Pre-funding vs. Prudent Segregation
20 November 2020
To pre-fund or to prudent segregate? That is the question for investment firms when needing to use their own money to cover a shortfall relating to one client without touching the money of another client. To get to the bottom of this we need to understand the two approaches and when to use them.
The CASS rules permit firms to pay their own money into a client bank account if it is 'prudent' to do so, to prevent a shortfall arising. If going down this route, a key consideration is that there are a number of rules that must be complied with. The prudent segregation rules were introduced in FCA Policy Statement PS 14/9 and are part of the current CASS regime.
Prudent Segregation may be used to cover risks where a shortfall could occur but the exact amount and/or the specific clients affected cannot be quantified or identified so an estimation method is used to create a 'buffer' which prudently segregates firm money in a client account. This buffer becomes client money and will be retained unless and until it is no longer prudent to do so. All clients can benefit from the buffer as it is not related to a specific client. Whenever a firm uses prudent segregation it must create and retain a record of the policy established to calculate the buffer, and the amounts actually segregated.
Pre-funding also known as ‘transaction funding’ may be used when a firm knows that a shortfall will arise that day or on the next business day. The amount that needs to be placed in the client money account may be either the potential shortfall or equal to an expected outflow of funds. The key word for pre-funding is ‘known’ as the quantified amount, the impacted client, and the timing can all be identified so that the practice can be triggered. There are multiple scenarios where pre-funding would be the ideal solution, which include cases of expected funding not received, trading on uncleared sales proceeds, or partial settlement on trades with insufficient funds that could lead to a debtor position.
Even though prudent segregation and pre-funding start from a similar point, their application depends on the individual circumstances of the arising shortfall. There are also important differences when it comes to taking the money back out when it’s no longer needed. Firm’s should consider when each of these application methods are suitable and even more importantly – when they are not.