FMA consultation on proposed client money or property service providers guidance

The Financial Markets Authority (FMA) is consulting on proposed new guidance for how providers of client money or property services can meet their obligations under the Financial Markets Conduct Act 2013 (FMC Act).  The deadline for submissions is 5pm, Tuesday 1 November 2022.

This proposed guidance will update and restate the FMA's 2014 Guidance Note: Broker Obligations, published under the now repealed Financial Advisers Act 2008 (FAA).  On the repeal of the FAA and the transition to the FMC Act, 'brokers' are now referred to as 'client money or property service providers' and their obligations were transferred from the FAA to the FMC Act with no substantial changes.   

In the proposed guidance, the FMA notes that it expects full compliance with the client money or property service provider obligations, given that it is "essentially a continuation of the same regime".  Once the proposed guidance is finalised, client money or property service providers should review their existing compliance monitoring processes to ensure they continue to comply with their obligations.

As part of this update, the FMA also proposes additional guidance specific to the additional custodian obligations under the FMC Act. 

Who does this guidance apply to?
This guidance applies to financial service providers who hold or deal with client money or property on behalf of clients (providers).  This includes stockbrokers, providers of portfolio administration services, financial advisers who receive property or money from clients and custodians (other than those acting as custodian of a registered managed investment scheme).

Key suggestions for all providers
The guidance addresses the key provider obligations set out through sections 431ZC to 431ZH of the FMC Act and provides suggestions for how providers can effectively manage their compliance.  We have set out below a summary of the FMA's recommendations for compliance with the key obligations.

• Protection of identifying information: Where a provider holds a client's common shareholder number (CSN), Security Reference Number (SRN) or Faster Identification Number (FIN) these must be protected in line with the provider's obligations to  use the care, skill and diligence that a reasonable provider would exercise when providing client money and property services. If held, FINs should be encrypted, should not be forwarded by email, and if not required on file should be destroyed.
• Deducting margins: Where providers deduct a 'margin' from client money (e.g. interest earned by retail clients, funds subject to foreign currency conversions) such margin deductions must be expressly, clearly and unambiguously disclosed in the relevant agreement with the client.  The FMA recommends that such disclosure should account to a dollar amount or percentage of interest earned.  Further, the purpose for which the margin is taken must be associated with the services provided to the client. 
• Cross-use of client money: Where there is 'co-mingling' of client funds and provider / custodian money in prescribed circumstances, provider money or property that is not held separately from client money or property will be treated as client money for the purposes of section 431ZC of the FMC Act. 
• Bank account and custody reconciliations: To effectively comply with the obligation to maintain account records that disclose clearly the position of the client money in the trust account, providers should maintain regular reconciliations.  The frequency of reconciliations will depend on the nature of the provider's business, taking into account frequency of trading, scale of operations or the availability of valuation data.
• Client reporting: The requirement for regular client reporting is underpinned by the general duty of care, diligence and skill expected of providers.  The frequency of reporting will vary depending on the nature of the provider's business.  The FMA recommends that for most portfolios, providers should be providing client reports on trading activity at least quarterly. 
• Wholesale clients: Where providers are wishing to enable wholesale clients to obtain the full protections and rights ordinarily given to retail clients under the FMC Act, providers must ensure that clients exercise their opt-out right under clause 5 of Schedule 5 of the FMC Act.  Not advising wholesale clients of the need to opt out amounts to misleading conduct. 
• Insurance intermediaries: An insurance intermediary’s right to invest premiums held in the client account is subject to the obligation to exercise the care, diligence and skill that a prudent person of business would exercise in managing the affairs of others.  The FMA recommends that all insurance intermediaries review their use of premiums and cease using premiums to fund their businesses. 
• Identifying the provider: The FMA recognises that many parties are involved in the transactional chain (e.g. the client, the financial adviser, the custodian, or other intermediaries).  In light of this, the FMA recommends maintaining a record of each party's responsibilities and in particular, ensure clarity between parties as to who the provider is and who will be responsible for the provider duties and obligations.  The FMA further suggests that such details are documented throughout client communications. 

Custodian obligations
Custodial services are a sub-set of 'client money or property services'. The Financial Markets Conduct Regulations 2014 (FMC Regulations) impose additional obligations specific to the provision of custodial services in addition to the general obligations on all 'client money or property service' providers set out above. These include auditing and assurance engagement, reporting and reconciliations. 

• Reporting: When providing a report to a client by sending it to the client's address, providers should ensure that the relevant address is the client's own.  This is to ensure that the client maintains an independent record of their holdings and allow them to effectively monitor their investments.  Clients providing an alternative nominated address (e.g. family member, attorney, or accountant) should be by way of exception and only where the client is unable to manage their own affairs.  This applies to email addresses also. Custodians must send a report to clients at least every six months, detailing transactions relating to the client’s money and property during the reporting period.
• Brokerage fees for DIMS reporting: Providers who hold client money or client property under a discretionary investment management service (DIMS) are subject to ongoing DIMS reporting obligations under regulation 210 of the FMC Regulations.  With respect to brokerage fees, the FMA clarifies that the definition of 'other charges' in that regulation does exclude trading expense.  However, in light of the requirement to report the cash balance held for the investor under regulation 210(3)(b), brokerage fees would need to be disclosed by the provider in order for them to meet this obligation

Our view
The proposed update to the guidance is welcome expansion and clarification of FMA's expectations since the 2014 Guidance Note was issued.  

Much of the proposed guidance is simply a restatement of the 2014 Guidance Note under the new FMC Act legislative regime.  However, some new and/or updated content is proposed – for example, in relation to insurance intermediaries, provider identification and custodian obligations.  

We would encourage custodians, administrators and other client money and property service providers to read the proposed guidance and consider whether to submit on the consultation.  

Consultation period
Consultation on this proposed guidance closes 5pm, Tuesday 1 November 2022.  We expect the finalised guidance to be issued early in 2023.

Please get in touch with us if you have any questions relating to the FMA's clarification on client money or property service provider obligations or if you would like any assistance submitting on the consultation.