CASS Resolution Pack Compliance: Don’t Expect Sympathy From the FSA

On 20 November 2012, the FSA published a speech given by Richard Sutcliffe, Head of the Client Assets Unit at the FSA on the background and purpose of the unit he leads and its future policy initiatives.

The speech underlined the priority given by the FSA to improving the client assets regime.  Mr Sutcliffe noted that there are over £9.7 trillion of custody assets within the UK, the protection of which is crucial if the FSA is to meet its objectives of protecting consumers and enhancing the integrity of UK markets.  In his words, CASS compliance is “not a regulatory fad, it is a fundamental duty” owed to customers.

The Client Assets Unit was created in the wake of the Lehman collapse and since that time has initiated a number of policy reforms, including:

  • the stratification of firms into “small”, “medium” or “large” based on the value of their holdings;
  • the requirement for all medium and large firms to submit a monthly Client Money & Assets Return; and
  • the introduction of the CF10a role – the dedicated control function with responsibility for client money compliance in all medium and large firms.

Mr Sutcliffe made clear that the FSA actively uses all of the material generated by firms and takes the issues of quality and accuracy of data very seriously.  Whilst acknowledging that progress has been made, he noted that concerns regarding CASS compliance remain – particularly the continuing failure of firms to properly document trust arrangements.  In light of these concerns the FSA will intensify its supervisory approach in the future, visiting more firms and returning to other firms to cover different issues or check on progress.

On the subject of CASS Resolution Packs, the FSA is aware of the costs involved in creating and maintaining a CASS Resolution Pack and the tight compliance deadlines.  However, it is not particularly sympathetic to the concerns of firms in this area on account of the fact that it is only asking for documentation which, in the main, should have been available to firms before the introduction of the CASS Resolution Pack requirements.

A CASS Resolution Pack provides a convenient snap shot of the state of a firm’s CASS compliance, which can be requested by the FSA at any time.  Given this, the particular concerns that that the FSA has regarding trust notifications and acknowledgments (which are required to be an immediately available component of every CASS Resolution Pack) and the stated intention to increase the intensity of future supervision, firms would be well advised to ensure that their approach to CASS Resolution Pack compliance is on a firm footing before the FSA next come knocking.

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Congratulations on the Completion of your CASS Resolution Pack! Now comes the hard part…

Introduction

Today marks the deadline for completion of a CASS Resolution Pack with respect to every investment firm to which CASS Chapter 6 (custody rules) or Chapter 7 (client money rules) applies.

The CASS Resolution Pack regulations are documented in PS12/6, published by the FSA in March 2012.  They require a firm to collate certain information regarding its handling of client money and safe custody assets that would be of use to an insolvency practitioner in the event of the firm’s failure.  The purpose of the rules is to facilitate the return of client money and safe custody assets to clients more quickly than is currently the case.

The Burden of Maintenance

At least in theory, the creation of a CASS Resolution Pack is a reasonably simple exercise.  However, in practice, the CASS Resolution Pack requirements imply a significant ongoing maintenance burden on firms due to the nature of the documentation forming part of the pack and the requirements regarding retrieval and updating of the pack’s contents.

The ’48 Hour Rule’

The documentation forming part of a CASS Resolution Pack must be capable of being retrieved within 48 hours of (a) the appointment of an insolvency practitioner or (b) the request of the FSA, irrespective of whether the firm in question is a going concern or has entered into insolvency/resolution.  It is worth noting that the 48 hour period continues to run whether the days in question are business days or non-business days. Moreover, where documents are held by a member of the firm’s group, the firm must have adequate arrangements in place to ensure that documents are still delivered within the 48 hour timescale.

The ‘Immediately Retrievable’ Rule

Certain documentation must be capable of being retrieved immediately so as to assist an insolvency practitioner in identifying and freezing client assets.  Additionally, firms should note that the FSA may rely on the inability of a firm to provide ‘immediately retrievable’ documentation as tending to establish that the firm is in contravention of the general requirement that documents be retrievable within 48 hours.

Inaccuracies and Corrections

Firms must ensure that the contents of a CASS Resolution Pack are reviewed on an ongoing basis to ensure that the pack remains accurate.  In addition, material inaccuracies in the content of any new documentation required to be produced as a result of the CASS Resolution Pack rules must be corrected within 5 business days of the inaccuracy arising.

The Future

To date, many firms have put in place a tactical, rather than strategic, solution to the issue of CASS Resolution Packs.  These first generation CASS Resolution Packs are generally created in MS Word or MS Excel.  Whilst easy to create and being fully compliant with the regulations, these products suffer from multiple user and data integrity issues.  Moreover, they are likely to come under further strain as recently proposed changes to the CASS regime, in particular the ability to create multiple legally and operationally separate client money pools and sub-pools, increase yet further the burden associated with maintaining a CASS Resolution Pack.  As a result, they are not well suited to being the foundation stone upon which an efficient and robust CASS Resolution Pack maintenance policy can be built.

However, the future is almost upon us.  We are already starting to see the emergence of second generation CASS Resolution Packs in the form of bespoke CASS RP databases.  In terms of speed and efficiency of updating, multiple-user access and data integrity, the longer-term advantages of these products is clear.  However, the main driver behind this development is not primarily the question of maintenance, but rather the appreciation of the value of a robust CASS Resolution Pack as a risk management tool, used to identify weakness in existing client money processes.  Indeed, discussions are already turning to the creation of third generation CASS Resolution Packs – being CASS Resolution Packs the contents of which are drawn automatically from existing systems and update, at least in part, on a semi-automatic basis.  It is at this point that the true value of the CASS Resolution Pack, as a competitive advantage tool demonstrating the robustness of client money systems and used in the marketing of a firm to new and existing clients, will be fully realised.

CASS Resolution Pack Seminar

I will be presenting a half-day workshop on CASS Resolution Packs on 29 November 2012 as part of the Infoline Client Assets & Client Money Protection Conference.  The workshop will address a number of topics, including:

  • The background to CASS RP;
  • The CASS RP regulations;
  • Implementing a CASS RP;
  • The form of a CASS RP;
  • Future FSA initiatives and their effect on CASS RP planning; and
  • The extension of CASS RP regulations to insurance intermediaries.

Finally, we will also be demonstrating a CASS RP database, and discussing the advantages of this solution over more manual forms of CASS RP.

As a speaker, I am entitled to offer a 20% discount to contacts, colleagues and clients.  Please just drop me a line at michael.beaton@drsllp.com if you would like to take advantage of this.

Hope to see you there.

Michael.

Recent Developments Highlight the Importance of the CASS Resolution Pack

Introduction

The FSA regards the protection of client money and assets (CASS) as one of the fundamental issues facing the financial services industry.  The failure of Lehman Brothers and MF Global served only to force the subject of CASS compliance yet higher up the FSA’s list of priorities.  Two recent events have brought CASS issues back into the news and highlighted the importance of creating a robust and scalable solution to the issue of CASS Resolution Pack (CASS RP) maintenance, as well as the role which the CASS RP can play in ensuring general CASS compliance.

CP12/22: Client assets regime

On 6 September 2012, the FSA published CP12/22, a combined Consultation Paper and Discussion Paper on changes to the CASS regime necessary to comply with the segregation and porting requirements of EMIR as well as the wider review of the CASS regime which is currently under way.

Under current CASS rules, the failure of a firm triggers a “primary pooling event”, following which all client money held by that firm is pooled pending distribution.  In an effort to comply with the requirements of Article 48 of EMIR, which requires segregation of client assets so as to facilitate porting, the FSA intends to allow firms to operate multiple legally and operationally separate client money pools and sub-pools.  In the event of insolvency, each pool would be distributed rateably to its particular beneficiaries.  All client money not held in a pool would form part of a general client money pool, in accordance with current CASS rules.

The FSA believes that multiple pools would allow firms to insulate clients from other clients with a greater risk appetite, or from the risks associated with more complex business lines.  As such, clients could be protected from exposure to delays in the return of client money and the potential for shortfalls in the general client money pool.

It is intended that there should be a great amount of flexibility in the way in which the pools are created.  So, for example, a firm could establish pools by reference to a business unit, such as Prime Brokerage.  Alternatively, a clearing member could operate separate pools of client money comprising (i) the margin held for a client in a client account at a CCP, and (ii) the client money held for that client by the clearing member itself.  If the clearing member subsequently became insolvent, the pooling would allow an insolvency practitioner to make the margin held by the clearing member available in order to facilitate porting.

BlackRock Fined for Breaches of CASS Rules

On 11 September 2012, the FSA published a final notice relating to the £9,533,1000 fine it had imposed on BlackRock Investment Management (UK) Ltd for failure to adequately protect client money in the period between October 2006 and March 2010.  This fine included a 30% discount for early settlement by BlackRock.

The specific failings of BlackRock related to the requirement to provide notification and obtain acknowledge of the trust status of client money placed on deposit.  The net result was that an average daily balance of approximately £1.36 billion had been at risk with the banks at which deposits had been made.

Conclusion

It is anticipated that the pooling arrangements proposed within CP12/22 will be finalised early in 2013.  Thereafter, it is expected that there will be a strong demand for segregated pooling from clients.  A rapid and large increase in the number of client money pools implies a degree of cost and administrative burden on firms providing this service due to the fact that they will be required to ensure that the segregation provisions of CASS 7.4 and the record keeping and reconciliation (both internal and external) requirements of CASS 7.6 apply to the general pool and to each sub-pool created.  Given that these requirements also track into a firm’s CASS RP, and the aggressive deadlines which apply to the updating of the information contained within a CASS RP, it is important to implement a robust and scalable solution to the initial form of a CASS RP and ensure that an appropriate amount of resource is committed to its maintenance.

The FSA press release accompanying the publication of the BlackRock fine reiterated that the identification and protection of client money should be at the top of every firm’s agenda.  In this regard, a CASS RP represents both a risk and a benefit to firms.  Risk arises from the fact that a CASS RP provides a convenient snap-shot of the state of a firm’s CASS compliance, which can be requested by the FSA at any time.  As such, in future, it will become far easier for the FSA to identify failings such as those affecting BlackRock and levy fines accordingly.  However, benefits arise if firms view the CASS RP as an internal risk management tool, highlighting areas of weakness or non-compliance with respect to CASS issues.  Being relatively self-contained, the CASS RP regulations are fairly easy to implement and yet provide good protection with respect to both client assets and a firm’s reputation.  In an environment of shrinking budgets, it is tempting to view the CASS RP as being of secondary importance.  However, if the BlackRock affair highlights anything, it is the price that can be paid for failing to heed the repeated warnings of the FSA regarding the importance of client money issues and the need to implement robust procedures with respect to all aspects of the client money process.

BBA Seeks Clarification on CASS RP from FSA

On 3 September 2012, the British Bankers’ Association (“BBA”) published a letter to the Client Assets Unit of the FSA seeking clarification with respect to several sections of the recently finalised CASS Resolution Pack rules contained within Chapter 10 of the FSA’s Client Assets Sourcebook, specifically:

  • CASS 10.3.1(11): Retail and Professional Agreements – whether a firm is permitted to include in its CASS RP only those agreements relating to clients where money or assets are actually held, or alternatively whether all agreements for all investment business clients should be included within the CASS RP;
  •  CASS 10.1.16R: FSA Notification – whether there is some concept of ‘materiality’ behind the requirement to notify the FSA immediately if a firm has not complied with, or is unable to comply with, the requirement to maintain and be able to retrieve a CASS Resolution Pack, or alternatively whether all breaches, no matter how small, must be notified to the FSA;
  • CASS 10.1.9E(2): Reliance on CASS Systems – under this rule, firms are obliged to put in place arrangements to ensure that systems upon which the firm is reliant for the performance of its CASS RP obligations remain operational and accessible after insolvency.  Noting the difficulty in securing the legal enforceability of this type of clause, the BBA asks for clarification as to whether a firm can instead rely on Section 14 of the Investment Bank Special Administration Regulations 2011 on Continuity of Supply, which obliges suppliers of key services to continue to supply those services to the administrator of a firm;
  • CASS 10.1.11R(2): Correction of Inaccuracies – this rule requires correction of inaccuracies within a CASS RP within 5 business days of the inaccuracy occurring.  The BBA seeks clarification as to whether the reference in the regulations to “material” implies that the FSA is only concerned with the correction of errors or mistakes, or alternatively whether it requires prompt updating of the entire CASS RP.  The BBA also seeks guidance on what is to be considered “material”, and an explanation of why 5 business days has been chosen as the applicable updating period instead of “…a more workable ‘monthly’ basis…”;
  • CASS 10.2.1R(3): Representatives and Agents – this rule requires the firm to identify each appointed representative, tied agent, field representative or other agent of the firm which receives client money or safe custody assets.  The BBA is seeking clarification of what is meant by “other agents”; and
  • CASS 10.2.1(6): CASS RP Affiliates and Third Parties – this rule requires a firm to identify group members and third parties “involved in operational functions relating to any obligations imposed on the firm under CASS 6 or CASS 7”.  The BBA is seeking clarification with respect to the meaning of the phrase “…operational functions…” together with examples of the types of third parties to which the regulation would apply.

FSA Consults on CASS Resolution Packs for Insurance Intermediaries

On 28 August, the FSA published Consultation Paper CP12/10, “Review of the client money rules for insurance intermediaries”.

The Consultation Paper is aimed at all insurance intermediaries to which CASS 5 applies.  It attempts to address a number of concerns which arose during the FSA’s review of CASS 5, including:

  • inappropriate controls around the use of non-statutory trusts;
  • ineffective risk transfer documentation;
  • infrequent client money calculations; and
  • the segregation of client money.

As part of its Consultation Paper, the FSA proposes to introduce the “CASS 5 Resolution Pack”.  The FSA estimates that there are approximately 3,000 firms in the UK which operate with permission to hold client money.  These will be the firms most affected by the CASS 5 Resolution Pack proposals.  The proposal itself largely mirrors the CASS Resolution Pack requirements for firms which are subject to CASS 6 (custody rules) and/or CASS 7 (client money rules) as detailed in Policy Statement PS 12/6 published by the FSA in March 2012 (see blogpost “FSA Policy Statement on CASS Resolution Packs” dated 28 March 2012).  However, there are a few notable differences, such as the absence of:

  • an express right to exhibit documentation in the CASS RP of an affiliate[1];
  • an express right to exhibit documentation in electronic form[2];
  • a requirement to ensure that any systems for the provision of component documents within the CASS RP remain operational and accessible after the insolvency of the firm[3]; and
  • a requirement for the firm to provide information with respect to the affiliates and third parties on which it is dependent for the performance of its CASS obligations[4].

The purpose of the CASS 5 Resolution Pack is to assist an insolvency practitioner access information required to deal with client money in a timely manner.  It is proposed that insurance intermediaries must, at all times, be able to provide the documentation specified in the schedule below to an insolvency practitioner within 48 hours of the firm’s failure.

CASS 5 Resolution Packs must be reviewed on an ongoing basis to ensure that they remain accurate, and any material inaccuracies must be corrected within 5 business days of the inaccuracy occurring.  The firm must notify the FSA immediately if it is not able to comply with these requirements.

In practice, updating of a CASS 5 Resolution Pack is likely to represent less of a burden than is the case with respect to a ‘normal’ CASS Resolution Pack.  This is due to the fact that the documentation to be incorporated within the CASS 5 Resolution Pack is more static in nature.  Nonetheless, the FSA proposes to change the frequency with which client money calculations must be performed, from the current once every 25 business day period to:

  • where the firm holds client money under a non-statutory trust:
    • at least every 7 business days if the firm held more than GBP 250,000 of client money at any time during the calendar year prior to the year the calculation is made; or
    • at least every 14 business days if the firm held less than or equal to GBP 250,000 of client money at any time during the calendar year prior to the year the calculation is made; and
    • at least every 25 business days where the firm holds client money under a statutory trust.

As each firm to which the CASS 5 Resolution Pack rules apply is obliged to include the latest client money calculation and reconciliation within its pack, a degree of effort to maintain the CASS 5 Resolution Pack remains.

The Consultation Paper is open for comments until 30 November 2012.  The FSA expects to publish its feedback to the consultation, together with final rules, in the second quarter of 2013.  It seems likely that the rules themselves will not come into force until 12 months from the publication of the final rules for all provisions (except for separate proposals regarding unclaimed client money).

SCHEDULE

DOCUMENTS FORMING PART OF THE CASS 5 RESOLUTION PACK

  • a master document containing information sufficient to retrieve each document in the firm’s CASS resolution pack;
  • a document identifying all the institutions with which client money may be held, including approved banks, money market funds or other third parties to whom client money may be passed;
  • a document identifying each appointed representative, field representative or other agent of the firm which may receive client money in its capacity as the firm’s agent;
  • a document identifying each senior manager and director and any other individual and the nature of their responsibility within the firm who is critical or important to the performance of operational functions related to any of the obligations imposed on the firm under CASS 5;
  • for the institutions identified in (2) all trust letters;
  • the latest client money calculation;
  • the latest bank reconciliation;
  • a copy of the firm’s annual reconciliation down to individual client balances; and
  • any Non-Statutory Trust deeds.

[1] See CASS 10.1.6R

[2] See CASS 10.1.13G

[3] See CASS 10.1.9E(2)

[4] See CASS 10.2.1(6)