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How independent are you?

Steve Bailey, director ATEB Consulting, looks at how the definition of independence has changed, the errors still being made by firms in their disclosure documents, and what action firms can take to help them be complaint  

The definition of independence changed with the coming of MiFID II on 3 January 2018. Many firms have not changed their disclosure to reflect the new definition. We still regularly come across disclosure documents that refer to long dead concepts such as ‘whole of market’ but mostly we see firms simply claiming ‘we provide independent advice’ when the firm does not actually meet the new definition for ‘full’ independence.

‘Full’ independence under MiFID II

For firms/advisers to be independent in the broadest sense under MiFID II, their assessment of suitability must include a sufficient range of financial instruments, structured deposits and other retail investment products. The products must be sufficiently diverse in terms of type and provider to ensure that the client’s investment objectives can be suitably met.

When advising retail clients based in the UK, firms must be ‘in a position’ to advise on the full range of vehicles indicated above. However, for any particular client, there is no requirement to consider every product available on the market, only those that are relevant to the meeting the client’s investment objectives.

So, the range of products that ‘full independence’ firms are required to be ‘in a position to advise on’ is as follows:

A) Markets in Financial Instruments Directive (MiFID) Financial Instruments

• Transferable securities;

• Money-market instruments;

• Units in collective investment undertakings;

• Options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash;

• Options, futures, swaps, forward rate agreements and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event);

• Options, futures, swaps, and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market and/or an MTF;

• Options, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in C.6 and not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls;

• Derivative instruments for the transfer of credit risk;

• Financial contracts for differences;

• Options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event), as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market or an MTF, are cleared and settled through recognised clearing houses or are subject to regular margin calls.

B) Structured deposits – and

C) Retail Investment Products

• a life policy;

• a unit;

• a stakeholder pension scheme (including a group stakeholder pension scheme);

• a personal pension scheme (including a group personal pension scheme);

• an interest in an investment trust savings scheme;

• a security in an investment trust;

• any other designated investment which offers exposure to underlying financial assets, in a packaged form which modifies that exposure when compared with a direct holding in the financial asset;

• a structured capital-at-risk product.

So a suitable disclosure wording for ‘FULL’ independence (i.e. only appropriate if the firm can demonstrate that it is in a position to advise upon A, B and C) would be something like:

“We provide independent advice. If we recommend a financial product as being suitable for you, our recommendations will be based on an assessment of a sufficient range of relevant products that are sufficiently diversified in terms of type and provider to ensure your investment objectives can be suitably met.”

It is likely that few firms are able to, or want to, fulfil the ‘full’ independence criteria listed described above, i.e. being able to advise upon the full range of products under A, B and C. Most firms are likely to continue as they were prior to MiFIDII, namely advising on retail investment products (C) and adding in Structured Deposits (B) (assuming a notification for SDs was sent to the FCA). Accordingly, such firms need to reconsider how they describe their status. Here are some clues.

‘Focused’ independence

Under MiFIDII, firms can be independent on a focused basis. The ‘focus’ could be on a particular type of product, e.g. Independent for pension products.

Example wordings for focused independence – use the following examples to create text that accurately describes the firm’s status.

• “We provide independent advice on packaged retail investment and insurance products (these include but are not limited to pensions, investment bonds, units, annuities, ISAs and savings plans) and structured investment products only. Our recommendations will be based on an assessment of a sufficient range of relevant products that are sufficiently diversified in terms of type and provider to ensure your investment objectives can be suitably met.”

• “We provide independent advice on packaged retail investment and insurance products (these include but are not limited to pensions, investment bonds, units, annuities, ISAs and savings plans) and structured investment products only. We only recommend products that meet ethical and socially responsible criteria. Otherwise, our recommendations will be based on an assessment of a sufficient range of relevant products that are sufficiently diversified in terms of type and provider to ensure your ethical investment objectives can be suitably met.”

• “We provide independent advice on packaged retail <NAME OF PRODUCT TYPE e.g. pension> products only. Otherwise our recommendations will be based on an assessment of a sufficient range of relevant products that are sufficiently diversified in terms of type and provider to ensure your objectives can be suitably met.”

Our View

In trying to absorb the deluge of rule changes that came with MiFIDII, followed closely by GDPR and the everyday pressures of business as usual, it is hardly a surprise that some of the detail was missed.

So, firms should check now that their status disclosure is compliant, albeit some 9 months after the definition changed.

It is nearly 7 years since the introduction of RDR and we still find firms with adviser charging structures that do not meet RDR standards so fixing any non-compliant disclosure now would be several years ahead of the RDR experience!

From the work we are currently doing, it is clear that disclosure problems remain very firmly on the FCA’s radar – don’t get caught out!

Action points

Review your status disclosure against the guidance given here;

Amend your documents as required.

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