Proposed custody rule bringing new safeguarding implications

Client asset protection

The SEC has proposed significant amendments to its custodial oversight rules. Seeking to increase asset protection, these changes also bring with them a number of implications for safeguarding assets, with the SEC proposing a phased implementation timeline.

The proposed amendments introduce several changes to the current custodial framework:

  1. Broadened custodial oversight: The SEC’s proposal expands custodial oversight to include all assets in advisory accounts, encompassing a wide range of financial instruments beyond traditional assets like funds and stocks.
  2. Verification and valuation requirements: Custodians would need to verify ownership, perform accounting and valuation, and handle the collection and distribution of income for all advisory assets.
  3. Enhanced liability for custodians: The proposal imposes liability on custodians for central securities depositories (CSDs), particularly impacting advisory assets in emerging markets.

Compliance dates and implementation timelines

To ensure firms have enough time to review their compliance arrangements, the SEC has proposed a phased implementation timeline:

Initial compliance period: Advisors and custodians have 12 months from the rule’s effective date to comply with the new requirements.

Full compliance: All aspects of the rule must be fully implemented within 18 months.

Considerations to look out for

The proposed amendments present several challenges and considerations, particularly concerning the safeguarding of assets:

Increased compliance burden
Advisors will need to implement new systems and processes to track and report a broader range of assets, increasing administrative overhead. Enhanced verification and valuation requirements will also require additional resources, potentially driving up operational costs.

Access to custodial services
The expanded custodial requirements may lead some custodians to refuse servicing certain financial instruments, making it harder to find custodial solutions for all assets. This could lead to increased costs as custodians adjust their fees to account for the heightened liability and operational complexities.

Impact on client relationships
Advisors must communicate these changes and potential cost increases to clients, which could strain relationships and impact client satisfaction. Enhanced disclosure and reporting requirements will also require more detailed and frequent updates to clients, potentially increasing the administrative workload.

Broader implications for custodians and the financial services sector

The proposed amendments also have significant implications for custodians and the broader financial services industry, particularly concerning the safeguarding of client assets:

Operational challenges
Custodians will need to segregate client assets into individual accounts, a requirement that could disrupt current pooling practices essential for providing market-related services. The increased complexity and liability may lead to higher operational costs, which could be passed on to advisors and investors.

Impact on emerging markets
Custodians may be reluctant to service advisory assets in emerging markets due to the increased liability for CSDs, potentially limiting access to these markets for advisors and their clients. If custodians accept this liability, the cost of servicing these assets is likely to rise significantly, reducing the attractiveness of investing in emerging markets.

Potential reduction in services
The proposal’s requirements could hinder custodians’ ability to provide vital services such as short-term loans, overdrafts, and intraday liquidity essential for efficient securities settlement. These increased costs and operational burdens could lead to a reduction in the availability and affordability of these services, impacting overall market efficiency.

How we can help

Our team of SEC regulatory experts can help you understand the implications of these changes and adapt your compliance systems accordingly. Get in touch if you’d like to discuss further.