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Our view on the latest SRA update, "Interest rates and the client account", What's yours?


law firm interest on client money percentage

The Solicitors Regulation Authority (SRA)'s recent article, Interest rates and the client account, discusses interest rates and the income that law firms are making on held client money. 


This area of business can be quite confusing for many law firms, and we feel that the recent article by the SRA unfortunately doesn't do much to clarify the situation. 


As interest rates were on the incline, we provided guidance in a prior article titled 'Your Client Interest Policy – Is it Fair?'. Twelve months later, given the updated information from the SRA, we deemed it appropriate to issue a follow-up that may assist law firms in evaluating their approach.


1 - Addressing the ‘1000% rise’


The latest findings from the LMS benchmarking survey have revealed a ‘1000% increase in interest received on money held in client accounts. According to respondents, total net interest income rocketed to £27.5 million this year, a steep increase from £2.6 million in 2022.


This eye-catching statistic undoubtedly grabs attention, presenting itself as a sensational headline. However, it's essential to look deeper into the context behind this rise to understand whether the result matches the sensationalistic nature of the headline.


Let's consider the interest rate environment: For years, interest rates paid were hovering at just 0.01%. A 1000% increase from that level only sees the interest rate rise to 0.11%. 


For those fortunate enough to have received a deposit interest rate of 0.10% on their client monies, a 1000% rise would only bring the new rate to 1.10%. While this is still worth taking note of, it’s definitely not as groundbreaking as the initial figure suggests.


While the surge in client account interest income is significant, it's crucial to analyse it within the broader context of prevailing interest rates to help understand the nuances behind headline-grabbing statistics. In fact, law firms could have, and still can, achieve even higher interest rates than the standard advertised client account deposit interest rates communicated by the big 4 high street banks.


2 - The amount of time that client money is held for


The SRA says that usually “money is held in the client account for such short periods of time” that earning interest on client money is not something that is of significance. 


The SRA rightfully acknowledges that client funds are typically held for brief durations, thus earning interest may not be a significant concern, particularly in the context of conveyancing monies, which are usually held for short periods. Indeed, it's uncommon for law firms to remunerate clients for interest accrued on such funds. 


However, in instances involving other categories of client funds, such as Probate monies, which often remain in custody for extended periods, the potential for substantial interest earnings arises. In such cases, it becomes pertinent to consider a fair compensation arrangement in lieu of interest to be disbursed to the client.


3 - Understating the potential value of interest earned on client money


The SRA says that “any interest earned across all client monies might be enough to pay for the bank's account charges for holding the money in the first place - that does not exactly qualify as 'financial benefit'.”


The assertion made is incorrect and has historically been so. Traditionally, banks have refrained from imposing charges for the operation of client accounts, thereby negating the concept of transaction fees. While CHAPS fees are indeed applicable, they are typically charged separately. Law firms commonly incorporate these fees into a comprehensive charge, encompassing the CHAPS payment along with a nominal administration fee.


The significant opportunity for firms to generate substantial income from client funds arose following the amendment of the Legal Services Act 2007. This legislative revision eliminated the distinction between interest accrued on client funds held in a general client account and those in a separate designated client account.


Consequently, firms gained the capability to consolidate funds into a ‘pooled general client account’, thereby enabling them to attain a more favourable rate of return. Despite this consolidation, firms retain the responsibility to provide clients with a payment in lieu of interest equivalent to the rate that would have been achieved had the funds been retained in a designated client account under the client's name.


In essence, this arrangement ensures no financial detriment to the client while affording the law firm the opportunity to generate interest income, thus constituting a mutually beneficial outcome.


4 - The SRA’s warning to law firms around fair practice


The SRA underscores its awareness of certain law firms benefiting significantly from the interest accrued on held client funds, while also noting that some firms may not be remunerating their clients fairly. They assert their commitment to taking action upon receipt of evidence regarding such practices.


First and foremost, it is imperative to emphasise the importance of adhering to regulations and conducting business ethically. Law firms have a responsibility to maintain transparency with clients regarding interest earned on held funds and to provide fair compensation rates.


However, it is worth noting that law firms do not necessarily increase their earnings at the expense of clients. Instead, they may negotiate higher interest rates with their primary or secondary banking providers. In situations where firms receive enhanced interest rates on client funds, determining a fair rate of interest to pay becomes a pertinent consideration. Notably, the recent article from the SRA does not offer guidance on this matter.


Addressing this issue is something we have extensively discussed and often assist firms in evaluating the optimal approach.


Secondly, it is crucial to highlight the potential benefits of diversifying client funds across multiple banking providers. Doing so can mitigate risk in fund management and enhance business continuity. Should one banking institution encounter difficulties, having funds spread across multiple providers ensures the firm can continue to meet their clients' needs effectively If the secondary bank provides higher interest rates compared to traditional high street banks, it offers an added benefit to the firm.


Conclusion:


While the SRA update provides valuable insights into their perspective on the client money situation, the discussions we've had this week suggest that certain points in the article may potentially lead to further confusion among some law firms.


We want to make it clear that law firms can and should optimise their client money strategy so that they can take advantage of the current high interest rates in a fair and ethical way. 


It is important to remember that law firms must have a clear policy in place regarding the treatment of interest earned on client money, and that you structure your accounts appropriately in light of your firm’s day-to-day processes, the SRA Accounts Rules, and any financial risks that might arise. 


Although law firms are duty bound to pay clients fair and reasonable rate of interest on monies deposited, you can still leverage your aggregate pool of client money to access higher interest rates, then retain a portion of the income. To that end, we’ve helped our clients to better generate thousands of pounds of additional income.

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