The choices brokers make on client monies will shape their future success, say John Quigley and Joe Egerton
The handling and management of client monies by intermediaries is a key issue for firms applying for FSA authorisation. The FSA is distinctly unenthusiastic about brokers holding client money.
Few independent financial advisers (IFAs) now have permission to do so. The FSA would very much like a similar situation in general insurance, but recognises its impracticality. The regulator is therefore determined that there will be effective segregation and will police the rules it creates.
The broking/intermediary community has been littered with grim examples of individuals and firms losing, misusing and misappropriating client funds. It is only as a result of the good endeavours of the wider industry - in particular insurers that have continued to provide cover even when they have not been paid - that a great hue and cry has not ensued.
As far as the big insurance companies are concerned, the sums have been relatively small (when compared with other calamities). In a number of cases, the insurers have been stuck with the liability as the errant broker has acted as their agents. Because in many cases policies were issued to commercial clients rather than broad swathes of private individuals, media interest has been minimised.
It is confusing and misleading to argue that special relationships and arrangements exist with regard to the handling of premium or claim funds. These funds do not belong to the intermediary. They belong either to the client or to the insurer.
With the advent of a strong regulatory regime across the entirety of general insurance, responsibilities and liabilities will be more clearly defined. Insurers will be increasingly resistant to paying out twice or providing free insurance, especially as many clients of a defaulting broker will be able to look to the Financial Services Compensation Scheme.
The FSA has clear statutory objectives, including maintaining confidence in the financial markets and protecting consumers. Given what has happened in some collapses, the objective of preventing financial crime also comes into play. It is impossible to deny that these objectives require effective segregation and accounting of client monies.
For Lloyd's brokers, the sanctity and segregation of premium and claims monies (in an IBA account) has been part and parcel of everyday operations for years.
Segregation was laid down and enforced by the Society of Lloyd's as Regulator of Lloyd's brokers until the late 1990s. At this time these accounts were also subjected to the additional protection of a Trust Deed.
The FSA will now police the arrangements made by Lloyd's brokers, effectively requiring them to be restored to the position when Lloyd's was regulator, but with some additional rules on management of the client accounts and reporting. The rest of the market will be subject to a new regime, which may well prove onerous and have serious consequences for their financial position.
A number of brokers feel that these changes are an unjustified intrusion into their affairs by a regulator that does not understand their business. Some criticisms of the approach taken by the FSA may prove to be valid as the regulator gets to grips with the complexities of an industry it does not yet fully understand. However, on client monies the FSA is starting from first principles and is undoubtedly right in the line it is taking.
Any intermediary or broker acts as agent for its clients, whether they are retail, commercial or insurance professionals. The intermediary must act in the best interest of the client in all instances.
When contracts are entered into with insurers on their behalf and funds are passed to the intermediary to complete and honour that contract (or indeed in reverse as claims settlements) these funds are implicitly being placed in 'trust' (in the purest sense of the word) with the intermediary, regardless of what practice, codes of conduct or regulations may say. These are premiums to pay to the insurer or claims funds to pay to the client.
The payment from a client may include an element of commission, or fees, but such money only becomes available to the broker when it is due/earned. Brokers may not use client accounts as a 'float' to fund the broking business. They will also have to take steps to ensure that client accounts are properly identified as such by banks and not available to offset overdrafts on the operating company accounts.
For brokers that are unaccustomed to tight regulation of client monies, introducing an appropriate regime will be time consuming and absorb resources. Some brokers may find that their cash position becomes uncomfortably tight, but the truth is that they should not have been dependent on client monies to finance their businesses in the first place.
The options choices to be made by firms at this time are of strategic importance and will likely shape their future development direction and success.
Whatever route a firm decides to pursue for the handling of client monies, the basic principle of the matter is remarkably simple. In essence, intermediary/broking firms must recognise at a high level within the company that their role is one of service provision for which they are rewarded in accordance with the terms they have agreed. Part of that service may be the transference of monies.
The FSA expects firms and their governance structures to impart and infuse this basic message and value throughout their organisations - to all staff - as a core principle. With this achieved adherence to the regulatory compliance, requirements become a walk in the park.