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TCC's regulatory update for the end of July

Regulatory Team, TCC, London, 28 July 2017

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This month the UK's Financial Conduct Authority has released its proposals to make 'defined benefit' (DB) transfers for customers better, its final policy statement about the implementation of MiFID II and the terms of reference for its investment platforms market study.

DB pension transfers in the spotlight

The DB transfers market has seen a surge in demand because of the 'pension freedoms' of 2015, the year when HM Government stopped requiring people to purchase annuities with their 'defined contribution' pensions and gave them several other options. The regulator’s concerns in this area have been well publicised. To address this, it has published a consultation paper, CP17/16, entitled "Advising on Pension Transfers," which looks at how advice about pension transfers should be provided for consumers with safeguarded benefits.

Why is the FCA asking about this?

The consultation paper outlines the regulator’s view about the issues it believes are affecting the quality of the advice that customers are receiving, including:

  • firms placing too much reliance on the Transfer Value Analysis (TVA) and failing to take the client’s personal circumstances into account;
  • the possibility that TVAs might not be very helpful to consumers, especially because they have been expanded to include numerous options, depending on how customers choose to access their funds;
  • poor practices relating to the methodology and 'personalisation' of TVA, resulting in critical yields that do not uncover the true risk of transferring;
  • poor communication, especially in respect of volatility and "transfer risk."

What is the FCA proposing?

The FCA is proposing that any advice given about the transfer or conversion of safeguarded benefits should include a personal recommendation. This ought to protect the customer in question from sharp practice and enable him to make informed decisions.

Although the FCA believes that the retention of safeguarded benefits will be in the best interests of most consumers, it is proposing to retract its existing guidelinnes that assume that a transfer is unsuitable until evidence is available to the contrary.

The FCA is also consulting interested parties about its plans to stop advisors from concentrating exclusively on TVAs, which have become less relevant to the advice that clients need. It proposes to replace TVA with an overarching requirement for each advisor to undertake an appropriate analysis of his client’s options, referred to as the Appropriate Pension Transfer Analysis (APTA), which should include:

  • an assessment of the client’s outgoings and potential income needs throughout his retirement;
  • the role of the ceding scheme in meeting those needs and any other sources of income;
  • consideration of any death benefits, on a fair basis; and
  • the prescribed Transfer Value Comparator or TVC.

FCA fines compliance officer for DB transfer failings

The FCA has recently fined a compliance officer £75,000 for failing to oversee approximately 500 DB transfers with a combined value of approximately £12.7 million.

The individual in question was authorised to perform the 'controlled functions' known as CF10 (compliance oversight), CF8 (apportionment and oversight) and CF4 (partner) at two firms, but FCA investigators found that he failed to exercise due skill, care and diligence in performing his duties, failing:

  • to gain a sufficient understanding of the FCA rules that were relevant to the firms;
  • to set up a compliant advice process and hire someone from outside the firms to review it; and
  • to take reasonable steps to identify and manage conflicts of interest inherent in the two firms’ operations.

This led to unsuitable pension transfer advice being given to retail customers. In many of the cases, the enhanced transfer value (ETV) analysis led to customers transferring their pension unnecessarily from DB schemes to defined contribution (DC) schemes, thereby losing their guaranteed benefits.

This personal fine that the FCA has levied should serve as a warning to all CF10s in firms that write this type of business or want to scale up their activity. It seems as though the regulators will keep looking at DB transfers, so it is important for every firms that operates in this area to review its advisory process thoroughly to meeting regulatory expectations.

The final MiFID II policy statement

The FCA has released its final policy statement about the implementation of the European Union's second Markets in Financial Instruments Directive. PS17/14 outlines the regulator’s rules to do with a range of conduct-related issues, including clients' assets, inducements, best execution, research and taping.

The FCA received a lot of feedback on the consultations relating to the policy statement and, as a result, has made significant changes to its proposals in certain areas, while pursuing the proposed course of action in others.

Key changes of which firms should be aware

* Changes to the FCA’s Client Assets Sourcebook (CASS) on the subject of MiFID II are not extensive, as the directive is broadly aligned to the UK's current regime, but they include:

  • a requirement for firms to have appropriate measures in place to prevent the unauthorised use of clients' assets;
  • an extension of the safeguarding provisions to third-party custodians who themselves delegate things to sub-custodians;
  • the need to obtain explicit consent and undertake appropriate internal assessments when placing clients’ money into a qualifying money market fund (QMMF).

The FCA will also continue with its "single rulebook" approach.

* Complaints Handling. The FCA will not extend the MiFID II complaints handling rules to all complaints, or to the way in which data about complaints is submitted, but will provide 'updates' about the ways in which it publishes data about complaints so as to make it clear which data relates to eligible MiFID II-related complaints.

* Inducements. Feedback from the industry supported consistent inducement standards fpr all advisors and the FCA plans to consult interested parties about amendments to the inducement rules to make it clear that advisory firms cannot continue to receive significant hospitality or inducements from product providers.

* Taping. The FCA consulted the industry about its idea of extending the MiFID II taping requirements to all corporate finance businesses, but has been dissuaded from doing so. "Article 3 firms" may now opt to take notes from telephone conversations rather than record them. They must, however, do so consistently in every case and the notes will have to detail any order taken, along with the gist of each conversation.

* Best Execution. Existing rules regarding best execution (COBS 11.2) will be replaced by the new COBS 11.2A, which contains MiFID II’s requirements for best execution. It also retains some of the existing 'handbook' guidance. The regime will be extended to "Article 3 firms," aside from the additional annual reporting requirements.

* Independence. The FCA will adopt MiFID II's standards for independence and provide additional guidance to help firms show it that they are meeting these new standards consistently. The regulator will apply it across the board to advice about financial instruments, structured deposits and other retail products that have nothing to do with MiFID II.

Disclosure. The policy statement outlines new disclosure requirements for undertaking MiFID II business in relation to:

  • cross-selling/ bundled products or services;
  • more detailed post-sale reporting requirements; and
  • a revised requirement to retain records for a minimum of five years.

The FCA will not introduce a standardised format for point-of-sale or post-sale disclosure, but will continue to work with the industry to develop a standardised format.

FCA embarks on Investment Platforms Market Study

The FCA has published its terms of reference for a forthcoming investment platforms market study. The regulator initially raised concerns about competition in its "asset management market study interim report," published in November 2016.

The FCA’s overarching aim is to find out whether competition between investment platforms works in the interest of consumers and whether "investment solutions" are cheap enough. On this subject it intends to concentrate on five core areas.

1. Barriers to entry and expansion. The FCA intends to explore the possibility that larger platforms benefit from economies of scale than smaller ones (or new market entrants) cannot achieve. It also wants to know whether its regulations are affecting competition within the market and will consider the usefulness of third-party IT to the market.

2. Commercial relationships. Platforms can influence, and be influenced by, other aspects of the value chain and this, in turn, can affect the "value for money" that the end customer receives. The market study will try to find out how investment platforms interact with other parts of the value chain and will explore the nature of existing commercial relationships.

3. Business models and the profitability of platforms. The regulator will review platforms’ business models, looking at the part that 'vertical integration' (where a company expands its business operations into different steps on the same production path) plays as it does so. The FCA is likely to focus on the degree to which vertically integrated firms have identified, and are mitigating, conflicts of interest.

On the issue of profitability, the terms of reference make it clear that there are certain charges and revenue streams that platforms make or retain. Because the asset management market study found that customers have a limited understanding of basic charges, it is likely that this market study will reach similar conclusions and may lead to similar remedies.

4. The "impact of financial advisors." The terms of reference indicate that the FCA is keen to explore the extent to which platforms are designed with the end customer in mind. It will probably be keen to inspect intermediated platforms' rules of governance to find out whether advisors have been influencing them. This indicates that the regulator might be worried that platforms are geared too heavily towards benefiting the advisor rather than the end customer.

5. The preference and behaviour of customers. For the market to function effectively, consumers should be able to access products that meet their needs and expectations. The FCA intends to assess the extent to which this happens in the market and the reasons behind any discrepancies, as well as the way each firm considers consumers' preferences and behaviour at the design stage. Depending on the outcome, this may result in the FCA advocating an RPPD-type (responsibilities of providers and distributors for the fair treatment of customers) consideration or MiFID II-style governance approach within the market.

The Retirement Outcomes Review

The FCA has published some 'interim findings' from its study of the retirement income market. It reports that consumers have been changing their behaviour in the following ways.

  • They now access their retirement pots earlier. People under 65 have accessed 72% of pots, mostly to release lump sums.
  • Full withdrawal is increasingly popular. 53% of accessed pots have been withdrawn fully, with 94% of the people who withdraw their pots in full also having other sources of income.
  • Drawdown is "number one." Twice as many pots are moving into drawdown than are moving into annuities.

The regulators voice the following concerns in their report.

  • 52% of fully withdrawn pots were subsequently transferred into other savings or investment vehicles, which may be partly attributable to a lack of trust in pensions. However, the regulator is worried that "consumer detriment" might arise from this approach.
  • A high proportion of consumers opt for the path of least resistance, taking the option offered by their pension provider without shopping around. This indicates weak competitive pressure in the market and the FCA wants to find out whether consumers are benefiting when moving into drawdown without taking advice.
  • The proportion of consumers who enter drawdown without taking advice has risen from 5% to 30% and the FCA is wondering whether they need more support and 'protection' to manage the drawdown process effectively.
  • Consumers have less choice when shopping around on the open market because annuity providers are leaving the market.
  • The FCA has not seen the amount of innovation that it once expected in the market, but also sees no significant regulatory barriers to innovation.
  • The FCA has outlined four remedies that it thinks might allay its concerns.
  • Additional 'protection' for consumers who enter drawdown without advice.
  • Measures to enable consumers to access their savings early without the need to move to a new drawdown product.
  • Making it easier to compare and shop around for drawdown products.
  • Helping consumers understand their options now that they are experiencing the UK's "pension freedoms."

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