In this article we summarise the recent changes to the Dubai Financial Services Authority's (DFSA) suitability rules, and look at their application to corporate finance activities.
On 1 January 2020 the DFSA implemented changes to its suitability rules and guidance. The DFSA consulted on the new rules and guidance in Consultation Paper No. 127, and while these changes were referred to as "miscellaneous changes" in the Consultation Paper, in fact they represent a significant change in the way in which the DFSA expects regulated firms to deal with Professional Clients.
We understand that there are further changes to the DFSA's suitability rules in the pipeline as the DFSA aims to bring the regime in the DIFC in line with the equivalent EU regime. We will provide further updates when the DFSA consults on these additional changes.
The current changes affect Investment Firms and firms conducting Insurance or Insurance Intermediation activities.
The New Suitability Rules and Guidance
The changes to the suitability rules, and the accompanying updated guidance, are set out in section 3.4 of the Conduct of Business Module (COB) of the DFSA's Rulebook and focus on the suitability assessments.
The amended rules and guidance apply to investment firms who recommend financial products and services, and undertake transactions on a discretionary basis for or on behalf of Professional Clients. In summary, the changes:
- remove firms' ability to waive suitability assessments for Professional Clients. Firms are now required to conduct suitability assessments for all Professional Clients. However, firms may conduct limited suitability assessments with the client's express prior consent;
- require firms who conduct limited suitability assessments on Professional Clients to provide a written warning to the Professional Client:
- in a stand-alone document (i.e. it cannot be incorporated into the client agreement or terms of business) which must be clearly acknowledged by the client;
- which sets out clearly how the suitability assessment will be limited; and
- which is provided in good time before the firm provides the relevant Financial Service, and
- expands the exclusion of the application of the suitability rules for Market Counterparties, from "transactions" to "financial services"; and
- sets out guidance on the minimum information firms should collect when conducting suitability assessments (including information about factors such as the length of time a client wishes to hold a financial product, an assessment of the client's financial situation including their general capacity to withstand losses arising from investing in financial products and the nature, volume and frequency of previous investments made a client when considering the client's knowledge and experience).
Firms conducting Insurance or Insurance Intermediation activities
The changes to the suitability rules and guidance will impact on firms conducting any Insurance or Insurance Intermediation business with or for a Retail Client in respect of Direct Long-Term Insurance. In summary, the new guidance:
- clarifies that simple insurance products such as motor insurance products do not require detailed suitability assessments;
- provides that in other cases, the general information Insurers and Insurance Intermediaries should obtain when assessing a Retail Client's demands and needs includes the purpose for which the Retail Client requires the insurance;
- provides that Insurers and Insurance Intermediaries should assess whether the relevant exclusions and applicable excess is suitable for the Retail Client; and
- clarifies that in relation to products that do not meet a client's demands and needs, the Insurer or Insurance Intermediary must provide an explanation with a sufficient level of information that allows the client to easily understand the difference between what has been recommended and the client's needs, and the advantages and disadvantages of the product that has been recommended.
The application of the DFSA's Suitability Rules to Corporate Finance
Whether the DFSA's suitability rules apply to "corporate finance" business will depend on the facts in question. Corporate finance business is not defined under DFSA rules. However, it typically involves advice to companies on capital structure, corporate or industrial strategy, and advice and services relating to mergers and acquisitions. There may be circumstances where a firm conducting corporate finance business with a client (who is not Market Counterparty) may be required to consider suitability for that client if the firm "recommends to a Client a financial product or financial service" in conducting corporate finance business.
In corporate finance business, the situations in which a firm may recommend to a Client a financial product are likely to be limited. "Recommending a financial product" must be read in light of the DFSA definition of "advising on financial products" which is:
"Advising on Financial Products means giving advice to a Person in his capacity as an investor or potential investor […] on the merits of his buying, selling, holding, subscribing for or underwriting a particular financial product (whether as principal or agent)." (see DFSA General Module Rule 2.11)
It is generally unlikely that in conducting corporate finance business a firm would give advice on financial products to a Person in his capacity as an investor. A company seeking corporate finance advice is generally doing so for strategic purposes, for example, by buying a competitor out or divesting of a non-core asset. The advice sought is not advice on whether a particular financial product should be bought but whether a particular company or asset should be bought or divested.
Therefore, unless it is clear that in conducting corporate finance business a firm is making a recommendation on a particular financial product to a person in his or her capacity as an "investor", the suitability rules would not apply to the relevant transaction. We set out in the table below some examples of circumstances where the suitability rules do and do not apply to firms conducting corporate finance business.
Even where the DFSA suitability rules do apply to in whole or in part to a firm conducting corporate finance business, complying with the rules is likely to be relatively straightforward and is unlikely to require material or indeed any changes to a firm's processes. This is because typically, in the course of winning and undertaking a corporate finance mandate, a firm is likely to have acquired more than enough information about the Client’s needs and objectives and financial situation to have a reasonable basis for considering a recommendation or transaction to be suitable for that particular Client. In addition, the Client's risk tolerance, knowledge, experience and understanding of the risks involved in a transaction, if not set out in the RFP, can be ascertained from publicly-available information or may reasonably be inferred from the firm's knowledge of the Client.
Next Steps for Firms Impacted by the Changes
The changes to the Suitability Rules are not retrospective, however:
- firms that currently have contractual provisions in place with their Professional Clients which allow them to dispense entirely with suitability assessments will need to amend their terms of business to remove such provisions;
- firms which previously dispensed entirely with suitability assessments, will need to conduct full or partial suitability assessments of the relevant clients;
- if firms propose to continue to limit suitability for Professional Clients, they will now need to provide a standalone written warning to Professional Clients and obtain the clients' signed, express consent; and
- the full or partial suitability assessments referred to in 2 above and, where relevant, client consents referred to in 3, will need to be completed by latest 30 June 2020.