The UK definition of financial advice is being aligned with that in MiFID. HM Treasury’s response to its consultation on amending the definition was published on 27 February 2017. We consider, in an article we first published in Compliance Monitor, the anticipated outcomes of this reform and how will it affect firms operating in the UK financial services sector.
A summary of the changes
Responding to its consultation on amending the definition of financial advice, HM Treasury (HMT) confirmed that amendments to Article 53 of the Regulated Activities Order1 (RAO) will introduce a new financial advice definition. HMT laid legislation on 30 March 2017, amending the RAO, together with an explanatory memorandum and impact assessment . The changes are expected to come into force on 3 January 2018, to coincide with the MiFID II implementation date.
At present, the Article 53 regulated activity of ‘advising on investments’ is broader than the EU’s definition of ‘investment advice’ under MiFID2 . Under the RAO, a regulated firm gives regulated investment advice if it gives advice that relates to the merits of a person buying or selling certain investments, whereas the narrower MiFID definition of ‘investment advice’ involves providing a ‘personal recommendation’ to a client in respect of one or more transactions relating to financial instruments. The MiFID definition of ‘investment advice’ has not been changed in the recast MiFID II3.
How the amendment operates for different types of firms
The effect of the proposed amendment to Article 53 will be to create a two tier financial advice boundary for regulated and unregulated firms. The policy objective of this change is to provide firms with the confidence to develop advanced guidance services without being subject to the higher regulatory requirements associated with regulated advice.
- Regulated firms - The amendment means that most regulated firms will be exempt from the need to hold a permission to ‘advise on investments’ under Article 53, unless the firm is providing a ‘personal recommendation’.
- Unregulated firms - The existing wider RAO definition of ‘advising on investments’ is left in place for unregulated firms. This means that unregulated firms will be unable to provide detailed and tailored guidance services without being within the scope of FCA enforcement action.
A number of respondents to HMT’s initial consultation on amending the definition of financial advice expressed concerns that unregulated firms would attempt to deliver ‘advice’ that stops short of a personal recommendation, but that nevertheless intends to persuade an individual to purchase risky investment products. Any such activity conducted by unregulated firms will continue to constitute a breach of the general prohibition4. HMT hopes that this approach will act as a shield to mitigate the risk of consumers being scammed.
The FCA has provided a helpful summary of HMT’s new financial advice requirements on its website, including the effect that the proposed changes to the UK regulatory perimeter will have on different firm types (summarised in the table below):
|Firm type||Effect of changes on the regulatory perimeter|
Impact for firms
Potential reduction in compliance costs: There will be some up front familiarisation costs for regulated firms including: reviewing existing operations; changing client documentation, policies, procedures and website disclosures; and providing guidance and training to staff on the new advice boundary. Eventually, however, HMT expects firms to see a reduction in their compliance costs.
HMT has suggested that firms will be able to allocate less time and resource to their compliance mechanisms associated with the advice boundary. However, there will still need to be perimeter policing conducted by firms’ compliance teams to ensure they do not unintentionally stray into ‘personal recommendation’ territory, and where this boundary is crossed, firms should have in place effective systems and controls to meet suitability requirements.
Enhanced competition: The amendment to the definition of financial advice should provide consumers with greater opportunity to access financial guidance rather than advice. With its innovation agenda and Advice Unit, the FCA is supporting firms to develop automated advice models. Firms operating such models are well placed to explore the new financial advice boundary and the provision of automated services to customers without offering a ‘personal recommendation’. This should help foster competition, as firms become more confident in their ability to provide such services to consumers.
The background story
When looking to exploit new opportunities as HMT is seeking to create here, it is useful to understand the background to the change. The UK government launched the Financial Advice Market Review (FAMR) in August 2015 to explore how financial advice could work better for consumers. FAMR is a joint review between HMT and the FCA. It considered the legal and regulatory framework governing the provision of financial advice and guidance to consumers and its effectiveness in ensuring that all consumers have access to the help they need to make effective decisions about their finances. FAMR published its final report in March 2016.
Regulated firms responding to FAMR identified that the MiFID definition of advice based on a personal recommendation is clearer than the RAO definition, and easier to build into their compliance processes. FAMR recommended that adopting the MiFID definition would allow firms to provide more useful guidance to support consumer decision making, so reducing the risk of consumers making poor investment decisions on their own.
The proposals are directly linked to closing the perceived ‘advice gap’ that has emerged since the Retail Distribution Review (RDR) and related restrictions on how firms can use commission trails, meaning some financial services retail-classified clients find themselves in “situations in which [they] are unable to get advice and guidance … at a price they are willing to pay” .
There are several causes behind the ‘advice gap’. The current wide Article 53 definition of regulated advice has in part caused many regulated firms to design guidance services to stop a ‘safe distance’ short of where they perceive the regulated advice boundary to be. The result being inadequate levels of support to consumers.
This is compounded by restrictions on sales commission payments. Advice has never been free, of course, but consumers seem to have behavioural challenges with the revised approach to charging. Faced with paying upfront for specialised and detailed financial advice, it seems many consumers do not seek help to make important decisions about their personal finances. Another factor is that the level of detail in the advice may well be more than is required or disproportionate to the investment pot. This tends to produce poor outcomes for consumers: the cost of advice often outweighs the benefits of non-advised investments.
The FCA is consulting on guidance frameworks for streamlined advice, fact find processes and non-advised services, which will help firms to develop new model service offerings. In April 2017, the FCA published its Part 1 Guidance Consultation on the FAMR Implementation (GC17/4) , which followed the publication of a FAMR Progress Report , aimed at clarifying the regulatory framework for firms.
Also, in this vein, the Financial Advice Working Group (FAWG) published a Final Report in April 2017 to HMT and the FCA outlining “Consumer explanations of “advice” and “guidance”. This sets out consumer-friendly explanations for “advice” and “guidance”, which, subject to the FCA’s required process of analysis and consultation, FAWG propose be mandated for use by regulated firms to provide consistent explanations of these terms and so to ultimately support consumers’ financial decision making.
In summer 2017, the FCA plans to publish its Part 2 Guidance Consultation on FAMR Implementation, including consequential Handbook changes arising from the amendments to Article 53 and also updated guidance on the advice perimeter. A response to Part 1 is expected in July 2017 and to Part 2 in December 2017. The finalised guidance is expected to emerge in January 2018 to align with the MiFID II effective date, so the early drafts will be informative to firms about the FCA’s position.
Will the ‘advice gap’ be bridged?
The UK government’s aim in changing the definition of financial advice is that it will allow firms to provide more useful information to support customer decision-making, such as the merits of, and the risks associated with buying and selling particular investments. The amendments to the definition of regulated advice are intended to clarify the point at which more general forms of consumer support become regulated advice.
It will be interesting to see if this opening up of different service models will be taken up by firms or consumers. Andrew Bailey, chief executive of the FCA, is clear that the FCA needs to: “reflect consumers’ growing responsibility for their own financial choices, at a time when these choices are becoming more complex … [and] encourage firms to address this growing need and ensure they provide consumers with the information they need to make suitable choices”6.