Quick action required following FCA inducements guidance
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Ashurst London
January 2014
Quick action required following FCA
inducements guidance
FCA has issued finalised guidance on
Rule on Inducements
inducements and conflicts of interest.
Whilst the guidance is issued as a result COBS 2.3.1
of the on-going thematic review into the
implementation of the Retail Distribution A firm must not pay or accept any fee or
Review (RDR), it is intended to help commission, or provide or receive any non-
firms interpret the existing inducements monetary benefit, in relation to designated
and conflicts rules generally and is investment business or, in the case of its MiFID or
therefore relevant to most FCA regulated equivalent third country business, another
firms. ancillary service, carried on for a client other
than:
FCA has issued a clear warning to firms that if they
are not clear on whether making/receiving a (2) a fee, commission or non-monetary benefit
payment will be line with the inducement rules, the paid or provided to or by a third party or a
payment should not be made/received. This person acting on behalf of a third party, if:
includes being able to demonstrate that all three
limbs of the test in COBS 2.3.1(2) are satisfied (see (a) the payment of the fee or commission,
box). Firms have traditionally found it difficult to or the provision of the non-monetary
demonstrate that the third limb, that the payment benefit does not impair compliance
must be designed to enhance the quality of the with the firm's duty to act in the
service to the client, is satisfied. Any ongoing best interests of the client;
difficulties in this regard will mean a firm cannot (b) the existence, nature and amount of
make such payments. The FCA has focused on the fee, commission or benefit, or,
ongoing trail payments where no ongoing service is where the amount cannot be
being provided (see below). ascertained, the method of calculating
that amount, is clearly disclosed to
COBS 2.3.15G gives guidance on the types of the client, in a manner that is
benefits that are capable of enhancing the quality of comprehensive, accurate and
the service provided to a client and which are understandable, before the provision
capable of being paid or received without breaching of the service; and
the client's best interests rule. FCA is concerned (c) in relation to MiFID or equivalent third
that firms have been taking an overly broad country business or when carrying on
interpretation of this guidance to justify a wide a regulated activity in relation to a
range of benefits that do not meet the inducement retail investment product, the
rule. FCA now expects firms to assess whether each payment of the fee or commission, or
benefit complies with the inducement rule even if, the provision of the non-monetary
the benefit is included in COBS 2.3.15G. benefit is designed to enhance the
quality of the service to the client.
The inducement rule applies to payments between
different group entities or between different Firms must remain alive to their obligation to
divisions of the same legal entity and so firms manage conflicts between their own interests and
should consider both external and internal those of their clients when making/receiving
payments in the context of this guidance. inducements. FCA is concerned with both potential
and actual conflicts. If a firm is in a situation where
it could receive a benefit but has yet to receive it,
this is enough to impair the judgment of that firm
from a conflicts management perspective.
AUSTRALIA BELGIUM CHINA FRANCE GERMANY HONG KONG SAR INDONESIA (ASSOCIATED OFFICE) ITALY JAPAN PAPUA NEW GUINEA
SAUDI ARABIA SINGAPORE SPAIN SWEDEN UNITED ARAB EMIRATES UNITED KINGDOM UNITED STATES OF AMERICAExamples of conflicts in an RDR context might advisors comply with RDR and the
include: inducement rule and payments to non-UK
distributors comply with the inducement
Panel selection – where an advisory firm rule.
operates a panel of providers, the inclusion of
providers on the panel should not be influenced More detailed guidance on specific arrangements
by the provider's willingness and ability to between providers and advisors and how these
purchase services from, or provide other comply with the inducement rule is set out in
benefits to, the advisory firm. This applies to the table at the end of this note.
both independent and restricted panels.
All regulated firms - There is clearly large
Exclusive distribution arrangements – disparity between FCA's interpretation of the
where an advisory firm has an arrangement with inducement rule and the way many firms
a single provider and the selection of the implement the rule in practice. Firms should
provider is influenced by sizeable payments or conduct a wholesale review of all inducements
benefits the provider offers, this will result in a paid/received to ensure that the firm's own
conflict whereby the advisor firm puts its interpretation of their compliance with the
commercial interests ahead of its customers' inducement rule is in line with FCA's latest
interests. One example where this may operate expectations as set out in its guidance.
is where a private banking division of a firm only
distributes the products of the investment This will involve reviewing the contracts which
banking division. document the relevant inducements since this is
likely to be the primary focus of the FCA should
Time to comply? it visit a firm in the next year. (See "Contract
reviews" below).
Firms must not underestimate the need to take
swift action to meet FCA's expectations. Systems and controls
In scope RDR firms - FCA said that it would Firms should revisit the systems and controls they
give firms one year post implementation (31 have in place around inducement payments to
December 2012) in order to implement both the ensure that there are appropriate governance
spirit and letter of RDR before it started taking arrangements in place to meet the firm's regulatory
enforcement action against firms. The thematic objectives. This might include:
reveals that FCA remains concerned that the
general RDR objectives are not being met. FCA's Ensuring that there is a clearly defined policy in
views publishing the results of its thematic as a place which governs the payment/receipt of
last chance for firms to get things right in this inducements and is approved by the board/an
regard. appropriate committee.
The policy should contain a clear statement to
A key part of FCA's review related to firms' the effect that if the firm is not certain that a
distribution agreements and FCA has given firms payment meets the rule on inducements, it must
until 16 April 2014 to review these agreements not be made.
in line with the guidance. This will be a big task The policy should include a documented list of
for firms, particularly those with large volumes payments/services which the board/an
of distribution agreements in place and will appropriate committee has signed off as not
involve amending and seeking the relevant conflicting with a duty to act in the best
distributors' consent to the changes within this interests of clients and is designed to enhance
three month window. (See "Contract reviews" the quality of the service to the client. This list
below). should take into account:
the reasonableness of the payment when
Firms must note that the paper not only applies viewed in light of the benefit obtained by the
to payments or benefits provided to advisors recipient;
(which would need to be UK regulated firms to the proportionality of the payment to the
fall within scope of RDR), but also to any other cost incurred by the recipient in providing
firms globally who receive payments or benefits the relevant service;
from the product provider. In short, a product the fact that the payment should be limited
provider must ensure that payments to UK in scale and nature taking into account anyother benefits offered or accepted (i.e. no inducements in line with the following general
annual or on going payments); principles. These contracts could include distribution
the payment should not result in a wider agreements, commission sharing agreements and
business benefit for the recipient; introducing broker agreements as examples.
the fact that the payment should not be
relied upon by the recipient to ensure its Long term multi-year agreements will have
ongoing commercial viability; more potential to create conflicts of interest
the payment should result in equivalent than short-term agreements. This is particularly
costs savings for the firm making the going to be the case where the agreement
payment or its clients; and represents a significant revenue stream for the
the payment should result in a genuine value recipient of an inducement concerned on which
add or business benefit for the firm making it it is dependent to sustain its business. The FCA
(in the case of RDR, the business benefit seems determined to attack trail commission
must not be increased revenue from the sale payments where no ongoing service is being
of investment products). provided.
Any unusual payments/services falling outside Clauses that allow the firm paying an
the above list should be subject to appropriate inducement to negotiate a reduced level of
senior level sign off. This should include a payments for a reduced level of services (e.g. if
limitation on the ability of sales staff negotiating the provider loses its place on the advisory
such payments to take discretionary decisions in firm's panel, or where there is a material
order to win business. reduction in sales of the provider's products) or
The policy should set out the detail required to in light of other benefits (discounts) will
be provided to client in order to properly generally indicate that the original payments
disclose an inducement/benefit to the client. were not designed in compliance with the
Firms must disclose both cash payments and inducement rule.
any other services provided to a counterparty Contracts for services that result in a firm
which falls within scope of the inducement rule. obtaining payments that exceed the
Records should be maintained confirming how reimbursement of costs incurred and are linked
each payment/service satisfies the three limbs (whether directly or indirectly) to some other
of COBS 2.3.1(2). Including that there is no benefit received by the payer of the inducement
conflict, that it is designed to enhance the will generally fall foul of the conflicts rules.
quality of the service to the client and that it has Contracts could include representations and
been properly disclosed. These records should warranties from the receiver of an inducement
be monitored by compliance. that any payment is proportionate to the costs
Ensure that staff are not incentivised to incurred by that firm and does not represent any
undermine the objectives of the inducement wider business benefit.
rules. Contracts should clearly allocate responsibility
for making appropriate disclosures to clients in
Contract reviews compliance with the inducement rule.
Firms should review the contracts they have in
place to document the payment or receipt of
Contacts
Rob Moulton James Perry
Partner, London Partner, London
T: +44 (0)20 7859 1029 T: +44 (0)20 7859 1214
E: rob.moulton@ashurst.com E: james.perry@ashurst.com
Nicola Higgs Jake Green
Senior Associate, London Senior Associate, London
T: +44 (0)20 7859 1033 T: +44 (0)20 7859 1034
E: nicola.higgs@ashurst.com E: jake.green@ashurst.com
Anne Mainwaring Tim Cant
Associate, London Solicitor, London
T: +44 (0)20 7859 2719 T: +44 (0)20 7859 3394
E: anne.mainwaring@ashurst.com E: tim.cant@ashurst.comGuidance on specific services
IT development and maintenance
COBS 2.3.1.15G(10) states that a product provider may pay cash amounts or give other assistance to a
firm not in the same immediate group to develop software or other computer facilities necessary to operate
software supplied by the provider, but only if it will generate equivalent cost savings to itself or clients. FCA
deems the following payments as likely to breach the COBS Inducement Rules:
payments, or other assistance from providers to advisory firms for developing software or other
computer facilities that go beyond that which is required to operate software supplied by the provider;
payments from providers to develop advisory firm's general IT systems or infrastructure; and
annual payments from providers for advisory firm's general IT maintenance.
The payment should reasonably be expected to result in equivalent cost savings to the provider or its
clients. In addition, the quality of the service received by the client must be enhanced (e.g. by reducing
the possibility of errors arising from manual processing and the time taken to process business).
Training
COBS 2.3.1.15G(13) states that a provider may provide an advisory firm with "training facilities of any kind
(for example, lectures, venue, written material and software)". Training to UK advisors should happen in
the UK and any hospitality offered must comply with the hospitality guidance below.
Training on the features and benefits of products, services, or subject to areas relating to the advisor's
continuing professional development is unlikely to impair its compliance with the client's best interest rules
if the training is made reasonably available to all advisory firms on an equal basis, even if only on a first
come first served basis.
Conferences and seminars
COBS 2.3.15G(7) states that "a provider may take part in a seminar organised by an advisory firm (or a
third party) and pay towards the cost of the seminar if its participation is for genuine business purposes
and contribution is reasonable and proportionate to its participation and by reference to the time and
sessions at the seminar when its staff play an active role".
Any proportionate contribution made by a provider should be calculated by reference to:
the overall cost to the advisory firm in organising the event;
the time allotted to the provider for presenting; and
the number of advisors attending a presentation.
FCA has issued the following examples of poor practice in this regard:
a provider calculating the contribution it made to an advisory firm for attending its seminars and
conferences, by reference to how much it might have cost to have face to face meetings with each of
the individual advisors attending;
advisory firms seeking a recovery of all costs incurred in running seminars and conferences from
providers, rather than it being a contribution designed to recover the costs associated with the
provider's active participation. FCA would always expect the advisory firm to pay a significant majority
of the overall costs of the seminar or conference.
"An active" role requires more than just attendance and more than simply having the opportunity to
network with advisor attendees at the event. For example, it should include presenting and/or a role that
aims to inform advisors on the features and benefits of the products or services or legislative/technical
matters relating to products or services.
It will be less obvious to FCA that there is an enhancement to the quality of the service provided to clients
where a provider contributes to a conference or seminar and that provider is on a restricted panel of the
advisory firm, especially if the panel if restricted to a small number of providers, or if it was a sole provider
arrangement. Advisors will generally already be aware of these providers products (as part of the training
they received when the panel was created).If a conference or seminar is held outside the UK, FCA would not expect the advisory firm to be able to
recover any of the costs of the events from providers, although providers can attend if required.
Hospitality and gifts
COBS 2.3.15(G)(1) states that a provider may give, and an advisory firm may receive, hospitality, gifts
and promotional competition prizes of "a reasonable value". Such payments should enhance the quality of
the services provided to the client. The following characteristics are indicative of a payment which
represents reasonable value:
an event at which the hospitality was located in the UK;
advisor attendance was not based on criteria that incentivised poor behaviours e.g. the volume of
business generated by the advisor for the provider's products;
the event was designed for business purposes, such as product training, that resulted in advisors being
able to provide a better services to their customers;
payments for food and drink were proportionate and not extravagant and any overnight
accommodation was only paid for by necessity (e.g. where the event was run over two days, or the
location meant that travelling on the day of the event was impracticable for advisors);
providers had calculated a "per head" cost of the hospitality and assessed the reasonableness of the
cost against previously agreed monetary limits set by an appropriate committee and verified by a
"second-line" function in the provider (e.g. compliance);
promotional prizes were not extravagant and were linked to activities which increased knowledge of a
provider's products or other services offered;
gifts were not extravagant and were not based on criteria that incentivised poor behaviours;
providers had maintained a log of all hospitality and gifts provided to advisors over a specified period so
that cumulative payments to individual advisors did not exceed previously agreed limits (both monetary
and number of occasions) and such logs were independently audited by compliance on a regular basis.
Firms should have a clear and defined policy approved by the appropriate board committee for determining
what constitutes reasonable hospitality and for authorising the provision or acceptance of such hospitality.
Such authorisation is likely to involve more senior approval for high levels of payments.
Promotional activity
COBS 2.3.15G(2) states that a provider may assist an advisory firm to promote its products so that the
quality of its services to clients is enhanced.
COBS 2.3.15G(6) states that a provider can supply draft articles, news items and financial promotions for
publication in an advisory firm's magazine, only if and in each case any costs by the provider for placing
the articles and financial promotions "are not more than market rate, and exclude distribution costs".
Market rates should not be determined by what everyone else has to pay to an advisory firm. It should
instead be based on more objective criteria (e.g. placing the same in a relevant trade publication).
Meetings
Arrangements whereby advisory firms charge providers for regular and structured meetings with senior
management are generally of commercial value to both sides. FCA therefore does not consider that
payments for such meetings are capable of meeting the requirements and inducement rules.
Management information, data and research
Such payments should be restricted to reimbursing the costs incurred by the advisory firm. Providers must
devise genuine business benefit from the information (e.g. compliance with regulatory product governance
obligations) and both the providers and the advisors must demonstrate how it is expected to enhance the
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