CASS Proposals

Following the proposed changes to CASS 1A (classification and oversight) and CASS 8 (mandates), as mentioned in Regulatory Roundup 43, and the introduction of the CASS resolution pack concept in (new) CASS 10 – see Regulatory Roundup 39 – further changes to the CASS regime are proposed in CP12/22 “Client assets regime: EMIR, multiple pools and the wider review”.

As suggested by the title the changes are, in part but not wholly, brought about by EMIR which, amongst other matters, introduces the concept of clearing standardised OTC derivative contracts through central counterparties (CCP): see Regulatory Roundup 42 for the most recent update.

The consultation paper is divided into three parts. Part I concerns changes required by EMIR; Part II concerns extending similar proposals to all client money held by all firms in relation to investment business; and Part III which is a discussion paper (“achieving better results”).

Please note that Part II (and Part III) will be relevant to all firms that hold client money.

The FSA press release refers to Part II as “the most radical change that has been made to the client money regime in over 20 years”.

Under current FSA rules the failure of an authorised firm that holds client money would give rise to a primary pooling event which requires all client money to be pooled for distribution – see CASS 7A for the applicable rules and guidance in respect of both primary pooling events (and secondary pooling events such as the failure of a bank).

Unfortunately this is not in accord with the requirements of EMIR. Under the latter, should there be a default of a clearing member (which could be an FSA authorised firm) of a central counterparty (CCP) then the latter will be required to undertake ‘porting’. This means that the CCP, in respect of the assets and positions recorded by it in the name of the failed firm, must transfer them to another clearing member. If that is not possible then the CCP will have to close out the positions and pay any balances owed to clients directly back to them. Obviously these obligations are incompatible with the FSA’s pooling and distribution requirements. The effect of the changes proposed in Part I will be to exclude client money that is held by a clearing member firm at a CCP from the pooling that would be required should the firm become insolvent.

A third possibility is that where the clients of the failed firm are not known to the CCP then the latter will remit the balance owing directly to the insolvent member. Here the distribution rules depend upon whether the monies relate to a client that has chosen individual client segregation (EMIR Article 39(3)) – not pooled – or whether it’s for an omnibus client account (EMIR Article 39(2)) – is pooled (see also CASS 7A.2.4(3) in CP12/22).

In Part II the FSA proposes to extend similar options to all client monies held by all firms and introduces the concept of sub-pools which will hold client money, that would otherwise be held in a general pool, for a specific client or class of clients. There will be strict requirements surrounding sub-pools including notifying the FSA in advance of the intention to establish a sub-pool and making the client aware of the possible risks in putting money in a particular sub-pool. Unless such a sub-pool has been created to facilitate porting, in the event of a firm’s insolvency each client money sub-pool will be distributed rateably to its client beneficiaries.

The FSA is considering whether to mandate the separation of client money along certain lines e.g. one for retail clients and one for non-retail clients, or possibly separating based upon business activities.

Part III looks at both client money and custody assets with a view to improving the speed of return of assets following the insolvency of a firm; reducing the market impact of such an insolvency; and achieving a greater return of client assets to clients after a firm becomes insolvent.

Comments on CP12/22 are invited by 16 October (Part I) and 30 November (Part II & Part III).

The consultation paper reminds us that it only deals with EMIR to the extent that it affects CASS and is separate from other EMIR related changes to the Handbook: “we will consult on these changes later this year”.

The proposed rules can be found in both Appendix 1 and Appendix 2 of CP12/22.

A link is provided to EMIR (Regulation 648/2012).

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