Third-party managed accounts: Your key questions answered

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Van Der Zant: FCA regulation is key

Guest post from Claire Van Der Zant, head of strategic partnerships at Shieldpay

Having sought input from the sector, the Solicitors Regulation Authority (SRA) is now going through the responses to its consumer protection review as it considers steps that could be taken to further protect consumers of legal services.

The regulator has given strong indications that it is headed towards greater restrictions on law firms when it comes to handling client money, even referencing the possibility of preventing firms from holding client money altogether.

Being a trustworthy partner to clients is key to a law firm’s success so naturally, relinquishing control of client funds to third-party providers will raise a number of questions for law firms.

Legal Futures recently hosted a webinar to explore some of these questions. With policy recommendations following the review expected later this year or early next, firms should be assessing their client money practices now to get ahead of any changes that could potentially follow.

Various concerns were raised during the webinar about using alternative solutions for handling client money, particularly third-party managed accounts (TPMAs). Legal Futures invited us to address them in this blog.

What additional security does a TPMA offer?

Placing client funds under the care of a TPMA means staking a firm’s reputation on the security of a third party. There are no means of receiving, holding and paying client money that are entirely impervious to fraud risk but working with a TPMA provider can mitigate risk in several ways.

Firstly, TPMAs are regulated by the Financial Conduct Authority (FCA) and subject to strict regulatory obligations on security. While all law firms are required to undertake ‘know your client’ on their clients and due diligence on any transactions, the risk of fraud, money laundering, terrorist financing and other financial crime is significantly reduced through using an FCA-regulated payments provider with expertise in identifying and mitigating such risks.

Furthermore, TPMA providers have transaction monitoring procedures in place and undertake spot checks on transfers between TPMAs and the law firm operational accounts to identify unusual transactions and protect against the misappropriation of client funds.

TPMAs must also comply with the FCA liquidity and capital requirements, which mean they have sufficient liquid assets to meet their financial obligations. They are also required to hold client monies in separate ring-fenced accounts to ensure client monies are safe in the event of the firm becoming insolvent.

What are the additional costs of using a TPMA?

While working with a new technology partner will inevitably come with costs, it could also bring savings.

Using a TPMA, for example, will exempt a firm from needing to contribute to the SRA’s Compensation Fund, which is set to increase more than three-fold.

Handling client money via an FCA regulated firm with greater protections against the mishandling of funds, fraud and enhanced cybersecurity protocols, could also mean a lower risk profile and fewer insurance claims, so there is the potential to lower insurance premiums.

A further financial consideration when it comes to moving away from handling client money in-house is the potential loss of interest income on these funds, especially with the current economic climate offering higher interest rates.

This was a hot topic during the webinar, with some justifying keeping the income to make up for other costs incurred by the firm to service the client, and others taking the view that the client should be the beneficiary of this additional income as it is their money.

Law firms using a TPMA do not typically receive interest on funds they hold in the account due to regulatory licensing restrictions; however, it is possible for payment institutions to share the income derived from holding the funds depending on the nature of the transactions being processed.

How does a TPMA fit with existing operating models and processes?

Using a TPMA and the potential re-organisation of an in-house function also presents logistical challenges. For the most part, TPMAs can work in harmony with an existing accounts team. All it requires is making the switch from using a banking solution to the TPMA solution.

The efficiency gains that come from adopting a TPMA, however, could impact the day-to-day responsibilities of the accounts team.

Shieldpay’s platform, for example, provides a mirror ledger of legal matters where each legal matter has its own unique ID, linking payers and payees to the matter itself. This makes reconciling payments made and received simpler, as well as streamlining reports and regulatory reporting.

For some law firms, fee-earners will be the primary users of the platform and be responsible for managing the transactions. This can reduce friction in the process as there are fewer stakeholders involved in making the payments.

How do TPMAs align with the SRA accounts rules? 

The SRA has taken the view that firms working with FCA-regulated TPMAs do not have to comply with the full gamut of the accounts rules, as that would be counterproductive. This is because TPMAs remove the risk of breaches arising from innocent mistakes (eg rule 3.3, providing a banking facility) and eliminates the need to deal with residual balances.

In this way, working with an FCA-regulated TPMA reduces the day-to-day regulatory burden for legal firms.

Conclusion

Law firms will have to wait to see the full results of the SRA’s review and the policy solutions that follow. Following high-profile cases of malpractice such as Axiom Ince, however, and faced with increasingly sophisticated financial fraud, the SRA is on a mission to put in place stricter measures when it comes to client fund management.

This will likely mean a greater role for TPMAs in the legal sector, which raises a number of questions around how firms will implement and manage this change.

From communicating with clients to adopting new processes amongst fee-earners and accounts teams, forward-looking firms should begin to prepare for these changes now, and embrace the positive opportunities they could bring.