Summary of C418 - Enhancement of procedures regarding safeguarding of client funds held by CIFs
Following the publication of Circular C418, the Cyprus Securities and Exchange Commission (‘the CySEC’) would like to inform the Cyprus Investment Firms (‘the CIFs’) about the Enhancement of Procedures regarding the safeguarding of client funds held by CIFs.
D. Depositing clients’ funds with a bank or qualifying money market fund of the same group as the CIF
A. Requirement for holding separate clients’ accounts – DIRECTIVE DI87-01 (“the Directive”)
1. CIFs must, upon receiving any client funds, promptly place those funds into accounts opened with any of the following entities listed below and further sufficiently distinguish them (“clients’ account”) from the account use to hold funds belonging to the CIF:
i. central bank
ii. credit institutions
iii. bank authorised in a third country
iv. qualifying money market fund
2. In the case when the applicable law of the jurisdiction(s) in which the clients’ funds are held, prevent the CIFs from complying with the requirements mentioned above the following should be applied:
i. CIFs must notify the entity stated in A.1. that they are obliged to keep clients’ funds separate from their own funds. CIFs must also keep proof of communication for CySEC’s review;
ii. CIFs must demonstrate to CySEC that they had no other alternative but to conduct such business, given the risk to clients’ funds in the event of the entity’s insolvency.
iii. CIFs must demonstrate to CySEC that they have done everything in their powers to obtain separately titled accounts, including using another third party.
In the case where a CIF cannot demonstrate the abovementioned to CySEC, then CySEC may request the CIF to segregate equivalent amount of its own funds in a separately titled account in another jurisdiction.
B. Use of Payment Service Providers (PSPs) and Electronic Funds Institutions (EMIs)
1. CIFs may maintain merchant accounts with PSPs and EMIs for among other purposes of, clearing/settlement of their clients’ payment transactions, however it must be ensured that clients’ funds are transferred to clients’ accounts held by the CIF with an entity, stated in points A.1. above, immediately after the clearing/settlement of the payment transactions.
2. Where a CIF’s policy is to accept deposits through electronic means and before the clearing of the funds, to credit its client trading account with the corresponding amount in order for the client to trade with immediate effect, the CIF must ensure that the corresponding amount is transferred before trading, unless part F below applies, from its own funds to client account held by the CIF with an entity, as defined in point A.1. above. These funds are considered as clients’ funds and are subject to the corresponding regulatory requirements.
3. The above-mentioned act can only be carried if the CIF is licenced to provide ancillary service of par. 2, Part II of the Law: granting credits or loans to an investor.
4. Where the PSP/EMI withhold funds, as rolling reserve or fix deposit, for chargeback or other purposes, for a period of time before releasing the funds to the CIF, the CIF must ensure that the funds are transferred from the CIF’s own funds in the clients account held by the CIF with an entity, as defined in point B(1).
5. CIFs’ merchant accounts must be used only and exclusively by CIFs.
6. The CIF must exercise all due skill, care and diligence in the selection, appointment and periodic review of the PSP/EMI with whom merchant accounts are maintained. CIFs may be considered that they have taken every possible measures to protect their clients’ funds, only if they maintain a merchant account with PSP/EMI which are licensed/regulated by a competent authority of a Member State or of a third country, that it imposes equivalent arrangements to those of the European Union.
7. CIFs are requested to post a list on their websites with the PSPs/EMIs they cooperate and the authority/country that supervise them.
C. Due diligence and diversification of institutions holding clients’ funds.
1. Where a CIF does not deposit client funds with a central bank, the CIF shall exercise all due skill, care and diligence in the selection, appointment and periodic review of the credit institutions and banks authorised in an EU and/or Third Country (hereafter banks), where the funds are placed and the arrangements for the holding of those funds and take into consideration the need for diversification of these funds as part of the required due diligence.
2. CIFs should consider diversifying placements of client funds with more than one bank where the amounts are, for example, of sufficient size to warrant such diversification
3. CySEC expects CIFs to consider the following when selecting a bank where clients’ funds are placed:
i. the capital of the bank;
ii. the amount of client funds placed, as a proportion of the bank’s capital and deposits;
iii. the credit rating of the bank (if available); and
iv. the level of risk in the investment and loan activities undertaken by the bank and its affiliated companies (if available).
D. Depositing clients’ funds with a bank or qualifying money market fund of the same group as the CIF.
1. Where a CIF deposits client funds with a bank or money market fund of the same group as the CIF, then the CIF must limit the funds that are deposited with any such group entity or combination of any such group entities so that the funds do not exceed 20% of all such funds.
2. The CIF may not comply with this limit where it is able to demonstrate that the requirement above is not proportionate, taking into consideration the nature, scale and complexity of its business.
3. CySEC considers that a CIF in the context of complying with its obligation to periodically review its initial assessment it should undertake:
v. a review and, where appropriate, should consider ceasing to use this exception when a change in the circumstances arises that might have led the CIF to a different conclusion on its previous assessment;
vi. a review at least when a year has elapsed since its previous assessment.
4. CySEC considers that the amount of small balance of clients’ funds with a bank or money market fund of the same group as the CIF should be, at any point of time, the lower of the:
i. €3.000.000 or
ii. 50% of the total clients’ funds held by the CIF.
5. Where the threshold stated above has been exceeded the CIF shall take immediate action, to reduce the balance with bank or money market fund of the same group as the CIF, within the allowable limit.
E. Use of Title Transfer Collateral Arrangements (“TTCAs”)
The CIFs are not entitled to:
1. Transfer funds belonging to retail clients to a third party.
2. Arbitrarily transferring funds belonging to non-retail clients, without being able to demonstrate that a TTCA would be appropriate for that non-retail client and without properly informing the non-retail client for the risks entailed.
F. Maintaining a ‘buffer’ in clients’ accounts
1. CIFs may decide to maintain their own decided amount of ‘buffer’ of own funds, which are considered as clients’ funds, into clients’ bank accounts in order to:
i. facilitate the smooth running of their business;
ii. ensure no delays, c. cover clients’ funds with PSP/EMI;
iii. manage the foreign exchange risk from maintaining clients’ funds in different currencies;
iv. to cover possible shortfalls.
2. For this purpose, when a CIF decides to maintain a ‘buffer’ per point F.1. above, the CIF must establish a written policy, which includes the specific risks and amount that the CIF intends to cover and retain from its own funds into clients’ accounts with an entity of point A.1., justifying the amount of the ‘buffer’ kept.
G. Single officer for the safeguarding of client financial instruments and funds.
1. The CIFs should appoint a single officer of sufficient skill and authority with specific responsibility for matters relating to the CIF’s compliance with its obligations regarding the safeguarding of client financial instruments and funds.
2. The single officer is expected to verify the accuracy and completeness of the clients’ money reconciliation that is included in CySEC’s QST-CIF Form (i.e. Reconciliation Tab) and the CIFs are expected to complete and keep up to date the details of their single officer for the safeguarding of client financial instruments and funds in CySEC’s portal.
H. Reconciliation of clients’ funds
1. When a CIF undertakes transactions for its clients on a daily basis, CySEC expects that reconciliations of clients’ funds will be contacted on each business day on the records of the CIF as at the close of business of the previous business day.
2. CIFs must ensure that reconciliations are performed between:
Clients’ bank accounts or any other third-party holding clients’ funds (as per CIF records) Vs bank statements or any other third-party statements and clients’ equity (as per records)
3. Equity includes deposits/withdrawals, credits, realised and unrealised profits/losses and represents the actual funds owed to each client. It is expected that reconciling items should only arise due to timing differences and cleared within a few days.
4. The internal auditor and the compliance officer of a CIF during their annual work plan are expected to review the procedures maintained by a CIF for the safeguarding of its clients’ assets.
I. Other Matters
1) As far as clients’ accounts with entities of point A.1. are concerned, CIFs must ensure that there are at least two persons with combined signatory powers. The following persons cannot be appointed as signatories:
i. the persons involved in the preparation of clients’ reconciliations; and
ii. the shareholders of the CIF if they do not have executive duties within the CIF.
2) CySEC expects that the CEO or the CFO or the Head Accountant or an Executive Director may be the persons to be appointed as the signatories of the clients’ accounts with entities of point A.1.
CySEC emphasises that the clients’ accounts with entities of point A.1. can only be used by the CIF for its clients.
If you have any questions, please do not hesitate to contact us.
Written by Angeliki Georgiou, Independent Legal Consultant