MiFID for insurers
Although article 2 of the Markets in Financial Instruments Directive (MiFID) makes clear that life, nonlife and reinsurance undertakings are exempt from the Directive’s provisions, MiFID affects insurers in several ways. There may be companies in an insurer’s group that are within the scope of the Directive (for example, asset management companies or some financial advisers). In addition, some changes to the FSA Handbook to implement MiFID will affect companies that are not strictly within its scope.
The FSA is undertaking a thorough revision of its Handbook of Rules and Guidance, in part as a result of its move to principles-based regulation and in part to implement MiFID. The proposed changes to the Conduct of Business Sourcebook (called NEWCOB), together with changes to the Training and Competence and Dispute Resolution Sourcebooks, were set out in CP06/19 and CP06/20 published in October 2006. These consultation papers outlined the MiFID changes, as well as those resulting from the FSA’s broader review. Because of the need to transpose MiFID into UK legislation by 31 January 2007, the FSA published its final MiFID-related changes in PS07/02 in January 2007. The consultation period for the non-MiFID changes ended in February 2007 and the FSA is expected to publish its feedback statement shortly. Although the broader revision of the Handbook will clearly have a greater effect on insurers, there are a number of important MiFID-related changes that will affect insurance companies. As the majority of these changes are to the Conduct of Business Sourcebook, the principal effects will be on life insurers. However, nonlife insurers should be aware of changes to the complaints handling rules in the Dispute Resolution section of the Handbook. This newsletter looks at some of the main conduct of business changes:
- client’s best interests rule;
- client classification; and
Client's best interests
MiFID contains, in article 19, an obligation on a firm to ‘act honestly, fairly and professionally in accordance with the best interests of its clients’. In NEWCOB this requirement, which is similar to a fiduciary duty, will be applied to all firms conducting designated investment business with retail clients. As a result, insurance companies selling life insurance to retail customers will be subject to this general obligation.
In many respects the obligation reflects firms’ existing duties under the Principles for Businesses: for example, a requirement to act honestly is covered by Principle 1, which requires a firm to act with integrity. However, the obligation to act in the best interests of clients does potentially go beyond existing principles and rules, particularly for firms that do not act in any sort of fiduciary capacity, for example those making nonadvised sales. The FSA acknowledged in CP06/19 that this aspect of the obligation may go beyond firms’ existing duties. The obligation is, on its face, an absolute one, not one that requires firms to use reasonable endeavours to act in the best interests of clients.
It is hoped that the content of this general obligation will be viewed in light of the services being provided to the client so that, for example, the requirement to act in the client’s best interests will not import any form of suitability assessment for non-advised sales. One would hope also that the reasonableness of the firm’s actions will be relevant to the FSA’s decision on enforcement even if the absolute nature of the obligation means that a firm may not have acted in the best interests of the client despite its reasonable efforts to do so. However, the scope of this general requirement and how it might apply in practice are, to some extent, unclear.
The FSA also proposes to apply some aspects of the MiFID provisions on inducements to all firms conducting designated investment business with retail customers. The current COB rule on giving or receiving inducements likely to conflict to a material extent with a firm’s duties to its customers will be replaced with the MiFID prohibition on firms paying or accepting any fee, commission or nonmonetary benefit except one provided to or by the client or one that ‘does not impair compliance with the firm’s duty to act in the best interests of the client’.
It is unclear whether there will be a change in practice in terms of permitted and prohibited inducements for non- MiFID firms, for example as a result of the loss of the qualification that an inducement must not be likely to conflict to a ‘material’ extent with the firm’s duties. The FSA does not propose to apply other aspects of the MiFID inducement provisions to insurers, for example the additional requirement that the fee, commission or benefit must enhance the quality of the service to clients. In addition, the FSA is retaining its detailed guidance on the disclosure of commission for packaged products, so firms will continue to be able to follow existing practice in this area.
MiFID has a different client classification regime to the current COB approach. Clients are divided into retail, professional and eligible counterparty (with the last being a subset of the professional category relevant only where a firm is dealing in investments). The tests for who qualifies as a professional client differ from the test for intermediate customer status under the current rules; in particular, the size thresholds for companies to be treated as professionals are higher than the current intermediate customer thresholds. The FSA is proposing to adopt the MiFID terminology for client classification for all designated investment business. However, its proposal outlined in CP06/19 is to retain the current threshold tests for intermediate customer status and apply these to the new professional status for non-MiFID business.
The FSA also proposes to apply the MiFID formulation of suitability. Broadly, the basic suitability obligation is similar to the current rule: to take reasonable steps to ensure that a personal recommendation is suitable for the client. However, the proposed suitability rule also incorporates other specific MiFID requirements. For example, the firm is required to obtain such information about the client as is necessary to have a reasonable basis for believing that the recommendation: (i) meets the client’s investment objectives; and (ii) is such that he is financially able to bear the risks; and (iii) that he has the necessary experience and knowledge to understand the risks. There is then further detail on the sort of information the firm will be required to obtain for each (in relation to knowledge and experience, this includes the level of the client’s education and profession). These provisions are more specific than the current requirements, and while they may reflect the information firms obtain in practice it will be worth confirming that these areas are covered.
Although outside the scope of MiFID insurers will, to a greater or lesser extent, be affected by some of the changes in UK regulation resulting from its implementation. As part of the general review of NEWCOB, insurers should consider the effect of these changes on their existing procedures, systems and controls.