How to avoid £126 million FCA fines

On 14 April 2015 the FCA published a notice against two subsidiaries of Bank of New York Mellon Group, referred to as “the Firms”, issuing them with a record financial penalty of £126,000,000 for failing to comply with the FCA Client Assets Sourcebook (Custody Rules, or CASS), which applies to safe custody assets and to client money. It was emphasised in the regulator’s notice that even though no client was affected by their failure to comply with the CASS rules such rules should be followed strictly as they are there to protect clients in the event of insolvency. The purpose of the CASS rules is to protect safe custody assets if a firm becomes insolvent and to ensure those assets can be returned to clients as quickly and easily as possible. FCA regulated firms are required to ensure they have adequate systems, controls and records to facilitate this,
and the regulator will be operating under a no-tolerance policy for any diversions from this requirement. Georgina Philippou, acting director of enforcement and market oversight at the FCA said:

“Our Custody Rules are in place to ensure that clients are protected in the event of insolvency. The Firms’ failure to comply with our rules including their failure to adequately record, reconcile and protect safe custody assets was particularly serious given the systemically important nature of the Firms and the fact that safeguarding assets is core to their business. Had the Firms become insolvent, the total value of safe custody assets at risk would have been significant. This is compounded by the fact that the breaches took place at a time when there was considerable stress in the market.”

While it is certain that the record fine is to serve as deterrence for future breach of custody rules by custodian banks, a number of other take away points can be taken from the notice and implemented by custodians to ensure that they do not face similar penalties.

Below we have set out a number of issues that could be taken into account when managing compliance with CASS requirements, which might help firms in setting up their systems, controls and general compliance arrangements regarding custody assets. Moreover, they might help firms evidence that they are taking reasonable steps to ensure such compliance.

Legal structure

It is essential that records and reconciliations reflect assets and client money towards the correct legal entity that has contracted with the client. Firms should consider demonstrating consideration and verification on the following matters:

  • clear understanding of, and distinction between, the legal entities that interact with customers; the legal entity that has contractual relationships with them; and the legal entity which holds their assets, each of these should be functionally independent and identified;
  • how records identifying which entity holds each asset can be made and the impact on this of having sub-custodians; and
  • the effect of sub-custodians on the custody chain in general and on the ability to reconcile and segregate assets.

Contractual terms

Firm should consider the following points when entering and/or negotiating a custody agreement:

  • whether the contractual arrangements of each client reflect the practical arrangements of where and with whom assets are custodied;
  • terms of business should be sufficiently clear and comprehensive in order to afford the best possible protection for the firm and clear provision of information to customers. Transparency of the custody arrangements should be emphasised when reviewing the terms of business;
  • there should be procedures in place to ensure that any changes to the terms of business do not infringe CASS requirements;
  • lien clauses which are in favour of sub-custodians in the custody agreement should be checked in light of their legal impact and whether they meet the permitted exemptions in the CASS rules; and
  • firms should aim to evidence comprehensive implementation of the latest CASS rules Policy Statement amendments on the contents of contractual documentation or consents from clients.

CASS governance and oversight

In order to further ensure sufficient CASS compliance on a more general level and to ensure continuous accurate implementation of upcoming CASS changes, firms should:

  • consider having a dedicated committee in charge of CASS compliance with the possibility to delegate individual aspects of the CASS rules or upcoming changes, delegations of CASS responsibilities should reflect individuals’ profiles and job description to a satisfactory extent;
  • any delegations of oversight should be able to be demonstrated and identified clearly;
  • any CASS policies should be reviewed regularly;
  • firms should consider regular CASS training programmes for both front line and compliance staff.

While the issues discussed above could be very helpful from a broader perspective, firms should consult experts on matters when entering into custody agreements, in such situations – Cleveland & Co is here to help.

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