FCA bans the promotion
of unregulated collective
investment schemes
and close substitutes to
‘ordinary’ retail investors
Effective from 1 January 2014 the FCA will
ban the promotion of unregulated collective
investment schemes (“UCIS”) and equivalent
pooled vehicles to retail investors. The new rules
are published in Policy Statement PS13/31.
The FCA is emphatic in its view that unregulated
pooled products should not be promoted
to ordinary retail consumers, believing such
investments are “niche, risky products almost
certainly inappropriate for ordinary retail
investors”. The new rules apply to the new
concept of a ‘non-mainstream pooled investment’
(“NMPI”). NMPIs include UCIS, Qualified Investor
Schemes, traded life policy investments and
special purpose vehicles (“SPVs”), that do not
fall into one of the newly created exemptions.
The regulator emphasises that regardless of
compliance with the black letter law of an
exemption from the ban, firms have an overriding
obligation to act in the customer’s best interests.
The critical question for the firm before relying on
an exemption is therefore whether the customer
is capable of taking a proper decision regarding
the NMPI.
The new rules will impact:
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Anyone promoting or advising on NMPIs, such
as IFAs and other advisory firms;
Discretionary managers with retail clients and
who include NMPIs in portfolios;
Those who provide NMPIs whether directly or
through plans or tax wrappers; and
The NMPIs themselves and those who create
them.
Key operational points:
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Firms will need to consider which NMPIs
they advise on or promote to retail clients,
look at whether their business models use
the existing COBS 4.12 exemptions for the
promotion of UCIS and determine whether
there are any exemptions available under the
new rules or if their clients can be elected up
to ‘professional client’ status.
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Even if a firm does not use the current COBS
4.12 exemptions that are changing, the FCA’s
comments about how financial promotion
exemptions generally should be used will need
to be considered.
While the rules relate to the promotion of
NMPIs, the FCA’s statements regarding the
lack of suitability of NMPIs for ordinary retail
investors will require discretionary managers
to reconsider their use of NMPIs in ordinary
retail clients’ discretionary portfolios.
Technical compliance with a financial
promotion exemption is not of itself sufficient.
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 a
NMPI to them – firms need to look at the
substance of a client’s ability to take a proper
decision, not just at the form of an exemption
certificate.
The new rules raise the bar in terms of the
required compliance process. The compliance
function must certify that any promotion
complies with the new rules and in doing so
the record must cite which exemption was
relied on and on what basis. As part of this,
firms may find it necessary to build in, as part
of the client take on process, the signing of
HNW/self-certified sophisticated investor
certificates (for applicable clients), and the
timetabling of certificate renewals.
What investments are within the scope of the
ban?
In an effort to prevent investment vehicle
arbitrage, the new rules will not just apply to
UCIS, but to the wider category of NMPIs. This
new concept includes units in UCIS and QIS,
traded life policy investments and securities in
SPVs (as defined in the FCA’s glossary).
1 http://www.fca.org.uk/static/documents/policy-statements/ps13-03.pdf
Following consultation feedback, the FCA
has narrowed the scope of the FSA’s original
proposal and PS13/3 confirms that the following
products now lie outside the scope of the ban:
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Securities issued by SPVs where the payment
obligation is linked to the performance of
shares, bonds or Government and Public
Securities (whether measured directly or
via an index). This means that where the
investment value deriving from an SPV is
linked to more exotic asset classes or a
derivative, the SPV will be an NMPI;
Exchange Traded Products;
Investment Trusts and overseas investment
companies that would meet the criteria for
Investment Trust status if based in the UK;
Real Estate Investment Trusts;
Venture Capital Trusts; and
Covered Bonds.
The ban
The rules, in conjunction with the prohibition
of UCIS contained in s. 238 FSMA, prohibit a
firm from communicating or approving financial
promotions in relation NMPIs that are addressed
to, or to be received by, retail clients.
The new rules and surrounding commentary
highlight that the provision of advice is likely to
include a financial promotion and that, therefore,
advice to retail clients in relation to NMPIs is also
highly likely to be subject to the ban.
Exemptions?
The ban has included the narrowing and, in
some cases, removal of certain UCIS exemptions
currently available to firms in COBS 4.12, with the
revised set of exemptions applying to NMPIs. In
particular, the new rules remove the following
exemptions that the FCA identify as commonly
giving rise to problems:
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Category 2: available when the firm has taken
reasonable steps to ensure the investment is
‘suitable’ for the target client; and
Category 8: available when the firm
assesses a target client as being capable of
understanding the risks.
Instead, from 1 January 2014 firms will generally
only be able to promote (or advise) NMPIs to
retail clients under COBS 4.12 if the retail client
meets the definition of:
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a ‘certified high net worth investor’;
a ‘certified sophisticated investor’; or
a ‘self-certified sophisticated investor’,
as set out in the new COBS 4.12.
These categories lean heavily on some fairly
restrictive concepts currently found in the
FSMA (Financial Promotion) Order 2005
(the “FPO”) and FSMA (Promotion of CIS)
(Exemptions) Order 2001 (the “PCISO”), but
have been adjusted to allow the firm to be the
party that provides the certificate where one
would normally be required from a third-party
professional. In addition the new rule does not
carry through the FPO/PCISO requirement that
for a UCIS to fall within the high net worth and
self-certified investor exemption, it must invest
wholly or predominantly in shares or debt of
unlisted companies. While these may appear
to be relaxations over the FPO and PCISO
equivalents, the FCA has indicated that they
plan to consult on whether the criteria for these
exemptions remains appropriate, or whether the
financial thresholds in the COBS 4.12 versions of
the exemptions should be higher.
In addition, when using the certified high net
worth and self-certified sophisticated investor
tests, a firm is only able to promote NMPIs which
it considers likely to be suitable for the client,
based on a preliminary assessment of the client’s
profile and objectives.
There are additional exemptions to deal with
specific circumstances, including exemptions
covering the following situations (provided
certain requirements are met):
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retail clients already invested in a NMPI that
is being liquidated or wound down or which is
undergoing a rights issue;
the promotion of enterprise and charitable
NMPIs to clients eligible to invest in them;
personal recommendations given to a retail
client following the client’s active solicitation
of advice from the firm in relation to a NMPI
that the firm (or a person connected with
the firm) has not previously promoted or
otherwise communicated to the client;
non-recognised EEA UCITS; and
promotions of investment companies registered
and operated in the US under the Investment
Company Act 1940 to certain US persons.
Compliance
Principles overrule exemptions – acting
in a client’s best interests: In terms of risk
management, the FCA make it clear that
ensuring the client technically falls within an
exemption is only part of the exercise; a firm’s
paramount duty is to act in its clients’ best
interests. So, for example, where a client meets
the self-certified high net worth or self-certified
sophisticated investor test, the firm still needs
to ask itself if it is fair to make the promotion
to that client: does the client have the ability to
properly understand and evaluate the product?
While these comments have arisen in the context
of the new COBS 4.12 exemptions, the guidance
also explicitly relates this guidance to the use of
such exemptions (and the ‘one-off’ exemption)
under the FPO/PCISO.
The clear principle to be derived from the
guidance and commentary is that firms must
always act in the client’s best interest when
making a financial promotion, regardless of
which specific exemption is relied on. While the
principle of acting in a client’s best interests is
not new, this increased focus makes it clear firms
cannot just rely on the black letter law of an
exemption. The reemphasis on the firms’ ‘best
interests’ duty front loads a firm’s need to assess
its clients’ capacity to understand the pros and
cons of any NMPIs promoted to them.
Compliance function sign off: The rules require
that for each promotion of a NMPI to a retail
client, the person allocated the compliance
oversight function (CF10 Approved Person) must
make and retain a record certifying compliance.
There is scope for the certification to be
delegated below the CF10 to others within the
compliance function and further commentary to
the effect that a client contact member of staff
could prepare a record of the relevant contact
with the client, for a member of the compliance
function to sign it off. This still represents new
territory as it means that:
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a client contact member of staff will need
to be sure of their ground in terms of
exemptions before any meeting where an
NMPI might come within contemplation; and
after each meeting / contact where an NMPI
has been mentioned, written sign off must be
obtained from the compliance team.
Advice = promotions: The FCA clarifies that it
is highly likely the provision of advice will include
a financial promotion, so the record keeping
requirement goes beyond simply signing off
non-real time financial promotions, but will also
capture any personal recommendation of an
NMPI made to a retail client during a meeting.
Regular customers: The rules do not seem
to permit any efficiency where a firm regularly
deals with a client. While a certificate will have
currency for the permitted time (12/36 months
depending on the certificate) it seems to be
the case that each time a client comes in for
a meeting, the compliance function will need
to sign off that any NMPI promotion at that
meeting was compliant.
Look beyond the paperwork: The rules make it
clear that firms should be taking steps that go
beyond the requirements of the FPO/PCISO
exemptions to make sure that the retail client
meets the underlying relevant tests; it is not
enough just to see the relevant certificate, the
firm should take reasonable steps that the retail
client does in fact meet the relevant threshold
criteria.
Impact on investment management: While the
rules attach to the promotion of NMPIs, the
Policy Statement urges discretionary managers
to take note of the FCA’s view that NMPIs
are unlikely to be suitable for ordinary retail
investors and that therefore a discretionary
manager “should exercise particular care when
placing ordinary retail investors’ money into
these products, to satisfy him or herself that it
is suitable for each particular client and is in the
best interests of that client”.
A point made clear as part of RDR
implementation has resonance here: when a
firm is discussing asset allocation and/or specific
products with a discretionary client and NMPIs
are referred to, the firm needs to challenge itself
as to whether these discussions have been
advisory / promotional. If so the firm will need to
work within the exemptions to the ban if it wants
to use NMPIs.
Comment
The promotion of UCIS has been on the
regulatory agenda for some time and this ban
is a clear example of the new interventionist
approach that the regulator has adopted. The
FCA’s policy decision is that retail consumers
should only find themselves invested in
mainstream pooled products, with the nonmainstream, riskier products the preserve of the
sophisticated or wealthy who can either afford
to suffer poor investment performance or who
know enough to evaluate and accept this risk.
The changes derive from the FCA’s assessment
that too many mistakes are still being made in
terms of the investment services delivered to
consumers.
For those firms that do advise and promote
NMPIs, while the fact the FCA has taken
account of some consultation responses is
encouraging, the revised rules do present
significant challenges to a firm’s ability to
promote and advise NMPIs to retail clients. Even
when such promotion and advice is possible,
the rules impose additional and substantial
compliance burdens, and bring forward the
suitability question to the time of first promotion,
which will require review and amendment to
firms’ existing business and compliance models.
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