In this column, Liz Coyle, the compliance policy manager at the SimplyBiz Group, reviews some of the biggest compliance news items of the past few months and suggests ways in which they might affect wealth management firms.

The Financial Conduct Authority’s recent mission statement suggested that it was looking at ways in which to lessen the regulatory burden that advisors had to shoulder. This is to be welcomed as the number of consultation papers and guidelines that the regulator has issued during 2016 is inordinate. The total number of papers published in the first nine months of this year stands at over 75, which is around two per week!

FS 16/11: Response to the Call for Input on regulatory barriers to social investments

In December last year, the FCA issued a Call for Input, with a view to exploring whether there were regulatory barriers holding up the development of the market for ‘social investments.’

Social investing is a ‘niche market’ at present and the regulator was seeking the views of all concerned – in particular those of the social enterprises themselves, along with those of financial advisors, other intermediaries (including crowdfunding platforms), consumers and consumer groups.

For those who are not currently involved, but who would like to understand this market better, ‘social investment’ is a broad concept which combines the idea that an investment can have a social ‘impact’ or ‘return’ as well as some form of financial return. This social impact or return is usually focused on a specific issue, geographic area or part of the population. HNW individuals often invest in enterprises that have a specific social objective as their primary goal.

HNWs can make social investments:

• directly in companies which are set up to achieve specific social objectives;
• by means of collective investment schemes which pool investors’ money and then invest in a range of companies that want to achieve social ends; or
• by means of ‘social impact bonds’ which aim to provide a specific service in return for a financial return if set levels of social impact are met.

 
The FCA is very clear that all of these routes to social investment involve risk to investors’ capital and that the expected social impact may not be achieved, so there may be no social return on capital and there may be no financial return either.

There is the very real risk that the social enterprises that receive the investments may prove to be unviable and fail, particularly as enterprises that try to achieve social ends often share a number of characteristics with ‘start-up’ companies in their early stages. As a consequence, there is a high risk that some or all of an investors’ initial capital may not be returned.

Taking these factors into account, we might find it helpful to look upon social impact investing as a form of venture capital, in a non-standard investment.
The role of the FCA in this sector is the same as for any other area where firms offer such investments to consumers. It aims to protect consumers from sharp practice and their own inexperience, and to maintain the integrity of the market.

This is a relatively new investment area and there is as yet no widespread understanding of its risks, rewards and potential vulnerabilities.

As this form of investment is ‘non-standard’ and may represent a higher risk than more conventional investments such as direct or collective holdings in shares, it is important that all communications to potential investors are clear, fair and not misleading when it comes to explaining the financial risks they are taking on. These are determined as complex, non-standard investments, and so it is important that an appropriate level of advice or disclosure is given on the financial risks inherent in making the investment. Many of these investments will be subject to the requirements of the Markets in Financial Instruments Directive (MiFID).

The FCA has some additional rules that are relevant for some types of MiFID investment, including social investments. These are as follows.

• Investments into non-mainstream pooled investments such as a unit in an unregulated collective investment scheme may only be promoted to retail investors whom firms have assessed and found to have met certain criteria in the FCA rules.
• There are restrictions on the promotion to retail investors of non-readily realisable securities, such as unlisted shares sold on crowdfunding platforms. Firms are asked to assess investors before making a sale and retail investors who do not take advice and are neither of high net worth nor ‘sophisticated’ are asked to commit to not invest more than 10% of their net investable assets.

MiFID II will come into force on 3 January 2018, introducing new ‘product governance’ requirements for firms manufacturing and distributing MiFID investments.

The jurisdiction of the Financial Ombudsman Service (FOS) to deal with complaints relating to the delivery of a social impact was raised as a concern amongst advisors, and the risk that an advisor might become subject to a complaint to the FOS over social outcomes could be difficult to predict or measure.

Regulated firms operating in this market are expected to consider the target market for social investments and also consider appropriate distribution strategies, to avoid consumer harm. The FCA has carried out this work in the context of the existing UK and EU regulatory framework. It remains under review as a result of the UK’s vote to leave the EU and any consequential amendments that may follow.

The FCA’s conclusions

The FCA wants to see the market for social investment develop in a way that provides appropriate ‘consumer protection’ and is sympathetic to the philanthropic motives shared by those who choose to invest in an investment because of its social purpose. It is in this spirit that the FCA made the Call for Input.

The regulator sees understanding the client as crucial. In particular, it is keen to focus on the key questions below.

• Is the client interested in the social impact only?
• Can he afford to lose all of his investment?
• Is he hoping for returns, but the primary objective remains a social one?
• Is he looking for returns with the social impact being a secondary objective?

Advisors need time to understand the market and to advise clients appropriately but, at the outset, the FCA sees nothing in its regulations that prevents them from doing this. The FCA will work with the FOS to give advisors, and their personal indemnity insurers, a clearer purchase on the type of complaints they may consider and how the FOS will weigh them up.

PS 16/23: Smarter Consumer Communications – Removing ineffective disclosure requirements from the FCA Handbook

This is the latest in a series of papers from the FCA on improvements to the ways in which we all communicate with customers/clients.

In simple terms, the FCA is removing the Initial Disclosure Document (IDD), the Combined Initial Disclosure Document (CIDD) and the Services and Costs Disclosure Document (SCDD) templates from its rulebook. This will give firms room to design communications to fit the needs of their customers.

In relation to the IDD and CIDD, firms may wish to continue presenting the information in the style of the templates. They are free to do so if they want but they must not use the templates themselves or use the Key Facts Logo after the rule has expired.

The FCA is also removing the template for the SCDD from its Conduct of Business Sourcebook. Again, firms may decide to present the information in the same way as in the templates, but will no longer be able to use the Key Facts Logo when the rules come into force.

The FCA will continue to expect firms to communicate in a way that is clear, fair and not misleading and to consider the needs of their customers in respect of information. They must be clear about the scope and costs of the service that they are providing. This change will take effect on 1 February 2017.

“Our Future Mission” – an FCA consultative exercise

As mentioned above, at the end of October, the FCA published a consultation on its ‘mission’. This has received wide coverage in the financial press. The objective of the paper is to “provide a guiding set of principles around the strategic choices the FCA makes.” I feel that this is a positive move on behalf of the regulator, with a clear acknowledgement of the need for a competitive commercial environment, in balance with an appropriate level of ‘consumer protection,’ especially for those who are ‘vulnerable.’

The FCA’s key objectives are set out in the Financial Services and Markets Act. It also follows a policy of saying what it wants to do, and why it wants do it, in each year’s Business Plan. This consultative exercise is intended to explain the FCA’s approach and to give the regulated community a clear understanding of its remit, the way it interprets its objectives when prioritise its work, and the way it chooses to deploy the many regulatory tools it has at its disposal to ensure that it is marshalling its resources in the ‘right place.’

The FCA asks a number of questions about important themes and invites replies to its proposals. These cover:

• the responsibility of consumers and their vulnerability, i.e. the task of striking a balance between the responsibility of consumers and the provision of appropriate protection for the ‘vulnerable’;
• the job of the FCA in encouraging change and innovation in the industries it regulates, including the job of balancing the benefits and potential pitfalls (for vulnerable clients, and possible on the subject of market abuse) of technological change;
• the way the FCA identifies harm and then decides what action to take to address it; and
• the interaction between regulation and public policy, i.e. where one ends and the other begins, including the influence of behavioural economics.

In the paper, the FCA is clear that a well-functioning market is not one without risk or one in which consumers can never lose or regulated firms can never fail. However, some markets have the potential to cause greater harm than others and some products present a more risk than others.

When the consultative exercise is over, the FCA intends to publish its final ‘mission’ document in the spring of 2017.

HM Treasury and the definition of ‘financial advice’

As outlined in the Fair and Effective Markets Review earlier this year, the Treasury is now consulting interested parties about its plans to revise its definition of ‘regulated financial advice,’ with a view to bringing it into line with the European Union’s definition, set out in MiFID.

As you may remember, the cause of this change was the Treasury’s belief that consumers face many complex financial decisions throughout their lives, and that they often want to, and often benefit from, seeking advice. The Treasury recognised that many consumers need guidance when making financial decisions, whether that means limited advice on a particular need, such as how to invest their spare income, or holistic advice throughout the years. For consumers with relatively straightforward financial needs or small amounts to invest, the cost of regulated advice may outweigh the benefits. Similarly, for some advice firms, it may not be profitable to provide those consumers with regulated advice. FAMR also found there was a growing trend towards consumers making and executing their own financial decisions, particularly online.

What difference will this make?

The main part of the MiFID definition concerns the giving of a personal recommendation, whereas the current definition, as contained in the Regulated Activities Order, is broader and less specific. The reason for the Treasury’s adoption of the MiFID definition is to ensure that it is “clearer for firms and customers and also much easier for firms to build into their compliance processes.”

Consumers are only to receive ‘regulated advice’ when they are offered a personal recommendation for a specific product. Please refer to the end of this article for the full definition of each.

The Treasury does not believe that this amendment to the definition of regulated advice will pose a significant increase in risk to consumers, from either regulated or unregulated firms that promote regulated products. Nor does it believe that this change will increase the risk of fraud significantly, as there will be a corresponding increase in access to guidance from regulated firms, thereby reducing consumers’ susceptibility to scams by unregulated entities.

As is often the case, however, it is not always as straightforward as this. There are good arguments both in favour of keeping the status quo and for bringing things into line with MiFID.

Definitions of ‘advice’

The regulated activity of ‘advising on investments’ under Article 53 Regulated Activities Order is wider in scope than ‘investment advice’ under MiFID. This is because MiFID requires advice to be of a personal nature, whereas the order does not.

For advice to be regulated under Article 53, it must:

• relate to a relevant investment, which might be a contract of insurance;
• be given to a person in his capacity as an investor or potential investor (or in his capacity as agent for an investor or potential investor); and
• relate to the merits of him buying, selling, subscribing for or underwriting the investment (or exercising rights to buy, sell, subscribe for or underwrite such an investment).

MiFID investment advice involves the provision of personal recommendations to a customer, either upon the customer’s request or on the firm’s initiative. It comprises three main elements:

• there must be a recommendation that is made to a person in his capacity as an investor or potential investor (or in his capacity as an agent for an investor or personal investor);
• the recommendation must be presented as suitable for the person to whom it is made or based on the investor’s circumstances; and
• the recommendation must relate to taking certain steps in respect of a particular investment which is a MiFID financial instrument, namely to buy, sell, subscribe for, exchange, redeem, hold or underwrite a particular financial instrument (or exercise a right to buy, sell, subscribe for, exchange, or redeem a financial instrument).

 
* Liz Coyle can be reached on +00 44 (0)1484 439 100