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How do we solve the unregulated investments problem?

At our recent Money Marketing In Focus conference, the FCA and Financial Services Compensation Scheme shared a stage to talk about the fallout from the freedoms and where we go from here. It is clear the advisers in the audience were focused on one in issue in particular: how unregulated investments are treated.

FSCS chief executive Mark Neale revealed that 80 per cent of all claims received by the lifeboat fund concerned unregulated products. By my count, it provoked at least five key issues that need to be tackled before we can begin to solve the unregulated investments problem.

  1. Should the FSCS continue to provide compensation to those who took out unregulated investments?
  2. Should advisers have to take additional qualifications to advise on unregulated investments?
  3. Should advisers have to pay more towards the compensation pot if they do advise on unregulated investments?
  4. Should the FCA regulate the product, not the advice, and provide a whitelist of all acceptable products outside of which no one could go?
  5. Should regulated advisers be allowed to recommend unregulated investments at all?

That this is just a selection of the potential debates to be had around ensuring a fair compensation system when it comes to unregulated products is a testament to how difficult the issue is to solve. Taking each of the points in turn, the cases for and against can often sound equally compelling, throw up even more questions and give rise to contradictions with other areas of regulation.

Should the FSCS continue to provide compensation to those who took out unregulated investments?

Advisers like the idea of caveat emptor. If you really want to buy into an African biofuels scheme, a Caribbean hotel complex or a car parking scheme investment, then knock yourself out, but don’t expect anyone else to pick up the tab if it goes wrong. Confirming the accuracy of a suitability report is essentially saying I understand the risks, and am willing to pay the price. This has been a campaign issue for trade bodies like Apfa in the past.

But speaking at the conference, FSCS chief executive Mark Neale raised a valid point: what if the consumer was in fact misled about the nature of the investment? The reason the FSCS picks up the tab now is because it judges the merits of the regulated advice, not the unregulated product. What if the adviser picked up a juicy marketing fee and then did a runner or went into insolvency? It looks unfair for the consumer to be liable for their losses in cases where they were blatantly mis-sold or worse, the victim of an outright fraud.

Should advisers have to take additional qualifications to advise on unregulated investments?

Advisers already need additional qualifications to advise on complex areas such as final salary pension transfers. Would it be such a stretch to apply this to high risk investments too?  Much in the same way as many IFAs hold equity release qualifications without actively advising in the area, a significant number would surely sit the exams just in case an unregulated scheme was right for a particular client, even if they had no intention on recommending them on a regular basis.

Yet for every extra exam, CPD point and regulatory hoop to jump through, the cost of advice will increase, disenfranchising more of the people who would never have taken on a risky investment in the first place, limiting advice to exactly that ultra-wealthy group who have the financial security already in place to warrant looking at more esoteric options. What if a client is adamant a high risk scheme is right for them, but the adviser has not yet sat his exams? Would IFAs have to turn away new clients on a regular basis? Who would double check that all the unregulated product sales are actually being done by sufficiently qualified advisers?

Should advisers have to pay more towards the compensation pot if they do advise on unregulated investments?

Neale, and to a lesser extent the FCA, have been clear on this: we need to minimise how much the good firms are paying for the bad. Unregulated products, by their nature, have a greater risk of failure and therefore are more likely to cause liabilities for the FSCS. From next year, advisers will have another question on their regulatory return asking how many non-mainstream products they recommended so the FCA can see whether this could be used to risk-rate how much they pay in fees.

What if all the unregulated investments were the most suitable options for clients though? Should an adviser have to underplay a client’s risk profile for fear of an increasing levy down the track, or be penalised for not doing so? There is an argument that this creates a sort of reverse moral hazard; play it super-safe and you’ll never have to pay up. That is not to mention the practical difficulties of judging exactly which firms or sales genuinely present a greater risk of failure, and by how much levies should be adjusted accordingly.

Should the FCA regulate the product, not the advice, and provide a whitelist of all acceptable products outside of which no one could go?

If you wanted to completely minimise firm failures, this would be the surest way to do it. The likelihood of an adviser, or anyone else for that matter, falling into insolvency and passing the bill onto the FSCS would be slim to none if only the highest-rated instruments were allowed to be passed into consumers’ hands. As a result, the amount paid out in FSCS levies – the largest part of bills advisers receive from the FCA every year – would be dramatically reduced.

But the direct corollary of this is that as FSCS costs fall, the burden on the FCA that would be passed on would increase in equal measure. The time and expense the FCA would need to undertake in vetting a myriad of increasingly complex products would be huge. New products come onto the market all the time. Innovation would be stifled and there would be no sure-fire way to ensure that the people behind them were telling the regulator the truth. The FCA has said repeatedly it does not want to offer carte blanche to advisers justifying suspect recommendations with the excuse that the regulator said the product was okay.

Should regulated advisers be allowed to recommend unregulated investments at all?

A significant number of advisers still believe that there can never be a case for recommending an unregulated product. No matter how high-risk your client, how complex their needs or how much yield they need, a suite of regulated investments from trusted providers will do the trick, and it would be good for the reputation of the profession if potential clients knew that there was zero chance their adviser would lose it all gambling on storage pods.

However, a significant number also feel such a restriction would be limiting. Thorough due diligence should be able to take into account the entire market to find the most suitable portfolio for a particular client, not be artificially turned away from certain avenues or provide a watered down version of what the best advice would look like.

So what’s the answer            

With all of these competing arguments swirling, it is little wonder that scant progress has been made to make sure the actual polluters pay more. But rest assured, the issue is high up the regulatory agenda.

Justin Cash is editor of Money Marketing. You can find him on Twitter @Justin_Cash_1



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There are 10 comments at the moment, we would love to hear your opinion too.

  1. … if only the highest-rated instruments were allowed to be passed into consumers’ hands…

    That is already the case. UCIS were banned (in mid 2014?)to retail customers (except for the exemptions under COBS 4.whatever).

    Unfortunately there are endless examples of advisers using self-certification of “experienced investor” status to work around that.

    The FOS have a habit of recategorising certified experts as certifiable numpties, which on the one hand is good (as many cock-sure consumers are actually numpties) but is also bad in that hell-bent consumers who have “sort of” opted out of the regulatory regime are then put back in by the FOS and then possibly onto the FSCS.

    And there are the issues around the edges. Some advisers think that SIPPs are self-invested, but if there is a whiff of their involvement, then they aren’t. Much misunderstood.

    And of course there’s the experienced (and insistent) investor who self-declares numptiness in arrears.

    Personally, I think all excessively greedy investors have a certain responsibility and I think the FCA agree, except of course when a load of them go on TV and weep and complain about the useless FCA. But you do have to also feel sorry for those people who are pressurised into making UCIS investments, especially as the adviser chain is often so heavily rewarded.

    So why not tighten the existing rules and laws up?

    Any UCIS sold using commission whether disclosed or undisclosed, is in the FSCS. But any party paying or receiving that commission is committing an illegal act, punishable by something very nasty indeed (and with the protection of normal ltd liability not applying). If no commission or fees are passed between the UCIS provider and the adviser, then no FSCS. Think about it.

  2. Thanks for a great article. If an Adviser is so convinced of their genius capabilities that they want to recommend UCIS without fear of complaint let them. Just don’t ask my clients to subsidise them and their clients. They can pay for the additional costs.

  3. Shouldn’t improving the FCA’s GABRIEL system be the first step, so that at least it may know who’s selling UCIS, then home in on them, analyse their DD processes, demand proof of relevant PII and, if they fail on the last two points, ban them from selling any more?

    It seems so obvious and so straightforward that one has to wonder why the FCA hasn’t just GTF on and done it.

    • Always assuming that they actually read the returns or have an algorithm that can flag up.

      Otherwise if the regulator wishes to mealy mouthed and refused to prohibit regulated advisers from selling these (if clients really want such an investment – go to a stockbroker), then perhaps the problem could be solved by the PI insurers refusing to cover any firm that deals in them. Without PI a firm cannot trade.

      • Yes indeed, Harry. Given the vast sums of money that the FSA and the FCA have spent on one IT system after another (one of which, I recall, turned out to be such a white elephant that they just wrote it off ~ a figure of £200m springs to mind, though I may be wrong), one might reasonably suppose that the installation of an algorithm to flag up automatically any reporting of involvement with UCIS would be pretty easy. How difficult can it be? What is the point of the FCA’s widely reviled GABRIEL system if it doesn’t flag up potentially dangerous activities on which it should then swiftly home in and curtail?

        The home page of the FCA’s website claims that the first two of its mission objectives are:-

        Protecting consumers. We secure an appropriate degree of protection for consumers.

        Enhancing market integrity. We protect and enhance the integrity of the UK financial system.

        Really? I can’t quite see it myself, but perhaps I’m missing something.

        Re: your second para, firms CAN in fact trade with PII cover that doesn’t cover all their activities and, amazingly (to my mind, appallingly), Andrew Bailey has been quoted as having said that the FCA actually isn’t particularly bothered about this. Whaat? How is such a statement supposed to accord with his alleged concerns about the cost burden of the FSCS, when 80% of all claims on it (so Mark Neale has said) are represented by the ongoing tsunami of uninsured liabilities in respect of failed UCIS that it’s continuing to take on? Just how incomplete and inadequate a PII policy might the FCA be prepared to tolerate? Is any old 3 page document considered satisfactory provided it says on the front Professional Indemnity Insurance Policy?

        Refer again to the FCA’s first two mission objectives quoted above.

  4. Anthony John Etkind 14th December 2017 at 4:34 pm

    How about looking at this from the Clients’ perspective?

    First up, what realistically are the chances of clients ending up with a superior result from investing in UCIS as opposed to regulated funds? If there isn’t any research, commission some. I have a strong suspicion that overall UCIS will come up with a pretty poor set of results.

    Secondly, think of the advantage to clients of UCIS being banned: lower costs all round to advisers (reduced PI premiums, lower compensation contributions) should lead to all mainstream clients benefiting, not just the poor sods who see all their money disappearing and wonder if they’ll get it back.

    Thirdly, as an alternative, FCA could stipulate maximum UCIS investment of say 5 to 10% of clients’ investable assets. That would seriously limit the damage and probably eliminate the problem as most of the cowboys wouldn’t be bothered for such a low percentage. And how often could any respectable adviser justify a higher allocation to UCIS?

    • I’m not sure that UCIS have any effect on PII premiums. If you don’t sell them, they’re not factored into your premiums. And even if you do, the likelihood of any PI insurer agreeing to provide cover is remote, which is why such volumes of uninsured liabilities continue to fall on the rest of us by way of the FSCS.

      The main reason why PII premiums are so high is the regulatory application of today’s suitability standards to yesterday’s business by way of hindsight reviews. The next one of those in prospect is, of course, DBP transfers, on which I think there’s a high probability that at the next renewal insurers will be asking firms to declare how many such cases have been examined by the regulator and been declared defective. Those which have been declared defective are, of course, likely to lead to an order to pay compensation and, should the number be anything more than a tiny percentage of all such cases, the insurer may well withdraw cover. That’s what they tend to do, isn’t it and, in the wake of the great Pensions Review of the 90’s, it’s easy to see why.

      Any other insurers approached will almost certainly demand details of any exclusions within the firm’s existing PII policy and, should any such exclusions relate to business in which the firm in question is currently engaged or in which it has in recent times been engaged, full details of exactly why will also be required. What’s the likelihood of any new insurer agreeing to provide cover that’s been withdrawn by another? Virtually zero would be my guess, leading to a high probability that many firms in the DBP transfer market will find themselves saddled with liabilities that they’re unable to meet. So they’ll default and those liabilities, as with uninsured liabilities for UCIS mis-sales, will pass to the FSCS.

      The prospects of our FSCS levies coming down any time soon can hardly be good. In fact, they may continue to go up for a number of years.

      As an aside, the FCA doesn’t regulate any products, it only authorises the providers of certain products so, really, the initials UCIS should stand for Unauthorised as opposed to Unregulated Collective Investment Schemes. And even if the FCA did regulate any products, what would this actually mean in practice?

  5. If the FSCS have paid out £100M (80% of £125M) on unregulated investment schemes, then this must have come through a regulated path somewhere for the FSCS to be involved.

    Some of these claims will no doubt have exceeded the FSCS limit so the actual client losses will be higher.

    This means there is a huge industry problem which the FCA seems unwilling or unable to resolve.

    Let’s not forget that the regulator has a number of statutory objectives;

    1. (1) for the FCA (as described in sections 1B, 1C, 1D and 1E of the Act):
    (a) its strategic objective of ensuring that the relevant markets function well; and
    (b) its operational objectives:
    (i) the consumer protection objective (as defined in section 1C of the Act);
    (ii) the integrity objective (as defined in section 1D of the Act); and
    (iii) the competition objective (as defined in section 1E of the Act);

    The size of losses experienced by clients would indicate FCA are failing its statutory objectives of ensuring the market is functioning well and that consumers are protected, unless of course they can sit back and say they are protected by virtue of the FSCS?

  6. FCA should regulate the product. If not then that advice & product should fall outside of the FCA and FSCS rules. If an adviser wants to sell Sand to the Arabs or Ice to the Eskimos as long as it is made clear that the sale is not protected or indemnified then Buyer Beware.

    • You (probably) know my views, Simon, on any proposals either for the FCA to regulate (certain classes of) product (completely impractical) or for the selective exclusion of certain products from the protections for consumers afforded by the regulated advice process. These things will never happen and nor should the FCA even consider trying to make them happen.

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