The Special Administration Regime
The SAR was created in 2011 in the wake of the collapse of Lehman Brothers to provide a specific insolvency regime for failing investment firms. By law, the Treasury had to review the regime within two years of its creation and to this end Peter Bloxham was appointed to undertake the review. Bloxham’s interim report, published in April 2013, considered whether the regime had met its objectives and recommended SAR be retained, with modifications.
The second stage of the report was aimed at providing recommendations to improve the regime and make it more efficient. Amongst all the recommendations set out in the report, the key ones include:
• Facilitating customer and client transfers, including expressly referring to transfers being part of the SAR objective instead of merely the return of client assets (for example, so this can be done at any early stage in the administration without the need for individual client consent).
• Reform of the bar date provisions (including introducing final ‘hard’ bar dates to exhaust client claims once ‘soft’ bar dates have been set and for client money (as well as general client asset) claims to be subject to the bar date provisions).
• Enhancements to the Financial Services Compensation Scheme (FSCS) and statutory co-operation (between the administrator and HMRC and the FSCS).
• Ensuring the CASS rules and the SAR can work more harmoniously together (for example, by adopting the hindsight principle in both regimes) and clarifying that CASS determines the regime for distributing client assets, while the SAR determines the regime as far as creditors are concerned.
Interestingly, the report suggests that bestowing personal immunity on administrators would not make the regime more efficient and that the feedback Bloxham received indicated that insolvency practitioners agreed. Separately, it suggests consideration be given to whether schemes of arrangement should be extended to apply to proprietary claims, which would have made a huge difference in the Lehman case.
FCA’s proposed revision of the CASS distribution rules
The relationship between CASS and SAR
At the same time that Bloxham was reviewing the SAR, the FCA was considering revisions to its client money distribution rules in CASS 7A.
CASS as a whole serves two different purposes: to regulate how firms in going-concern mode protect client money and assets; and (in CASS 7A) to provide the regime for distributing client money in the event of a firm’s failure (i.e. gone-concern mode).
The SAR and CASS 7A operate side-by-side: on the insolvency of an investment firm, the Administrator will have to distribute:
• the assets beneficially owned by the firm (‘Firm Estate’) to unsecured creditors in accordance with insolvency law and the SAR; and
• Custody Assets and assets held on statutory trust under CASS, (the ‘Client Pool’) to clients in accordance with the CASS rules (and, where there is a gap, general property and insolvency law).
(Although this division had eventually become apparent following the lengthy litigation over LBIE and MF Global, Bloxham’s final report suggested amending SAR Objective 1 to make it absolutely clear that, in “ensuring the return of client assets”, the Administrator will be applying the rules in CASS.)
Consultation Paper CP13/5 was published on 12 July 2013, a month after Bloxham’s interim report. The FCA noted that its proposed rule changes were subject to the recommendations of the final Bloxham report, and any legislative changes that the Government might enact in consequence of it.
The FCA consultation ended in October 2013, but the FCA agreed to re-consult if necessary later on.
Bloxham’s final report contains a chapter responding, in part, to CP13/5 (see below). The author added that he hoped the FCA would consider his comments alongside other consultation responses, and also stakeholder responses to his own final report. He also approved the suggestion in CP13/5 that the FCA and Treasury should collaborate on and co-ordinate changes to SAR and CASS.
The ‘Speed Proposal’
The most important proposal in CP13/5 was a new, two-stage process for the return of client assets. (Bloxham labels this the ‘Speed Proposal’). Under the Speed Proposal, an Administrator could make an initial distribution of money to clients in a matter of weeks, based on the failed firm’s own records. Later there would then be a second distribution, based on client entitlements not apparent from the records, and using whatever surplus remained from the first distribution plus any other client monies that had since been identified.
If the Administrator considered that the failed firm’s own records did not allow for a reasonable determination of client entitlements, they could instead use a single-stage process not dissimilar from the present CASS procedure. (Bloxham labels this the ‘fall-back’ approach.)
The impetus for the Speed Proposal, as the name suggests, was the desire to improve the promptness of distributions. The trade-off for speed is the risk clients might lose out if the failed firms’ records are not up-to-date.
Bloxham’s comments on the Speed Proposal mainly focused on the difficulties in deciding when to use the Speed Proposal or the fall-back approach. The key criterion - when client entitlements may be “reasonably determined” from existing firm records - was not an easy one to make out; and, as the Speed Proposal involves the risk that some clients may lose out, Administrators might be loath to make use of it unless they could be guaranteed some form of immunity, or else following directions from the court (and consequent delays).
Bloxham suggested that the solution could be either a ‘fast track’ process for obtaining the court’s directions on which system to use; or else a system where Administrators could provide the FCA with a ‘reasoned analysis’ of their proposal to use one system or the other, in return for legal immunity on a case-by-case basis. He also proposed that the Insolvency Act 1986 be amended to qualify the rights of persons adversely affected, and that the revised CASS rules be drafted with as much clarity and certainty as possible.
The FCA had proposed, as an alternative to the Speed Proposal, simply clarifying and codifying the present CASS procedure. However, Bloxham suggested that, since the ‘fall-back’ approach would be based on the existing procedure in any case, the FCA should seek to clarify and codify the existing procedure anyway.
Other recommendations for the FCA
Among his other suggestions, Bloxham recommended that the FCA encourage firms to use wholly-owned subsidiaries as nominee companies for holding legal title to client investments (other than cash). This would allow the easier transfer of shares from the nominee company as part of the transfer of client positions, without the need for transfers of all the individual holdings.
The Bloxham report is generally positive about the SAR and recommends it be retained, with modifications. The report’s emphasis on the need for harmonisation and clarity between the SAR and CASS is sensible and encouraging, but we will need to wait until the FCA reports on its 2013 consultation to understand how far this is likely to be achieved. The Treasury, having agreed with the recommendation to retain the SAR, is currently considering the report’s further recommendations, following which a further consultation is likely to take place. However, as the report notes, ensuring a fast and efficient return to clients depends as much on firms maintaining accurate and up-to-date records and segregating money as it does on reform of the SAR framework. In this sense, the recommendations of the FCA in relation to the CASS rules will be crucial, as will firms’ compliance with any new rules.