Follow the money flow DVP issues arising from PS14/9 Ash Saluja 8 - PowerPoint PPT Presentation

Follow the money flow – DVP issues arising from PS14/9 Ash Saluja 8 July 2014

Overview Removal of the DVP exemption for authorised fund managers proposed in − CP14/9 Following huge lobbying effort, compromise proposed by FCA in PS14/9 − Do the new rules allow some flexibility? − A few caveats: − • Principle 10 still requires firms to provide adequate protection for client assets – need to think about the broader risk of your insolvency regardless of any technical arguments under the rules • There are numerous exceptions that occur in practice (e.g. late renunciations, failed settlements etc.) – need to consider processes to cope with those as well 2

Current DVP exemption – CASS 7.2.8B Money need not be treated as client money in respect of a delivery versus − payment transaction, for the purpose of settling a transaction in relation to units in a regulated collective investment scheme, if: • the authorised fund manager receives it from a client in relation to the authorised fund manager's obligation to issue units… or to arrange for the issue of units… in accordance with COLL; or • the money is held in the course of redeeming units where the proceeds of that redemption are paid to a client within the time specified in COLL (i.e. cash transferred or cheque issued to client by T+4) Implication that the authorised fund manager is dealing as agent (i.e. issue − and redemption of units) rather than dealing as principal (i.e. sale and purchase of units) 3

Proposal under CP14/9 to remove DVP exemption FCA proposed to remove the DVP exemption due to several concerns: − • what happens if DVP transaction fails to settle in time? • more importantly, what happens if firm becomes insolvent before transaction has settled? Practical implications of this… − • authorised fund managers would be expected to adopt the normal approach to segregation • removal of DVP exemption entirely would effectively have required authorised fund managers to receive subscription monies into and pay redemption proceeds out of a client money bank account only • liquidity issues for authorised fund managers as currently redemption proceeds paid to investors are funded temporarily by new subscriptions • issues around converting “old” house accounts to “new” client money bank accounts 4

Revised DVP exemption post PS14/9 - CASS 7.11.21R Money need not be treated as client money in respect of a delivery versus − payment transaction for the purpose of settling a transaction in relation to units in a regulated collective investment scheme if: • the authorised fund manager receives the money from a client in relation to the authorised fund manager's obligation to issue units... or to arrange for the issue of units… in accordance with COLL; or • the money is held in the course of redeeming units where the proceeds of that redemption are paid to a client within the time specified in COLL PROVIDED THAT if the authorised fund manager has not, by close of − business on the business day following the date of receipt of the money, paid this money to the depositary, the [fund], or to the client, the authorised fund manager must stop using the DVP exemption under for that transaction (i.e. the money must then be transferred to a client money bank account) 5

Implications of the revised DVP exemption Does this help? − • Still the implication under the rules that the authorised fund manager is dealing as agent (i.e. issue and redemption of units) rather than dealing as principal (i.e. sale and purchase of units) • Seems to address the issue re converting “old” house accounts into client money bank accounts and/or not being able to use the alternative approach to segregation • May help partially address the intra-day liquidity concerns that arose with the proposed removal of the DVP exemption (i.e. where redemption proceeds are paid out of an account in morning, when the relevant funds only reach the account later that day from the fund/depositary, by using subscription monies/other redemption proceeds temporarily) • Likely that firms will have less liquidity than at present – impact yet to be determined. • Timescale for segregation on redemptions now runs from receipt of proceeds. Under principal model authorised fund manager may fund sales using purchase monies from investors as well as redemption monies from fund – it receives these for its own account so no clear receipt of money falling within DVP exemption. Under both principal and non-principal models authorised fund manager may use netting rather than receiving actual payment of redemption monies from fund. 6

Subscribing through fund manager under non-principal model Investor/Agent Manager Instructions (before or on T) Investor bank Initially operating/settlement Cash (before or on T+4) account/agent’s client money account, transfer to client bank account money bank account COB T+1 Key points: - Cash received prior to T must be treated as Units created at T? client money - Cash received on or after T is arguably not Units registered in name the investor’s money if the investor goes on of client at T (irrevocable to the register at T once fund manager - Cash will still be client money in any event if receives funds) it belongs to/is owed to the fund - DVP exemption permits intra-day funding using the subscription monies Cash (on T+4) assuming (i) no netting and (ii) intra- Fund Depositary/trustee day funding/cash received by fund manager Fund Register Fund account in time to transfer 7

Redeeming through fund manager under non-principal model Instructions (before or on T) Investor/Agent Manager Cash or cheque (on T+4 Investor bank Initially operating/settlement assuming renunciation at T, may account/agent’s client money account, transfer to client money precede receipt from depositary/trustee bank account bank account by COB T+5 Key points: - Investor will no longer be on the register at Units cancelled and renunciation but money not payable to them until removed from register on T+4 renunciation - If money not paid to client/agent by T+5 then pay into client money bank account - DVP exemption still permits intra-day funding - Cheques to be issued from client bank account Fund Cash (on T+4 assuming (i) Depositary/trustee no netting and (ii) Fund Register Fund account renunciation at T) 8

Alternative structures Need to rely on the DVP exemption only if you are dealing with what would − otherwise be “client money” • operate under mandate over fund account (CASS 8 not CASS 7)? • deal as principal (using a manager’s box)? Comments in PS14/9 at paragraph 7.47 need assessing − “It is for AFMs to assess on the basis of their business models and relevant client money rules when their activities are subject to the client money rules… …Where an AFM is carrying out principal or other transactions for its clients and the client is legally entitled to a unit(s) in a regulated collective investment scheme either before or when the AFM receives money from the client, the money may not be client money under the client money rules as the money is owed to the AFM on receipt. However, firms must assess their own business models against the client money rules.” 9

Analysis of purchases through a manager’s box Manager Investor/Agent Instructions (before or on T) Operating/settlement account, Investor bank transfer to client money bank account/agent’s client money Cash (before or on T+4) account only if funded pre T-1 bank account Key points: Fund register updated at - COLL 6.4.4(5) - “The register is conclusive evidence of the persons entitled to T (transaction reversed if the units entered in it.” cash not received by fund - CASS 7.11.27 - “Money held as client money becomes due and payable to the manager by end of T+4) firm or for the firm's own account, for example, because the firm acted as principal in the contract…The circumstances in which it is due and payable will depend on the contractual arrangement between the firm and the client” - If fund manager is dealing as principal, then units in the box are owned by the Fund manager - if the investor gets the unit at T through a sale by the fund manager (i.e. register is updated and unit is fully paid for) then no client money is held by Fund Register the fund manager - But what if the manager has not paid the fund for the creation of new units - money only due and payable to the fund on T+4 - Will require a review of client and fund documentation to confirm the position but no Principle 10 concern for purchasing client if client always has cash or the unit. Fund as a whole exposed to authorised fund manager insolvency prior to settlement if authorised fund manager has updated register and received cash. 10