The impact of negative interest rates on law firms
There has been much speculation recently surrounding the introduction of negative interest rates. The impact on law firms has yet to be clarified, although the consequences will be far reaching in respect of holding client funds.
In simple terms, negative interest rates will mean that banks and financial institutions will charge for holding monies. Individuals may therefore seek alternative arrangements to depositing funds into a bank account. It may be that long term bonds for example, will offer a more an attractive alternative.
However, this is not a realistic option for law firms who hold client funds, as under Rule 2.4 of the Solicitor Accounts Rules 2019, client monies must be available “on demand” unless an alternative is agreed in writing for the client who that money is held. That may be viable for specific client circumstances, but access to funds is a key principle in the protection of client monies.
The SRA Accounts Rules themselves do not include provisions for negative interest rates. Rule 7.1 states that “You account to clients or third parties for a fair sum of interest on any client money held by you on their behalf.” Rule 7.2, states that “You may by a written agreement come to a different arrangement with the client or the third party for whom the money is held as to the payment of interest, but you must provide sufficient information to enable them to give informed consent.”
One further complication however is that whatever charge is applied to holding client money, it will be extremely difficult and time consuming to allocate that cost fairly and proportionately across all clients, except where software is available to automate the process.
I believe we may see further guidance on Rule 7 to accommodate the introduction of negative interest rates. The SRA will need to ensure firms are acting in their client’s best interests, whilst being practical about how law firms address the issue.
What the SRA will announce (if anything) at this stage is open to speculation. It may be that fees need to be increased to factor in this charge or it becomes permissible to pass on a reasonable charge to clients for holding their money. Such a charge would need to be expressly stated in the client’s terms and conditions and/or care letter. It is important that the client is given sufficient information to “enable them to give informed consent” before agreeing to such a charge as per Rule 7.2. If this approach is allowable, it is vital that such a charge is proportionate to what the cost to the firm is, rather than to enhance profit. Being pragmatic, this will not be an exact science, but the SRA and reporting accountants will need to assess what basis the firm has used to pass on the negative interest rate cost to each client, and how this compares to what the bank is charging them.
Such complications may be avoided if firms don’t operate a client account in the first place. Third party managed accounts (TPMAs) offer an alternative to holding any client funds and could reduce the burden of dealing with the impact of negative interest rates. Either way, negative interest rates may no longer be a hypothetical issue and law firms should consider the issue accordingly.
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