Navigating the changing nature of escrow
Article 4 minute read

Navigating the changing nature of escrow

26 September 2018

Despite playing an important role in many major transactions, escrow - the holding of assets such as cash, securities, contracts or other collateral on behalf of the parties involved in the transaction until key processes are concluded - is often taken for granted.

This is both because it’s perceived as a relatively straightforward service, and because traditionally there have been a wide range of parties willing and able to offer it - particularly banks and law firms. Yet this is changing in a way that we believe warrants attention, and builds the case for independent escrow services.

Law firms leaving escrow alone?

The escrow landscape is changing in several ways. Firstly, law firms are increasingly being discouraged from providing escrow services, most notably in the UK by the Solicitors Regulation Authority (SRA). There are good reasons for this. Separating legal counsel and escrow services helps ensure law firms maintain a degree of independence and are less exposed to money laundering and other risks associated with holding client assets. It also encourages law firms to focus on higher-value advisory rather than administrative services, and prevents the co-mingling of client funds and expenses.

It should be noted that the SRA’s view takes the form of recommendations rather than regulation, and it is not yet clear to what extent this call will be taken up in other jurisdictions. Nonetheless, given the potential benefits we expect more law firms to reconsider offering escrow services, and more such firms and their clients to seek alternatives. 

Banks getting choosier

The second example of industry change is banks, who, like law firms are altering the way they engage with escrow.

Rising compliance pressures have made banks more reluctant to support some transactions. One dramatic example is “ship-closing” escrows. When a ship is bought and sold when still at sea, the parties often turn to banks to hold the necessary funds in escrow for a short period of time. Unfortunately for banks, emerging capital frameworks such as Basel III will make it harder for banks to hold such short-dated escrows on their balance sheets. Furthermore, due to the complications of transactions at sea, there is a small but real risk in such transactions that banks could find themselves holding an asset which falls foul of international law. 

None of this is to say banks will avoid escrow services altogether. But they are getting choosier, and the willingness to extend these services will increasingly depend on the relationship with the client - and the potential for profit.

Together, these factors will encourage more firms to explore independent escrow providers. Indeed many such providers have emerged recently, leaving clients with no shortage of options. But that leads to the question - how do you choose the right one? From our point of view there are several important factors to consider: 

The balance of flexibility and governance

A significant advantage of independent escrow providers is that they are generally not subject to the same regulatory obligations as banks, allowing them to be more flexible in terms of the transactions they accept and clients they are willing to onboard. At the same time, this creates an element of risk, since an escrow agent that lacks established governance processes, or fails to apply the requisite due diligence on a transaction and the counterparties involved, can expose the client to regulatory or reputational damage, and even the potential loss of assets.

While not regulated in the same way as a bank, TMF Group is just as thorough and robust in terms of governance and KYC processes, providing the assurance needed in a compliance-driven environment. At the same time, not being a bank, we are more neutral and able to put client interests first; we do not insist clients have a prior relationship with us, or deposit escrow assets with us so we can reap the balance sheet impact.

International footprint and experience

Many independent escrow providers (and indeed many banks) lack the onshore presence across markets to support complex cross-border transactions. The importance of local market knowledge, even in a seemingly simple escrow arrangement, cannot be overstated. In China, for example, the law does not technically recognise the ability to hold funds on behalf of multiple parties, meaning escrow agreements may not stand up to a challenge in court. And a number of ex-British colonies, such as India and Pakistan, attach criminal liability to the language around trusts, meaning escrow documentation needs to be worded in a way that does not leave those involved exposed. TMF Group has the resources, global network and on-the-ground experience to navigate these international variations.

For further information on TMF Group or our escrow services, please feel free to make an inquiry

 
Written by

Paul Wilden

Head of Capital Markets Services

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