Client money segregation in the UAE

The problem segregation was invented to address 

Money paid to a broker to trade with does not buy anything at the moment it arrives. It sits as a balance, and a balance is a claim on the firm. If nothing further were required, that claim would be an ordinary unsecured one, indistinguishable from the claim of a landlord or a software supplier, and it would rank alongside them if the firm failed. Segregation exists to change what kind of claim it is.

The rule is deceptively simple in statement and demanding in operation. Money belonging to clients is held separately from money belonging to the firm, in accounts designated as client accounts at a bank, and it is not available to the firm for its own purposes. The firm holds it for the clients rather than owning it, which is what makes it identifiable as theirs in an insolvency instead of forming part of the estate available to the firm's general creditors.

The safeguarding arrangement YAL operates is stated in the register rather than described loosely: client funds are held in segregated accounts, as its regulator requires, and the licensed entity that holds them is named in the client agreement as Yal Group Inc..

What it obliges a firm to do 

• Hold client money at a bank, in accounts titled so that the money is identifiable as client money and not as the firm's, with the bank acknowledging that characterisation.
• Pay client money in promptly on receipt, so that funds do not rest in the firm's own operating accounts while they are being processed.
• Reconcile the internal records of what each client is owed against the money actually held, on a regular cycle, and make good any deficiency identified.
• Withdraw only what has properly become the firm's, when it has become the firm's. Commission, financing adjustments and realised losses cease to be client money once they are due; unearned amounts do not.
• Keep records adequate to reconstruct each client's entitlement, since an entitlement that cannot be evidenced is difficult to pay out.
• Diversify or assess the banks used, because holding the entire pool in one place concentrates the risk that the arrangement is trying to spread.

Reconciliation is the load bearing item in that list and the one a reader is least likely to have heard of. Segregation is not a single act performed when an account is opened. It is a continuing arithmetic exercise: the sum of what all clients are owed must match the money in the client accounts, every cycle, and a difference is a deficiency the firm has to fund from its own resources immediately. Most client money failures in the historical record are failures of reconciliation rather than deliberate misappropriation.

What counts as client money, and what stops counting 

The balance in a trading account is not a single undifferentiated pot. Money deposited and not yet spent is client money. Money required as margin against an open position is generally still client money, held against an obligation that has not yet crystallised, though the treatment of margin passed on to a third party depends on the regime and on the client agreement. Money that has become due to the firm, such as a commission charged or a financing adjustment applied, has stopped being client money at the moment it became due, whether or not it has been moved.

Unrealised profit on an open position is a different category again. It is a number produced by revaluing a contract that has not been closed, so it is an entitlement contingent on a contract rather than money held on the client's behalf, and it is realised into money only when the position closes. That distinction is invisible on a screen, where a balance and an unrealised profit are displayed one line apart in the same currency, and it matters a great deal in an insolvency.

What happens if the firm fails 

In a failure, an administrator or liquidator is appointed and the segregated money is treated as a pool held for the clients as a class rather than as the firm's asset. Clients are paid from that pool ahead of the firm's general creditors, and each client's share is calculated from the records. That is the whole of what segregation buys, and it is real, but three features of the process are routinely omitted from descriptions of it.

1. The pool is pooled. Clients do not have individually ring fenced accounts in the ordinary case; they have a beneficial share of a common pool. If the pool is short of what the records say is owed, the shortfall is shared across all clients in proportion to their entitlements rather than falling on whoever is identified last.
2. Distribution takes time. Records must be reconstructed, entitlements verified and claims resolved, and a distribution can be preceded by interim payments or by nothing at all for a considerable period. Money that is legally the client's is not therefore money the client can use.
3. The costs of the process are real, and whether they fall on the pool or on the general estate depends on the regime and on the circumstances. That question has been litigated at length in other jurisdictions, which is a fair indication that it is not simple.

What segregation is not 

• Not protection against market loss. Money lost on a position is gone from the entitlement before any question of segregation arises, and no client money rule alters the arithmetic of a price.
• Not deposit insurance and not a compensation scheme. Segregation returns the client's own money from a pool; it does not top up a shortfall from anywhere. Where a jurisdiction operates a compensation scheme, that is a separate arrangement with its own perimeter and its own limits, and it is never implied by the existence of segregation.
• Not a guarantee against the bank. The money sits at a bank, so the failure of that bank is a risk the pool carries, which is why the choice and spread of banks is itself a regulated question.
• Not a warranty that records are correct. The pool is distributed against the firm's records, so a firm whose reconciliation has failed produces a shortfall whether or not anyone intended one.
• Not liquidity. A legal entitlement in an administration is not money available to use, and the interval between the two can be long.

Where practitioners disagree 

The first argument is about pooling. Pooling is defended as the only workable arrangement at retail scale, since individually designated accounts for very large numbers of clients would be expensive to operate and would make daily reconciliation harder rather than easier. It is criticised on the ground that a pool socialises a shortfall caused by the treatment of some clients' money across all of them, so a well documented client bears part of a loss created elsewhere. Both descriptions are accurate, and the regimes that have moved toward individual segregation have done so for institutional clients rather than retail ones.

The second argument is about how much comfort the arrangement should be presented as offering. One position holds that segregation is a strong and well tested protection whose historical record is good, and that describing it cautiously understates a genuine safeguard. Another holds that the phrase segregated funds is read by most people as meaning insured, that the gap between the two is where the disappointment lives, and that the honest presentation always states the shortfall case and the delay in the same breath. This page takes the second view, which is why the section above exists at the length it does.