The Central Securities Depositary Regulation (CSDR) is an EU regulation aimed at ensuring that transactions between buyers and sellers of securities are settled in a safe and timely manner by: harmonising the different rules applicable to the Central Securities Depositories (CSDs) in the European Economic Area (EEA) and increasing the safety and efficiency of securities settlement and the settlement infrastructures in the EEA.
CSDs are institutions that can hold a variety of financial instruments (including equities, bonds, money market instruments and units or shares in collective investment schemes). They allow ownership of such instruments to be recorded in electronic form and transferred by the updating of such electronic records rather than paper copies. CSDs are therefore a key part of the infrastructure of financial markets. The UK’s CSD is Euroclear UK and International (EUI) which operates the CREST system.
Following its departure from the EU, the UK has decided not to implement all the requirements of the CSDR; however, those elements of it that were already in force prior to the UK leaving the EU will continue to apply. Therefore, the purpose of this document is to disclose the levels of protection and legal implications associated with the different levels of segregation that we provide in respect of securities held by us for clients within the CREST system, as required by Article 38 of the CSDR.
2. Choice of Omnibus or Individual Client Segregated Account
As we have accounts with EUI in our name or in our nominee’s name in which we hold clients’ securities, Article 38(5) of the CSDR requires us to make available to those clients two types of account: (a) an omnibus client segregated account (also known as a pooled nominee account) or (b) an individual client segregated account.
An omnibus client segregated account (OCSA) is used to hold securities belonging to a number of clients on a collective basis, but we do not hold any proprietary securities in such accounts. An individual client segregated account (ICSA) is used to hold the securities of a single client and therefore that client’s securities are held separately from the securities of any of our other clients and any of our own proprietary securities. Securities will be registered in our nominee company’s name, whether they are held in an OCSA or an ICSA.
Our default approach is to use OCSAs within the CREST system so we will hold your securities on that basis unless you instruct us otherwise. It is important to note that, notwithstanding our use of OCSAs, in our books and records we record each client’s individual entitlement to securities held for them separately so that we can identify and report on such entitlement at any time.
3. Legal and regulatory implications of levels of segregation
Client Asset Rules
We are subject to the Financial Conduct Authority’s client asset rules (CASS Rules), which contain strict and detailed requirements as to the maintenance of accurate books and records about client money and assets and the reconciliation of our records against those of the CSDs with which accounts are held. We are also subject to regular audits in respect of our compliance with those rules. Our continued compliance with the CASS Rules should ensure that your securities will receive the same level of protection whether held at the CSD in an OCSA or an ICSA.
We are also subject to the rules contained in the Jersey Client Assets Order (CAO) in relation to securities held for any clients of our Jersey branch and are audited on our compliance with those rules.
If we were to become insolvent, the insolvency proceedings would be governed by English law and would take place in England. Under English insolvency law, securities that we held on behalf of our clients would not form part of our estate on insolvency for distribution to creditors. Rather, they would be deliverable to clients in accordance with each client’s proprietary interest in the securities. As a result, it would not be necessary for any client to make a claim in our insolvency as a general unsecured creditor in respect of those securities.
Accordingly, where we hold securities in custody for clients and those securities are considered the property of those clients rather than our own property, they should be protected on our insolvency or resolution. This applies whether the securities are held in an OCSA or an ICSA.
Although considered unlikely in practice, bankruptcy proceedings relating to our Jersey branch may also take place in Jersey and be subject to Jersey bankruptcy law. Under Jersey bankruptcy law, client assets held by us on trust would not form part of our bankrupt estate for distribution to creditors. Rather, they would be deliverable to clients in accordance with each client’s proprietary interest in those assets. As a result, it would not be necessary for any client to make a claim in our bankruptcy as an unsecured creditor in respect of those assets.
The table below expands on some of the issues mentioned above and summarises some of the other main risks and implications you should be aware of.
Issue / Risk
As described above, securities held for clients should be protected in the event of our insolvency regardless of whether those securities are held at the CSD in an OCSA or an ICSA. In practice, the distribution of the securities on an insolvency would depend on a number of factors including the relevant law which, as mentioned above, would be English on the insolvency of Quilter Cheviot Limited (unless relating solely to the activities of our Jersey branch in which case such proceedings could theoretically take place in Jersey under Jersey law).
The nature of clients’ interests in the relevant securities would also be an important consideration in the event of an insolvency. Although our clients’ securities are registered in our nominee’s name at the relevant CSD, we hold them on behalf of our clients, who are considered as a matter of law to have a beneficial proprietary interest in those securities. This is in addition to any contractual right a client may have against us to have the securities delivered to them. This applies both in the case of OCSAs and ICSAs. However, in an ICSA, each client is beneficially entitled to all of the securities held in that account whereas, in an OCSA, as the securities are held collectively in a single account, each client is normally considered to have a beneficial interest in all of the securities in the account proportionate to its holding of securities.
A “shortfall” describes a situation when there is a difference between the number of securities that we are obliged to deliver to clients and the number of securities that we hold on their behalf. Were such a scenario to arise (in respect of either an ICSA or an OCSA) this could result in fewer securities than clients are entitled to being returned to them on our insolvency. Shortfalls can arise for a variety of reasons including because of administrative error, intraday movements and settlement or counterparty default.
In the case of an ICSA, the whole of any shortfall on that ICSA would be attributable to the client for whom the account is held and would not be shared with other clients for whom we hold securities. Similarly, the client would not be exposed to a shortfall on an account held for another client or clients.
In the case of an OCSA, the shortfall would be shared among the clients with an interest in the securities held in the OCSA. Therefore, a client may be exposed to a shortfall even where securities have been lost in circumstances which are completely unrelated to that client.
The risk of a shortfall arising is, however, mitigated as a result of our obligation under the CASS Rules in certain situations to set aside our own cash or securities to cover shortfalls identified during the process of reconciling our records with those of the CSDs with which securities are held.
If a shortfall arose and was not covered in accordance with the CASS Rules, clients may have a claim against us for any loss suffered. If we were to become insolvent prior to covering a shortfall, clients would rank as general unsecured creditors for any amounts owing to them in connection with such a claim. Clients would therefore be exposed to the risks of our insolvency, including the risk that they may not be able to recover all or part of any amounts claimed.
If securities were held in an ICSA, the entire loss would be borne by the client for whom the relevant account was held.
If securities were held in an OCSA, the loss would be allocated between the clients with an interest in that account.
In order to calculate clients’ shares of any shortfall in respect of an OCSA, each client’s entitlement to securities held within that account would need to be established as a matter of law and fact based on our books and records. Any shortfall in a particular security held in an OCSA would then be allocated among all clients with an interest in that security in the account. This could be a time-consuming process giving rise to delays in returning securities and initial uncertainty for a client as to its actual entitlement on an insolvency. Ascertaining clients’ entitlements could also give rise to the expense of litigation, which could be paid out of clients’ securities.
Security interest granted to third party
Where a client purported to grant a security interest over its interest in securities held in an OCSA and the security interest was asserted against the CSD with which the account was held, there could be a delay in the return of securities to all clients holding securities in the relevant account, including those clients who had not granted a security interest, and a possible shortfall in the account. However, in practice, we would expect that the beneficiary of a security interest over a client’s securities would seek to enforce the security against us rather than against such CSD, with which it had no relationship. We would also expect CSDs to refuse to recognise a claim asserted by anyone other than ourselves as account holder.
Security interest granted to CSD
Where the CSD benefits from a security interest over securities held for a client, there could be a delay in the return of securities to a client (and a possible shortfall) in the event that we failed to satisfy our obligations to the CSD and the security interest was enforced. This applies whether the securities are held in an ICSA or an OCSA and the CASS Rules restrict the situations in which we may grant a security interest over securities held in a client account.
When securities are pooled in an OCSA a client may not receive the same treatment, options or outcome when there is a corporate action or other event as they would if those securities were held in an ICSA.
Depending on the nature and circumstances of the event in question, the differences in treatment or outcome may sometimes prove to be more favourable to those clients with holdings in an OCSA or, sometimes less favourable than would otherwise have been the case. For example, following an allocation or share issue that favours smaller investors, an allocation to clients with holdings in an OCSA may be less than it otherwise would have been if the client’s securities had been registered in their own name. Conversely, an optional tender offer may benefit shareholders with their holdings in an OCSA arrangement to a greater extent if a number of other shareholders in the OCSA choose not to accept the tender. The application of scaling may, in this case, favour the OCSA arrangement.
Our insolvency may also have an impact on our ability to collect any entitlements (e.g. dividends) due on, or exercise any voting rights in respect of, clients’ securities held in an ICSA or an OCSA.
Where securities are held in an OCSA, we may receive one allocation of shares or units for all our clients represented in that account. Such shares or units will be allocated to the relevant clients in proportion to their entitlement within the overall pool but we may occasionally be left with fractional entitlements that cannot be properly allocated to those clients. When this occurs: (a) in the case of shares or units, we will aggregate the fractional entitlements, attempt to sell them at the prevailing market rate and then distribute the resulting cash proceeds to the relevant clients in proportion to their original fractional share entitlement and, on completion of this process, retain any residual cash amounts from the sale of the fractional entitlements; and (b) in the case of cash, any residual amounts will be retained by us.
Where securities are held in an ICSA, the shares and any cash payment in respect of corporate actions will be posted to the client’s account. However, where that distribution would result in a fractional entitlement, the issuer may round down the allocation to the nearest whole share. In that event the client would not benefit from any fractional entitlement distribution (following the process outlined above) that may be available to clients whose securities are held in an OCSA.
4. CSD disclosures
Set out below is a link to the disclosures made by EUI which is the only CSD in which we (or our nominee companies) are a participant. These disclosures are provided by EUI and we have not investigated or performed due diligence on them so any reliance you may place on them is at your own risk.
Link to CSD disclosures or website
Euroclear UK & International
5. What are the costs?
As described above, OCSAs are the standard account structure that we offer at CSDs and the costs for holding securities in an OCSA are included in the annual management charge that our clients currently pay. We do not currently intend to change this existing cost structure.
Given the nature of ICSAs, they typically have higher set-up and maintenance costs than OCSAs due to the increased operational complexity involved in setting-up and maintaining them. Therefore, if you opt to hold your eligible securities in an ICSA there will be an additional quarterly fee of £1000 + VAT (or currency equivalent). If you were to open or close an ICSA part way through a quarter, this fee would be charged on a monthly pro-rata basis.
The fees associated with OCSAs and ICSAs are subject to change in line with our standard terms and conditions.
If you would like to open an ICSA or require any further information, please contact your Investment Manager.
The above is not intended to constitute legal or other advice and should not be relied upon as such. Clients should seek their own legal advice if they require any guidance on the matters discussed.