New on FinoLib · Volume III: Finance Encyclopedia
My latest article is now live on FinoLib, the free finance library I write: Reconciliation as a Regulatory Control in Finance, from Volume III: Finance Encyclopedia. Read the summary below for the substance of the topic, then continue to FinoLib for the complete treatment.
The idea in plain words
Reconciliation means comparing your records with someone else’s and fixing the differences. It is a regulatory control because, when a firm fails, only accurate, reconciled records keep client money and assets out of its creditors’ hands. The UK’s CASS rules require internal and external reconciliations, same-day funding of client money shortfalls, monthly reports, an annual audit, a 48-hour resolution pack and a named senior person who is accountable.
Key points
■CASS 7 compares the client money requirement (client balances, with debtors counted as zero) with the client money resource every business day; a shortfall is funded by close of business.
■CASS 6 checks the aggregate custody record against the client-specific record and against custodians at least monthly; gaps are covered with the firm’s own assets.
■A bank must countersign an acknowledgment letter before client money is held there, so it cannot set off the money against the firm’s debts.
■The “CASS Officer is SMF18” shorthand is wrong: CASS responsibility can sit with any existing SMF holder.
A closer look
Volume II’s Part 9 established that client asset protection depends on continuous reconciliation: segregation has to be proven in practice, not only documented. This Part supplies the toolkit underneath that statement, starting here with the reconciliations regulators prescribe for client money and custody assets.
A worked example
Worked Example — A Client-Money Shortfall, Found and Fixed
A UK broker holds client money in US dollars. Last night’s client balances: A $420,000; B $185,500; C $96,250; D −$38,000 (bought stock, not yet paid); E $12,750. D is a debtor and counts as zero. Requirement = 420,000 + 185,500 + 96,250 + 12,750 = $714,500. Resource = two client bank accounts, 500,000 + 190,000 = $690,000. Shortfall = 714,500 − 690,000 = $24,500, transferred from the firm’s own account before close of business; then the investigation starts. A classic cause is a client purchase settled from the client bank account before that client paid, which spends other clients’ money.
Under the hood
Under the Hood: CASS 6 and CASS 7 Reconciliations Side by Side
Both regimes ask two questions: do the firm’s own records agree with themselves (the internal check), and do they agree with the banks, custodians and depositories that actually hold the assets (the external check)? Control CASS 6: safe custody assets CASS 7: client money Internal check Internal custody record check: aggregate record (by location) against client-specific record (by client); at least monthly (CASS 6.6.11R) Internal client money reconciliation: requirement against resource, every business day, on the previous day’s close (CASS 7.15.15R) External check External custody reconciliation against custodian, depository and registrar records; at least monthly (CASS 6.6.37R) External client money reconciliation against bank and third-party statements; at least monthly (CASS…
Decision rule
If the client money requirement, computed client by client with every negative balance floored at zero, exceeds the resource by any amount, fund the gap from firm money the same day and then investigate. Withdraw an excess only after confirming it is not unallocated client receipts. If custody records disagree and the cause is not found, cover the gap with firm assets until it is. If a discrepancy cannot be resolved, notify the regulator without delay.
The costliest mistake
Netting a debtor client against everyone else. In the worked example, netting D’s −$38,000 shows a false $13,500 excess. Withdraw it and the resource falls to 690,000 − 13,500 = $676,500 against a true requirement of $714,500: a shortfall of $38,000, exactly the netted debt. If the firm fails that night and the pool is shared pro rata, every client loses 38,000 ÷ 714,500 = 5.32%; client A’s share is 420,000 × 38,000 ÷ 714,500 ≈ $22,337, recoverable only through the insolvency. Avoid it by building the zero floor into the reconciliation system so no one can net by hand.
Recap
Reconciliation is a regulatory control because, in a failure, only accurate and reconciled records keep client assets out of creditors’ hands. CASS 7 compares the client money requirement (debtor balances counted as zero) with the resource every business day and funds any shortfall by close of business; CASS 6 checks custody records internally and against custodians at least monthly and covers gaps with the firm’s own assets.
What the full article covers
The full article includes worked examples, a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume III: Finance Encyclopedia
Read the full article on FinoLib
The complete article, Reconciliation as a Regulatory Control in Finance, with every worked example, diagram, quiz and source, is free to read in Volume III, Finance Encyclopedia on finolib.com.
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