails some client margin that it held in a client transaction account at a CCP instead of being ‘pooled’ together and then distributed to clients, which happens under existing rules, could now be excluded from pooling to allow porting or repayment to the clients directly. The FSA is proposing these amendments so that its rules will be compatible with EMIR.
Part II: Introduction of multiple client money pools
The introduction of EMIR will allow options on how to safeguard client margin held at the CCP but the FSA proposes to go further and bring in rules that extend similar options to all client money held by all firms in relation to investment business. This will be done by the introduction of ‘multiple client money pools’ which will be the most radical change that has been made to the client money regime in over 20 years.
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The client money regime currently treats all client money as part of a single pool in the insolvency of an investment firm. However the proposals will allow firms, with their clients’ agreement, to operate legally and operationally separate client money sub-pools. Splitting client money into sub-pools provides a number of advantages, including:
restricting any client money shortfalls to a particular sub-pool, so that all the clients of a firm do not share all losses, thereby maximising client money return for some clients; and
allowing the distribution of client money from a particular sub-pool where no contentious issues have arisen in relation to that sub-pool, leading to a more rapid distribution of some client money.
The FSA proposes to permit firms to create multiple client money sub-pools in relation to any investment business, with the discretion left to the firm and the clients to determine the basis. For example, a firm may wish to create a separate client money sub-pool for its prime brokerage business, separating it from other parts of business. Alternatively, a client may agree with a firm to have only its own client money held in a client money sub-pool, separate from all other clients’ money. The FSA also asks whether firms should be forced to operate certain client money sub-pools, for example splitting out retail from wholesale clients.
Part III: Client Assets Regime: Achieving better results
Part III is a DP that provides an overview of the fundamental review of the client money and custody assets regime that the FSA has started. The fundamental review is focused at improving the regime to lead to better results in the insolvency of a firm although it is important to recognise that insolvency law is determined by primary legislation and not the FSA rules. The review will take lessons learnt from recent insolvencies, such as Lehman Brothers International and MF Global, and is intended to assess the industry’s appetite for change.
The objectives of the review are:
Improving the speed of return of client assets following the insolvency of an investment firm;
Reducing the market impact of an insolvency of an investment firm that holds client assets; and
Achieving a greater return of client assets to clients following an insolvency of an investment firm.
The DP provides a number of examples of the rule changes the FSA is considering and welcomes responses to help maintain an appropriate regime for the UK.
Richard Sutcliffe, FSA’s client assets unit leader, said:
“The protection of client assets remains a key priority for the FSA and today’s proposals will go a long way to ensure confidence in UK markets is maintained. In addition to the changes required by EMIR the FSA proposals will lead to the most radical change in the client assets regime in over 20 years with the introduction of client money sub-pools that are designed to bring further safeguards to the industry. Furthermore, the fundamental review of our client assets regime also invites debate on the changes required following the lessons learned from ongoing insolvencies.”