CASS 7 reconciliations – Common fallacies and rule misconceptions

Navigating the intricacies of CASS 7 reconciliations involves understanding common fallacies and rule misconceptions. Holding client money isn’t a regulated activity per se but requires FCA permission. Firms must adhere to strict rules to protect client money, ensuring accurate reconciliations and compliance with FCA regulations. This article delves into defining approaches, prudent segregation, interest allocation, post-insolvency activities, reconciliation frequency, and audit trails, providing insights into managing CASS 7 obligations effectively.

CASS 7 Reconciliations: Context

Holding client money is not defined as a Regulated Activity, but its use is restricted for FCA-regulated firms. Such firms that wish to be able to have and receive client money must apply to the FCA to be permitted to do so.

Holding client money is an activity that cannot ordinarily be delegated, so, with a minimal range of exceptions, the money must belong to the firm’s clients. The firms permitted to hold and receive such monies must ensure that it is controlled by strict rules and systems of control so that, should the firm fail and exit the market, the continuing protection and return of client money to customers can be achieved successfully by the firm or an insolvency practitioner.

Such money can only be held and receipted in connection with a firm’s Designated Investment Business (CASS 7.10.1R) (or a limited number of other activities).

With very few exceptions, holding client money cannot be performed on a delegated basis (as per CASS 7.14), and any agreement to do so must be with the owner of the money.

These distinctions, and the tight controls exerted through by the associated FCA regulations, are important considerations for firms who have these permissions.

Systems of control across a firm ledger system that holds client books and records are of critical importance to a firm’s ability to calculate the total amount of client money completely and accurately it holds for each of its clients and the total value it ought to hold as client money at its respective banks.

This activity reinforces the “gone concern” mindset of CASS practitioners, which introduces a central tenet of CASS;  an internal client money calculation that ensures a firm has processed all relevant ledger postings for any given business day so that the close of business position will be a reliable representation of all cash movements arising on each ledger.

Should a firm enter into insolvency at this point, the complete and accurate balance of client money is therefore known, fully reconciled to the penny, and protected under legal trust, which reinforces the concept of segregation, giving accounts a legal standing that protects monies held against the claims of creditors in an insolvency situation.

Within this context, aligned with the legal basis on which such monies are protected under trust law, the detective nature of reconciliations acts as a practical control that complements the preventative control of legally segregated trust accounts. Both types of control work in unison to reduce the risk of loss or diminution of client money.

We will now examine some common misconceptions around CASS 7 reconciliations:

Defining the approach to CASS 7 Reconciliations:

Firms who hold and receive client money need to ensure the method or “approach” by which it handles sums of money is clearly defined.

This is a crucial point since the selected approach will have a significant impact on how a firm will perform client money reconciliations.

Under the “normal approach” the rules are clear, firms operating their client money bank accounts must ensure that money received in connection with designated investment business will be placed immediately into a client bank account and not into a firm account. The firm must ensure that all the payment channels by which monies can be received directly into a client bank account can be accounted for and administered operationally in such a way that these proceeds do not touch a firm’s account.

Under this approach, and depending on a firm’s level of complexity, CASS teams can administer multiple client bank accounts for specific use scenarios, and depending on the intended use for such accounts, customers will be directed as to which bank account to use. Such scenarios can include but are not limited to, designated accounts for specific payment channels, such as cheques, CHAPS, and Faster Payments. Similarly, a firm may wish to organise its client bank account structure by distinct and separate product offerings such as ISA, Pension, stocks, shares dealing, etc.

Firms may also choose to segregate client money by an “alternative” approach whereby client money is received first into a firm’s account, which is then segregated as client money after a daily calculation to determine this value. Unlike client money receipted under the normal approach which results in immediate segregation, the alternative approach presents a delay to segregation since the action to transfer client money out of the firm account would happen the following day, after the completion of the reconciliation.

Regardless of the model adopted, firms must be clear on the approach adopted, ensuring operational controls, procedures, policies, and regulatory declarations are accurate.

Prudent segregation

The CASS rules include an option to segregate a value within a firm client money requirement that reflects specific scenarios that, should they crystallise and occur, would expose clients to a shortfall risk in the event of insolvency and that there may not be sufficient segregated client money to pay each client the amounts due back to them.

Prudent segregation concerns how specific risks are assessed, quantified, and subsequently mitigated using firm money held within a client bank account.

Prudent segregation should not be used to avoid CASS breaches or provide a simplified solution to transactional challenges through “blanket” shortfall coverage that may act as a substitute for system and control weaknesses or inadequacy.

It is imperative for firms to meticulously outline the exact and specific scenarios and risks they intend to cover. This detailed planning is crucial in designing calculation methodologies for each of these scenarios, ensuring comprehensive coverage and effective risk management.

While the frequency and methodology of calculation may vary for each specified risk, it is a regulatory requirement, as per CASS 7.13.43 (1) & (3), that any prudent segregation balance must be included in the internal client money calculation on a daily basis. This daily inclusion ensures continuous monitoring and compliance with the CASS rules.

Firms must ensure a prudent segregation balance is calculated as a contributing value to the firm’s client money calculation and is not used to replace the firm’s requirements to keep accurate books and records under CASS 7.15 generally.

Interest

The FCA has specific rules under CASS regarding how interest earned on client money balances should be treated. Under client terms and related disclosures, firms must ensure that their contractual obligations are aligned with how their systems and approaches to interest calculation and reconciliation are set up operationally.

The recent FCA focus, particularly through Consumer Duty, has significantly influenced firms’ decisions to allocate interest amounts to clients. This shift presents contractual challenges that directly affect operational processes, including reconciliations. Firms must ensure timely allocation or payment of such monies as per contractual obligations and when they become due and payable to underlying clients.

Incorrectly calculated allocations of client money, whether paid too early or too late, can lead to serious consequences. This includes CASS non-compliance, inaccuracies in books and records, and breaches of fiduciary discharge. Firms must be diligent in their calculations to avoid these risks.

Given the likely complex operational process and the sheer number of clients impacted by any interest calculation, a firm will need integrated systems to manage client money and its calculated interest accurately and promptly. Legacy systems or inadequate integrations can lead to errors and inefficiencies that will be reported as discrepancies in related client money reconciliations.

Post insolvency activity

The client money distribution rules detailed in CASS 7A are designed to speed up the distribution of client assets, improve the return of assets to clients, and reduce the market impact of a firm failure. CASS functions within firms must implement and manage controls with a “gone concern” mindset, as this proactive risk management approach is key to compliance. Firms naturally focus on CASS 10 and the readiness and useability of a CASS Resolution Pack in the event of insolvency, but firms should consider core CASS activities after an insolvency event.

CASS 7A considers the practical need for critical CASS activities a firm would be expected to support. This support includes the involvement of an insolvency practitioner, who plays a crucial role in guiding and supporting these critical activities following firm failure or a pooling event.

Note that provisions within CASS 7A can be applied in circumstances where the firm is not yet insolvent or a primary pooling event has been triggered, but the FCA may decide such steps must be taken to protect client assets. For example, the FCA may trigger a pooling event where a firm is unable to comply with its record-keeping requirements following a secondary pooling event.

After firm failure and a pooling event, reconciliations are expected to be performed beyond the point of failure, and firms must ensure they can do this to enable the transfer or distribution of client assets back to underlying customers.

Reconciliations will continue to be a business-critical activity after a firm ceases business.

CASS teams must continue to conduct internal client money reconciliations based on the firm’s records at the close of business on the previous business day and external client money reconciliation between internal records and accounts and those of any third parties holding client money even after failure.

Shortfalls arising from a discrepancy in its internal client money reconciliation will continue to be funded, and any surplus arising must not be removed.

Frequency

CASS 7 regulations require firms to perform reconciliations regularly. The frequency can vary depending on the firm’s size and the volume of transactions. Firms must perform internal reconciliations daily based on the firm’s close of business ledger positions from the previous business day. While external reconciliations can be performed less frequently, under best practice it’s accepted that most firms will perform such reconciliations at the same frequency as the internal calculation.

Firms are required to review and reevaluate their rationale for the frequency of reconciliations annually. This practice ensures that the chosen frequency remains appropriate and in line with the firm’s operations.

Audit trail and Record-Keeping

Demonstrable evidence of identifying, managing, and resolving any discrepancies that arise on the external reconciliation is essential for demonstrating good governance and compliance during regulatory audits and inspections.

Establishing procedures for identifying, investigating, and consistently resolving discrepancies found during reconciliations is fundamental to exception handling and must include tracking unresolved discrepancies, ensuring they are addressed promptly.

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If you would like to book a call with one of our specialists to learn more about CASS 7 within Grath’s reconciliation solution, please contact us here. We have a team of subject matter experts with over 40 years of combined experience completing CASS reconciliations.