Regulators in Britain are proposing a “radical shift” in the way that investment firms are required to protect client money in the event that the firm goes under.
Britain’s Financial Services Authority (FSA) issued a combined consultation and discussion paper on Thursday that proposes a number of changes to the client money and custody assets regime for investment firms. Some of the proposed changes are required by changes to European rules, but the FSA is also proposing additional changes that, it says, could lead to a fundamental transformation in how firms protect client money.
Currently, all client money is treated as part of a single pool when a firm falls into insolvency. Now, the FSA is proposing to allow firms to operate legally and operationally separate client money sub-pools, which it says could limit losses to certain clients, and allow for assets to be returned more quickly to others.
The FSA says that splitting client money into sub-pools could restrict client asset shortfalls to a particular sub-pool, so that all the clients of a firm do not share all losses, thereby maximizing client money return for some clients; and, allowing the distribution of client money from a particular sub-pool where the assets are not in dispute, leading to a more rapid distribution of some client money.
The paper concedes that this approach could face new risks, such as the potential increased risk of litigation. For example, clients of one pool may contend that losses should have been allocated to a different sub-pool. And, the increased complexity of managing multiple sub-pools may lead to more operational errors, it notes. However, it says that these risks can be mitigated with certain operational controls, and it concludes that the ability for firms to create multiple sub-pools introduces flexibility that could improve investor protection and client confidence.
The regulator is proposing to permit firms to create multiple sub-pools, with it left to the firm and clients to determine how the assets would be divided. The paper also asks whether firms should be forced to operate certain sub-pools, for example splitting out retail from wholesale clients.
Additionally, the paper aims to consult more broadly on improving the regime for handling an insolvency, incorporating the lessons learned from large bankruptcies in recent years, such as Lehman Brothers and MF Global (although this goes beyond FSA rules to insolvency legislation).
The FSA says that the objectives of the review are to: improve the speed of returning client assets following an insolvency; reducing the market impact of an insolvency; and, achieving a greater return of client assets.
“The protection of client assets remains a key priority for the FSA and today’s proposals will go a long way to ensure confidence in U.K. markets is maintained,” says Richard Sutcliffe, FSA’s client assets unit leader.