Client money
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CASS Anatomy™
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The FCA’s client money rules are designed to minimise credit exposure to firms which hold client funds, but who are not themselves 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. Therefore, the client money account is isolated the firm’s creditors on the firm’s insolvency (such a failure a “primary pooling event”). It is not isolated, however, from the client money bank’s creditors.
How is client money different to ordinary cash?
It isn’t. Cash is cash is cash. “Client money” describes the relationship between the giver and the receiver of cash, not the cash itself. The cash itself, as it moves around, is just cash.
You can’t encumber cash, as a matter of basic banking ontology. Cash is special. It is unlike any other financial instrument. You can’t deal with your interests in cash. You can hold it, or pass it, and that’s it. Whoever physically holds cash, “owns it” against the rest of the world for all purposes.
So at the moment a client’s cash hits a broker’s client money bank account, neither the client nor the broker holds the cash. The bank does.
Therefore:
- As between client and broker it is client money.
- As between client and the client bank it is indebtedness.
- From the client bank’s perspective it is working capital that the bank can lend out as it could any cash on its balance sheet.
Then the broker instructs the client money bank to pay some cash to an intermediary. Now:
- As between the broker (as trustee for the client) and the intermediary, it is indebtedness.
- From the intermediary’s perspective it is working capital the intermediary can use as it sees fit.
- If the intermediary deposits the cash with its own bank, it as between intermediary and bank it is indebtedness and in that bank’s own hands working capital etc.
OK: curly scenario: here the original broker instructs the client money bank to pay some cash to an intermediary who is, in turn, subject to its own client money regime and deposits it with its own separate client money bank.[1] Here:
- As between broker and intermediary is it “local client money” as neither of them hold it but the local bank does
- As between the local bank and the intermediary who is acting as trustee for the broker (who in turn is acting as trustee for the client) it is indebtedness
- In the local bank’s hands it is working capital.
When do client money obligations arise?
Generally, there are two reasons you might pay money to someone else:
The general case, where client money does not apply: 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 all delivery of cash it title transfer. There is no title to cash.
The special case where client money might apply: Because you want your counterparty to look after it for you, in connection with some other service — designated investment business for example (there are many others) — it is providing you. As to this, see CASS 7.10.1, the applicability of the client money rules. The key phrase is not “in connection with designated investment business”, but “money received for and on behalf of a client”. That implies an agency, trust or banking kind of role, and is quite different from “money owed to a client”, which implies an outright contractual obligation. Agency, trust and banking doesn’t happen all that often in connection with designated investment business — unless you are acting as an agent, trustee or bank.
- 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.
- 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.
Banks
Deposit-taking credit institutions and “approved banks” benefit from the general “banking exemption” and do not have to offer client money protection – see CASS 7.10.16 - 7.10.19 — but may do so if they wish, or their clients insist.
But they may well find it is quite painful and difficult to do, seeing as the one thing banks like to do most — that is, taking cash in and onto their balance sheet — is the one thing[2] a provider of client money protection may not do.
That won’t stop certain ETD clients — especially UCITS funds who can’t have credit exposure to single entities, not even banks — insisting that their initial margin is held as client money and thereby diversified.
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.