Uncovered: Consumer Duty and CASS
Interest on client money balances
The Financial Conduct Authority’s (FCA) Consumer Duty (the Duty) came into force on 31 July 2023, and has already had significant impact on financial services firms driven in part by a change in supervisory strategy by the FCA. As a recap, the Duty is the FCA’s flagship reform to its conduct of business requirements, with firms that serve retail customers now being evaluated on the outcomes their customers receive across all the firm's business activities.
There are numerous areas of the Duty that intersect with the way that firms may currently achieve compliance with the CASS rules. The fundamental purpose of CASS is to protect client’s money and assets in the event of firm failure, and therefore there is a natural synergy between compliance with CASS and the prevention of consumer harm. However, there are areas where firms may not be meeting its obligations under the Duty if simply complying with the written requirements of CASS.
This is the first in a series of blogs that will explore the implications of the Duty and its connection to CASS requirements. We begin by considering the payment of bank interest earned on client money balances held under CASS 7. We will explore the challenges faced by firms in this area, and the factors that firms may wish to consider when applying the requirements of the Duty.
Interest from a CASS perspective
In recent years, the combination of low interest rates and low expectations of clients to be able to earn a return on money in investment accounts has made the interest rates paid by investment firms to clients on cash balances a relatively uncontroversial topic. However, with recent rises in base rates, challenges around appropriate practice have returned. This has the FCA’s attention, with the FCA issuing a questionnaire to platform firms in July to understand the extent that interest earned by firms on client balances was passed on to the firms’ clients and, more recently, the FCA listed the payment of interest as one of two “emerging risks of harm” in a Dear CEO letter to platform firms.
The CASS rules in this area are permissive – the firm simply needs to abide by whatever is stated in the client’s contractual agreement. This means that the firm is entitled to keep all interest earned, or only pay a portion of the interest earned, so long as it communicates that to its clients1.
Firms have the potential to earn significant return on their clients’ money, as illustrated in the table below:
| Client money held | Interest rate offered by the firm | Interest rate recieved by the firm | Annual interest paid to clients | Annual interest paid to firm | Value of interest retained by the firm |
|---|---|---|---|---|---|
| £125,000,000 | 2% | 5% | £2,500,000 | £6,250,000 | £3,750,000 |
There are good reasons why a firm may not pay on all interest it earns to its clients, for example:
- The diversification requirements2 in the CASS rules mean that firms will often have multiple banking providers holding client money, which are likely to pay different interest rates. Calculating a net rate to apply to all client accounts is complex and errors could lead to over or under segregation. Further complications arise if the interest paid by banks is immediately recognised as client money because it then needs to be fully allocated to clients within ten business days.3
- Firms may be cautious about offering elevated rates of interest to clients. Firms are often able to obtain a higher rate of interest than is available to retail clients and, if firms pass on the full interest earned, it may incentivise clients to place cash in the account with no intention of investing it. This is an inappropriate use for an investment account, and the FCA expressed concern over increased client money balances in such accounts in a 2020 Dear CEO letter to Wealth management firms during Covid.
While the CASS rules do not make strict assertions on how interest earned on client balances should be treated, the new obligations of the Duty bring a new dimension to the considerations that firms are now required to act on.
Bank interest from a Consumer Duty perspective
The Consumer Duty comprises a new consumer principle, three new cross-cutting rules, and four customer outcomes. Every firm involved in the selling of products (either directly or indirectly) to retail customers needs to proactively demonstrate the good outcomes they are providing to customers as well as how they are avoiding foreseeable harm to customers.
There is often judgement involved in concluding whether good outcomes have been provided to customers. We therefore set out examples of the types of questions firms should ask themselves when considering if their bank interest approach is in line with the Consumer Duty requirements:
| Consumer Duty Outcomes | Questions firms may want to consider |
|---|---|
| Outcome 1: Products and services |
|
| Outcome 2: Price and value |
|
Outcome 3: Consumer understanding; and Outcome 4: Consumer support |
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Next Steps
Ultimately, firms should consider whether their current arrangements for paying interest on client money balances are providing good customer outcomes as required by the Consumer Duty. It is important firms consider their own circumstances so they can effectively evidence and demonstrate that they are providing good customer outcomes. Firms may wish to begin by taking the following steps:
- Considering the firm’s bank interest arrangements in the context of whether it provides fair value and good outcomes to clients;
- Review communications to clients to establish whether they are clear and easily comprehensible in the context of customers’ circumstances; and
- Consider whether the governance arrangements need improvement in light of heightened regulatory scrutiny.
References:
1 CASS 7.11.32R, guided by CASS 7.11.33G
2 CASS 7.13.22R
3 CASS 7.13.36R, as guided by CASS 7.11.33G(c)
