Tower Bridge

Security of Client Assets

David Ogden, Head of Compliance

Reports about Beaufort Securities where administrators accessed client assets prompted a number of questions. We conducted as full a review as possible into the circumstances to be able to address our investors’ concerns.

Following reports regarding the situation at Beaufort Securities where administrators have been able to access client assets we have received a significant number of queries on the subject from clients and their advisers. We have been intending to publish information on this subject but given its importance have been carrying out detailed research on this situation to ensure confidence in its accuracy.

Clearly this is an important distinction from the commonly held view that assets held on behalf of clients by authorised firms are sacrosanct and even in the event of the failure of a firm will always be returned to their beneficial owners.

Firstly we should put the Beaufort situation into what we believe is the appropriate context. Clearly we are not aware of the fine details of what occurred, the specific nature of the regulator’s intervention and the nature and extent of the work being carried out by the administrators. However the following factors do seem relevant:

  • Beaufort acted as its own custodian. This is an important distinction from 7IM’s operating model as I shall explain later.
  • Beaufort may have invested in assets of very limited liquidity on behalf of its clients and the process of unwinding these may have proved to be complex. This particular circumstance is likely to have been a significant factor in increasing the cost of the administration and necessitating the steps taken by the administrator to seek reimbursement of their expenses.
  • Despite the plethora of newspaper headlines which have appeared on the subject it now appears unlikely that any Beaufort clients will be disadvantaged. This is because the number of portfolios which may be accessed has been limited to a small number of clients and the amounts involved have been capped to a level which is significantly below what was originally published and well within the limits which would be covered by the Financial Services Compensation Scheme (FSCS). Actual coverage by the FSCS would depend on the eligibility of those investors to claim under the scheme.

The conclusion is therefore that the impact on individual investors has been insignificant although, understandably, overstated. That is understandable given the situation and the apparent overturning of long held understanding of the ring-fencing process.

I shall now explain the arrangements that 7IM have made to protect client assets. I should stress that while there is no such thing as an absolute guarantee of security, we believe that the structure described below provides the best possible environment to provide appropriate assurance.

7IM’s Role

7IM is not authorised to hold client assets and does not do so. Like all firms which are authorised and regulated by the FCA our auditors are required to conduct and annual review to confirm that this is not the case and a report of their conclusions is provided by them direct to the regulator. We do have authority to hold client money (i.e. cash) but this is only utilised in specific relation to the processing of dealing with buying and selling instructions relating to the 7IM authorised fund range.

When 7IM first commenced business we partnered with Pershing Securities Limited (“PSL”) under what is known as a Model B arrangement. This means that PSL have a direct contractual link with all of 7IM’s clients to provide custody and settlement services; the terms of this service are included within the terms and conditions that all 7IM clients enter into when establishing a relationship with us.

In the event of 7IM’s insolvency the assets held by PSL would not be accessible to an administrator or receiver to reimburse them for the work involved. We understand that it may be possible for such an entity to seek a court order to enable it to be reimbursed but there is no precedent for such a course of action and therefore any comment we could make on the likelihood of such an application being successful would be mere speculation.

Despite not holding the assets 7IM has a full reconciliation process between our records and those of PSL.

PSL’s Role

As described above PSL acts as custodian and provides safe keeping for all assets within 7IM client portfolios and segregates these holdings from its own assets. Wherever possible (depending on the type and location of the assets), further segregation is achieved by registering the assets in the name of a nominee - Pershing Nominees Limited. PSL is ultimately a wholly owned subsidiary of The Bank of New York Mellon Corporation (BNYM). Based on the most recently available figures, BNYM is the largest custody bank in the world with assets held in custody valued in excess of US$30 trillion and it has a high and stable credit rating. It is in the event that measures put in place by PSL under FCA Rules to ensure recovery of its business or its orderly resolution prior to actually becoming insolvent that a Special Administrator is likely to be appointed. It is at this point that the provisions of the Special Administration Regime could come into effect.

The Investment Bank Special Administration Regime (“IBSAR”)

These regulations were brought in as a response to the financial crisis and in particular, to our understanding, to the demise of Lehman Brothers as that broadly unforeseen occurrence proved to be extremely problematical to resolve within existing regulation. Despite its title the IBSAR may apply to firms outside most definitions of being an Investment Bank and it may be this factor that has led to the issues at Beaufort coming as a clear surprise to much of the financial services industry.

Conclusions

  • There is no arrangement that could be described accurately as carrying no risk. We are confident that the arrangements in place minimise the risks as far as can be achieved.
  • The function carried out by PSL has the backing of a very large and stable organisation and is subject to regular internal and external audits and FCA supervision
  • In the event of the insolvency of 7IM, an administrator would have no right to access 7IM client assets. There are also no regulations which would clearly enable an administrator to access client assets. Any such access would require specific court intervention.
  • Eligible Claimants under the terms of the Financial Services Compensation Scheme would be able to secure compensation up to £50,000 in the event of claims being made successfully against their assets. There are current proposals which, if adopted, will raise that limit to £85,000 as is currently the case for cash accounts.
  • We have considered whether we can add any process or controls to existing arrangements to enhance the security of assets and have concluded that we cannot identify any such realistic action

We hope that this summary will help to put investors’ minds at rest and importantly provide some context which will enable them to properly consider the risks to which they are subject.

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