Obligations of Cyprus Investment Firms to Ensure the Safeguarding and Segregation of Client Funds

  

The below information is based on Law 114 (I)/2007 which provides for the Provision of Investment Services, the Exercise of Investment Activities, the Operation of Regulated Markets and other Activities (as amended) (“Law”) and further material provided by the Cyprus Securities & Exchange Commission (“Cysec") which fully explains and evaluates the necessary requirements of a Cyprus Investment Firm (“CIF”) for the safeguarding of client funds.

 

In accordance with the relevant Law and furthermore, Directives and Circulars issued by Cysec, and in particular Circular COXX which evaluates the safeguarding of client funds’, please note the following:

 

Section 18(2)(j) of the Law states that

 

Directive DI144-2007–01 of 2012 further assesses a CIF’s obligation to ensure the segregation of the client funds’ and in particular emphasises a CIF’s responsibility to ensure that clients’ funds are held in accounts identified separately from any accounts used to hold funds belonging to the CIF. It must be duly noted that for compliance purposes, CIFs must ensure that, when opening a clients’ account with either The Central Bank of Cyprus, a credit institution (as defined within the Law), a bank duly authorised in a third country and/or qualifying money market fund, in any jurisdiction, a written confirmation is obtained from the relevant aforementioned institution(s), stating that all funds are held by the CIF as trustee (or if relevant, as agent) and that the institution is not entitled to combine the account with any other account or to exercise any right of set off or counterclaim against money in that account in respect of any sum owed to it on any other account of the CIF.

It is imperative to note that client accounts of CIFs must have at least two signatories monitoring, approving and/or denying transactions for this purpose.

In the normal course of business of a CIF generally transfers client funds’ to liquidity providers/market makers, clearing houses, exchanges and/or intermediary brokers, those of which must be fully regulated within their jurisdiction. In order for a CIF to comply with the relevant Law and Directives, certain conditions must be fulfilled.

Prior to transferring any client funds’ to any of the abovementioned institutions, the CIF must:

1. Notify the relevant institution that the CIF is obliged to maintain client funds’ wholly segregated form its own funds.
2. Duly inform the relevant institution that any funds paid regarding a specific transaction must be credit to the CIF’s client transaction account.
3. Receive a written confirmation from the relevant institution that the clients transaction account must not be in any way combined with any other account nor must these funds be used to set off any amount due by the CIF to that institution.

It is imperative to note that all retail clients must be informed that their funds may be transferred to any of the above-mentioned institutions. A CIF will usually include such terms in their Terms and Conditions and/or via their website.

In accordance with Directive DI144-2007-01, a CIF is required to conduct reconciliations between its internal accounts and records and those of third parties where assets are held. CIFs must ensure that reconciliations are performed between:

1. Clients’ accounts or any third party holding client funds in accordance with the said CIFs trial balance against bank statements/third party statements.
2. Clients’ accounts or any third party holding client funds in accordance with the said CIFs trial balance against clients credit balances as per the trading platform information.

The aforementioned reconciliations must be preformed on a regular basis. The definition of what constitutes to “regular basis” is dependant on the CIFs business exposure, as well as the nature, complexity and volume of its business. It is also imperative to take into account where the clients’ funds are held. Additionally, if a CIF conducts transactions daily, it is normal practice for a CIF to undertake reconciliations daily in order to ensure that funds held are equal to amounts owed to clients. 

Payment Service Providers (“PSP”) are one of the key institutions used by CIFs in order to facilitate client transactions. CIFs must, at all times, ensure that clients’ funds are transferred to clients’ accounts held by the CIF within a credit institution immediately after the clearing/settlement of transactions. However, in accordance with CP (2016 - 08) issued by Cysec, there are certain circumstances whereby CIFs are not required to send amounts held within the PSP immediately to the CIFs client account within a credit institution. In order for this to be applicable, the PSP must fulfil the below criteria:

1. “The PSP is an EU regulated payment institution.
2. The PSP holds the funds in a segregated bank account with an EU credit institution, under which it is specifically allowed and is legally bound by the credit institution to make use of these funds solely for the benefit of the CIF’s clients.
3. The PSP has provided the CIF with the necessary written confirmation indicating that the PSP holds the funds with a credit institution on behalf of the CIF’s clients in denoted clients’ bank account in the name of the CIF.”

It is important to note that the credit institution must, at all times, be aware that the said account is in the name of the CIF and is solely for the purpose of client funds’.

In the event that a CIF chooses to internally implement the condition that prior to the clearing of funds that the client’s trading account is funded with the corresponding amount allowing the client to trade instantly, the CIF must ensure that the said amount is transferred from its own funds to the client account within a credit institution, prior to the client trading.

In circumstances whereby a PSP withholds funds as rolling reserve or fix deposit, for instances such as chargebacks, the CIF must ensure that amounts equalling to rolling reserves and/or fix deposits are transferred from the CIF ’s own funds in the client account held by the CIF with a credit institution.

The core requirements for the safeguarding of client funds’, including segregation and record keeping, under the Markets in Financial Instruments Directive 2014/65/EU (MiFID II) remain similar to the rules applicable under MIFID I.

The fundamental amendment under MiFID II is specifically the absolute prohibition on title transfer collateral arrangements (TTCAs) for retail clients (Article 16(10) of the MiFID II).

 

For non-retail clients of a CIF, the use of TTCAs is permitted only in the event that certain criteria are met, such as whether the amount of client funds or financial instruments subject to TTCAs far exceeds the client’s obligation to the firm.

 

Furthermore, MiFID II shall impose the obligation for CIFs to employee a specific officer with sufficient skill, experience and authority and of which shall have the exclusive responsibility to monitor the CIFs obligations regarding the safeguarding of client funds/assets. The aforementioned role can be undertaken by another employee of the CIF, for example by the compliance officer. MiFID II shall also impose the requirement for an annual audit on the adequacy of client assets.

Additionally, in the event a CIF selects to place client funds’ in a qualifying money market fund, as defined within the Law, clients must give their explicit consent for the CIF to proceed. CIF’s will be required to inform clients that funds placed with a qualifying money market fund will not be held in accordance with the requirements for safeguarding client funds.

MiFID II also introduces the rule that CIF’s will not be permitted to place more than 20% of client funds with a bank or money market fund within their own group, unless such a restriction would be disproportionate. For example, a CIF must take into consideration the nature, scale and complexity of the business, and the balance sheet size of client funds.

It is imperative that all CIFs pay close attention to the safeguarding and segregation of client funds’ and take all necessary steps to comply with the Law and regulations applicable, and now in particular, given the ever-changing financial environment and specifically, with the new stringent measures that will become applicable with the implementation of MIFID II.

For further advice and assistance please contact [email protected].

 

Andrea Stefani, Partner, Head of Financial Services and Capital Markets, Playbell & Co.

 

The above does not constitute advice and should not be relied upon. 

This article was originally publichsed on the 25 January 2017 at www.playbell.com