Our resident British compliance consultant looks back on an eventful year and forward to the new one that has just begun.

When 2016 began, I am not sure that many could have predicted what was to come. Certainly, for those working in and around financial services, it has been a rather testing 12 months – what with Brexit and the aftermath that ensued, through to the ‘shock’ presidential elections across the pond and wider political unrest across Europe, there has been much to keep us on our collective toes.

An avalanche of CPs

People who were hoping for quieter times to allow them to respond to everything else that was going on were to be disappointed. 2016 began with an avalanche of consultation papers and although we may have had a ‘quieter’ summer (it’s all relative), things have been hectic throughout.

To end 2015, and to give us something to get our teeth into from the outset, the FCA published a thematic review of the suitability of investment portfolios, TR15/12. Although the review was not directly targeted at retail investment advisors, it did serve as a helpful reminder to firms that recommended investment portfolios to their clients, with examples of good and poor practice included as a benchmark.

This paper demonstrated the importance that the regulator placed on three important areas, namely:

• on regularly reviewing and updating information about clients including such ‘soft facts’ as their family circumstances, aims and objectives, as well as hard facts, for example changes in income and outgoings, value of assets and where they are held;
• on firms adopting a structured investment process in every case, reviewing clients’ goals and ensuring that the investment portfolios that the firms recommend are aligned with the clients’ objectives; and
• on the regulatory need to look again at each client’s circumstances and risk profile during each review.

It is important, however, for firms to review all processes at regular intervals with the aim of ensuring (and being able to show the regulator) that they remain appropriate and continue to yield the right results for clients.

Moving into March, we saw the outcome of another of the regulator’s ‘thematic’ reviews – TR16/1, which was entitled “Assessing suitability: research and due diligence of products and services.” Although the sample of firms that the regulator reviewed was small and the results told us nothing new, it did stand as a reminder to firms to do various things, which included the following.

• Use a platform. The review underlined the importance of researching platforms and being ‘duly diligent’ on a regular basis (at least annually). It used the phrase "research and due diligence" to refer to the process that a firm follows when assessing the nature of the investment and its risks and benefits and deciding whether it is appropriate to entrust the provider with clients' assets. The FCA’s review stated that firms can often have an “if it isn’t broke, don’t fix it” attitude and this can lead to failures if they are not monitoring the ‘solution’ continually to ensure that it provides suitable results, for both the firm and its clients, when compared with other ‘solutions’ that are available.
• Challenge the sales process. It is important for firms to carry out their “research and due diligence” reviews at regular intervals and challenge the results of these. Such an exercise will help them test the suitability of this-or-that arrangement for each client. They should also challenge the information they receive from service providers before relying upon it.

All of this was supposed to be the warm-up act for the eagerly anticipated final report from the Financial Advice Market Review or FAMR which, as we all now know, was something of an anti-climax. The review covered a lot of key subjects and I think that most of us were expecting results on a par with those from the Retail Distribution Review.

I think we can all be happy to have avoided unnecessary disruption, but it is worth bearing in mind that the final report does not say “continue as you were, everything is fine.” In fact it lists a great number of areas about which additional consultation will be taking place.

The implementation of RDR arrived with one big bang in January 2013; it is too early yet to guess whether we are going to feel any aftershocks from FAMR in the coming months!

So what else happened last year?

In early April, the regulator wrote to the vast majority of firms to tell them that, with immediate effect, they could now add a new regulated activity called “advising on peer-to-peer (P2P) agreements” to their existing ‘permissions.’

The Chancellor of the Exchequer had already announced in his budget speech of 2014 that he would be introducing the Innovative Finance Individual Savings Account (IFISA), which would let P2P lending agreements be included in ISA tax wrappers. At the same time, the act of advising people about P2P agreements would become a regulated activity. These changes came into effect on 6 April.

If you currently hold permission for the regulated activity of “advising on investments,” you will automatically have had your permissions varied to add the new regulated activity of “advising on P2P agreements” with effect from 6th April onwards. Although this suggests that it will only be added to firms that hold ‘investment permissions,’ it should be noted that some ‘non investment’ firms that have permission to give people advice about investments for the purposes of non-investment insurance mediation business will also be caught up in the changes.

The annual business plan

Later that month, the FCA released its business plan for 2016/17, which set out its work programme and priorities for the coming year. Alongside the analysis of the medium-to-long-term risks set out in the document’s risk outlook, the FCA also brings together the intelligence that it collects from a wide range of sources to “form a common view” (an unexplained phrase) of each of the markets and sectors that it regulates.

From here, we know what the FCA’s seven areas of priority are for the year ahead, which include the following five.

• Pensions. This is an important sector in view of fundamental changes that have befallen the market. The FCA will look all over the sector to ensure that its policies support the provision of fair treatment for customers and encourage competition.
• Financial crime, including money laundering. The British financial system is a major global hub that attracts investment and activity – and therefore crime – from all over the world. The FCA emphasises the importance of ensuring that financial crime regimes are proportionate and operate efficiently, and that any unintended consequences of regulation are minimised.
• Advice. Because the needs of consumers are changing and because the Government has reformed the pensions scene, access to affordable, professional advice is now more important for consumers than ever. A well-functioning advice market is crucial if people are to access the support they need to make informed financial decisions at all stages of their lives.
• Innovation and technology. Technology plays a fundamental and increasingly pivotal part in the evolution of innovative products and services. The FCA has a part to play here, by ensuring that firms’ IT and systems become more resilient to cyber-attacks and more traditional outages, safeguarding consumers and markets and building confidence in the effectiveness of financial technology.
• Firms’ governance and culture. The FCA wants to see firms managed in a way that promotes the right culture.

Moving on, back in December 2015, the regulator outlined plans for changes in Capital Adequacy, which came to fruition in June of this year. The ‘new’ Capital Adequacy requirements were outlined in a policy statement (PS15/28) entitled “Capital resources requirements for personal investment firms (PIFs): feedback on CP15/17 and final rules” and came into effect on 30th June, which in summary were:

the higher of; £15,000 (from 30 June 2016) followed by £20,000 (from 30 June 2017)

OR

5% of investment income plus, 2½% of any non-investment insurance and mortgage income.

In August, the regulator said that it was concerned about consumers being referred to authorised firms. This is not a new phenomenon and the regulatory dangers have been highlighted many times over and are all too plain to witness where authorised firms switch personal pensions into self-invested personal pension (SIPP) arrangements to make use of non-mainstream investment options, often doing so on the direct instruction of the customer.

When customers are adamant

As the trade press often shows, authorised firms run substantial risks when they comply with direct requests from their customers to invest in highly risky, unregulated (and often offshore) investment options or accept business from an introducer. Sometimes they deal with introducers on an execution-only basis or even involve them in the investment process. Despite all these known dangers and regular notices from the regulator, they carry on regardless.

It is vital for you to protect the interests of your firm and to do this you should make sure that an agreement is in place with your introducer(s) that sets out the responsibilities of (and the relationship between) each party with the utmost clarity.

As you can see, the old year began with a busy few months. Although there were many more regulatory happenings, these are the more pertinent ones.

The MiFID II consultative paper

The summer months were perhaps a little quieter, but in October and the regulator released CP 16/29, which it entitled “Markets in Financial Instruments Directive (MiFID) II – Consultation on the Conduct of Business standards.”

This consultative paper follows a discussion paper of March 2015 to which the SimplyBiz Group responded. We shared our concerns with the regulator because MiFID II arguably represents the most significant change to the FCA’s “conduct of business” rules since the implementation of the RDR.

The Markets in Financial Instruments Directive (MiFID) is a piece of European Union legislation for:

• investment intermediaries that provide services to clients in respect of shares, bonds, units in collective investment schemes and derivatives (collectively known as ‘financial instruments’); and
• the organised trading of financial instruments; and
• these ‘financial instruments’, often termed UCITS (Undertakings for Collective Investment in Transferable Securities).

MiFID does not classify pensions, insurance-based investments and structured deposits as ‘financial instruments.’

The reason why MiFID rules do not apply to all investment business is that the EU is preparing a further law called the Insurance Distribution Directive. This focuses on the aforementioned investment business which MiFID does not cover. It is likely that it will produce similar results but we must wait until the regulator consults parties about it before we can gauge its full effect.

Areas of greatest relevance

The MiFID II paper covers a wide number of different subjects that relate to the FCA’s “conduct of business” standards but not all are relevant to advisory firms that deal with retail clients. The areas of most relevance are as follows.

• Inducements, including ‘advisor charging.’ There is actually no change in either of these two areas. MiFID II brings the EU in line with the requirements set out in the RDR and it is therefore business as usual in this area. The only notable exception to this is that commission payments are now banned for all types of client (professional and eligible counterparties) including portfolio managers. As for inducements, acceptable minor non-monetary inducements remain and are those allowable under the current rules in COBS, the FCA’s conduct-of-business sourcebook. These include the provision of seminars, conferences and other training events, together with hospitality at events (food and drink).
• Client categorisation. This has little or no impact on the majority of firms. Here the FCA proposes criteria for the opting up of local authorities (and local authority pension schemes) from retail client status to elective professional client status.
• Disclosure requirements. The FCA proposes changes to implement the wide variety of disclosure requirements in MiFID II. These include information about the firm and the products it sells, and the disclosure of costs and charges. These are consistent with the level of disclosure that firms are already required to provide to their retail clients. Whenever continuing relationships exist, firms will have to state charges at least annually. The rules that govern the content of financial promotions remain in a prescribed format but will apply to all categories of client.
• Independent investment advice. In response to the MiFID II discussion paper, SimplyBiz made the case that the FCA should align its definition of ‘independence’ to that in MiFID. MiFID II states that an investment firm that provides independent advice must “assess a sufficient range of financial instruments available on the market which must be sufficiently diverse with regard to their type and issuers or product providers to ensure that the client’s investment objectives can be suitably met.”

We are encouraged to see the FCA proposing to apply MiFID II’s standard of ‘independence’ to personal recommendations. This is a watering-down of the current requirement to demonstrate independence, as it only calls on firms to consider a sufficient range of retail investment products, being both MiFID and non-MiFID products, that can suit their clients’ objectives. In other words, they need not consider all retail investment products. While proposing this definition of ‘independence,’ the regulator says that firms must continue to consider cash ISAs (individual savings accounts) and National Savings and Investments products.

Firms may continue to be independent within a ‘specialist’ area such as ‘ethical’ investments or ‘pensions’ as long as they disclose this in a suitable way.

The directive does remove one option: an individual advisor can no longer be both independent and ‘restricted.’ The FCA always allowed this on the understanding that the client would receive enough information to be able to form an accurate opinion of the nature of the service he was receiving. The directive, however, states that only a firm and not an individual can provide both independent and restricted advice. The FCA is therefore not canvassing opinion about this and will simply incorporate this point into its rules when the time comes.

The compliance community has much to look forward to in 2017. I wish you all a Happy New Year.

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