Client Money and Assets Protection - the reason for being in Financial Services and yet...

By Jim Muir | 29 April 2014

The issue

It’s a long established principle in Financial Services all over the world that an institution should protect its clients’ assets. You’d think it didn’t even need written down. Yet, the principle appears not to be held so dearly as customers and regulators would hope. As a consequence, a plethora of very specific rules and regulations have been foisted (at no small cost) on organisations to ensure that in the event of a collapse of an institution, the assets that belong to the clients are not used to satisfy the liabilities of that institution.

There is nothing quite so destabilising to a market than the news that an organisation has misappropriated clients assets. Arguably, the negligent misapplication of client assets is worse than the deliberate act. Nevertheless, regulators and governments require orderly financial markets and there’s votes in protecting the electorate from rogues and careless managers of institutions. So unsurprisingly, the punishments are becoming increasingly severe on those who do not follow the rules with the most serious sanction being the closure of a business and the incarceration of its management.

Is it that difficult?

Yes it is.

The sheer volumes, and variety, of transactions passing through many of our best-known and best-loved(!) banks, insurers and asset managers means that very precise definitions of what belongs to the client from what point to what point require to be embedded in processes, people and technology. Manual reconciliations, poor audit trail and legacy technology can spawn such a complex flow of money, assets and data that the slightest deviation from the norm can leave a client, or more likely, a lot of clients exposed to loss should the business be unable to meet its obligations.

The institution must make sure that should a client deposit any asset (cash or non-cash) that the asset to which they have been entrusted as custodian is not used for any purpose other than for that intended by the client. Using cash of client A to pay the insurance premium of client B is patently not the intention of client A yet it happens all the time. Similar instances occur in the purchase of stocks and shares.

So what’s the answer?

The regulators are constantly irritated that the principles have not driven out the desired outcomes. Their response has been to introduce and monitor closely, very specific detailed rules. Monitoring has become so labour intensive that they have introduced two new phenomenon. The first is that they are asking for more and more information on more and more frequent returns. By tracking this data and benchmarking it, the can spot trends in patterns to alert them to possible errors and worse, abuse. Furthermore, they are insisting on personal accountability with certain designated functions being created whereby a nominated official in the company is responsible for client money (similar methods have been long set for anti-money laundering). Increasing the use of attestation is set to continue where declarations are made by these designated individuals or even the CEOs to the regulator that all is as it should be with respect to particular themes or issues. There is no hiding place.

Implementing best practice in many countries is a requirement on participants in Financial Services. This can take a rule beyond the written word and into a new dimension. For participants to understand and apply best practice requires constant interaction with thought leaders and (subject to competitive secrecy) other market participants. Innovation moves the baseline and redefines best practice so the less leading edge a business’ people, processes and technology, the further behind they become from best practice and therefore vulnerable to sanction.

Technology clearly has a role to play. Technology standardises processes. Technology brings consistency. Technology delivers scaleability. Technology brings constancy.

In the case of client money and asset protection, the strongest control is reconciliation. Reconciling what you think you have on behalf of a client to what you actually have is a fundamental need. Advising the client what you hold on their behalf is the second leg of that process.

For businesses today to perform manual reconciliations of client money and client assets clearly leaves them and their clients exposed. Inaccurate client reporting, or reporting based on a non-reconciled client register weakens that protection even further. Automating the end to end client money and asset process from reconciliation, classification and reporting is not only going to deliver better client service and lower costs, it’s going to make the regulator more comfortable that the business is a trustworthy one which is adhering to rule number one – Client Asset Protection. The spin-offs in a more collaborative relationship with the regulator and the auditors as a consequence means that the management can focus their energy on running the business for all the stakeholders and be more comforted that they are not at risk of serious regulatory censure.

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