The FCA Conduct of Business and Client Asset Sourcebooks

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The FCA Conduct of Business and Client Asset Sourcebooks

37 questions

Chapter 4



Section 1: Application and General Provisions of COBS


(4.1.1) General application: All clients

• The Conduct of Business Rules (COBS) apply directly to firms conducting designated investment business or conducting insurance business from an establishment maintained by them (or their appointed representatives) in the UK

• The COBS therefore apply indirectly to appointed representatives

(1.3.2) Fair treatment: All clients

• All firms must ensure that they act honestly, fairly and professionally- Clients’ best interests rule

Application and General Provisions of COBSLinksEU MiFID COBS: Effect of passporting

Authorised Branch Client COBS

Spain Spain Spain Spain

Spain Spain France Spain

Spain France France France

Spain France Germany Spain

Further information

The Impact of LocationThe general application is modified depending on the firm’s location and activities. For example: • The rules in COBS that derive from MiFID apply to UK MiFID firms

carrying on MiFID business from a UK establishment. • Due to Brexit, the COBS handbook no longer applies to MiFID business

of a UK MiFID firm carried on from an establishment in another EEA state.

• The rules in COBS that derive from MiFID apply to a non-UK MiFID investment firm (i.e., a third country firm) operating a branch in the UK carrying out MiFID business within the UK.

• EEA firms are now considered third country firms in the UK


(4.1.5) Electronic media – all clients

• Website conditions- A firm is permitted to communicate via a website if the following conditions are met:

• There must be evidence that it is an appropriate method of communication• The client has specifically consented to this method• The client is notified of the website address electronically• The information is kept up to date• The information must be continuously accessible for as long as the client requires it

• Recording voice or electronic communications- Good quality recording should be made and kept for five years when relating to:

• Receiving client orders• Executing client orders• Arranging for a client order to be executed

- …in qualifying investments admitted to trading on a prescribed market (e.g. securities)- Includes communications via fax, email, instant messaging, and mobile phones- Applies to communications with any client or eligible counterparty

Application and General Provisions of COBSFurther information

Durable mediumA medium that allows the unchanged reproduction and storage of the information, for example:• Paper• Floppy disc, CD Rom, DVD• Hard drive of recipient’s computer



Section 2: Client Categorisation COBS


Professional clientEligible counterparty

Protection

Least

Most

Most

Least

Knowledge and experience

Accepting Clients(4.2.1) Client Categorisation: All clients

Authorised/Regulated firmCentral bankGovernment

Supranational

Large undertaking

Elective professional client

Per seeligible counterparty

Electiveeligible counterparty

Per seprofessional

client

Other institutional investors

Retail client‘Customers’

‘Clients’

Links

COBS and FCA statutory objectivesThe COBS exist to allow the FCA to discharge its operational objective of securing an appropriate degree of protection for consumers when dealing with regulated firms.

Hints

Make sure you are clear on the terminology used:• Customer – Retail client and professional client • Client – Retail client, professional client and eligible counterparty• Consumer – a retail client that is also a natural person

Further information

Local authoritiesLocal authorities and/or municipalities are classified as retail clients. They can be reclassified as an elective professional client where they meet/comply with certain requirements. They can never opt up to elective eligible counterparty status.


(4.2.1) Professional clients

• A professional client is either a ‘per se’ professional client or an ‘elective’ professional client.

• Per se professional clients- Authorised/regulated firm- Government, Central Bank, Supranational - Other institutional investors e.g. special purpose vehicles- Large undertaking

• At a company level, a large undertaking must satisfy at least two of:- Balance sheet €20m- Net turnover €40m- Own funds €2m

Accepting ClientsFurther information

Per se professional clientsFirstly, it is organisations required to be authorised or regulated to operate in the financial markets, including:• A credit institution• An investment firm• An insurance company• An authorised CIS or pension fund (or its management company)• A commodity or commodity derivatives dealer• A local• Any other institutional investorNext, a large undertaking:• In relation to MiFID business

– A company that meets two out of the three tests below • Balance sheet total of €20m• Net turnover of €40m• Own funds of €2m

• In relation to non-MiFID business the tests are different:– A company, partnership or unincorporated association with called up

share capital or net assets of at least £5m–A trustee of an occupational pension scheme with at least 50 member

and £10m assets under management–A company meeting two of the following three size requirements:

• Balance sheet total of €12.5m• Net turnover of €25m• Average number of employees: 250

Also • Governments, certain public bodies (such as one that manages public

debt), a central bank, an international/supranational institution (such as the World Bank or the IMF)

• An institutional investor whose main activity is to invest in financial instruments


(4.2.1) Elective professional clients – where a retail client opts up to professional client

• Qualitative test (all business)- Firm to assess expertise, experience and knowledge to provide reasonable assurance about

capability and understanding

and

• Quantitative test (MiFID business only)

• Meet two of the following three:- Average trade frequency ten per quarter over previous four quarters- Portfolio > €500K- Works or worked in financial sector for ≥ one year in professional capacity

• Procedure- Written intent from client to be classified as professional- Written warning to client explaining lost protection- Written client consent to lost protection

Accepting ClientsKeeping on target

To be treated as an elective eligible counterparty for MiFID business, what conditions must be satisfied using the net turnover and/or funds criteria? A. The company must have a net turnover of at least €20 millionB. The company must have funds of at least €4 millionC. The company must have a net turnover of at least €20 million and

company funds of at least €4 millionD. The company must have a net turnover of at least €40 million and

company funds of at least €2 million

Further information

Per se eligible counterpartiesThe following are per se eligible counterparties (this includes entities from inside and outside the EEA):• An investment firm• A credit institution• An insurance company• A UCITS scheme (or its management company)• A pension fund (or its management company)• Another authorised or regulated EEA financial institution• Certain own account dealers in commodities or commodity derivatives• A national government (including a body dealing with public debt)• A central bank• A supranational organisation, such as the IMF or World Bank

Further information

Eligible counterparty business:• Dealing on own account• Execution of orders on behalf of a client• Transmission of orders


(4.2.1) Eligible counterparties

• An eligible counterparty is either a ‘per se’ eligible counterparty or an ‘elective’ eligible counterparty

• The classification only relates to ‘eligible counterparty business’; dealing on own account and/or executing orders on behalf of clients

Per se eligible counterparties

• Certain per se professional clients (below) conducting eligible counterparty business:- Authorised/regulated firm- Government, Central Bank, Supranational

Accepting Clients

Answer to question on previous slide:DThese are two of the quantitative requirements that must be met by a company to be a ‘large undertaking’. A large undertaking can opt up if a per se professional client and can opt up to eligible counterparty if they wish.


(4.2.1) Recategorising clients

Elective eligible counterparties (PC EC)

• Available to any undertaking that is a per se professional client (except an individual investor) – e.g. a large undertaking

• Procedure- Obtain client confirmation to be treated as an eligible counterparty

Accepting Clients

EC PC RC

There is a great deal of fluidity between the categorisations for clients.

Further information

Opting up and down

HintsIndividual elective professional clientsAn ‘elective professional client’ cannot opt up to be an ‘elective eligible counterparty’.

HintsOpting downOpting down to RC gives full protection under the COBS, but does not guarantee the right of access to bodies such as the FOS and FSCS.


(4.2.1) Acting as agent

• Where the person with whom the firm is dealing (A) is acting as an agent of another person (B), then A should be regarded as the client

• Exceptions:- There is a written agreement between the firm and the agent to treat B as the client- The purpose of the agency is to avoid duties owed to B

Accepting Clients

Firm

B

Investor

AA is the client

Agent


(4.2.5) Reliance on others

• Firms often need to rely on information provided by other organisations- If the information is from a MiFID firm:

• A firm may rely on the information and recommendations

- If the information is from a non-MiFID firm:• A firm may rely on information if:

- The information is in writing- The non-MiFID firm is independent- The non-MiFID firm is competent

Accepting ClientsHintsReliance on othersWhere a firm relies on the information provided by a MiFID firm, the MiFID firm retains responsibility for the accuracy of that information.Where a firm relies on the information from another firm that is not a MiFID firm, the firm receiving the information takes responsibility for the accuracy of that information.



Section 3: Communications and Financial Promotions Rules


(4.3.1) Financial promotion

• Invitation or inducement to engage in investment activity communicated in the course of business.

• S21 FSMA 2000- Must not communicate a financial promotion unless:

• It is an authorised person; or• The content has been approved by an authorised person

Communicating with ClientsHintsLinks to Principles for BusinessesPrinciples for businesses:• Principle 6 – Customers’ interests• Principle 7 – Communication with clients

If an authorised firm approves a financial promotion for an unauthorised firm, for example an appointed representative, the authorised firm takes on the responsibility for the promotion and any inducement offered.

Further information PenaltiesBreach of S21 FSMA 2000 has a maximum penalty of two years and/or an unlimited fine.

Values in FinanceRespect and tolerance – COBS and FTOCCompliance with the COBS helps ensure consumers receive an appropriate degree of protection when being served by financial services firms. It is important that firms do not apply a ‘one-size-fits-all’ policy, however – the individual needs of each consumer should be considered.


(4.3.10) Approval of Financial Promotions

• Before a firm approves a financial promotion it must confirm that it complies with the relevant regulations

• A firm that communicates a financial promotion produced by a third party would never be in breach of the rules if:- It has established that an authorised firm has approved the promotion- It communicates the promotion only to those it was intended- The promotion has not ceased to be fair, clear and not misleading

(4.3.2) Exceptions

• The FCA rules on communications do not cover communications- Exempt under the financial promotions order (FPO)- From outside the UK, and cannot have an effect within the UK- Subject to Takeover Code or any similar code- Personal quotes or illustrations- One-off promotions that are not cold calls

Communicating with ClientsFurther information

Prospectus rules on financial promotionsWhere a firm issues new securities to the public and produces a prospectus for investors the financial promotions rules are disapplied. If any financial promotion is made relating to this, the prospectus rules are followed. These state that when communicating a promotion that relates to an offer of securities, the communication must:• Be identified as a promotion• State where the prospectus can be obtained• Must be consistent with the prospectus

The Prospectus DirectiveThe aim of the Directive is to harmonise the rules on prospectuses throughout the EU when the securities are to be admitted to a regulated market. It sets out prescribed contents for the prospectus, the process of approval by a competent authority and allows passporting of prospectuses.


(4.3.1) Application

Types of communication

• Communication media:- Non-written communications- Written communications

Communications with clients

• Fair, clear and not misleading

• Identifying promotions as such- Firms must ensure that financial promotions are clearly identifiable as such

• Note: There are some exceptions to these rules if the communication is a financial promotion made solely to a professional client or eligible counterparty


DefinitionsNon-written (Real time)• Personal visit• Telephone conversation• Other interactive dialogue

Written (Non-real time)• Newspaper• Television• Internet

Made When a financial promotion is addressed specifically to a person or persons.

Directed atThis is where a financial promotion is generally accessible, for example via a newspaper or the television.

RecipientAny person who reads or hears the communication.


(4.3.5) Communicating with retail clients

• Firms must ensure that:- Name of the firm is included- Details are accurate and fair- The promotion is comprehensible- The promotion does not obscure important items, statements or warnings

• Particular focus on ‘Capital at risk’ products

• Fair, clear and not misleading- Amplifies Principles for businesses 6 and 7

Communicating with ClientsLinksCriminal lawIf a financial promotion is not ‘fair, clear and not misleading,’ it may also be a criminal offence under FSA 2012 S89-91 Misleading Statements and Impressions.

Keeping on target

Which of the following communications would not have to follow the COBS promotions rules? A. A telephone communication requested by an existing client to

promote readily realisable securitiesB. An advert in a national newspaper communicating the logo of the

firm, a contact point and the regulated activities providedC. A video presentation sent out to potential clients promoting

investments in UK government giltsD. A direct offer communication to promote investment in derivatives


(4.3.6) Past, simulated past and future performance

• Past performance- Must not be the most prominent feature- Cover at least five years (or life of investment) in complete 12-month periods- Reference periods and sources must be clearly shown- State this is not an indicator of future performance- If relevant, currency stated and warning of currency risk provided- Disclose effect of fees and commissions if gross performance shown

• Simulated past- Must be based on actual performance of a similar investment/index- Comply with the rules above

• Future performance- Must not to be based on simulated past performance- Assumptions must be reasonable- Disclose effect of fees and commissions- Warn that forecasts are not reliable indicators

Communicating with Clients

Answer to question on previous slide:BAll would need to follow the communications rules except the one simply showing the firm and its services. These general types of promotions are often referred to as image advertising.


(4.3.7) Direct offers or invitations – Retail clients only

• A financial promotion that contains a method of response for the client to invest in a product- For example, an application form

• Must contain sufficient information to enable a person to make an informed assessment- Provide information about:

• The firm and its services• Safekeeping of client investments and money• Costs and charges

- Additional appropriate information to allow an understanding of the nature and risks of the investment (non-MiFID business only)

• Links with the Distance Marketing Directive


Distance Marketing DirectiveThe distance marketing directive covers this kind of communication.It applies when there is no face-to-face contact between the client and the firm, e.g. telephone banking, postal accounts or internet.When a distance contract is concluded the client is given:• Minimum specified information about a financial product• A right to cancel


(4.3.8) Unwritten Promotions

All unwritten promotions (both solicited and unsolicited):

• Must be fair, clear and not misleading

• Must identify:- The caller- Their employer- The purpose of the call

• Ask whether the client wishes to continue with the call, and terminate it if requested to do so

• Provide client who has an appointment with contact point in the event of a cancellation

• Communicate at an appropriate time of day

Communicating with ClientsHintsUnwritten financial promotionsAn unwritten financial promotion must be communicated by an authorised person. Unwritten communications cannot be approved in advance.


(4.3.8) Unwritten Promotions and Cold Calling

• Cold calls- An unwritten promotion which is not expressly requested or initiated by the client- Permitted cold calls:

• An existing client who envisages a call• All retail clients where the promotion relates to:

- Generally marketable packaged product (not a high volatility fund)- Services relating to readily realisable securities other than warrants

Communicating with Clients

Keeping on target

Which of the following can be promoted via a cold call?A. Any regulated CISB. Unregulated CISC. FTSE 100 shareD. Advice on FTSE 100 shares

Further information

Packaged product• Life policy• Regulated CIS• Investment trust savings scheme• Stakeholder pension• Personal pension

High volatility fund A high volatility fund is a regulated collective investment scheme which invests in warrants or derivatives, or borrows over the long term causing the movements in the price of units to be significantly amplified



Section 4: Accepting Clients and Product Disclosure


(4.2.3) Information disclosure: All clients

• Provide all clients with the following general information (if relevant):- Name and address of firm- Method and language of communication- Name and contact details of competent authority- Whether the firm is acting through an appointed representative- Nature, frequency and timing of performance reports - If a common platform firm, the conflicts of interest policy

• This information is typically produced in a standardised format, and will be provided in an initial disclosure document (IDD) before engaging in business

• Additionally, all customers must be provided with a formal ‘client agreement’- Sets out the essential rights and obligations of the firm, and of the customer

Information Disclosure: The Firm

Answer to question on previous slide:DAdvice on FSTE 100 shares

Further information

Client agreement provision: TimingGenerally, a client agreement should be provided in good time before the customer is bound by the agreement. However, a firm may provide a client agreement immediately after the customer is bound by the agreement where it was impossible to supply the agreement earlier, since the agreement was concluded via distance communications.

Hints

Insurance business, where the firm acts as principal, is excluded from the client agreement rule.


(4.2.4) Retail Distribution Review (RDR): Retail clients

• Firms making personal recommendations to retail clients must be either independent or restricted

• Remuneration- Adviser charges agreed in advance with the client ‘as early as practicable’ in a durable

medium or via a website• No commissions from the product provider permitted • Clients can choose either to pay the adviser charge upfront or have it deducted from their

investment over time

• Disclosure- Must disclose adviser status, and the costs of the service before:

• Providing a service; or • The client is bound by any agreement

Information Disclosure: The AdviserFurther information

Retail investment productsThe RDR has widened the scope of retail investments, as shown below:

Packaged product Retail investment product

A life policy Life policies (including investment bonds)

A unit in regulated collective investment schemes

Units in regulated and unregulated collective investment schemes

An interest in an investment trust savings scheme

An interest in an investment trust savings scheme

A stakeholder pension A stakeholder pension / group stakeholder pension

A personal pension A personal pension scheme (including self-invested personal

pensions) / group personal pension scheme

Share in an investment trust

Structured capital at risk products

Any other product that has been packaged in order to change the

features of the product

Further information

Trail commissionsAdvisors have been prohibited from receiving any trail commissions (including from existing clients) as of April 2016.


(4.5.1) Product disclosure rules: Retail clients

• Purpose- To provide enough information about the nature and risks of a product to enable a retail client to

make an informed decision

• Types of document- Key Information Document (KID)

• Packaged Retail and Insurance-based Investment Products (PRIIPS)

- Key Investor Information Document (KIID)• UCITS schemes

- Key Features Document• Any non-PRIIP packaged product

- e.g. Pension annuities

• Post-sale cancellation rights- Providers of the above products and services covered under the Distance Marketing Directive

• Life products and pensions – 30 calendar days• Other products (e.g. ISAs) – 14 calendar days

Information Disclosure: ProductsFurther information

PRIIPs – Packaged Retail and Insurance-based Investment Products• Investment funds• Insurance-based investment products• Retail structured securities• Structured term deposits

Further informationContent of product disclosure documentsKIDs contain prescribed information about the nature and complexity of the investment. This is presented to the retail client in the form of a series of rhetorical questions:• What is this product?• What are the risks and what could I get in return?• What happens if [firm] is unable to pay out?• What are the costs?• How long should I hold it, and can I take the money out early?• How can I complain?• Other relevant information

KIIDs and KFDs contain broadly similar information. Both KIIDs and KFDs will shortly be replaced by KIDs from 2022.


(4.6.3) Inducements: All customers

• MiFID II strengthened inducement rules, to reduce risk of conflicts of interest

• For MiFID business:- A firm must not pay to, or accept from, a person other than the customer, any fee,

commission or non-monetary benefit, unless:• The fee (etc.) is designed to enhance the quality of service to the customer• The fee (etc.) does not impair the firm’s duty to act in the best interests of the customer

- Disclosure• The firm must disclose the existence, nature and amount of the fee (etc.) to the customer

before providing the service

- Proper fees necessary for the provision of the business (e.g. custody costs, settlement fees, legal fees, etc.) are permissible

• This prohibition does not apply to ‘minor non-monetary benefits’

Information Disclosure: InducementsFurther information

Non-MiFID inducement disclosuresFor non-MiFID business, inducement disclosures are only required for personal recommendations for packaged products. Disclosure is not required if the benefit is a minor, non-monetary benefit, or consists of basic advice on stakeholder products.

Further information

Minor non-monetary benefitsA minor non-monetary benefit is one which is of a scale and nature that it could not be judged to impair the firm’s compliance with its duty to act honestly, fairly and professionally in the best interests of the customer.It may include: • Information or documentation relating to a financial instrument or service,either generic or personalised

• Written material commissioned and paid for by a corporate issuer topromote a new issuance by the company

• Participation in conferences, seminars and other training events• Hospitality of a reasonable de minimis value, such as food and drinkduring a business meeting


(4.6.3) Provision of research: All customers

• Firms must apply a charge when providing research to other firms- The receiving firm can only use the research if it pays for it with either:

• Direct payments by the firm out of its own resources; or• Payments from a separate research payment account controlled by the firm

• The research payment account- The account must only be funded by a specific research charge agreed with and

charged to customers- The firm must disclose:

• The budget, as well as the charges, before providing services• Annual information on the total costs that each customer has incurred for third-party research

• The firm must also regularly assess the quality and effectiveness of the research paid for

Information Disclosure: Paid For ResearchFurther information

The FCA and Provision of ResearchThe FCA has disapplied this rule for Alternative Investment Funds and Collective Investment Schemes that invest mainly in non-MiFID investments, e.g. commercial property.


The FCA Conduct of Business and Client Asset SourcebooksSection 5: Suitability and Appropriateness Rules


(4.4.1) Suitability: All customers• This rule requires firms to obtain sufficient information to give suitable advice to

retail clients (all business) and professional clients (MiFID business)

• Application - Acting as investment manager (‘discretionary services’)- Personal recommendation (‘advisory services’)

• Relevant personal and financial information is obtained via a ‘fact find’

• Give suitable advice with regard to the information disclosed and other facts that the firm ought reasonably to be aware of in order:- To meet the client’s investment objectives (PC and RC)- That the client is able to bear financial risks (elective PC and RC)- That the client has the necessary knowledge and experience to understand those

risks (RC only)

• Churning and switching are considered unsuitable

Advising and Selling StandardsFurther information

Application of suitability rule• Acting as investment manager (‘discretionary services’)

– Where the firm makes all the investment decisions for the customer.• Personal recommendation (‘advisory services’)

– Where the firm gives advice and recommendations on investments, but the investor has the final decisions.

The suitability rule does not apply to:• Execution only services

– Where the firm has no input into the decision making of the investor.Insufficient informationIf a firm cannot gain sufficient information, no recommendations or decisions to deal must be made.Churning and switching These refer to excessive trading, engaged in to generate commissions for the firm. Churning relates to freely transferable investments, switching to packaged products.Insistent clientsInsistent clients are clients who wish to proceed with a transaction against the advice of an investment firm. Where a firm proceeds it should communicate to the insistent client: • That the firm has not recommended the transaction and that it will not be

in accordance with the firm’s personal recommendation; • The reasons why the transaction will not be in accordance with the firm’s

personal recommendation; • The risks of the transaction proposed by the insistent client; and • The reasons why the firm did not recommend that transaction to the

client.

HintsInvestment decisionsInvestment decisions could be to buy, sell or hold an investment.


(4.4.2) Suitability report: Retail clients

• Purpose is to confirm why the firm believes the recommendation is suitable and should be provided for both MiFID and non-MiFID investments- Specify the client’s demands and needs- Explain why the firm believes the recommended transaction meets those needs- Explains any possible disadvantages of the transaction for the client

• Form- The report must be provided in durable medium before the contract is concluded- Timing can be delayed if

• Agreement is concluded at a distance and• The client agrees to this delay

Advising and Selling StandardsFurther informationWhen a suitability report is not required:• Where the firm, acting as investment manager for a retail client, makes

a personal recommendation in connection to a regulated CIS• Client is habitually resident outside EEA and is not present in UK at the

time of acknowledging consent to the proposal• In ‘small-life policies’ sold by friendly societies (premium no more than

£50 pa)• If recommendation is to increase regular premiums to an existing

contract• If investing further premiums to an existing packaged product into which

contributions have already been paid

HintsMiFID IIMiFID II extended the scope of suitability reports from packaged products alone to include most investments.

HintsTiming for pension advice (non-MiFID)In the case of a personal pension scheme or stakeholder pension scheme where the right to cancel applies, The suitability report must be provided no later than the fourteenth day after the contract is concluded.


(4.4.3) Appropriateness: All customers

• Purpose is to ensure the firm obtains sufficient information to assess if a product is appropriate for the customer- Applies to MiFID business (both RC and PC), and direct offers (RC only)

• Before acting, the firm must assess whether the client:- Is able to bear the financial risks in relation to the product or service- Has the knowledge and experience to understand those risks (retail clients only)

• Warnings are provided when:- The firm believes the investment or service is not appropriate- The client has not produced sufficient information for the firm to come to a conclusion

• Assessing appropriateness is not necessary for execution-only business involving non-complex financial instruments

Advising and Selling StandardsHints

Non-complex financial instrument• Shares or bonds• Money market instruments• Units in a UCITS scheme


YES NO

Does the service provide management

or advice?

Is the investmenta complex product?

Neither suitability nor Appropriateness apply

Suitability applies

YES NO

YES NO

Is the investment for a retail client? Appropriateness applies

Neither suitability nor Appropriateness apply

YES NO

Appropriateness applies

Advising and SellingSuitability and appropriateness: Summary

Is the product promotedThrough a direct offer?

Keeping on target

When is the FCA’s conduct of business rule relating to suitability required?

When carrying out:A. Discretionary MiFID services on behalf of any MiFID clientB. Discretionary services on behalf of retail clients onlyC. Execution only services on behalf of retail clients onlyD. Execution only services on behalf of any client



Section 6: Conflicts of Interest COBS


(4.6.2) Conflicts of interest: All clients• Apply to services provided by firms irrespective of client or counterparty

• Conflicts identified and managed effectively

• Principle for Businesses 8 – Conflict of interest

• Management or disclosure of conflicts- A firm must have systems and controls in place to manage conflicts (SYSC)

• Prepare, maintain and implement a conflicts policy• Organisational arrangements such as Chinese Walls• Disclose in a durable medium any conflicts (last resort)

• Conflicts of interest policy- In writing- Identifies potential conflicts relevant to the firm’s operations- Specifies procedure to manage the conflicts- Provide retail clients (and potential retail clients) with a description of the policy

Dealing and Managing

Firm

Client A Client B

Conflict

Conflict

Hints

Conflicts of interestThe most common conflicts are as follows:

Answer to question on previous slide:ADiscretionary MiFID services on behalf of any MiFID client


(4.6.2) Chinese walls: All clients

• Internal arrangements to restrict the flow of confidential information

• Not mandatory

• If used, they must be monitored and effective


Fund manager

Marketmaker

Agencybroker

Corporatefinance

CHINESE WALLCHINESE WALL CHINESE WALL

CH

INESE W

ALL

HintsChinese wallsChinese walls do not prevent individuals from different departments of a firm socialising or talking with each other.


(4.6.2) Investment research: All clients

• Where a firm publishes research to its clients or the public, it must ensure:- That it does not receive inducement from those with a material interest- Not to promise issuers favourable coverage- Issuers covered are not permitted to review drafts of the research

• An FCA firm must not knowingly deal for its own account until the clients for whom the publication was intended have had a reasonable time to react to it unless:- The firm is a market maker dealing in the normal course of business- Unsolicited client (including eligible counterparties) orders


TIME

SHAR

E PR

ICE

Publication date

Further information

Unsolicited client ordersUnsolicited in this case means unsolicited by the firm or at the initiative of the client.

Relevant parties involved in investment research must abide by the conflict of interest rules and the personal account dealing rules.

Hints

Dealing on investment research before giving clients time to react is referred to as ‘dealing ahead’ or ‘front running’.



Section 7: Dealing and Managing COBS


(4.6.4) Best execution: All customers

• Purpose- A firm must take all sufficient steps to obtain the best possible result for its clients,

taking into account the execution factors

• Execution factors- Price, costs, speed, likelihood of execution and settlement or any other consideration

• Best execution criteria- Client categorisation- Type of order- Type of financial instrument being traded- Characteristics of execution venues


Hints

The best execution criteriaThe best execution criteria will show the firm’s assessment of the relative importance of the execution factors.

Further information

Role of price (retail clients)This must take into account the total consideration including:• Price of the financial instrument• Costs related to execution, e.g. execution fees and settlement fees

Applicability of fair treatment rulesThese rules apply to MiFID and non-MiFID firms, except for the exemption for operators of regulated CISs.


(4.6.4) Order execution policy: All customers

• Purpose- To ensure that a firm obtains the best possible result for the client- To be provided before providing services

• Prescribed information (retail clients)- A list of execution venues- Factors that will affect the firm’s choice of venues

• Written two-way agreement (all clients)- Monitored and reviewed annually- Notify clients of any material changes

Specific client instructions: All customers

• When acting on specific client instructions a firm is deemed to have obtained ‘the best possible result’

Dealing and ManagingFurther information

Execution venuesWhere a firm owes best execution to a client, it will be required, on an annual basis, to provide a report on the top five execution venues where it has executed client orders. The concept of the report is for clients to assess and judge the quality of execution obtained on their behalf.

Further information

Specific client instructionsFirm must execute order as instructed, even if an alternative means of executing the order would give a better result.


(4.6.5) Client order handling: All customers

• Purpose- Prompt, fair and expeditious execution of client orders

• In general, orders should be:- Promptly recorded and allocated- Carried out sequentially

• Exceptions (notify retail client)- Interests of the client- Material difficulty



(4.6.6) Aggregation: All customers

• Aggregation is permitted if:- Aggregation is unlikely to operate to the disadvantage of clients- Disclose (oral or written) that on some occasions it may operate to the disadvantage

of clients

• Order allocation policy is in place

Allocation: All customers

• Timely allocation- Promptly and in accordance with the order allocation policy

• Fair allocation- Allocate to clients first

• Unless- The firm has reasonable grounds to allocate proportionally

Dealing and ManagingHints

Reasonable grounds to allocate proportionally?If the firm has evidence to show the client’s order materially benefited from the aggregation with the firm’s order, this would be considered reasonable grounds to allocate proportionally.

Keeping on target

Which of the following is NOT true of the order execution policy? A. A firm must be able to demonstrate on request that it has followed the

policyB. A firm can gain prior consent in a general agreement to executed

trades outside a regulated market of MTFC. A firm must monitor the effectiveness of the policy on a transaction by

transaction basisD. The clients of the firm must consent to the order execution policy

before the firm can deal for them


(4.6.7) Limit orders: all customers

• Limit orders not executed immediately must be made public

• Unless- Client expressly instructs otherwise- The limit order is greater than normal market size

Dealing and ManagingHints

Orders made publicTransmitting an order to a regulated market or multi-lateral trading facility (MTF) or organised trading facility (OTF) is considered making the order public.

Answer to question on previous slide:CIt is true that the firm must monitor the effectiveness of the policy, but not on a trade by trade basis. The COBS states that it must be done 'regularly' and that the policy as a whole must be reviewed annually.



Section 8: Reporting


Trade and Transaction Reporting(3.8) Reporting channels and systems: All clients

Trade report Transaction report

Why? MiFID post-trade transparency

Market surveillance

Who? Senior/Selling firm Both counterparties

When? AutomaticWithin 3 mins

By T+1

To whom? To exchange To the regulator via approved reporting mechanisms E.g. UnaVista and TRAX

Further information

Short Selling RegulationsAllows FCA to intervene and restrict short selling during adverse market conditions.(2.10.7) Securities Finance Transaction Regulation (SFTR)Requirements for transactions that use securities as collateral. Enhances transparency and regulators’ ability to monitor risk.

Further informationTrade reports submission

When?Reporting period: 7.15am to 5.15pm every business day

Firm 1 Firm 2 Responsibility to trade report

Member firm Non-member Member firm

Market maker Broker dealer Market maker

Market maker Market maker Selling market maker

Broker dealer Broker dealer Selling broker dealer

Time of trade Submission of report

7:15 – 8:00 Before 8:00

8:00 – 17:15 Within 3 minutes or 17:15, whichever is sooner

After 17:15 Before the start of the next reporting period


(4.7.1) Transaction confirmations: All clients

• Purpose- Ensure clients are advised of the essential details of a transaction

• Requirement to confirm a transaction- In a durable medium and- Promptly

• No later than the next business day

• Exceptions- For MiFID business – none- For non-MiFID business – if requested by the client

Reporting to ClientsFurther information

Trade confirmation information• The firm’s identification• Name/Designation of the client• Trading day and time• Type of order• Venue and instrument identification• Buy/Sell indicator or the nature of the order if not buy/sell• Quantity, price and total consideration• Total commission and expenses, including mark-up or mark-down (if

relevant)• Rate of exchange (if relevant)• Client’s responsibilities for settlement• Statement that the firm was the client’s counterparty (if relevant)

HintsFCA terminologyThe FCA calls transaction confirmations ‘occasional reports’.


(4.6.8) Personal account dealing: All clients• Purpose

- Arrangements to prevent inappropriate dealings which:• Are prohibited under the Market Abuse Regulation• Involve misuse or disclosure of confidential client information• Conflict with the firm’s obligations to the client

• Arrangements- Relevant persons are aware of the restrictions- Relevant persons inform the firm- Firm records all notifications, including a copy of the transaction confirmation

• The rule on personal account dealing does not apply to personal transactions in:- Funds managed independently- Shares in certain classes of fund- Life policies

Dealing and ManagingFurther information

Disapplication of personal account dealing rulesOn the instruments where the rule on personal account dealing does not apply, it is believed that the staff are sufficiently removed from price sensitive information.

Keeping on target

For a UK firm operating in the UK the rules on personal account transaction are based on which of the following general approaches? A. Host state basisB. Home state basisC. Pan EEA basisD. Pan EU basis


(4.7.1) Periodic statements: All clients

• At suitable intervals, send periodic information to clients

• Periodic information includes:

• Timings

Reporting to Clients

Periodic statements

General rule

Prepared every 3 months

Sent out promptly

Derivatives

Prepared every month

Sent out promptly

(Clients can ask for

annual statements)

Client portfolio

Value and composition

Total fees and charges

Total dividends and interest

£

£

Further information

Contents of a periodic statementThe full list of prescribed information is:• The name of the firm and retail client’s account• The contents and valuation of the portfolio, including details of:

– Each designated investment held, its value – The cash balance at the beginning and at the end of the reporting

period– The performance of the portfolio during the reporting period

• The total amount of fees and charges incurred during the period• A comparison of performance during the period covered by the statement

with the investment performance benchmark (if any) agreed between the firm and the client

• The total amount of dividends, interest and other payments received during the reporting period in relation to the client’s portfolio

• Information about other corporate actions giving rights in relation to designated investments held in the portfolio

HintsNotificationsWhere a client’s portfolio falls 10% or more since the last valuation, a portfolio manager must provide a depreciation notice.If a retail client’s derivative positions move against the client beyond a pre-specified limit, the firm must notify the client by the end of the business day on which the breach occurred.

Answer to question on previous slide:BAs this is a UK firm operating in the UK, home state rules will apply.



Section 9: Client Asset Rules


(4.8.1) The purpose of the client money and custody rules: All clients

• Purpose- The fiduciary duty to provide adequate protection for client money

• CASS 6 – Custody rules- MiFID and non-MiFID business

• CASS 7 – Client money rules- MiFID business

• Opt-in available for non-MiFID business

• Segregation of assets- For client money held in an approved bank and identified as separate from the firm’s

money

Client AssetsFurther information

Definitions‘Safe custody investments’ – designated investments that the firm receives or holds.‘Custody assets’ – any other assets the firm holds within the same portfolio as a designated investment on behalf of the client.‘Client money’ – any money the firm holds which belongs to somebody else.

Links

If an EEA firm has passported its business into another EEA country, which regulator has the responsibility over client assets?

Further information

Approved bank:A central bank, a Banking Consolidation Directive (BCD) credit institution, a bank authorised by a third country or a qualifying money market fund.

Values in FinanceRule of law – CASS complianceCompliance with the CASS helps ensure firms meet their fiduciary duties towards their clients of protecting their assets, and ensuring their assets are only used in ways the client has authorised.


(4.8.2) The requirement to reconcile: All clients

• Reconciliations- Reconcile records of client asset balances

• As often as necessary

- Shortfalls corrected as soon as possible• This is close of business on the day of reconciliation for client money held by the firm

- A firm must write to the FCA if they are unable to reconcile

• Exemptions include- ICVC and UCITS schemes- Incoming EEA firms (other than insurers)- BCD credit institution- Coins held for the value of the metal- Money held for delivery versus payment (DvP)- Money due and payable to the firm

Client Assets

Answer to the ‘Links’ question on the previous slide: The home state regulator looks after the client asset rules.

Client Assets

Custody Assets Client money

Adequate protection

Segregation Reconciliation Record keeping

Custody investmentsDesignated Investments

Other investments e.g. gold, antiques

Further information

Keeping on target

Under the FCA client money rules (CASS 7), in which of the following situations is a firm deemed to have discharged fiduciary duty? A. When a cheque drawn from the client account is paid into a client

bank accountB. On receipt of an instruction to return funds from the client account

from a clientC. The despatch of funds to clientD. At the point where the payment clears from the client account


(4.8.4) Enhancing the CASS regime

• CASS audit- Required annually and submitted to the FCA within four months of the audit- Client asset assurance standard set by the Financial Reporting Council- Firm to explain any breach identified

• Right of use- Where the right to use a client’s assets is transferred to the firm

• Rehypothecation• Right-to-use clause

• CASS resolution pack- Specific documents and information relating to client money and assets

• Must be available to the regulator on request

• Mandate accounts- Where a client gives a firm control over their assets or liabilities

• e.g. direct debits, pre-approved companies with PayPal

- Firms must establish and maintain adequate records and controls

Client AssetsFurther informationRight of use and TTCAIf client assets are placed into the control to the firm (e.g. used as collateral for a loan), the firm and the client must have a proper ‘right of use’ agreement in place. Such an agreement is called a ‘title transfer collateral agreement’ (TTCA).

Further informationCASS MandatesThe FCA has defined a mandate as ‘any means that give a firm the ability to control a client’s assets or liabilities’.

A mandate is required from the client when the client is giving the firm control over their assets and/or liabilities. A mandate is required if a firm is undertaking designated investment business (including MiFID business), insurance mediation activity (except if it relates to a reinsurance contract) and debt management activity. In most instances, the mandate will be provided to the firm through the firm’s terms of business. Where a client has a mandate with a firm over the control of their assets held at a third party, the client money (CASS 7) and custody rules (CASS 6) will not apply.

The mandate rules require firms to establish and maintain records and internal controls to prevent any misuse of the mandate authority granted by the client.

Answer to question on previous slide:DClient money ceases to be such once it has been cleared. This is normally once the funds leave the account.



Section 10: Record-keeping


(4.7.2) Time limits: Summary

• General rule (from date of dispatch):- Three years (non-MiFID business)- Five years (MiFID business)

• Pension contracts, stakeholder pensions and life assurance:- Five years

• Pension transfers and opt-outs, free-standing additional voluntary contributions (FSAVCs): - Indefinitely

• Recordings of telephone communications- Five years from the creation of the record

Keeping records offsite

• These records must be ‘readily accessible’

Record KeepingLinks

Other record keepingThe slide refers to the record keeping requirements of COBS and CASS.Other requirements on your syllabus include:• Records of directors’ responsibilities under SYSC – six years• Records of identification under Money Laundering Regulations – five

years• Records held in data form under the Data Protection Act – not longer

than necessary


Quick reference

• Rules that include eligible counterparties (‘all clients’) - Client categorisation- Most information disclosure rules- Conflict of interest rules, including:

• Chinese Walls• Investment research• Personal account dealing

- Occasional and periodic reporting rules- Client assets

• Rules that apply to retail clients only- Financial promotions rules- Retail investment product disclosures, including KFDs, KIIDs and KIDs

• All other rules apply to retail and professional clients (‘all customers’)

COBS / CASS Quick Reference

The FCA Conduct of Business and Client Asset Sourcebooks

Documents