Single Officer: Safeguarding of Client Assets. Governance arrangements concerning the safeguarding of client assets
ESMA’s Technical Advice to the Commission on MiFID II and MiFIR regulates the safeguarding of client assets with the help of a Single Officer. Additional Standards had been published by the IOSCO. With S+P news you get an overview concerning the Single Officer and the following related topics:
- Inappropriate use of title transfer collateral arrangements (TTCAs) for non-retail clients
- Securities financing transactions and TTCAs
- Securities financing transactions and collateralisation
- Considering diversification of an investment firm’s holding of client funds as part of due diligence requirements
- Intragroup deposits of client funds
- Inappropriate security interests, liens or rights of set-off over client financial instruments and funds and recording liens and other encumbrances
- Segregation of client financial instruments in third country jurisdictions
- Preventing unauthorised use of client financial instruments
Single Officer: Safeguarding of Client Assets
- Investment firms shall appoint a single officer of sufficient skill and authority with specific responsibility for matters relating to the firm’s compliance with its obligations regarding the safeguarding of client instruments and funds.
- In accordance with the MiFID proportionality principle, investment firms shall decide where it is appropriate for the officer appointed under (1) to be dedicated solely to this task, or to have additional responsibilities.
Inappropriate use of title transfer collateral arrangements (TTCAs) for non-retail clients
- Article 16(10) of MiFID II prohibits firms from concluding TTCAs with retail clients for the purpose of securing or covering present or future, actual or contingent or prospective obligations. For non-retail clients, investment firms shall not conclude TTCAs without proper consideration.
- TTCAs are not appropriate where:
- there is only a very weak connection between the client’s obligation to the firm and the use of TTCAs, including where the likelihood of a liability arising is low or negligible;
- the amount of client funds or financial instruments subject to TTCAs far exceeds the client’s obligation, or is even unlimited if the client has any obligation at all to the firm; or
- firms insist that all clients’ assets must be subject to TTCAs, without considering what obligation each client has to the firm.
- Investment firms shall consider and be able to demonstrate that they have properly considered the use of TTCA in the context of the relationship between the client’s obligation to the firm and the client assets subjected to TTCA by the firm.
- Where using TTCAs, Investment firms shall highlight to clients the risks involved and the effect of any TTCA on the client’s assets.
Securities financing transactions and TTCAs
- While some transactions permitted under Article19 of the MiFID Implementing Directive may require the transfer of title, it shall not be possible to make use of Article 19 to effect arrangements that are prohibited under Article 16(10) of MiFID II.
Securities financing transactions and collateralisation
- Investment firms shall adopt specific arrangements for retail and non-retail clients to ensure that the borrower of client assets provides the appropriate collateral and that the firm monitors the continued appropriateness of such collateral and takes the necessary steps to maintain the balance with the value of client assets.
- Where an investment firm enters into arrangements for securities financing transactions under Article 19(1)(a) of the MiFID Implementing Directive, the express prior consent of the client shall be clear, recorded in writing, and affirmatively executed by signature or equivalent. In addition, Article 19 should clarify that prior client consent is required for use of client assets by any person.
Considering diversification of an investment firm’s holding of client funds as part of due diligence requirements
- An investment firm that deposits client funds at a third party in accordance with Article 18(1) of the MiFID Implementing Directive shall consider the diversification of these funds as part of their due diligence in the selection, appointment and periodic review of that third party (as set out in Article 18(3) of the MiFID Implementing Directive).
- Where an investment firm has transferred client funds to a transaction account in order to make a specific transaction, such funds shall not be subject to a requirement to diversify.
Intragroup deposits of client funds
- Where an investment firm deposits client funds at a third party (as per Article 18(1) of the MiFID Implementing Directive) and that third party is within its own group, an intragroup deposit limit of 20% of such funds shall be imposed.
- However, an investment firm shall be allowed not to comply with the previous paragraph if it is able to demonstrate that, in view of the nature, scale and complexity of its business, and also the safety offered by the third parties considered in the previous paragraph, and including in any case the small balance of client funds it holds, the requirement under the previous paragraph is not proportionate. Investment firms shall periodically review the assessment made in accordance with this paragraph and should notify their initial and reviewed assessment(s) to NCAs.
Inappropriate security interests, liens or rights of set-off over client financial instruments and funds and recording liens and other encumbrances
- Security interests, liens or rights of set-off over client assets that enable a third party to dispose of these assets in order to recover debts that do not relate to the clients or provision of services to the clients shall not be permitted except in cases where this is required by applicable law in a third country jurisdiction.
- Where a firm is obliged to enter into agreements that create such security interests, liens or rights of set-off, the firm shall disclose this information to clients so that they are informed of the risks associated with these arrangements.
- Where security interests, liens or rights of set-off are granted by the firm over client assets, or where the firm has been informed that they are granted, these shall be recorded in client contracts and the firm’s own accounts to make the ownership status of client assets clear, e.g. in the event of an insolvency.
Segregation of client financial instruments in third country jurisdictions
- Investment firms shall only be permitted to rely on ‘other equivalent measures’ as outlined in Article 16(1)(d) of the MiFID Implementing Directive when they are unable to comply with the segregation requirements in third country jurisdictions, due to reasons of applicable law. In these cases, Member States shall be responsible for specifying the necessary ‘other equivalent measures’ to be taken.
- A specific disclosure shall be made to clients when relying on ‘other equivalent measures’ under Article 16(1)(d) of the MiFID Implementing Directive to make clients aware they do not benefit from the provisions envisaged under MiFID in these instances.
Preventing unauthorised use of client financial instruments
- Investment firms shall take appropriate measures to prevent the unauthorised use of client financial instruments. These measures may include (but are not limited to):
- the conclusion of agreements with clients on measures to be taken by the investment firms in case the client does not have the provision on its account on the settlement date (e.g. borrowing of the corresponding securities on behalf of the client or unwinding the position);
- the close monitoring, by the investment firm, of its projected ability to deliver on the settlement date and the putting in place remedial measures if this cannot be done; and
- the close monitoring and prompt requesting of undelivered securities outstanding on the settlement day and beyond.
- Making information readily available to insolvency practitioners and relevant authorities and strengthening record-keeping requirements
- Investment firms shall make information readily available to NCAs, insolvency practitioners and those responsible for the resolution of failed institutions, including the following information:
- related internal accounts and records (reconciliations, client ledgers, cash books etc.) that readily identify the balances of funds and instruments held for each client;
- where client funds are held by the investment firm in accordance with Article 18 of the MiFID Implementing Directive, details of the accounts where client funds are held (bank or qualifying money market fund) and the relevant agreements with those entities;
- where financial instruments held by the investment firm in accordance with Article 17 of the MiFID Implementing Directive, details of accounts opened with third parties and the relevant agreements with those entities;
- details of third parties carrying out any related (outsourced) tasks;
- key individuals of the firm involved in related processes, including those responsible for oversight of the firm’s requirements in relation to the safeguarding of client assets; and
- relevant client agreements.
- The record-keeping requirements in existing Article 16 of the MiFID Implementing Directive should also state that records shall be maintained in such a way ‘that they may be used as an audit trail’, in line with IOSCO Principle 1.
The 9 IOSCO Principles – Principles regarding the Custody of Collective Investment Scheme Assets
Principle 1: The regulatory regime should make appropriate provisions for the custodial arrangements of the CIS.
Principle 2: CIS assets should be segregated from:
- the assets of the responsible entity, its related entities and other schemes;
- the assets of the custodian / sub-custodian throughout the custody chain; and
- the assets of other clients of the custodian throughout the custody chain (unless CIS assets are held in a permissible omnibus account).
Principle 3: CIS assets should be entrusted to a third party custodian. In limited circumstances where the regulatory regime permits self-custody of CIS assets,
additional safeguards should be put in place to ensure proper segregation and protection of CIS assets.
Principle 4: The custodian should be functionally independent from the responsible entity.
Principle 5: The responsible entity should seek to ensure that the custody arrangements in place are disclosed appropriately to investors in the CIS offering documents
or otherwise made transparent to investors.
Principle 6: The responsible entity should use appropriate care, skill and diligence when appointing a custodian to safekeep CIS assets.
Principle 7: The responsible entity should at a minimum, consider a custodian’s legal / regulatory status, financial resources and organisational capabilities during the due diligence process.
Principle 8: The responsible entity should formally document its relationship with the custodian and the agreement should seek to include provisions about the scope of the custodian’s responsibility and liability.
Principle 9: Custody arrangements should be monitored on an ongoing basis for compliance with the terms of the custody agreement.