REGULATION | cLienT Money

WHEN (NON-STATUTORy) TRUST IS NOT ENOUgH

With consultation soon drawing to a close on the FSAs client money proposals, Kin Ly looks at what they could mean for small and medium-sized brokers, and why you should have your say
in its inspection, the fsA identified a number of significant errors, including inaccuracies in how brokers monitored the amount of credit being advanced out of this account, as well as the absence of trust deeds that detail the terms of the nst. the fsA says this raises concerns over whether the amount of credit advanced will be recoverable, particularly in the event of a brokers insolvency. As a result, the regulator is reducing the amount of time brokers are given to conduct a client money calculation. Under cAss 5, brokers must perform a client money calculation every 25 business days to work out how much client money it is actually holding, compared with the amount detailed in its records. the fsA is proposing that this should be done every seven days for large brokers and every 14 days for small and medium-sized brokers. however, this will place significant cost pressures on smaller intermediaries. tim goodger, a specialist in insurance and

rokers and insurance professionals have just one month left to help shape the financial services Authoritys (fsA) client money proposals, and as the consultation deadline nears, concerns over compliance costs intensify. while the insurance industry generally supports the fsAs objective to increase client money protection, some industry figures warn that the cost implications could force small and mediumsized brokerages out of business. it is clear from the fsAs 2009 inspection of brokers across the country that the rules around client money need tightening. the regulators investigation detailed in Client Money & Asset exposed a number of significant shortfalls, including inconsistencies between terms of business arrangements and client money calculations, as well as a lack of accurate records. this has promoted the fsA to draw up an overhaul of chapter five of the Client Asset Sourcebook (cAss 5), which focuses on insurance mediation activity. Among the number of its reforms, those related to non-statutory trust (nst) accounts and risk transfer could have the biggest impact on brokers, according to four firms that will be responding to the consultation paper. nsts allow brokers to advance credit to their clients. for example, they could advance credit to the customer for the payment of claims or a premium refund before receiving those funds from the insurer. the regulator found major flaws in how brokers were managing client money using an nst.

reinsurance law and partner at law firm elborne mitchell solicitors, says the proposals are a positive move in improving client money protection, but warns: theres certainly a possibility that smaller brokers are going to find it difficult to implement these at nil cost and if they are finding it difficult at the moment, then clearly theres greater potential for them to go out of business. i think in the current climate, some of these measures will mean some brokers wont be able to fund the nst account balances. that will impact on their banking facilities. however, steve white, head of compliance and training at the british insurance brokers Association (bibA), while acknowledging that the proposed changes will increase costs, says: the balance of that is there are concerns about how client monies are being protected. the fsAs fundamental interest is that, in the event of a firm failing, client money is securely ring-fenced from unsecured creditors thats where the fsA is trying to get to with these rules.

Risk transfer proposals

Round up: key changes Before: Chapter five of the Client Asset Sourcebook client money calculation: every 25 business days After: fsA proposals

Effect on brokers

Non-statutory trusts large brokers: every seven days small to medium-sized brokers: every seven days Unconditional risk transfers: insurers no longer able to grant a risk transfer with attaching condition. the risk transfer agreement must be clear and unequivocal

Risk transfer conditional risk transfers allowing insurers to place conditions in the terms of business arrangements

in addition to sizing up the compliance costs, brokers may be faced with fewer insurers wanting to head into a risk transfer agreement, if proposals around unconditional risk transfers are ratified. the fsA wants to prohibit insurers from placing conditions on risk agreements with brokers that hold money on their behalf. in a risk transfer agreement, the insurer agrees to bear the risk for any client money losses arising from the broker. but insurers have been able to place conditions on these agreements such as requiring the broker to pay premiums onto an insurer within 30 days. if at any one point, the broker fails to meet the insurers conditions, the risk transfer agreement will be void and brokers may need to seek permission to hold the funds as client money. Jane bean, risk and compliance director at insurance intermediary firm bluefin, says this change will discourage insurers from granting risk transfer, resulting in many of the 3,000 general insurance intermediary firms currently without client money permissions, requiring the permission going forward. but insurance and financial reconciliation and data management firm Autorek says the impact could be much worse and brokers are likely be forced out of the market. Jim mcgivern, senior business consultant at Autorek, claims similar legislation brought into ireland 15 years ago had inadvertently pushed brokers out of business.

he witnessed this when working as a finance operations director in ireland, tasked with the job of assessing the financial health of businesses as well as the brokers ability to comply with the new rules. You did a risk profiling and an assessment and you looked at their capital adequacy and whether they could comply, then you took a view. the effect of it was that smaller brokers were cut out of the market. that was partly due to cost but it was also because brokers and insurers had to be more specific about where the risk lies and where responsibility for protecting client money lies. larger insurance companies will effectively be required to take on the full risk of holding the client money and i suspect at that point, smaller brokers will be more trouble to them than theyre worth. however, other experts disagree that an unconditional risk transfer will have the scope to push brokers out of business. for them, the real concern is that insurers will become more sceptical about entering into such an agreement with the broker, forcing many to reassess their client money arrangements. while this may be the case, suggesting small brokers that may struggle with costs to seek a risk transfer agreement is still valid advice. stuart markley, partner at consultancy firm moore stephens and specialist in compliance issues, says: brokers may not have the funds or the resources to implement the client money rules in full and the way out for smaller

brokers is to try and get out of the client money rules all together by going risk transfer all the way. they should certainly abandon any non-statutory trust arrangements. Another option for smaller brokers is to consider holding client money in a statutory trust account. while this may not allow the flexibility to advance credit, it will mean brokers will still have the wider timeframe of a 25-day calculation cycle, according to mr white.

Serious consideration

it is clear the current rules governing client money need to be improved in order to prevent incidences where client money is lost. but what that will mean for brokers, particularly smaller brokers that may struggle with costs, is serious thought and consideration over whether or not they need to hold client money at all. trade bodies, brokerages and insurance businesses will be bringing some of these points to the fsA in their consultation response. And as that deadline nears, brokers are being urged to make their views heard on policy that could pose a major shake-up to their business.
ONLINE /// The FSA intends to publish its client money policy statement at the end of the first quarter next year, following public consultation. The client money consultation closes on 30 November. To participate, please visit: www.fsa. gov.uk/library/policy/cp/2012/12-22.shtml

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