For the purpose of this paper, client assets are defined as money, securities and positions which are held or controlled by authorised investment firms for investment purposes on behalf of their customers. In order for markets to operate effectively, it is unavoidable that authorised firms should hold or control client assets when undertaking investment business on their behalf. Consequently, it is of great importance to investor protection and to confidence in markets that customers should know that their assets will be protected so far as practicable from the risk of loss at the authorised firm which holds those assets.

Section 1 of the paper outlines the basic objectives of any system of client asset protection. It recognises that there are a number of risks to client assets, but notes that these become particularly acute in the event of the insolvency of an authorised firm which holds client assets. It also recognises that a system of client asset protection will inevitably need to be adapted to the particular legal and regulatory framework of each jurisdiction, and will need to take into account the cost implications of such measures. It notes the role of transparency in making clear to clients the protection arrangements that apply to their assets, and the preventative role played by effective internal controls at authorised firms and by regulatory supervision arrangements for authorised firms which hold client assets.

Section 2 of the paper outlines the techniques which can be used to protect clients assets in the event of the insolvency of an authorised firm and discusses the advantages and disadvantages of such techniques. It analyses three types of technique:

- techniques which seek to ensure that client assets are treated in a more favourable way than the other obligations of a firm in the event of insolvency;

- techniques which aim to compensate clients of insolvent firms; and

- techniques which customers themselves can use to minimise their exposure to authorised firms.

Particular techniques which are discussed in this section include according client assets preferential status in insolvency law; arrangements whereby client assets are kept separate at all times from the assets of the authorised firm; the securitisation of money through the use of money funds; compensation schemes; and the use of commercial insurance arrangements such as professional indemnity insurance. The paper notes that there are merits to all such techniques, but none is without disadvantages.

Section 3 identifies a number of issues relating to client asset protection generally and recommends the appropriate regulatory response. Issues addressed in this section include considerations related to the selection of custodians; the particular risks for client asset protection regimes when dealing takes place through a chain of related parties; issues associated with cross border dealing and differing levels of client asset protection in different jurisdictions; consideration of the risks associated with the use of omnibus accounts; and arrangements for opting out of client asset protection regimes.

Section 4 then considers issues specifically related to the protection of client money, securities and positions respectively. This includes the protection of client money where banks act as brokers; the regulatory status of custody as an activity; the risks associated with stock lending; the treatment of clients' securities in the course of settlement; the legal status of client positions at authorised firms where the firm is acting as agent for the customer; arrangements to facilitate the transfer of client positions from insolvent firms; and the need for effective identification and segregation of client margin.

In the course of the analysis in the paper, the Technical Committee makes the following twenty recommendations for use by securities regulators when considering client asset protection regimes.

Recommendation 1:

Regulatory authorities should recognise the benefits for investor protection and confidence in financial markets of effective mechanisms to protect client assets from the risk of loss and the insolvency of investment firms.

Recommendation 2:

Regulatory authorities should choose within their jurisdictions those mechanisms which best achieve the overall objective of client asset protection, taking into account their national insolvency and investment services laws, regulations and practices; the needs of market efficiency and investor protection; and the costs of any such measures.

Recommendation 3:

Regulatory authorities should seek to ensure that investors are adequately informed about the arrangements for client asset protection within their jurisdictions. In particular, they should require that authorised firms report on a regular basis to their clients as to the assets which they hold on their behalf, and to make appropriate disclosure to clients about the way in which client assets which the firm holds are protected within their jurisdiction. Where client assets are to be held in another jurisdiction, and different client protection arrangements apply to those assets, the firm should be required to inform the client of that fact.

Recommendation 4:

Regulatory authorities and authorised firms should recognise that effective internal controls for identifying, accounting for and safeguarding client assets are essential prerequisites for effective client asset protection.

Recommendation 5:

Regulatory authorities should:

i) recognise the need for appropriately intensive supervision of firms that hold or control client assets; and

ii) review the techniques and powers of intervention available to regulators or other relevant authorities both before and after the default of a firm which holds client assets.

Regulatory authorities should ensure that the provision of margin is the subject of clear, written agreements between the firm and its clients and that the firm should operate appropriate internal controls to ensure that margin posted for client positions is properly accounted for and segregated on behalf of such clients.