The challenges of CASS 5: the FCA is watching

Broking Business - Winter 2023

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The current macro-economic climate, coupled with weak financial resilience caused by the cost of living crisis, may tempt firms to cut corners in their client money compliance.

At our recent meeting with the FCA to discuss client money issues, the regulator gave us valuable insight into its current concerns about breaches. We share them now, helping our clients to stay  compliant with the CASS rules.  

Bad debt provisioning

The FCA has been challenging firms on the adequacy of their provisioning, particularly in the case of funded balances.

It’s keen to make sure that all bad or doubtful debts are properly provided for and that there is robust documentary evidence to support any unprovided balances.

Where balances are funded and left unprovided, the regulator is now seeking assurances of recoverability. And, where non-recoverability could lead to capital adequacy issues, it would like firms to bridge any gaps through the injection of capital or letters of credit.  

Although the regulator didn’t specify timing, the general impression was that it would start to ask questions if debts were not collected after six months and were left unprovided, particularly if funded.

With increasing financial challenges ahead for the sector, we expect the FCA to continue to pay close attention to this in 2023 and beyond.

Credit write-backs

The FCA is concerned that credit write-backs appear to be making a reappearance and was keen to hear whether this was something that we, too, were seeing.

Given the current financial conditions, it doesn’t want firms to resort to credit write-backs as a way of supplementing their income in times of hardship or to be unrealistically quick to release unclaimed credits.

The regulator has seen examples of firms undertaking credit write-backs for substantial sums where the underlying liabilities were, in some cases, as recent as two years old.  It was clear that they hadn’t followed due process in evaluating whether the liability could be written back or not. In such cases, the FCA is expecting auditors to challenge their clients.

It does not see the credit write-back process as being compatible with Principle 10: “A firm must arrange adequate protection for client assets when it is responsible for them”. So credit write-backs are only permitted in very limited circumstances, and when all routes to identify the rightful owner of the funds have been exhausted after a realistic period.

The regulator mentioned two main areas of concern:

  • Firms must take proper legal advice to establish that the credit write-back doesn’t breach trust law. There’s little evidence, based on our own work and that of the regulator, to show that firms are getting the necessary legal advice. They may therefore be releasing client funds to their own monies, which may not be rightfully theirs.
  • Firms are applying ‘deemed consent’ rather than ‘actual consent’ in effecting a credit write- back. The FCA wants them to be proactive by obtaining direct written confirmation that no funds are owed to a counterparty before effecting a credit write-back, rather than proceeding to effect it simply by not hearing back.

The FCA will be paying close attention to the credit write-back process and taking action where it believes due process has not taken place.

Mid-month transfers of realised brokerage

The regulator is seeing examples of transfers of brokerage at various points during the month, unaccompanied by a client money calculation.

It recognises that in times of financial hardship firms may need to access their cash more promptly to meet cash flow requirements.

Where funds are received as part of a mixed remittance, it reminds firms that this is a perfectly acceptable way to access funds more quickly. The proviso is that they accompany the withdrawal of funds from the client account by a properly constituted client money calculation.

NST systems sign-off/adverse opinions

Where a firm operates under a non-statutory trust (NST) account, it must obtain an auditor’s letter to confirm the adequacy of its systems and controls in respect of the NST environment, as well as the usual annual client money audit report.

A firm cannot operate an NST without an auditor’s letter. So what happens when an auditor issues an ‘adverse’ client money opinion and is unable to issue the NST systems sign off (as one is incompatible with the other)?

The regulator understands that the auditor cannot issue a confirmation when there are pervasive breaches in the firm’s compliance with the CASS 5 rules. In these cases:

  • the firm should inform the FCA and plan to redeem all relevant breaches, so that an NST systems sign-off letter can be issued.
  • once rectified, the firm should re-establish contact with the auditor to check they agree the breaches have been sorted out. . The NST systems sign-off letter can be renewed at any point in the year.
  • if the auditor is still unable to sign off, the firm should update the FCA who will give direction and most likely request that it switches client money environment to that of a statutory trust.

In these challenging economic times, the regulator is determined that firms do not take their eye off the ball on client money protection. It will ensure that all firms’ client processes and procedures are in place to avoid shortcuts and poor practices that might supplement their income at the expense of clients.

For more information on issues raised in this article, please contact Paul Goldwin.