CASS 11 and Prime Brokerage: What Investment Firms Need

CASS 11 is the chapter of the FCA’s Client Assets Sourcebook that applies specifically to investment firms with prime brokerage arrangements — firms where client assets may be used by the prime broker under rehypothecation rights or title transfer agreements. It creates a distinct client asset regime that differs materially from the standard CASS 6 custody rules.

What Is Prime Brokerage?

Prime brokerage is a set of services provided by large financial institutions — typically investment banks — to hedge funds and other sophisticated investment managers. The services typically include custody, financing (margin lending and stock borrowing), execution, settlement and reporting. The defining characteristic of prime brokerage that creates regulatory complexity under CASS is that the prime broker typically has the right to use client assets — specifically, to rehypothecate or transfer title to those assets — in connection with financing provided to the client.

CASS 11 vs CASS 6: The Key Differences

Standard custody arrangements for most investment firms fall under CASS 6, which requires client assets to be held in custody — separated from the firm’s own assets and unavailable for the firm’s use. CASS 11 creates a different framework for prime brokerage arrangements, recognising that the use of client assets under rehypothecation or title transfer is an inherent feature of prime brokerage financing. CASS 11 imposes specific disclosure, governance and monitoring requirements that are more demanding than CASS 6 in some respects, in exchange for permitting forms of client asset use that CASS 6 would not allow.

Rehypothecation: The Core Issue

Rehypothecation is the practice by which a prime broker uses securities pledged as collateral by its client for the prime broker’s own purposes — for example, lending them to another counterparty in a stock lending arrangement. The right to rehypothecate must be explicitly granted in the prime brokerage agreement and is typically limited to a percentage of the client’s net asset value. Under CASS 11, the prime broker must: disclose the extent of the rehypothecation right clearly to the client; maintain records of the assets rehypothecated; and ensure the client’s exposure to the prime broker’s insolvency through rehypothecated assets is clearly communicated and managed.

Title Transfer Collateral Arrangements

A title transfer collateral arrangement (TTCA) is a related structure under which the client transfers full legal title to assets to the prime broker as collateral for financing. Unlike rehypothecation — where the client retains beneficial ownership — a TTCA extinguishes the client’s ownership of the transferred assets entirely, leaving only a contractual right to equivalent assets on return. CASS 11 imposes strict disclosure requirements for TTCAs: clients must be clearly informed that transferred assets are not held under custody and are not protected by CASS in the event of the prime broker’s insolvency.

The SMF18 CASS Oversight Function at Prime Brokers

Investment firms with prime brokerage operations must designate an SMF18 (CASS Oversight Function) holder who is accountable for the firm’s compliance with CASS 11. The SMF18 holder at a prime broker faces a more complex oversight task than at a standard custodian — they must oversee not only the standard custody and client money operations but also the governance of rehypothecation limits, TTCA disclosures, daily reconciliation of rehypothecated assets, and the adequacy of information provided to clients about their CASS 11 exposure. Full detail on the SMF18 function →

Daily Reconciliation Under CASS 11

CASS 11 requires daily reconciliation of: the assets held in custody for each client; the assets rehypothecated under exercise of the prime broker’s rehypothecation right; the assets subject to TTCAs; and the net client exposure to the prime broker after netting off collateral. This reconciliation is operationally intensive and requires close integration between the prime brokerage operations team, the finance function and the compliance function. Where discrepancies are identified in the reconciliation, CASS 11 requires prompt remediation and — where the discrepancy is material — potential notification to the FCA.

Client Disclosure Obligations

CASS 11 imposes extensive client disclosure requirements. Prime brokers must: provide clients with a clear explanation of their rights in respect of custody assets, rehypothecated assets and TTCA assets; disclose the extent of the rehypothecation right and the maximum percentage of net assets that can be rehypothecated; provide regular statements showing the breakdown of assets in custody, rehypothecated and subject to TTCAs; and give clients the information they need to assess their counterparty exposure to the prime broker. These disclosures must be made in writing and updated when material changes occur to the arrangement.

FCA Supervision of CASS 11

The FCA’s CASS supervision at prime brokers focuses on: the adequacy of the TTCA and rehypothecation disclosure documentation; the robustness of the daily reconciliation process; the governance oversight by the SMF18 holder; and the adequacy of the CASS resolution pack — the documentation required to enable a CASS administrator to return client assets in an insolvency. The FCA has taken enforcement action against firms that had inadequate TTCA disclosures or that failed to maintain adequate reconciliation records for rehypothecated assets.

Key References

• FCA Handbook CASS 11 — Prime brokerage
• FCA — Client assets guidance