07/9. Conduct of Business regime: non-mifid deferred matters. (including proposals for Telephone Recording) Financial Services Authority

Transcription

1 Consultation Paper 07/9 Financial Services Authority Conduct of Business regime: non-mifid deferred matters (including proposals for Telephone Recording) May 2007

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3 Contents Overview 5 Part I: Specialist Regimes and additional topics from Annex 5 of CP06/19 Introduction 13 1 Corporate Finance 15 2 Commodity and Exotic Derivatives 17 3 Non-Financial Spread Betting 19 4 Service Companies 21 5 Locals 23 6 Depositaries 24 7 Lloyd s 26 8 Collective Investment Scheme (CIS) operators 29 9 Occupational Pension Scheme (OPS) firms Authorised Professional Firms (APFs) carrying on non-mainstream regulated activities UCITS Qualifiers Investment Companies with Variable Capital (ICVCs) Best Execution, Order Handling, Client Limit Orders and Client Order Record Keeping Investment Research Client Categorisation 49 The Financial Services Authority 2007

4 Part II: Other non-mifid topics 16 Non-MiFID Projections and Charges Information for Packaged Products Financial Promotion Section Part III: Other related topics 19 Telephone Recording Recording of voice conversations and electronic communications Client Assets Sourcebook 84 Annex 1: Annex 2: List of questions Compatibility with our objectives and the principles of good regulation Appendix 1: Draft Handbook text 2 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

5 The Financial Services Authority invites comments on this Consultation Paper. Comments should reach us by 3 August Comments may be sent by electronic submission using the form on the FSA s website at ( Alternatively, please send comments in writing to: Sue Bailey MiFID Implementation Office Financial Services Authority 25 The North Colonnade Canary Wharf London E14 5HS Telephone: Fax: cp07_09@fsa.gov.uk It is the FSA s policy to make all responses to formal consultation available for public inspection unless the respondent requests otherwise. A standard confidentiality statement in an message will not be regarded as a request for non-disclosure. A confidential response may be requested from us under the Freedom of Information Act We may consult you if we receive such a request. Any decision we make not to disclose the response is reviewable by the Information Commisioner and the Information Tribunal. Copies of this Consultation Paper are available to download from our website Alternatively, paper copies can be obtained by calling the FSA order line: Financial Services Authority 3

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7 Overview Introduction and purpose 1. The purpose of this Consultation Paper (CP) is to seek views on our proposals for reforming the remaining elements of the Conduct of Business (COB) regime 1 that are outside the scope of the Markets in Financial Instruments Directive (MiFID) and on which we did not consult in CPs 06/19 ( Reforming Conduct of Business Regulation ) or 06/20 ( Financial promotion and other communications ). In the areas of client categorisation and financial promotion, we are also revising some of the mainly non- MiFID proposals consulted on in CPs 06/19 and 06/20 respectively. 2. The scope of MiFID 2 is narrower than the scope of designated investment business for which we have responsibility under the Financial Services and Markets Act 2000 (FSMA). As a result, there are a number of areas of business covered by the COB sourcebook which are outside the scope of MiFID. In this CP we have addressed the remaining COB requirements on which we have not yet consulted. In the main, these concern Specialist Regimes a tailored set of requirements for particular, often narrow classes of business. We have considered whether and to what extent each of these should be preserved given other developments such as the creation of NEWCOB and the move to Principles-based Regulation (PBR). We also cover some topics of broader application to non-mifid business not previously covered, such as projections and charges and remaining aspects of client categorisation. This CP also asks for comments on proposals to introduce a telephone recording requirement that could apply to both MiFID and non-mifid firms. It also consults on a series of small changes to the Client Assets sourcebook. 3. We invite views on the issues set out in this paper by 3 August Structure and scope 4. Aspects of this CP will be of general interest to all firms that are currently subject to the provisions of the COB sourcebook. Chapters that are of relatively broad interest include 1 The majority of these were set out in Annex 5 of CP06/19 2 Throughout the CP, we use the terms non-mifid firms and non-mifid business when referring to the firms and activities to which these requirements will apply. Financial Services Authority 5

8 Chapter 13, best execution, order handling client limit orders and client order record keeping; Chapter 15, client categorisation; Chapter 16, non-mifid projections and charges information for packaged products; Chapter 17, financial promotion and Chapter 19, telephone recording recording of voice conversations and electronic communications. However, specific chapters (such as many of the Specialist Regimes in Part I), will be of direct relevance to a much narrower range of firms. 5. We have organised the CP as follows: Part I Specialist Regimes and additional topics from Annex 5 of CP06/19 Part II Other non-mifid topics (including projections and charges; financial promotion) Part III Other related topics (including telephone recording and client assets) We have set out further details on the topics covered in each section under Topics and key issues below. Our policy approach 6. The approach set out in this CP reflects our general move towards Principles-based Regulation, of which NEWCOB 3 as a whole is an important element. We do not repeat here the detailed motives behind our work; these are set out in the strategy paper which we published in April We would, however, reiterate our belief that Principles-based Regulation will lead to better outcomes for both firms and consumers. 7. The cost-benefit analysis (CBA) carried out on the proposals in this CP took into account the fact that we are moving to a single COB sourcebook derived to a large extent from MiFID. We have taken a practical approach given our overall aim of establishing NEWCOB by 1 November We propose to apply MiFID requirements to non-mifid firms and business only where we believe this to be appropriate. 8. For those requirements in NEWCOB that do not flow directly from MiFID, we are able to be flexible in our use of transitionals. We believe the proposals we have set out give enough flexibility to firms in their planning for NEWCOB implementation. Topics and key issues Part I: Specialist Regimes and additional topics from Annex 5 of CP06/19 Specialist Regimes 9. CP06/19 listed the Specialist Regimes within COB that cover non-mifid business. The regimes are tailored requirements for specified types of activity and generally take the form of a series of modifications and disapplications of provisions of the COB sourcebook. We have looked at each of the regimes individually, developing proposals based on discussions with stakeholders and some external research. 3 The term NEWCOB is used throughout this document to clearly distinguish the proposed new sourcebook regime from the existing one, COB. However, when the proposals are made into Handbook text, we will use the reference code COBS for the new sourcebook. 6 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

9 10. In broad terms, we propose to carry forward the existing Specialist Regimes as they reflect a sensible application of the COB sourcebook to the particular characteristics of the activities they cover. We propose to modify them in two ways: updating the applications, exemptions and modifications as necessary in line with the NEWCOB rules and MiFID terminology; and removing some rules we believe are unnecessary in a principles-based environment. 11. The most significant example of the latter is that we plan to delete most of the rules which apply to designated investment business in relation to the Lloyd s market. Further details on our proposals for the Lloyd s regime can be found in Chapter Overall, the impact of our proposals should be limited, both for firms and consumers. Most existing requirements will be carried forward although reworded. The costs of change for firms should be largely restricted to costs of training to familiarise staff with the new wording of rules. Market impacts should also be limited given that, in most cases, activity within the Specialist Regimes and outside of MiFID does not directly compete with activity inside the scope of MiFID. In addition, there are generally fewer asymmetries in these markets due to the professional nature of the participants. Additional topics 13. This section also contains our proposed approach to a number of requirements where the scope of MiFID is narrower than existing COB. On best execution, order handling, client limit orders and client order record keeping, we are proposing a general application of the MiFID provisions but with additional flexibility for certain non- MiFID firms. On investment research, we plan to apply the MiFID requirements to firms outside the scope of the Directive that produce such research. Our proposals for client categorisation are to use MiFID terminology for wholesale non-mifid business but with appropriate modifications of definitions and grandfathering. The proposals reopen certain issues discussed in CP06/19 in relation to non-mifid firms and business. 14. Further details on these proposals are set out in Chapters Part II: Other non-mifid topics Projections and charges for non-mifid packaged product business 15. We have conducted an extensive review of our point-of-sale disclosure requirements, in terms of their overall effectiveness and in the context of our general move toward Principles-based Regulation. We intend to better organise our packaged product projections and charges rules and improve their presentation so firms can quickly identify what they are required to prepare and provide under different circumstances. Further details are set out in Chapter 16. Financial Services Authority 7

10 Financial promotion 16. We propose a number of minor changes to the financial promotion requirements in the following areas: promotion of unregulated collective investment schemes; exemption available to authorised professional firms when communicating certain financial promotions; and a transitional provision for non-mifid financial promotions with a long shelf life. 17. We plan to merge Chapters 4 and 5 of COBS when we publish the Handbook text as part of the NEWCOB PS. As a consequence subsequent chapters will be renumbered. However, for the purpose of this CP, references in the Handbook text are to the COBS provisions on which we consulted in CP06/19 and as set out in PS07/ Further details can be found in Chapter 17. Part III: Other related topics (including Telephone Recording and Client Assets) Telephone recording 19. The prevention, detection and deterrence of market abuse is a key priority for the FSA. Good quality recordings of voice conversations and of electronic communications assist firms and the FSA in the detection of inappropriate behaviour, and in its investigation and punishment. Importantly, the knowledge that such behaviour can be detected and may be punished acts as a deterrent to individuals who might be tempted to act inappropriately. We have therefore reviewed our current provisions for firms to make and retain such communications and propose to make rules to require firms to record certain telephone lines and to retain certain electronic communications. 20. We propose firms be required to record telephone lines used for voice conversations that involve the receipt of client orders and the negotiating, agreeing and arranging of transactions across the equity, bond and financial commodity and derivatives markets, and to retain electronic communications relevant to these activities. The term electronic communications has wide application and includes fax, , chat and instant messaging but, obviously, is not limited to those. Client assets 21. In PS07/2, we identified a small number of issues in relation to client assets which required further analysis. Further details on our proposals in this area are set out in Chapter CP07/9: COBS: Non-MiFID deferred matters (May 2007)

11 Cost-benefit analysis (CBA) 22. In proposing new rules or general guidance on rules, we are obliged, under sections 155 and 157 of the Financial Services and Markets Act (FSMA) to publish a CBA, unless we consider the costs will be of no more than minimal significance. The CBA should contain an estimate of the costs, and an analysis of the benefits, arising from the proposals. 23. To make the CP easier to read we have included CBA in each of the sections of the text rather than in an annex at the end. The CBA is a statement of the differences between the baseline (the current position) and the position that will arise if new rules and guidance are introduced or if existing ones are removed. Using the current position as a baseline allows us to fulfil our legal obligations to publish a CBA which makes appropriate comparison between the overall position if the rules are made and the overall position if they are not made. References to the FSA Handbook 24. In this CP, references to Handbook text are based on the numbering and structure of the text on which we consulted in CPs 06/19 and 20, and as set out in the transposition instrument that accompanied PS07/2 published in January. In the main body of the document, we use the term NEWCOB to refer to the new Conduct of Business sourcebook as a whole. When referring to specific provisions within that sourcebook, we use the term COBS. This is in line with the Handbook text at Appendix 1. Waivers 25. In CP06/19 we pointed out that the existing COB rules will fall away with the transition to NEWCOB and the adoption of MiFID requirements and so will waivers attached to those COB rules. 26. Rules implementing MiFID requirements may not be waived. However, waivers are possible where MiFID rules have been extended to non-mifid business and firms. 27. In NEWCOB there may be some rules that are substantially the same as existing COB provisions and, in respect of which, some firms have waivers. There will be no roll-over of existing waivers, so firms will need to consider whether any existing waivers will still be needed. 28. We mentioned that we would communicate directly with firms that have waivers from existing COB provisions and in March 2007 we wrote to these firms to inform them of their options and to ask them about their future plans. Financial Services Authority 9

12 Next steps 29. In our NEWCOB PS, which we plan to publish in May, we will set out the decisions we have reached in the light of responses to the consultations on CPs 06/19 and 06/20, together with the revised text of the new sourcebook, COBS. We aim to publish the PS on this CP in October. 30. The other documents we plan to publish in the coming months remain as set out in the FSA s Business Plan 2007/08 4 and our Implementation Plan for MiFID Update. 5 Firms affected by the CP may be particularly interested in the consultation planned for the third quarter, which will set out proposals for applying the common platform of systems and controls requirements to firms outside the scope of MiFID and the Capital Requirements Directive (CRD). 31. The Committee of European Securities Regulators (CESR) continues its work at Level 3, which is designed to promote convergence in applying MiFID provisions as national regulators implement the Directive. Where possible, we will explain in more detail the impact of this work in the NEWCOB PS. Consumers Although we are making changes to a number of the COB provisions that apply to non-mifid firms and business, we do not believe our proposals will lead to significant changes in the outcomes for consumers. Where we are proposing changes, we have been mindful of the need to ensure an adequate level of investor protection CP07/9: COBS: Non-MiFID deferred matters (May 2007)

13 Part I: Specialist Regimes and additional topics from Annex 5 of CP06/19 Financial Services Authority 11

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15 Introduction Background As the Overview set out, we committed in CP06/19 to bringing forward proposals in relation to non-mifid business covered by the Specialist Regimes in COB. This section includes our proposals in respect of each of these regimes and includes cost-benefit analysis in relation to each set of proposals. Systems and controls In looking at the Specialist Regimes we have not considered provisions dealing with conflicts of interest and Chinese walls. These will be considered later this year in a CP dealing with systems and controls for firms outside of the scope of MiFID and the CRD. In the interim, the existing COB conflicts of interest and Chinese wall provisions will continue to apply through transitional provisions. Timing of rule changes As set out in the Overview, we aim to publish the PS on this CP, including new rules and guidance, in October this year. The new rules and guidance will not be brought into effect until 1 May 2008 for most Specialist Regimes to give firms time to prepare for the changes. Under a transitional provision, the existing COB rules will continue to apply until that date (unless a firm wants to comply with the new rules earlier). Client categorisation The client categorisation rules that we propose for Specialist Regimes are those discussed in Chapter 15 of this CP. They involve MiFID terminology for client categories but with appropriate modifications of definitions, and grandfathering. Financial Services Authority 13

16 Training The proposals will result in changes to the existing COB rules which are applied to firms. This will involve a mixture of regulatory standards being disapplied, changes to the language in which regulatory standards are expressed and some changes in applicable regulatory standards. Firms will need to familiarise staff with the changes through training. The same issue was covered in CP06/19 in relation to firms whose activities are covered by MiFID. There it was reported that survey work suggested the one-off median costs of training staff in relation to the MiFID requirements would be 6,000 for small firms, 17,000 for medium-sized firms and 169,000 for large firms. The one-off median costs of training staff in relation to the new requirements for activities that are outside the scope of MiFID but inside one of the Specialist Regimes are likely to be significantly lower than for activities inside the scope of MiFID. Only a limited number of COB rules apply in the Specialist Regimes in the first place. And most of the areas in which MiFID significantly changes regulatory standards are not being applied in the Specialist Regimes. There are also likely to be some economies of scale in training for firms who conduct activities both inside and outside the scope of MiFID. We estimate there are between 1,200 and 1,400 firms who are affected by the Specialist Regimes. Assuming the average training costs of adapting to their Specialist Regime are similar to those of a medium sized-firm dealing with MiFID, this gives a total one-off training cost of between 20m and 24m. 14 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

17 1 Corporate Finance Introduction 1.1 Most firms undertaking corporate finance business are inside the scope of MiFID. However, some firms undertaking such business will be non-mifid firms because, for example, they fall within the MiFID Article 2(1)(c) exemption for professional firms who carry on an investment service which is incidental to a professional activity, or the MiFID Article 3 exemption 6 which covers firms who only provide investment advice. 7 Existing Provisions 1.2 There is a concessionary regime for firms undertaking corporate finance business in COB 1.6. The main provisions which are applied are those covering inducements, suitability, conflicts, customers understanding of risk, information about the firm, customer order and execution records and personal account dealing. Proposal 1.3 We propose to maintain and in some cases extend the policy approach reflected in existing COB that is the disapplication of many NEWCOB provisions. Disapplication will be extended to provisions covering customers understanding of risk, information about the firm, suitability, personal account dealing and customer order and execution records. In respect of the rules which will continue to apply we will apply the NEWCOB equivalents of the existing COB rules which apply to these firms. 6 MiFID Article 3 gives Member States the discretion to exempt from the scope of the Directive firms who: do not hold client funds or securities; only receive and transmit orders and/or provide investment advice in relation to transferable securities and units in collective investment undertakings; and only transmit orders to a limited range of other firms. The UK is exercising this optional exemption. 7 Whilst the Article 3 exception can also apply to firms who receive and transmit as well as providing investment advice, a firm who may receive and transmit as part of its corporate finance business will generally be transmitting orders to firms falling outside the category of permitted persons for the purposes of the Article 3 exception. Therefore, the Article 3 exception will generally only be relevant for corporate finance firms who just provide investment advice. Financial Services Authority 15

18 1.4 The effect of our proposals will be to create a NEWCOB regime for firms outside the scope of MiFID who undertake corporate finance business that is not the same as that for firms inside the scope of MiFID. Implications for firms and consumers 1.5 The implications for firms should be modest. The additional disapplication of certain rules will give them slightly more flexibility about the information they give to their clients. Given that the consumers of these services are experienced corporate entities there should be no diminution of investor protection. Discussion 1.6 The proposals reflect the fact that customers of corporate finance firms are corporate entities themselves with access to professional advisers. Cost-benefit analysis 1.7 The proposals should not have significant impact on firms and consumers relative to the costs and benefits of the existing rules in this area. Firms will not face substantial new regulatory obligations but a slimmer set of reworded obligations. The removal of some detailed provisions will grant firms additional flexibility as to how to meet their regulatory obligations. 1.8 We do not believe that having a different regime for firms undertaking corporate finance business inside and outside the scope of MiFID will introduce a distortion in the market for such services for the following reasons: where non-mifid and MiFID firms operate in the same market, price (which could be driven by a differential regulatory regime) is only one factor that will be relevant in securing the business of clients. Other factors such as range of services, access to capital, technical expertise, speed and reputation are at least as important as the price of the service; and the incremental costs associated with MiFID standards for MiFID firms undertaking corporate finance business are low. Therefore the disparity in compliance costs across the corporate finance market is not expected to be significant. References The current regime is at COB 1.6. Q1: Do you agree with our proposals to maintain the concessionary regime for firms engaged in non-mifid corporate finance business? 16 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

19 Commodity and Exotic 2 Derivatives Introduction 2.1 MiFID extends the scope of EU regulation to activities relating to commodity and exotic 8 derivatives. However, MiFID does not cover all firms undertaking activities in relation to commodity and exotic derivatives subject to, or all commodity derivatives caught by, existing UK regulation. For example, existing UK regulation does not contain exemptions as broad as those in MiFID for firms undertaking commodity and exotic derivatives business and the definition of financial instruments in UK legislation covers a wider range of physically-settled options on precious metals and a wider set of physically-settled commodity futures than does MiFID. Existing provisions 2.2 COB 1.6 provides a concessionary regime for firms undertaking energy and oil market activity 9 disapplying provisions including those on inducements, advising and selling, product disclosure and best execution. It applies provisions including financial promotion, client classification, conflicts, dealing ahead and investment research. For firms undertaking other regulated commodity derivatives and exotic derivatives business the COB provisions apply but in a limited way because most such business is undertaken with clients who are classified as, at least, intermediate customers (many COB rules only apply to business done with private customers whilst others provide limited protections for intermediate customers). Proposal 2.3 For commodity or exotic derivatives business outside the scope of MiFID we propose to maintain the policy approach reflected in existing COB. This entails retaining the concessionary regime for oil and energy market activity, and, for other regulated commodity derivatives and exotic derivatives business, applying only those NEWCOB 8 Exotic covers derivatives based on underlyings such as emission allowances, climatic variables and telecommunications bandwidth. 9 Oil and energy market activity includes dealing on own account through transactions executed on an exchange, business done with or for corporate entities/persons who are not private customers and operating an energy or oil collective investment fund for corporate entities/persons who are not private customers. Financial Services Authority 17

20 provisions which are substantially the same as those COB provisions which currently apply. So, for example, provisions in NEWCOB, such as suitability requirements for professional clients, will not apply because they only apply to MiFID business. The one specific modification we propose to make is to retain the existing COB best execution rule rather than apply the NEWCOB MiFID standard (other than for oil and energy activity where the existing disapplication of best execution will be maintained). Implications for firms and consumers 2.4 Our proposals substantially maintain the existing standards and should not therefore impact on firms or consumers. Discussion 2.5 The European Commission is currently conducting a review of the European regulation of commodity and exotic derivatives looking at, amongst other things, which firms and instruments should be regulated and what prudential and COB standards should apply to firms undertaking this activity. The review is due to be completed by the end of October This review could lead to changes in regulation affecting commodity and exotic derivatives business currently outside the scope of MiFID. We do not consider it appropriate to make changes to existing regulatory standards ahead of the completion of the review. Cost-benefit analysis 2.6 Because COB requirements are not being substantially changed the ongoing incremental costs and benefits of the proposed rule changes are of minimal significance. For firms engaging in oil and energy market activity we do not expect there to be any substantial one-off costs associated with these changes. There may, however, be some training costs. For firms engaging in other activities there may be some modest one-off costs related to the inducement and personal transactions requirements. Details of the impact of these changes were discussed in CP06/19. References The current treatment of oil and energy market activity is at COB 1.6.6R to R. Q2: Do you agree we should maintain existing standards in view of the EU s review? 18 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

21 Non-Financial Spread 3 Betting Introduction 3.1 Under MiFID, spread-betting transactions on shares and other financial instruments and indices are captured by MiFID as financial contracts for differences ; most other spreadbetting transactions, such as spread bets on sports, political or leisure events are outside the scope of the Directive. Such transactions are inside the scope of UK financial services legislation. They are currently offered by a small number of regulated firms most of which also offer MiFID spreadbetting products. Existing provisions 3.2 COB applies to non-financial spread betting as it applies to execution-only transactions of other contracts for differences except that firms have waivers from best execution in executing orders for these instruments. The waivers prevent firms from giving investment advice in relation to these transactions. Proposal 3.3 Our proposal for non-financial spread betting is to disapply the best execution requirement when firms do not give investment advice in relation to these transactions. We intend that this new rule should apply from 1 November 2007 because most existing waivers are due to expire in the course of November. Implications for firms and consumers 3.4 There are no implications for firms and customers. The existing best execution requirement has typically been waived for these transactions where firms have sought it. Discussion 3.5 Certain NEWCOB rules (for example suitability requirements) are not relevant for non-financial spread bets as these sales are non-advised and at the instructions of the client. In respect of some of the relevant NEWCOB rules we propose either modification or to provide flexibilities for non-mifid business. Financial Services Authority 19

22 3.6 There are some other areas of change firms should be aware of, namely the proposal to delete the product specific risk warnings from COB and ask all firms to rely on the MiFID high level standards when they are preparing their risk warnings 10 ; the proposal to retain existing COB flexibilities for reporting to non-mifid retail clients 11 and the proposals in relation to the appropriateness test 12. Cost-benefit analysis 3.7 Our proposal to disapply the best execution provisions for non-mifid spreadbetting transactions is not expected to lead to competition or regulatory arbitrage issues with the equivalent in-scope products, as we believe the MiFID and non-mifid spreadbetting markets do not overlap. 3.8 There will be some small savings to the firms affected who will no longer have to apply for a waiver to get an exemption from best execution obligations. References The NEWCOB best execution provisions we propose to disapply are in Chapter 12 of NEWCOB. Q3: Do you agree with our proposals for non-financial spread betting? 10 See CP06/19, ch See CP06/19, ch See CP06/20, ch CP07/9: COBS: Non-MiFID deferred matters (May 2007)

23 4 Service Companies Introduction 4.1 There are some companies outside the scope of MiFID but within the scope of UK regulation because they arrange deals in investments 13 but do not receive and transmit orders on behalf of clients under MiFID. Those companies are service companies; our non-mifid review has not identified any other type of firm engaged in this activity which has not been covered already by another non-mifid work-stream. 4.2 Service companies are firms whose only permitted activities are making arrangements with a view to transactions in investments, and agreeing to carry on that regulated activity. They are, in the main, technology companies who provide market professionals with trade support services. They are outside the scope of MiFID as they do not provide MiFID investment services nor do they engage in MiFID activities. Existing provisions 4.3 The only provisions in COB which apply are those relating to financial promotion and investment research. Proposal 4.4 We propose to maintain the existing approach by applying only the NEWCOB rules equivalent to the COB rules which currently apply. Implications for firms and consumers 4.5 There are no implications for firms and consumers. 13 Article 25 (2) of the Regulated Activities Order (SI 2001/516) captures the activity of arranging deals in investments when these arrangements are with a view to a person who participates in the arrangements buying, selling, subscribing or underwriting investments (whether as principal or agent). Financial Services Authority 21

24 Discussion 4.6 Because service companies engage in a very narrow regulated activity, there is no need for most of the COB provisions to apply. We propose to maintain this policy approach. We draw to the attention of service companies the provision in NEWCOB 5, Annex R which sets out exemptions to the financial promotion rules. Cost-benefit analysis 4.7 Given that no changes are being proposed, there is no requirement for cost-benefit analysis. References The existing rules are COB 1.9; COB 3 and COB Draft NEWCOB rules are NEWCOB 5 and NEWCOB Q4: Do you agree with our proposals for service companies? 22 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

25 5 Locals 5.1 Locals are own account traders on markets in financial futures, options or other derivatives 14. They are outside the scope of MiFID by virtue of the Article 2.1(l) exemption in the Directive. COB is not applicable to locals as they are own account traders concluding transactions with or for other exchange members. We therefore have no policy proposals. 14 Please see the Glossary for the full definition. Financial Services Authority 23

26 6 Depositaries Introduction 6.1 Depositaries of collective investment schemes are those persons to whom the property of a scheme is entrusted for safekeeping; they include trustees of authorised unit trust schemes in the UK. Depositaries are exempt from MiFID by virtue of the exemption in Article 2(1)(h) which exempts, amongst others, depositaries of collective investment schemes. Existing provisions 6.2 There is a concessionary regime for depositaries in COB 11 (principally 11.4). The main rules which apply to depositaries include inducements, financial promotion, information about the firm, conflicts of interest, Chinese walls and personal account dealing. Proposal 6.3 In broad terms, we propose to carry forward the existing policy approach but with some modifications to align requirements to MiFID standards in some cases and to disapply requirements in others, where this seems sensible. 6.4 Specifically we propose in respect of: Inducements: to apply the MiFID rules, as modified for non-mifid retail firms and business. Financial promotion: to apply the NEWCOB standard (which, as with the COB standard, will effectively exempt promotions made to other authorised persons). Information about the firm: to move to reliance on Principle 7 (Communications with clients). Personal account dealing: to apply to the MiFID standard which is broadly similar to the COB standard. 24 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

27 Implications for firms and consumers 6.5 The changes we are proposing would have only a limited impact on depositaries as COB rules are not central to their activities. The clients of depositaries, who are other authorised firms operating collective investment schemes, should be unaffected by the changes. Discussion 6.6 There are currently eight authorised persons acting as depositaries. They conduct their business either as a separate legal entity within a wider group or as a division of an entity that also provides non-depositary services. 6.7 External research indicated that depositaries consider that current UK regulations are good and comprehensive; COLL is the most important regulation they face. It also indicated that depositaries look to the wider group compliance function to advise where changes to the group resulting from regulatory changes such as MiFID could bring consequential operational changes to the depositary business. It was indicated that depositaries would level up their processes and procedures to bring them in line with MiFID where MiFID provisions apply to group wide activities, and where there was operational efficiency to be gained from using the same operating platform as for MiFID activities. Cost-benefit analysis 6.8 External research suggested that existing depositaries are concerned that a principlesbased approach to regulation could result in increased costs by requiring greater internal analysis and external advice. We do not believe that any of the changes proposed here should have such an impact. They do not involve matters which are central to the daily activities of depositaries. At the margin, they provide depositaries with more flexibility. 6.9 The application of the new rules on inducements and personal account dealing should have limited cost implications. The relevant issues were discussed in CP06/19. Given depositaries are part of firms or groups which do MiFID business this is likely to further reduce the costs of these rules being imposed on depositary activities. References The existing rules applicable to depositaries are set out in Chapter 11.4 of COB. Q6: Do you agree with the proposed approach to COB 11.4 for depositaries? Financial Services Authority 25

28 7 Lloyd s Introduction 7.1 Our current rules are at COB 12. They consist of application provisions and definitions, as well as cross-references disapplying some chapters in COB and applying others. 7.2 We propose not to carry forward many of our existing requirements, consistent with our desire to be principles-based. This approach is appropriate because the existing COB regime covers similar ground to that in the Society of Lloyd s (Lloyd s) detailed byelaws, general code of conduct and agency agreements, and our Principles for Businesses ( the Principles ) provide adequate standards for this business. Existing provisions 7.3 COB 12 (Lloyd s) applies and disapplies certain COB provisions in relation to firms undertaking Lloyd s related activities listed in COB R. Most COB provisions apply when a firm provides advice on joining a Lloyd s syndicate or conducts designated investment business in relation to funds at Lloyd s. Only a small number of COB provisions apply to a firm managing the underwriting capacity of a Lloyd s syndicate as a managing agent. Where a firm seeks to promote its services in relation to one or more of these activities, the financial promotion requirements apply. Proposal 7.4 We propose not to carry forward the current application of detailed rules in COB 12. There will be guidance to remind firms carrying out the activities currently covered by COB 12 (which will be defined in the Handbook glossary as Lloyd s market activities ) that the Principles will continue to apply to those activities. 7.5 We propose to continue to apply the financial promotion rules to firms carrying on Lloyd s market activities. In practice, much of the activity of communicating or approving a financial promotion in relation to Lloyd s market activities is likely to be able to benefit from one or more of the exemptions from the financial promotion rules NEWCOB 5, Annex 1R, 1.2.9R (General exemptions) exempts promotions to recipients who the firm reasonably believes are eligible counterparties or professional clients. Also, some of our financial promotions rules are directed at packaged products which are not relevant in the Lloyd s context. 26 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

29 Implications for firms and consumers 7.6 We do not expect (or intend for) our proposals to impact significantly on firms. This is because firms behaviour will continue to be subject to the Principles, as well as the Society s detailed byelaws, general code of conduct and agency agreements. Together these cover much the same ground as the existing COB regime. 7.7 Nor do we expect (or intend for) a move to a reliance on the Principles to impact significantly on Lloyd s members. Members will continue to be afforded COB-type protections via the relevant Principles, as well as more detailed requirements set out by the Society. 7.8 However, the move to a reliance on the Principles in preference to detailed COB provisions will impact on actions for damages by private persons (including Lloyd s members). While a contravention of a rule in COB would give rise to a right of action under Section 150 of FSMA 16, a contravention of the Principles would not 17. We do not expect this to have a significant effect on consumers for the reasons explained below. Discussion Advising on syndicate membership 7.9 COB R (Advising on syndicate membership) was introduced following industry feedback to CP Respondents expressed concern that advising on Lloyd s membership itself remained outside the regulatory regime and therefore the risk of unrealistic or misleading claims as to the advantages of Lloyd s membership was not addressed The proposals set out above involve deleting COB R on the grounds that our Principles, and detailed requirements for Members agents set out by the Society, provide adequate protection for Members. Funds at Lloyd s 7.11 MiFID exempts insurance undertakings 19 and insurance contracts are not MiFID financial instruments. This means most of the activities covered by COB 12 are outside the scope of MiFID. The only activity covered by COB 12 that might fall within the scope of MiFID is carrying on designated investment business in relation to funds at Lloyd s. 16 Section 150 of FSMA provides that a private person, or in specified cases a non-private person, may take out an action for damages through the courts if he suffers loss as a result of a contravention by an authorised person of a rule made by the FSA. Private person is defined by statutory instrument and includes individuals provided they are not carrying on regulated activities. 17 PRIN 3.4.4R (Actions for damages): A contravention of the rules in PRIN does not give rise to a right of action by a private person under section 150 of the Act (and each of those rules is specified under section 150(2) of the Act as a provision giving rise to no such right of action). 18 The Conduct of Business Sourcebook Supplement, June Article 2(1)(a) of MiFID. Financial Services Authority 27

30 7.12 This activity will only fall within MiFID where it involves investment firms (or banks) undertaking activities linked to buying and selling MiFID financial instruments. An investment manager engaged by a Member to manage their funds at Lloyd s could be undertaking activities within the scope of MiFID. If the Society itself undertakes designated investment business in relation to funds at Lloyd s, this will not be MiFID business Where firms are inside the scope of MiFID and carry on designated investment business in relation to funds at Lloyd s, the specialist Lloyd s regime in NEWCOB will not apply and these firms must instead comply with the relevant NEWCOB chapters that implement MiFID. Cost-benefit analysis 7.14 The CBA research in CP57 20 concluded that the application of COB provisions to Lloyd s should have minimal cost impact on those firms affected. This was on the basis that there were a number of existing regulatory provisions which covered similar ground as the applicable COB provisions. Introducing COB 12 was expected to have only a minimal cost impact on relevant firms, and removing prescriptive rules is expected to have a similarly low impact We believe the loss of the right to action for damages under Section 150 will lead to costs of minimal significance to consumers because: Section 150 is hardly ever exercised; Lloyd s members enjoy protections under the Society s rules 21 ; and Members would still potentially have recourse to legal action for negligence under contract or agency law Firms will benefit from a simplified Handbook with a clearer focus on the outcomes that really matter for Lloyd s members. We expect no foregone benefits or additional risks to our objectives because firms will remain subject to the Principles and the Society s regulatory framework. Q7: Do you agree with our proposed approach to COB 12 (Lloyd s)? 20 The Conduct of Business Sourcebook Supplement, June For example the Members Ombudsman Byelaw establishes an Ombudsman to facilitate the satisfaction, settlement or withdrawal of any compliant by making recommendations (which may include that ex-gratia payments be made) or representations to any person named in the complaint or the Society. The Lloyd s Arbitration Scheme Byelaw provides a method of resolving disputes arising between Members and Members agents or managing agents where the sum (if any) claimed by the Member does not exceed 100, CP07/9: COBS: Non-MiFID deferred matters (May 2007)

31 8 Collective Investment Scheme (CIS) Operators Introduction 8.1 Collective investment scheme (CIS) operators are outside the scope of MiFID because Article 2(1)(h) of the Directive exempts them. For the reasons set out below, we propose to maintain the current concessionary treatment of CIS operators in COB 10 (including operators of private equity schemes) in NEWCOB. The terminology will be updated to reflect MiFID and some existing obligations are disapplied. Existing provisions 8.2 Chapter 10 applies parts of COB to operators of regulated and unregulated CISs when undertaking scheme management activity, with modifications in respect of best execution, suitability and order aggregation and allocation. 8.3 COB 10 applies COB provisions in a CIS environment where there are three parties the operator, the scheme and the participants in the scheme rather than the usual two (firm/customer). Parts of COB that are applied include inducements, conflicts of interest, best execution, aggregation and allocation, customer order and execution records and use of dealing commission. 8.4 COB 10 modifies COB provisions regarding suitability (to require each transaction and the portfolio itself to be suitable for the scheme) and best execution (to allow funds for professionals only to be opted out) for unregulated schemes. As unregulated collective investment schemes are outside the UCITS framework, they are also subject to specific requirements in respect of scheme documentation and reporting to clients. 8.5 For both regulated and unregulated schemes there is a modification of the rule on prompt allocation of orders to allow up to five business days for orders to be allocated for schemes which have no private customers. Financial Services Authority 29

32 Proposal 8.6 We propose to apply the NEWCOB equivalent of most of the existing provisions in COB Chapter 10, disapplying some rules that are no longer necessary. For example: Suitability (COB 10.4): we do not believe it is necessary to retain a rule which requires an operator of an unregulated scheme to take investment management decisions which are suitable for the scheme this is a statement of the obvious; Order allocation (COB 10.3): given the NEWCOB rule no longer specifies a time period for the allocation of orders beyond the high-level standard of prompt, the modification of the time period for CIS operators running schemes for intermediate customers is no longer necessary. 8.7 On best execution, it is proposed that CIS operators are subject to the MiFID-based rules but that the existing exemption in COB 10.5, which can be used by operators of unregulated schemes, be retained. The parts of the new best execution rules likely to be of most relevance to CIS operators are those which apply to portfolio managers in NEWCOB and to Implications for firms and consumers 8.8 A number of the firms that operate CISs also do MiFID business and will be gearing up for MiFID NEWCOB requirements already. We do not, therefore, expect there to be any additional difficulties for these firms in extending compliance requirements to CIS operators. 8.9 As many provisions are being carried across, we see no major impact for other non- MiFID firms. We foresee no additional risk for consumers arising from some rules not being carried forward. Discussion 8.10 We do not believe that the current COB regime for CIS operators needs to be fundamentally remade. It already involves a selective approach given the specificities of the sector Many regulated schemes have been set up to comply with European legislation (the UCITS Directive). This provides for a regime of cross-border marketable CISs and applies product regulation (e.g. investment and borrowing powers) to such schemes The UCITS regime does apply some high-level COB requirements (in the style of the ISD, rather than MiFID). There is a possibility that CESR will do some Level 3 work on how those requirements should be interpreted, which is likely to take account of relevant MiFID standards. However, such work is not imminent. 30 CP07/9: COBS: Non-MiFID deferred matters (May 2007)

33 Cost-benefit analysis 8.13 Given that most of the existing substantive regulatory obligations on firms are being maintained, firms should not in the main face significant new, additional ongoing costs. The deletion of some requirements might reduce costs by slightly reducing compliance requirements. We do not believe the proposed changes will significantly alter the benefits provided by the current regime The main change proposed relates to best execution. To assist us in quantifying the costs for CIS operators of complying with the MiFID best execution requirements, we carried out a survey of a small number of compliance consultancies. We asked these firms to provide an estimate of the amount they would charge to review a firm s best execution arrangements and ensure compliance with MiFID requirements. We received three responses ranging from 6,000 to 33,000 for one-off costs and 1,000 to 17,000 for additional annual ongoing costs The costs for best execution will obviously vary from firm to firm for CIS operators. Amongst other things, they will depend on whether or not a firm employs external consultants, the scale of a firm s activities, whether or not a firm conducts business inside the scope of MiFID, whether or not they execute decisions to deal directly (rather than through other firms) and whether they can avail themselves of the exemptions from best execution Assuming that unregulated schemes will be unaffected by best execution (because of the exemption available where investors are not retail clients) the one-off costs of best execution across the 177 operators of regulated schemes could be between 1m and 5.8m and the additional annual ongoing costs could be between 177,000 and 3m The best execution requirements might have some positive market impacts. They might make it easier for clients to assess the performance of fund managers. They might also increase competition between firms who provide execution services to fund managers. And, to the extent that they help to improve funds returns, they might increase the volume of funds invested in fund management products. References The existing provisions for CIS operators are in COB Chapter 10. Q8: Do you agree with our proposals for CIS operators? Financial Services Authority 31