The Financial Conduct Authority's new regime on client money changes is likely to cause problems for the investment and wealth management industry, warns wealth management consultancy Walbrook Partners.

"The proposed changes need careful analysis to get under the skin of the practical implications for each firm as well as for clients. The changes will be lucky for some, but painful for others," said Karen Bond, director at Walbrook Partners.

In its consultation paper on the client assets regime for investment business, which it published this week, the FCA unveiled plans to improve the speed of return of client assets following the insolvency of an investment firm and new rules on how firms handle client assets.

Walbrook identified a number of potentially challenging implications as a result of the proposed changes.

The consultation paper proposes the removal of existing delivery versus payment exemption for operators of collective investment schemes, thereby requiring these firms to protect monies they hold in relation to redemptions and purchases, which Walbrook believes will lead to increased costs.

"Requiring all money to be processed through client money accounts will add significant costs to firms. Some will question whether this is justified by the perceived risk of an asset manager failure," said Walbrook.

A firm holding client money is currently required to pay a retail client interest, unless the firm has notified the retail client that it will not be paying any interest.

This can lead to confusion about when interest should be segregated by firms for client money and could result in retail clients not receiving interest they are entitled to.

The FCA said it planned to clarify the application of this rule and further enhance it through additional guidance setting out the segregation and allocation requirements when the firm receives interest or contractually agrees to pay interest to clients. Walbrook pointed out that this could lead to firms' incomes being hit.

"The proposals would allow firms to either keep the funds in their entirety, with the client’s agreement, or not at all. Surprisingly, there is no option to share. Some firms could lose significant income if cutting off interest from their clients altogether is unacceptable to them," said Walbrook.

As part of the new proposals, firms are prohibited from placing client money in unbreakable term deposits or notice accounts by requiring the ability to make withdrawals of client money promptly, within one business day of a request for withdrawal.

Walbrook said that while it seemed logical to ensure the speedy return of money, as is not clear who would bear the cost associated with breaking a term deposit it could potentially reduce the clients’ money post-insolvency.

Under the alternative approach to client money segregation, client money may be received into and paid out of a firm’s own bank accounts rather than client bank accounts. The FCA said it expected it only to be used by the largest investment banks and not by any other types of firm.

Walbrook believes that restricting the alternative approach in this way could lead to "unpleasant surprises on implementation" as many firms are unaware of parts of their business which are using an alternative approach that has not been either recognised or signed off.

When arranging to place client money with a bank or other third party, firms are required to engage in an exchange of letters providing and confirming notice to the third party of specific matters. The purpose of these rules is to ensure that the segregation of client money placed with third parties is appropriately secure.

Under the new proposals, firms will be required to obtain an acknowledgement letter for all client bank accounts, including those located outside the UK.

Walbrook warns that standardised acknowledgements letters for client money accounts will be impossible to obtain from many overseas banks for a variety of reasons, ranging from local market practice to differences in insolvency laws.

"If implemented, this proposal could leave firms scratching around for an effective way of processing overseas business, which sidesteps the client money rules altogether," Walbrook said.

Walbrook predicted the proposal that firms must allocate receipts of client money to the relevant clients within five business days is unworkable as it is often not feasible to receive reliable details about corporate actions and distributions from all markets in time for allocation within time. It said this was particularly true for smaller firms, and that for overseas receipts greater flexibility may be required.

The FCA has also proposed that unclaimed cash cannot be released into firms’ balance sheets, even after undertaking to make good any claims, and that payment of unclaimed balances should be restricted to registered charities. However, Walbrook pointed out that there was an upside to this as charities and firms could potentially benefit.       

"Registered charities could be particularly pleased as substantial amounts of small balances could be flowing their way and firms will benefit from the reduced administrative costs from releasing these leftover sums," said Walbrook.