CASS Anatomy

CASS Anatomy™ Go Premium {{{2}}} IMPORTANT: CASS changed quite a bit after MiFID II. This resource therefore may well be out of date, even if it was accurate once, which it might not have been. This is an article about the FCA’s custody and client money rules — client assets — and is fondly known by its chapter in the FCA SourcebookTable of Contents | 1 | 1A | 3 | 5 | 6 (custody rules) | 7 (client money rules) | 7A | 8 | 9 (PBDA) | 10 Comments? Questions? Suggestions? Requests? Insults? We’d love to 📧 hear from you. Sign up for our newsletter.

Client money

The FCA’s client money rules are designed to minimise credit exposure to firms which hold client funds, but who are not authorised to hold client deposits themselves (in otherwords, are not regulated banks). Such firms must deposit client funds with an approved bank which record the deposits in the firm’s name but belonging to the firm’s clients, so it is clear that the firm has no proprietary claim on the account.

In this way, the client account is isolated the firm’s creditors on the firm’s insolvency (such a failure a “primary pooling event”).

Banks

Approved banks do not have to offer client money protection – they have a specific exemption from doing so in the CASS rules – but may do so if they wish. But they may well find it is quite painful and difficult to do.

When do client money obligations arise?

In a nutshell, when you give someone money apropos nothing in particular. Generally, there are two reasons you might pay money to someone else:

The general case: Because you owe it under a contract.

• In some cases (for example a CSA or even a loan) the payee might in turn have to pay some money back to you at a later date. But you are exposed to the payee’s credit risk in the mean time: you are a creditor.
• This general case does not involve client money (see CASS 7.11.25).
• You could say this is “title transfer” of cash, but you don't need to, because cash is special: title to cash, by definition, passes by delivery.
  

The special case: Because you want your counterparty to look after it for you, in connection with some other service it is providing you.

• Here, you don't owe the payee anything. The only contract you have arises because it has agreed to look after your money for you.
• This special case is a sort of safekeeping: it is a regulated activity. In the UK it is regulated by the FCA under the Client Asset Sourcebook (fondly known as the CASS rules).
• Now this special case creates a metaphysical problem, because when you look after something, you’re not meant to take ownership of it. You’'re just a custodian. But as noted above, you can’t "just look after" someone else’s cash: Cash is special. Just by holding it, you own it.
• This necessitates two things:
  • First: A person agreeing to look after your money can’t keep it: it must pass it on to someone else to look after, and since — hang on: that creates an infinite regression doesn’t it? — therefore...
  • Second: there needs to be one class of special people who are allowed to look after your money by keeping it for themselves but promising to pay it back when you want it.
  • And so, lo and behold, there are: they are called banks.
  • When you deposit your money with a bank you have its credit risk. But, as we all now know, banks are special: they’re carefully regulated, well capitalised and generally designed to be appropriate places to look after your money.

In a Nutshell™ then?

Anyone can borrow some money off you; only someone special can hold your money for you. Everyone else has to look after your money by giving it to a bank to hold for you in your name. In that case there is no debtor/creditor relationship with the payee as long as the payee promptly transfers the cash on to a bank with whom you will have a debtor/creditor relationship. Note this is also title transfer (you can’t not title transfer cash), but within a prescribed period, the transfer goes to a third party bank. (if the intermediary were to go insolvent in the mean time it's tough luck).

Banks

Deposit-taking credit institutions benefit from the general “banking exemption” (CASS 7.10.16) from the obligation to hold money on behalf of clients subject to the client money rules.

Client money and cash brokerage

Should an investment manager ask an executing broker bank to offer it client money protection, consider the following:

• regulated credit institutions (Banks, to you and me) are not required to hold customer cash as client money under the CASS rules (CASS 7.10.16) – banks hold “as banker” and not as trustee for their clients.
• If a bank were to treat cash as client money (it could in theory do this, though it doesn't make a lot of sense):
  • The bank would have to deposit the cash with another bank — in practice a diversified network of them — cue operational mayhem.
  • The client would still, ultimately, be exposed to those other banks, just not the immediate one. Cash is always presents a credit risk to whoever holds it for the time being.
• Brokers generally settle cash equities transactions delivery versus payment under their terms of business. Clients will not pay any money in advance receiving their settlement securities. Therefore the client’s payment obligation is in discharge of its contractual liability to the broker, so is not a “client money” obligation in the first place (see CASS 7.11.25);
• When an investment manager instructs a broker to execute an order for a client it does so as agent for the client, but in the client’s own name.
  • The broker will book the order against the underlying client directly and not against “investment manager as trustee for Client XYZ”.
  • Therefore, at the moment when the investment manager pays the “client money” to the broker, the investment manager ceases to hold it as client money at all, but pays the cash to discharge the client’s obligation to the broker (again, see CASS 7.11.25).

Delivery versus payment

Note that transactions that are settled DVP do not usually involve the holding money on a client's behalf at all: (instead the client would be paying the broker either as its contractual counterparty, where the broker acts as principal, or in settlement of the client's obligation to reimburse the broker for moneys it jhas already disbursed on the client's behalf (in acquiring the stock in the first place), where the broker acts as agent).

Even without the general banking exemption, the obligation to hold fclient money only arises after a certain period (generally longer than the period for which a broker would expect to be holding money in case)

There are specific exemptions from the obligation to hold as client money relating to delivery versus payment transactions.

Anatomy™

This is an anatomy of the CASS Rules in the FCA Sourcebook.

1 - Application and General Provisions

1.1 Application and Purpose (General)
1.2 General application: who? what?
1.3 General application: where?
1.4 Application: particular activities
1.5 Application: electronic media and E-Commerce

1A - CASS firm classification and operational oversight

1A.1 Application
1A.2 CASS Firm Classification
1A.3 Responsibility for CASS operational oversight

3 - Collateral

3.1 Application and Purpose
3.2 Requirements

5 - Client money: insurance mediation activity

5.1 Application
5.2 Holding money as agent of insurance undertaking
5.3 Statutory trust
5.4 Non-statutory client money trust
5.5 Segregation and the operation of client money accounts
5.6 Client money distribution
5.7 Mandates
5.8 Safe keeping of client's documents and other assets
5 - Annex 1 Segregation of designated investments: permitted investments, general principles and conditions

6 - Custody rules

6.1 Application
6.2 Holding of client assets

6.2.1 Requirement to protect clients' safe custody assets

6.2.2 Requirement to have adequate organisational arrangements

6.2.3 Registration and recording of legal title

6.2.4 (Nominee companies)

6.2.5 Recording title to safe custody assets

6.2.6 (Adequate investigations)

6.2.7 (documents of title to bearer assets)

6.3 Depositing assets and arranging for assets to be deposited with third parties

6.3.1 - Criteria for depositing assets with a third party

6.3.2 - Considerations when discharging obligations under this part

6.3.3 - Issues firms should address in their agreements with third party custodians

6.3.4 - Suitable jurisdictions for the deposit of safe custody assets

6.3.4A - Third-party custody agreements

6.3.4B - Third-party custody agreements

6.3.5 - Agreements with third party custodians not to contain security interests ...

6.3.6 - ... er, except in the following cases

6.3.7 - When a firm is considered to be acting on the instructions of a professional client

6.3.8 - Safe custody asset includes client money

6.3.9 - And don't think this provision allows a right of set-off

6.4 Use of safe custody assets
Template:CASS Section 6.5 TOC 6.6 Template:Records, accounts and reconciliations (From 1/6/2015)

6.6.54 Treatment of shortfalls

7 - Client money rules

7.1 Application and Purpose

Banking exemption: 7.1.8A | 7.1.8B

Template:CASS Section 7.2 7.3 Organisational requirements: client money
Template:CASS Section 7.4 7.5 Transfer of client money to a third party
7.6 Records, accounts and reconciliations
7.7 Statutory trust
7.8 Notification and acknowledgement of trust
7.10 Application and purpose

7.10.3 Opt-in to the client money rules

7.10.8 Money that is not client money

7.10.9 Professional client opt-out

7.10.11 Opt-outs for non-IMD business

Credit institutions and approved banks

7.10.16 R The banking exemption

7.10.17 G

7.10.18 G

7.10.19 R Disclosure required where held under banking exemption

7.10.20 R Disclosure required where money ceases to be held under banking exemption

7.10.21 G

7.10.22 R

7.10.23 G

7.10.24 R

7 - Annex 1

7A Client money distribution

7A.1 Application and purpose
7A.2 Primary pooling events
7A.3 Secondary pooling events

Failure of a bank, intermediate broker, settlement agent or OTC counterparty: secondary pooling events:7A.3.1 | 7A.3.2 | 7A.3.3

Failure of a bank: 7A.3.4 | 7A.3.5

Failure of a bank: pooling: 7A.3.6 | 7A.3.7 | 7A.3.8 | 7A.3.9 | 7A.3.10 | 7A.3.11 | 7A.3.12

Client money received after the failure of a bank: 7A.3.13 | 7A.3.14 | 7A.3.15

Failure of an intermediate broker, settlement agent or OTC counterparty: Pooling: 7A.3.16 | 7A.3.17

Client money received after the failure of an intermediate broker, settlement agent or OTC counterparty: 7A.3.18

Notification to the FCA: failure of a bank, intermediate broker, settlement agent or OTC counterparty: 7A.3.19

8 - Mandates

8.1 Application
8.2 Definition of mandate (Comes into force on 01/01/2013)
8.3 Records and internal controls (Comes into force on 01/01/2013)

9.0 - Prime brokerage

9.1 Application
9.2 Prime broker's daily report to clients
9.3 Prime brokerage agreement disclosure annex
9.4 Information to clients concerning custody assets and client money

Schedule: Transitional Provisions and Schedules