CASS 6 Challenges – Getting Your Custody Reconciliations Right

Safe custody regulations under Chapter 6 of the the Client Asset Sourcebook require firms that hold client assets are doing so accurately and completely, reconciling such assets to protect clients and to comply with the regulatory requirements under CASS. The reconciliation process ensures that internal records of client assets held in custody match to actual holdings and helps identify any discrepancies or potential issues.

While client money rules are more detailed and prescriptive under CASS 7, with over twice as many rules and guidance notes compared to CASS 6, the basic control principles carry over between each chapter, with equivalence seen across aspects such as segregation, books and records accuracy, record maintenance, prompt and accurate receipting, and of course the general structure and data sources that support reconciliations.

Legal Title

A client’s safe custody assets are not held within a legal trust in the same manner as client money. Still, it is imperative that firms maintain segregation of such assets from firm assets and that these are easily identifiable as client holdings. Firms often record and hold such assets or securities in nominee omnibus structures, reflecting the holding as recorded in the security register of the issuer. This nominee separation supports the accurate return of assets in such accounts should the firm become insolvent.

The firm must therefore have distinct systems of control and record keeping in place that maintain this corporate veil between firm and customer safe custody assets.

CASS 6: Internal Custody Record Checks – “ICRC”

Internal safe custody reconciliations are the means by which a firm ensures a firm’s internal records and accounts of safe custody assets match its obligations to clients. This involves regular checks to confirm that the firm’s records accurately reflect the assets held on behalf of clients. Unlike CASS 7, a firm holding safe custody assets is not required to maintain aggregated safe custody assets separately from its client ledger level records and so under the CASS rules allow two methods by which the ICRC can be performed, but both must be performed at a frequency of no less than one month between reconciliations.

Not dissimilar to CASS 7, firms that custody assets for their clients must articulate and document the methodology by which they reconcile such holdings.

Firms must be very clear on the method they employ. The first is the internal custody reconciliation method which caters to firms that maintain independent and separate asset records that capture those at a client-specific level of entitlement and a record of aggregated holdings by asset, operating similarly to client ledgers and bank ledgers respectively under CASS 7.

Should a firm’s ledger system not be able to produce aggregated and independent asset positions then the second method, known as the internal system evaluation method (known as ISEM) will be employed to compete and perform the ICRC.

Future insights will delve deeper into the Internal System Evaluation Method (ISEM), focusing on the wide scope of controls firms are expected to have in place and use to continuously monitor its custody records. These controls are crucial for maintaining accurate client entitlement and associated records, thereby minimizing potential system weaknesses.

CASS 6: External custody reconciliation

Similar to the external client money reconciliation, a firm will use either the client-specific ledger entitlement record it holds internally for each of its clients, or the nominee, aggregated position it holds on to its systems and compares this against the aggregated asset position held by third parties such as (sub) custodians, central security depositories or other such counterparts.

Firms should explicitly state the frequency of such reconciliations within their policy and governance frameworks, with the justification of that frequency on the basis of transaction volume, firm size, and product complexity. The minimum expectation is that such reconciliations should be performed on a monthly cycle at a minimum, however, best practice would be for daily reconciliations, depending on third-party registers and records being available.

Discrepancies

Compared to client money discrepancies, exceptional breaks that arise across safe custody reconciliations can take longer to resolve by nature of the underlying mechanisms of the market or the relative illiquidity of certain assets creating a delay & shortfall in settlement cycles. Strong discipline around exception management for asset breaks is therefore imperative, with the best practice steps previously discussed for CASS 7 expected of firms. A comprehensive and consistent audit trail that clearly demonstrates attempts made by the firm to remedy and close outbreaks is crucial when reducing break volumes and maintaining business control through the operational units that process and instruct upon transactions that ultimately get reported within a CASS 6 reconciliation.

Shortfalls

Should a firm determine it is responsible for a client asset shortfall it may elect to transfer its own assets or equivalent funds into the client account to rectify the deficit in the same manner as a shortfall that would arise if the firm’s client money requirement was greater than its resource.

Practically, firms will likely decide to segregate the equivalent cash value of the shortfall in a client money bank account, given the likely period of time it would take to settle the transaction and the requirement for the firm to cover any such shortfall immediately upon completion of next-day reconciliation.

This presents its own operational challenges for firms, particularly around the need to value the custody position daily and adjust the corresponding shortfall value within the client money reconciliation. Price and value information must be readily available and as near to current state as is reasonable to ensure the value segregated is accurate. Firms must also recognise when such shortfalls are rectified and the steps to remove the segregated cash equivalent as quickly as possible.

Grath’s solutions can help to tackle common reconciliation issues such as trade vs settlement discrepancies, multiple custodian data sources, shortfall identification and treatment, human error, and CASS 6 reporting requirements.

If you would like to book a call with one of our specialists to learn more about CASS 6 within Grath’s reconciliation solution, please contact us – we have a team of experts with over 40 years combined experience completing CASS 6 reconciliations.