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Cobs: the principle

The review of the conduct of business regime is a significant milestone in the FSA’s move towards more principle-based regulation and away from reliance on prescriptive rules.

The FSA implemented its new conduct of business sourcebook for investment business on November 1 last year. It is the first major part of the handbook review in line with more principle-based regulation to come into effect – although followed closely by the new Icob – and gives firms more flexibility to decide how to achieve the required outcomes in line with their own business models.

Cobs also implements the conduct of business requirements of the Markets in Financial Instruments Directive. Mifid is a European directive which aims to establish common standards for investment business and markets across Europe. Much of the new terminology in Cobs comes from Mifid. All firms doing investment business have to follow Cobs but there are some differences in the requirements that apply to Mifid firms which are clearly flagged.

Cobs has a different look and feel to its predecessor. The simplification and streamlining of requirements means that the sourcebook is now about half the size it was. It is structured in such a way as to follow the stages of the advice process, so it should be easierfor firms to navigate.

It has fewer prescriptive requirements so there is more of an emphasison high-level rules and principles. It aims to focus more on required outcomes while giving firms more flexibility to decide for themselves the most appropriate way of achieving these for their particular business.

There are still areas where we have kept some element of prescription if we think it is needed to ensure appropriate consumer protection. Some of these derive from Mifid. For example, there are fairly detailed rules regarding the information that an adviser must obtain from a customer before making a recommendation.

The regulatory outcomes and expected standards of adviser behaviour are fundamentally unchanged under Cobs.

The challenge to firms is to consider how they meet the standards within the more flexible regulatory operating environment.

We have heard some firms saying they prefer the more prescriptive approach to regulation as this enables them to ensure they are meeting the necessary requirements using a tick-box approach. However, this approach was restrictive for firms as it did not always allow them to consider what was best for their clients as they focused more on meeting the rules. We believe that a more principle-based approach to regulation means that firms’ senior management have to take more direct responsibility for their business practices and consider what they want to achieve and how to do this. More principle-based regulation gives firms the flexibility to do this.

An example of an area where we have tried to streamline and focusour requirements is on suitability letters, now referred to as suitability reports. We have sought to give firms more flexibility to tailor their documents to the needs of the client.

During our supervisory work, a number of firms have told us that they try to make their suitability reports bulletproof to protect the firm from potential complaints.This has led to them becoming long documents with a lot of standard wording. We understand a firm’s wish to include everything in a suitability report but we do not believe this is necessarily a good example of treating customers fairly.

Clients may find such documents difficult to read and understand, especially if they are long, contain jargon and are not tailored specifically to that client. Examples of where we have seen a good approach is where firms produce short, tailored letters which are personalised to the client, explaining why the recommendation meets their needs and objectives and the risks of the recommendation.

The firm then uses appendices to include any additional information they want to cover. Firms can therefore achieve the outcome of producing fair, clear and not misleading communications to clients by deciding what is the relevant information to include for that client.

Due to the extent of the changes from Cob to Cobs, we did not expect firms to embed all the changes on day one but we did expect firms to know what the changes are and consider how they fit with their business practices.

Some of the main changes for advisers concern disclosure and suitability, including the information that a firm must obtain when making a recom-mendation. To help firms with this, we have takena number of initiatives over recent months to make firms aware of the changes.

The FSA website contains a variety of information, including factsheets and case studies. For small firms, we have included sessions in our roadshows and provided workshops across the country. We have also produced our own e-learning packages.

It has now been more than three months since Cobs was introduced, so we expect firms to have reviewed their processes and made any necessary changes to ensure they have fully implemented Cobs, allowing for the relevant transition periods.

This may require a shift from previous practices and more thought may be needed to establish how firms will operate in a more principle-based environment by giving consideration to what they want to achieve for their clients and designing their business practices around this.

Other firms may require little or no change tohow they operate.

Cobs is the first example of a more principle-based sourcebook and we want to assess how it works in practice, including the benefits and challenges for firms in operating ina more principle-basedway. This year, we are starting a review of Cobsand its effects.

We will be looking to see how firms have implemented Cobs and collecting examples of where changes have been made to their practices and documentation. For example, as the initial disclosure document and menu now have the status of guidance for investment business, we are interested in finding examples of where firms have developed their own disclosure documents, understanding why they decided to do this and what were the benefits and challenges of doing so.

Since many small firms use external compliance consultants to provide template documents, such as disclosure documents, fact-finds and suitability reports, we will also look for examples of where these templates have changed.

Our review of the effects of Cobs will be integrated into our ongoing work in a number of ways, including through our assessments of treating customers fairly for small firms. As small firms are aware, we will conduct assessments face to face or on the phone to assess firms’ progress with meeting the TCF deadlines. Part of this assessment will look at how firms have linked the principle-based approach of Cobsto TCF, how they have reviewed their businessand what changes theyhave made, if any.

These assessments will be conducted with a large number of firms, so we hope to get a good feel for what they are doing.

The FSA will also be looking to contact other firms through phone conversations, focus groups and our day-to-day supervision.

We will continue to provide assistance to firms to help them comply with Cobs by sharing examples of good practice and providing case studies on the FSA website.

For further information on the new conduct of business sourcebook, look at the FSA website at The new sourcebook can be found by clicking on the links Doing Business with the FSA, Being Regulated and then New Conduct of Business Sourcebook.


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