Most IFA firms fall outside Mifid but the FSA has taken the opportunity presented by the changes to review and amend the Cob handbook to a more principle-based approach known as Newcob. The rules come into force on November 1 but what will they mean for most firms?
More principle-based regulation should mean greater flexibility for firms to decide how they deal and communicate with clients and to use their discretion and judgement to personalise their branding and business model.
The Newcob handbook will be significantly smaller than the current Cob rules as many rules will disappear to allow firms a more flexible approach. The FSA has made it clear that under principle six – treating customers fairly – that each firm is expected to create its own guidance and culture.
Principle-based regulation is about outcomes and how best to achieve them. The outcomes are the 11 FSA principles of business and they should be treated by firms as rules and breaching them could result in FSA action against you.
Some will argue that it is more rope to hang yourself by while others will say they will be better off as it allows them to adapt the rules to their business model.
If firms do not adopt the new rules as they are intended, then, yes, they could be vulnerable to FSA scrutiny. The FSA expects firms to “act honestly, fairly and professionally in accordance with the best interests of clients” and firms must show how they have set out to achieve this.
Think strategically, document why you are taking your chosen route and review your processes, as you are doing with TCF.
Training and competence will become even more important tools in showing evidence of the adviser’s competence at point of sale using file assessments, reviews of key performance indicators and other skills and knowledge assessments.
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.”
By recording how Newcob is implemented and interpreted within your firm, you can demonstrate that the outcomes you are achieving are compliant and treat customers fairly.
Risk management and managing conflicts of interest has always been part of Cob rules. Mifid has brought into focus the requirement to manage inducements for IFAs. Senior management must ensure that advisers are not influenced by such gifts or payments.
Create a register and use it to review any potential risks of bias or conflicts of interest during the year but especially when reviewing KPIs, in-house research and board decisions.
IFAs are still expected to have evidence that they know their customers, have conducted wholeof-market research, that client communications are fair, clear and not misleading and that communications explain clearly why a recommendation is appropriate and suitable for their needs, including the advantages and disadvantages.
Under Newcob, the suitability letter becomes the suitability report where the FSA expects to see the communication become punchy and to the point.
The initial disclosure document and menu, while currently under review, stay under the new regime, as does RU64. The FSA requires suitability reports and communications to provide a clear and prominent indication of the availability of a stakeholder pension, if appropriate.
The key features document will become the key facts of the [name of product] and will become shorter and more focused while still allowing the customer to make an informed decision.
Each provider will be allowed to produce its own style of key facts document so IFAs have to understand to what extent disclosure has taken place and, if necessary, add to the risk warnings, explanation of exclusions, and so on, within their own suitability report.
The standard warnings regarding complaints, cancellation and compensation will stay but IFAs must consider more carefully the extent to which they can rely on provider literature.
The post-sale notice of cancellation will no longer be issued, putting more emphasis on the adviser to disclose the clients’ rights. This will impact on the T&C requirements as it must be evidenced that this is done.
Fact-finding must include the essential facts, including the client’s risk profile, but must also include sufficient information to ensure the correct outcome. If your fact-find is poor, you cannot prove the outcome was correct or you have treated your customer fairly.
Recent fines have emphasised this point. Newcob will put a lot of emphasis on robust fact-finding as this is one area where there have been additional rules.
The illustration will also change, with different reduction-in-yield calculations and projections, but the purpose and outcome are fundamentally the same ? – to make full disclosure.
Risk, how it is explained to the customer and how the client’s understanding of their risk profile is recorded have also been reviewed under Newcob. High-level standards are particularly important here and documentation is vital as most firms have different ways of assessing and recording the client’s risk profile. Firms must also take responsibility for identifying the risks of the product and explaining it to the client, especially as key features documents are to change.
The assessment of the client’s risk profile must now take into account their investment objectives, financial situation and their knowledge and experience in the investment field relevant to the specific investment. Some firms may not be doing this presently and the new requirements will necessitate a change in systems to ensure that they are met.
Advisers are expected to assume more responsibility for identifying relevant risks and explaining them to clients “so that the client is reasonably able to understand the nature and risks of the service or of the specific type of designated investment that is being offered and consequently to take an investment decision on an informed basis”.
Assessment must also include information on the length of time for which the client wishes to hold the investment, his preferences regarding risk taking, his risk profile and the purpose of the investment.
The Newcob rules on promotions and client communications have changed from clear, fair and not misleading to fair, clear and not misleading. However, we must look at the other changes, namely, that the specific risk warnings will be removed, leaving the firms themselves to decide the risk warnings they want to insert into the communication.
The Cob risk warnings should not be applied after November 1, 2007 as they are considered dated. All promotions must be balanced, fair, meaningful and not hide any of the risks.
Replacing the existing detailed rules on financial promotions in Cob3 with much shorter principles-based rules is one change that is likely to cause firms significant concern.
Risks arising from a non-compliant financial promotion can be significant and are also more likely to be picked up by the FSA as, by their nature, financial promotions are often in the public domain.
The FSA has made it clear that there is no safe harbour for firms in relying on the old rules in Cob3 or, indeed, any other part of Cob after November 1, 2007.
Newcob demands a new way of thinking and a new approach from firms.
The new regulations raise a number of issues for advisers and Bond Peace will be holding a series of free seminars on the Newcob changes.