“The failure of a number of international financial institutions, such as Lehman Brothers and MF Global, during the global financial crisis underscored the importance of financial institutions having effective and robust arrangements in place for the identification and safeguarding of customer’s moneys and assets. In addition to minimising the risk of loss or misuse of customer’s moneys and assets during normal times, these arrangements facilitate the prompt return or transfer of customer’s moneys and assets in the event of the default, resolution or insolvency of the financial institutions.” [MAS, Consultation Paper on Enhancements to Regulatory Requirements on Protection of Customer’s Moneys and Assets, July 2016]
Change to the definition of ‘Customer’s Moneys’
Lessons learned are still emerging from the Lehman Brothers and MF Global bankruptcy cases, in particular around ‘who owned what’ and which customer’s moneys should have been protected at the precise moment that the organisations failed – at which point many trades would still have been ‘mid flight’. It was recognised by the Singapore Court in the MF Global Singapore Pte Ltd v Vintage Bullion case heard in late 2015 that the as soon as money is due and payable to the customer, it must be protected.
The current rules cover ‘money received from or on account of a customer’ and the definition is proposed to be widened to include contractual rights arising from transactions entered into on behalf of or with a customer. MAS does not intend to change the definition of customer assets.
Due diligence on deposit-taking institutions and custodians
Under the current rules, CMS licencees do not have to conduct due diligence on the deposit taking institution that maintain their client money bank accounts. This is proposed, in addition to ongoing due diligence. The need for diversification is also important – to make sure, where appropriate, you have more than one bank which you use to hold customer money.
Due diligence is already required for the custodian that will hold assets, and the consultation paper sets out the proposal to ensure that CMS licencees also carry out a periodic review of the custodian.
The current rules require that you seek acknowledgement from local banks that they are correctly treating your customer’s money accounts as customer money accounts – i.e. they are designated trust accounts, segregated from the firm’s own money and assets, and cannot be used to set off any debt owned by the firm to the bank. This is proposed to be extended to overseas banks.
The source of this change could be the MF Global Singapore Pte Ltd v Vintage Bullion case, in which it was confirmed by the Singapore Court that mere segregation of funds into a customer account alone does not create an express trust.
Information systems and controls
Record keeping requirements already exist such that CMS licencees must keep detailed records of the amounts of assets held for each customer, date and quantity of each transfer, amount and purpose of each withdrawal etc. There is the intention to introduce more robust information systems and controls that can promptly produce, both in normal times and in times of insolvency, the following:
- Location of customer’s moneys and assets
- How assets are held, identity of all depositories
- Type of segregation at all levels of the holding chain
- Applicable rules (where overseas)
- Outstanding loans of customer’s securities
Computations and Reconciliations
Under the current rules, firms licenced to trade in futures contracts or carry out leveraged foreign exchange trading are required to perform daily computation of the amount of its moneys and assets deposited in the customer’s trust accounts or custody accounts. The daily computation requirement is proposed to be extended to all licensees, not just futures or leveraged FX traders.
The daily computation requirement ensures proper accountability and reconciliation of moneys and assets held in trust on behalf of customers.
“MAS understands in practice, CMS licencees perform such computation on a daily basis for all moneys and assets, regardless of product traded” [MAS, Consultation Paper on Enhancements to Regulatory Requirements on Protection of Customer’s Moneys and Assets, July 2016]
Re-hypothecation and other use
Under the current rules, if you lend securities that belong to a customer, you must disclose the risks involved to your customer, and you must get their written consent before you lend. If your customers are Accredited Investors, then the requirement to explain the risks falls away. But you still must obtain consent.
The existing rules are a little narrow, and so the proposal is to extend the risk disclosure and consent obligation to all situations when you may reuse your customer’s assets, to include when CMS licencees mortgage, charge, pledge or rehypothecate assets (e.g. reuse of the collateral received for a securities financing transaction, typically undertaken by prime brokers). The risk disclosure is also being a little more prescribed.
Other proposals of interest set out in the consultation paper include:
- Customer Disclosure: proposed new disclosures will require you to set out to your customer precisely how money and assets are held, the type of segregation (omnibus or individual segregation) and where held in a foreign jurisdiction, the potential consequences of such differences.
- Prompt response to request for statement of account from customer: Under current rules, you must provide your customers with monthly and quarterly statements, showing the status of every asset held. This obligation falls away if there has been no change to the assets, or the customer is an accredited investor. The consultation proposes that in future, firms must respond promptly if a customer requests a statement at any time.
- Dis-application of regulation which allows the customer to direct which account to use: The current rules allow a customer to direct the firm to deposit their money or custody assets into an account that the customer chooses. The MAS feel that this could be open to abuse and that, in the case of a retail customer in particular, it is unlikely that the customer will be well informed as to which is the most secure place to deposit their funds. Hence the proposal to drop this option, in order to increase the protection for customers.
- Application to banks: The MAS notes that banks carrying out investment activity “would not generally make a determination up front as to the purpose of moneys received from their customers”. And so a carve-out is being introduced for Exempt FIs that will disapply the Customer’s Moneys rules.
How Bovill can help
The MAS have not consulted on the proposed new rules yet, but have introduced the proposed changes that they intend to make. So this is a topic that is still in the early stages of implementation.
We can help with an initial review of the proposed impacts, which could be operational changes due to the point in time at which customer’s moneys are recognised and protected, or practical aspects of the robust processes required for documenting and recording the arrangements. Some of the impacts could be systems changes with a long lead time, and so it is important to start thinking about this topic early on in the regulatory consultation process.