May has seen the UK's Financial Conduct Authority publish its review of automated investment services, along with the facts that it has gleaned while inspecting assets that are hard to value.

In both these reports the regulator says that there is room for improvement and that all relevant firms should think of making improvements in relation to their own practices. We also bring you details of the FCA’s interim mortgage market report and new guidance on variation terms under unfair contract terms legislation.   

Innovation to help customers choose the best mortgage deals

The FCA has published an 'interim' report on its mortgage market study, which says that competition in the market is working well for many consumers. However, the FCA has identified a number of additional ways in which the market can help consumers (and especially ‘mortgage prisoners’) to find the best deals.

The things that are working well are as follows.

• A large proportion of consumers are 'engaged'.
• There is a wide range of products on offer and evidence of price competition.
• There is little evidence that commercial agreements between firms are causing consumers harm.

Ways in which the market could work more effectively are as follows.

• It could make eligible mortgage products more accessible at an early stage to help consumers compare and access mortgages.
• The removal of "barriers to innovation" in the mortgage sales process.
• The provision of greater support for consumers who are trying to choose intermediaries.
• Fair treatment for mortgage prisoners.
• It could weigh up ways of helping long-standing customers switch mortgages.

The 'interim' report is designed to let interested parties understand and comment on the FCA’s view of how the sector is working. The mortgage market study's final report is expected at the end of the year and will contain some proposals for action.

Alongside its 'interim' report, the FCA has published three so-called occasional papers, which are as follows.

• Occasional Paper 33: Choices of dominated mortgage products by consumers in the UK – this explores the phenomenon of product dominance and whether consumers are missing out on cheaper deals as a result.
• Occasional Paper 34: Effects of "the advice requirement" (which, since 2014, has dictated that each firm should provide regulated mortgage advice with every 'interactive' mortgage sale, whether conducted by a lender directly or an intermediary) and intermediation in the UK mortgage market – this investigates the effect of that Mortgage Market Review (MMR) advice requirement on people who opted not to take advice before its implementation and the post-MMR effect of obtaining advice through an intermediary; and
• Occasional Paper 35: Choices of intermediary in the British mortgage market – this paper investigates the things that might cause mortgage prices to vary between intermediaries.

FCA fines and penalties

At the FCA's request, a court has issued confiscation orders totalling £1.69 million against two people who were found guilty of insider dealing in relation to five stocks.

Using an elaborate strategy, the pair managed to keep their activity under cover. They used unregistered mobile phones, encrypted records and safe deposit boxes, but their meticulous records served as sufficient evidence of their criminal activity.

The director of a debt management company was found to have used client money to fund the purchase of another firm. To the FCA, this demonstrated a lack of honesty and integrity. The regulator believes that this person was aware of his obligations to only use the money to pay customers’ creditors, or else return it to them. Instead, he used it to fund the purchase of another company at a time when the original firm had a client money shortfall of more than £6 million.

The FCA has published a decision notice outlining its findings and conclusions in which it bans the individual from performing any regulated activity in the financial services industry, stating that his actions show that he is not a fit and proper person. This decision is being disputed and therefore the decision notice currently has no effect, pending a judgement by the Upper Tribunal.  

New guidelines for variation terms

The FCA has published a consultative paper which contains its suggestions for guidelines to govern the factors that firms ought to consider in accordance with the Consumer Rights Act 2015 when putting variation terms in their contracts.

The regulator has concentrated on the fairness of terms that enable firms to vary [i.e. unilaterally change] the terms of contracts without the prior consent of their customers, although most firms do give them notice of such things. The FCA admits that fair unilateral variation terms can benefit both firms and consumers, but it is worried about such terms not being fair, or being drafted incorrectly, with harmful consequences for consumers.

The guidelines it proposes cover a number of things that each firm should consider when drafting or reviewing variation terms, including:

• the validity of the reasoning for the variation term;
• whether the term is intelligible;
• whether the firms is providing consumers with adequate notice as part of the term; and
• the ability of consumers to 'exit' their contracts if they are not willing to accept variations.

Retiring FG12/15 and FG14/1

The FCA is 'retiring' both FG12/15 (entitled "Retail Distribution Review: Independent and restricted advice") and FG14/1 (entitled "Supervising retail investment advice: Inducements and conflicts of interest"), with immediate effect as both publications have been superseded by recent regulatory developments, including the European Union's second Markets in Financial Instruments Directive (MiFID II).

MiFID II introduced new requirements for the description of advice services, rendering the guidelines to be found in FG12/15 ineffective. FG14/1 has also been superseded by changes to the FCA’s inducement and advisor-charging rules. Its proposals to 'retire' these documents first appeared for public comment in PS17/25 (entitled "Financial Advice Market Review (FAMR) implementation part II and consultation on retiring FG12/15 and FG14/1") and the public supported them in the main.

Regulator releases summary of its work on assets that are hard to value

Last year the FCA made efforts to understand how asset management firms value assets that they find ‘hard to value’ as conflicts of interest may arise in this area, particularly if incentives exist to inflate the market price.

The FCA expects firms to ensure that all independent valuations are conducted with due care, skill and diligence. If an alternative investment fund manager (AIMF) conducts the valuation, he/it must be independent of the portfolio management process.

As part of its review (the name it gives to such efforts), the FCA examined the valuation of unquoted equities, fixed income instruments and private equities at several firms of different types. It found room for improvement in the way they were valuing these assets. The FCA’s head of asset management, Nick Miller, outlined the regulator’s expectations in a public video, calling for the following.

• Genuine valuation expertise to be found among portfolio managers and in the "second line of defence" (risk and compliance management) at firms, the aim being to "provide independent challenge."
• Valuation committees which provide genuine, robust and effective "challenge" while also taking overall responsibility and accountability for the valuation process.
• Depositories checking to see that the valuations process works well rather than approaching it merely as a box-ticking exercise.
• Firms being able to prove to it that their people are obeying their policies "in a meaningful way" every day.

Regulatory expectations for automated investment services

The FCA, which has the never-ending job of monitoring the developing automated investment services market, has undertaken two reviews of firms that offer such services. The first involved seven firms that offered automated online discretionary investment management (ODIM) and the second looked at three early entrants in the automated advice market. The findings of these two reviews will help the regulator decide how to supervise this market.

Both reviews uncovered some weaknesses and the regulator has spoken to each firm about its failings. Many of them have made significant changes to their processes as a result and the FCA is keeping an eye on progress. Its main findings were as follows.

Disclosure

The FCA found that most of the ODIM firms in its review were not telling consumers about the nature of the services they were providing (and the related fees) in a clear way. Some did not state clearly whether a service was advised, non-advised, discretionary or non-discretionary; some compared fee levels with alternative services in a potentially misleading manner. The FCA's rulebook, of course, obliges all firms to ensure that information, including fees, that they provide to customers is clear, fair and not misleading.

Suitability

Automated advice services, like any other discretionary or advice services, must include suitability assessments that ensure that customers receive a personal recommendations that are suitable for their needs.

The FCA says that:

• firms that thought that their services were suitable for a wide range of investors failed to gather adequate information about the  knowledge and experience of those investors;
• some streamlined advice models failed to gather enough know-your-customer (KYC) information as part of the 'fact find' process;
• advisers were intervening in the advisory process without recording the nature of their intervention, making it difficult for their firms to show regulators that the advice was suitable for the customers' needs; and
• some automated advice services allowed customers to disregard recommended options without first seeing adequate risk warnings or safeguards.

Vulnerable customers

The regulator spotted weaknesses in the ways in which firms identified and treated vulnerable customers, especially when dispensing some services that required customers to identify themselves as vulnerable. The FCA urged firms to think of more effectively ways of identifying and supporting vulnerable customers at all stages of "the customer journey."

Governance

The FCA found little evidence that firms had given adequate thought to the risks that it associated with automated advice, notably in the areas of cyber-security, 'outcome testing' and stress testing.

On the whole, the management information (MI) collected by the services that the FCA was reviewing concentrated on compliance, operations, risk and marketing, but the regulator believes that firms ought also to consider the ways in which they review the 'outcomes' they generate. Some firms were able to show it that people were overseeing all their services at every stage, some were unable to demonstrate a clear allocation of responsibilities.