The introduction of the revised Client Asset and Investor Money Regulations will have implications for investment firms and the fund service providers industry in particular, writes Joseph Ryan.
The protection of client assets has been a regulatory priority for the Central Bank of Ireland for some time, arising from certain failures both internationally and domestically to protect and appropriately segregate client assets. The Central Bank commissioned a task force in 2011 to review the regulatory regime for safeguarding client assets with a view to replacing the Client Asset Requirements, which were issued by the Central Bank on 1st November 2007.
The Central Bank has actively inspected firms for compliance with the regulations as part of their supervisory and thematic reviews through their Client Asset Specialist Teams (CAST). Where gaps are found, the Central Bank has the power to initiate skilled person reviews and initiate enforcement proceedings against the firm. This is similar to the UK experience under the Client Assets Sourcebook (CASS rules) issued by the Financial Conduct Authority (FCA), which has been very active in commissioning skilled persons reports under Section 166 and issuing significant fines and enforcement to those found to be in breach of the rules.
Development of the revised regulations
The task force developed proposals to enhance the current client asset protections, particularly in the event of insolvency of regulated firms. The proposals were put to industry for consultation in 2013 with the publication of Consultation Paper 71 (CP 71). Following a lengthy consultation period and detailed submissions from both investment firms and the funds industry, the revised regulations – which were signed into law on 25th March 2015 – were split into two separate categories. The first is the Client Asset Regulations (CAR) for Investment Firms, which are typically MiFID-authorised; and Investor Money Regulations (IMR) for fund service providers, which include fund administrators, depositaries and management companies.
While the investment firms have experience operating under the previous client asset requirements, the IMR regulations apply for the first time. They are specifically drafted to apply to the funds industry where fund service providers operate collection accounts (i.e. bank accounts that are used by fund service providers to receive subscription monies being paid into a fund and remit redemption monies being paid out of a fund), which are deemed to fall within the scope of the IMR.
The CAR is effective from 1st October 2015 and the IMR is effective from 1st April 2016. The regulations are based on six (IMR) and seven (CAR) core principles of the protection regime.
Implications for investment firms and fund service providers
Investment firms and fund service providers will see greater focus on governance arrangements over client assets, with greater oversight and focus from boards and non-executive directors.
They will also be required to appoint an individual as Head of Client Asset Oversight or Head of Investor Money Oversight, which will be a pre-approved controlled function approved by the Central Bank. This role will involve reporting to those charged with governance. The individual will also be tasked with managing the preparation of a client asset management plan or investor money management plan, which will document the firm’s business model and related risks in respect of safeguarding assets and the controls in place to mitigate these risks. The role will also involve making information readily available and assisting in the prompt distribution of investor money, particularly in the event of an investment firm or fund service provider becoming insolvent.
The client asset management plan must be in place by 1st January 2016 for investment firms and 1st July 2016 for fund service providers and be approved by the board of directors.
Compliance with the new regulations will likely have operational implications for investment firms. These include, for example, the abolition of the ability to hold a ‘buffer’, which previously involved the firm’s own funds being held in client accounts. The new regulations forbid any co-mingling or lack of segregation of funds and obtaining facility letters, which can be problematic – particularly for international banks who are not familiar with Irish CAR regulations.
The introduction of IMR will result in fund service providers critically evaluating their business model around the bank ‘collection’ accounts utilised as part of the subscriptions and redemptions process. There has been significant industry dialogue around what constitutes an appropriate business model, with significant variations throughout the industry. These aspects are yet to be finalised by each fund service provider, as they seek to ascertain whether they are in or out scope of IMR.
One particular business model that is emerging from industry discussions involves designating collection accounts as part of the fund’s assets. However, there are operational complexities around this approach and it may also impact the fund accounting – particularly for umbrella structures.
The IMR are effective on 1st April 2016, as set out by the legislation. Considering the IMR is a completely new regime for fund service providers, this area will require significant focus in the coming months. It will also be an area of interest for fund boards, which will potentially be impacted by changes in the operation of related collection accounts.
The Central Bank’s Client Asset Specialist Team (CAST) held information briefing sessions in May and June 2015 for investment funds and fund service providers. CAST is expected to publish Q&As for each regulation soon and provide application guidance for topical issues.
Examination by the firm’s external auditor
A key aspect of CAR/IMR that applies to both investment firms and fund service providers is the requirements for an independent auditor to conduct a client asset examination and an investor money examination on at least an annual basis. Chartered Accountants Ireland, in consultation with the Central Bank, has formed a working group to prepare new guidance, which will replace Miscellaneous Technical Statement – M47. This guidance is likely to be released in Q1 2016.
The independent auditor will prepare an assurance report (which must also be submitted to the Central Bank within four months) providing assurance on whether:
1. The firm has maintained processes and systems adequate to meet the requirements of these regulations throughout the period of the examination;
2. The firm was in compliance with CAR (or Investor Money) regulations as at the period end date;
3. Any matter has come to the attention of the auditor to suggest that the firm has acted in a manner inconsistent with that documented within the client asset management plan, which has been in operation throughout the period to which the examination relates; and
4. Changes made to the client asset management plan since the date of the last report have been drafted in sufficient detail to meet the requirements of CAR (or Investor Money) regulations, capturing the risks faced by the entity in holding client assets given the nature and complexity of the entity under examination up to the date of the current report (for second and subsequent client asset management plan reviews).
Transitional arrangements
The Central Bank has written to investment firms with a 31st December or 30th June year, advising that that the bi-annual audit report due for the period ending 30th June 2015 due under the previous client asset regime can be extended to a nine-month reporting period. In these specific circumstances, the Central Bank is permitting a departure from the existing in bi-annual requirement imposed on investment firms to facilitate closing out the period covered by the existing CAR requirements. It is not anticipated that firms with March or September financial reporting year-ends will have this difficulty, as the reporting period for their in biannual CAR audit report ends on 30th September 2015, which coincides with the revocation of the existing CAR.
Joseph Ryan, FCA, is an Assurance Director at KPMG, specialising in financial services.