The FCA has been accused of “gold plating” European rules and imposing onerous costs on advisers after proposing firms record all client conversations.
As the regulator fires the starting gun on implementing the EU’s recast markets in financial instruments directive, experts warn the legislation will have significant implications for advisers.
Last month, the FCA published a discussion paper on its approach to the Mifid II rules. It says the EU timetable for implementation is “challenging” and it wants to get firms’ views on the legislation as early as possible.
The FCA plans to consult on rule changes in December and will confirm final rules by July 2016. Firms have until 3 January 2017 to comply with Mifid II.
Independent regulatory consultant Richard Hobbs says: “The FCA is trying to warm up the industry for Mifid II and I suspect it is worried this is not high enough on firms’ agendas.”
Recording client calls
To help combat market abuse, Mifid II proposes requiring firms to record telephone, and electronic communications relating to client orders, a requirement which may extend to some face-to-face conversations.
Records must be kept for five years and provided to the client on request. National regulators have the option to extend the retention period to seven years.
When the FSA implemented Mifid I in 2007 it created exemptions on recording rules for certain firms, including advisers.
But the regulator says it is considering removing this exemption, arguing to do so will allow it to “assess firms’ compliance with the conduct of business requirements, pursue enforcement cases for market abuse and support claims of non-compliance with our regulatory requirements”.
It says requiring all firms to record calls may also help resolve complaints more quickly.
But Apfa director general Chris Hannant says: “This aspect of Mifid II is aimed at monitoring firms like stockbrokers to prevent market abuse. It is not about investment advice and the FCA is going over the top by gold plating the rules.
“Firms need to keep a record of the advice they have given but to suggest a blanket requirement to record all conversations is not what Mifid II intended.”
A senior source at another major trade body says: “Firms will have to store the data and use new technology to access particular parts of conversations. This will be difficult to do and extremely expensive.”
It is understood a medium-sized advice firm could expect to pay around £2,500 a year to record all telephone calls but additional costs would be involved in recording
face-to-face meetings and storing the data.
City law firm Reynolds Porter Chamberlain associate Sam Bishop says firms would have to record all calls as they could not know in advance whether a call related to a client order.
He says: “Market abuse in relation to advisers is unusual, so this seems disproportionate.
“However, one of the problems we see when advising firms defending complaints is firms often have insufficient documentation. So while recording calls would mean incurring an upfront cost, it could reduce costs in the long term by helping firms defend complaints and stem liabilities.”
Compliance consultancy firm The Consulting Consortium offers a RecordSure tool for advisers which records face-to-face and telephone conversations.
TCC chief executive Joanne Smith says meeting notes and other paper-based methods of recording “cannot be relied upon to be 100 per cent accurate”.
She says: “An audio recording is the only authentic validation of what has occurred during a conversation between adviser and client. Knowing there is evidence of the suitability of the advice should provide advisers with peace of mind and greater assurance against future complaints.”
The paper also sets out the FCA’s initial thinking on how Mifid II will affect its independent advice label.
In December, the FCA said it was “open-minded” about changing its independent and restricted labels after its post-implementation review of the RDR found they were not well understood by consumers.
Mifid II introduces a European-wide definition of independence for the first time.
It requires independent firms to make recommendations based on a “sufficient range” of providers’ products rather than the whole market as under the FCA’s definition.
However, experts say Mifid II’s definition may actually be stricter as it covers a broader range of products.
The FCA’s independent definition covers retail investment products while Mifid II’s independent standard also covers structured deposits, shares, derivatives and bonds.
The regulator is proposing including structured deposits within its independence requirements and developing a separate independence standard for shares, derivatives and bonds.
The FCA is asking for views on how Mifid II’s definition compares with its own but says any change to its labels risks creating confusion.
Hannant says: “The Mifid II definition is superior but whatever the standard is it has to be consistent across all products. To have one standard for retail investment products and another for other products would be a recipe for confusion.”
Law firm Clarke Willmott partner Philippa Hann says the range of products covered by Mifid II means it will become “ever more difficult” for advisers to maintain the independent label.
She says: “Very few, if any, lawyers offer advice on every aspect of law; most deal only with a relatively narrow specialism.
“Similarly, financial advisers will develop their specialisms further and we may see more styling themselves as independent ethical advi-sers or independent advisers for shares and bonds.”
In the execution-only market, Mifid II will introduce stronger protections for consumers.
It proposes requiring firms to carry out an appropriateness test for complex products sold without advice.
Further details on which products will be classed as complex are due in January 2016.
But the FCA says few instruments other than vanilla shares and bonds, non-structured Ucits funds and some structured dep-osits are likely to be classed as non-complex.
Zurich head of regulatory developments Matthew Connell says: “The paper sets out that for a lot of products, execution-only is not going to be an option any longer.
“But the appropriateness test has to be proportionate and not so onerous that it locks everyone out of buying a product on their own.”
Bishop says the rules place a greater onus on product providers which issue marketing materials on a non-advised basis.
He says: “Can you really continue to sell products on the basis of a direct offer financial promotion and comply with these obligations? It is going to be very difficult.”
Hann says advisers should be cautious when carrying out execution-only transactions. She says: “As the definition of non-complex products is restricted, if in doubt, advisers would be well advised to consider the appropriateness test in each case. There may be pressure from clients to avoid this step but the risk of falling foul of these new requirements simply isn’t worth taking.”
The FCA says Mifid II will tighten inducement standards for all investment firms. In January 2014, the regulator published its final guidance on inducements, which banned “extravagant” hospitality given to advisers. This followed earlier guidance on distribution deals between providers and advisers.
For independent advisers, Mifid II bans the receipt of all benefits except “minor non-monetary benefits”.
The European Commission may publish a list of what falls into this category in its implementing measures in the summer.
The FCA says acceptable benefits may be limited to generic information relating to a product or service, participation in conferences and seminars and hospitality of a reasonable value. Benefits must also meet a “quality enhancement” test to show they benefit the customer.
The regulator says it plans to apply the “more restrictive” rules to both independent and restricted advisers to avoid the confusion of having two regimes.
Bishop says firms will have to int-roduce procedures to show they are reviewing the quality of benefits they receive rather than simply whether they fall below a certain monetary value.
Connell says: “Training, technology and research have been grey areas so this is where Europe may impose tougher standards.”
The FCA is also considering banning third-party rebates for discretionary fund managers. Under Mifid II rules, DFMs are allowed to accept commissions so long as they are passed along to investors but the FCA is considering ruling out rebates altogether.
One area where the FCA is taking a more lenient approach is cost disclosure. Mifid II requires firms to disclose all costs and charges related to a product at the point of sale and aggregate the information to show the cumulative effect of costs on the return on investment.
Experts have previously argued it will be near impossible for advisers to obtain this information and present it as a single figure.
The FCA says it recognises the “technical challenges” involved and potential overlap with the key information document set to be introduced by the Priips regulation in summer 2016.
It says it will not apply the costs and charges requirements for pension products and insurance-based investments, which includes unit-linked and with-profits policies, investment bonds and annuities.
The regulator says this is because there are a number of changes to disclosure requirements for these products in development, including the Kid and the FCA’s work with the Department for Work and Pensions on transparency of workplace pension costs.
Deloitte regulatory strategy manager Rosalind Fergusson says: “There has been a whole raft of new measures and proposals in the UK and Europe aimed at increasing the transparency of costs and charges to consumers. But the FCA seems to recognise the more information you provide to consumers, the more challenging it can be for them to make sense of it.”
March 2015: FCA discussion paper published
Summer 2015: EU legislation on Mifid II implementing measures is adopted and formal approval process begins
December 2015: FCA consults on implementing Mifid II requirements
Early 2016: EU legislation on Mifid II implementing measures is finalised and published
June 2016: FCA policy statement on implementation of Mifid II
January 2017: Mifid II rules come into effect
The FCA is trying to warm up the industry for preparing for Mifid II. Part of the problem is the FCA does not control the timetable.
European regulators can cause national authorities a real headache because until they publish their technical standards, there is not a lot of information national regulators can give to firms.
The recommendations on recording client conversations gives us an insight into European legislators’ thinking.
This rule is based on a bancassurance model, where firms use call centres. It is only really the Netherlands and the UK which have a community of independent and sole trader advisers and this legislation is an example of Europe not appreciating that model.
Recording calls can be done but there are economies of scale.
It would cost a bank with a large call centre tens of thousands of pounds a year to record its calls but as it has hundreds of staff the cost per call would be relatively cost-effective. However, an IFA only doing a few interviews a week would have to pay a higher cost per call.
As a defence against potential complaints, recording calls is very useful and some advisers might take that view.
But for a trusted, local IFA, if you set up a tape recorder in a meeting a lot of clients would really hate it and it would be an impediment to the client relationship.
Some people may even hang up if they call a firm and are told the call will be recorded.
The loss of potential or existing clients is a very serious consequence for firms.
This is part of a wider trend towards increasingly intrusive oversight techniques and further evidence of the rising tide of regulation.
Richard Hobbs is an independent regulatory consultant
Lee Robertson, chief executive, Investment Quorum
We currently record all calls and as a firm with discretionary investment permissions, that is a nice safeguard for us. Our professional indemnity insurer really likes it and it helped resolve a potential client dispute a few years ago. But not every client would be comfortable having meetings recorded, particularly face-to-face, and the Mifid II requirements could cause huge data storage problems for advisers.
Aj Somal, chartered financial planner, Aurora Financial Planning
Some clients might be uneasy about recording calls or meetings, particularly new clients. It all comes down to how you introduce the concept. Most advisers are aware Mifid II is coming down the track but there is a lack of knowledge about what the legislation involves. There needs to be more information out there, particularly when there is a short deadline.