The Omnibus Dilemma

Omnibus accounts are falling under the regulatory spotlight, meaning the securities services industry may no longer be able to rely on the status quo.
By Lexi Deluca(45176)
Omnibus accounts are falling under the regulatory spotlight, meaning the securities services industry may no longer be able to rely on the status quo.

The days of the omnibus account appear to be numbered. Regulators are zeroing in on them for three powerful reasons: investor protection; tax transparency and geopolitical policing. Any one of these reasons would be enough to make it difficult to see how this industry-standard account structure to remain untouched.

Omnibus—or “nominee” accounts—in which assets are held in the name of the custodian as opposed to the “named accounts” of the underlying beneficial owner, were once the hallmark of a developed, sophisticated and operationally efficient market.

Network managers placed a huge emphasis on the ability of their sub-custodians to persuade local regulators to authorize omnibus accounts in their local market. The omnibus option routinely ranked at the top of their list of what to demand of the authorities in markets as various as Poland, Bulgaria, Ukraine and the United Arab Emirates (UAE). “We continue to see an improvement in the reactivity in our [relationship manager], especially when we talk about important projects such as the omnibus accounts. Please continue,” pleaded one respondent in a recent Global Custodian agent bank survey.

Although the ability to offer an omnibus account structure does not entirely separate the major from the emerging markets—countries such as Norway have long taken the view that holding accounts in the name of the underlying beneficial owner was the right approach in terms of efficient administration as well as asset safety—but it was the emerging markets that tended to resist their imposition as adding a layer of opacity to inbound flows of capital and the activities of domestic investors.

Now regulators in developed markets have woken up to that risk as well. In January, Clearstream settled with the Office of Foreign Assets Control (OFAC) of the U.S. Treasury Department for $152 million over allegations it had allowed access to the U.S. financial system by the central bank of a sanctioned state as far back as 2007. “Today’s action should serve as a clear alert to firms operating in the securities industry that they need to be vigilant with respect to dealings with sanctioned parties, and that omnibus and custody accounts require scrutiny to ensure compliance with relevant sanctions laws,” OFAC Director Adam J. Szubin said at the time of the settlement.

OFAC took the view that Clearstream had violated U.S. sanctions by allowing the Central Bank of Iran (CBI) to transfer securities from its account to a newly opened one in Europe. “This new custody account allowed the Central Bank of Iran to continue holding its interests in the securities through Clearstream’s omnibus account in the United States,” OFAC said at the time. “Given the totality of facts and circumstances surrounding the transfers, Clearstream had reason to know that the CBI was retaining beneficial ownership of the securities following the FOP transfers. As a result of the FOP transfers, the record ownership of the securities entitlements on Clearstream’s books changed, but the beneficial ownership did not, resulting in the CBI’s interest being buried one layer deeper in the custodial chain. Clearstream’s exportation of services from the United States to the CBI then continued after the securities entitlements were moved to the European bank’s custody account.”

This hefty fine has provided a vivid reminder to custodians that regulators, especially in the U.S., fear that omnibus accounts can be used to disguise securities transactions that involve money launderers, terrorists, tax evaders and “politically exposed persons” (PEPS) as well as sanctioned states. “Since the recent enforcement cases, omnibus accounts are under more scrutiny than before,” said one industry observer who preferred to remain anonymous. “There is a feeling that the banking industry does not offer much additional room for improvement regarding AML, sanctions and transparency.”

Taking the lead on this is the International Organization of Securities Commissions (IOSCO), the body of the world’s securities regulators, which in January of this year published its final report, “Recommendations Regarding the Protection of Client Assets. Citing the recent events such as Lehman Brothers and MF Global as the impetus behind their efforts to “place client asset protection regimes in the spotlight,” the paper put forth seven recommendations for intermediaries and one for regulators. In October, IOSCO followed up with another set of principles “Regarding the Custody of Collective Investment Schemes’ Assets,” which also focused on custodial arrangements.

Many in the custody industry recognize that it is now time to take action as an industry, before the regulators impose a regime that is costly or unworkable. “Maybe it is time to look for solutions to prevent a large enforcement or sanctions case to happen,” says one.

Some expect a move by custodians that aims to enhance the transparency of the omnibus model, perhaps by adapting SWIFT message standards to transmit several layers of ownership information as a transaction settles. This effectively extends Know Your Client (KYC) obligations to Know Your Client’s Client obligations.

“This would help to preserve the efficient and widely appreciated omnibus model for the industry and create the necessary additional transparency the regulators are looking for,” says the observer. “In any case the solution should originate from the industry rather than from the regulators. During the last ISSA (International Securities Services Association) symposium the Swiss regulator confirmed that regulators actually want us as an industry to come up with solutions rather than the regulators providing them. It is likely that a solution provided by the regulators will be less pragmatic and less costly than an industry solution.”

There is no expectation that the securities services industry needs to re-invent the wheel, he adds. In the payments industry, there are existing message types in place that could be replicated. “A correspondent banking account is relatively close to what the securities services industry defines as an omnibus account and nobody questions the use of it in the payments services industry. In the Wolfsberg Principles for correspondent banking there are guidelines for the industry on how to manage such relationships. This includes Customer Due Diligence (CDD) standards that consider correspondent banking as a high risk business and may mean that in future not all participants of a market will be in a position to participate in the omnibus model if they cannot prove that they are not a threat to the system.”

Others point to an information deficit plaguing the securities and funds industries as regulators lay obligations on banks, fund administrators and transfer agents to check depositors, counterparties and investors are not money launderers, terrorists, tax evaders, PEPs sanctioned states. They think this can be solved by creating utilities to furnish the industry with accurate information about individuals. SWIFT is building a KYC utility for correspondent bankers. The Depository Trust & Clearing Corporation (DTCC) and six banks have launched the Clarient KYC service, and Markit has joined forces with Genpact to develop a rival.

So it is paradoxical to find another major regulatory initiative—the TARGET2-Securities (T2S) single settlement platform for Europe—will use omnibus accounts. But it is just a matter of timing and priorities. For now, launching T2S is more important than segregated client accounts.

“It’s a moving playing field,” notes an observer. “It is an exciting time because models are going to have to adapt and change. The custodian and transaction banking processes that we know are having to change to the new regulatory landscape, and it brings out certain elements you have to comply with and think differently about. Custodians have always been important and the way they go about doing their business will have to adapt.”

The earlier the industry realizes that it cannot rely on the status quo, the better, he adds. “Better start having this debate now,” he says. “Once you start heading down the regulatory path it can impact the real economy in a way that regulators do not want. At the same time, we absolutely have to be clear that transparency and investor protection have to be met in the model and that intermediaries understand that and cater toward it.”