Through the proposals set out in CP12/19 the Financial Services Authority (FSA) is looking to define clearer routes for intervention to prevent non-mainstream products reaching the majority of retail investors. Unregulated collective investment schemes (UCIS) and a number of close substitutes mentioned further below are to be recognised as specialised products that are unsuitable for general promotion to the UK retail market. By limiting the promotion of UCIS, and clarifying in the FSA Handbook that a financial promotion is generally involved when providing financial advice, the FSA aims to limit the number of retail clients receiving unsuitable advice to invest in these types of products.
Narrowing the pool of uncategorised retail customers
Under the current rules, promotions of UCIS can only reach the specific categories of customers meeting the available exemptions set out under the Promotion of Collective Investment Schemes (PCIS) Order (i.e. certified sophisticated or certified high net worth investors), or under one of the eight categories set out in the FSA's rule Conduct of Business Sourcebook (COBS) 4.12.
Fewer options, however, will exist under the proposed regime which will eliminate some of the more flexible COB 4.12 exemptions. Category 1 (existing investors in UCIS) will have more limited application, but the key changes involve the removal of the category 2 and 8 exemptions.
Taking "reasonable steps" under the category 2 (suitability exemption) to ensure suitability provides a somewhat more elastic approach than the strict criteria demanded under the PCIS Order for an exemption as a sophisticated or a high net worth investor. However, the suitability exemption has been involved in the majority of cases involving an inappropriate promotion and the FSA believes it also plays a major part in poor selling practices.
The FSA also has concerns around the improper use of, and poor standards under, the category 8 exemption for sophisticated or highly experienced investors. The FSA now wants full reliance to be placed on the PCIS Order certified sophisticated investor exemption as a "better way" to improve customer outcomes. The procedural requirements and investor warnings dictated by the PCIS Order are also thought to offer a degree of protection in contrast to category 8.
Catching a wider range of investments
Creative efforts to employ structures that get around the UCIS regulatory restrictions are also tackled in this consultation.
A number of investments have been identified as close substitutes for UCIS. These are products which can carry similar risks to UCIS but are not currently subject to the same marketing restrictions and so can be widely promoted in the retail market. These have been included within the consultation and the FSA intends to intervene "more firmly" by preventing the promotion of these close substitutes to ordinary retail investors. All of the following investments will be categorised in the new regime as "non-mainstream pooled investments" along with UCIS:
- Qualified investor schemes
- Securities issued by special purpose vehicles (SPVs)
- Traded life policy investments
If the proposal to add these investments to COBS 4.12 is adopted, firms will be unable to promote these products to retail customers unless an exemption is available under the Financial Promotions Order (FPO).
SPVs are a particular area of interest for the FSA because they can be used as an investment vehicle to pool investment assets that are traditionally found within UCIS. The FSA comments on unusual assets (e.g. fine wines, crops) which are often structured as UCIS but sometimes take on other legal forms such as securities issued by SPVs. Since these types of assets carry risks that are difficult to assess, and governance controls can be weaker than more mainstream investment vehicles, the FSA wants them included within the scope of the marketing restrictions. The proposed definition is intended to capture pooled investment SPVs that are functionally the most similar to UCIS.
Product providers should also note that some structured products will fall within the scope of non-mainstream pooled investments. The aim is to prevent providers structuring offerings to get around the marketing restrictions. The proposals would impact any structured product where its risk profile or investment strategy are non-mainstream by virtue of their reference assets. In such cases, the FSA believes that these products should be subject to the same restrictions and consumer safeguards as other non-mainstream pooled investments.
Firms may wish to respond to the proposals around close substitutes as the FSA concedes that the lack of data gathering requirements around these products has limited its ability to produce a comprehensive picture of the market.
The new rules will not apply to execution only sales (so long as there is no financial promotion), or to advice given to existing customers on the suitability of an investment which the customer already owns.
Link between promotion and advice
Clearer guidance is proposed setting out the FSA's view that a personal recommendation generally involves a financial promotion. Advice can result in an unlawful promotion if no valid exemption is available.
FSA work to date has found that many distributer firms do not understand that advice can involve a financial promotion. The FSA has found that firms are breaking the law when giving advice on UCIS because they had not taken steps to ensure they were in compliance with the marketing restrictions in s.238 of FSMA.
Heightened role for compliance and CF10s
A heightened role for compliance will follow as the new rules will require procedures and practices that pay due regard to the marketing restrictions, as well as precise records that provide clearly demonstrable evidence that the rules have been complied with.
New guidance on the use of the PCIS Order and FPO Order will make it clear that an exemption which is technically available can be lost if it would not be appropriate or in the customer's best interests.
To pinpoint senior management responsibility around the promotion and selling of these niche products, the consultation proposes a specific rule which will require the individual exercising the CF10 function to "confirm" that each promotion of a non-mainstream pooled investment to retail clients complies with the marketing restriction rules. These changes will involve significant time and associated costs.
Compliance has always had a role to play around financial promotions, but placing a specific confirmation requirement on an identified individual exercising a CF10 function raises questions around how this marries up with the FSA's general position on senior management accountability. Does this mean that senior management will be able to rely on CF10 compliance confirmations to protect themselves from personal liability where their firm has breached the proposed marketing restrictions?