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Investment Management Certificate

Unit 1 The Investment Environment
Syllabus version 11

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Published November 2013

ISBN 9781 4727 0410 8
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the
British Library
Published by
BPP Learning Media Ltd,
BPP House, Aldine Place,
142-144 Uxbridge Road,
London W12 8AA
www.bpp.com/learningmedia

Printed in the United

Kingdom by Ricoh
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Your learning materials, published by BPP Learning

Media Ltd, are printed on paper obtained from traceable
sustainable sources.
All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system or transmitted, in
any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without the prior
written permission of BPP Learning Media.

Page ii

The contents of this book are intended as a guide and not

professional advice. Although every effort has been made to
ensure that the contents of this book are correct at the time of
going to press, BPP Learning Media makes no warranty that
the information in this book is accurate or complete and accept
no liability for any loss or damage suffered by any person
acting or refraining from acting as a result of the material in
this book.
Every effort has been made to contact the copyright holders
of any material reproduced within this publication. If any have
been inadvertently overlooked, BPP Learning Media will be
pleased to make the appropriate credits in any subsequent
reprints or editions.

BPP Learning Media Ltd

2013

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Preface

Contents

Welcome to BPP Learning Medias Investment Management Certificate Unit 1 Passcards.

 Passcards save you time. Important topics are summarised for you.
 Passcards include diagrams to kick start your memory.
 Passcards follow the overall structure of the BPP Learning Media Study Texts, but Passcards are not
just a condensed book. Each card has been separately designed for clear presentation. Topics are self
contained and can be grasped visually.
 Passcards are still just the right size for pockets, briefcases and bags.
 Passcards focus on the exam you will be facing.
Run through the complete set of Passcards as often as you can during your final revision period. The day
before the exam, try to go through the Passcards again. You will then be well on your way to passing your
exams. Good luck!

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Preface

Page
1

Financial markets and institutions

2
3

Contents

Page

Legal concepts

109

Ethics and investment professionalism

27

Client advice

119

Financial regulation

33

Taxation

145

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1: Financial markets and institutions

Topic List
Financial institutions
Role of government
Financial markets
Listing & governance
International markets
The agency problem

The financial services industry plays a key role in the

economic system. Here, we look at the institutions and
markets within the industry. We also examine the roles of the
national Government, and the status of EU legislation.
The London Stock Exchange is a market place for trading
bonds and other securities. The creation of Multilateral Trading
Facilities (MTFs) since MiFID is a challenge to the mainstream
exchanges, with MTFs taking a significant market share.
The FCA operates as the UK Listing Authority (UKLA) to
regulate company listings on the Exchange.

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Financial
institutions

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Role of
government

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Financial
markets

Functions of financial intermediaries

Financial intermediaries bring together providers
and users of finance, either as a broker facilitating a
transaction, or in their own right, as principal.
 Source of funds for borrowers
 Aggregation of deposits (eg small savers) to
lend on to borrowers (eg for mortgages)
 Maturity transformation: between for example
depositors wanting instant access and borrowers
needing a 25-year loan
 Pooling of collective funds, giving small
investors access to diversified portfolios

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Listing &
governance

International
markets

The agency
problem

UK financial intermediaries
 Banks
 Building societies
 Insurance companies, pension funds, collective
funds
 National Savings & Investments (NS&I) a
Government agency
 Capital markets for raising and investing
largely long-term capital (eg the Stock
Exchange)
 Money markets for lending and borrowing
largely short-term capital (eg banks short-term
lending)

As well as its domestic market in equities (company shares) & bonds (interest-bearing securities), the UK is
a major centre for the eurobond markets for debt denominated in non-domestic currencies.

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

Flow of funds in an open economy, showing the role of financial intermediation

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1: Financial markets and institutions

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Financial
markets

UK financial services industry

Listing &
governance

 Clearing banks operate the system for settling

payments
 Retail banks the High Street banks
 Wholesale banks lend in large amounts, to
larger customers
 Investment banks serve institutional investors
and corporate customers
 Central bank Bank of England (for UK)

Building societies mutual organisations

 Main assets: mortgages of their members
 Main liabilities are to investor members

The agency
problem

The central bank (BoE)

 Employs over 1 million people in the UK

 Accounts for around 5% of national output

Banks

International
markets

Functions of Bank of England











Banker to the central government

Banknote-issuing authority
Manager of the National Debt
Manager of UK's foreign currency reserves
Adviser to the government on monetary policy
Monetary policy control (through MPC)
Key role in prudential regulation (see Ch. 3)
Banker to the commercial banks
Lender of last resort to the banking system

 Monetary Policy Committee (MPC) aims to meet

UKs 2% (CPI) inflation target.

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Financial
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Financial
markets

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Listing &
governance

International
markets

The agency
problem

1: Financial markets and institutions

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Financial
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Role of
government

Products and functions

Banks and building societies









Current accounts: non- or low interest

Deposit or savings accounts
Trend towards e-banking and ATMs
Overdrafts and personal loans
Mortgages, including buy-to-let
Trustee services
Portfolio management services
FInancial planning services

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

Life offices provide protection on death and disability,

long-term savings and lump sum investments, through the
issue of term assurances, whole life assurances,
endowments, pensions, investment bonds, annuities.
Products are marketed by personal advice and by
advertisements.
Bancassurers are banks with their own life offices. Banks
may establish independent subsidiaries employing
independent financial advisers, who must advise on the
most suitable product available in the whole market or
market sector.
Friendly societies: mutual organisations offering
investment products.

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Financial
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Financial
markets

Brokers buy and sell securities

 Individual clients
 Corporate clients

 Services may include:






Page 7

Unit trusts and OEICs

Investment trust offers
ISAs
Discount share dealing
Internet dealing services

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Listing &
governance

International
markets

The agency
problem

Functions may be combined in

discretionary portfolio management:
 Manager makes buy/sell decisions
 Within parameters agreed with the client

Investment managers
 Portfolio management
 Research and analysis

7:24 PM

E-commerce: transacting business via the internet

E-commerce has changed the industry, with:
 Internet banking & online share trading
 Real-time share price information services
 Marketing of products, with online completion of applications
Funds supermarkets offer:





Various providers collective funds

Mix and match facility to combine different providers funds in an ISA
Online dealing by credit or debit card
Online account tracking facilities
1: Financial markets and institutions

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

Legislation

Fiscal policy

EU law takes precedence over national laws, and UK lawmaking must follow the Treaty of Rome and EU Directives.

A government's fiscal policy concerns its plans

for Government spending, taxation and
Government borrowing.

The UK has a mixed economy market-based with

some State intervention

Monetary policy

is concerned with:

 Changes in the amount of money in circulation

the money supply and
 Changes in the price of money interest rates
These variables are linked with:
 Inflation in prices generally
 Exchange rates the price of the domestic
currency in terms of other currencies

Government spending is an injection into the

economy, adding to demand for goods and
services, whereas taxes are a withdrawal.

A government's fiscal stance may be neutral,

expansionary or contractionary, according to
its overall effect on national income.

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Financial
markets

Easing of monetary policy

BoE reduces interest rates:

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Listing &
governance

International
markets

The agency
problem

Tightening of monetary policy

BoE increases interest rates:

 Loans are cheaper, and so people borrow &

spend more. Companies find borrowing cheaper
while consumer demand may rise, both factors
boosting profits.

 Loans cost more, property prices may be

dampened & consumer demand may fall.
Company profits could reduce through higher
borrowing costs & lower demand.

 Asset values rise. Eg, Government bonds (gilts)

rise in price, since required returns are now
lower.

 Other asset prices may fall. Investors will

require a higher return than before & so pay
less for fixed interest stocks (eg gilts).

 Those dependant on income from cash

deposits will be worse off.

 Those reliant on interest for income will be

better off.

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Financial
markets

Exchange rate policy

The Government can try to influence exchange
rates by buying & selling currency, to the extent
that it has sufficient currency reserves.

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Listing &
governance

International
markets

The agency
problem

Changes in interest rates affect exchange rates:

currencies with higher rates attract money inflow,
and their values relative to other currencies rise.

The European Union

EU law

The EU seeks to remove barriers to the free

movement of goods, persons, services and capital.

EU legislation takes three forms:

 Regulations have the force of law in every EU
state without need of national legislation.
 Directives are issued to the governments of the
EU member states requiring them within a
specified period (usually two years) to alter the
national laws of the state.
 Decisions of an administrative nature are made
by the European Commission in Brussels.

The European Central Bank is the central bank for

eurozone countries which use the euro as their
common currency.

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Financial
markets

Asset types
 Tangible assets eg, property, equipment,
commodities are real assets. Claims on a
return such as interest or dividends are
financial assets. Loans (debt) and shares
(equity) represent the two main types of
financial security.
 Ordinary shares (equities) offer the prospect of
dividends and capital growth, if the company
succeeds. Fixed income securities (debt, for
the issuer) are often generally called bonds.
Pooled or collective funds package securities,
allowing diversification and index-tracking.

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Listing &
governance

International
markets

The agency
problem

Sell side and buy side

Traders in financial markets can be categorised
broadly into sell-side & buy-side.
 Sell-side firms comprise investment banks,
brokers, & dealers who provide investment
products & transaction services
 Buy-side firms are mainly investment managers
(including pension funds, mutual funds, hedge
funds & insurance companies) who purchase
investment products & transaction services
Many firms encompass market participants on the
buy-side as well as the sell-side.

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

Financial markets
 .... Mobilise peoples savings and put them to use in enabling firms to grow, thus contributing to the
wealth of the economy
 .... Enable the transfer of risk. Eg, derivatives markets enable investors, entrepreneurs and market
participants to hedge risks as well as to speculate on the prices for assets
Attributes of an effective & efficient securities market
 Cost efficiency electronic order systems lower costs (operational efficiency)
 Liquidity the ability to enter or exit the market with reasonable price spread, on a transaction of a
reasonable size (promotes operational efficiency). Contributing factors: effective IT & settlement
systems, diverse membership & stock availability, stock lending facilities
 Price discovery the process through which an equilibrium price for a financial instrument is revealed
continuously through bid & offer prices, and trading (enabling informational efficiency)
 Transparency investors knowing the price before, during & after a deal in order to be satisfied that they
have a good deal (informational efficiency: prices reflect all relevant information)

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

Round trip (purchase / sale) transaction costs include: bid / offer spread, brokers commissions, Stamp
Duty Reserve Tax (CREST, dematerialised transactions) or stamp duty (non-CREST), Takeover Panel levy (1,
on transactions over 10k).
A less easily quantified element of transaction costs is the cost effect of the tendency for fluctuating order
sizes to move prices: this is market impact or price impact. For major stocks with deep liquidity, bid-ask
spread and potential price impact can be very low for typical transactions. Smaller issues may have high
liquidity risk or marketability risk, which has to do with the ease with which an issue can be sold. This risk
can become acute at times of market stress, and is built into the price of securities.
Limit orders only filled if price is better than the stated limit compare with market orders, which are filled
at the best available price when the order is placed.The opportunity cost of a limit order is that the price may
move against the trader before the order is filled.
More opaque (less transparent) markets will typically have larger bid-ask spreads because dealers will find it
more difficult to judge demand for stock, and so know the equilibrium price (price discovery). Real-time pretrade & post-trade transparency are required for many securities (especially equities) under MiFID rules.
Over-The-Counter markets are typically less transparent.

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Financial
markets

Order- v quote-driven markets

 Order-driven: trading system matches willing
buyers & sellers automatically. Prices of
securities are driven by buyers & sellers.
 Quote-driven: market makers act as buyers &
sellers to the market, quoting prices continuously.

Exchange trading v OTC

 Exchange-traded instruments: standardised in
respect of (eg) contract size and dates,
facilitating a liquid market in the instrument
 Over the counter instruments: generally
negotiated with a financial institution, to fit client
needs

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Listing &
governance

International
markets

The agency
problem

London Stock Exchange plc

 Initially, companies issue securities to investors
the primary market.
 LSE also provides a secondary market for
trading in already-issued securities.

Stock Exchange members

LSE members are:
 Broker/dealers, who may act in dual capacity, ie
broker a customers business (agent) or deal
directly with them (principal)
or
 Equity market makers / GEMMs, who quote
2-way prices

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Role of
government

SETS

SETSqx

SEAQ

Combined order- Quoteand quote-driven driven

No market makers
1+ market
2+ market
makers per stock makers per
stock
Liquid listed stocks as Illiquid stocks No listed
classified by MiFID, i.e. under MiFID
stocks
FTSE All Share stocks,
ETFs, Exchange Traded
Commodities & actively
traded Irish stocks
Most traded AIM stocks All AIM stocks in
All
AIM EURO
remaining
sectors not
AIM stocks
traded on SETS
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Listing &
governance

Financial
markets

LSE trading platforms

Order-driven

7:24 PM

International
markets

The agency
problem

SETS (Stock Exchange Electronic Trading Service) is

called The Order Book. LCH.Clearnet is the central
counterparty, keeping trades anonymous. Brokers orders:
 Match automatically with an order currently displayed, or
 May be matched later
SETSqx (SETS quotes & crosses):


Market makers must quote buying & selling (two-way)

prices up to Exchange Market Size (EMS)

Also, periodic auctions, where anonymous limit orders

are placed

SEAQ (known as a quote display system): secondary

system, used for fixed income securities and less frequently
traded AIM stocks.
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Listing &
governance

Financial
markets

International
markets

The agency
problem

Cum- and ex-div

Shares trade cum div (with right to receive next dividend)
until 2 business days before books close date.

Fixed interest: usually go ex-div 7 business days

before coupon dates.

Company determines

Dividend
announcement

LSE determines
Ex-div
date

Books
close

2 business days

Cum div buyer will

receive next dividend

Ex div seller will

receive next dividend

Dividend
payment
date

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Financial
markets

Alternative trading venues

 Dark pools: electronic trading platforms where

neither price nor identity of trading firm is

revealed


Multilateral Trading Facilities (MTFs):

electronic trading platforms functioning similarly
to SETS, but generally cheaper than SETS
trading

Systematic Internalisers (SIs): Investment

banks executing client orders by trading for their
own account, rather than with an exchange or
MTF

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Listing &
governance

International
markets

The agency
problem

Automated & high frequency trading (HFT)

Benefits
 Improved liquidity & bid/ask spreads
 Lower transaction costs
 More efficient market pricing
Risks
 HFT traders may squeeze unfair price
advantage
 Technical glitches could lead to erroneous
orders & volatility (flash crashes)
 Possible market manipulation

1: Financial markets and institutions

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Financial
markets

Settlement conventions
Equities
Gilts/ US T-Bonds
Eurobonds/ Corporate bonds
Currencies/ German equities

T+3
T+1
T+3
T+2

Dual listing
Corporations in different jurisdictions act as single
operating business. Consequences:
 Access to a wider pool of investors
 Increased liquidity may reduce bid/offer spreads
 Greater compliance costs

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Listing &
governance

International
markets

The agency
problem

Gilts market
Gilts settle via Euroclear UK & Ireland (EUI).
 Gilt Edged Market Makers (GEMMs) must
quote firm two-way prices in all conventional
gilts and/or all index-linked gilts.
 Inter Dealer Brokers (IDBs) arrange matched
principal-to-principal anonymous trades
between GEMMs, allowing GEMMs to unwind
positions.

Order Book for Retail Bonds (ORB)



Electronic order-driven trading service for

selection of gilts & UK corporate bonds
 Investors can enter orders directly, or via a
broker with Direct Market Access (DMA)

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

New gilts issues



Issuer: Debt Management Office (DMO), to fund Public Sector Net Cash Requirement (PSNCR)
New issue

Tranche
Large

Auction
Competitive


Page 19

Pay bid price

Non-competitive

Tap

If small (tranchette) or
failed auction, issued
into secondary market

Maximum bid is 0.5 million

nominal value
 Pay weighted average of
successful bid prices in
competitive auction
1: Financial markets and institutions

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Financial
markets

UKLA and AIM rules

Summary

AIM

3 years*

None

25%*

None

700,000 for
equity; 200,000
for debt

None

Free transferability

Yes

Yes

Prospectus requirement**

Yes

Yes***

UKLA

LSE

Percentage in public hands

Minimum market value

Applicable rules

Listing &
governance

AIM
Main List

Trading record

Page 20

*Not required for a Standard (non-Premium) listing. **Exemptions:

qualified/larger investors; smaller offers/private placements. *** For
AIM, a simplified Admission Document.

International
markets

The agency
problem

Alternative Investment Market

Applicants must:
 Appoint NOMAD (nominated adviser)
 Produce Admission Document

ISDX (previously PLUS Markets)

 ISDX Growth Market: for growing small- and
medium-sized enterprises (SMEs)
 Rules for issuers include application &
continuing obligations requirements
 Market makers Peel Hunt & Shore Capital
make markets in ISDX's major stocks, ensuring
its operation as a secondary & primary market

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Financial
markets

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Annual General Meeting (AGM)

 Listed company: must hold within 6 months of
financial year end
 21 days notice required (unless Articles specify
longer) can be waived if all members agree
 Member attends/sends proxy, to exercise
members rights
 Private company (Ltd): AGM not required most
decisions can be made by written resolution

Other general meetings

 14 days notice required can be waived if 95%
of members agree (90% for private company)
Page 21

International
markets

Listing &
governance

The agency
problem

Standard AGM tasks






Approve accounts
Approve dividend
(Re)appoint directors
(Re)appoint auditors

Resolutions
 Ordinary resolution needs 50% majority /
14 days notice.
 Special resolution needs 75% majority /
14 days notice.
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Financial
markets

Disclosure/transparency
Key rules
 Holders (including connected parties) of 3% of voting
rights, & where holdings cross a % point up or down,
must notify company by T + 2 (two business days)
 Directors and senior executives (PDMRs) must get
clearance to deal in own company shares /
derivatives, & notify company of such transactions by
T+4
 Company informs the market via Regulatory
Information Service (RIS)/ Primary Information
Provider (PIP) by T + 1

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Listing &
governance

International
markets

The agency
problem

Corporate Governance Code

Key points









Chairman/Chief Executive split

Non-executive directors balance
Re-election every 3 years
Audit & renumeration committees
Service contracts & notice periods
Review of internal controls
Disclosures in annual accounts
Encourages institutional shareholders to
use votes

The 7 Principles of the FRCs 2010 Stewardship Code aim to make fund managers and institutional investors more
active and engaged in corporate governance, eg by monitoring investee companies and having clear voting policies.
Like the FRCs Corporate Governance Code, the code is based on a comply or explain principle.

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Financial
markets

USA
 US Government bonds: issued by Dutch auction,
a form of tender
 Market makers on NYSE: known as specialists
 Super Display Book System: the NYSEs primary
order processing system

France
 French bonds: longer dated OAT (T + 3) &
shorter dated BTAN (T + 1)
 OATi: inflation-protected bond
 Bonds issued by Dutch auction

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Listing &
governance

International
markets

The agency
problem

Japan
 Japanese stocks settle at the Japanese
Securities Depository Centre (JASDEC)
 Japanese Government bonds (JGBs): mostly
traded over-the-counter (OTC)
 JGBs settle at Bank of Japan

Germany
 Government bonds are the Bund: stock
exchange-traded & also OTC
 Equities settle T + 2, where counterparties are
both German

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Emerging markets
Attractions
Rapid economic growth
Low correlations
Potentially attractive valuations
Inefficient pricing

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Financial
markets

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Listing &
governance

International
markets

The agency
problem

Central securities depositories (CSDs)

Most major markets have a CSD to hold securities,
which will be either
 Immobilised (certificates held in depository), or
 Dematerialised (no physical certificate)

Possible drawbacks
Transparency
Volatility
Regulation
Liquidity
Taxation

International CSDs (ICSDs) such as Euroclear &

Clearstream provide clearance, settlement &
custody in Euromarkets & in international equities.

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Financial
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Listing &
governance

International
markets

The agency
problem

The principal-agent problem

A small firm typically has a strong alignment between its ownership and its control. The enterprise will typically
be run by owner-managers, who are perhaps within the same family. It is in the interests of the ownermanagers for the company to succeed, and for shareholder wealth to be maximised. In larger companies,
professional managers may be hired who may have little or no shareholding in the company. There is then a
separation of ownership & control.
Agency theory sees employees of businesses, including managers, as individuals, each with their own
objectives. Various people are involved as agents. The department of a business has its own departmental
objectives. If achieving these various objectives leads also to achieving the organisations goals, there is goal
congruence. In practice, this may not occur. Managers who work for the company (as agents) may have
different objectives, such as gaining benefits (perks) for themselves, dealing on their own account (in a
financial firm), pursuing pet projects or empire-building.
Agency problems arise from the misalignment of goals, and this can make clients, including individuals, more
reluctant to provide finance intermediaries in the investment industry: they might tend to prefer keeping their
assets as cash, for example. This will limit market liquidity and makes it more difficult for firms to grow,
potentially hurting growth prospects in the economy.
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Listing &
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International
markets

The agency
problem

Ways to reduce the agency problem

One strategy aiming to enhance goal congruence
and to mitigate the 'agency problem' is the use of
remuneration incentives.
Examples
 Profit-related/economic value-added pay
 Rewarding managers with shares
 Executive Share Options Plans
In financial trading firms, the wrong remuneration
structures could encourage short-term risk-taking
by traders, potentially putting the future of the
enterprise in jeopardy, if risks turn bad.

Other measures
 Separation of roles one individual not to
have too much power
 Accounting standards auditied accounts an
important source of 'post-decision' information
for investors
 Corporate governance a check on
management power
 Regulation in the financial services industry,
rules & principles aim to ensure that financial
services firms deal properly with conflicts of
interest and treat customers fairly

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2: Ethics and investment professionalism

Topic List
Ethics and compliance
CFA Code of Ethics

Ethical conduct is a matter of continuing debate. The

reputation of individuals and firms is at stake when there
are shortcomings in professional behaviour. In business as
in other areas of life, reputation must typically be built up
over a long time, but it can be lost quickly.

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Ethics and
compliance

Ethics in organisations
Firms must follow law and regulations.
Ethics in organisations relates to social
responsibility & business practices.
 Personal ethics derive from a person's beliefs
& opinions.
 Professional ethics eg, the CFAs Code of
Ethics.
 Corporate culture eg, 'Customer first'.
 Organisation systems. Ethics might be
contained in a formal code. Possible problem:
good ethics does not always save money, &
there is a real cost to ethical decisions. Equally,
there can be substantial risk, & costs, if poor
ethics results in loss of reputation.

CFA Code
of Ethics

Senior managements role

As the regulator stated (CP10/12), promoting standards
of ethical behaviour improves outcomes for consumers
& their perception of the financial services industry.
Beyond mere compliance with rules, firms must through
their leaders foster a corporate culture congruent with
regulatory principles, if regulation is to work.
Senior management must use their leadership
positions to move the culture of their firm in the desired
direction, with:
 Communication of the principles at all levels of the
organisation, & possibly external stakeholder groups
 Leaders (senior management, and team leaders)
setting an example
 Appropriate training of staff

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Ethics and
compliance

CFA Code
of Ethics

Regulations

Ethics

A set of rules designed to control the behaviour of

industries, firms, or individuals

A set of basic principles about how individuals and

organisations should behave, for the benefit of all

The rules or principles that regulate behaviour of

individuals and businesses derive from:
 The law
 The requirements of rules & regulations
 Regulatory guidance that is not mandatory
 Professional standards & codes of conduct
 Ethics & ethical values

The ethical environment refers to justice,

respect for the law and a moral code. The
conduct of an organisation, its management and
its employees will be measured against ethical
standards by customers, suppliers & other
members of the public.

Page 29

The FCA expects firms to consider properly if their

incentive schemes increase the risk of misselling.
2: Ethics and investment professionalism

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Ethics and
compliance

The principle of integrity

Financial services is an important industry, affecting
the lives of most people in some way. The industry
needs not simply to provide the necessary expertise,
but to do so with integrity and professionalism.

As we shall see in the next Chapter:

The first FCA/PRA Principle for Businesses is Integrity:
A firm must conduct its business with integrity.

&
The first Statement of Principle for Approved Persons is
also Integrity:
An approved person must act with integrity in
carrying out his accountable functions.

CFA Code
of Ethics

Attributes of professional
integrity
 Honesty: the person will not deliberately
mislead another
 Reliability: the person can be relied upon to
maintain appropriate levels of competence &
skill in practice
 Impartiality: treating different people fairly,
where the people involved could be
customers, employees or others
 Openness: implying transparency, where
appropriate & where justified confidentiality
is not breached

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Ethics and
compliance

Compliance-based approach
A rules-based compliance approach seeks to ensure
that a firm acts within laws & regulations, & that
violations are prevented, detected & punished.
Some organisations, faced with the legal consequences
of unethical behaviours, take legal precautions such as:
 Compliance procedures to detect misconduct
 Audits of contracts
 Systems for employees to report criminal
misconduct without fear of retribution
 Disciplinary procedures to deal with transgressions
A compliance-based approach suggests that
bureaucratic control is necessary; an integrity-based or
principles-based approach relies on cultural control.
Page 31

CFA Code
of Ethics

Integrity-based approach
An integrity-based approach combines a concern
for the law with emphasis on managerial
responsibility for ethical behaviour.
Integrity strategies define companies' guiding values,
aspirations & patterns of thought & conduct:
 To prevent damaging ethical lapses, while
 Tapping into human impulses for moral thought &
action
This approach echoes the FCAs principles-based
approach to financial regulation eg, the principlesbased approach requires firms to act with integrity
and to treat customers fairly. Unlike rules, such
principles require senior management to apply
higher-level professional values in their business.
2: Ethics and investment professionalism

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Ethics and
compliance

CFA Code of Ethics

1.
2.
3.
4.
5.
6.

III. Duties to Clients

A. Loyalty, Prudence & Care
B. Fair Dealing
Act with integrity, competence, diligence and respect, & in an ethical
C. Suitability
manner with others
D. Performance Presentation
Place the integrity of the investment profession & the interest of client
E. Preservation of Confidentiality
above personal interests
Use reasonable care & exercise independent professional judgement IV. Duties to Employers
A. Loyalty
Practice & encourage others to practice in a professional & ethical
B. Additional Compensation Arrangements
manner
C. Responsibilities of Supervisors
Promote the integrity of, & uphold the rules governing, capital markets
V. Investment Analysis, Recommendations & Actions
Maintain & improve their own, & others, professional competence
A. Diligence & Reasonable Basis
B. Communication with Clients & Prospective Clients
C. Record Retention
Professionalism
VI. Conflicts of Interest
A. Knowledge of the Law
A. Disclosure of Conflicts
B. Independence & Objectivity
B. Priority of Transactions
C. Misrepresentation
C. Referral Fees
D. Misconduct
VII. Responsibilities as a CFA Institute Member or Candidate
Integrity of Capital Markets
D. Conduct as Members & Candidates in CFA program
A. Material Non-Public Information
E. Reference to CFA Institute, designation & program
B. Market Manipulation

Standards of Professional Conduct

I.

II.

CFA Code
of Ethics

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3: Financial regulation

Topic List
Regulatory framework
FCA high level standards
Exchanges & markets
FCA business standards
Supervision & redress
Financial crime

The Financial Services Act 2012 (FSA 2012) amended

the Financial Services and Markets Act 2000 (FSMA
2000) to reform the system of regulation of the UK
financial services industry.
Re-structuring of the UK regulatory framework with effect
from 1 April 2013 has seen the establishment of the PRA
and the FCA as twin regulators, to replace the FSA.

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markets

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FCA business
standards

Supervision &
redress

Financial crime

European regulatory framework

Home State/ host State

The aims of the EUs Financial Services Action Plan

(FSAP) have been to create a single wholesale market,
an open and secure retail financial services market, and
state-of-the-art prudential rules and regulation. Various
EU Directives have been issued to further these aims.

For a passporting firm (home-State authorised):

 Organisational matters regulated by the home
State: eg authorisation, fitness & propriety,
capital adequacy, Principles for Businesses,
senior management arrangements, systems &
controls, client assets, conflicts of interest,
personal account dealing, transaction reporting
& transparency, compensation
 Operational matters, eg conduct of business
rules that are not organisational matters,
regulated by:
The host State, for activities of a branch
within its territory
The home State, for cross-border
services

Passporting
Passporting (under MiFID rules) enables firms to use
their domestic authorisation to operate not only in their
home state, but also in other host states within the
European Economic Area (EEA) (EU + Norway, Iceland
& Liechtenstein).

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Exchanges &
markets

Role of ESMA

FCA business
standards

Supervision &
redress

Financial crime

MiFID

European Securities & Markets Authority:

The Markets in Financial Instruments Directive:




Part of the FSAP, implemented November 2007

Applies to all investment firms, eg investment &

retail banks, brokers, asset managers, securities &
futures firms, securities issuers & hedge funds

1 of 3 European Supervisory Authorities

To ensure integrity, transparency, efficiency, orderly
functioning of securities markets, and
 Enhance consistent EU-wide investor protection.
 Works on laws to develop single EU rulebook,
promoting equal competition, limiting regulatory
arbitrage
 Standard setting, promoting international
supervisory co-operation
 With ESRB, identifies & advises on systemic risks:
short-, medium- and long-term
 Would co-ordinate emergency crisis measures
 Able to prohibit products that threaten stability
Page 35

Instruments covered by MiFID







Transferable securities, eg shares & bonds

Money market instruments
Units in collective investment undertakings
Derivatives of various types
Financial contracts for differences (CFDs)
3: Financial regulation

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Scope of MiFID

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FCA business
standards

Financial crime

MiFID applies to core investment services and activities of:

 Investment firms (which are also regulated for non-core ancillary services)
 Credit institutions including UK banks & building societies, for activities in MiFIDs scope
Ancillary services

Investment services and activities










Supervision &
redress

Receiving & transmitting orders

Execution of orders on behalf of clients
Dealing on own account
Discretionary portfolio management
Investment advice
Underwriting financial instruments
Placing financial instruments
Operating MTF







Safekeeping & administration of financial

instruments
Credit / loans to an investor in a transaction
involving the firm
Advice on capital structure, industrial
strategy, mergers & acquisitions
Currency services connected with
investments
Investment research & financial analysis

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FCA business
standards

Supervision &
redress

Financial crime

UCITS Directives

EMIR European Market Infrastructure Regulation

Undertakings for Collective Investment in

Transferable Securities (UCITS) collective investment
schemes (CISs) that can be marketed across the EEA.
CIS must comply with marketing rules of host State &
documentation requirements of Directive.

EMIR sets standards for OTC derivatives, central

counterparties (CCPs) & trade repositories:
 Reporting obligations for OTC derivatives
 Obligations for eligible OTC derivatives to be
cleared through CCPs
 New risk mitigation requirements for all OTC
derivative trades that are not centrally cleared
 Common rules for CCPs and for trade repositories
 Rules on the establishment of interoperability
between CCPs
Under EMIR, all standardised OTC derivative contracts
should be traded on exchanges or electronic trading
platforms, where appropriate, and cleared through
CCPs.

Permitted UCITS investments







Transferable securities
Money market instruments
Forward contracts & financial derivatives
Deposits
Units in other CISs
[Not permitted: Commodity derivatives]
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FCA business
standards

Supervision &
redress

Financial crime

The UK regulatory structure

The Financial Services and Markets Act 2000
(FSMA 2000) is amended by the Financial Services
Act 2012 (FSA 2012), which established:
 The independent Financial Policy Committee
(FPC) at the Bank of England (BoE), and
 The Prudential Regulation Authority (PRA) a
subsidiary of the BoE
The Financial Services Authority (FSA) legal entity
became the Financial Conduct Authority (FCA).
The BoE became supervisor of financial market
infrastructure providers: regulated clearing houses
(RCHs), payment systems & securities settlement
systems.

PRA & FCA

The late 2000s financial crisis brought into focus
problems of financial instability affecting some banks
and other financial sector institutions.
In 2013, the UK's single-regulator system (under the
old FSA) was abolished.


The PRA was established to oversee the stability

of 'prudentially significant' firms.
 Regulation of conduct across the sector,
including retail consumer advice, became the
responsibility of the new FCA.

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FCA business
standards

Twin peaks regulation: since 1 April 2013

Prudential Regulation Authority
Bank of England
PRA is a BoE subsidiary.
 Objective: to promote safety
and soundness of firms
 Prudential regulator of banks,
larger firms (Dual-regulated)
 Makes prudential rules
 Recovery & resolution plans
 Authorisations, permissions,
supervision, enforcement
The twin peaks are Prudential &
Conduct regulation. Note the dual
regulation of banks & other large
Prudentially Significant Firms.
Page 39

Role to protect & enhance stability

of UK financial system, working with
other bodies.
 Prudential regulator of
clearing houses, and settlement
& payment systems
 Special Resolution Unit to
resolve failing banks
 The Banks Financial Policy
Committee monitors stability &
resilience, risk and advises /
directs PRA & FCA as
appropriate

Supervision &
redress

Financial crime

Financial Conduct Authority

FCA is independent company.


Objective: ensuring that the

relevant markets function well
 Oversees FOS, FSCS, Money
Advice Service
 Conduct regulator of banks,
larger firms (Dual-regulated)
 Conduct & prudential
regulator of smaller firms and
providers
 Powers over criminal market
abuse
 Acts as UK Listing Authority
3: Financial regulation

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FCA business
standards

Supervision &
redress

Financial crime

HM Treasury
The Minister with overall responsibility for the Treasury, the Chancellor of the Exchequer, is ultimately responsible
for the regulatory system for financial services under FSMA 2000.
HM Treasury, to which the FCA is accountable, will judge the regulator against the requirements laid down in FSMA
2000 which includes a requirement to ensure that the burdens imposed on the regulated community are
proportionate to the benefits it will provide.
Accountability of the FCA to HM Treasury


HM Treasury has the power to appoint or to dismiss the Board and Chairman of the FCA.

HM Treasury requires that the FCA submit an annual report covering such matters as the discharge of its
functions and the extent to which the regulatory objectives have been met.

HM Treasury also has powers to commission and publish an independent review of the economy, efficiency and
effectiveness of the FCA's use of resources and to commission official enquiries into serious regulatory failures.

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FCA business
standards

Supervision &
redress

Financial crime

Financial Policy Committee (FPC)

The FPC includes the FCA Chief Executive and representatives from HM Treasury. The FPC will also have some
external representation and will meet four times annually and at times of crisis.
S9C Bank of England Act 1998 (as amended by FSA 2012) provides for the FPC to exercise its functions with a
view to:
 Contributing to the achievement of the BoEs Financial Stability Objective (to protect and enhance the stability
of the financial system of the UK), and
 Subject to that, supporting the economic policy of the Government, including its objectives for growth and
employment.
The FPC will seek to identify, monitor, and remove or reduce, systemic risks, including:
 Systemic risks due to structural features of financial markets, eg connections between financial institutions


Systemic risks attributable to the distribution of risk within the financial sector, and

Unsustainable levels of leverage, debt or credit growth.

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Exchanges &
markets

Office of Fair Trading

 Investigates if combined entity > 25% market share
or targets UK turnover > 70m
 Refers matter to CC if substantial lessening of
competition
 Will report to FCA/PRA, HMT and CC if it believes
that regulatory rules adversely impact competition

Competition Commission
 Ultimate power to block a takeover and fine for
failure to comply with requests
 May take up to 24 weeks to investigate
 Appeals to rejection of the bid can be made to the
Competition Appeal Tribunal

Page 42

FCA business
standards

Supervision &
redress

Financial crime

Statutory merger control

Office of Fair Trading
Looks at current takeovers/mergers
to ascertain if there has been a
substantial lessening of competition
May clear (ie, bid can go ahead) or
refer the bid to CC
Competition Commission
CC investigates bid & recommends
whether there has been substantial
lessening of competition
Bid is blocked

Bid is cleared

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markets

Takeover Panel
The Takeover Panel administers the Takeover
Code (City Code). The Panel:


Regulates offers for shares in public

companies
 Is funded by a levy on share transactions

Department for Business, Innovation & Skills

The Governments Department for Business,
Innovation & Skills (BIS) is responsible inter
alia for business regulation, company law &
consumer affairs.

Page 43

Page 43

FCA business
standards

Supervision &
redress

Financial crime

City Code has statutory effect, under Companies Act 2006

 Equal treatment for all shareholders of a particular
class
 Reasonable period for bid to be considered
 Reduces defensive measures by target company
 Mandatory bid if shareholder acquires =/> 30% voting
rights
 Minimum offer price = highest price paid to acquire
shares in last 12 months
 Offer must remain open for =/> 21 days
 If =/> 90% acceptances, can compulsorily purchase
remaining 10%
 Directors of target company should not deny
shareholders opportunity to consider bid

3: Financial regulation

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FCA business
standards

Supervision &
redress

Financial crime

Data Protection Act 1998

Data Protection Register

Regulates the use of all personal data, placing

obligations on the organisation, which may be taken to
Court for a breach.

The DPA 1998 requires persons who process

personal data to register (unless exempt) with
the Information Commissioner (who maintains
a public registry of data controllers).

Eight DPA 1998 Principles personal data must be:

 1: Processed lawfully and fairly
The organisation must have
 2: Obtained only for specific and lawful purposes
a data protection policy.
 3: Adequate, relevant and not excessive
 4: Accurate and kept updated
 5: Not kept longer than necessary
 6: Processed in accordance with data subjects wishes
 7: Protected against unauthorised or unlawful access, and damage
 8: Not transferred outside the EEA unless to a territory with adequate data protections
Recording sensitive personal data requires explicit consent.

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Exchanges &
markets

General prohibition
FSMA 2000 establishes the authorisation of firms to
carry out regulated activities and the general
prohibition: no person may carry on a regulated activity
in the UK, unless they are either authorised or exempt.
Sanctions may be civil and/or criminal.

Civil sanctions:
 Contracts voidable
 Compensation/damages
 Restitution Orders
 Regulator may seek injunctions
Criminal sanctions:
 6 month sentence and/or 5,000 fine
 2 year sentence and/or unlimited fine
Page 45

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FCA business
standards

Supervision &
redress

Financial crime

FCA or PRA authorisation?

Firm will apply to either FCA or PRA, depending on
firm type.


Dual-regulated firms (banks & building societies,

credit unions, insurers & some investment firms)
are authorised by PRA but only with FCA
approval. In the process, FCA will focus on
conduct issues, while PRA will focus on a firms
financial soundness.

FCA-only regulated firms (including independent

financial advisers, investment exchanges,
insurance brokers & fund managers) are
authorised by FCA.

Passporting under MiFID is another authorisation

route.
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Is authorisation required?
1

Are regulated activities to be

undertaken?

Covered by exceptions?

Covered by exemptions?

Page 46

FCA business
standards

Supervision &
redress

Financial crime

Exceptions






Dealing as principal (for yourself)

Newspapers/media (but not tipsheets)
Acting as an unremunerated trustee
Employee share schemes
Certain overseas persons, for UK business

 Passported EEA firms are authorised in their home State

Exempt persons

Authorisation by FCA/PRA gives

permission (Part 4A, FSMA 2000) to
carry out regulated activities by way
of business relating to specified
investments.

 Appointed (tied) representatives

 RIEs, ROIEs, RCHs, Lloyds members, Bank of England,
National Savings & Investments, local government authorities
 Certain professions, eg lawyers, accountants, actuaries, for
non-mainstream investment business (regulated by DPBs)

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FCA business
standards

 Establishing/operating collective investment

schemes, stakeholder pension schemes







Safekeeping/administering investments
Lloyds insurance business
Carrying out contracts of insurance
Accepting deposits
Regulated mortgage business
Operating a Multilateral Trading Facility (MTF)

Page 47

Financial crime

Specified investments

Regulated activities
Including:
 Dealing in, arranging deals in, managing,
advising on investments

Supervision &
redress

Including:
 Deposits and electronic money
 Contracts of insurance
 Shares, warrants, ADRs etc
 Debentures, loan stock, and govt/local authority
securities





Units in collective investment schemes

Options, futures, contracts for differences
Lloyds syndicates
Regulated mortgages

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FCA business
standards

Supervision &
redress

Financial crime

Excluded activities
The following activities are specifically excluded from the requirement for authorisation.
 Dealing as principal where the person is not holding themselves out to the market as willing to deal. The requirement
to seek authorisation does not apply to the personal dealings of unauthorised individuals for their own account
 Trustees, nominees and personal representatives, if they do not hold themselves out to the general public as
providing the service and are not separately remunerated for the regulated activity, are excluded from the authorisation
requirement
 Employee share schemes. This exclusion applies to activities which further an employee share scheme
 Media, eg TV, radio and newspapers. Authorisation is not required if investment advice is not the primary purpose of
the publication.
'Tip sheets' (written recommendations of investments) will however require authorisation
 Overseas persons firms which do not carry on regulated activity from a permanent place within the UK. This
exclusion covers: first, where the activity requires the direct involvement of an authorised or exempt firm; and, second,
where the activity is carried on as a result of an unsolicited approach by a UK individual. Thus, if a UK individual asks
a fund manager in Tokyo to buy a portfolio of Asian equities for them, the Japanese firm does not need to be
authorised under FSMA 2000

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FCA business
standards

Supervision &
redress

Financial crime

SYSC in FCA/PRA Handbooks

Whistleblowing

Principle for Businesses 3: A firm must take reasonable

care to organise its affairs responsibly & effectively, with
adequate risk management systems. SYSC requires firms to
maintain Senior management arrangements, SYstems and
Controls: a common platform of requirements for almost all
regulated firms.

Whistleblowers are protected by the Public

Interest Disclosure Act 1998 if:
 A response from their firm was lacking, or they
felt unable to raise the matter internally
 They reasonably believe matters raised to be
substantially true

SYSC common platform









Business structure & contingency planning

Training, competence & expertise
Compliance, internal audit & financial crime
Risk control
Outsourcing
Record keeping (5 years min., for MiFID business)
Conflicts of interest

Page 49

Whistleblowing provisions are detailed in SYSC.

Contracts must not prevent employee blowing the
whistle: the legislation protects whistleblowing
employees from unfair dismissal.
Employees concerned about something may
contact the regulator.

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FCA business
standards

Supervision &
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Financial crime

Trustee Act 2000

Pensions Act 2004

Does the trust deed offer investment

guidance?

 Pensions Regulator regulatory body for work-based UK pensions:

Adopts pro-active, risk-focused approach

Has powers to intervene in scheme affairs

 Yes

Follow the deed

 No

Follow TA 2000
Trustee Act
2000

 A statutory duty of skill and care

 Functions may be delegated
 Invest in any asset except land
overseas
 Keep investments under review

Work-based pension schemes may be defined

benefit (DB) or defined contribution (DC).

Occupational (work-based) schemes:







Must have member-nominated trustees (except one-member schemes)

Must have adequate liquidity
Pensions Protection Fund for where an employer running a scheme
becomes insolvent & unable to pay liabilities
PPF provides compensation up to 100% of benefits to existing
pensioners and 90% to those not yet retired, funded by charges on
other DB pension schemes
Trustees Statement of Investment Principles (SIP) gives members
information about investment of pension schemes funds & investment
returns received

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Exchanges &
markets

FCA business
standards

Supervision &
redress

Financial crime

Financial Conduct Authority objectives

The FCA has a single statutory strategic objective
(s1B(2) FSMA 2000) of:

The relevant markets are:



The financial markets

Markets for regulated financial services, and

The markets for services that are provided by nonauthorised persons in carrying on regulated
activities without contravening the general
prohibition

Ensuring that the relevant markets function well.

FCA also has 3 supporting operational objectives:





Consumer protection objective: securing an

appropriate degree of protection for consumers
Integrity objective: protecting and enhancing the
integrity of the UK financial system
Competition objective: promoting effective
competition in the interests of consumers in the
market for regulated financial services and for
services provided by a recognised investment
exchange

Page 51

The regulator aims to ensure that firms put consumers

at the heart of their business. The FCAs duties to promote competition may involve analysing pricing.
The FCA also has duties to address financial crime
(broadly, following the existing approach to tackling such
crime).

3: Financial regulation

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FCA Handbook
High Level Standards
Principles for Businesses (PRIN)
Training & Competence (TC)
Statements of Principle & Code of Practice for
Approved Persons (APER)

Business Standards
Conduct of Business Sourcebooks (including COBS)
Client Assets (CASS)
Market Conduct (MAR)

Threshold Conditions (COND)

Senior Management Arrangements, Systems &
Controls (SYSC)
Financial Stability and Market Confidence (FINMAR)

Regulatory Processes
Decision Procedures &
Penalties Manual (DEPP)
Supervision (SUP)

Redress
Dispute Resolution: Complaints
(DISP)
Compensation (COMP)

Fit & Proper Test for Approved Persons (FIT)

Listing, Prospectus and Disclosure

Prudential Standards
Prudential Sourcebooks for different types of firm

Listing rules (LR)

Prospectus Rules (PR)
Disclosure Rules & Transparency Rules (DTR)

Specialist Sourcebooks
Cover certain specialised sectors of the industry

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The Principles for Businesses

A firm must:

1
2
3

Conduct its business with integrity

Conduct its business with due skill, care and diligence
Take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk
management systems (management and control)
4 Maintain adequate financial resources (financial prudence)
 Treating Customers Fairly is
5 Observe proper standards of market conduct
an important regulatory theme.
6 Pay due regard to customers interests & treat them fairly
7 Pay due regard to information needs of clients: communications with clients must be clear, fair, not
misleading
8 Manage conflicts of interest fairly
9 Take reasonable care to ensure suitability of advice and discretionary decisions (customers:
relationships of trust)
10 Arrange adequate protection for clients assets
11 Deal with regulators openly & cooperatively, making appropriate disclosures (relations with regulators)
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Scope of the Principles

Principles-based regulation

Some principles (eg, 10) refer to clients, while others

(eg, 9) refer to customers.

This is regulation that is focused on the over-arching

Principles, which firms must then apply. The
regulators focus is not so much on the principles
themselves, but on the actual outcomes and
consequences of what firms do. Since the financial
crisis, there has also been a shift to a more
intrusive style of regulation.

'Client' includes everyone from the smallest retail

customer through to the largest investment firm
(eligible counterparties, professional customers &
retail customers).
'Customer' includes professional and retail clients but
excludes eligible counterparties. Principles 6, 8 and 9,
& parts of Principle 7, apply only to customers.
Principle 3 would not be considered breached if the
firm failed to prevent unforeseeable risks.

Breaches of the Principles, and of rules

Breaching a Principle makes the firm liable to
enforcement or disciplinary sanctions. A private
person who suffers a loss from a rule breach may sue
under s150 FSMA 2000, but not in respect of breach
of a Principle.

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Approved persons
Section 59 FSMA 2000
says that a person (that is a member of staff at an authorised firm) cannot carry out a controlled function in a firm unless the
individual has been approved by the appropriate regulator

If a person carries out a controlled function but they not approved, this is a
breach of statutory duty

Where such a breach of statutory duty occurs, a private person has the right to sue the
firm for damages if they have suffered loss, using s71 FSMA 2000

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For all approved persons:

2
3
4

An approved person must act with integrity in carrying out

his accountable (ie, regulated) functions

And with due skill, care and diligence

Must observe proper standards of market conduct

Supervision &
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Financial crime

Code of Practice
Examples of non-compliance

Statements of Principles

Page 56

Must deal with regulators openly and co-operatively 

Senior management only:
5 Must take reasonable steps to ensure business is
organised so it can be controlled effectively
6 Exercise due skill, care and diligence in managing the
business
7 Take reasonable steps to ensure compliance by business
with regulatory requirements

 Misleading or attempting to mislead

customer/firm/regulator, eg about risks of
investment or by falsifying documents
 Failing to give information to
customer/firm/auditor/actuary when you
know/should have known it should be
provided, eg failing to disclose charges or
surrender penalties
 Market abuse, eg trading on insider
information, trading to distort the market,
spreading false stories (FCA can impose
unlimited fines under s123 FSMA 2000)
 Failure to report matters through internal
reporting procedures

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Threshold conditions (for attaining Part 4A permission)

Before it grants permission under FSMA Part 4A (formerly Part IV), the regulator must be satisfied that the firm meets and
continue to satisfy the 'threshold conditions' for the activity concerned in order to be deemed fit and proper.
General threshold conditions
 One condition relates to the location of the offices of the applicant. If the applicant is a UK company, its head and
registered offices must be located in the UK. For an applicant that is not a company, if it has its head office in the UK,
then it must carry on business in the UK.
 Firms will need to ensure that no impediment to their effective supervision arises from: the nature and complexity of
regulated activities undertaken, products offered, and the business organisation. This condition also covers the effect
of close links of the applicant with other entities, eg other members of the same group, and whether these have an
effect on effective supervision by the regulator.
 An applicant for FCA authorisation must have adequate resources for the activities they seek to undertake. Such
resources would not only include capital, but also nonfinancial resources such as personnel
 Another threshold condition relates to the suitability of the applicant. The firm must be considered to be 'fit and
proper', ie it must have integrity, be competent and have appropriate procedures in place to comply with regulations.
The management and staff of the firm must also be competent.

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Threshold conditions (for attaining Part 4A permission)

FCAs Business Model Threshold Condition


The FCA will apply the Business Model Threshold Condition, which refers to the risk that might be posed for a firm, for
its customers and for the integrity of the UK financial system. The FCA has stated that this new threshold condition
demonstrates the importance that the FCA will place on a firms ability to put forward an appropriate, viable and
sustainable business model, given the nature and scale of business it intends to carry out. The regulator will expect
firms to demonstrate adequate contingency planning in their business models. Firms will be expected to make clear
how their business model meets the needs of clients and customers, not placing them at undue risk, or placing at risk
the integrity of the wider UK financial services industry.

PRAs Business to be Conducted in a Prudent Manner Threshold Condition



The PRAs Business to be Conducted in a Prudent Manner Threshold Condition is closely equivalent to the FCAs
appropriate resources and business model conditions, which we have described above. PRA-authorised firms must
hold appropriate financial and non-financial resources. Appropriate resources are evaluated by reference to complexity
of activities, the liabilities of the firm, effective management, and the ability to reduce risks to the safety and
soundness of the firm.

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Individuals carrying out controlled functions must have regulatory approval as fit and proper persons.
Fit and proper assessment

Controlled functions
 Governing functions (eg directors)
 Required functions (eg Money Laundering
Reporting Officer)
 Systems and control functions (eg senior
internal audit staff)

Honesty
Integrity
Reputation

 Employment record
 Criminal record

Competence
Capability

 Experience
 Training and exams

Financial
soundness

 Court judgements?
 Bankruptcy?

 Significant management function (eg heads

of divisions in larger firms)
 Customer functions, including:
Investment advice
Customer trading and investment
management

Page 59

Covers most personnel advising customers

In dual-regulated firms, significant influence functions (ie,

excluding customer functions) are divided between PRA and
FCA.
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Training and competence

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 For roles involving private

customers (eg investment
advice):
 Take account of individuals
knowledge and skill
 Find out about individuals
previous relevant activities
and training

Financial crime

FCAs T&C Sourcebook covers the retail sector.

 Firm to determine training needs,

and organise, monitor & record
appropriate training
 Recruitment

Supervision &
redress


Training

Appropriate examinations

 Exams and supervision


Attaining
competence

Maintaining
competence


 Continuing Professional
Development (CPD)

Required for advising retail clients, eg on retail investment products,

securities & derivatives & for some specialist roles (eg: advice on
mortgages, equity release, long-term care insurance, pensions
transfers).

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Rules on training and competence

The firms commitment to training & competence
should be that employees:






Are competent
Remain competent
Are appropriately supervised
Have competence reviewed regularly
Have levels of competence appropriate to the
business

Retail advisers must complete 35 hours of

verifiable CPD annually, of which 21 hours must be
structured (ie, with a defined learning outcome).

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Supervision &
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Financial crime

The competent employees rule is the main FCA

Handbook requirement on employee competence,
and applies to both MiFID and non-MiFID firms:
Firms must employ personnel with the skills,
knowledge and expertise necessary for the
discharge of the responsibilities allocated to them.

Professionalism requirements

Retail investment advisers (RIAs) need to hold a

Statement of Professional Standing (SPS) issued
by an accredited body to give independent advice
or restricted advice. The SPS shows customers that
the RIA subscribes to a Code of Ethics, is qualified,
and has up-to-date knowledge.

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Recognised Investment Exchanges (RIEs) (but not their

members) are exempt from regulatory authorisation.

Recognised Overseas Investment Exchanges (ROIEs) operate in

the UK without FCA authorisation. ROIEs:

RIEs:  ICE Futures Europe  LIFFE

 London Stock Exchange
 ISDX  London Metal Exchange

 Australian Securities Exchange Ltd  CBOT  Eurex

 ICE Futures U.S., Inc  NASDAQ  NYMEX  NYSE
Liffe US  SIX Swiss Exchange AG  Chicago Mercantile
Exchange

RIE requirements cover: Financial resources,

Suitability, Systems & controls, Investor
safeguards, Issuer disclosures, Complaints
arrangements, Discipline, Member default.

RIEs

ROIEs

RCHs

DIEs

Recognised Clearing Houses (RCHs) may perform clearing

and settlement for an exchange.
RCHs:  CME Clearing Europe Ltd  Euroclear UK &
Ireland  European Central Counterparty Ltd  ICE
Clear Europe Limited

Designated Investment Exchange (DIE) status

of overseas exchanges gives some assurance
about local regulation but does not exempt from
UK authorisation.

RCHs, along with recognised payments systems &

securities settlement systems (collectively Financial
Market Infrastructures (FMIs)) are supervised by the BoE.

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A contract for differences (CfD), a

future or an option. (FCA definition)

UK derivatives markets members are

regulated under FSMA 2000.
MiFID applies to firms carrying out activities in
relation to various derivative instruments
 Financial and commodity derivatives
 Derivatives relating to credit risk
 Financial CfDs
 Derivatives relating to climate, freight,
carbon emissions, inflation & other
economic statistics
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UK

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IAS 39 states: (non-hedge) derivatives must be recorded in

balance sheet at fair value.


Changes in fair value (ie, gains or losses) can be

recognised in the income statement

For derivatives used as a hedge, gains and losses are

recognised in reserves

EMIR standards for OTC derivatives covered in Chapter 1.

USA

(Main law: Commodity Futures Modernization Act 2000)

In the USA, there are two key regulatory bodies:



Securities and Exchange Commission (SEC)

regulates derivatives on securities

Commodity Futures Trading Commissions (CFTC)

regulates derivatives on commodities
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LCH.Clearnet
LCH.Clearnet:
 Acts as guarantor in the derivatives market,
honouring contracts in the event of a party
defaulting
 Formerly, London Clearing House
 Owned by exchanges and their members
 Is central counterparty for all trades
(novation)
 Administers all margin cash flows
 Registers all matched trades for the market

Initial margin



Returnable good faith deposit paid on

opening positions
Based on maximum probable one-day loss

Variation margin



Cash settlement of daily profits or losses

based on closing price of each day
Paid to or received from LCH.Clearnet the
following morning

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Central Counterparty novation

Short seller to every buyer

LCH.Clearnet

Long buyer to every seller

Trade
Long oil @ $80

Novation

Short oil @ $80

Novation eliminates counterparty risk

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Where? Activities in UK, and

business brought into UK


Exchanges &
markets

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FCA business
standards

Who? All authorised firms, but not 

professional firms in respect of nonmainstream regulated activities

Supervision &
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Financial crime

Firms should ensure that

inducements do not conflict with
duty to customers



Communications by
electronic media
count as written
communication


7:25 PM

Exclusion of liability

COBS



Communication must be clear, fair
and not misleading (Principle 7)




Advising on investments
Dealing in investments


What? Generally, designated
investment business

Firm may not exclude its duties or

liabilities to customers under FSMA
2000 or the regulatory system
ie
Customers cannot sign away their
rights under COBS

Designated investment business covers includes various regulated

activities but excludes deposits, mortgages nor non-savings insurance
contracts.

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Client
Customer

Eligible counterparty*
Per se

Elective
Elect

*Only for
eligible counterparty business:
 Receipt & transmission of orders
 Execution of orders
 Dealing on own account

Page 67

Professional
client

Retail
client

Authorised firms
Large undertakings
Elective
professional clients

Individuals

Elect

Small
businesses

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Client classifications

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Financial crime

Clients can opt up or down.

Professional clients
(eg large businesses, experts)

Retail clients
(eg individuals, small businesses)

Eligible counterparties
(eg government, other firms)

COBS applies
More protection
Firms must notify clients of:
 Categorisation
 Rights to request a different categorisation
 Resulting limitations to client protection

Retail clients
A retail client is any client who is not a
professional client or an eligible
counterparty.

More knowledge/size

Client agreements
If a firm carries on designated investment business,
other than advising on investments, for a new retail
client (eg, a discretionary investment management
service), the firm must enter into a basic agreement
with the client.

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For MiFID Business

 An entity requiring authorisation or regulation to

operate in financial markets, whether authorised in
the EEA of by a third country
 A large undertaking meeting conditions:

2 out of three of:

20m balance sheet total
40m net turnover
2m own funds

Per se Eligible counterparties

Non-MiFID Business

Per se Professional clients

 Insurance company, investment firm or credit

institution
 UCITS CIS or its management company
 Pension fund or its management company
 Another EEA-authorised financial institution
 National government, central bank or
supranational organisation

Page 69

5m called-up share capital or net

assets,
or 2 out of 3 of:

12.5m balance sheet total

25m net turnover
250 average employees in year

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Exchanges &
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Elective Professional clients

FCA business
standards

Firm carries out a qualitative test:

& for MiFID business a quantitative test:

Firm gives a clear written warning of

protections & investor compensation
rights lost

Client states separately in writing that

they are aware of consequences

Client makes requests in writing

Financial crime

Qualitative test

Firm undertakes assessment of clients knowledge,

expertise and experience.
Assessment gives firm reasonable assurance that client is
capable of making their own investment decisions &
understanding risks.

To treat a retail client as an elective

professional client:

Supervision &
redress

Quantitative test for MiFID business

At least 2 of the following 3 must be satisfied:

 Client has traded, in significant size, on relevant market at
average 10 times per quarter over previous 4 quarters
 Financial instrument portfolio > 500,000
 Client works/has worked in financial sector for at least 1
year in professional position requiring knowledge of
transactions/services

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Financial promotion (FP)

An invitation or inducement to engage in investment
activity communicated in the course of business
(s21(1), FSMA 2000).
Means of communicating FPs:
 Product brochures, mailshots
 General advertising
 Telemarketing
 Written correspondence
 Sales aids, presentations
 Tip sheets
 Other publications containing non-personal
recommendations
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Financial crime

There is a general prohibition on FPs (s21, FSMA

2000) unless issued or approved by an authorised
person.
Exemptions/exclusions
 Qualifying credit
 Home purchase plans & home reversion
schemes
 Personal quotations & illustrations
 One-off communication that is not a cold call
 Generic promotions (eg, of Investment Trusts)
 Communications to investment professionals
 Overseas recipients
 Deposits & insurance
 Certified high net worth individuals
 Sophisticated investors
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Financial promotions

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Fair, clear and not misleading

A firm must ensure that a communication or FP is:

 Fair, clear & not misleading,

 Appropriate & proportionate
 Considering the means of communication & the
information to be conveyed.

FP addressed to a retail client & falling within the

rules must be clearly identifiable as FP.
The FCAs rules are:
 media-neutral (print/fax/email/internet/phone etc)
 mainly directed at regulated activities

Guidance
A firm should ensure:
 It is clear if a clients capital is at risk
 Any yield figure quoted gives a balanced
impression of short/long term prospects
 Complex charging structures are explained
 The regulator is named
 A clear impression is given of any third party
packaged/ stakeholder product provider

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Financial crime

Unwritten promotions and cold calling

Someone making an unwritten FP outside the firm's premises must:
 Do so at an appropriate time of day
 Identify self & firm, and make his purpose clear
 Clarify if client wants to continue or terminate communication, and terminate on request
 If appointment is arranged, gives a contact point

Direct offer financial promotions

A direct offer FP is a FP:
 Containing an offer or invitation
 Which enables investors to purchase investments
directly 'off the page'
 Without receiving further information.
The promotion must include relevant disclosures for
the product.
Page 73

Firms may only make cold (unsolicited) calls:

 To a client having established relationship with the
firm justifying such calls, or
 About a generally marketed packaged product (not
based on a high volatility fund), or
 Relating to controlled activities by an authorised
person or exempt person, involving only readily
realisable securities (not warrants)

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FCA business
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Controls & approvals

Supervision &
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Financial crime

Communicating with retail clients

SYSC requires that a firm communicating or approving FP

has systems & controls or policies & procedures.

Requirements:

 Approval of FP by an authorised firm enables it to be

communicated by an unauthorised firm.

 Understandable by target group

 Fair & prominent indication of relevant
risks

 Firm approving FP must confirm that it complies with

the FP rules.
 Promotion made during a personal visit, phone
conversation or other interactive dialogue cannot be
approved.
 Firms approval may be limited, eg to communications
to professional clients or eligible counterparties.
 In communicating FP, firm can rely on another firms
confirmation of compliance. FP should only be
communicated to types of recipients for whom intended.

 Key items not disguised, diminished,

obscured
 Must include name of firm
 Investment comparisons should specify
sources, key facts, assumptions
 Firm should consider if omissions will
make information insufficient, unclear,
unfair or misleading

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Record keeping
Records of FPs must be kept:
 Indefinitely for pension transfers
 6 years for life policies & most pension
schemes
 5 years for MiFID business
 Three years in other cases

Distance contracts
Firms must give clear information before a
contract is concluded, including:
 Identity & address of supplier
 Product details (incl. price & fees)
 Contract details (incl. cancellation rights)
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Financial crime

Financial Promotions Power

FCA has power (under FSA 2012) to ban misleading
financial promotions.
 The regulator can give (and publish) a direction to
firms requiring them immediately to withdraw or to
modify promotions which it deems to be misleading.
 The firm will be able to make representations to the
FCA to challenge its decision. The FCA may then
amend or revoke its decision, or confirm its original
decision.
 The FCA can then publish: (1) Its direction, (2) A copy
of the promotion, and (3) The regulator's reasons for
banning it. The FCA may publish details even if it has
decided to revoke its decision.

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Financial crime

Past, simulated past and future information

Past performance information

Simulated past performance

information
Past performance information should:
Simulated past performance information
 Not normally be the most prominent must:
feature of the communication
 Relate to an investment or a
 Include appropriate information
financial index
covering at least the five preceding
 Be based on actual past
years, or the whole period
performance of investments/indices
 Be based on and must show
which are the same as, or underlie,
complete 12-month periods
the investment concerned
 State the reference period and
 Contain a prominent warning that
source of the information
figures refer to simulated past
 Contain a prominent warning that
performance and that past
the figures refer to the past
performance is not a reliable
 If denominated in a foreign currency,
indicator of future performance
state the currency clearly
 If based on gross performance,
disclose the effect of commissions

Future performance information

Future performance information must:







Not be based on nor refer to

simulated past performance
Be based on reasonable
assumptions supported by objective
data
If based on gross performance,
disclose the effect of commissions,
fees or other charges
Contain a prominent warning that
such forecasts are not a reliable
indicator of future performance
Only be provided if objective data
can be obtained

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Financial crime

Ethical implications of misleading communications

The pressure for short-term gain in a firm could encourage the use of a misleading financial
promotion.
This could have undesirable longer-term ethical and professional consequences:


When the misleading nature of the promotion comes to light, it may be that customers have
lost money, while others may feel cheated. Many may feel aggrieved. Consumers may have
diminished financial prospects and may view the firm unfavourably

Consumers coming to know about the firms actions, as well as those directly affected, may
come to view the firm as unethical, and damage may be done to the reputation of the firm

Customers may become less loyal to the firm and the firm may find it more difficult to retain
and acquire customers

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Financial crime

Suitability

Appropriateness (for non-advised services)

Firm recommending designated investments must

assess whether the recommendation is suitable for
the client, based on clients:

For investment services other than: personal

recommendations & managing investments.

 Knowledge & experience

 Investment objectives
 Financial situation
Suitability report (letter) required following personal
recommendation to retail client on:

Assessing appropriateness
Client to provide information about relevant
knowledge/ experience to enable firms to assess
appropriateness.

 Life policy
 Stakeholder pension scheme, & some other
pensions transactions
 Regulated collective investment schemes

 If the product/service is not appropriate, firm must

warn the client
 If there is insufficient information to assess
appropriateness, firm must notify the client

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Best execution

Order execution policy

The rules on best execution apply to retail &

professional clients.

Clients must give prior consent to execution policy.

Information must be given on the policy.
For each class of financial instrument, policy should include:
 Information on different execution venues, &
 Factors affecting the choice of venue

 When executing orders, a firm must take

all reasonable steps to obtain the best
possible result for clients, taking into
account the execution factors
 A firm will satisfy this rule by executing a
client order in accordance with the
specific instructions of the client
 Execution factors are: price, costs, speed,
likelihood of execution and settlement, size,
nature or any other consideration relevant
to the execution of an order.
Page 79

For retail clients, the following information must be given

in advance:
 Relative importance of the execution factors
 List of execution venues
 Warning that specific instructions may prevent firm
from following its policy to obtain the best possible
result
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Page 80

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Financial crime

Client order handling

Inducements

Rules cover retail & professional clients.

 Procedures must provide for prompt & fair
execution of client orders
 Comparable orders to be executed according to
time of receipt by the firm

A firm must act honestly, fairly and professionally in

the best interests of their client (Clients best
interests rule.)

Use of dealing commission

Investment manager must be satisfied that
goods/services purchased with commission:
 Do not impair compliance with clients best
interest rule
 Relate to the execution of trades, or
 Comprise the provision of research

 Any fee, commission or non-monetary benefit

paid to or provided by a third party must be
designed to enhance the quality of service to the
client
 A firm must disclose to the client any fees,
commissions or non-monetary benefits in
summary form

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Churning and switching

Page 81

FCA business
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Supervision &
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Financial crime

Personal account dealing

Firms must have arrangements to:

Churning is prohibited: switching products in order

to make more commission or fees regardless of the
clients interests.
Customers must not be advised to switch products
unless it is in their interests.

 Prevent employees engaging in market abuse

 Ensure all relevant persons are aware of
restrictions
 Ensure any deals are notified promptly to the firm
 Ensure adequate transaction records are kept

A series of transactions that are each suitable when viewed in isolation may be unsuitable if the recommendations or the decisions to trade are made with a frequency that is not in the best interests of the client.

A firm should have regard to the client's agreed investment strategy in determining the frequency of transactions.
This would include, for example, the need to switch within or between packaged products.

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standards

Independent advice

7:25 PM

Exchanges &
markets

Page 82

FCA business
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Supervision &
redress

Financial crime

Retail investment advice rules

Restricted advice

Advice must be either independent or restricted.

If an adviser declares themselves to offer
independent advice, they will need to consider a
broader range of retail investment products (RIPs)
wider than the definition of packaged products.
Independent advice
 Covers all retail investment products
 Unbiased, based on comprehensive & fair
analysis of market

Advice that is not independent must be labelled as

restricted advice, for example as advice on a limited
range of products or providers.
Retail investment advisers (RIAs) are still required
to meet the regulators suitability requirements, even if
they offer restricted advice.
Restricted advice
 Covers limited products or providers
 Includes basic advice (stakeholder products)
 Suitability requirements still apply

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Retail investment products (RIPs)

Page 83

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Financial crime

Packaged products definition

RIPs are defined to include:

Collective Investment Schemes (regulated)

 Life policies

Life policies

 Units/shares in collectives: ITs, UTs, OEICs

Investment trust savings schemes

 IT savings scheme investments

Personal pensions

 Personal and stakeholder pension schemes

Stakeholder pensions

 Other packaged investments offering exposure

to underlying financial assets

Adviser charging

 Structured capital-at-risk products (SCARPs)

 Adviser must not take any other benefit, even to

pass on to client

Advice is paid for through an adviser charge.

 Firm must account for any reasons for charges

varying materially from its charging structure
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Page 84

FCA business
standards

Supervision &
redress

Financial crime

FCAs product intervention power

Referring to specialists

The FCAs product intervention power gives it the

flexibility to intervene quickly and decisively, normally
after public consultation, where it considers that a
product or product feature is likely to result in significant
consumer detriment.

If dealings with a client involve actions beyond

advisers authority (because of firms or
regulators rules), the adviser should seek
authority from an appropriate person.

The FCA may impose temporary product intervention

rules (TPIRs) for up to 12 months without the usual
consultation process, eg where:





Products involve inappropriate consumer targeting

Product access is restricted to boost firms profit
Significant consumer detriment could result
Inherently flawed products, from which consumers
unlikely to benefit

 Advisers should be able and willing to refer

to other specialists within the firm.
 Advisers may also need to refer to
specialists outside their business in
certain areas & should explain to client when
it would be necessary.

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Exchanges &
markets

Investment research
Rules:
 Apply to investment research which is intended/
likely to be disseminated to clients/public
 Cover written & oral material
Firms must manage conflicts of interest:
 No personal or firm transactions in unpublished
research until clients have had a reasonable
opportunity to act on it
 No personal transactions contrary to current
recommendation
 No promises of favourable research
 No editorial control for subject of research
 No front running of trades by firm or its
employees
Page 85

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Financial crime

Required disclosures
Firms should take reasonable care to ensure fair
presentation of information:
 Disclose identity of person responsible for
research
 Disclose relationships & circumstances which
may impair objectivity
 Do not tie remuneration to specific transactions
or recommendations
 Fact should be distinguished from opinion,
analysis, interpretation etc

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Page 86

FCA business
standards

Supervision &
redress

Financial crime

Non-independent research

Conflicts of interest

Investment research is research described as investment

research or in similar terms, or is otherwise presented as
an objective or independent explanation of the matters
contained in the recommendation. Otherwise, research is
non-independent research.

Principle for Businesses 8: A firm must

manage conflicts of interest fairly, both between
itself & its customers & between a customer &
another client.

Non-independent research must:

 Be clearly identified as a marketing communication
 Contain a clear & prominent statement that it does
not follow the requirements of independent research
and is not subject to prohibitions on dealing ahead of
dissemination of research

Identify material conflicts that arise or may arise

between:
 Firm & client
 Clients
SYSC provisions:




Financial promotions (FP) rules apply to non-independent 
research as if it were a marketing communication.

Organisational & administrative arrangements

Written conflicts policy
Keeping records of the conflicts
Disclosure of potential conflicts is the measure
of last resort, if conflicts cannot be managed

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Page 87

FCA business
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Supervision &
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Financial crime

Disclosures
From Principle 7 Communications with clients &
Principle 9 Customers: relationships of trust comes
a general obligation to disclose risks. Specific
warnings may be needed eg, for warrants,
derivatives, non-readily realisable investments.
Key Facts Document (KFD) must be given to a
retail client when providing a recommendation on a
packaged product, including:
 Details on nature & complexity of the product
 Complaints handling procedures
 Compensation schemes
 Cancellation rights

Page 87

Key Investor Information (KII)

Managers of authorised UCITS funds must prepare
short KII document, containing:
 Identification of the scheme
 The words key investor information
 Investment objectives and policy
 Past performance presentation / scenarios
 Costs and charges
 Investment risk/reward profile, with guidance &
risk warnings
 How to get more information

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Information on client transactions

Immediately after executing a client order, an
investment firm should record key details of the
transaction.
A firm must provide promptly in a durable medium the
essential information on execution of orders to
clients in the course of designated investment business
(except where it is managing the investments ie, under
a discretionary management agreement). The
information may be sent to an agent of the client,
nominated by the client in writing.
For retail clients, a notice confirming execution (a
confirmation) must be sent as soon as possible and
no later than the first business day following receipt of
confirmation from the third party.

Page 88

FCA business
standards

Supervision &
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Financial crime

Cancellation rights
The consumer must be informed of a right to
cancel.
The cancellation date is the date of dispatch by
the consumer.
 Life policies & pensions (including stakeholder
& personal) 30 calendar days
 Other products 14 calendar days

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Page 89

FCA business
standards

Supervision &
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Financial crime

Periodic reporting

Progress reports for funds

Firm managing investments must provide periodic

reports showing:

Managers of authorised funds must report to

unitholders:

 Name of the firm

 Name / designation for a retail clients account
 Statement of contents & valuation of portfolio,
including details of:
Designated investments & their value
Cash balance at beginning & end of period
Performance of portfolio
 Total fees & charges, itemising management
fees & execution costs
 Comparison of period performance with any
agreed benchmark
 Dividends, interest & other payments received
 Information about corporate actions
Page 89

 Short report (send to all holders) & long

report (available on request), half-annually &
annually
 The reports must be available within 4 months
of the year-end & within 2 months of the end
of the half-year

Record keeping periods

 MiFID records 5 years
 Non-MiFID general rule: as long as is relevant
for the purposes for which the records are made
 Pension transfers & pension opt-outs indefinitely
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Page 90

FCA business
standards

Supervision &
redress

Financial crime

Client assets

Client money

Make adequate arrangements to safeguard clients

ownership rights in event of:

Client money is money the firm looks after which is

not its own. Client money must be held on trust.
Client bank account should be separately identifiable
from firms own account. Adequate records and
procedures must cover mandated accounts (eg
direct debit mandates and credit card details held).
A firm must reconcile its internal records with those
of third parties:
 As regularly as necessary
 As soon as reasonably practicable after
reconciliation date
Correct any discrepancies promptly:
 If shortfall, top up account the same business day
 If excess, remove the same business day

 Insolvency of firm
 Unauthorised use by the firm client must give
prior consent to their use in security transactions
such as stocklending
Firm should have adequate arrangements to
minimise risk of loss or reduction of financial
instruments, misuse, fraud, poor administration,
inadequate record keeping or negligence.
Custody reconciliations:
 Reconcile internal records with third parties
regularly
 Correct any discrepancies promptly

Notify the regulator of any breaches without delay.

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Financial crime

Powers of the new regulators (FCA and PRA)






Granting authorisation & permission to firms (under Part 4A FSMA 2000) to undertake regulated activities
Approving individuals to perform controlled functions
Issuing rules which appear to be necessary or expedient to advance regulators objectives (Part 9A FSMA 2000)
Supervision of authorised firm to ensure that they continue to meet the regulators authorisation requirements &
that they comply with the regulatory rules and other obligations
 Powers to take enforcement action against authorised firms and approved persons
 Powers to discipline authorised firms & approved persons
 The FCA & PRA jointly oversee the Financial Services Compensation Scheme (FSCS)
Applications for variations or cancellations of permissions:
 Dual-regulated firm will normally apply to PRA, which may determine an application to vary a permission only
with FCA consent, and to cancel a permission only after consulting the FCA.


FCA-only regulated firm will apply to FCA. If the applicant firm is part of a group that includes a dual-regulated
firm, the FCA must consult the PRA in making its decision

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Page 92

FCA business
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Supervision &
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Financial crime

FCA supervisory approach

The FCAs process for assessing conduct risks puts firms into categories C1 (larger firms with most consumer/market impact: most intensive supervision) to C4 (smaller firms). Firms are also put into prudential
categories CP1 (firms whose failure has greatest impact) to CP3 (least impact).
The FCAs supervision approach:
1 Firm Systematic Framework (FSF): analysing firms business models to assess sustainability from conduct perspective, and future risks; evaluating firms culture and tone for the top regarding fair treatment of
customers and market integrity
2 Event-driven work: covering emerging issues, eg mergers, spikes in complaints, whistleblowing allegations
3 Issues and products: analysis by FCAs sector teams

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Complaints
What is a complaint?
Any oral or written expression of dissatisfaction
whether justified or not, alleging loss, distress
or inconvenience
Eligible complainants for Ombudsman purposes:
 Consumers
 Enterprises with fewer than 10 employees and
turnover or annual balance sheet not
exceeding 2 million (micro-enterprises)
 Charities with annual income < 1 million
 Trusts with net asset value < 1 million

Page 93

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Supervision &
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Financial crime

Firms must report to the regulator twice-yearly, on:




Complaints categories & product types

Numbers of complaints closed: within 4 weeks; within
4-8 weeks; & more than 8 weeks
 Numbers of complaints: upheld; referred to & accepted
by Ombudsman; outstanding
 Total amount of redress paid

To whom should customers complain?

1

Contact the provider firm, using the firms formal

complaints procedures if necessary.

If complaint not resolved with the firm, use an

independent scheme, eg the Financial Ombudsman
Service (FOS), or the courts.
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Complaints handling
 Effective and transparent complaints
handling procedures
 Allow complaints to be made by any
reasonable means
 Recognise complaints as requiring resolution
 Complaint must be:
Investigated competently, diligently,
impartially
Assessed fairly, consistently, promptly
 Assessment must be explained in a fair,
clear & not misleading way, & any
appropriate redress or remedial action
offered

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FCA business
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Supervision &
redress

Financial crime

Financial Ombudsman Service (FOS)

Firms must cooperate with FOSs Compulsory
Jurisdiction which applies to regulated activities:
 Where complaint not resolved after 8 weeks
 Max. FOS award: 150,000 (including any
compensation for suffering, damage to reputation,
distress, inconvenience), plus interest & costs

Financial Services Compensation Scheme

For default/insolvency in respect of:
 Investments & home finance: 100% of 1st 50,000
 Deposits: 100% of 1st 85,000
 Long-term insurance: 90% of claim
 General insurance: 90% of claim, but 100% for
compulsory insurance

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Exchanges &
markets

Complaints
Procedures must be in place for complaints
handling by a firm, and a complaints log must
be maintained.
Publish summary of procedure & refer eligible
customers to it at the point of sale.
An FOS decision is binding on the firm.

FCA business
standards

Page 95

Financial crime

Supervision &
redress

Timeline


Receive complaint, within 6 years of event, or 3 years

of when complainant should have been aware of it

Promptly on receiving a complaint, acknowledge it,

providing early assurance that it is being dealt with

By 8 weeks after receipt, send final response or

holding response explaining why final response
cannot be made, stating when it is expected to be
made, and informing complainant of his right to go to
Ombudsman

Final response starts the clock on ...

... 6 month limitation period on using FOS

Records of the complaint and measures taken

for its resolution must be kept for three years,
but five years for MiFID business.
Twice-yearly reports to regulator required.

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Exchanges &
markets

Anti-money laundering (AML) provisions

Three aspects to AML:

Page 96

FCA business
standards

Supervision &
redress

Financial crime

Money laundering: conversion of money obtained

illegally into apparently legitimate funds.

 Deterrence
 Co-operation
 Detection

Proceeds of Crime Act 2002

 Makes it a criminal offence to facilitate
arrangements involving the proceeds of
any crime (including, eg, tax evasion)

International & UK action

International
Financial Action Task Force (FATF)
UK
 Criminal Justice Act 1993
 POCA 2002 (updated CJA 1993)
 Anti-drug trafficking & counter-terrorism
financing (CTF) legislation

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Page 97

FCA business
standards

Supervision &
redress

Financial crime

Proceeds of Crime Act 2002

Three main offences:


Assistance If any person knowingly helps another person to launder the proceeds of criminal conduct, he or
she will be committing an offence

Failure to report If a person discovers information during the course of his employment that makes him
believe or suspect money laundering is occurring, & he fails to make the report as soon as is reasonably practicable, he is committing a criminal offence

Tipping off (s333A) Even where suspicions are reported, the parties must generally be careful not to alert the
suspicions of the alleged launderer since, within the regulated sector, this is an offence

Money laundering: Sequence

 Depositing funds in respectable investments (placement)
 Multiple transactions to conceal origins of funds (layering)
 Conversion of funds into a business (integration)
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Page 98

FCA business
standards

Supervision &
redress

Financial crime

Anti-money laundering regulation

Money Laundering Regulations 2007
 Risk-sensitive policies and procedures required
 Customer due diligence (CDD) means
identifying customer or beneficial owner, if
different, and verifying identities
 Enhanced due diligence (EDD) applies for
higher-risk situations, such as non-UK
politically exposed persons
 Simplified due diligence (SDD) means not
having to apply the usual measures, eg for
CTFs, listed companies and public authorities
Penalty Failure to implement MLR 2007 is a crime:
2 years imprisonment and/or fine

Joint Money Laundering Steering Group

Guidance Notes
Identity information may come from (in order of
preference):
 Government department or Court
 Other public sector body
 Regulated financial services firms
 Other firms subject to MLR or similar regime
 Other organisations
Keep records for five years.

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Criminal Justice Act 1993

Money laundering regulations
(secondary legislation)
Joint Money
Laundering
Steering Group
guidance
Identity checks are designed to
prevent money laundering. To prevent
financial exclusion, there is some
flexibility on the evidence necessary.

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Page 99

FCA business
standards

Financial crime

Supervision &
redress

Money laundering: maximum penalties (POCA 2002)

14 years for knowingly assisting in laundering of criminal
funds
5 years for failing to report knowledge or suspicion of
money laundering
2 years for tipping off a suspected launderer, in regulated
sector (s333A POCA 2002)

The suspected launderer must not be alerted!

Suspicions
of
laundering

report
to

Money
Laundering
Reporting
Officer

may
report to

National
Crime
Agency

The regulator requires annual reporting by MLRO to senior management and training of staff.
Page 99

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Page 100

FCA business
standards

Supervision &
redress

Financial crime

SYSC & financial crime

SYSC requires firms to:

 Systems & controls need to identify,

assess, monitor money laundering
risk the risk that firm is used to
further financial crime

 Allocate to a senior manager (could be the MLRO

but does not have to be) responsibility for
establishment & maintenance of AML systems and
controls

 Systems & controls should be

comprehensive & proportionate to
the nature, scale & complexity of the
business

 Provide appropriate training

 Appoint MLRO, who must provide a report at least
annually to the governing body/senior management
 Appropriately document ML risk profile/policy
 Ensure ML risk is considered in day-to-day
operations
 Ensure identification procedures do not
unreasonably deny access to services

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Page 101

FCA business
standards

Terrorism
What is terrorism? Terrorism 2000 Act
definition encompasses violent actions designed
to influence a government or intimidate the public.
How does terrorism financing differ from money
laundering?

 Relatively small amounts may be

involved
 Terrorists may be funded from legitimate
income

Page 101

Supervision &
redress

Financial crime

Terrorist offences






Fund raising
Use & possession
Funding arrangements
Money laundering

Law on Counter-Terrorism Financing (CTF)

 The duty to report Terrorism Act 2000
 Regulated sector Anti-Terrorism, Crime &
Security Act 2001
 Failure to disclose 5 years in jail and/or fine
 Protected disclosures Not a breach of client
confidentiality
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Who is an insider?

Page 102

FCA business
standards

FCA supervision
& redress

Financial crime

Insider
Inside
Source

Inside
Information





Price-sensitive
Unpublished
Specific or precise
Particular issuer or
security

Must not:
Deal
Encourage
Disclose






Company Director
Employee
Office or duties
Direct or indirect
source

Insider dealing is a criminal offence under Part IV of the Criminal Justice Act 1993.
Under CJA 1993, an insider is an individual who has information in her possession that she knows is inside information and
knows is from an inside source either directly from her own profession or indirectly from someone with access due to their
own profession.

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Page 103

FCA business
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Financial crime

Supervision &
redress

Where are insider dealing restrictions found?

Insider dealing: Criminal Justice Act 1993

Many rules and regulations:

 Individuals who are insiders

 Regulated market/ professional
intermediary







Financial Services & Markets Act 2000

Criminal Justice Act
Principles for Businesses
Exchange rules
Civil offence

 Not all investments covered

 Various bodies involved

Special defences

General defences
 Did not expect to profit
 Believed on resonable grounds that
information was in public domain
 Would have dealt anyway
Page 103

Defences

 Market maker
 Market information including bid
facilitation
 Price stabilisation rules
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Page 104

FCA business
standards

FCA supervision
& redress

Financial crime

Market abuse

Market manipulation

Market abuse: due diligence defence

Behaviour by any person

occuring in relation to
qualifying investments traded
on a prescribed market

Manipulating devices

Section 123 FSMA 2000

 Person believed on reasonable grounds
that he was not committing market
abuse, or

Insider dealing
Insider dealing
Improper disclosure
Misuse of information

Manipulating transactions
Dissemination of false or
misleading information
Misleading behaviour &
distortion

 Person took all reasonable precautions

and exercised due diligence to avoid
committing market abuse
 No financial penalty

Safe harbours if acting within one of these safe harbours, a person is not
committing market abuse:
 Regulators rules
 The Takeover Code
 Buy-back programmes and stabilisation
 Due diligence defence see above

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Insider dealing

Improper disclosure

Where an insider discloses inside

information to another person otherwise
than in the proper course of the exercise
of her employment, profession or duties

Misuse of information

Where a transaction is based upon

information not generally available, which a
.
regular market user would regard as
relevant and would cause them view the
persons behaviour as being below reasonable
market standards

Page 105

Exchanges &
markets

Page 105

FCA business
standards

Where behaviour Is likely to give a regular market

user a false or misleading impression as to the
supply of, demand for, or price or value of,
qualifying investments; or cause a distortion of the
market

Market abuse
offences
4

Dissemination

Dissemination of information which gives, or

is likely to give, a false or misleading
impression as to a qualifying investment by
a person who knew it was false or
misleading

(detail set out in the Code

of Market Conduct)

Financial crime

Supervision &
redress

7 Misleading behaviour & distortion

Where an insider deals, or attempts to

deal, in a qualifying investment or related
investment on the basis of inside
information

7:25 PM

Manipulating devices

Effecting transactions or orders to trade which

employ fictitious devices or any other form of
deception

Manipulating transactions

Where a transaction or orders to trade (are effected otherwise than for legitimate reasons
and in conformity with accepted market practices) which:
Give, or are likely to give a false or misleading impression as to the supply, demand or
price of one or more qualifying investments; or Secure the price of one or more such
investments at an abnormal or artificial level

3: Financial regulation

(003)IMC1PC_v11_CH03.qxp

Regulatory
framework

12/4/2013

FCA high level

standards

7:25 PM

Exchanges &
markets

Page 106

FCA business
standards

Supervision &
redress

Financial crime

Enforcement of market abuse The FCA may impose one or more of the following penalties on those
found to have committed market abuse:
 An unlimited fine
 Issue a public statement
 Apply to the court to seek an injunction or restitution order
 Disciplinary proceedings, which could result in withdrawal of authorisation/approval where an authorised/approved
person is guilty of market abuse as they will also be guilty of a breach of the Principles for Businesses
Note that the regulator has criminal prosecution powers to enforce insider dealing and Part 7 Financial Services Act
2012 (see below). The regulator has indicated that it will not pursue both the civil and criminal regime.
Part 7 Financial Services Act 2012 has created criminal offences relating to:




Misleading statements
Misleading impressions, and
Misleading statements relating to benchmarks (including LIBOR)

There will also be new provisions relating to regulated activities that are connected with setting benchmarks.

(003)IMC1PC_v11_CH03.qxp

Regulatory
framework

12/4/2013

FCA high level

standards

7:25 PM

Exchanges &
markets

Page 107

FCA business
standards

Supervision &
redress

Financial crime

Bribery Act 2010

The Bribery Act 2010 (BA 2010) replaces existing anti-corruption legislation and introduces a new offence for commercial
organisations of negligently failing to prevent bribery.

Bribery offences
There are four main offences under BA 2010:
 Section 1: Active bribery Offering, promising or giving a bribe
 Section 2: Passive bribery Requesting, agreeing to receive or accepting a bribe (passive bribery)
 Section 6: Bribing a foreign public official A breach of this section may also breach s1 BA 2010, and prosecutors will need to decide which is the more appropriate offence for the case
 Section 7: Failure of firms to prevent bribery Failure by a commercial organisation to prevent persons associated with it from bribing another person on its behalf.
An organisation has a defence against the s7 offence (failure to prevent bribery) if it can prove that, despite a particular
instance of bribery having occurred, the organisation had adequate procedures in place to prevent persons associated
with the organisation from committing bribery.
Page 107

3: Financial regulation

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Notes

Page 108

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Page 109

4: Legal concepts

Topic List

Those working in the financial sector must operate within

various regulations, laws and statutes.

Legal persons

As in any business, the law of contract has a bearing,

and the law on power of attorney, wills and trusts needs
to be understood.

Power of attorney
Contracts & agency
Property
Bankruptcy & insolvency
Trusts & wills

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Legal
persons

Power of
attorney

12/4/2013

7:25 PM

Contracts
& agency

Page 110

Property

Bankruptcy
& insolvency

Trusts &
wills

Legal personality

Companies

Legal persons include:

A company is a legal person. A creditor cannot

demand payment of company debts from its
shareholders. The company is liable without limit for its
own debts.






Companies
Nations
Co-operatives
Individuals

Legal persons can:

 Enter into contracts
 Sue & be sued
 Incur debt
 Own property

Sole traders
For a self-employed trader, there is no legal
distinction between individual & business. The
trader is personally liable for debts of the business.

 An individual human being is a natural person

 A corporation (eg, a company) is an artificial
person
 A public company (plc) has a nominal share
capital of at least 50,000 & may be Stock
Exchange-listed
 Others are private companies (Limited or Ltd)
not permitted to offer their securities to the public

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Legal
persons

12/4/2013

Power of
attorney

7:25 PM

Contracts
& agency

Page 111

Property

Bankruptcy
& insolvency

Trusts &
wills

Powers of attorney

Lasting power of attorney

Power of attorney: formal document made by donor

which appoints attorney or donee to act for donor in
legal matters (eg, to sign documents).

A lasting power of attorney (LPA) under the Mental

Capacity Act 2005 can take effect if the donor
becomes mentally incapable, and can cover Personal
Welfare as well as Property & Affairs.

 General power of attorney allows donee to act

for donor in all matters
 Power may be restricted to specific act, eg to
execute a specific document

To take effect, LPA must be registered with the

Office of the Public Guardian.

Ordinary power of attorney:

 Valid while donor capable of giving instructions
 Revoked by death or bankruptcy of donor or
attorney, or at choice of donor
Existing enduring powers of attorney (EPAs) are
still effective, but new EPAs cannot be set up.
Page 111

If no replacement attorney, LPA is cancelled if:

 Attorney cannot or will not act, or dies
 Married attorney & donor divorce
 For a Property & Affairs LPA, if attorney or donor
become bankrupt
4: Legal concepts

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Power of
attorney

Legal
persons

7:25 PM

Contracts
& agency

Page 112

Property

Bankruptcy
& insolvency

Trusts &
wills

Elements of a contract
A contract is a legally binding agreement between persons in any form (eg, inferred, written or oral).
 Offer




Intention to create legal relations 

Consideration


 Acceptance

 eg A life assurance proposal form constitutes an offer

Other factors affecting validity of a contract:

 Capacity. Some people have restricted capacity to enter into contracts, eg, minors (under 18)
 Form. Some contracts must follow a particular form
 Content. There may be some implied terms in a contract. Express terms may be unlawful
 Genuine consent. There may be undue influence or duress, or misrepresentation or mistake
 Legality. The courts will not enforce a contract which is illegal or contrary to public policy
Effect of failure to satisfy the validity tests:
 Void contract. This is no contract
 Voidable contract. This contract can be avoided by one party
 Unenforceable contract. This contract is valid but performance by one party cannot be enforced

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Power of
attorney

Legal
persons

12/4/2013

7:25 PM

Page 113

Contracts
& agency

Property

Bankruptcy
& insolvency

Trusts &
wills

Agency
The agent-principal relationship forms a contract
between the principal & a third party.

 Principal
 Agent (eg broker, appointed representative)
 Third party

Contract discharge
Agents obligations

Ways in which a contract can come to an end:






Breach
Performance
Agreement
Frustration

A verbal contract is legally binding, except for sale of

property, and tenancy agreements.
Page 113







Performance & obedience

Skill & accountability
No conflict of interest
Keep confidence
Benefit only as agreed

4: Legal concepts

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Legal
persons

Power of
attorney

12/4/2013

7:25 PM

Contracts
& agency

Page 114

Property

Bankruptcy
& insolvency

Trusts &
wills

Real property

Co-ownership

In legal terminology, land includes buildings &

anything else permanently attached to the land.
 Real property (also called 'realty') is land owned
in perpetuity ie, freehold property.
 With leasehold property, the right of the rentpaying tenant (or lessee) to possession ends
either by expiry of a fixed period or by notice.
 A lease is a form of contract. If granted for a
term of more than three years, it must generally
be in the form of a deed.

2+ persons may own land. (Applies to owning

freehold land outright, in spite of the word tenant.)
 Joint tenancy a common form of ownership of
a house by a couple. The transfer does not state
what share in the land each person has. The
land is 'held by X and Y'.

Personal property
Personal property (personalty) is anything that
is not real property (freehold land).

If a joint tenant dies, his interest lapses & the land

is owned wholly by the survivor(s).
 Tenants in common. A conveyance may state
that the land should go to 'P, Q and R equally'
each then owns one-third part of the interest.
With a tenancy in common, each tenant can
bequeath his interest.

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Legal
persons

Power of
attorney

12/4/2013

7:25 PM

Contracts
& agency

Bankruptcy
Bankruptcy: when an individual is no longer able
to pay debts and his or her financial affairs are
taken over by a court. The assets are transferred
into a trust.
Bankruptcy proceedings start with a Bankruptcy
Order to the court.
 Court will decide whether to declare the individual
bankrupt.
 The Official Receiver takes control of assets, as
receiver & manager.
A bankruptcy order is normally discharged
automatically one year after the date of the order,
unless the bankrupt is culpable (Enterprise Act 2002).
Page 115

Page 115

Property

Bankruptcy
& insolvency

Trusts &
wills

Receiver & manager protects bankrupt's property

until trustee in bankruptcy is appointed to get
possession of bankrupts assets & realise their value.

Trustee is entitled to the excess income above what

is needed to support bankrupt and his/her family.

If the debtor owns their own home, & lives alone,

lives with a co-habitee or lives with adult children,
interest in the home normally passes to the trustee.

4: Legal concepts

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Legal
persons

Power of
attorney

12/4/2013

7:25 PM

Contracts
& agency

Insolvency procedures
Three types of corporate insolvency:
 Administration to provide a better way of
realising company's assets than could be
achieved by liquidation or receivership
 Receivership concerned principally with
interests of secured creditors who want to
take control of charged assets
 Liquidation mainly for the interests of
unsecured creditors and members
(shareholders) of the company. The company is
dissolved and its affairs 'wound up'.

A voluntary liquidation cannot be initiated by

shareholders if a company is insolvent.

Page 116

Property

Bankruptcy
& insolvency

Trusts &
wills

If there was intent to defraud creditors or others,

the court may decide that persons (usually, directors)
who were knowingly parties to the fraud shall be
personally responsible for debts and other liabilities
of the company.

Aims of insolvency law

 Protect the creditors of the company
 Balance the interests of competing groups
 Control or punish directors responsible for
company's financial collapse
 Encourage 'rescue' operations

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Legal
persons

12/4/2013

Power of
attorney

7:25 PM

Page 117

Contracts
& agency

Property

Bankruptcy
& insolvency

Trusts &
wills

Valid will
 Signed by testator
 Witnessed by two people
 Not made under pressure

Intestacy
Yes

Is there a valid will?

Administrators deal
with the estate.

No

Types of trust
Executors carry out the terms of a will, to distribute estate in
accordance with testators wishes. A witness or their spouse
cannot be a beneficiary. Marriage invalidates a will, unless the
will states it is made in contemplation of marriage.

Trusts
A trust is an equitable obligation in which
trustees are bound to deal with property
they control (as legal owners) for the
benefit of the trust beneficiaries.
Page 117

 Bare Trust
 Interest in Possession Trust
 Discretionary Trust
 Charitable Trust

Some uses of trusts: will trusts, life trusts, family

settlements, unincorporated associations, land gifted to
children, protecting the identity of a beneficial owner
4: Legal concepts

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Notes

Page 118

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Page 119

5: Client advice

Topic List
The retail consumer
Advising clients
Institutional funds
Client interaction

A clients life stage, employment status and current financial

position all influence the clients needs in the financial
planning context. Just as important are the clients future
prospects and aspirations. Planning is by definition forwardlooking and it is what the client can make of their current
situation that matters.
Different factors shape asset allocation for a client portfolio
and for a fund. Accurate recording of information is of
course vital, to help the financial planning process as well
as to demonstrate compliance with regulatory provisions.

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The retail
consumer

Page 120

Advising
clients

Institutional
funds

Client
interaction

Consumers perceptions

Treating Customers Fairly (TCF)

In DP 18 An Ethical Framework for Financial

Services (2002), the previous regulator (FSA)
recognised that consumers increasingly
understand an ethical stance.

The FCAs TCF initiative identifies 6 improved outcomes to

achieve for retail customers.

 Professional conduct & ethical behaviour could

strengthen confidence in the industry, but
 If consumers have diminishing trust in the
sector & in firms, they will hesitate to use
products & services

1.

Customer confident of receiving fair treatment (TCF is viewed

as a matter of corporate culture)

2.

Products/services designed to meet the needs of specific

consumer groups

3.

Customers are provided with clear (ie, simple &

understandable) information

4.

Advice given to retail customers takes account of their

circumstances

5.

Products perform as customers expect

6.

No unreasonable post-sale barriers imposed by firms (eg,

when switching provider, making a complaint, etc)

There is also pressure from consumers &

government for the sector to put something
back, eg combating social exclusion.

TCF outcomes

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The retail
consumer

Trust and confidentiality

The consumer must have every reason to trust a
financial adviser.
 Trust is gained through respect, through the
way advisers deal with customers.
 The adviser must always treat personal
information with the utmost confidentiality.

RDR
The Retail Distribution Review (RDR) set up
arrangements (since end of 2012) to enhance
consumers confidence in using financial
services.

Page 121

Page 121

Advising
clients

Institutional
funds

Client
interaction

The advisers fiduciary duty

An adviser's fiduciary responsibility implies that the
adviser (or firm) acts in the best interests of the client
(Clients Best Interests Rule), to the exclusion of his
or her own interests.

Firms obligations to consumers

Authorised firms have an obligation to abide by the
FCA Principles for Businesses and detailed rules,
as set out in the FCA Handbook, in their dealings
with consumers.

5: Client advice

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Page 122

The retail
consumer

Advising
clients

Institutional
funds

Client
interaction

Stages in giving advice

 Obtain relevant information

 Establish & agree clients financial objectives 
 Process & analyse information identify &
analyse clients needs
 Formulate recommendations in a plan

 Implement recommendations, as agreed with
client
 Review & regularly update the plan

 Fact-find (questionnaire)
 Detailed in the fact-find

Analysing client circumstances, eg:






Structure of liabilities might be re-arranged

Are protection arrangements adequate?
Consider changes in circumstances: house, job, children
Assess clients disposable income to determine
affordability of a recommended product










Factors in formulating
recommendations

Regulation & compliance

Economic conditions
Taxation
State benefits
Savings & investments
Protection
Clients attitude to & understanding of
risk

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The retail
consumer

Page 123

Advising
clients

Client objectives
Two potential client requirements:
 To maximise returns, eg positive net worth individuals looking
for a portfolio to match their risk/return preferences
 To match liabilities, eg pension funds, where aim is to match
assets & liabilities or to minimise a mismatch
Private clients could have objectives that mix liability matching (eg
to pay school fees) & returns maximisation (for other funds, say).
Maximising returns. Given the choice, investors would elect for
high performance with minimal risk. In practice, this is not
achievable: a risk/reward trade-off applies.
Matching liabilities. Investments in government bonds can match
income & capital inflows precisely with liabilities. Extending into
more risky assets means that liabilities might not be met.
Page 123

Institutional
funds

Client
interaction

Types of investor risk

 Capital risk potential variability in

investment values
 Inflation risk potential variability
in inflation rates
 Interest rate risk the risk of
changes in bank base rates on
asset returns
 Shortfall risk the risk of a fund
failing to meet any specified
liabilities
Liabilities can be nominal (eg bank
loan) or real (eg living costs, which
will rise with inflation).
5: Client advice

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The retail
consumer

Page 124

Advising
clients

Institutional
funds

Client
interaction

Know your customer: collect information using the

fact-find.

Typical fact-find
 Personal details: hard facts

 Family details

 Employment details

 Advisers

Financial details (hard facts)

 Assets

 Liabilities

 Name, address, date of birth, contact details, NI

number/tax reference
marital status, state of health
country of domicile
 Dependants,
other immediate family
 Occupation, employer
time with employer, previous employer
 Bank, accountant, stockbroker, solicitor
 Property, belongings, antiques,
stocks and shares, unit trusts,
savings accounts, cash, other assets
 Mortgages, other loans and debts
Get letter of authority for information needed from third parties.

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The retail
consumer

Typical fact-find
 Income

 Expenditure

 Protection

 Pensions

 Wills and legacies

Customers attitudes (soft facts)

 Customers views on savings/
investment/protection

 Customers objectives

Page 125

Advising
clients

Institutional
funds

Client
interaction

 Pay, bonus, benefits profits, if self-employed,

investment income, pensions
 Living expenses, mortgage payments,
school fees, regular savings, life assurance
 Life cover, disability insurance details
 Occupational schemes, personal pension schemes,
preserved benefits
 Current will when last reviewed?
gifts in last seven years, anticipated legacies
 Attitude to risk, ethical investments?
perceived needs?
 Moving/childrens education/retirement plans?

Review client information each time he/she seeks advice

Page 125

5: Client advice

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The retail
consumer

Clients typical life stages

 Minors (under 18)
 Young and single
 Married or cohabiting

Page 126

Advising
clients

Institutional
funds

Client
interaction

Clients employment status

 Employed
 Self-employed
 Non-employed

 Both working, no dependants

 One working, no dependants
 One working, with dependants
 Married or cohabiting, older children
 Children left home
 Retired

Client needs







Protection of financial stability

Protection against adverse events
Provision for future financial needs
Pension provision
Maintenance of living standards
Ability to pass wealth on

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The retail
consumer

Page 127

Advising
clients

Institutional
funds

Client
interaction

Protection products
Protection products help to protect financial stability from
the potential adverse effects of common life events.
Possible adverse events
 Death

 Illness

 Incapacity

 Redundancy

Protection needs
 If there are
dependants
 State benefits are
limited

Emergency funds can act as a temporary cushion.

Page 127

CAPITAL

INCOME

Financial stability
If the unexpected happens:
 What is the likely loss of earnings?
 What are the housing & mortgage
implications?
 For a self-employed person, what are the
likely effects for the business?
5: Client advice

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Page 128

The retail
consumer

Advising
clients

Institutional
funds

Client
interaction

Typical protection needs at different ages

Age

Death

Sickness

Redundancy

Under 18

None

None

None

18-25

If married or in debt

If employed or self-employed

If employed

25-40

Significant: marriage, children,

mortgage

Significant

Mortgage cover needed?

40-50

Less significant if children growing

up

Increasing age increases risk Mortgage cover needed?

50-60

Less significant unless there is a

second family

Long-term care cover may be If there is still mortgage

considered
debt

60+

Protection of assets, IHT liabilities

Health protection and longterm care

Some possible needs are shown above, but every case is different.

Not usually significant

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The retail
consumer

Page 129

Advising
clients

Institutional
funds

Client
interaction

Mortgages: loans secured on property.

Lending sources

Capital and interest (or repayment) mortgage

Borrowers
payments

 Banks

Interest
Lender

Capital

 Building societies
 Insurance companies

Investment-related (or interest only) mortgage

Borrowers
payments
Capital

Interest
Lender
Savings
vehicle

On
maturity

eg: ISAs, pension lump sum,

endowment policy
Page 129

 Mortgage corporations
 Credit companies (mainly unsecured loans)
Islamic mortgages avoid interest, since interest is
against Islamic (Sharia) law. The homebuyer may
pay rent to the bank, with part of it going towards
buying out the banks share in the property.

5: Client advice

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The retail
consumer

Page 130

Advising
clients

Institutional
funds

Client
interaction

Planning for retirement

What age am I now?
How much can I afford from income?
What investment returns can I expect?
Tax relief is available on pension provision

At what age will I retire?

What income do I want in retirement?
How will inflation erode the value of savings?
Pensions in payment are taxed

Planning points

In retirement

 Evaluate existing provision

 State provision is limited

 Consider PP or stakeholder

 Housing costs can be significant

 Consider additional contributions

 What are the clients aspirations?

 Consider ISAs as alternative

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Page 131

The retail
consumer

Investment risks
The adviser must:
 Understand investment risks

 Ensure that the client understands
investment risks, before the
recommendation or transaction

Advising
clients

Institutional
funds

Client
interaction

 The investor risks:

Loss of income

Eg variable interest

Loss of capital

Assets which rise or fall in value, eg shares

Information on risks is included in the

Key Features Document.

RISK

SAFETY

Risky investments

Safe investments

Investments with high potential return come with the

risk of low or negative returns and loss of capital (eg:
shares, collective investments, options, warrants).

Investments with low risk of loss of capital come

with lower potential returns (eg: bank deposits,
NS&I).

Page 131

5: Client advice

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The retail
consumer

Diversification

two sorts of risk:

Page 132

Advising
clients

Institutional
funds

Client
interaction

Attitude to risk

 The general market (systematic) risk of

A clients attitude to risk may be influenced by:
investing in shares or bonds
Investment timescales. Eg: in managing a pension fund,
 The specific (non-systematic) risk of any attitude to risk may depend on how far out in time liabilities fall
individual investment
Clients risk tolerance. Standard fact-find approach: ask
client to select a mix of, say, equities & bonds, to give an idea
 Diversification by asset class portfolio of the normal mix (& hence risk) that the client wishes to face
possibly spread across: cash, fixed interest
(bonds), equities, property, & other assets
 Diversification within asset classes a
variety of investments, possibly spread
The trade-off between risk & potential reward:
across different geographical markets
 Low-risk investments offer low returns, but low probability
 Diversification by manager to reduce
of loss
risk from a manager performing poorly (as
in 'manager of manager' and 'fund of
 High-risk investments offer the possibility of high returns,
with higher probability of loss
fund' structures)

Investment risk & rewards

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The retail
consumer

Risk profiles
Rational
Emotional
decision making decision making
High risk
Methodical
Cautious
aversity
Low risk
Individualist
Spontaneous
aversity
Based on Bronson, Scanlan, Squire
Cautious investors
 Highly loss averse
 Need for security
 Want low-risk investments with safe capital
 Typically do not like making decisions but do
not listen to others
 Tend not to use advisers
 Portfolios are low risk & with low turnover
Page 133

Page 133

Advising
clients

Institutional
funds

Client
interaction

Methodical investors
 Analytical & factual
 Make decisions slowly
 Little emotional attachment to investments &
decisions
 Tend to be conservative in investment approach
Spontaneous investors
 High portfolio turnover
 Do not trust the advice of others
 Some are successful investors, but most do less
well, given high transaction costs
 Make decisions quickly & fearful of missing
opportunities
Individualist investors
 Self-confident
 Prepared to do analysis and & expect to achieve
their long-term goals
5: Client advice

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The retail
consumer

Page 134

Advising
clients

Maintaining wealth

Institutional
funds

Client
interaction

Passing on wealth

Employees
 An employer may meet some protection
needs
 Economic conditions affect
 What form of
 Is the remuneration package flexible?
values of shares and other assets
investment is most
 On pensions, salary sacrifice, additional
and investments
tax-efficient?
contributions & stakeholder pensions
 Inflation erodes the real value of
 Non-housing assets
might be considered
assets expressed in money terms
might be gifted to
Self-employed
reduce IHT liabilities
 House price inflation boosts
 Spouse might be employed to use
equity but it may need to remain
 Life assurance
personal allowance
policies (usually
tied up in housing
 No S2P (2nd State pension) entitlement
whole of life) can be
 Own pension provision is necessary
 Future inheritances may change
used to cover an IHT
a clients position
Non-employed
liability
 Are all benefits due being claimed?
 Can any expenses be met from capital?
 Personal pension contributions can be up
Clients who have actively accumulated their
to 3,600 p.a. for non-earners
wealth typically have higher risk tolerance

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The retail
consumer

Page 135

Advising
clients

Institutional
funds

Client
interaction

Affordability

Client review

Affordability of investments & protection policies to

be recommended for the client must be considered.

The adviser is concerned with identifying and

satisfying client needs. This is not just a one-off
process. Clients will have a continuing need for
financial advice. Their circumstances will change, &
there may need to be a review of whether products
initially recommended continue to be suitable.

 The client's prospective disposable income

should be ascertained in order to assess the
affordability of regular contributions to policies
& investment plans.
 Existing assets & policies, such as life
assurance contracts & other savings need to
be taken into account in quantifying the sizes
of investments needed to meet client needs.

Page 135

 Regular reviews of client circumstances will

enable the adviser to make best use of future
business opportunities with that client.
 For the client, there are benefits of advice arising
from the review.

5: Client advice

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Client
interaction
Institutional
funds
Advising
clients
The retail
consumer

Risk spectrum of investments

Low/
medium
risk

Low risk

Gilts (pre-redemption capital)

With-profits funds

Bank deposits
Building society deposits
Cash ISAs
Annuities

Negligible NS&I deposit products

risk
Gilts (income)
Gilts (redemption)

Medium
risk
Unit-linked managed funds
Unit trusts & OEICs/ICVCs (UK funds)
Investment trusts (UK)
Residential and commercial property

Medium/ Unit-linked overseas

high risk Unit trusts & OEICs/ICVCs (overseas funds)
UK single equities
Commodities
High risk Venture capital trusts
Unlisted shares
Warrants
Futures & options when used to speculate
Enterprise Investment Scheme
Enterprise Zone Property

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The retail
consumer

Approach to fund management

Evaluation
performance

Strategies

Advising
clients

Institutional
funds

Client
interaction

Strategic asset allocation

Objectives
Establish
investment
policy

Page 137

Stock Selection

Allocation of the fund between various:

 Asset classes (shares/bonds etc)
 Currencies
Based on:

Fund selection criteria

 Past performance
 Charges
 Entry (initial) & exit charges, annual
management charges
 Financial stability of provider
 Stability, independence & standing of
trustees, auditors & fund custodians
Page 137

 Objectives of fund & client

 Assets available for investment

Concept: the objectives & constraints direct you

towards certain asset classes and away from others

5: Client advice

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The retail
consumer

Active and passive management

An active investment manager tries to use individual
expertise to enhance the overall return of the fund.

 Passive investment management, on the other hand,

establishes a strategy which, once established, should
guarantee the appropriate level of return for the fund.


Indexation
The index fund manager selects an appropriate
index and builds a portfolio to mimic the index.
 Index funds typically based on a sampling
approach, and thus exhibit some tracking error.
 Transaction costs will typically be low, although
the portfolio must change to accommodate
changes in index constituents.

Page 138

Advising
clients

Institutional
funds

Client
interaction

a range of criteria to meet

Ethical funds cover
client ethical preferences.

Fund review
Fund performance should be reviewed at least
annually to evaluate whether fund is achieving its
objectives.
 Client circumstances any changes, which
might require a change in strategy?
 Performance review monitor against funds
selected benchmark
 Portfolio rebalancing consider potential
changes to agreed asset allocations

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The retail
consumer

Page 139

Advising
clients

Institutional
funds

Client
interaction

Benchmarks

Risk profile of funds

Three forms of analysis of a fund's performance:

Each type of institutional fund has its own

particular risk/reward profile stemming from:

 Comparison to relevant stock/index, eg a published

market index
 Comparison to similar funds, ie performance of other
similar fund managers, measuring:
Short and long-term investment return
Asset distribution of funds
Performance against peer groups, market indices &
medians
 Comparison with customised benchmark for funds
with a unique constraint, eg ethical funds that cannot
invest in arms/tobacco (standardised FTSE4Good
indices meeting ethical criteria are available)
Page 139

 Its initial objectives, return

maximising/liability matching
 The value and time horizons of the
liabilities it has to meet (if any)
 The assets it can invest in
 The liquidity required within the fund
 The risk that can be tolerated
 Its tax status
 Legislation governing its powers
5: Client advice

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The retail
consumer

Page 140

Advising
clients

Institutional
funds

Client
interaction

Pension funds liability matching

Funds:Tax

A pension fund is a pool of money to be

invested now, to achieve either:

Approved pension funds pay no UK tax on

either fund income or capital gains.

 A specific return based on the

employee's salary & number of years'
service with the company a defined
benefit (DB)/ final salary scheme, or
 A general increase in value of the
contributions paid on behalf of the
employee a defined contribution
(DC)/ money purchase scheme

Life funds: all fund income & capital gains are

taxable, so the investment manager will tend to
select more tax-efficient investment vehicles.

General insurance: business profits are subject

to normal corporation tax rates.

Reasons for decline in DB schemes and rise of DC schemes Pressure on DB schemes from:
 Increased longevity  Flling returns on scheme assets  Poor financial position of schemes
 Requirements to disclose scheme funding position in companys financial statements

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Page 141

The retail
consumer

Advising
clients

The time horizon for the attainment of the return,

or the matching of liabilities, will influence types of
investment selected. A fund with a long-term time
horizon can probably stand a higher risk: poor
returns in some years will tend to be cancelled by
high returns in other years.
Pension funds & life assurance companies will
have statistical projections of their liabilities into
the future & the fund must attempt to achieve
these.
Currency risk. A pension fund may have all its
liabilities denominated in sterling. If the fund
were to invest heavily in overseas assets, this
would expose it to additional risk, other than the
risk inherent in the assets themselves.
Page 141

Institutional
funds

Client
interaction

Liquidity needs. Within any fund, there needs to

be a degree of liquidity, to respond to changing
events.
Risk aversion & risk tolerances. The
risk/reward trade-off impacts on ways in which
the funds requirements can be achieved.

Constraints on funds
Asset allocation

The fund or portfolio manager has legal &

professional duty to base the asset allocation on
client's wishes with particular regard to:





Matching liabilities
Meeting any ethical considerations
Remaining within risk tolerances
Maximising fund performance
5: Client advice

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The retail
consumer

Page 142

Advising
clients

Institutional
funds

Client
interaction

Asset and liability matching

Constraints
Time

Young pension
fund
Long-term

Mature pension
fund
Short-term

Life assurances
fund
Long-term

General insurance
fund
Short-term

Liability
Liquidity

Real
Very low

Real
High

Nominal
Low

Nominal
Very high

Risk tolerance
Tax status

High
Low
Medium/high
Gross fund, no tax on Gross fund, no tax on Tax on income and
income or gains
income or gains
gains

Very low
Tax on income and
gains

Possible asset
allocation
Equities
Property

60% - 80%
5% - 10%

20% - 30%
0% (illiquid)

55% - 65%
0% - 5%

0%
0%

Bonds

15% - 25%

55% - 65%

15% - 30%

100%

Cash

0% - 5%

15% - 25%

5% - 15%

100%

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Page 143

The retail
consumer

Advising
clients

Institutional
funds

Client
interaction

Factual v evaluative statements

Closed and open questions

Factual information is distinct from evaluative statements

about someones hopes, wants, plans, opinions or feelings.

Closed questions ask for specific information, & typically

the answer is very short, or is Yes or No.

Examples
Closed questions

Factual information



Disregarding dividends, the fund has grown in value by

more than the FTSE 100 index over the 3-year period.
Brenda has fallen into two months' arrears on her
mortgage payments.

 Could you please tell me your address?

 Do you have any ISAs?
Open questions give the client more opportunity to express
views or feelings in a longer response.

Non-factual statements



Graham thinks that he should invest more of his

portfolio in foreign stocks, in order to diversify risk.
Matilda was disappointed by the service provided by
her previous financial adviser.

Page 143

Open questions



How do you feel about taking risks with your

investments?
What do you think are the most immediate financial
needs to be addressed?
5: Client advice

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The retail
consumer

Know your customer (KYC)

To know your customer basic requirement of the
regulatory regime and part of advisers fiduciary duty.

Page 144

Advising
clients

Institutional
funds

Client
interaction

Written reports to clients

Parts of a financial planning
report

 Obtain sufficient information about a customer's

personal & financial situation, before giving advice or
(if applicable) before constructing a portfolio for the
customer.

 Statement of client's objectives

 Summary of client's income & assets; other
relevant circumstances/ problems

 Know the customers capabilities, adapting both

spoken & written communication to suit the
customer. Such adaptation should cover technical
terminology & quantitative analysis presented.

 Appendices, if appropriate

 In presentations to clients, continually check (eg, by

asking open questions) for indications that the client
understands, explaining points again & more simply
as necessary.

 Recommendations, including any

proposals for immediate action as well as
longer-term suggestions

The language in the report should be phrased

concisely with explanations to suit capabilities of
client, avoiding unnecessary jargon.

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Page 145

6: Taxation

Topic List
Income tax
National insurance
Capital gains tax
IHT & trusts
Other taxes
Tax on investments

In covering the tax element of the syllabus, we examine

various aspects of the taxation of individuals. Different
products suit clients with different tax situations, and there
may be a financial advantage in careful tax planning.
Inheritance tax (IHT) is charged on lifetime gifts and on an
individuals estate at death.
Same-sex civil partnerships established under the Civil
Partnership Act 2004 follow the same tax treatment as
married couples.

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Income
tax

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National
insurance

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Capital gains
tax

Page 146

IHT &
trusts

Other
taxes

Tax on
investments

Residence If an individual ...

1

Satisfies automatic overseas test > then,

non-resident

Satisfies automatic UK test (eg, spending

183+* days of tax year in UK) > then, UKresident

If neither, then a sufficient ties test is

applied.

*Counting days when person is in UK at midnight.

Domicile
An individual is domiciled in the country which is
his permanent home. Someone can only change
domicile by severing ties with old country &
establishing a permanent life in a new one.

UK residents are taxable on worldwide income.

Non-residents are taxable on UK-derived
income.

 A remittance basis charge may be payable if

claiming remittance basis: 30,000 for nondoms who were UK-resident for 7 of the last 9
tax years; 50,000 if resident for 12 of last 14
tax years.
Non-UK domiciled UK residents are only
taxable on overseas income if it is remitted to
the UK or if it is from employment.

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Income
tax

National
insurance

12/4/2013

7:26 PM

Capital gains
tax

UK income tax system

 Pay as you earn (PAYE): tax on employment
earnings, deducted at source
 Self-assessment: where additional tax is payable
 Payments on account: 31 January & 31 July (if
self-employed or < 80% of last years tax paid at
source)
The fiscal year runs from 6 April to 5 April.

Page 147

IHT &
trusts

Other
taxes

Tax on
investments

Income tax rates (2013/14)

Rate

Taxable
income

Salary and Dividends

interest

Basic

0 to
32,010

20%

10%

Higher

32,011 to
150,000

40%

32.5%

Additional

>150,000

45%

37.5%

Tax avoidance v.Tax evasion

Tax avoidance: the taxpayer uses tax rules to his/her
advantage
Tax evasion: the taxpayer does not pay all tax due, eg
by under-reporting his/her income
Page 147

There is also a 10% starting rate for savings

income only, with a limit of 2,790 of taxable
earnings. The starting rate is not available if taxable
non-savings income exceeds 2,790.
6: Taxation

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Income
tax

12/4/2013

National
insurance

7:26 PM

Capital gains
tax

Gross taxable income less

 Personal allowance
 Qualifying pension contributions
 Allowable gifts to charity
equals Taxable income

Allowances (2013/14)
 There is a personal allowance of 9,440*
 The personal allowance is reduced by 1 for
every 2 excess income above 100,000 (thus
falling to zero for incomes over 118,880)
 Those born before 6 April 1948 may get a higher
personal allowance, subject to an income limit.

Page 148

IHT &
trusts

Other
taxes

Tax on
investments

Pension contributions
 Contributions to personal or stakeholder pension
plan are paid net of basic rate tax, even for eligible
non-taxpayers. Higher/ additional rate taxpayers
can reclaim more, to get tax relief at marginal rate.
 Annual allowance cap on tax-relievable
contributions is the lower of 100% of income and
50,000 (2013/14), with carry forward rules. Low or
non-earners can make up to 3,600 gross
contributions and still get tax relief.
 Contributions to an occupational pension scheme
are deductible from earnings for tax purposes.

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tax

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National
insurance

7:26 PM

Capital gains
tax

Page 149

IHT &
trusts

Other
taxes

Tax on
investments

A basic principle of income tax is the aggregation of income. Income from all sources is aggregated in a
personal tax computation.
Income taxed at source
Exempt income

Taxing income

 Non-savings income is taxed first, then

savings (excl. dividend) income then
dividend income is taxed last.
 Non-savings income is taxed at 20% (basic
rate), then 40%, & 45%.
 Savings income starting rate of 10% (only
where savings income falls below starting
rate limit), then 20% (in basic rate band),
then 40%, & 45%.
 Dividend income is taxed at 10% (not
20%) in basic rate tax band, at effective
total rate of 32.5% for higher rate, & 37.5%
for additional rate taxpayers.
Page 149

Bank/building society
interest: received net of 20%
tax
Debenture interest: received
net of 20% tax
Dividends: received net of
10% tax credit
Include GROSS income in
computation

 Premium Bond
prizes
 Returns on NS&I
Savings Certs.
 Income in ISAs
 Betting/gaming
winnings
Do not include in
computation

 Tax credits on dividends can be offset to reduce tax but are

never repaid to taxpayer.Tax suffered on other taxed income can
be repaid.
6: Taxation

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National
insurance

7:26 PM

Capital gains
tax

Page 150

IHT &
trusts

Other
taxes

Tax on
investments

Dividends taxation

Planning points

Higher rate (40%) taxpayers liability for tax at 32.5% on

dividends. This equates to:
10% of gross dividend + 25% of net dividend

Transfer assets?
Transfer income yielding assets to the
spouse with the lower marginal tax rate. To
be effective, such transfers should be
unfettered rights.

Example
A higher rate taxpayer is paid a gross dividend of 400
He receives 360 after withholding tax (40 collected at source)
He has to pay 25% of 360 = 90 further to meet his liability
Total tax paid = 130
(32.5% of 400 = 130)
Additional rate (45%) taxpayers pay 37.5% on dividends.

Children
If parent gives income
(or assets which
generate income) to a
child, the income is
treated as the parents
if the child is under 18
and unmarried.

 Does not apply

if the income is
100 a year or
less
 Does not apply
to gifts from
grandparents,
uncles etc

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Income
tax

National
insurance

Class

Page 151

12/4/2013

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Capital gains
tax

Page 151

IHT &
trusts

Other
taxes

Tax on
investments

National insurance contributions

Payable by employees on their earnings above the primary threshold

Amount payable depends on an individuals income

1A

Payable by employers on certain types of non-monetary benefits given to

employees (eg, a company car)

1B

Payable by employers on an employees earnings

Payable by self-employed persons

If earnings below the small earnings exemption, no NICs payable

Voluntary usually to fill gaps in contributions

Payable by self-employed, if profits exceed a threshold

6: Taxation

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tax

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insurance

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Capital gains
tax

Page 152

IHT &
trusts

Other
taxes

Tax on
investments

Capital Gains Tax: rates

For individuals, taxable gains are taxed at 18%, but at
28% for gains (after the annual exemption) that fall in
the higher rate band.

Married couples / civil partners

1

Disposals between spouses / civil partners living

together do not give rise to gains or losses.

Spouses / civil partners are taxed as separate

people, each with an annual exemption.

Capital gain calculation

 Disposal consideration (or market value)
Less disposal costs
Less costs of acquisition / enhancement
Equals
 Capital gain

Annual CGT exemption of 10,900 (2013/14) is deducted when computing individuals total taxable gains.

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Income
tax

12/4/2013

National
insurance

7:26 PM

Capital gains
tax

Chargeable persons, disposals and assets

Three elements are needed for a chargeable gain to
arise.

A chargeable disposal: this includes sales,

gifts and the destruction of assets.

A chargeable person: individuals.

A chargeable asset: most assets are

chargeable, but see exempt list.

Page 153

Page 153

IHT &
trusts

Other
taxes

Tax on
investments

Exempt assets
Exempt from capital gains tax:
 NS&I Savings Certificates & Premium Bonds
 Betting & lottery winnings
 Foreign currency, for private use
 Gilts (Government stocks)
 Qualifying corporate bonds
 Tangible movable property up to 6,000 per item
 Wasting assets (life of 50 years or less)
 Private cars
 Investments in ISAs, Enterprise Investment
Scheme & Seed EIS
 Own home (principal private residence)
6: Taxation

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Income
tax

12/4/2013

National
insurance

7:26 PM

Capital gains
tax

Example
Donna has taxable income of 22,000. In 2013/14, she
sold shares for 42,000 that she had bought five years
ago for 28,000. The annual CGT exemption is
10,900. What CGT must Donna pay?
Solution
42,000 28,000 = 14,000 net gain.
14,000 10,900 = 3,100 taxable gain.
22,000 [income] + 3,100 = 25,100, within the basic
rate band.
Donna must pay CGT of 18% x 3,100 = 558.

Page 154

IHT &
trusts

Other
taxes

Tax on
investments

CGT planning
Ways to mitigate extent of CGT liabilities:
 Spread ownership of assets among family
members
 Phased encashments
 Realise paper loss
 Sell shares & repurchase other shares as
substitutes
 Use ISAs

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insurance

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Capital gains
tax

Page 155

IHT &
trusts

Other
taxes

Tax on
investments

Deduct allowable capital losses from chargeable gains in the tax year in which they arise.
 Any loss which cannot be set off is carried
forward to set against future chargeable gains.
 Allowable losses brought forward are only set
off to reduce current year chargeable gains less
current year allowable losses to the annual
exempt amount.

Example
Zo made chargeable gains of 12,200 in
2013/14. She had brought forward capital losses
of 7,000.

Matching gains on shares

Disposals by individual shareholders are matched with
acquisitions in the following order.
 Same day acquisitions
 Acquisitions within the following 30 days
 Other shares: the share pool

Page 155

Brought forward capital losses of 12,200

10,900 = 1,300 will be set off in 2013/14. The
remaining losses will be carried forward to
2014/15.

 Stops bed and breakfasting

6: Taxation

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Income
tax

12/4/2013

National
insurance

7:26 PM

Capital gains
tax

Inheritance tax (IHT) is charged:

(1) on death, (2) on gifts within 7 years of
death, (3) on chargeable lifetime transfers

Page 156

IHT &
trusts

Other
taxes

Tax on
investments

Exemptions for lifetime transfers only



Small gifts 250 or less per donee per tax year

Annual exemption 3,000: 1 yr carry forward possible

Potentially Exempt Transfers

Normal expenditure out of income

PETs include lifetime transfers to individuals and

to trusts for the disabled
 PETs are initially assumed to be exempt
 They are chargeable if the donor dies within
7 years

Marriage exemptions

Most lifetime transfers into trusts not covered by an

exemption are immediately liable to IHT
(chargeable lifetime transfers (CLTs)).

5,000 from parent

2,500 from remoter ancestor
1,000 from anyone else

Exemptions for lifetime and death transfers

 Transfers between spouses/ civil partners
 Transfers to charities, political parties or for national
purposes
 Transfers of land to housing associations

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tax

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insurance

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Capital gains
tax

Page 157

IHT &
trusts

Other
taxes

Tax on
investments

IHT planning
Potentially Exempt Transfers (PETs). Gift made
by individual in lifetime is potentially exempt IHT
provided not made in last 7 years of life
Gifts to trusts. Transfer to a discretionary trust will
attract IHT rate of 20% if transfer not made in last
7 years of life
Gifts with reservation of benefit (GWR) A gift
with strings attached. Still considered part of
individuals estate for IHT purposes.

Example: transfer of nil rate band

Eric McMullan dies & leaves his entire estate to his
wife.
100% of his nil rate band has been unused. This
transfers to his wife.
If the individual nil rate band is 350,000 when his
wife dies then her nil rate band will be:
= 350,000 + 100% of 350,000
= 350,000 + 350,000 = 700,000

Nil rate band. Transfer of nil rate band between

spouses / civil partners. Transfer is on percentage
basis, not on a cash basis (see Example).

Page 157

6: Taxation

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tax

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insurance

7:26 PM

Capital gains
tax

Page 158

IHT &
trusts

Other
taxes

Tax on
investments

Inheritance tax on death

IHT on the estate is found by taking into account all transfers in 7 years before death.
IHT on each lifetime transfer made in 7 years before death is found as follows:
1 Take into account all chargeable transfers (including PETs which have become chargeable) in 7 years
before the transfer
2 Find the tax at full rates: 325,000 at 0% (2013/14); remainder at 40% then deduct any taper relief (percentage reduction in IHT charge given if transfer was made more than 3 years before death)
3 Deduct any tax already paid on the transfer

Trusts and beneficiaries: tax

Tax

Non-dividend income

Dividend income

1st 1,000

20% (basic rate)

10% (dividend ordinary rate)

Income > 1,000

45% (trust rate)

37.5% (dividend trust rate)

Beneficiary may be able to

reclaim tax charged on income
received from a trust (if nontaxpayer or basic rate taxpayer)

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Income
tax

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National
insurance

Stamp Duty Land Tax

7:26 PM

Capital gains
tax

payable on buying property

Value (residential property)

Up to 125,000
Over 125,000 up to 250,000
Over 250,000 up to 500,000
Over 500,000 up to 1,000,000
Over 1,000,000 up to 2,000,000
Over 2,000,000

SDLT rate
0%
1%
3%
4%
5%
7%

Value (non-residential property)

Up to 250,000 *
Over 250,000 up to 500,000
Over 500,000

SDLT rate
1%
3%
4%

* SDLT is 0% on non-residential property up to

150,000 if it earns annual rent of less than 1,000.
Page 159

Page 159

IHT &
trusts

Other
taxes

Tax on
investments

Stamp duty reserve tax (SDRT)

% rate of tax (rounded to nearest 1p)
Payable (in a paperless transaction) by buyer of:
 Shares in a UK company
 Shares in a foreign company with UK share
register
 An option to buy shares
 Rights arising from shares already owned
 An interest in shares, ie an interest in the
money made from selling shares
Payments are made through CREST.
For unit trusts & OEICs, the fund manager pays
SDRT when units are surrendered.
6: Taxation

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tax

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insurance

7:26 PM

Capital gains
tax

Corporation tax (FY 2013)

IHT &
trusts

Other
taxes

Tax on
investments

Value Added Tax (VAT)

Corporation tax is payable by:

 Companies resident in the UK on worldwide profits
 Overseas companies on UK-derived profits
Companies pay main rate in quarterly instalments, based on the
estimated corporation tax liability. Other companies pay whole
amount 9 months & 1 day after end of accounting period.

Main rate

Page 160

Company profits

FY 2013 rate

> 1.5m

23%

Chargeable on supply of goods & services in the

course of business a tax on turnover, not profits
VAT rates
 0% eg, books & childrens clothing
 5% energy services & products
 20% standard rate on most other goods

Small profits rate

< 300k
20%
Companies with profits falling between 300k & 1.5m pay on a
sliding scale to give an effective rate between 20% and 23%.
Losses can be offset against:
 This years profits
 Last years profits, or
 Future years profits from same trade

VAT on investment services

 Commissions exempt (not the same as 0%)
 Advisory services standard rate, if invoiced
separately (otherwise, exempt)
 Nominee services exempt
 Portfolio management standard rate

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Income
tax

12/4/2013

National
insurance

Capital gains
tax

Tax on investments
Direct investments are taxed based on
relevant income tax or CGT rate.
Indirect investment






Pension funds
Individual Savings Accounts (ISAs)
Existing Child Trust Funds (CTFs)
Real Estate Investment Trusts (REITs)
Collective Investment Schemes (CISs)
& investment companies
 Life insurance funds
 Venture Capital Trusts (VCTs)
 Enterprise Investment Schemes (EISs)
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IHT &
trusts

Other
taxes

Tax on
investments

Tax treatment of pension benefits

Key points
 Tax-free lump sum (up to 25% of accumulated
funds) can be taken from age 55. Remainder used
to produce an income, subject to income tax.
 Lifetime limit of 1.5m (2013/14)
A lifetime allowance charge applies on any excess:
 25% for funds taken as income
 55% for funds taken as a lump sum

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IHT &
trusts

Other
taxes

Tax on
investments

ISAs

Junior ISA

Key points
 Not an investment, but rather a tax wrapper
 Cash ISA or Stocks & Shares ISA
 Annual limit on how much can be invested in ISA
(11,520 for 2013/14)
 Up to 50% of this can be invested in a Cash ISA
 Investments within ISA not subject to income tax
or CGT
 Tax paid at source (eg, 10% tax credit on
dividends) is not recoverable
 Withdrawals allowed at any time

Available since 1 November 2011:

 Max. 3,720 can be invested for a child per tax
year in cash, stocks & shares (2013/14)
 Holdings are not subject to income tax or CGT
 Replaces the Child Trust Fund

Real Estate Investment Trusts (REITs)

Rental income and capital gains exempt within fund, but
REITs are required to distribute most rental income.
Investors are subject to income tax on distributions,
which are subject to 20% withholding tax.
Investors are also subject to CGT.

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IHT &
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Other
taxes

Tax on
investments

Collective investments
Unit Trusts & OEICs
In general, an authorised unit trust is treated as an investment
company, with its units being treated as shares in the company &
any distribution as a dividend. Basic principle: to make the unit trust
effectively transparent for tax purposes, with no additional tax borne
solely, because assets are held within a unit trust.
Income
Authorised and unauthorised unit trusts and OEICs pay corporation
tax at 20%. Franked income is not subject to corporation tax.
Capital gains
Authorised unit trusts & OEICs are exempt from CGT on disposals of
investments & are thus able to switch investments free of tax.
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Investment trusts (ITs)

Income
Income for an investment trust is
divided into franked investment income
(largely dividends received from other
UK companies) & unfranked income.
Franked income is not chargeable to
corporation tax, while corporation tax
is payable on unfranked income.
Capital gains
Capital gains are free from tax for
HMRC-approved ITs.

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IHT &
trusts

Other
taxes

Tax on
investments

Distributions

Life funds

Dividend distributions from a collective

investment fund are treated like dividends for income
tax purposes.
Interest distributions are taxed as yearly interest of
the share or unit holder & tax is deducted for UK
residents.
On sale, the investor is subject to CGT (unless the
holding is within a tax wrapper).

Proceeds from a qualifying life assurance policy

are usually free of income tax & CGT.
Requirements:
 Premiums paid for at least 10 years
 Premiums paid at least annually
One-off or regular payments from single premium
UK life assurance policy (or life assurance bond)
usually lead to no income tax.
Up to 5% of original premium can be withdrawn per
year without incurring additional income tax liability.

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IHT &
trusts

Other
taxes

Tax on
investments

Enterprise Investment Scheme (EIS)

Venture Capital Trusts
Investors tax liability is reduced by 30%
of the invested amount (subject to
200,000 investment maximum).
 If shares are not held for 5 years, the
relief is clawed back
 Dividend income is tax-free
 No CGT (both within VCT and for
investor)

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Offers tax incentives to individuals to

invest in new & growing businesses

Certain unquoted
shares & AIM shares

Gains on disposals
are not taxed (if held
for 3 years)

Income tax relief given at 30%

of investment (1,000,000 max.
investment 2013/14)

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IHT &
trusts

Other
taxes

Tax on
investments

Offshore funds
Reporting funds

Non-reporting funds

Must notify HMRC annually of

reportable income as well as
distributed income

A fund without reporting status

Income Income tax on their share of income*

Gains

18%/28% CGT on realised gains

* Even if not distributed

Income tax**
Income tax on realised gains
** When distributed

Like earlier rules they replace, the current Offshore Funds (Taxation) Regulations 2009 seek (as above) to:
 Stop investors accumulating untaxed income offshore while only paying tax on realised capital gains
 Apply income tax on gains by investors in funds that roll up income

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Notes

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