Background

In the Spring 2016 edition of our quarterly publication, Authorised Fund Horizons, we reported on the prospect of non-UCITS retail schemes (NURS), investment trusts and other multi-asset funds being designated as "complex" – meaning that firms would need to carry out an appropriateness assessment (to understand a potential investor's knowledge and experience prior to investment) which would effectively mean that such products could not be sold on an execution-only basis.

Broadly, a NURS has wider investment powers than UCITS, including the power to invest directly in real property, gold and/or unregulated collective investment schemes.

Hopes for relaxed or modified rules

Some industry players had hoped that the rules would be relaxed or modified to produce a narrower scope of complex investments for the purpose of the appropriateness test, or otherwise a more qualitative test would emerge by reference to criteria such as the number of holdings, the actual risk to the consumer involved and/or whether there are frequent opportunities to dispose of, redeem or otherwise realise the instrument at prices publically available to market participants.

Hopes dashed?

It would appear that hopes for a narrower scope of “complex funds” might be have been dashed following the publication of the FCA’s latest consultation paper on the implementation of MiFID II (CP16/29). The FCA has asked for comments on the consultation paper by 4 January 2017.

At paragraph 8.16 of CP16/29, the FCA states that:

“Our view of the MiFID II provisions on complex and non complex financial instruments is that, as in MiFID, Non UCITS Retail Schemes (NURS) and investment trusts are neither automatically non complex nor automatically complex. They need to be assessed against the criteria in the MiFID II delegated regulation. When firms apply these criteria, they should adopt a cautious approach if there is any doubt as to whether a financial instrument is non complex.”

This approach will likely be welcomed by some in the industry as some commentators have long argued that “some NURS are less complex than others” and therefore NURS should not all be “lumped” in the same basket and labelled as complex funds (which appeared to be the view taken by the European regulators). The FCA’s statement appears to acknowledge that whether a non-UCITS fund is complex or non-complex for the purposes of MiFID II is not always a straightforward dichotomy.

A word of caution

The FCA pointedly notes that firms need to “adopt a cautious approach if there is any doubt as to whether a financial instrument is non-complex”. If a firm wrongly concludes that a NURS is a non-complex fund and the fund is consequently sold without the completion of an appropriateness test in breach of the rules, the consequences might include regulatory sanction, financial penalties and damage to a firm's reputation. Getting it wrong might prove costly, so firms need to tread carefully.

What should firms do?

MiFID II comes into force on 3 January 2018. Subject to the final rules and the UK's implementation of MiFID II, it appears that some of the points that firms will need to think about include the following:

  • It appears that there will be no ready reckoner with an exhaustive list of complex funds and non-complex funds that firms can refer to. Firms will need to put in place a rigorous assessment process and should err on the side of caution if there is any doubt as to whether the NURS is complex or not. However, it is possible that over time, a general consensus will emerge within the industry (some might say there already is!) as to which types of NURS are more likely than not to fall in the “complex column”, or in the “non-complex column”, or which types of NURS sit somewhere in between and could go either way depending on certain factors... the “difficult column”
  • Distributors will probably expect that it is the product manufacturer who should assess whether a NURS is a complex product or a non-complex product. Product manufacturers will therefore need to determine the most appropriate way to communicate their assessment to distributors, especially where the NURS is sold through multiple distribution channels.
  • Product manufacturers will also need to ensure that where a fund moves across the spectrum, for example from a non-complex fund to a complex fund, this is communicated to the distribution channels in a timely manner. (The move across the spectrum could be caused by for example, a change of investment objectives and policies, or because a NURS that didn’t previously use the wider investment powers available to it, intends to do so going forward.)
  • Where a NURS is deemed to be a complex product, distributor firms should ensure that their processes for assessing appropriateness comply with the relevant rules and are “fit for purpose” in terms of the type of customer, the type of fund, how the assessment questions are framed, the distribution channel, etc.
  • Firms should also revisit their distribution agreements to see whether these need to be bolstered in light of the MiFID II proposals.