New client money rules for insurance intermediaries
Insurance intermediaries have been subject to the Financial Services Authority (FSA) rules on holding client money since 2005. Amid growing concerns that client money is not being adequately protected, the FSA has revisited the rules in chapter 5 of the Client Asset sourcebook (CASS 5). In keeping with the FSA’s tougher regulatory approach, intermediaries will face more stringent requirements on how they deal with client money and assets. As expected, the implementation of effective governance, systems and controls forms a fundamental part of the proposed changes.
With the introduction of the dual regulatory structure next year, firms are facing considerable costs in complying with the new regime; a recent survey estimates an increase of as much as 20 per cent. Regardless of the intended benefit of the new client money rules, the more onerous changes (and the cost of implementing such changes) are unlikely to be welcomed by firms.
Why change the rules?
For some time now the FSA has made compliance with CASS 5 a priority having found evidence that firms’ practices for dealing with client money are inadequate. Visits to regulated firms were conducted throughout 2010 specifically to address this issue, with the FSA warning that “this intensive supervision will persist and we will continue to take action where we believe that client assets are not sufficiently protected”. The firm visits highlighted various failings that the FSA believed “very likely to be indicative of weaknesses in other firms doing similar business”. The regulator has blamed poor compliance on a lack of understanding of the rules and ineffective controls at management level.
Regulated firms have an obligation to arrange adequate protection for clients’ assets when the firm is responsible for them. Unsurprisingly in light of the current economic climate, the overarching objective of the FSA’s proposals is the protection of client money in the event of a firm’s failure.
Consequently, the proposals focus on simplifying the distribution and transfer of client money, enhancing record keeping and reconciliations and improving segregation, risk transfer and the diversification of client money. Methods of dealing with unallocated funds and some specific provisions in relation to credit write backs are also addressed. Finally, the FSA expects firms to operate a robust system of governance to ensure adequate oversight, and comply with new reporting obligations.
Following its review of CASS 5 rules, the FSA is now consulting on the proposed changes. CASS 5 is expected to be replaced with a new CASS 5A which, under the new regulatory architecture, will be designated to the Financial Conduct Authority (FCA) Handbook.
The proposals
Segregation
Adequate segregation of client and non-client money is vital so that, in the event of insolvency, money can be identified and returned to clients quickly. Client money will not be protected if a firm has failed to properly segregate and, on insolvency, the money cannot be traced. Without proper segregation the money will go into the general pot to be divided amongst the firm’s creditors.
The manner in which client money is held dictates how it can be used. Insurance intermediaries can currently hold client money under a statutory trust (ST) or a non-statutory trust (NST). Under an NST firms are able to advance credit out of client money either to a client or an insurer; however, such advances are prohibited under an ST. Failure to understand this distinction could potentially see firms in breach of the rules. The FSA is also concerned that some firms may not have a trust deed in place; a requirement for operating an NST. The proposed changes to the use of an NST aim to ensure that firms operate appropriate controls to monitor credit advanced and include requiring firms to:
- Perform client money calculations every seven business days instead of every 25 business days. The regulator can therefore ensure that, at least once a week, the correct amount of money is held in the client accounts.
- Conduct a reconciliation of their client money balances within two business days of the calculation, instead of the current ten day time limit.
- Limit any credit advanced to a maximum period of 45 days and 90 days for a client and an insurer respectively.
- Ensure that any risk transfer arrangement between the firm and the insurer is agreed in writing. Conditional risk transfer (for example conditional on payment of premium) will be prohibited.
Distribution and transfer
In the event of a firm’s collapse the insolvency practitioner (IP) acts as trustee of the client money and must comply with the CASS rules. Under the proposals, the IP is granted greater discretion in dealing with open transactions with the ultimate goal of reducing consumer detriment. The IP will be required under the proposals to use “reasonable endeavours to complete open transactions using client’s entitlements to client money”. Where this is not possible, the IP must distribute the money back to clients.
Significantly, the FSA will allow the IP up to three months to sell all or part of the business to another broker along with the client money. If after this time the business has not been sold, the IP is obliged to return the client money. Clients who would rather retain their insurance cover than have the money returned will benefit from this three month rule.
In an effort to make transfers of business less problematic for firms, the new rules propose a ‘pre-consent’ mechanism allowing firms to transfer books of business, along with the client money, without the need to obtain consent from all relevant clients. Firms would be required to include specific clauses detailing any such transfer in their terms of business. In addition, the FSA must be notified of the intention to transfer client money at least seven days in advance of the transfer. This ‘pre-consent’ option will not apply if the transferee firm is outside the scope of the Insurance Mediation Directive.
Diversification, record keeping and reconciliations
Firms are encouraged to hold client money across an appropriate number of banks thereby limiting loss should any of these banks fail. To improve diversification, the new rules limit the amount of money that can be held by a bank within the same group as the firm to 20 per cent of the total amount of client money held by the firm.
In the event of insolvency, client money can be dealt with more efficiently if a firm has maintained accurate records. With this in mind, the FSA proposes that firms keep a ‘resolution pack’ containing key documents that should be given to the IP within 48 hours of the firm’s failure. Amongst other things the pack should include: documentation on any institutions holding client money; any NST deeds; and the latest bank reconciliation and client money calculation.
On an annual basis firms will be required to reconcile their client money down to individual client balances. At a minimum firms must match at least 95 per cent of client money to individual clients.
Credit write backs
Evidence suggests that some firms might have breached their duty as trustee of client money. The FSA is particularly keen to address pre-2005 legacy balances and encourage firms to deal with money that is inappropriately being held in client bank accounts.
A new procedure will allow firms to make credit write backs for a limited period of thirteen months from the date the rules come into force. After this period has expired, credit write backs will not be allowed and firms will have to follow the new unclaimed client money procedure instead. To take advantage of this option firms must have properly investigated any legacy balances and be unable to identify the beneficiaries. Only then can firms claim the money as their own.
In further efforts to ensure that firms maintain adequate records, client money must be matched to a specific client or transaction within 90 days. Any money not allocated within this time must be returned.
Governance and reporting
Notably, firms will be required to allocate the responsibility of client money oversight to a sufficiently senior approved person. This person will be the regulator’s ‘point of contact’ on all CASS-related matters. Should this person cease to perform the role, firms will have a maximum of two months to appoint a replacement. These rules aim to achieve effective ongoing governance and oversight, which the FSA’s investigation found to be a significant failing in the current regime.
Current CASS 5 rules require intermediaries who operate an NST, or an ST holding more than £30,000, to perform an annual client money audit. Various options to impose more stringent reporting requirements are being considered. One proposal is that all firms will be required to submit client money audit reports to the FSA. Alternatively, a report would need to be submitted where a firm held more than a specified threshold (either £250,000 or £1m according to current proposals) of client money at any point during the previous year, or where the report contains an adverse opinion and/or identifies a notable breach. The final option would be for the FSA to undertake random samples of firms’ client money audit reports. Firms are asked to give their views on these options and the appropriateness of the proposed thresholds.
Impact on insurance intermediaries
Should the proposals be accepted in full, firms can expect their client money practices to be subject to far greater scrutiny. It is clear that the FSA is determined to address failings and firms will have to undertake a thorough review of their current systems to meet the new requirements. The cost implications are not insignificant but, perhaps more importantly, the time it will take to prepare for the new regime will be the biggest burden for firms. Responsibility for client money oversight must be delegated to an individual at senior level and effective processes implemented throughout the business. Firms must ensure that the rules are understood across the organisation and there is a clear allocation of duties. It would appear that both the relevant approved person and the Board will be held accountable for poor compliance.
Whilst the majority of the proposed changes impose more onerous requirements on firms, some could potentially be beneficial. In particular, the introduction of a ‘pre-consent’ mechanism for the transfer of business between intermediaries will be a welcome addition, and perhaps suggests that the FSA anticipates more transactions of this type. Firms may be encouraged to reorganise or consolidate books of business if they are no longer required to obtain a waiver for consent to transfer client money from the FSA. Likewise, the thirteen month period within which firms can take credit write backs provides an opportunity to clear any legacy balances and claim any unallocated money.
The deadline for comments on the proposals is 30 November 2012 and the FSA expects to publish the final rules in the second quarter of 2013. With the exception of the proposal on unclaimed client money, the FSA plans to delay commencement for 12 months from publication of the final rules. Views are sought on whether this would allow firms sufficient time to implement the changes or whether a different deadline should apply. Intermediaries must wait to see how many of the proposed changes will be adopted in the final rules.
For further information: Review of the client money rules for insurance intermediaries
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Insurance Europe response to IAIS consultation on ComFrame
Insurance Europe has published its response to the International Association of Insurance Supervisors (IAIS) consultation on a common framework for the supervision of internationally active insurance groups (IAIGs), known as ComFrame. Insurance Europe supports the implementation of a global framework for group supervision and believes it is “an appropriate response to the increasing globalisation of insurance markets”.
In its response, Insurance Europe identifies some key benefits of ComFrame: convergence of supervisory practices; greater consistency in supervisory requirements; and coordination and cooperation. The response does, however, address a number of issues that Insurance Europe feels should be addressed to provide an appropriate structure to the framework. In particular, Insurance Europe recommends the following:
- There should be a clear statement on the purpose of group supervision to provide focus on how the standards, parameters and specifications should develop and justification for the aims and drivers.
- The framework should focus on facilitating supervisory understanding of IAIG’s and not blur this with the creation of a separate prudential regime for IAIGs through setting standards surrounding valuation and capital requirements.
- The current parameters and specifications are too prescriptive and should instead be positioned as indicative guidance on how standards may be met with supervisors exercising discretion in assessing appropriateness.
Additionally, Insurance Europe identifies a list of components and principles that it believes should be included in ComFrame and states that regulator and industry agreement of these elements is essential to the success of the framework. These principals include, among other things that: group supervision should only be exercised at ultimate parent level; there should be one group supervisor with clear supervisory responsibilities; and solo entity supervision should remain the responsibility of the national supervisor.
In order to agree on a framework that includes the key elements, Insurance Europe advocates a two-phase approach comprising a development phase, focusing on supervisory cooperation and coordination, and a calibration phase.
For further information: Insurance Europe response to ComFrame consultation
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