Financial Services: New tricks
7 May 2007
16 July 2013
28 October 2013
12 July 2013
23 July 2013
24 October 2013
There are only six months to go until the Markets in Financial Instruments Directive (MiFID) is implemented in the UK. The majority of banks and larger investment companies are well along their timetables for implementation. Law firms with Financial Services Authority (FSA) regulatory teams should now be reaching out to the investment services retail sector to assist them with implementation.
The FSA says it will publish a guide to help companies decide whether they need to apply for variations of permissions or make passporting notifications as a result of changes arising out of MiFID, but many companies will still need outside assistance.
The medium to smaller-sized investment service providers will face a real challenge, as they will not have the depth of resources to follow these issues through.
Smaller independent financial advisers (IFAs), which are exempt from MiFID, should have manageable changes to make. The FSA’s new Conduct of Business Rules (Newcob) will apply to all companies, but little else will change for non-MiFID firms.
If an IFA does not hold client money then MiFID implementation will mean little change for them and their customers in the domestic market, as they will be excluded. This arises from the Treasury’s exemption at Article 3 of MiFID, which provides that companies that do not hold client money and that only arrange and advise (on a non-discretionary basis) on certain investments will be outside the scope of MiFID.
However, those IFAs which hold client money and so are not excluded need to consider both the changes required by implementation and the opportunities arising from those changes. They should see MiFID as part of a package of changes largely covering opportunities for EU expansion, Capital Resource Requirement changes and Newcob.
Any IFA that does not qualify for the Article 3 exemption, or opts out of that exemption, will find it easier to carry out activities in other European Economic Area (EEA) states.
Under MiFID it is intended that, if a company wishes to supply services in one EEA state (the host state) from another EEA state in which the company is authorised (the home state), then only the rules of the home state regulator will apply. This is much simpler than the current regime, under which the company would have to familiarise itself with and comply with the host state regulator’s rules. The current rules make the provision of cross-border services very difficult for many small companies with limited compliance resources.
There are, however, complications in conducting activities through a branch in the host state. It is likely that a combination of home and host state regulatory rules will apply and the division of the regulator’s responsibility is not clear. This is bad news. However, direct sales to the EEA from the UK will be more clear-cut. Prior to implementation, the FSA, with the assistance of the Committee of European Securities Regulators, is hoping to clarify the division of responsibility between home and host state regulators where activities are carried out through a branch.
The concept is to have a Europe-wide regime for investment services, but as usual each EU country goes at its own pace. The result may be similar to the implementation of the Insurance Mediation Directive, where for example Spain and Portugal did not implement it for a year or more after the UK. Staggered implementation will inevitably create uncertainty for investment services providers.
What is clear is that providing services elsewhere in the EEA direct from your home state will be much easier.
As well as the cross-border opportunities all companies will need to consider their approaches to the changes to the conduct of business rules that will appear in Newcob, which will replace the current Conduct of Business (COB) Rules in their entirety, with a shorter and less prescriptive set of rules drafted on a more ‘principles-based’ approach.
More principles-based regulation (PBR) should mean more flexibility for companies to decide how they deal and communicate with their customers and how to exercise their own discretion and judgement to personalise their branding and business models.
The Newcob handbook will be significantly smaller than the COB Rules, as many specific rules will disappear. The FSA has made it clear that, under Principle 6 – Treating Customers Fairly, each company is expected to create its own guidance and culture. This approach will allow opportunities to tweak products and promotions in the best interest of the customer, with opportunities for innovation.
PBR also affects other handbooks – Dispute Resolution, Complaints (the DISP); and Senior Management Arrangements, Systems and Controls, for example.
The greater use of discretion could be a problem for some, while others will be better off as it allows them to adapt the rules to their business models. If companies do not adopt the new rules as they are intended then they could be vulnerable to FSA scrutiny. The FSA expects companies to “act honestly, fairly and professionally in accordance with the best interests of their clients”, and companies have to demonstrate how they have set out to achieve this.
Compliance officers will need to evidence why they are taking a chosen route. Terms and conditions will become an even more important tool in evidencing advisers’ and companies’ competence at ‘point of sale’, using file assessments, key performance indicator reviews and other skills and knowledge assessments.
PBR should not be seen as a ‘soft option’. The FSA has said: “We do not expect our proposals to reduce the standards of service received by retail clients. If anything, we see MiFID as reinforcing existing standards of good market practice in terms of suitability and quality of advice.”
Advising and selling
IFAs are still expected to have evidence that they know their customers, have conducted market research and that communications to the client are fair, clear, not misleading and explain clearly why the recommendation is appropriate and suitable for a client’s needs, including the advantages and disadvantages. Newcob will put a lot of emphasis on robust fact-finding and the assessment of the client’s risk profile, as this is one area where there have been additional rules.
Newcob rules on financial promotions and client communications have changed from ‘clear, fair and not misleading’ to ‘fair, clear and not misleading’. But what else has changed?
The specific risk warnings for certain products required by the COB Rules will be removed and should not be applied post-1 November, as they are considered dated. All promotions must be balanced, fair, meaningful and not hide any risks. Companies must choose their own appropriate risk warnings in each case. Again this is an opportunity to innovate and provide information useful to the target audience, but it is also a change likely to cause significant concern.
Newcob demands a new way of thinking and a new approach from firms. Compliance departments will need to be able to justify their decisions and, although they will have more power to decide whether wording is appropriate, they will also have to be robust in saying ‘no’ from time to time.
Tony Woodward is a partner at Bond Pearce