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Thursday, 25th April 2024 |
| New client money rules to impact on investment intermediaries, stockbrokers and fund administrators |
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| Two recent High Court cases involving MMI and W&R Morrogh, an investment management firm and a stockbroking firm respectively, which each resulted in the loss of client assets and payments by the Investor Compensation Company, have necessitated a review of existing client money requirements by IFSRA. Following a long period of consultation with interested parties new client money rules will be issued shortly to replace the original Client Money Rules issued in 1996 write Paula Kelleher and Orla Beaton. The New Rules will be contained within a revised IFSRA Handbook and there will be a 6-month transitional period before the requirements come into force. |
Authorised investment business firms and stock exchange member firms which receive, hold, control or pay out client money or client investment instruments are subject to the revised requirements. The New Rules therefore will apply across a number of industries including investment intermediaries, stockbrokers and other investment firms including fund administrators.
Key features of the new rules
Key features of the New Rules include clarification of some terminology, the creation of new definitions, the introduction of certain New Rules and in many cases a tightening up of the 1996 Rules.
The term ‘client assets’ is used throughout the New Rules to include both client money and client investment instruments. However, the terms ‘client money’ and ‘client investment instruments’ continue to be defined separately in the New Rules. The change in terminology was made in the interests of clarity to confirm that both money and investment instruments belonging to clients are subject to the same level of regulation. There appeared to be a perception in the past that the rules applied to client money only.
The new rules
A set of 11 General Principles has been added to the beginning of the New Rules, which outlines and summarises the underlying obligations imposed on firms. The principles deal with the a variety of areas including holding client assets on behalf of and for the benefit of the firm’s clients, segregation, registration, timely lodgement, satisfactory systems of control and timing of cessation of monies as client money.
It is worth noting that the New Rules are broadly drafted and not overly prescriptive and this is not advantageous for firms when seeking to apply them. Many terms and phrases are used in the New Rules are not defined and little guidance is provided to assist in interpreting them. General Principle 8 which provides that ‘firms must be open and fair with clients in relation to their client accounts’, is a case in point as no guidance or assistance is provided in interpreting this statement.
Before looking at some of the rules, it is worth noting a few general points, which apply throughout the Handbook. These include a requirement that certain prior written disclosures must be made to clients before the service commences and a requirement to obtain prior written consent of the client in certain circumstances. Rule 2.3 specifically provides that where private clients have not already given the necessary approval by the time the New Rules come into force immediate steps must be taken to obtain these consents. Disclosure in a firm’s terms of business or an investment management agreement entered into between the firm and its client(s) may, depending on the provisions thereof, constitute sufficient disclosure and/or consent for the purposes of these requirements.
It should also be noted that the Handbook contains a definition of ‘written instructions’ which provides that instructions issued to the firm by the client in writing may be issued by e-mail or fax provided that the firm has verified that the e-mail or fax actually came from the client. This broadens the scope for obtaining written instructions and may assist firms in discharging their obligations under the New Rules. Rule 3.1 provides that completion of an order form may also be deemed to be sufficient consent in some cases.
Firms are required to keep copies of all disclosures made by them, written acknowledgements received by them from private clients and acknowledgements received from eligible credit institutions, relevant parties or eligible custodians as and when required under the New Rules. Rule 3.7 (among others) expressly states that ‘a copy of this written confirmation shall be retained by the firm’.
No time periods are specified in the New Rules governing record retention periods. Nonetheless it is important for firms to retain records evidencing compliance with the New Rules in accordance with retention periods specified in the Books and Records section of the IFSRA Handbook.
Eligible credit institutions, relevant parties and eligible custodians outside of Ireland (Rule 3.6)
The requirements in relation to holding client assets outside of Ireland have been tightened in two aspects. Firstly, the New Rules refer to Ireland whereas the previous rule referred to holding client money outside the European Economic Area.
Secondly, under the New Rules the prior written consent of ‘private clients’ is required before the assets are passed outside of Ireland. Furthermore, a firm cannot hold assets with a Relevant Institution outside Ireland unless it has previously made the prescribed written disclosures to both professional and private clients. Rule 3.7 sets out the list of written confirmations which the firm is obliged to receive from the Relevant Institution prior to lodging any client assets with it. The list which is very comprehensive includes among other things, the procedures and authorities for giving and receiving instructions.
Rule 3.7 has also been updated to include a provision that a Relevant Institution can claim a lien over an individual client’s investment instruments, where ‘that client of the firm has failed to settle a transaction by its due settlement date’. This represents an extension of the existing position whereby a lien was permitted in the case of unpaid fees only.
Auditors’ report (Rule 9)
The changes to Rule 9 represent perhaps the single biggest change in the New Rules. Rule 9 of the New Rules formalises the requirement for an Auditors’ Report. The 1996 Rules did not include any specific requirements in this regard, however, in authorising a firm, IFSRA routinely required that an annual client money audit be carried out by the firm. The new Rule 9 provides that firms must ensure that their Auditors undertake the following on an annual basis;
- Examination of the books and records of the firm;
- Review of the systems and procedures employed by the firm in relation to the safe-keeping of and accounting for client assets;
- Examination of compliance by the firm with the New Rules; and
- Report to IFSRA stating whether, in their opinion, the New Rules have been complied with by the firm.
The requirement for a firm’s auditors to form an opinion on the conduct of the firm’s business is very onerous indeed both on the auditors and particularly the firm in question. It is also likely that this provision will add considerably to the audit preparation time as a more extensive review of documentation will be required which in turn is likely to lead to increased audit costs.
Funding the client account (Rule 12.3)
The changes to Rule 12, most notably the introduction of the ‘buffer’ also represent considerable changes to the New Rules. Firms are required to ensure on a daily basis that their internal records reconcile with the client assets which they should be holding on behalf of clients. In respect of their daily client money calculations, under Rule 12.3, firms will be required to maintain an amount in the client account (sometimes called a ‘buffer’) equivalent to 8% of the average level of ‘settled debtors’ over the preceding 5 business days. ‘Settled debtors’ are defined as clients of the firm who have failed to pay the firm for purchase transactions, which the firm has settled with the market.
It should also be noted that another new provision contained in Rule 12.5 requires firms to notify IFSRA immediately of any deposits made to the client account which exceed 0.5% of monies the firm should be holding for that particular client including cash and dividends etc. but excluding any monies deposited by the firm into a client account (either as a ‘buffer’ as set out in Rule 12.3 or to protect clients’ interests as set out in Rule 12.4), together with the reason for such deposit.
Accounts over which the firm exercises control (Section E)
In an effort to clarify the 1996 Rules, the New Rules now include reduced requirements for firms which simply ‘control’ as opposed to ‘hold’ client assets. Firms are deemed to exercise ‘control’ over an account when the client opens an account in it’s own name and the firm has sole control over the initiation of transactions on the account (including issuing settlement instructions).
A firm will be deemed to exercise control over an account only for so long as it has the power to initiate transactions on that account. Where the firm does not have sole control of the relevant account the client must be advised of this and required to confirm in writing that he/she understands the consequences of assets being held in this manner. The books and records of the firm together with all relevant correspondence must clearly distinguish between client accounts and accounts over which the firm exercises control.
Practical changes required to comply with the new client money rules
As outlined above a number of the New Rules require prior disclosures to be made to and written confirmations to be received from clients and Relevant Institutions alike. Firms are also obliged to retain copies of all disclosures made and written confirmations and/or acknowledgements received by them. Furthermore, firms are now also obliged to carry out daily cash reconciliations and monthly investment instrument reconciliations. Therefore, it would be prudent at this stage for all firms (if they have not already done so) to carry out a review of their systems, operational processes and documentation to ensure compliance with the New Rules.
In this regard, general principle number 6 should be noted which provides as follows: ‘A firm is obliged to ensure that it maintains satisfactory systems of control and keeps proper accounting records in relation to client money and client investment instruments. In particular, it must ensure that it has proper systems of internal control designed to ensure that:
- the balance on client accounts is not less than the amount it should be holding on behalf of clients; and (b) the amount and type of client investment instruments held by the firm or lodged with relevant parties or eligible custodians is not less than the amount and type of client investment instruments that the firm should be holding on behalf of the clients’.
It would also be very beneficial for firms to review their operating procedures from an audit perspective to ensure that they will meet the criteria set out in Rule 9 enabling the auditors to make a positive report to IFSRA each year. Following a review of operational procedures, staff training and regular compliance monitoring will be essential components of the ongoing compliance framework.
Conclusion
Although the New Rules are not yet in force IFSRA has indicated that they will issue shortly. In this article some of the key changes have been highlighted but these are not exhaustive. Many other changes are also contained in the Handbook. It would be prudent when planning and implementing changes to comply with the New Rules to have regard to any guidance on interpretation or implementation of the New Rules which may be issued by IFSRA in due course. Evolving business or market practice may also necessitate change on an ongoing basis, which should also be borne in mind. |
Paula Kelleher is a partner and head of the regulatory and compliance department and Orla Beaton is a director in the department.
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| Article appeared in the March 2004 issue.
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