DVP exemption - CASS Provision: Difference between revisions

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 {{anat|cass|}}The [[DVP exemption]] allows a firm a waiver from the full rigours of the CASS [[safe custody]] and [[client money]] rules for money or assets delivered to the firm when settling a [[delivery versus payment]] transaction.
-*'''For securities''': CASS {{cassprov|6.1.12}}.
+*'''For securities''': CASS {{cassprov|6.1.12}}, but see also {{cassprov|6.1.4}} for an important qualification.
 *'''For client money''': CASS {{cassprov|7.11.14}}.
-The first thing to note is this covers money and financial instruments ''belonging to the client'' (see CASS [[6.1.1 - CASS Provision|6.1.1]]. There must be some kind of agency or trust arrangement here. If your [[broker]] acts as a [[riskless principal]], as most do, moneys and assets in its hands are amounts it [[owes]] the client under a transaction. That is to say these are the broker’s liabilities; it is not holding assets or money under some kind of [[bailment]] arrangement.
+The first thing to note is this covers money and financial instruments ''belonging to the client'' (see CASS [[6.1.1 - CASS Provision|6.1.1]]). There must be some kind of [[agency]] or [[trust]] arrangement here. If your [[broker]] acts as a [[riskless principal]], as most do, moneys and assets in its hands are amounts it [[owes]] the client under a transaction. That is to say these are the broker’s liabilities; it is not holding assets or money under some kind of [[bailment]] arrangement.
-There is a limited case where there may be a kind of bailment: where the client has expressly pre-funded the broker with its own cash or assets so the broker can make a DVP transaction as its [[agent]] with the street, and when it has done so the broker is holding the resulting cash or assets on the client’s behalf. In this case the broker is not in the contractual flow, is not owed the assets or money, so can only be holding the assets as trustee (or — cough — banker).
+===Cash brokerage===
+When handling a customer order there are three ways a [[broker]] could do it:
+#.'''As [[principal]]''': [[client]] buys from [[broker]]; broker hedges by buying in its own name [[DvP]] in the market and settling DvP against the client. This is not “on behalf of” the client, but an unconnected [[hedging]] transaction.
+#.'''As [[undisclosed agent]]''': [[client]] instructs [[broker]] to buy; [[broker]] executes in its own name in the market [[DvP]] and subsequently settles [[DvP]] against the client. This ''is'' “on behalf of the client.”
+#.'''As [[custody]] [[agent]]''': [[client]] pre-delivers securities to broker and instructs it to sell them; broker executes in its own name in the market [[DvP]] and subsequently pays sale proceeds to the client.
-As long as the transaction takes place through a [[commercial settlement system]], is intended to settle within one business day of the client's payment or delivery, and actually does settle within the “[[DVP window]]” (a period from the intended settlement date to the close of business on the third business day thereafter).
+Note that economically, 1 and 2 are identical. 3 is a bit different. You should also have the feeling that 1 is not like custody at all, 2 resembles it but only really in form, and 3 is custody-like, but c’mon only for a short period. That feeling would be right. so:
+'''[[Principal]]''': Brokers (in the UK) almost always operate as principal under (1); this is a function of stock-exchange rules; the fact that they aggregate client orders and route to different venues to get best execution, and because it’s easiest. No question of [[custody]] arises. The broker and client are arm’s length counterparties. CASS does not apply by dint of the basic applicability clause, i.e.: “''This chapter applies to a firm when it holds financial instruments belonging to a client in the course of its MiFID business''.” The broker is not holding financial instruments belonging to a client.
+'''[[Undisclosed agent]]''':  Sometimes brokers may operate as undiscloseds agent under (2). That is the basic US model. It may apply in the UK where, for example, the client is an affiliated asset manager, and cannot be seen to trade as a principal against the broker (due the apparent [[conflict of interest]]<ref>US rules. [[Investment Advisers Act of 1940|’40 Act]]. [[ERISA]]. That sort of thing.</ref>). But the pipes everything travels down are the same as for 1 (except that the router will exclude broker-affiliated counterparties and prop books). This is the case that is caught by {{cassprov|6.1.4}}:  “The custody rules do not apply where a firm carries on business in its name but on behalf of the client where that is required by the very nature of the transaction and the client is in agreement.”<ref>By the way, the guidance in 6.1.5 here is very odd, for a stock lending transaction is nothing of the kind.</ref> Here it ''is'' an agency agreement, but the firm trades with the street in its own name.
+'''[[Custody]] [[agent]]''': A broker will rarely do (3). Here the custody rules generally would apply, but the [[DvP]] exemption in  CASS {{cassprov|6.1.12}} and {{cassprov|7.11.14}} would exclude the need for CASS protection as long as the settlement happens within the prescribed periods: as long as the transaction takes place through a [[commercial settlement system]], is intended to settle within one business day of the client's payment or delivery, and actually does settle within the “[[DVP window]]” (a period from the intended settlement date to the close of business on the third business day thereafter).
 ===The changes wrought by [[PS14/9]]===