IOSCO principles compel brokers to ensure client asset safety

Recent guidance from the International Organization of Securities Commissions places the onus on brokers to safeguard client assets in the event of broker default.

Recent guidance from the International Organization of Securities Commissions (IOSCO) places onus on the brokers to safeguard client assets in the event of broker default.

A consultation from IOSCO, a forum for global securities regulators, has been developed to help policymakers improve and coordinate supervision of the intermediaries holding client assets. The body cited the insolvencies of MF Global and Lehman Brothers, which led to major difficulties for clients claiming money back from failed institutions as key drivers for the need to better supervise and guard client assets.

The consultation paper lays out eight principles designed to help regulators with their supervision of intermediaries, i.e. brokers, that hold client assets, but notes “it is first and foremost the intermediary’s responsibility to ensure compliance with these rules, through the development of internal systems and controls to monitor compliance”.

The principles include:

  • The requirement for an intermediary to maintain records and accounts of client assets that establish the precise nature, amount, location and ownership status of client assets for use as an audit trail.
  • The provision of a statement to clients on their assets held, both on a regular basis and on demand.
  • The establishment of appropriate safeguards to protect assets and minimise the risk of loss and misuse of assets.
  • A need for intermediaries that deposit client assets in a foreign jurisdiction to understand the rules of that jurisdiction to ensure full compliance.
  • Full disclosure and transparency in the disclosure of relevant client asset protection regimes and associated risks.
  • The need to ensure clients have a full understanding of the risks associated with waivers to asset protection regimes.
  • Comprehensive oversight of intermediaries compliance with domestic rules by securities regulators through the use of reporting tools, preferably through a risk-based approach.
  • A requirement for regulators to garner as much information as possible when client assets are deposited in a foreign jurisdiction.

As well as ensuring they don’t lose money as the result of an intermediary insolvency, the guidelines are also designed to ensure positions can be transferred to other entities if required.

The IOSCO guidance will also apply to OTC derivatives markets, which are undergoing major reforms in the US and Europe.

New regulation will require the buy-side and other users of swaps to deposit more collateral with clearing brokers – which subsequently pass margin to central counterparties (CCPs) on their behalf – as many OTC derivatives will be brought on exchange-like platforms and centrally cleared. As such, the IOSCO guidance puts the onus on intermediaries and their clients to ensure they fully understand how central counterparties segregate assets.

Swaps that remain bilaterally traded will require formalised and higher margin against them than is typically the case, making it more important for the buy-side to monitor how their collateral is held for the duration of a contract.

Central clearing of interest rate swaps and credit derivatives will begin for some classes of market participants on 11 March in the US, but is not expected in Europe until the middle of 2014.

IOSCO will seek feedback on its eight principles until 25 March, after which it will assess the feedback and compile the finalised guidance.