FSCS's work on special administrations

You may have heard of the term ‘special administration’ before – but do you know what it means, what makes the process ‘special’, and how it affects the work we do at the Financial Services Compensation Scheme?

There are many different special administration regimes designed to protect customers in critical industries, including water and power supply. In this piece, I will be focusing on investment bank special administrations and diving deeper into what this work looks like for FSCS.

What is an ‘investment bank special administration’?

Our work on investment bank special administrations is one of the lesser known parts of FSCS’s remit.

An investment bank special administration, like ordinary administration, sees control of a failed firm assigned to joint special administrators to either turn the company around, or to wind it up as efficiently as possible. The main difference however is that an investment bank special administration has three key objectives set out in the regulations:

1. The return of client assets as soon as is reasonably practicable
2. The timely engagement with the Bank of England, HM Treasury, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA)
3. Either the rescue or the winding up of the investment bank in the best interests of its creditors.

The investment bank special administration process applies not only to investment banks, but also to institutions that serve consumers. This is because the regulations apply to UK firms holding client assets which have authorisations from the FCA including to safeguard and administer investments. This means it also includes businesses like wealth management firms and discretionary fund managers.

The origin of special administration

The investment bank special administration process was first introduced after the 2008 banking crisis following the failure of Lehman Brothers, at the time the fourth-largest US investment bank. The effect of Lehman Brothers’ collapse on the financial system as a whole led to considerable changes in how bank failures are dealt with.

At that time, it was unclear what should happen on the collapse of a firm holding client assets on trust. This is why the investment bank ‘special’ administration process was developed: to ensure there was a clear route for returning customer assets fairly. A new insolvency regime, the Investment Bank Special Administrations Regulations 2011, was enacted by HM Treasury under the Banking Act 2009 to implement this new process.

This new special administration process increased the oversight of the court, to avoid decisions being taken solely by company directors and insolvency practitioners (IPs). The aim of the process is for the court to approve the appointment of the IPs and their distribution plan, facilitating the swift return of customer assets and thereby reducing the wider impact of the failure. Client money is dealt with under the Client Assets Sourcebook (CASS) rules in the FCA Handbook, but it is often preferable for the asset and money transfers to happen in parallel. In the 13 years since, updates have been made to the regulations which now require the administrator to work more closely with FSCS throughout the process.

FSCS’s involvement

Investment Bank Special Administrations, much like standard administrations, involve considerable work and expense for administrators with these costs being addressed before any returns are made to creditors. As I explain in the case study below, FSCS protects eligible customers by paying their share of the costs of transferring their assets to a new firm, up to the FSCS limit of £85,000 per eligible customer. This means that eligible customers can usually receive their client assets and money back without contributing to the costs of the transfer. Where there are shortfalls in the client’s assets or money held by the firm (e.g. through maladministration or, more rarely, fraud), FSCS will also cover those shortfalls in addition to the costs of the transfer, with the total up to the FSCS limit of £85,000 per eligible customer.

Due to this endpoint, our role early in the special administration process is to assess if FSCS protection is available to an investment firm’s customers. Where FSCS can pay compensation, investors will assign their rights against the firm to FSCS, and so FSCS will become a major creditor of the failed firm. As such we will usually seek a place on the clients’ and creditors’ committee and will collaborate directly with the administrators throughout the life of the case.

FSCS has been involved in a number of special administration processes in the past few years, including Beaufort Asset Clearing Services, SVS Securities and Reyker Securities. More recently, we are currently involved in the special administration processes for WealthTek, IBP Markets and Blankstone Sington.

Special administrations are often demanding failures, requiring work from many teams across FSCS.

Our role in the Beaufort special administration

I’ll use Beaufort Asset Clearing Services as an example of how we are involved in investment bank special administrations. Beaufort went into special administration on 1 March 2018. In order to reconcile and return outstanding client money and assets, the joint administrators required funding to cover their fees and those of other parties involved. This included retaining the Beaufort staff and IT system providers to ensure they had continued access to necessary systems and data. Under the Investment Bank Special Administration process, the costs incurred by the administrators in reuniting investors with their assets and money must be funded out of the remaining assets and money of the failed firms’ clients.

FSCS was able to establish that deducting these costs from clients’ assets and money would give rise to compensable claims under our rules. Therefore, to speed up the return of client assets, instead of processing 17,000 individual claims after the special administration process was completed, we were able to work with the administrators and agree to make bulk payments to cover the costs of FSCS-eligible clients (which was around 99% of the client base). This approach ensured that most customers wouldn’t have to file a claim directly to the FSCS later down the line.

Once FSCS has established that we are able to pay these costs, our role is to work closely with the administrator to ensure that money is spent effectively and the best value for money is achieved. We achieve this through various methods, including arranging a funding agreement, which provides a framework for how FSCS will pay compensation. The creditors’ committee also has a statutory role in approving the administrators’ fees and will normally look at the overall cost picture.

To return client assets, the administrators will prepare a distribution plan which is reviewed and approved by the creditors’ committee and then the court. In general, the administrators will propose a parallel process for returning client money, which is governed by the CASS section of the FCA Handbook. In most cases, the potential losses to customers which would have occurred from taking the transfer costs from client money and assets (as set out in CASS and the IBSA Regulations) can be FSCS protected - so once the distribution plan is approved, we start to pay these protected costs to the administrator, so that investors don’t have to.  In most cases, our compensation will allow the administrators to transfer investors’ assets and money whole, without deductions, to a new firm, which investors then have access to.

In the case of Beaufort, over £53m of client money and £500m in client assets was returned via transfer to new brokers across 17,000 clients. Like many investment bank special administrations, this was a complex and nuanced failure. It’s very important that our processes complement the overall procedure to achieve the return of client assets as soon as is reasonably practicable.

The customer journey

For customers who have lost access to their money and assets (often their savings), it can be an incredibly stressful experience. FSCS will continue to work with administrators in investment bank special administrations to establish the eligibility of customers and efficiently arrange our contributions so that transfers can be as seamless as possible. That’s why, although much of FSCS’s work in this space isn’t  seen by the customer and takes place behind the scenes, we issue frequent web updates about special administration failures to make sure customers are kept in the loop with the latest developments.

With that said, in most cases, these customers won’t have any direct engagement with FSCS. During the special administration process, their assets and money will generally be transferred to a new broker, and they will once again have access to their money.

I hope this article has been useful to you, and that it has shed light on how we are involved in the complex world of investment bank special administrations. To keep an eye on updates for the latest failed firms, you can visit our dedicated webpage.