4.1.2 Statutory or on-balance sheet asset segregation

172. Statutory segregation requires a legal framework establishing a regime for legally and administratively segregating client assets from the assets of the investment firm.1 A legal system for segregating client assets from those of the investment firm will usually take the form of on-balance sheet asset segregation.2

173. When using on-balance sheet asset segregation, national law3 has to provide for a means whereby the clients’ assets are bankruptcy remote, meaning that the failure of an investment firm will not result in the creditors of the investment firm having a claim on the assets of the investment firm’s clients. However, this requires the investment firm to employ an extensive and up-to- date administrative segregation system. If this administrative segregation is not complete or does not make explicitly clear which assets belong to which client and which assets belong to the investment firm, the client assets might still end up being part of the bankruptcy estate. The advantage of on-balance sheet asset segregation is that no separate legal entity has to be set up and maintained. It has a disadvantage, however, in that the on-balance asset sheet segregation is only effective if and when the administrative segregation is complete and up to date. Any errors in the administrative segregation by the investment firm which could lead to losses for its clients could expose the investment firm to a direct liability risk.4

174. An example of this can be found in article 39 of EMIR, which requires a central counterparty to “keep separate records and accounts that shall enable it, at any time and without delay, to distinguish in accounts with the CCP the assets and positions held for the account of one clearing member from the assets and positions held for the account of any other clearing member and from its own assets”.5 It can however be questioned if this requirement in EMIR achieves an effective legal segregation or if this will only achieve administrative segregation.6 A similar system of segregation to that of EMIR is also included in the CSD Regulation, which requires, at least, a form of administrative segregation.7

175. To achieve legal segregation of assets, the Dutch legislator introduced legislation that ensures the legal and administrative (on-balance) segregation of financial instruments of clients from the financial instruments of the investment firm.8 Although the method used to segregate derivative positions9 differs from the method used to segregated ‘regular’ financial instruments,10 both methods intend to create a separation between the assets belonging to clients and the assets belonging to by the investment firm. The administration of the investment firms indicates which client has a right to which financial instrument and the legal segregation ensures that only those clients who have a claim according to the administration of the investment firm can indeed claim those separated financial instruments.