FSA plans shake-up of client asset rules for prime brokers

Source: Financial Services Authority

The Financial Services Authority (FSA) has today published a consultation on changes to its client asset rules. The aim of the consultation is to ensure that clients have confidence their money and assets are safe and will be returned within a reasonable timeframe in the event that a firm becomes insolvent.

The failure of Lehman Brothers International (Europe) (LBIE) highlighted a number of areas where the client assets sourcebook (CASS) could be strengthened. Keen to learn lessons, the FSA has been reviewing this area on a number of fronts including engagement with a number of working groups and extensive pre-consultation with firms. The FSA also input into the Treasury's consultations which considered effective resolution arrangements for investment banks.

The consultation focuses on the following:

* Re-hypothecation of client assets - Creating a requirement that all prime brokerage agreements will contain a disclosure annex which will highlight relevant definitions and the contractual limit on re-hypothecation. These are provisions in the contract which apply when a firm can 'use' its clients assets in specified circumstances;
* Increased reporting to clients - The FSA will require daily reporting on client money and assets holdings to all prime brokerage clients. This will mean that clients will know exactly what is happening to their assets, what transactions have been completed and, if relevant, which and how many of their assets have been re-hypothecated;
* Holding client money with group banks- Restricting the placement of client money deposits held in client bank accounts within a group to 20%. This will limit the amount by which a client is exposed to group credit risk;
* Prohibiting the use of general liens in custodial agreements - The FSA considers it unacceptable that a client's assets held with a custodian were subject to a lien exercised because of the debt of a completely unrelated group entity to the relevant custodian This emerged as part of the Lehman insolvency and contributed to significant delays in the insolvency practitioners' ability to recover assets from deposits not under their direct control;
* Creating a new controlled function with specific responsibility for client money and assets - A senior individual within the fiwithiiwithin the firm should be responsible for oversight and protection of client assets and money. Proportionate to the size of the firm, this should be one named individual who may be interviewed for the post and who will hold an FSA significant influence controlled function; and
* Introducing a client money and assets return (CMAR) - This return will be reviewed and authorised on a monthly basis for medium-large firms and twice a year for small firms. This will provide the FSA with an overview of firm-specific CASS positions and an overview of UK firms' CASS holdings and will enable the FSA to make regulated interventions on a firm-specific or thematic basis.

Paul Sharma, FSA director of prudential policy, said:

"The financial crisis has been well documented and the publication of this Consultation Paper follows extensive work on our behalf since the collapse of Lehmans. However, the paper goes far wider than Lehmans - it sets out ways to protect clients and consider market stability in the event of a firm's insolvency.

"We are keen to learn the lessons of the recent crisis and this paper is the first of many that we will publish on the subject of client money and assets. It outlines a number of areas where we believe the client assets sourcebook can be strengthened to ensure greater protection of client assets and financial stability as a whole."

The consultation period closes on 30 June 2010. The FSA intends to finalise rules in a policy statement in the third quarter of 2010.

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