Enhancement of procedures regarding safeguarding of client funds held by CIFs

CySEC has issued the Circular C458 on July 14^th, 2021, to inform Cyprus Investment Firms (“CIFs”) that CySEC’s Circular C418 ‘Enhancement of procedures regarding safeguarding of client funds held by CIFs’ shall be amended. Specifically, the amendment refers to the deletion of paragraph 10 of CySEC’s Circular C418.

Based on the amendment, where it is the CIF’s policy, upon accepting a deposit through electronic means and before the clearing of the funds, to credit its client trading account with the corresponding amount in order for the client to trade with immediate effect, the CIF must ensure that the corresponding amount is transferred before trading, unless the CIF has a ‘buffer’ in the clients’ bank account, from its own funds to client account held by the CIF with an entity required to keep the clients’ funds, without the need to be licensed to provide the ancillary service of granting credits or loans. It is noted that, these funds are considered as clients’ funds and are subject to the corresponding regulatory requirements.

Moreover, you can find below the most important points of Circular C458 regarding the safeguarding of clients’ funds held by CIFs:

1. Requirement for holding separate clients’ accounts

According to par. 6(1) of the CySEC Directive DI87-01 (hereinafter, the ‘Directive’), CIFs must, upon receiving any client funds, promptly place those funds into one or more accounts opened with any of the following entities:

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

It is provided that the title of the clients’ account sufficiently distinguishes that account from any account used to hold funds belonging to the CIF, as it is required by par. 4(1)(e) of the Directive (i.e. denoted as clients’ accounts).

1. Use of PSPs / EMIs

CIFs may maintain merchant accounts with PSPs and EMIs for, among other purposes, the clearing/settlement of their clients’ payment transactions (inwards and outwards payments). CIFs must, at all times, ensure that clients’ funds are transferred to clients’ accounts held by the CIF with an entity, as stated in Section 1 above, immediately after the clearing/settlement of the payment transactions.

Where the PSP/EMI withhold funds, as rolling reserve or fix deposit, for chargeback or other purposes, for a period of time before releasing the funds to the CIF, the CIF must ensure that the funds equal to rolling reserves or fix deposits, are transferred from the CIF’s own funds in the clients account held by the CIF with an entity, as stated in Section 1 above, to ensure compliance with the provisions of par. 6(1) of Directive.

CIFs merchant accounts must be used only and exclusively by the CIF and not by any other person.

CIFs should maintain merchant accounts with PSPs/EMIs which are licensed/regulated by a competent authority of a Member State or of a third country, which it is considered that it imposes equivalent arrangements to those of the European Union and in particular, to those of the European Directives 2005/06/EC1 and 2007/64/EC2.

For purposes of transparency and full information of investors, CIFs are requested to post on their websites a list with the names of the PSP/EMI they cooperate, as well as the competent authority/country that supervise them.

1. Due diligence and diversification of institutions holding clients’ funds

CIFs are expected on a regular basis (and no less than once in each financial year) to perform due diligence procedures of the banks where clients’ funds are placed.

CIFs should 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 the following when selecting a bank where clients’ funds are placed:

1. the capital of the bank;
2. the amount of client funds placed, as a proportion of the bank’s capital and deposits;
3. the credit rating of the bank (if available); and
4. 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.

1. Depositing clients’ funds with a bank or qualifying money market fund of the same group as the CIF

According to par. 6(3) of the Directive, where a CIF deposits client funds with a bank or money market fund of the same group as the CIF, then 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:

1. €3.000.000
2. 50% of the total clients’ funds held by the CIF.

In some cases, exceptions can be applied and where the threshold stated above has been exceeded for reasons stated in CySEC Circular, the CIF shall take immediate action to reduce the balance of clients’ funds within the allowable limits.

1. Use of Title Transfer Collateral Arrangements (“TTCAs”)

CIFs are not entitled to:

1. 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 87(I)/2017 CySEC Law.
2. 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 would be appropriate for that non-retail client and without properly informing the non-retail client for the risks entailed, as per par. 8(3) of the Directive.

1. Maintaining a ‘buffer’ in clients’ bank accounts

CIFs may decide to maintain a ‘buffer’ of own funds into clients’ bank accounts in order to:

1. facilitate the smooth running of their business,
2. ensure no delays,
3. cover clients’ funds with PSP/EMI,
4. manage the foreign exchange risk from maintaining clients’ funds in a different currencies,
5. to cover possible shortfalls.

It is up to the CIF to decide the amount of the ‘buffer’ that will be maintained. CySEC emphasizes that these funds are considered as clients’ funds and are subject to the regulatory requirements of the Directive and the Law.

In case the CIF considers to apply the above, written policy should be established and approved by the Board, indicating the procedures and percentage that shall be kept, the relevant risks and justification of the percentage / amount kept based on the exposures and risks that the CIF faces.

1. Single officer for the safeguarding of client financial instruments and funds

According to par. 9 of the Directive a CIF should appoint a single officer of sufficient skill and authority with specific responsibility for matters relating to the CIF’s compliance with its obligations regarding the safeguarding of client financial instruments and funds. A single officer with overall responsibility for the safeguarding of client instruments and funds should be appointed in order to reduce risks of fragmented responsibility across diverse departments, especially in large and complex CIFs, and to remedy unsatisfactory situations where CIFs do not have overarching sight of their means of meeting their obligations.

The single officer is expected to verify the accuracy and completeness of the clients’ money reconciliation that is included in CySEC’s QST-CIF Form (ie. Reconciliation Tab).

The details of the single officer should be indicated in CySEC’s Portal.

1. Reconciliation of clients’ funds

When a CIF undertakes transactions for its clients on a daily basis, CySEC expects that reconciliations of clients’ funds will be contacted on each business day on the records of the CIF as at the close of business of the previous business day. 3

CIFs must ensure that reconciliations are performed between:

1. Clients’ bank accounts or any other third party holding clients’ funds (as per CIF records) Vs bank statements or any other third party statements.
2. Client bank accounts or any other third party holding clients’ funds (as per CIF records) Vs clients’ equity (as per CIF records).

Equity includes deposits/withdrawals, credits, realised and unrealised profits/losses and represents the actual funds owed to each client. It is expected that reconciling items should only arise due to timing differences and cleared within a few days.

1. Other Matters

CIFs must ensure that there are at least two persons with combined signatory powers in relation to the clients’ accounts. It is stressed that the following persons cannot be appointed as signatories:

1. the persons involved in the preparation of clients’ reconciliations and
2. the shareholders of the CIF if they do not have executive duties within the CIF.

CySEC expects that the Chief Executive Officer or the Chief Financial Officer or the Head of the Accounting Department or an Executive Director may be the persons to be appointed as the signatories of the clients’ accounts with entities of Section 1 above.

CySEC emphasizes that the clients’ accounts with entities of Section 1 above, can only be used by the CIF for its clients and not for the clients of the group that the CIF belongs to.

Our team at FiveComply can assist you in complying with the relevant regulatory framework by identifying any deficiencies in your CIF’s internal operations. We can provide you with tailored-made solutions based on your CIF’s business model.

Do not hesitate to contact us!