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Review of the client assets regime for investment business

On the 12th July 2013 the Financial Conduct Authority issued a consultation paper setting out its plans to review the rules relating to the manner in which investment firms such as brokers handle assets which their clients have entrusted to them. This is an important consultation . I have today sent my response.

There is much to like about the proposals in this consultation paper. The client money rules have long been seen as a key protection for clients in the event of a firm’s insolvency. They do not mean that clients always get every penny of their money back, but they have normally provided a better outcome than would have otherwise been achieved.

That does not mean, however, that improvements could not be made. A common concern has been the time taken to pay money back to clients. This has been a particular problem for clients dealing in derivatives. Generally when a broker is insolvent, derivatives trades are automatically closed. The client seldom has any control over the price at which the trade is closed and are often unable to open an equivalent trade elsewhere because their margin money is locked up in the insolvent broker. The provisions in EMIR relating to porting positions and the proposals in this consultation for faster return of client money are therefore particularly welcome.

This consultation relates to client assets rather than to the Financial Services Compensation Scheme. However, I do believe that it would be beneficial to consider the interaction between the two if at all possible. When a bank becomes insolvent, the compensation scheme is involved at an early stage and can assist with the transfer of accounts to another bank. I believe that a similar process for insolvent brokers would substantially improve the outcome for clients.

I have expressed reservations about the proposal that where a broker is insolvent, all client money should be converted to the predominant currency in the client money pool. This could mean that if you are a client of an insolvent broker, the money you get back will be in a currency completely alien to you and that the amount you get will be decided by reference to a rate not of your choosing. Moreover, if you have ever tried to bank a foreign cheque as a retail customer of a bank, you may know that the combination of charges and the bank’s own exchange rate can significantly reduce the value of the payment.

I remain concerned by the simultaneous restriction of the proposals for multiple pooling to members of central counterparties (CCPs) and extension of the porting proposal to non CCP members. Given that multiple pooling was proposed as necessary to facilitate porting, we must assume that this will severely restrict the potential for the widening of porting envisaged in the paper. In fact, CCP members are the least likely to need multiple pools because they alone are permitted to pay margin on a gross basis. Where margin money is paid other than to a CCP, the client money rules require that only the minimum amount necessary is paid over.

There is a proposal to restrict the payment of interest to either passing on all interest received or none at all. Most firms that pay interest on client money at present do so at a set rate - or perhaps banded rates. I am concerned that passing on all client money received on a fair basis may prove unduly complicated and unduly costly and that firms that currently pay interest will be encouraged to stop.

My other main concern relates to the proposal to prohibit the use of uncleared effects by clients. This proposal makes a lot of sense from a logical perspective, but I wonder if the benefit will outweigh the cost, which may be substantial. If firms do not already have the systems to identify cleared and uncleared funds, this may involve costly changes. Neither is the question necessarily as easy as it might at first appear. While we are familiar with cheque clearing times within the UK, clearing times for foreign cheques may vary. And anecdotal evidence suggests that even banks are (sometimes) unable to explain the time frame for these. Do we expect brokers to know what the banks can not explain.

Foreign cheques, of course, may represent only a small minority of the total remittances received by a broker. But so, I suspect, might remittances which are returned unpaid. Certainly a much greater credit risk arises in the wider client money pool from the risk of underpaid margins by clients trading derivatives. Although the daily internal reconciliation will result in these being made good by the firm, margins will be paid initially from the client money bank account irrespective of whether the individual clients concerned have sufficient funds to cover them.

A problem may also arise on UK cheques which, under the 2-4-6 clearing schedule may be bounced after they have technically cleared. (The cheque is counted as cleared effects on day 4 but may be returned any time prior to day 6 and deducted from the payees bank account.

You can read the full text of my response here.

FCA Consultation Paper 13/5