10 April 2014

Considering the impact of the change in client money rules on Treasury operations

By Naresh Aggarwal and Heather Page

Client money rules are being further strengthened. As a result, Treasurers need to ensure that they can clearly identify client from corporate money. Getting it wrong can (and has) resulted in significant fines - SEI was fined £900k in November 2013, Aberdeen was fined £7.2m in September 2013, and Blackrock was fined £9.5m in September 2012.

Our recent survey showed that only a few Treasurers understood or were aware of the recent changes. Whilst for some there is limited impact, Treasurers can apply their expertise and relationships to use the rules to drive greater transparency and better processing of client money – ultimately offering organisations improved controls and an increase in the funds available for investment.

Treasurers (and those involved in banking arrangements), working with client money, will need to ensure they follow the new rules. This can include:

1. Opening new bank accounts

2. Processing post-dated cheques

3. Dealing with new forms of banking arrangements (such as trust letters)

4. Faster reconciliation processes

5. Changes to the products available and the terms of business

As described below, the FCA’s July 2013 consultation paper CP 13/5 proposed significant changes to the client money rules. This regulation covers insurance intermediaries such as asset managers, wealth managers, and banks with investment operations; however, any Treasury that manages client money (including those of law firms) should consider the following when assessing the sufficiency of their operational, governance, and risk management frameworks in the context of best practice and regulatory compliance.

Reconciliations: The required frequency for internal and external client money reconciliations is to be made more explicit. The application of the ‘negative add-back method’ as a standard method of internal client money reconciliation will be restricted to asset managers only. The requirements for firms intending to use a non-standard method of reconciliation will be tightened up.

Treasurers must consider how an increase in the frequency of the internal and external client money reconciliations will impact their team’s workload and system requirements. Existing manual processes may require redesign and in some cases, a system applying auto-reconciliation may be a more cost effective tool.

Trust letters: the FCA continues to observe significant deficiencies in trust letters which are likely to delay or prevent the release of client money following the failure of a firm. The FCA proposes:

  1. a standardised template acknowledgement letter for money held in client money bank accounts,
  2. requiring the bank to agree that it will ‘release on demand all money standing to the credit of the account upon proper notice and instruction’,
  3. additional guidance for firms to ensure appropriate authority of the individual counter-signing the letter,
  4. requiring firms to obtain an acknowledgement letter for all client bank accounts including those outside the UK, and
  5. removing the 20 business days grace period for firms to obtain a duly countersigned acknowledgment letter. This in effect prohibits the placement of client money into an account until the relevant letter has been signed and returned to the firm.
  6. Firms must repaper all existing client money bank accounts with the new wording within a transitional period of six months and will be expected to review their letters at least annually.

Treasurers must consider how the increase in trust letter administration will impact business as usual. There must be a clear plan in place to execute the changes, to deliver external communications as required, to report to management internally, and to oversee future trust letter production and processing.

Unbreakable term deposits or notice accounts are to be banned. Time deposits subject to penalty clauses will be allowed provided money can be withdrawn within one business day of giving notice. On a positive note, provisions will be introduced to facilitate firms eliminating trivial balances of unclaimed client money by making a payment to charity.

Treasurers must confirm the business no longer offers unbreakable term deposits. Furthermore, Treasurers must continue to ensure that all client assets are protected and correctly classified in separate accounts from those used for investment for the business.

Overall, Treasurers must ensure that clients can be confident that their assets are being held within a framework of robust controls and strong risk management. This will be done through, among other activities, effective staff training, efficient bank account management, and timely reporting.

Furthermore, Treasurers must work with the business so that clients can be assured that their assets are safe and will be returned within a reasonable timeframe in the event of firm failure.

In summary, updates to client money regulation will significantly impact Treasury and banking resources (time, people and systems). Treasurers need to ensure that their organisations have a clear execution strategy for complying with this critical regulation.

17 March 2014

EMIR reporting post go-live update

February 12, 2014 was the big day for counterparties conducting trading activities in OTC or exchange traded derivatives to begin reporting to Trade Repositories (TR). We outline below market feedback received post go-live as well as key challenges faced by corporates and next steps.

How did day 1 go?

Several of the TR’s, the Financial Conduct Authority (FCA) and corporates have commented on readiness as well as the initial reporting performance:

Trade Repository Insights

  • UnaVista - 17million trades  (6m of which were historic trades reported by LCH.Clearnet)
  • 276 reporting clients
  • Exposure of open trades £370 trillion
  • 24 million trades received in total, including trades back loaded before start date

 

  • IceClear - 4.5 million trades
  • 300 reporting clients (as reported in Financial Times)

 

  • Other trade repositories, including DTCC Derivative Repository, Regis TR, and CME Trade Register have not yet published statistics

Regulator’s insights (FCA pre-implementation review commentary)

  • Lack of certainty around delegated offering.  Smaller firms seeking delegated reporting still have no commitment from sell side brokers. FCA reminds firms that delegation is not abdication i.e. firms must implement controls to supervise reporting undertaken by third party or affiliated reporting agents.  Regulated firms must also comply with FCA outsourcing rules.

 

  • Missing UTIs.  Uncertainty how to generate and by whom.  Many firms are reporting UTIs that have not yet been agreed with counterparties with a view to amending later.  Back loaded trades will likely have to be matched again.

 

  • Missing LEIs.  Not all counterparties have applied for LEIs, although EMIR contains a strict requirement to identify counterparties and other parties using LEIs in reports.  Reports that LEI local operating units authorised to issue LEI codes have substantial backlogs of applications.

 

  • Multijurisdictional data protection issues unresolved.  EMIR requires counterparty identification, regardless of the data protection rules and restrictions governing disclosure in a counterparty’s jurisdiction.  Firms are still struggling with how to implement.

 

Corporate’s insights

  • Divergence in practice - Reporting to TR’s. Some companies are reporting directly to the TR’s on their own behalf while others are outsourcing to banks (typically where their trade activity is lower in volume and complexity).The start of clearing of non-centrally cleared margin requirements in 2015 is expected to push much OTC activity onto derivatives exchanges – thereby transferring reporting from agents to CCPs.

 

  • Diversity in approach to data reporting. Some companies have invested in enhancing internal systems for straight through processing of trade data while others continue to do manually via excel spreadsheets.

 

  • Significant time to implement. Most corporates are using in-house resources to implement changes however it is a significant constraint on resources and time to implement and manage business as usual moving forward.

 

PwC Point of View: Irrespective of how companies choose to report trade activity to TR’s (direct reporting vs. outsourcing to banks), they are still responsible for assuring the quality of data submitted to TR. It is imperative that companies have internal controls and governance mechanisms in place to monitor TR submission data as well as the data and systems to manage, report, and reconcile data reported externally.

 

Recent regulatory developments

The derivative reporting journey has just begun and there are still several uncertainties which must be resolved (eg industry agreed practice for UTI generation, harmonisation of UPIs for complex products).

Uncertainty around reporting for FX and physically settled commodity derivatives. On 14 February, ESMA requested that the EU creates legislation clarifying the position of certain physically settled commodity forwards and FX forwards settling T+3 – T+7 as financial instruments subject to EMIR. ESMA notes that certain member state competent authorities (Luxembourg) are suspending reporting requirements until the position of instruments is confirmed.

PwC Point of View: The UK rules stating the position of these contracts are well established, if not terribly straightforward and UK firms should seek advice on the UK rules. The European Commission, the body that would propose new legislation to create an EU standard classification of these instruments, is under no obligation to respond to ESMA’s request.  Any EU legislation which would change the status of such contracts under Member State law could take up to two years to be implemented.  .

 

What next?

EMIR. As EMIR reporting is now live, the focus of corporates will now shift to managing day-to-day EMIR reporting activity and the related governance and risk management processes.

As TR’s begin to sift through data, there will likely be a backlog of outstanding breaks between what the TR and the company (or banks on behalf of the company) have reported. Companies will need to allocate resources to manage and update/re-submit the trade reports to the TR. Consequently, it is important to assign dedicated resources to manage business as usual EMIR reporting and risk management governance.

EMIR reporting of collateral and exposures will start on 11 August 2014.  Many uncertainties still exist about how to report collateral.  Companies need to understand their collateral management approach and ensure that systems support more complex collateral reporting requirements, such as reporting collateral on portfolio basis.

Securities Financing Transactions (SFT).  In late January the European Commission published a Securities Financing Proposal legislative proposal that would require daily reporting of all securities financing transactions, in particular repurchase agreements and re-hypothecation transactions.  This would create an entirely new daily repo reporting obligation which would run alongside EMIR derivative reporting and MiFID reporting focussed on more traditional financial instruments.

11 October 2013

Time to think about the impact of new UK GAAP on Treasury

By Chris Raftopoulos

Companies that currently adopt UK GAAP, including those that have adopted FRS 26, need to be thinking about the implications and their choices available for the standards that will replace current UK GAAP.

From a Treasurer’s perspective, early analysis of the financial instrument implications will be essential to:

  • Understand the consequences of conversion on key ratios, reserves, covenants, distributable profits, systems, cashflows etc;
  • Balance the benefit of reduced disclosure choices against future listing requirements;
  • Allow time to do something differently;
  • Consider the tax implications;
  • Make certain elections related to hedging, derivatives and/or functional currency; and
  • Ensure suitable hedging documentation is in place by the accounting transition date.

In my discussions to date a few issues have cropped up that I believe Treasurers should be alert to:

  • FRS 102 and IFRS both use the concept of functional currency not local currency. The functional currency of many treasury companies, holding companies and SPEs will change, particularly if the company is not seen as autonomous from the parent. This may cause foreign exchange volatility in the income statement impacting taxation, distributable profits and covenant compliance.
  • SSAP 20 net investment hedging will not be allowed under FRS 102 or IFRS Specific consideration of foreign currency loans (both internal and external) is important to ensure that these do not trigger the foreign exchange volatility issues described above. In particular FX hedging strategies that work from a group perspective will need to be re-evaluated to ensure that the entity accounting treatment remains acceptable.
  • More financial instruments will be recorded at fair value – including derivatives and certain instruments containing terms that lead to cashflow volatility (effectively embedded derivatives). IFRS requires embedded derivatives to be separated. FRS 102 requires the whole instrument to be measured at fair value. Identifying all embedded derivatives/unusual terms may take some time and may be difficult to value. In addition the accounting for debt instruments that don’t pay interest, or have off market terms, may prove a particular challenge with unexpected consequences.
  • Hedge accounting requirements will change. FRS 102 has a limited list of permitted hedges and, as derivatives must be recorded at fair value, there will be more P&L volatility if you don't hedge account. The FRC are currently planning to bring FRS 102 more in line with the new IFRS 9 hedging proposals but, under both current FRS 102 and the proposed changes, hedges will need to be documented in advance and expected to be highly effective. The transition date is 1 January 2014 so, if Treasurers want to achieve hedge accounting in the first year of adoption as well as in the comparative period, the hedges need to be documented appropriately as well as any tax elections.
  • The transition date is only a few months away. Just because the timeline for implementing changes to IFRS financial instruments accounting keeps slipping, the timeline for the removal of old UK GAAP will not change. All entities who currently prepare UK GAAP statutory accounts will have to convert to a new GAAP, be that new UK GAAP (FRS 102), full IFRS or IFRS with reduced disclosures (FRS 101) by periods beginning on or after 1 January 2015 at the latest.

There are plenty of other non-financial instrument changes too, but the points above are likely to take significant resources (time, people and systems) to resolve so Treasurers need to ensure that their organisations have a clear transition strategy and plan that also includes the treasury and tax consequences.

Chris Raftopoulos:
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