At the time of writing, bank interest rates are sitting at an all-time low of 0.1%. Only a couple of years ago, a rate as low as this, let alone a sustained hold at this level, seemed inconceivable and yet we now face a possibility, if not likelihood, of interest rates flipping over into the red.
In simple terms, that means it will become expensive for any of us lucky enough to have savings to actually hold onto our money.
Of course, for many of us mortgage holders who have spent our adult lives financially insolvent, this would not be the worst thing that has happened this year, but it may have a rather less favourable impact on law firms that routinely hold very large amounts of client money.
Let’s not forget that this is an industry where the size of the client account doesn’t necessarily correlate to the size or financial stability of the firm that is holding that money, and we frequently see that it is the smaller firms that hold the larger amounts of client funds.
One example of this was a small, provincial law firm client being asked to carry out a simple exercise for their PII broker and total up the amount of client funds passing through their one general client account in the preceding 12 months. The figure caused somewhat of a surprised expression on the finance director’s face, a total of a little over half a billion pounds.
Typically, but not exclusively of course, the larger law firms tend to avoid holding onto client money where they can and, especially where these firms may favour a smaller number of heavy weight cases over high volume work the need to hold onto client money becomes even less.
The question facing these firms is whether or not banks would choose to pass the cost of negative rates to law firms and, if so, would it be fair to do so?
Taking a step back for a moment, negative interest rates are not a unique Covid-19 related crisis. Although the current pandemic certainly hasn’t helped matters, interest rates on Euro holdings have been negative now for several years – as far back as 2014 in fact when the European Central Bank introduced a policy of negative rates.
Up until now, most of the larger banks have resisted passing these negative rates to their customers but, as rates have slipped further over recent months, we have seen this change.
In many cases, this has been met with relatively little in the way of resistance from domestic businesses – the levels of Euro holdings are typically low relative to sterling after all. However, what would the attitude be if the Bank of England took a further step into the unknown?
Given the scale of the issue, it seems unlikely that banks would shield their customers to the same extent that they did with Euro rates. From an economic point of view, the intention of the Bank of England would be clear with negative rates – the economy needs people spending money, not saving, and a block on this policy by the commercial banks just wouldn’t be right.
So where would this leave law firms?
The impact of holding client money on firms’ inflated PII premiums, and the cost to the SRA through calls on the Solicitors’ Indemnity Fund when things go wrong, already hit law firms in the pocket, but this may have a more profound effect when every pound sitting to a client’s credit has a direct and proportional impact on their finances.
Practices have been required to have clear interest policies in place for a number of years now, but they have (up until now) been based around paying a fair amount of interest to their clients, not the other way around. If rates became negative, we may see firms adopting a more ‘dynamic’ policy whereby the interest benefit or cost swings both ways.
Practically speaking, is there anything stopping a firm doing this now irrespective of what the current interest rates are?
With that in mind, what is the SRA’s view on this? It’s no secret that the SRA would rather law firms do not hold only client money as a matter of course. The regulator accepts that it is a largely unavoidable side effect of law firms acting in their clients’ best interests, but the recent new rule around the use of Third Party Managed Accounts (TPMAs), not to mention warning notices about the risk of providing prohibited banking facilities to clients, makes the position clear.
At the time of writing, the SRA has yet to give an update on its position.
Whatever the SRA’s view is, we will presumably see firms becoming more resistant to holding onto client money. Firms shouldn’t be holding onto client money just for the convenience of their clients anyway, but firms will look even more closely at the commercial arrangement they have with their client.
It will be interesting to see what, if any, effect this change in appetite will have on the speed of transactions. Where client money becomes a hot potato that nobody wants to hold on to, will this have an unexpectedly positive impact on completion efficiencies and will we see firms taking an increasingly bullish approach in the final stages of a matter?
Alternatively, firms may look beyond the traditional client account to other means of facilitating a deal, such as the use of TPMAs.
Whether or not it is fair for banks to view a law firm’s client account in purely commercial terms is a point for debate, though nobody took issue when rates were much more positive.
While this may not be an immediate concern for most law firms; we are still after all trying to navigate our way through a much larger problem at the moment, it is unlikely that banks will sit on the cost of negative sterling rates for quite as long as they did for other currencies, and so forward planning now by firms may save us all a headache further down the line.
For advice on any issues raised here, please speak to your usual Saffery Champness partner.