Third party custody proving hard to wade through

27 February 2020 | UK & Europe | Articles

FCA visits are increasingly focusing on third party agreements. It’s an area where lack of clarity around CASS responsibility can cause problems and the regulator is taking notice.

In recent months we’ve seen more and more cases of firms with unclear third party arrangements when it comes to client assets. We understand that FCA thematic visits have included scrutiny of third party agreements and identified issues, so firms are reviewing and revising their arrangements to ensure clarity and compliance. In some cases, the third parties themselves are being targeted and tasked by the FCA with revisiting all relevant relationships to ensure compliance.

Clear model for third party arrangements

At the centre of these issues around third party arrangements is a lack of clarity around how they work in practice and who has regulatory responsibility for the money or assets.

Traditionally, firms have used two types of model for third party arrangements for CASS:

1. Sub-custody in accordance with section 6.3 of the FCA’s Client Assets Sourcebook.
   These rules are clear that under this type of arrangement, the firm itself (and not the third party) has regulatory responsibility to its clients to hold the assets compliantly. The sub-custodian will then have responsibility to the firm in performing the custody services.
2. External custodian appointed by the client.
   In this type of arrangement, there may be a three-way agreement between the firm, the client and the third party, or there may be two separate agreements, one between the firm and the client for management of the assets and one between the client and the third party for custody of the assets. In this arrangement, the third party has direct regulatory responsibility to the client for holding the assets and the firm simply controls assets held elsewhere.

The hazards of hybrids

Recently, however, arrangements have surfaced that appear to be a hybrid of the two. Often, confusion is caused by the firm acting as agent to appoint an external custodian but the external custodian not having visibility of the underlying clients where they might actually need it. The situation can become even more confused, when the third party also acts as outsourced service provider and runs CASS record keeping and reconciliation processes for the firm.

A hybrid arrangement isn’t necessarily a problem in these circumstances, but a lack of clarity around roles and responsibilities in the agreements can cause problems.

Can the client get their money back?

For any third party arrangement, you need to consider who the client thinks has their assets and whether that is reflected clearly enough in the third party agreements as well as the client terms of business. Consider whether an insolvency practitioner would be able to determine who assets belong to in the event of the collapse of either the firm or a third party.  Would the client ultimately be able to get back what belongs to them?