Negative interest rates in CASS: failing to prepare is preparing to fail
01 December 2020
With a flurry of Client Assets (‘CASS’) Dear CEO letters being issued over the summer, the FCA’s expectations are clear: treat CASS seriously and think about your clients’ best interests. Could the risk of negative interest rates be the first test for you to show that you have got the message?
While the readiness of banks has been the primary focus, the FCA and others are starting to consider the flow through impacts of negative interest rates on other areas of the financial system, one of which is client money pools.
With billions of pounds held in client money accounts, firms could face some difficult choices. While there are only really two options (pass on or don’t pass on), neither of these are easy.
We’re not going to pass these on
For many, the easiest option will be to absorb the negative rates (similar to bank charges) as little immediate action is needed.
This is a very attractive proposition for clients faced with negative rates on their deposit and savings accounts. By not passing these on, you would offer a safe harbour to protect the real value of their money. However, this could lead to a growth in client money pools, which creates additional issues:
- P&L - In Ireland, negative rates are already being charged by some banks at rates of -0.5% to -1%. For a CASS Large firm, this would mean taking (at least) a £5m hit to the bottom line.
- Diversification - Firms already struggle to find institutions to take client money. What will happen if you suddenly have more? In Ireland, some firms are looking at third-country banks and qualifying money market funds. While an option, there are conditions on their use which could make adequate diversification a real challenge.
- Governance - If your client money balances increase significantly, so should your governance. Would you have a credible answer if the FCA asked what changes you had made?
We’re going to pass these on
Given the above, you may think that passing on negative rates is the only option. Unfortunately, it too has challenges:
- Acting in your clients’ best interests - The FCA has already issued a Dear CEO letter questioning whether growing client money pools are in the clients’ best interests. If you pass on negative rates, the spotlight will be on to make sure customers aren’t overly disadvantaged.
- Systems - To calculate negative interest, your systems need to recognise that interest can be a charge as well as an income. Have you considered whether development is needed?
- Contracting - Unfortunately, the CASS rules around discharge of fiduciary duty do not explicitly cover negative interest rates, so you will need to assess your client agreements. If these don’t cover it, repapering / recontracting may be needed which can be a significant undertaking.
What should you be doing about it?
Negative rates are not a certainty, but if operational resilience has taught us anything, it’s that we need to plan ahead.
You should engage with the rest of the business, feeding into discussions and decisions. CASS isn’t the only consideration at play, but it is an important component.
You should make sure you are engaged, comfortable with the direction of travel and ready to show the FCA you took heed of their letters, putting CASS firmly in the middle of what soon may become an important business decision.