In June 2013 the Financial Conduct Authority (FCA) published a policy statement and final rules to ban the promotion of units in unregulated collective investment schemes (UCIS) and other non-mainstream pooled investments (NMPIs) to the vast majority of retail investors in the UK from 1st January 2014.
It was said in the FCA's initial proposal that "...the flexibility allowed within the rules has often been misunderstood or exploited...". This led to high numbers of Ordinary Retail investors investing in what are considered to be high risk investment schemes, and sadly, to the detriment of some of those investors.
This article relates specifically to UCIS so no comment will be made with regard to other NMPIs.
Recap on the imposed restrictions
The FCA has removed 3 categories of customer (under the Conduct Of Business Sourcebook 4.12.1R (4)) to whom firms may promote UCIS. By limiting the promotion of UCIS, the FCA’s aim is to limit the number of retail clients being wrongly advised to invest in UCIS. Put simply, these categories are:
Category 1 - Existing investors
Category 2 - Advised investors
Category 8 - Investors who have expertise, experience and knowledge to be capable of making their own investment decisions
The FCA distinguishes between 3 types of retail customer:
> High Net Worth Individuals; and
> Ordinary Retail Investors.
Ordinary Retail Investors are investors of ordinary means and experience who make up the vast majority of the retail market in the UK and face difficulty understanding complex financial products. They are therefore at particular risk in relation to inappropriate promotion of non-mainstream pooled investments, such as UCIS.
Removing these categories is not to reduce the types of investor that can invest in an UCIS but to make the rules clearer and to prevent Ordinary Retail investors investing in inappropriate products.
What has changed
Where marketing is permitted, firms are now subject to a more onerous compliance burden, requiring suitability assessments to be made and properly documented at the promotion stage. Issuers, Distributers/Financial Intermediaries and Operators will be separately taking their own steps to mitigate the risk of Ordinary Retail investors investing in UCIS.
How will this work in practice
The onus has hitherto been placed on Distributers/Financial Intermediaries to only recommend UCIS to suitable clients. Now, the FCA also expects Issuers and Operators of the UCIS to take equal responsibility for ensuring that Ordinary Retail investors are not promoted to and, more importantly, not accepted as subscribers of UCIS.
1. Prominent reference to UCIS at the promotion stage (Issuer responsibility)
Some disclaimers of UCIS financial promotions have historically referred to COBS 4.12 generally. It would be prudent to list the specific exemptions to make it clearer exactly who can invest in the scheme. This is in addition to the relevant articles under FSMA (Promotion of Collective Investment Schemes) (Exemptions) Order 2001.
The cover and contents of the financial promotion could make more obvious references to UCIS to make it clear from the offset what the investment product is.
2. Promoting to the relevant categories of investor (Issuer and Distributers/Financial Intermediary responsibility)
Getting the financial promotion in front of the right recipients may be difficult to do in reality as there is only a limited amount of control that can be applied however there are steps that can be taken to mitigate the risk of Ordinary Retail investors being approached. The Issuer can separately document the list of exemptions when handed to 'promoters' making it clear whom the promotion is available for and also make reference to the *client’s best interests (COBS 2.1.1R).
*Firms should not promote products, even where an exemption is technically available, if it would not be appropriate or in the client’s best interests to do so. Intermediaries promoting the scheme and operators processing subscriptions should take the steps to ensure that the client's best interests are also taken into account.
3. Subscription process to include provision of suitability assessment evidence (Distributers/Financial Intermediary and Operator responsibility)
To improve compliance with the rules and thus secure better consumer outcomes, the FCA has introduced a new, more specific rule requiring firms to document and retain records of the precise
basis on which they make each promotion of a non-mainstream pooled investment to a retail client. This should set out which category the investor falls within and the basis for that decision.
Operators should not accept an investor into an UCIS until such records have been obtained.
The FCA now expects a more proactive approach is to be taken by compliance functions within firms throughout the promotion process. It is the duty of the Compliance Officer to review the records and ensure that the appropriate steps have been taken in advising/accepting an investor and that the documentation is in order. The Compliance Officer may delegate day-to-day reviews to another member of the compliance team so long as the Compliance Officer undertakes an annual review (being no more than 12 months following the acceptance of an investor in a scheme).
It will depend on which link in the promotion chain that your firm takes in this process in order to determine how to best comply with the rules and to ensure that the end result is that Ordinary Investors are no longer being missold NMPIs, such as UCIS. If you would like some help in determining what your obligations are, do give us a call. Our contact details can be found here.
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