Cypriot regulator consults on enhancement of procedures for client funds safeguarding by CIFs

Maria Nikolova

CySEC expects investment firms to consider a raft of factors when selecting a bank where clients’ funds are placed, such as the capital of the bank, and the amount of client funds placed, as a proportion of the bank’s capital and deposits.

The Cyprus Securities and Exchange Commission (CySEC) today published a consultation paper regarding enhancing the procedures for safeguarding of client funds held by Cyprus investment firms (CIFs).

According to paragraph 6(1) of the Directive, CIFs must, upon receiving any client funds, place those funds into one or more accounts opened with any of the following entities:

  • central bank
  • credit institution as defined in article 2(1) of the Business of Credit Institutions Law
  • bank authorised in a third country
  • qualifying money market fund

The title of the clients’ account must sufficiently distinguish that account from any account used to hold funds belonging to the CIF.

CySEC outlines a set of requirements in case the applicable law of the jurisdiction in which the clients’ funds are held, prevent a CIF from complying with the requirement concerning clients’ accounts identified separately from any accounts used to hold funds belonging to the CIF.

In such cases, the investment firms must notify the entity with whom the clients’ account is opened, that they are obliged to keep clients’ funds separate from their own funds. This communication should be kept in the CIFs’ records and be available for review by CySEC. Furthermore, the investment firm must demonstrate to CySEC that it had no other alternative but to conduct such business, given the risk to clients’ funds in the event of the entity’s insolvency. CIFs must also demonstrate to CySEC that they have done everything in their powers to obtain separately titled accounts, including using another third party.

If a CIF cannot demonstrate to CySEC that it has fully applied the above-mentioned requirements, then CySEC may request from the CIF to segregate an equivalent amount of its own funds in a separately titled account in another jurisdiction where the CIF can comply with the requirement of paragraph 4(1)(e) of Directive.

CySEC explains that, according to par. 6(2) of the Directive, 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 a third country, 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.

CIFs are expected on a regular basis (at least once per financial year) to perform due diligence procedures of the banks where clients’ funds are placed. Investment firms have to consider diversifying placements of client funds with more than one bank where the amounts are, for example, of sufficient size to warrant such diversification.

CySEC expects CIFs to consider a raft of factors when selecting a bank where clients’ funds are placed, such as:

  • the capital of the bank;
  • the amount of client funds placed, as a proportion of the bank’s capital and deposits;
  • the credit rating of the bank (if available); and
  • to the extent that the information is available, the level of risk in the investment and
  • loan activities undertaken by the bank and its affiliated companies.

The consultation paper also addresses the issue of depositing clients’ funds with a bank or qualifying money market fund of the same group as the CIF. In such cases 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.

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:

  • a. €3.000.000
  • b. 50% of the total clients’ funds held by the CIF.

The regulator notes that CIFs are not entitled to:

  • transfer funds belonging to retail clients to a third party, as there is an outright prohibition of such practice in section 17(10) of the Law.
  • arbitrarily transferring funds belonging to non-retail clients, without taking into account the factors provided for in par. 8(1) of the Directive, without being able to demonstrate that a TTCA (Title Transfer Collateral Arrangement) would be appropriate for that non-retail client and without properly informing the non-retail client for the risks entailed, as per Paragraph 8(3) of the Directive.

Investment firms may decide to maintain a ‘buffer’ of own funds into clients’ bank accounts in order to facilitate the running of their business, or to manage the foreign exchange risk from maintaining clients’ funds in a different currencies, or to cover possible shortfalls. CySEC notes that it is up to the particular investment firm to decide the amount of the ‘buffer’ that will be maintained.

The regulator will accept responses to the consultation paper by May 18, 2020.

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