The Cyprus Securities and Exchange Commission (CySEC) today has agreed on a final set of reforms to the legal framework governing the operation of the Investor Compensation Fund, or ICF.
CySEC has introduced a new ICF directive that will be applied to all Cypriot investment firms (CIFs) that provide investment or any ancillary services. Overall, the updated rules reflect a tougher approach by the Cypriot regulator as it tries to find solutions in response to losses of client funds observed in recent years.
The action comes nearly two years after the regulator released a set of proposals for changing how the lifeboat fund is paid for in April 2017.
While the CySEC’s final outcome may be exactly what many industry participants were hoping for in terms of broadening out the contribution basis of ICF fees, some of the consequences captured below may be less welcome for Cyprus-regulated brokers.
The changes imposed by the regulator are to come into force immediately with all CIFs required to satisfy the following mandatory provisions.
In order to cover ICF’s administrative and operational expenses, the new directive introduces annual fees of €700 for firms holding clients assets and €100 annually for members who do not hold eligible funds.
Most radically for the service providers, the CySEC will not return their contributions to the ICF at any stage, including when their authorization is withdrawn for any reason. However, the new rule will apply only on new entrants as funds collected prior to the new directive will continue to be kept as an asset of its payers.
To help it judge the riskiness of a company, and the likelihood of its clients calling on the Compensation Fund, the CySEC has amended the way it uses to calculate the annual contribution to take other specific risks into consideration.
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Specifically, the regulator will charge 0.5 percent (five per thousand) of the CIF’s total eligible client assets each year. Under the CySEC’s plan, it is likely that those companies deemed lower risk would qualify for discounts on their ICF levy. The regulator offers an 80% discount on the annual fees if the company meets all deadlines and its external auditors expressed an “Unmodified Opinion.”
However, if the audited statements or financial instruments are not submitted on time, the annual contribution rate will be increased to €130.000, or one percent (1%) of eligible funds, whichever amount is the highest. To our understanding, many brokers will see this clause arbitrary and ambiguous.
To understand this point, the regulated CIF was previously stopping its payments to the ICF if its cumulative contributions reached the 0.5% cap. But under the updated rules, they would continue to pump more contributions every year even if their retail client assets remain constant. However, they now can benefit from the offered discounts as long as their business and accounting affairs remain compliant.
The new paper also includes a provision that enables CySEC to calculate the extraordinary contribution per category or sub-category of members, rather than on a single basis for all members.
Furthermore, in order to ensure that there will be a minimum limit of liquidity for immediate payment, CySEC now requires members to keep a minimum cash buffer of 3 per thousand of their clients’ assets in a separate bank account. The CIFs will begin to submit a confirmation on the availability of such contingency reserves effective 2020.
Investors have to be more vigilant
On the clients’ side, the regulator also considers forcing retail investors to take due care in choosing their brokers or service providers. This is apparently in order to curb the use of the compensation scheme as a first line of defense if a company collapses, rather than as a backstop.
As such, the CySEC has changed maximum compensation for valid claims from the current 100% with a maximum of €20.000 to be either 90 percent of the cumulative covered claims or €20.000, whichever is lower. Therefore coverage = Min (90 percent Χ claimed amount, €20.000). This means that an investor who holds €50.000 with a CIF, which runs into trouble and is unable to pay, will get €20.000 from the ICF. However, if the claim is for €10.000, the coverage will be only 90 percent or €9.000, not 100 percent as previously calculated.
Commenting on the new regulations, Demetra Kalogerou, Chair of CySEC, said: “The upgraded regulatory framework governing the Investor Compensation Fund provides for a balanced, proportionate and risk-based approach to determining the level of contributions required by member firms. The robustness of the ICF is fundamental to maintaining investor confidence, and ultimately investor protection. Our thorough consultation and resulting changes will help ensure it is a well-funded and resilient mechanism to support the compensation of eligible investors in the event of last-resort market failure.”