Background
The new guidance note carries over much of the commentary from the 2014 guidance note, as the general obligations on providers under the Financial Markets Conduct Act 2013 (FMCA) are largely equivalent to their obligations under the FAA. However, changes have been made to align the guidance with the FMCA obligations and to address issues that the FMA has identified through monitoring compliance of providers’ obligations over the last decade. The guidance note also reflects specific feedback the FMA received from its 2022 consultation on an exposure draft of the proposed guidance note.
Key takeaways of the new guidance note
- Outsourcing of client money or property services to custodians or other third parties.
Providers of client money or property services should carry out (and record) a reasonable level of due diligence on the outsource provider and the proposed arrangements under the agreement between the client money or property service provider and the outsource provider.
- Identifying the client money or property provider
Contractual documentation and any client communications should clearly identify who the client money or property service provider is and who is responsible for compliance with the relevant client money or property service provider obligations under the FMCA (including who is contracting with whom and for what services), particularly where there is a number of parties or entities in a transactional chain.
- Provider obligations relating to the use and management of client CSNs, SRNs and FINs
The FMA expects that where it is necessary to hold a FIN on file, a prudent provider would encrypt it electronically and where it is not required to hold the FIN on file, the record of them should be destroyed immediately after each transaction. If clients’ CSNs, SRNs and FINs are forwarded by email, these should be protected by encryption or two-factor authentication. - Cross-use of client money
Client money or property service providers cannot use client money held on trust for one client to fund shortfalls in client money for other clients, even temporarily. - Deducting margins from client money
The FMA expects there be express, clear and unambiguous disclosure to clients before “margin” deductions are made from client money, including disclosure of the value of the margin and the purpose for which the margin is taken. - Naming and notification of client money trust accounts
The FMA considers it best practice that the trust bank account name contains the words ‘trust’ and/or ‘client funds account’. It is not acceptable to name it ‘working account’ or ‘business account’. Providers should obtain written confirmation from third parties (e.g., registered banks, custodians) with whom they hold client money, acknowledging the status of the accounts as trust accounts. - Bank account and custody reconciliations
To meet the FMA’s expectations in relation to record keeping generally, the FMA recommends that providers consider the following:
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- records are readily identifiable and comprehensible;
- regular review and oversight of record keeping arrangements;
- records are easy to access, use and understand, and can be made available for inspection in a timely manner;
- record keeping is subject to effective systems of controls and appropriate protections and safeguards; and
- records are retained for at least seven years.
The frequency of reconciliation against money and property records of external providers depends on the nature of the provider’s business. For larger providers of equity securities, the FMA recommends the use of automated feeds and auto-reconciliations, and preferably daily reconciliation. Direct physical property investments can be reconciled when transactions occur.
- Reporting to clients
Custodians are encouraged to report on a quarterly basis to provide clients with the opportunity to review their portfolios more frequently (the regulations require at least six-monthly reporting).
- Identification of wholesale clients
The FMA expects providers to ensure that wholesale clients who wish to opt-out of being treated as a wholesale client follow the correct FMCA procedures for opting out. The FMA is of the view that providers who advise their wholesale clients that they have retail client protections and rights but do not advise them of the need to opt out will be misleading their clients. If providers and clients agree contractually to a retail client level of protection but the FMCA opt-out requirements are not complied with, then the FMA may take regulatory action against the provider.
- Non-bank insurance intermediaries
The FMA confirms that in its view a person who is an “insurance intermediary” but is not a “broker” under the Insurance Intermediaries Act 1994 (IIA), is not subject to the FMCA client money or property services regime.
- Use of premiums by insurance intermediaries
The FMA confirms that it does not consider the IIA permits intermediaries to fund their own businesses and related premium funding companies with premiums held for insurers.
- DIMS providers
The FMA clarifies that DIMS providers and custodians are subject to the regulations that apply for client money or property services. - Custodians’ obligations
The FMA’s guidance in this section is largely directed at custodians’ reporting obligations to clients, which the FMA sees as “fundamental to the custodial regime, as it provides independent reporting to clients about the activities of the financial adviser or provider”. This guidance provides that:- Custody reporting should be provided directly to a client via an address of their choosing, rather than to a financial adviser or other person involved in the transactional chain.
- Where reporting is provided via an electronic platform, the platform should be the custodian’s own, or else have appropriate systems and controls in place to ensure the reports and information cannot be altered by the platform provider or anyone else involved in the transactional chain.
- Where reporting is provided to a client’s nominated electronic address, the custodian should take all reasonable steps to verify that it is an address of the client and not an address of (or an address shared with) someone involved in the transactional chain. For existing clients, the FMA expects this to occur when the custodian next interacts with a client (or it can request another party in the transactional chain to seek confirmation).
- Reports can be ‘posted’ to an electronic portal (a secure website login) if the client agrees and the information is made available on a substantially continuous basis.
- Custodian assurance testing should include testing of client addresses (where electronic facilities are utilised for client reporting, testing should be applied where possible).
The guidance also sets out the FMA’s view that a provider will not be a custodian if they provide execution only services to clients on a T+3 basis, where the client money or property are returned to the client (or a party acting on the client’s behalf) immediately following execution.
Next steps
Now that the final guidance has been published, market participants should consider the content of the guidance note against their existing and proposed policies and procedures and client communications. Custodians should also put in place a process to verify clients' electronic addresses in accordance with the guidance.
If you have any questions about how the guidance applies to your business, please get in touch with the contacts listed or your usual Bell Gully adviser.