It is more than two years since the Financial Conduct Authority (FCA) extended its rules relating to the promotion of unregulated collective investment schemes (Ucis) to retail investors, emphatic in its view that ordinary consumers are vulnerable in the face of such products.
In basic terms the expanded restrictions mean that a regulated firm cannot promote a group of similar asset classes known as non-mainstream pooled investments (NMPIs) to the majority of retail clients. NMPIs include Ucis as well as qualified investor schemes, traded life policy investments and special purpose vehicles. Although the restriction relates to the promotion of NMPIs, it is likely to extend to advice too (as advice necessarily involves a promotion).
With NMPIs, the bar is high in terms of compliance processes and firms must meet this challenge head on.
For advisers, it is essential to consider situations where it is permissible to promote to or advise clients on NMPIs.Although there is a broad exemption for non-retail clients in the FCA Handbook (see the Conduct of Business sourcebook, COBS 4.12), there is a much narrower range of exemptions for retail clients who can be advised on this asset type. Most advisers will be interested in exemptions relating to the following groups of retail investors:
• certified high net worth investors,
• certified sophisticated investors, and
• self-certified sophisticated investors.
The firm must show it has taken "reasonable steps" not to promote an NMPI to an 'ordinary' retail client (that is, those to whom an exemption does not apply) or has directed an NMPI at clients in a way that has been designed to reduce the risk of an ordinary retail client engaging. The detail of COBS 4.11 is important in this context.
Simply complying with a financial promotion exemption is not of itself sufficient to meet a firm's regulatory obligations. The firm's compliance officer must certify that any promotion complies with the FCA rules on NMPIs and in doing so the record must cite which exemption was relied on and on what basis.
Added to that the firm must take reasonable steps to establish a client actually falls within the exempt category relied on. A key challenge then is to ensure that the firm works with the client to demonstrate their category appropriately and not just rely on self-declaration – for example, a certified high-net-worth (HNW) investor is a client that has certified their financial position, but COBS 4.12 requires a firm to take reasonable steps to assess that is correct.
Accordingly, firms must have in place the relevant certificates, fact-finds, and evidence.
Firms should also ensure procedures build in, as part of client take on and file review processes, the signing of HNW/self-certified sophisticated investor certificates (for applicable clients), and the timetabling of certificate renewals.
Assessments for certificates must be undertaken with due skill, care and diligence. This requires firms to look at the substance of a client’s ability to take a proper decision, not just at the form of an exemption certificate.
Advisers must question inconsistent or unclear answers. As firms need to act in their clients’ best interests, firms must be satisfied that it is fair and in the clients’ interest to promote any given NMPI to them, particularly given the FCA's view that NMPIs are unlikely to be suitable for ordinary retail investors.
There are no prescriptive standards for these assessments. Firms must track a careful path between client experience, regulatory requirements and adopting compliance standards that place it competitively. But this is an area that warrants some caution.
Another important assessment is ascertaining, on a preliminary basis, whether suitability requirements are met before advising the client on an NMPI. A more rigorous COBS 9 assessment of suitability must be made at the appropriate stage to ensure that personal recommendations (investment advice) are suitable.
For a self-invested personal pension (Sipp), any such investment must be a permissible investment under the scheme as well.
Within the context of advised services, the firm must consider "treating customers fairly" and general conduct. It needs to ask itself if it is fair to advise that client to invest. In terms of risk management, the client should be able to evaluate the product, properly.
Is this really compatible with their knowledge and experience; financial situation; and investment objectives? Also, the FCA is clear that a firm’s paramount duty is to act in its clients’ best interests. These are relatively high standards. As a result of such rules, record-keeping and evidence is important.
The obligation to ask introspective and searching questions about the client base generally and specific clients is heightened when dealing with NMPIs. Following a review of 150 files from 15 firms (see TR 15/12 9 December 2015), the FCA extrapolated that 59 per cent of advisory client files did not meet expected suitability standards – a key challenge area when dealing with riskier and more exotic investment types.
An early consideration must be to identify and understand the characteristics of the NMPI in question. Recent FCA Thematic Reviews (TR 15/12 and TR16/1, 19 February 2016) found that many firms do not meet the FCA’s standards, particularly relating to their research and due diligence assessments.
The FCA considers sound research and due diligence to form a central part of the advice process, making it easier to demonstrate that the firm places client interests at the heart of its business model.
Investment selection integrity is a consideration whether clients invest through a wrapper like a Sipp or not.
Suggesting advisory firms invest additional levels of time and effort researching products and providers reflects an obvious continuing concern about the potential for retail investors to find themselves involved in investments that are almost certainly wrong for them. It may not be enough to rely on sales discussions, marketing and assessments from the provider firm.
NMPI due diligence presents additional challenges for advisers, who may be hampered by limited resources – whether it be time or their knowledge of issues presented by offshore jurisdictions frequently used for Ucis domicile, leverage, true liquidity, closed ended structures, the existence of a secondary market, suspension of redemption rights, underlying asset classes, varied and opaque structures.
Indeed, meeting management teams or finding independent sources of information on NMPIs may be difficult. However, it is usually these factors that come to the fore when determining whether an NMPI has been fairly promoted or suitably advised and is not simply a case of assessing whether the risk/reward profile of the asset matches the client's objectives.
It is truly challenging to assess and quantify risk within NMPIs – particularly through the prism of assessing a client's level of knowledge and understanding for suitability purposes. Have confidence to question any inconsistencies and, arguably, if in doubt about any NMPI or how well the firm understands it, do not select it.
With the march of accountability, a system of oversight and governance is essential. File reviews must include a genuine qualitative assessment of client information and decisions about client knowledge. Audit decision making on financial promotion requirements, due diligence and research.
Assess the competence of advisers and researchers (within the confines of employment law and FCA requirements). Reviews should be part of normal business activity, on a logical timescale rather than when prompted by the FCA.
Finally, as many compliance requirements for financial advisers are codified through the Markets in Financial Instruments Directive framework, the FCA's approach to implementation of the recast and expanded MiFID II will necessitate change by firms (from 3 January 2018). Firms should continue to review and refresh their business and compliance approach notwithstanding the outcome of the UK’s referendum on EU membership.
Jonathan Rogers is head of Financial Services Regulatory at international law firm Taylor Wessing
Key points
A regulated firm cannot promote a group of similar asset classes known as non-mainstream pooled investments (NMPIs) to the majority of retail clients
Advisers must question inconsistent or unclear answers.
With the march of accountability, a system of oversight and governance is essential.
