The FCA has set an uncompromising compliance standard for what it sees as unacceptable payments from product providers to advisors in the retail investments sector; and laid down a marker for similar payments in the mortgages, protection and other ICOBS sectors. Firms affected must review their distribution/services agreements and other payment arrangements by 16 April 2014.

Following its first thematic review on implementation of the RDR in 2013, the FCA consulted on new guidance to address its concerns about payments potentially undermining the RDR objectives ("Guidance Consultation 13/5 - Supervising retail investment advice: inducements and conflicts of interest" (GC 13/5)) in September last year. It has now published its Finalised Guidance. In light of feedback received, the FCA made some changes to give "greater clarity to our expectations of providers and advisory firms when entering into service or distribution agreements". The result is a high overall threshold for firms making or receiving many common categories of permissible 'inducements'; and a challenge to firms to check that their arrangements comply.

1.        Key points for firms

•       All manufacturers and distributors of COBS retail investment products (see under 'Scope' below and 'Which firms and products does the Finalised Guidance apply to' above) need to review their existing services and distribution arrangements

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within three months of its publication – by 16 April.

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Differences from September draft guidance: There are some important differences from the consultation draft, discussed below.

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•       Scope

COBS retail investment products:

The guidance applies to all providers of retail investment products to be sold by advisers and advisory firms providing personal recommendations on such products. It is also relevant where payments are made by providers to unregulated third party firms that are for the ultimate benefit of an advisory firm. Vertically integrated firms: the FCA stated in its September consultation paper that the guidance would not apply to firms within the same group where the product is both manufactured and distributed within the group or where the advisor is an associate of the provider (where COBS 6.1A.9R applies). The Finalised Guidance has amended this to clarify that, as the COBS inducement rules and Principle 8 apply to such firms, in addition to complying with the requirement in COBS 6.1A.9R they may also find the guidance "relevant". This is vague and unsatisfactory, but it would be prudent for vertically integrated firms to review their current arrangements in light of the standards in the Finalised Guidance.

MCOBS/ICOBS products:

Although the Finalised Guidance does not apply to these non-COBS products, the FCA makes some observations on mortgage (MCOBS), protection and other ICOBS business which points towards what could be effectively an informal read across: "Some respondents to the guidance consultation pointed out to us that our guidance does not apply to mortgage or protection business. Payments provided in relation to mortgage and protection business are still subject to the Principles for Businesses including Principle 8 (Conflicts of interest), and so similar considerations apply to such payments as outlined in this guidance. We expect firms to act responsibly and not attempt to circumvent this guidance by soliciting and making excessive payments for other product lines."

At face value, this suggests the FCA is principally concerned about circumvention in circumstances where a product provider has two relationships with the same distributor (one for COBS business and one for mortgages/insurance business). Our reading, however, is that firms should also treat it as establishing an expectation about the effect of all arrangements between product providers and mortgages/insurance distributors, on the basis they can give rise to the same conflicts concerns.

2.        What firms should do now

Retail investments product (COBS) providers/advisors

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Make sure the firm has, and can demonstrate, robust systems and controls which support the objectives of the RDR and which are at the same time consistent with the FCA's inducement rules:

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Consider how non-commission payments and services arrangements fit with the FCA's conflicts of interest rules:

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MCOBS/ICOBS providers/advisors

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3.        Key changes from September 2013 draft guidance

Our briefing on Guidance Consultation 13/5 can be found here. What we see as key amendments to the Finalised Guidance are set out below (pages 2-3 of the Summary of feedback also summarises some of the amendments).

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and that the Finalised Guidance will be relevant when these services are procured and paid for.  The FCA provides no support for this assertion which, in our view, must be questionable.

4.        Inducements – allowable reasonable non-monetary benefits (RNMB)

The inducement rules pre-date, and were largely unamended by, the RDR (except to extend their scope to cover retail investment products and to add some guidance in relation to the reasonable non-monetary benefits table). They effectively ban the payment or receipt of any fees, commissions or non-monetary benefits that relate to designated investment business carried on for a client, which:

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•ae notealyiledtolnts –ith e eeptonsfornon-iFIDbuins etoutn the abe atBS.3.5). BS2.3.15G(teBable)ies uiane onthetpes ofbeefis tatae capable ofehaig theqalityofeie

provided to a client and, depending on circumstances, are capable of being paid or received without breaching the client's best

interests rule.  If a benefit is permitted within the RNMB Table it does not have to be disclosed (non-MIFID business only).

The FCA considers that some firms interpret the RNMB Table too broadly. The Finalised Guidance identifies good and poor practices. These are summarised in Table A below.

Table A: RNMB Table (COBS 2.3.15G): Good and poor practices identified by FCA

COBS 2.3.15G

Poor practices:

FCA considers are likely to breach conflicts of interest and inducement rules

Good practices:

FCA considers are more likely to be acceptable

IT development and maintenance (para 10)

Payments or other assistance from providers to advisory firms for developing software or other computer facilities that go beyond that which is required to operate software supplied by the provider Payments from providers to develop advisory firms' general IT systems or infrastructure Annual payments from providers for general IT maintenance

Payments from providers to advisory firms for IT development and associated on-going maintenance that are restricted to costs necessary to integrate and feed information into a provider's IT systems and:

Providing or receiving the payment does not impair the firm's duty to act in the best interests of its clients Payments can reasonably be expected to result in equivalent cost savings to the provider or its clients Quality of service received by the customer can reasonably be expected to be enhanced by e.g. automating business processes to reduce the possibility of errors arising from manual processing and the time taken to process business

Training (para 13)

Payment (which is not reasonable reimbursement) or other incentives from providers to advisory firms to attend training Training provided for UK-based advisers outside the UK Provision of training results in channeling of business to the provider or is dependent on appearance on a panel

Training is made reasonably available to all advisory firms that could recommend the provider's products or services on an equal basis, even if only on a first-come, first- served basis Reimbursement by providers which is limited to reasonable costs incurred by advisory firms in holding events where providers deliver training on their products; providers should be willing to offer similar training and associated payments to other advisory firms

Conferences and seminars

(para 7)

"Excessive" payments from provider to advisory firm to take part in the advisory

Contribution from provider to cover relevant costs incurred by advisory firm calculated by

COBS 2.3.15G

Poor practices:

FCA considers are likely to breach conflicts of interest and inducement rules

Good practices:

FCA considers are more likely to be acceptable

firm's conference – where the payment does not reflect the time and sessions at the conference when the provider's staff take an active role (an active role does not include hosting a presentation stand or meals for a relatively small number of advisers)

Larger than necessary payments to advisory firm calculated by reference to how much it might have cost to have face-to-face meetings with each individual advisor Advisory firms seeking recovery from providers of all costs incurred in running seminars and conferences – should be a contribution designed to recover costs associated with the provider's active participation Questionable whether quality of service to clients would be enhanced when a provider is on a restricted panel of the advisory firm or if it is a sole provider arrangement

reference to:

Overall costs to advisory firm in organising the event Time allotted to the provider for presenting or providing training Number of advisors attending the presentation

Advisory firm retains a "significant majority" of the overall costs Providers attend events held outside the UK, if required, but do not make any contribution to the costs of the event

Hospitality (para 1)

Providers offer hospitality and gifts/prizes to advisers that are of "an unreasonable value" in the specific circumstances in which they are made and could lead to a channelling of business to that provider

Firm has clearly defined policy, approved by an approved person or board committee, for determining what constitutes reasonable hospitality and for authorising the provision or acceptance of hospitality Firm has processes and controls to ensure that hospitality does not have the potential to influence unduly advisory firms in their selection of providers Where payments satisfy the "reasonable" test, a number of key characteristics are evident:

Event in the UK Adviser attendance not based on criteria that incentivise poor behaviours Event designed to enable advisers to provide a better service to customers Payments for food and drink proportionate and overnight accommodation only paid where necessary Provider assesses reasonableness of "per head" costs against previously agreed monetary limits set by an appropriate committee and verified by a "second-line" function in the provider Promotional prizes that are not extravagant and that are linked to activities that increase knowledge of provider's products or other services offered

COBS 2.3.15G

Poor practices:

FCA considers are likely to breach conflicts of interest and inducement rules

Good practices:

FCA considers are more likely to be acceptable

Gifts that are not extravagant and are not based on criteria that incentivise poor behaviours Logs are kept of all hospitality and gifts provided to advisers over a specified period so that cumulative payments do not exceed previously agreed limits; compliance with such limits ensured by regular review of logs

Promotional activity (para 2)

Interpretation of "market rate" as "what everyone else has had to pay to the advisory firm" – often resulting in sizeable payments Where a restricted panel of providers: significant payments in connection with the promotion of the provider's products to individual advisers are less likely to be justifiable

Costs paid by provider for placing articles and financial promotions are not more than "market rate" and exclude distribution cost "Market rate" is based on objective criteria

e.g. the cost of placing the promotion in a trade publication

Firm can evidence how rate is derived

Advisory firm must be aware of potential conflicts of interest if financial promotions lead to significant revenues and profits for the firm Alternatively, firm restricts payments from providers for placing financial promotions to the reimbursement of costs incurred by the advisory firm

Meetings between providers and advisory firms (para 3)

Advisory firms charge providers for regular and structured meetings with their senior management team in relation to joint marketing initiatives and new business opportunities

Management information (MI), data and research services

Provider pays advisory firm for MI, data and research at a rate which includes a profit margin for advisory firm

Payment from provider to advisory firm for information restricted to reimbursement of the costs incurred in producing the information Provider derives genuine business benefit from the information; and both provider and advisory firm can demonstrate that information is expected to enhance the quality of service to clients