Whenever wholescale regulatory developments in the financial services sector are announced, they tend to dominate the headlines and conferences and events programmes. But they don’t often provide the clarity over action required, leaving firms to work it out for themselves.
The Retail Distribution Review, the Financial Advice Market Review and the pension freedoms are all recent examples of regulation taking over and becoming the main focus of most conversations that our profession has to contend with.
This understandably has led to some significantly stressful times as advisers try to navigate their way around a completely new landscape on a strict deadline, alongside running their business full-time. This often creates a feeling of uncertainty, and sometimes bewildered confusion, as certain things feel unclear. Some advisers worry about regulatory repercussions if they don’t fulfil certain obligations by the deadline, even if they have tried their best to do the right thing, or indeed don’t need to take any action.
As a professional body, we continue to address such change events by creating clear guidance and in particular through the use of good practice benchmarking to better help advisers interpret the rules. Our evolving relationship with the regulator has ensured we not only convey advisers’ views to the FCA, but also relay the regulator’s thoughts back to the sector.
The latest regulatory hurdle is Mifid II which kicks in next year. Many across the financial services sector are concerned whether they are prepared for the changes, what challenges lie ahead and whether there any unexpected last-minute announcements that will send us into a spin.
However, our message to advisers is do not panic - you are almost certainly closer than you may appreciate. From our experience of engaging with many advice firms across the UK, the majority are prepared and feel reasonably comfortable about what lies ahead, which is reassuring, but of course no one can afford to be complacent about significant regulatory reform.
Although Mifid II has parts that touch on advice, it is not at the heart of the changes and therefore advisers have little reason to be overly concerned. Since we started to first talk about Mifid II, there have been a lot of changes which have caused some confusion, for example the numerous tweaks to the recording client conversations piece which has added to advisers feeling unsure.
But far from requiring a complete overhaul of systems and revamping client propositions, advisers can feel secure they are Mifid II compliant and ready as long as they bear the following in mind:
Recording client communications
The Mifid II provisions require "recording of conversations and communications with all clients where these relate to/ intend to lead to the conclusion of a transaction, even where the transaction is not concluded." Mifid requires these or ‘analogous’ requirements to be imposed for all advisers.
The FCA has recently said the record can be written up by the adviser afterwards instead of being taped. In practice, these requirements will have little implication for the majority of advisers who deal with clients on a face-to-face basis. But where the telephone or other remote mechanisms are used, it makes good sense and indeed good practice to record these and be consistent with other remote services.
Advisers may also consider setting one standard across a firm; for example implementing a rule where all advisers must record client communications within 72 hours of the event to ensure accuracy and that it gets done.
Reporting to clients
Mifid will give advisers a powerful tool in the form of transaction costs (including broker commissions, stamp duty and ‘slippage costs’). As part of the new Mifid II rules, fund groups must give clients a more detailed breakdown of transaction costs if requested.
This will help advisers greatly because it will enable them to make comparisons between different funds in a more detailed and insightful way. The trick is how advisers use this to their advantage; after all, just because clients can request information doesn’t mean they will, or that they will fully understand it. This gives advisers a significant opportunity to add value to clients by explaining what this information means, and how they should use it to make investment decisions.
The EU has followed the RDR to a certain extent by banning commission payments, but only for advisers that hold themselves out as independent. The Mifid definition of the kinds of investment that advisers must consider includes non-packaged investments like standalone shares and derivatives. However, the FCA has made it clear advisers do not have to consider these as part of the advice process, so long as the scope of the advice is clear in any marketing materials. The key thing to bear in mind is, if you hear rumblings about Mifid II defining independence, not to worry as we won’t be experiencing an RDR II.
Mifid II inducement rules tighten up existing inducement rules even further. The most significant one will be the banning of the rebating on inducements to portfolio management. The logic is providing rebates creates a ‘ceiling’ for fees, and therefore rebates give a signal about the maximum remuneration that can be taken. Offering the rebate is giving signals about the remuneration that could be taken, which undermines competition.
But this is just another thing advisers need to be aware is not going to heavily impact on them, unlike perhaps previous inducement rules, as they do not constitute a large change to existing regulation and have limited significance for UK advisers.
Complex products and the appropriateness test
Mifid II will ban execution-only sales of complex financial instruments to retail clients. These complex instruments include derivatives, but do not include Ucits (except for structured Ucits – which are pay out according to a pre-defined formula).
All clients who want to buy complex financial instruments without advice will have to pass an appropriateness test to see if they have the necessary knowledge and experience of investing. Interpretations of what an appropriateness test is vary, but the FCA has said clients are not allowed to self-certify, for example, by answering ‘yes’ to the question ‘do you have the knowledge and experience necessary to make a decision about buying this product?’ There is some debate over whether clients have to do an appropriateness test if they already own a similar investment product.
Appropriateness tests can vary according to how complex the product is, and it is likely the least risky types of complex products will have an appropriateness test that discloses certain risks in detail, with a tick box for clients to complete to confirm they understand the risk. The riskiest products (such as products where clients can lose more than their original investment) are likely to have more elaborate appropriateness tests, for example, online modules that clients must complete before buying the product.
If non-Ucits retail schemes were to be considered complex, many retail funds sold on a non-advised basis would have to be sold with an appropriateness test.
If advisers sell funds on a non-advised basis, they are responsible for deciding if an appropriateness test is necessary and what form this should take. This will probably be rare, because most funds will be considered non-complex. However, advisers will need to decide what their overall approach will be, and how this relates to the funds distributed on a non-advised basis.
If in doubt, double check your firm specific requirements with your compliance expert or support service supplier, or watch out for some straightforward guidance and a checklist from the Personal Finance Society.To download the Nucleus white paper MiFID II: A guide for financial advisers, prepared in partnership with Phil Young of Zero Support, click here