The FSA's latest review of brokers' compliance with client money rules has found improvements but there are still concerns. Andrew Honey explains
We have just completed a major piece of work to review whether general insurance intermediaries are providing adequate protection of client money. We are encouraged to see that the help we have made available to firms – a comprehensive Guide to the Client Money rules and an e-learning package – are effective in enabling firms to achieve compliance.
But the challenge remains of ensuring that all firms take the necessary steps to ensure proper protection. Now that easy-to-use help is available we will be taking a tough approach with firms that don't put the necessary controls in place.
Although there are a lot of detailed rules relating to client money, it is important to remember that arranging adequate protection for clients' assets is one of the 'principles for businesses', one of the fundamental obligations which firms must fulfil.
Since the FSA began regulating general insurance in January 2005 we have been concerned about poor levels of compliance with, and understanding of, the client money rules among wholesale and retail firms. Our early review identified a number of serious concerns including:
• Shortfalls in client money accounts that could not be corrected
• Firms failing to do the client money calculation correctly (with some not doing it at all) or on time
• Firms failing to observe trust law and potentially risking client money
• Non-compliance with terms of risk transfer agreements
• Firms failing to account for money held at third parties
• A general lack of awareness of the requirement to have client money systems and controls audited
• Clients not told about matters affecting their money.
We highlighted our concerns in a 'Dear CEO' letter in 2005 and again in our press release of May 2006 which announced a further review of the handling of client money.
But it soon became apparent to us that firms were not responding to the challenge we set for them to make greater progress towards compliance.
Recognising that part of the reason for non-compliance stemmed from a lack of understanding of the rules, we decided to focus our attention on firm education.
In 2006 we published a Guide to Client Money for General Insurance Intermediaries which was distributed to all firms, and later in the year produced a web-based training course.
In a subsequent review of 161 wholesale and retail firms in the later part of 2006 we were able to assess the effectiveness of these tools. We were pleased to see that the majority of firms visited had used the guide and we received a lot of positive feedback on it from firms. As a result, most of the firms we visited were:
• Setting up trust accounts correctly
• Segregating client money in trust accounts within one day of receiving funds
• Ensuring they have signed, written agreements with insurers to transfer the risk of holding client money to the insurer; and those agreements cover the activities of the firm
• Regularly doing a client money calculation correctly and reconciling their client money records to their bank statements within 10 days of the calculation
• Managing and monitoring client money and using systems that enable them to do this effectively
• Withdrawing commission when it is due and payable
• Arranging for client money systems and controls to be audited.
Nevertheless it was often apparent that the guide had only been used when firms found out we were going to visit them to review their client money procedures. For that reason we are not making any claims about overall levels of compliance with our requirements on the back of this work. Client money stays on the regulatory agenda and firms that haven't been visited need to understand that they may well be reviewed in future.
Even taking account of the improvements we have seen, we are still concerned by the fact that 7% of firms visited were not doing a client money calculation at all, and another 7% of firms did the calculation for the first time ahead of our visit.
We require firms to do a calculation at least every 25 business days. One firm we visited who had not been doing a calculation discovered a deficit of over £90,000 in its client money account when it finally did the calculation. That deficit was promptly put right by the firm, but they received a private warning from us because of the risk they had subjected their clients' money to as a result of poor systems and controls.
We also found that there is still some confusion over when client money is covered by our rules and, therefore, when it is necessary for a firm to have permission to hold client money.
To help overcome this, we have produced a flowchart so that firms can understand when they are holding client money and to check whether they are protecting it. We are also launching a client money health check to give firms an opportunity to test their own understanding of the rules.
We will continue to offer information on our website at www.fsa.gov.uk/smallfirms and through our programme of training and events.
This is not the end of the story. We are now clear that firms have the tools to ensure they meet the required level of protection of client money and for our part we will continue to monitor through routine supervision, analysis of regulatory reporting and spot checks. Firms are on notice that the standard expected of them has been raised. Any subsequent failures identified will be viewed seriously given the emphasis we have placed on this matter and the tools we have provided. We therefore strongly urge all firms holding client money to act now to ensure they have the right controls in place. IT
Andrew Honey is head of insurance in the small firms division of the FSA