Financial  markets  and  Institutions  Types  of  Investments  

Debt  –  i.e.  tradable  bond,  issued  by  a  company  or  govt  or  non-­‐tradable  bank  loan,  bank  deposit  

Equity/share  –  tradable  securities  giving  an  ownership  stake  in  a  company  

Other  include  commodities,  property,  derivatives,  foreign  exchange  

Savers  can  invest  in  the  above  directly  or  indirectly  (through  an  intermediary)  –  through  insurance  companies,  pooled  investment  vehicles,  or  pensions  schemes.  The  indirect  method  gives:  

• Diversification  • Reduction  in  transaction  costs  • Access  to  expertise  • Access  to  assets  that  would  otherwise  not  be  available  

UK  banking  system  uses  the  universal  bank  model  involves  providing  financial  services  of  various  kinds,  including  advisory  services,  in  addition  to  deposit  and  lending  services.    

 

Types  of  Assets  

Tangible  assets  such  as  land  and  buildings  (property,  or  real  estate),  machinery,  oil,  sugar  and  gold,  are  all  real  assets.  The  utility  of  such  an  asset  gives  it  an  intrinsic  value.  

In  a  monetary  economy,  there  are  claims  that  may  represent  the  right  to  a  return,  such  as  interest  and  the  eventual  repayment  of  principal  (on  a  loan),  or  dividends  payable  out  of  a  company’s  profits  (for  shares  in  a  company).  Such  claims  are  financial  assets.    

 

Shares  

The  ordinary  shareholders  of  a  company  are  the  owners  of  the  company.  However,  it  is  normal  for  ordinary  shares  to  possess  a  vote.  

Companies  legally  do  not  have  to  declare  a  dividend  on  ordinary  shares,  many  of  them  do  in  order  to  maintain  shareholder  loyalty.  

For  public  companies,  this  will  not  be  paid  until  the  shareholders  have  agreed  it  at  the  AGM.    

Companies  may  only  pay  dividends  out  of  post-­‐tax  profits  –  that  is,  from  their  distributable  reserves.    

In  any  single  year,  the  dividend  paid  could  exceed  the  profit  for  that  year,  because  there  may  be  distributable  reserves  brought  forward  from  earlier  years.    

Bonds  (fixed  income  securities)  

A  bond  may  be  defined  as  a  negotiable  debt  instrument  for  a  fixed  principal  amount  issued  by  a  borrower  for  a  specific  period  of  time,  making  a  regular  payment  of  interest/coupon  to  the  holder  until  it  is  redeemed  at  maturity,  when  the  principal  amount  is  repaid.      Derivatives  Derivative  contracts  is  a  term  encompassing  contracts  such  as  futures,  options  and  swaps  which  derive  their  value  from  the  movement,  up  or  down,  in  the  price  of  an  underlying  asset.    Derivatives  contract  enable  investors  to  take  a  position  in  the  price  of  an  asset  without  actually  taking  delivery  of  the  underlying  asset.  For  example,  a  position  can  be  taken  on  the  price  of  oil,  without  participants  in  the  related  derivative  contract  taking  physical  delivery  of  oil  at  any  point  

Derivatives  can  be  divided  into  exchange-­‐traded  and  over-­‐the-­‐counter  (OTC)  types.    • Exchange-­‐traded  derivatives  are  more  standardised  and  offer  greater  liquidity    • OTC  contracts  are  tailor-­‐made  to  meet  the  needs  of  buyers  and  sellers.  

 Currency  transaction  

Currency  or  foreign  exchange  trading  (or  FOREX  as  it  is  commonly  known)  is  the  dealing  of  the  currencies  of  various  countries.      No  formal  market  place  for  FOREX  trades:  in  London,  trading  is  over-­‐the-­‐counter  (OTC).    Prices  are  advertised  on  screens  and  deals  are  conducted  over  telephones.  The  major  players  are  investment  banks  and  specialist  currency  brokers    FOREX  transactions  are  described  either  as  spot  or  forward.    

• Spot  means  the  trade  is  to  meet  immediate  currency  needs  and  will  settle  in  two  business  days  after  the  trade  day  (known  as  T  +  2).    

• Forward  is  when  an  exchange  rate  is  agreed  today  for  settlement  at  some  future  date  

 

Pooled  Funds  

In  order  to  minimise  the  risk  involved  in  investment,  it  is  often  a  good  idea  for  the  investor  to  spread  invested  money  over  a  range  of  instruments,  thereby  diversifying  risk.    Individual  investors’  investments  to  be  grouped  together  and  form  a  collective  investment  vehicle.  Here  they  pool  their  money  in  a  large  fund,  which  is  managed  and  invested  for  them  by  a  fund  manager.      There  are  different  types  of  ‘pooled’/collective  investment  vehicle:  

• Unit  trusts  • Open-­‐ended  investment  companies  (OEICs)    • Investment  trusts.    

There  are  also  exchange  traded  funds  (ETFs),  which  are  typically  designed  to  track  an  index.      Authorised  unit  trusts  and  OEICs  are  Authorised  Investment  Funds  (AIFs)  and  are  often  referred  to  simply  as  funds.      Differences  A  unit  trust  differs  from  investment  trusts  and  OEICs  in  the  way  it  is  set  up,  as  a  unit  trust  is  not  a  company  with  shares.    Pricing  For  unit  trusts  and  OEICs,  there  is  a  direct  relationship  between  the  value  of  the  underlying  investments  and  the  value  of  units.  Units  are  priced  according  to  Net  Asset  Value  (NAV).      Investment  trust  shares  and  also  ETFs,  however,  are  priced  according  to  supply  and  demand  in  the  stock  market.      Unit  trusts  are,  like  OEICs,  called  open-­‐ended  funds  as  there  is  no  limit  to  the  amount  of  money  which  can  be  invested.  If  no  ‘second-­‐hand’  units  are  available,  the  fund  is  permitted  to  create  more  units  and  expand  the  fund.      Investment  trusts,  on  the  other  hand,  are  closed-­‐ended:  except  when  new  shares  are  issued  –  eg,  on  launch  of  the  trust  –  the  buyer  of  investment  trust  shares  is  buying  them  from  existing  holders  of  the  shares.      The  function  of  securities  market    

• Raising  of  capital  • Transfer  of  risk    • Price  discovery  • Creation  of  liquidity  

By  short-­‐term  capital,  we  mean  capital  that  is  lent  or  borrowed  for  a  period  which  might  range  from  as  short  as  overnight  up  to  about  one  year,  and  sometimes  longer.    

By  long-­‐term  capital,  we  mean  capital  invested  or  lent  and  borrowed  for  a  period  of  about  five  years  or  more,  but  sometimes  shorter.    

 

Price  transparency,  liquidity,  transaction  costs  

Price  discovery    

The  process  through  which  an  equilibrium  price  for  a  financial  instrument  is  revealed  continuously  through  bid  and  offer  prices,  and  trading  

• Market  establish  equilibrium  price  • Markets  disseminate  the  price  to  investors/the  public  

Price  Transparency    

Important  that  the  investor  knows  the  price  before,  during  and  after  a  deal  in  order  to  be  satisfied  that  he  has  a  good  deal    

• Pre-­‐trade  transparent  (data  on  quotes  and  orders)  vs  post  trade  transparency  (publication  of  sizes  and  prices  of  trades)  

• Organised  markets  are  transparent  than  OTC  

Liquidity  

• Liquidity  measured  by  bid  ask  spread  in  quote  driven  market  or  by  difference  between  the  best  sell  and  buy  prices  in  order  driven  markets  

• Liquid  markets  are  those  where  large  quantities  are  traded  or  where  order  need  to  be  very  large  to  have  an  impact  on  price  

Factors  contributing  to  liquidity  are:  • Effective  and  efficient  IT    • Settlement  systems  • Stock  availability    • Stock  lending  facilities  • Diverse  membership  

 

Must  calculate  round  trip  transaction  costs  incorporating  bid-­‐ask  spreads,  dealing  commission  and  transaction  taxes,  both  in  percentages  and  in  absolute  amounts  

Transaction  costs  

Broker  commissions  (pay  fee  to  broker  because  investor  can’t  invest  directly),  bid  ask  spreads  and  market  impact    

Costs  of  a  share  transaction  for  a  UK  investor  can  be  broken  down  as  follows:  

Purchase  cost.    • The  purchase  cost  includes  a  spread  which  is  the  difference  between  the  bid  and  

offer  price  of  the  share.  Broker's  commission  

• Brokers  incur  various  costs  for  the  resources  they  employ  to  fill  orders,  including  costs  for  market  data  and  order  routing  systems,  exchange  memberships  and  fees,  regulatory  fees,  clearing  fees,  accounting  systems,  office  space,  and  staff  to  manage  the  trading  process.    

• A  typical  charge  could  be,  say,  1.5%  on  a  deal  up  to  £7,000  and  1.0%  above  that,  with  a  minimum  charge  of  £25  

Stamp  Duty  and  SDRT  • Stamp  Duty  Reserve  Tax  (SDRT)  is  payable  at  0.5%  on  the  value  of  purchases  of  UK  

equities  settled  through  CREST  (ie  most  transactions),  rounded  up  to  the  nearest  1p  and  on  equities  not  settled  through  CREST,  at  0.5%,  rounded  up  to  the  nearest  £5.  (There  is  no  Stamp  Duty  if  the  charge  so  calculated  would  be  £5  or  less.)    

Panel  on  Takeovers  and  Mergers  Levy  

• The  PTM  levy  is  a  flat  £1  on  transactions  (sales  and  purchases)  that  are  in  excess  of  £10,000  

 Market  Impact  

• Buyers  putting  through  large  buy  orders  may  need  to  push  up  the  price  of  the  security  up  in  order  to  make  the  trade.    

• Sellers  who  want  to  put  through  a  large  sell  order  quickly  may  need  to  accept  a  lower  price  than  is  immediately  available  to  a  seller  with  a  small  order.    

• The  cost  effect  of  this  tendency  for  fluctuating  order  sizes  to  move  prices  is  called  the  market  impact  or  price  impact,  and  is  a  significant  component  of  transaction  costs  for  large  financial  institutions.    

 

Limit  orders,  which  will  be  filled  only  if  the  price  is  better  than  the  stated  limit,  provide  a  way  of  limiting  transaction  costs,  Market  orders  are  filled  at  whatever  prices  are  available  when  the  order  is  placed.      

LSE  trading  platforms  

Three  domestic  trading  platforms  at  the  LSE  

Characteristics  of  these  platforms  can  be  summarized  as  whether  or  not  they  are:  

• Order  driven  v  quote  driven    

This  is  decided  by:  

• Depends  on  liquidity  of  share  

The  trading  platforms  for  domestic  securities  are:  

• SETS  • SETSqx  • SEAQ  

LSE  Settlement  period  T  +2-­‐  when  all  paper  work  and  legal  details  are  in  place/money  also  moved  between  relevant  bank  accounts  

Stock  Exchange  Electronic  Trading  Service  (SETS)  

• Automatic  matching  for  trades  in  most  liquid  listed  shares  • Only  LSE  members  can  place  orders  • Only  standard  settlement  permitted    

o T+2  • Orders  ranked  by  price  then  time  of  input  • Change  in  order  -­‐>  new  input  time  • All  trades  anonymous  due  to  LCH  Clearnet  acting  as  central  counterparty  service  

(CCP)  –  process  known  as  novation  

SETS  –  Quote  and  crosses  (SETSqx)  

• Hybrid  System  –  for  less  liquid  stocks  • Combines  quote  driven  platform  with  periodic  (orders)  electronic  auctions  

(uncrossings)  • Auctions  at  opening  (8:00am),  11:00am,  3:00pm  and  closing  (4:35pm)  • If  want  to  trade  at  other  times  of  the  day,  Market  makers  must  quote  bid  and  offer  

prices  for  transactions  of  at  least  1*  NMS  (Normal  market  size)  –  per  person  or  on  a  whole  basis?  

NMS  is  a  minimum  volume  set  by  LSE  

Stock  Exchange  Automated  Quotation  System  

Price  dissemination  system  

Pure  quote  driven  

System  used  by  the  LSE  to  display  market  maker  prices  on  AIM  stocks  (not  traded  through  SETS  or  SETSqx)  

• Minimum  of  two  market  makers  input  bid-­‐ask  spread  into  SEAQ  • SEAQ  displays  two  way  prices  to  Public  (brokers/dealers/investors)  • Brokers  Dealers  deal  by  phone  with  market  makers  

Only  market  makers  are  able  to  quote  prices  on  SEAQ  

 

Gilt  Market  

The  gilt-­‐edged  market  is  a  further  major  capital  market  in  the  UK.  The  government  borrows  over  the  medium  and  longer  term  by  issuing  government  stocks  (called  'gilt-­‐edged  stock'  or  ‘gilts’).    

Trade  in  second-­‐hand  gilts  will  continue  until  the  debt  eventually  matures  and  the  government  redeems  the  stock.    

Gilts  settle  T+1  via  Euroclear  UK  &  Ireland  (using  the  CREST  system)  

Less  liquid  than  shares,  so  will  need  quote  driven  system  with  market  makers  (investment  banks)  

Gilt  Edged  Market  Makers  (GEMMs):  

• Required  to  make  2  way  prices  to  customers  • Must  provide  information  on  closing  prices,  market  conditions  and  their  turnover  

and  positions  • Are  expected  to  participate  in  Debt  Management  Office’s  gilt  issuance  program  • Must  always  participate  when  DMO  issues  further  debt  

Main  holders:  UK  pension  funds,  insurance  companies  overseas  investor  +  less  extent  wealthy  private  individuals  

Quoted  excluding  interest  (clean  pricing),  however  settlement  price  includes  accrued  interest  (dirty  pricing)  

Actual  bond  transaction  prices  reflect  accrued  interest  based  on  actual/actual  basis  

Holders  of  gilts  can  now  receive  coupon  payments  gross  

 

New  Issues  of  gilts  

Issued  by  Debt  Management  Office  (DMO)  to  fund  the  public  debt/Public  Sector  Net  Cash  requirement  (PSNCR)  or  to  refinance  maturing  debt  

DMO  typically  issues  gilts  by  auction  (preferred  method)  

  All  bidder  in  market  bid  what  prepared  to  pay  for  certain  volume  of  gilts  

Alternative  arrangement  is  ‘tap’  method  –issue  announced,  investors  invited  to  tender.  Smaller  volume  of  gilts.  

 

• If  a  part  not  take  up  at  the  required  price  –  that  part  is  withdrawn  and  released  into  the  market  later  

Alternative  trading  venues  

Set  up  outside  of  LSE  

Dark  Pools  

• Price  transparency  does  not  need  to  be  as  high  • Electronic  trading  platforms  where  neither  price  nor  identity  of  trading  firm  is  

revealed    • Don’t  know  prices  someone  else  is  willing  to  buy  or  sell  at  • Post  trade  transparency  is  possible  but  not  pre-­‐trade  

Multilateral  trading  facility  

• Electronic  trading  platforms  arranged  in  a  similar  manner  to  SETs  but  designed  to  be  cheaper  than  SETs  trading  

• Lots  of  investment  banks,  get  together  cause  LSE  charges  hefty  fee  to  trade:  BATS,  CHIX,  less  than  half  blue-­‐chip  now  trade  on  LSE  

Systematic  internalises  

• Investment  banks  who  execute  client  orders  by  trading  for  their  own  account  rather  than  with  an  exchange  or  MTF  

• Trade  their  own  stock  

Should  know  description  to  match  to  right  platform  for  exam  

 

Algorithmic  trading  

Algorithmic  trading  

A  broad  term  describing  all  scenarios  where  electronic  platforms:    

• initiate  orders  or  • decide  on/  recommend  aspects  of  orders  (timing,  price,  quantity)  generated  by  

humans  

High  frequency  trading    

• A  subset  of  algorithmic  trading  where  computers  make  decisions  or  initiate  orders  based  on  electronically  received  information  before  (human)  traders  get  change  to  process  what  they  observe.    

Role  of  LSE  member  firms  

Main  market  is  London  Stock  Exchange  whose  members  are:  

Broker/Dealers  

May  act  in  dual  capacity  (Big  bang  in  the  1980s  made  this  possible)  

• Broke  a  customer’s  business  (agent)  • Deal  directly  or  buy  securities  for  own  business    (principal)  

Equity  market  makers/Gilt  Edged  market  makers  

• Must  quote  two  way  prices  • Make  market    

Interdealer  brokers  (IDB)  

• Arrange  matched  anonymous  principal  to  principal  trades  between  market  makers  • Safety  valve,  esp.  for  gilt  edg3d  market  makers  who  are  obliged  to  follow  through  on  

deal  up  to  certain  size,  could  find  themselves  loaded  up  with  securities.  If  large  stock  cant  shift  on  market  directly  as  other  members  will  lower  price.  To  help  them  unwind  large  positions  the  IDB  act  as  brokers  to  market  makers  to  allow  them  to  trade  large  positions  anonymously.  

 

The  Stock  Borrowing  and  Lending  Intermediaries    

• If  market  makers  wish  to  take  a  short  position  in  a  stock,  ie  sell  more  than  they  currently  have  on  their  books,  they  will  need  to  have  stock  in  order  to  settle  the  trade.    

• The  Stock  Borrowing  and  Lending  Intermediaries  (SBLIs)  provide  access  to  large  pools  of  unused  stock.    

• The  institutional  investors  in  the  UK  buy  large  blocks  of  securities  and  often  hold  these  blocks  for  a  number  of  years.  The  SBLIs  borrow  stock  on  behalf  of  market  makers  from  these  

dormant  positions.  The  stock  is  passed  to  the  market  maker  who  uses  it  to  settle  the  trade,  and  in  effect,  to  go  short.    

 

Central  counterparty  (Novation)  

Clearing  house  (LCH:Clearnet)  

Central  counterparty  stands  between  buyers  and  sellers  

• Short  seller  to  every  buyer  • Log  buyer  to  every  seller  

Purpose:  eliminates  counter  party-­‐risk  

When  dealing  directly  with  someone  else  there  is  risk  that  they  won’t  deliver  on  their  promise  (won’t  pay  before  delivering  security)  

 

LCH.Clearnet  Margining  

Initial  Margin  

• Returnable  good  faith  deposit  paid  on  opening  positions  • Based  on  maximum  probable  one  –day  loss  (amount  security  can  fall  in  value  in  one  

day)  

Variation  Margin  

• Cash  Settlement  of  daily  profits  or  losses  based  on  closing  price  each  day  • Paid  to  or  received  from  LCH  Clearnet  the  following  morning.    • If  one  side  decides  to  default  whole  contract  is  void  

 

UKLA  and  LSE  

Companies  have  limited  liability  and  can  be  private  (cannot  offer  shares  to  public)  or  public  

Public  PLC  can  offer  shares  to  public  (majority  do  not)  

If  offer  shares  to  public:  

May  choose  to  trade  shares  on  exchange  as  will  struggle  to  sell  shares  without  secondary  market  for  buyer  to  sell  shares  and  realise  profit.    

To  trade  on  exchange  most  commonly  you  have  shares  listed  on  full  list  of  LSE,  must  satisfy  req  of  UKLA  (FCA)  referred  to  as  competent  authority  

• Listing:  must  satisfy  UKLA  listing  requirements  

Onerous  requirement  led  to  junior  markets  

• AIM:  not  regulated  directly  by  FCA,  is  reg  by  LSE  requirements  • ISDX:  UKLA  requirements  

 

UKLA  listing  Rules  

Main  conditions  for  full  listing:  

There  are  two  tiers  of  listing:  

• Premium  listing  (required  for  FTSE  UK  Index  membership),  involving  the  UKLA’s  ‘super-­‐equivalent’  requirements,  which  go  beyond  EU  standards    

• Standard  listing,  with  less  stringent  requirements  that  are  broadly  similar  to  AIM  requirements  

 

Requirements:  

• Minimum  market  capitalisation:  o ≥£700,000  shares  o ≥200,000  debt  –  if  want  debt  to  be  traded  

• Freely  transferable    -­‐  cant  restrict  • 25%  in  public  hands  –  free  float/in  public  hands  (excludes  shares  held  by  founders,  

or  huge  blocks  of  shares)  

Premium  listing  extras:  

• Must  have  3  years  continuous  trading  record/    • 3  years  of  audited  accounts  (waived  for  innovative  high  growth  companies  and  

investment  companies.    • Company  must  show  that  it  has  sufficient  working  capital  to  cover  the  next  12  

months  at  least,  • Must  be  a  sponsor  for  the  admission    

 

Prospectus  (prospects  of  company  before  they  offer  shares  to  public)  has  to  be  published  unless  the  offer  is  made  to:  

• Qualified  investor      • Fewer  than  150  persons  (private  placement)  • Minimum  amount  you  can  invest  per  investor  is  high  -­‐  €100,000  • Total  consideration  of  the  offer  less  than  €100,000  • Shares  representing  less  than  10%  of  the  shares  already  admitted  for  trading    

 

UKLA  Continuing  obligations  

Must  allow  market  to  have  full  understanding  of  company’s  position  

Disclose  

• Price  sensitive  information  • Significant  transactions  –  plans  to  sell  large  chunk  of  buswiness  • Changes  in  directors  • Changes  in  registers  –  key  shareholders  • Dividend  distributions  –  when  they  decide  to  distribute  

Listed  company  discloses  to  -­‐>    

Primary  Information  providers  (PIP)/Regulatory  Information  Service  (RIS  –  part  of  LSE)  (these  entities  are  signed  off  by  the  FCA)  tells    -­‐>  

Quote  vendors  (Bloomberg  and  reuters  etc.)  

 

AIM/ICAP  –  ISDX  markets  rules  

AIM  

• Appoint  NOMAD  (nominated  advisor)  –  expert  financial  services  firm  that  ensure  they  fulfil  obligation  to  aim  rules  

• Produce  admission  document  • Securities  must  be  freely  transferable  • Should  have  broker  to  support  trading  of  the  company  shares  • On-­‐going  obligations  to  publish  price  sensitive  information  immediately  and  

disclose  significant  transactions.    • Lock  in  –  companies  with  less  than  2  years  track  record  must  agree  to  lock-­‐in  where  

directors,  significant  shareholders  and  employees  with  0.5%  or  more  of  the  capital  agree  not  to  sell  their  shares  for  1  year  following  admission.    

• No  minimum  market  capitalisation  • NO  minimum  proportion  of  shares  held  by  public  

ICAP  Securities  and  derivatives  exchange  (ISDX)  

Applicants  must:  

• Appoint  ISDX  corporate  advisor  –  specialists  financial  services  firm  • Demonstrate  appropriate  corp  governance  –  how  comp  managed  and  directed  • Have  published  audited  accounts  no  more  than  9months  prior  to  date  of  admission  

to  trading  • Adequate  working  capital  –  short  term  finance  for  business  to  run  for  next  12  

months  • Free  transferability  of  shares  –  cant  restrict  ownership  • No  minimum  market  capitalization  

 

Dual  listed  companies  

Structure  where  two  corporations  function  as  single  operating  entity  (e.g.  Royal  Dutch  shell  (UK  &  Netherlands))  

• Separate  legal  entities  and  stock  exchange  listings  –  with  supervisory  board  • Equalisation  agreement  –  legal  contract  –  describes  how  ownership  is  shared  • Single  board  of  directors,  single  management  structure  • May  have  tax  advantaged    • Arbitrage  opportunities  may  arise-­‐  risk  free  profit  where  two  things  should  be  the  

same  but  are  priced  differently  

Cross-­‐Listing    

A  company  may  list  its  shares  on  more  than  one  exchange  –  for  example,  a  UK  company  may  list  in  on  the  LSE  in  London  while  also  making  its  shares  available  through  American  Depository  Receipts  (ADRs)  (discussed  further  later  in  this  Chapter)  in  New  York.  This  is  termed  a  cross  listing.    

 

Note  characteristics  for  exam  

 

Disclosure  and  Transparency  Rules  -­‐  UK  

Companies  keep  registers  for  all  shareholders  but  sometimes  shareholders  could  be  hidden  

Nominee  broker  deals  on  behalf.    

Holders  (including  connected  parties)  of  3%  and  go  up  or  down  through  a  %  point  

• If  holdings  reach  (3%),    • falls  below  3%  • or  moves  through  any  percentage  point  above  3%  • Notify  company  by  T+2  

Persons  discharging  managerial  responsibilities  (PDMR)  (and  their  connected  persons  (family))  must  inform  company  of  any  transactions  in  own  company  shares/derivatives  

• Notify  company  by  T+4  • Company  tells  market  via  regulatory  information  service  (RIS)/Primary  information  

provider  (PIP)  by  next  business  day.  T+1  

Not  just  shares  but  also  any  derivatives  

Legal  owner  is  anyone  connected  whether  directly  or  indirectly  

 

Settlement  period  

• From  6  October  2014,  standard  settlement  in  the  UK  is  T  +  2  for  equities.  • The  ex-­‐dividend  date  will  always  be  a  Thursday  • These  changes  comes  ahead  of  a  proposed  January  2015  start  date  for  T  +  2  

settlement  across  the  European  Union.    • Settlement  of  UK  Government  stocks  (gilts)  is  normally  T  +  1,  or  on  the  same  day  

 • Settlement  in  sterling  or  euros  is  made  on  a  Delivery  versus  Payment  (DVP)  basis,  

where  both  parties  are  ready  to  settle  with  each  other  at  the  same  time,  known  as  real  time  gross  settlement.    

 

Connected  parties  

Includes:  

• Family  stockholding  • If  you  own  a  third  or  more  of  any  company,  that  companies  stockholdings  are  

included  • Concert  party  =  two  or  more  persons  who  agree  (formally  to  informally)  to  act  in  

agreement(e.g.  investment  club)  

Each  persons  must  notify  that  they  are  party  to  the  agreement  

 

Meetings  

Annual  general  meetings  (AGM)  

• Must  be  held  every  calendar  year  (max  gap  15  months)    • Must  be  within  6  months  of  financial  year  end  • ≥21  days  notice  required  

 

• Members  attend/send  proxy  • Standard  tasks  undertaken  

o Approve  accounts  o Approve  dividends  o Approve  (annual)  reports  of  the  directors  and  auditors  o (Re)appoint  directed  o (Re)appoint  auditors  

All  of  these  will  be  voted  on.    

Can  be  done  via  show  of  hands    

• If  more  than  10%  or  at  least  5  shareholders  present  request  paper  vote,  company  must  do  so  

Proxy  

Proxy  power  normally  lasts  for  given  meeting  and  any  adjournments  that  may  be  created  

• General  proxy  –  flexibility  in  decision  making,  vote  as  they  feel  is  appropriate  • Special  (two  way  proxy)  –  told  how  to  vote  

 

General  Meetings    

General  meeting  (any  meeting  other  than  AGM)  

Can  be  requested  by  holders  of  >  5%  in  private  company  or  10%  in  public  of  paid  up  capital  share.    

If  this  happens:  

• Directors  must  call  general  meeting  within  21  days  • Notice  Period  (≥  14  days)  -­‐  notice  to  allow  shareholders  to  come    • Meeting  must  be  held  within  28  days  of  the  notice  calling  to  a  meeting  being  sent  

out.  

Ordinary  resolutions  require  >  50%  votes  cast  

Special  resolutions  require  >75%  of  votes  cast  

 

Corporate  governance  regulations  (1)  

UK  Code  on  Corporate  Governance  

Main  principles  of  the  Code:  

• Leadership    -­‐  Board  is  collectively  responsible,  lead  by  chairman  • Effectiveness  –  board  to  have  balance  of  skill,  experience,  knowledge  • Accountability  –  board  should  present  a  balance  assessment  of  firm  position  • Remuneration    -­‐  remuneration  levels  to  be  able  to  attract  retain  and  motivate  (NB  

All  Medium  and  late  companies,  irrespective  of  listed  status  are  require  to  public  remuneration  report)  

• Relations  with  stakeholders  –  dialogue  and  mutual  understanding  

Code  applies  to  listed  firms  only,  compliance  non-­‐mandatory,  disclosure  required  or  if  they  don’t  they  must  explain  in  AGM  why  they  did  not  

 

Stewardship  Code  

Financial  reporting  council  also  crated  the  stewardship  code  (2010)  directed  at  (big  shareholders)  institutional  investors,  consisting  of  7  principles:  

1. Publicly  disclose  their  policy  on  how  discharge  stewardship  responsibilities  2. Have  a  robust  policy  on  managing  conflicts  of  interest  3. Monitor  investee  companies  4. Guidelines  on  when  and  how  activities  escalate  to  protect  or  enhance  shareholder  

value  5. Be  wiling  to  act  collectively  with  other  investors  6. Clear  policy  on  voting  (and  periodic  disclosure  of  voting  activity)  7. Report  periodically  on  stewardship  activities  –  to  underlying  clients  using  them  as  

investment  manager  

 

The  Principal  –  agent  problem  

Small  firms  

• Owners  =  managers  

Large  firms  

• Owners  (principal)    • Managers  (agents)  

This  is  Separation  of  ownership  and  control  

The  agency  problem  arises  when  large  firms  often  owned  by  many  shareholders  appoint  managers  to  run  the  firm.    

The  interests  of  the  shareholders  may  be  significantly  different  to  the  interests  of  the  managers.  

Possible  solutions:    

• Align  the  incentives  –  shares  and  stock  options  • Board  of  directors  monitoring  managers  • External  pressure  (on  managers)  –  if  not  being  run  well,  it  becomes  a  takeover  target  • Shareholder  activism  –  turning  up  at  AGM,  grouping  with  other  shareholders  to  

remove  poor  directors  by  voting  them  out  

 

Functions  of  financial  services  industry  

4  Function  of  financial  services  industry  

Financial  intermediation  

• Linking  those  with  capital  to  lend  with  those  who  need  capital  

Pooling  and  managing  risk  

• Pooled  investment  funds  insurance  or  derivative  products  

Payment  and  settlement  services  

• Mechanisms  for  the  transfer  of  money  or  assets  

Portfolio  management  

• Allows  investors  to  manage  their  wealth  through  advice  and  management  services  

 

The  role  of  the  government    

• Production  of  services  that  the  private  sector  is  unwilling  or  unable  to  deliver  • Regulation  of  firms  (to  ensure  consumer  protection)  • Intervene  in  the  distribution  of  income  and  wealth  • Stabilization  of  the  economy  (reduce  fluctuations  of  income  employment  and  prices)  

 

EU  and  UK  

The  European  Union  is  an  example  of  an  international  economic  association.    

It  has  a  common  market  combining  different  aspects,  including  a  free  trade  area  and  a  customs  union.    

• A  free  trade  area  exists  when  there  is  no  restriction  on  the  movement  of  goods  and  services  between  countries.    

• This  may  be  extended  into  a  customs  union  when  there  is  a  free  trade  area  between  all  member  countries  of  the  union,  and  in  addition,  there  are  common  external  tariffs  applying  to  imports  from  non-­‐member  countries  into  any  part  of  the  union.  

 A  common  market  encompasses  the  idea  of  a  customs  union  but  has  a  number  of  additional  features.    

• Free  markets  in  each  of  the  factors  of  production.    o E.g.  A  British  citizen  has  the  freedom  to  work  in  any  other  country  of  the  

European  Union.  • Also  aims  to  achieve  stronger  links  between  member  countries    

o e.g.  by  harmonising  government  economic  policies  and  by  establishing  a  closer  political  confederation  

 UK  membership  of  the  EU  has  restricted  the  previously  unfettered  power  of    Parliament.  There  is  an  obligation,  imposed  by  the  Treaty  of  Rome  on  which  the  EU  is  founded,  to  bring  UK  law  into  line  with  the  Treaty  itself  and  with  EU  Directives.  Regulations,  having  the  force  of  law  in  every  member  state,  may  be  made  under  provisions  of  the  Treaty  of  Rome    Monetary  Policy  

The  Monetary  Policy  Committee  (MPC)  of  the  Bank  of  England  was  charged  with  the  responsibility  of  setting  interest  rates  with  the  aim  of  meeting  the  government’s  current  inflation  target      

-­‐    2%  measured  by  CPI,  plus  or  minus  1%      The  MPC  decides  the  short-­‐term  benchmark  ‘repo’  rate  at  which  the  Bank  of  England  deals  in  the  money  markets.      

International  securities  markets  

Why  would  investors  want  to  invest  in  overseas  securities?  

Maybe  Diversification,  more  return.  

European  Equity  

• Typically  done  on  electronic  order  matching  systems  (like  SETS)  • Operate  under  European  directives  from  EU  to  make  sure  rules  are  broadly  similar  

US  equities  

• NYSE  uses  floor  based  specialist  system  –  trading  floor,  individual  trading  directly  on  floor  

• Presence  of  designated  market  makers  –  each  stock  that  trades  is  run  from  central  trading  post-­‐  more  than  one  stock  attached  to  trading  post.  Each  trading  post  will  have  designated    MMs  assigned  

• A  lot  trade  by  universal  trading  system  (like  SETS)  

Emerging  markets  equity  

Unique  challenges  due  to  often  poor:  

• corporate  governance  • Transparency  • Regulation  • Liquidity  • Political  risk=>volatility  

 

Eurobonds  

Eurobonds  markets  (international  bond  issue  use  by  governments,  corporations  and  banks)  

Debt  instrument  issued  by  borrower  normally  outside  of  the  country  in  whose  currency  it  is  denominated.  

Companies  issuing  debt  in  the  Eurobond  market  have  their  securities  traded  all  around  the  world.  

Since  its  Unsecured  debt,  the  market  only  accepts  highly  rated  companies.    

• Pay  coupons  gross  and  annually/issued  in  bullet  form  • Bearer  (form)  instruments  –  issuer  does  not  retain  a  formal  register  of  ownership,  

however  to  make  sure  settlement  go  through  CCP  will  hold  register  (not  open  to  government  or  tax  authorities)  

• Does  not  attract  withholding  tax  for  this  reason    (bearer  form)  • There  is  no  formal  market  place    • Market  is  telephone  driven  • Market  Regulated  by  ICMA  (international  capital  market  association)  • Gilts  settle  T  +1  • Corporate  bonds:  confirm  T+1,  settle  T+2  –  requirement  of  ICMA  

 • 2  independent  clearing  houses  do  settlement:  Euroclear  or  clearstream  • These  clearing  houses  immobilise  the  stocks  in  their  vaults  and  then  operate  

electronic  registers  of  ownership  

   

Eurobond  Process  

• The  most  common  form  of  issue  used  in  the  Eurobond  market  is  a  placing.    • Issuer  appoints  a  lead  manager  and  award  them  the  mandate.    • Mandate  gives  lead  manager  power  and  responsibility  to  issue  the  bond  on  the  

issuer's  behalf.    • Lead  manager  then  creates  management  group  of  other  Eurobond  houses.    • Each  house  then  receives  a  portion  of  the  deal  and  places  it  with  its  client  base.  • The  lead  manager  may  elect  to  run  the  entire  book  alone,  and  miss  out  the  other  

members  of  the  management  group.    

Fixed  price  re-­‐offer  

• Lead  manager  can  amend  the  terms  of  the  issue  as  market  conditions  dictate.    • Under  fixed  price  reoffer,  members  of  management  group  are  prohibited  from  

selling  bonds  in  secondary  market  at  below  the  issue  price  until  the  syndicate  is  broken  

• Syndicate  breaks  when  lead  manager  believes  the  bulk  of  issue  has  been  placed  

Central  Securities  Depositories  

Central  Securities  Depositories  (CSD)  hold  securities.    The  fundamental  objectives  for  the  establishment  of  a  CSD  are  for  gains  in  efficiencies  and  for  reduction  in  risk.    Efficiency  gained  through:  

• the  elimination  of  manual  errors  

• lower  costs    • increased  speed  of  processing  through  automation  

Which  all  translate  into  lower  risks.      Almost  all  countries  have  some  form  of  central  depository  where  the  securities  are  either  immobilised  or  dematerialised    

• In  a  'dematerialised'  system,  there  is  no  document,  which  physically  embodies  the  claim.    

o The  system  relies  on  a  collection  of  securities  accounts  o instructions  to  financial  institutions  which  maintain  those  accounts,  and  o  confirmations  of  account  entries  

• Immobilisation  is  common  in  markets  that  previously  relied  on  physical  share  certificates,  but  the  certificates  are  now  immobilised  in  a  depository,  which  is  the  holder  of  record  in  the  register.  Access  by  investors  to  the  depository  is  typically  through  financial  institutions  which  are  members  of  the  depository  

 

ICSD  and  CSD  

International  centrals  securities  Depositories  (ICSDs)  have  established  linkages  with  several  domestic  CSDs  and  have  created  a  sub-­‐network.  

E.gs.  Euroclear  &  Clearstream  

ICSD   CSD  International  Client  Base   Domestic  client  base  Cross-­‐border  activities   Domestic  activity  only  All  securities   Local  securities  only  Settlement   Settlement  Custody     Custody  Collateral  management    Securities  lending    Other  Services      

 

 

   

Regulatory  Environment  Eu  Directives  is  an  obligation  for  member  states  to  ring  their  law  in  line  with  the  directive.    

 

Member  states  (UK)  

• UK  government  –  writes  the  laws  in  UK    • HM  Treasure  

Acts  

• Public  interest  disclosure  act  • Trustee  Act  2000  • Data  Protection  Act  98  • Pensions  Act  2004  • Financial  Services  &  Markets  Act  (2000)  -­‐  most  relevant  for  exam  • Financial  Services  ACT  -­‐1021  

 

Regulatory  bodies  

• FCA  • Bank  of  England  

o FPC  o PRA  

• Take  Over  Panel  • Competition  Markets  Authority  

 

Legislative  Structure  

Financial  Services  &  Markets  Act  

Primary  law  –  tend  to  deal  with  top  level  stuff,  guidelines  and  principles  

Enables  secondary  legislation    

• (Regulated  activities  order,  financial  promotions  order)  

Enables  the  power  of  regulator  to  write  detailed  rules  for  industry  and  enforce  those  rules  

Historically  there  was  single  regulator  –FSA  

Disbanded  in  2000  and  his  power  was  handed  to  two  regulators  (FCA  and  PRA)  

 

Prior  to  2013  

Single  regulator  FSA  –  covered  botha  spwcts  of  regulation  which  has  two  starnds  

Conduct    -­‐  dsy  day  operations  of  company  

Prudential  –  financial  safety  and  soundness  of  cpmany  –  make  sure  company  isn’t  ging  bust  ensuring  that  if  nees  to  payback  debt  can  do  without  falling  into  default.    

 

Problem  with  this  was  that  it  ws  hard  to  keep  eye  on  both  aspects  at  once.    

• Analysts  felt  UK  felt  credit  crunch  so  badly  because  regulator  took  eye  of  the  whole.  Northern  rock  was  looked  into  and  made  sure  customers  were  being  treated  fairly,  but  didn’t  see  that  it  was  about  to  go  bust  

 

Financial  Services  Act  split  FSA  into:  

• Conduct  was  taken  on  by  FCA  • Prudential  take  on  by  PRA  

 

FCA  -­‐  accountable  to  government  (Her  majesty  treasury)    

• Regulates  provision  of  financial  services  to  consumers  • Will  aim  to  protect  and  enhance  confidence  in  UK  financial  system  • Deal  with  conduct  of  around  >26,000  firms/every  firm  across  the  industry  

 

PRA  –  division  of  the  bank  of  England  (Micro  picture,  individual  firms  and  spotting  if  issues  at  the  individual  firm  level)    

• Objective  to  promote  safety  and  soundness  of  regulated  firms  • Designed  to  minimise  the  adverse  effects  of  firms  failure  • Only  do  checks  on  3000  firms,  those  that  are  systemically  important  (firms  that  

would  be  too  damaging  to  fail:  

Includes:  

• all  banks  • Insurers  • And  large  firms  

Leaves  prudential  bit  for  other  23,000  to  FCA.  

 

FPC  –  division  of  bank  of  England,  looks  at  Macro  across  industry  as  a  whole  

• Responsible  for  macro  prudential  regulation  • Aim  to  ensure  the  stability  of  financial  system  as  a  whole  

 

FCA  

FCA  took  legal  structure  of  FSA  in  April  2013  

Responsible  for  conduct  supervision  of  all  firms  and  for  prudential  supervision  of  non-­‐pra  firms  

Supervises  trading  and  market  infrastructure  

Competent  authority  for  listing  and  prospectuses  and  is  referred  o  as  the  UK  listing  Authority.  UKLA  and  FCA  –  two  separate  roles,  but  conducted  by  same  body.  

UKLA  responsible  for  approving  companies  seeking  a  listing  and  for  writing  and  enforcing  the  listing  rules  (part  of  FCA  handbook)  

Responsibility  for  client  assets  oversight  and  countering  financial  crime  

 

FCA  has:  1  strategic,  3  operational  objectives  

Legal  high  level  strategic  objective  to  ensure  relevant  markets  are  functioning  well  

Operational  objectives:  PIC,  protection,  integrity,  competition  

• Secure  and  appropriate  degree  of  protection  for  consumers  o Keeping  bad  companies  and  products  out  of  the  industry  o Compensation  and  redress  in  event  of  things  going  wrong  

• Protect  and  enhance  the  integrity  of  the  financial  system  • Promotion  of  effective  competition  in  the  interests  of  consumers  

 

PRA  

General  objective:  promotion  the  safety  and  soundness  of  regulated  firms  

• Uses  resolution  planning  (companies  version  of  living  will  –  preparation  for  in  case  they  go  bust)  to  ensure  that  firms  that  fail  do  so  in  an  orderly  way  

• The  PRAs  approach  to  supervision  emphasises  the  importance  of  judgements  made  by  supervisors.    –  is  company  at  risk  of  going  bust  in  the  future,  judging  the  firms  to  find  at  risk  firms  

FPC  

• Responsible  for  identifying  monitoring  systematic  risks,  and  taking  action  to  address  them  

• Makes  recommendations  and  gives  directions  to  PRA  and  FCA  

• FPC  is  required  to  take  economic  growth  into  account  • FPC  will  publish  two  financial  stability  reports  every  6  months.    

 

Authorisation  Requirement  

Firms  are  required  to  be  authorised  –  licensing  program  imposed  by  regulators  on  companies  

Section  19  of  FSMA  2000  –  The  general  prohibition  

• Company  cannot  conduct  a  regulated  activity  in  the  UK  by  way  of  a  business  (financial  service  main  part  of  business)  unless  they  are  authorised  or  exempt.    

If  breached,  then  company  taken  to  court  

Civil  court  or  criminal  court  –  difference  relies  on  evidence  of  guilt  

 

Dual  regulation  

Banks  and  Insurers    

• Systematically  important  so  they  are  monitored  by  PRA  for  financial  safety  and  soundness  • They  are  also  supervised  by  FCA  who  will  be  monitoring  their  day  to  day  conduct.  

All  other  firms  –  FCA  is  responsible  for  financial  safe  and  soundness  as  well  as  conduct.    

 

FCA/PRA  Permission  

Dual  regulated  firms  will  apply  to  the  PRA  for  authorisation.  However,  the  FCA  will  be  consulted  and  will  give  or  refuse  consent  to  the  PRA  based  on  conduct  implications.  PRA  will  be  bound  by  the  decision.    

What  are  regulators  looking  at  when  looking  to  authorise  a  firm:  

Authorization  is  given  by  obtaining  part  4a  permission  and  fulfilling  the  relevant  threshold  conditions  which  depend  on  whether  dual  or  FCA  only  regulated.  

 

Threshold  conditions  depend  on  whether  regulated  by  FCA  or  FCA  and  PRA  

Threshold  Conditions     Application  Location  of  Office  (head  office  needs  to  be  in  UK  so  you  can  be  sued  by  UK  law  if  problems)  

FCA  &  dual  reg  

Effective  supervision  (is  business  transparent  enough  for  regulators  to  check  your  meeting  requirements,  FCA  –  business  activities,  (how/what  selling)  PRA  –  finances)  

FCA  and  Dual  Reg  

Suitability  (fitness  and  properness,  are  you  going  to  be  run  well  y  good  directors  who  will  benefit  customers)  

FCA  and  Dual  Reg  

Business  Model  (what  you  have  planned/is  it  sustainable)  

FCA  and  Dual  Reg  

Appropriate  resources  (financial  and  non-­‐fin)  Need  to  see  whether  your  human  resources  are  good,  people  of  right  calibre.  Financials  are  needed  as  FCA  will  be  looking  at  soundness  of  these  companies  

FCA  firms  only  

Business  conducted  in  prudent  manner  (Reason  for  being  of  PRA,  company  must  be  prudent  in  how  dealing  are  handled/ensure  not  about  to  go  bust)  

Dual  regulated  firms  only  

Appropriate  non-­‐financial  resources  (PRA  interested  in  whether  you  have  right  people  around  to  run  the  business)  

Dual  regulated  firms  only  

Claims  reps  (insurers  only)  –  claims  reps  

Dual  regulated  firms  only  

Legal  status  (insurers  only)   Dual  regulated  firms  only    

Need  to  know  all  9  of  these  

 

Legislative  structure  

Does  the  firm  need  authorisation?  –  very  examinable  

1. Is  it  doing  a  regulated  activity?  If  Yes,  2. Is  it  regarding  a  specified  Investment?  If  Yes,    3. Is  it  an  exempt  person?  If  No  

You  would  need  Authorisation!  

 

Regulated  Activities  

Regulated  activities  or  (specified  activities  under  the  Regulated  Activities  Order)  –  there  are  16  

Can  be  divided  into:  

Wholesale  financial  services  activities  –  big  financial  (investment  banks  -­‐buyside)  service  firms  (7)  

• Dealing  in  investments  (buying  and  selling  assets)  

• Dealing  as  an  agent  (executing  orders/trading/broker  for  others  (3td  parties))  • Operating  a  MTF  Multilateral  trading  Facility  (alternative  trading  platform  outside  of  

conventional  stock  exchange  –  institutions  trade  between  themselves  and  allow  some  others  to  trade  on  their  exchange  too)  

(Investment  Management  Community  (sell  side))  

• Managing  investments  (managing  money  for  clients)  • Advising  clients  

(Back  Office  functions)  

• Safeguarding  of  investments    -­‐  (custody,  making  sure  legal  title  has  ben  correctly  transferred,  making  assets  have  been  bought  legally  and  are  safely  kept  and  all  legal  title  in  clear)  

• Sending  de  materialised  instructions    -­‐  (Clearing  houses  perform  this  -­‐  no  longer  have  bits  of  paper  floating  about,  information  sent  electronically  via  various  dedicated  systems  (SWIFT)    to  make  sure  custodians  know  what  has  been  dealt)  

Insurance  

• Offering/effecting  insurance  –  selling  or  running  insurance  contracts  to  clients  • Assisting  in  insurance  –  certain  activities  that  may  be  carried  out  by  legal  3rd  party  for  

insurer  (underwriting  risk,  claims  handler  –  may  not  offer  or  handle  insurance  but  are  vital  if  you  want  to  claim  on  insurance)  

• Lloyds  (of  London)  –  specialised  insurance  market  (original  home  of  insurance)  –  specific  insurance  market  for  insuring  big  ticket  risks  ships  sinking  or  office  being  attacked)  on  Lloyds  trading  floor  these  big  things  are  insured  then  the  risk  is  traded  between  the  various  Lloyd  companies  or  members  

Retail    

• Deposits  takers  • Offering  electronic  money  services  (paypal)    • Regulated  Mortgage  (on  primary  residence)  mortgages  on  second  homes  or  buy  to  let  are  

not  necessarily  regulated    • collective  investment  schemes  (CIS)  –  a  fund  

o Authorised  unit  trust  o Open  ended  investment  company  (investment  company  with  variable  capital)    

• Funeral  plans  -­‐  really  a  form  of  collective  investment  scheme  

 

Agreeing  to  provide  regulated  activities  –  process  of  becoming  regulated  is  quite  long,  what  firms  do  is  while  going  through  service  they  start  legally  committing  to  provide  services  by  agreeing  contracts  with  parties  for  the  future.    

 

MADAM  LEASES  ACAFE  

• Multilateral  trading  ability  • Advising  on  investments  regulated  mortgage/home  finance  contracts/stakeholder  products  

• Dealing  in  investments  as  principal  or  agent  • Arranging  regulated  mortgages/deals  in  investments  • Managing  investments  

 

• Lloyds  insurance  market  related  activities  • Entering  into/administering  a  regulated  mortgage  or  home  finance  contract  • Accepting  deposits  • Safeguarding/administering  investments    • Establishing/operating  winding  up  a  CIS  or  pensions  scheme  • Sending  dematerialised  instructions  

 

• Agreeing  to  provide  regulated  activities  • Carrying  out  or  effecting  contracts  of  insurance  • Assisting  in  the  administration  and  performance  of  a  contract  of  insurance  • Funeral  plan  contracts  • Electronic  money  

 

 

What’s  an  Investment?  

Specified  investment:  

Securities:  

• Shares      -­‐  in  any  company  • All  tradable  debt    

o gilts    o bonds  o treasury  bills  (short  term  tradable  debt  issued  by  British  government)    o commercial  papers  (short  term  tradable  debt  issued  by  companies),    o certificate  of  deposits  (bank  account  that’s  tradable),    o FRNs  (floating  rate  note-­‐    bond  with  variable  rate  of  interest.  o Private  loans  are  not  tradable  unless  they  are  securitised.    o Premium  bonds  are  not  tradable  –  they  are  like  private  loans  between  individual  

and  companies  • Hybrids    

• Depositor  Receipts  –  don’t  actually  take  ownership  of  share,  share  remains  in  hand  of  depositary  investment  banks,  but  you  get  any  benefits  of  share  like  price  appreciation  or  dividend  s  and  votes  –  allows  people  who  don’t  want  to  trade  directly  to  trade  • Global  depositary  receipt  • American  depository  receipt  

• Warrant  o Options  right  to  buy  shares  are  specified  price  

• Rights  to  or  interest  in  investments  

o Repos  –  sale  and  repossession  agreement  –  investment  bank  sells  bond  cause  it  needs  some  short  term  money  and  when  it  sells  bond  it  includes  agreements  to  repurchase  bond.    

Derivatives  –  very  examinable  

• Options  on  investments    (anything  in  securities)  and  on  currencies,  gold,  silver,  platinum  and  palladium  (precious  metals)    

o Options  on  commodities  are  not  specified  investments  (neither  are  commodities  themselves)  

• Futures  for  investment  purposes    -­‐  obligation  to  buy  or  sell  some  underlying  asset  in  the  future  (regardless  of  underlying  asset,  it  is  a  specified  investment)  

• Contracts  for  difference,  e.g.  swaps,  forward  rate  agreements,  spread  betting  in  general  

Insurance  

• Contracts  of  insurance  –  life  and  general  • Lloyds  investments  

Retail  

• Deposits  • Rights  under  a  regulated  mortgage  (primary  residence)  • Rights  under  a  funeral  plan  • Units  in  CIS  –  unit  trusts  &  OEICs  • Personal  and  stakeholder  pensions  (private  –  personally  made  decision  to  take  out  which  

differs  form  occupational  investment)    -­‐  subset  of  above  

 

Exempt  persons  –  from  formal  regulation  process  

Reason  recognised  institutions  are  exempt  is  because  they  are  recognised,  recognition  process  is  far  more  demanding  

5  different  classes  of  exempt  people  -­‐  APRIL  

Appointed  representatives  (Tied  agent)  

• Independent  legal  entity  e.g.  self-­‐employed  insurance  salesman  • If  tied  agent  breaks  any  rule,  the  parent  company  will  be  punished  

Professional  People  (regulated  by  designated  professional  body)  

• Lawyers,  accountants  and  actuaries  

Recognised  Institutions  

• Recognised  investment  exchanges  (LSE)  • Recognised  overseas  investment  exchanges  (NASDAQ)  

o Overseas  exchange  that  can  trade  on  form  the  UK  with  approporate  terminal  • Recognised  Clearinghouses  

o e.g.  Euroclear  (crest)  

Intuitions  (that  are  specifically  exempt)  

• e.g.  IMF  or  Bank  of  England,  

Lloyds  members    

• Made  up  for  firms  or  syndicates/members  that  trade  insurance  on  Lloyds  of  London  trading  floor.    

• To  do  this  trade  you  must  be  a  formal  Lloyds  member  • Lloyds  itself  is  regulated  but  its  member  firms  are  not  • If  any  firms  breach  FCA  rules,  Lloyds  will  punish  (like  appointed  representatives)  

 

Principles  for  Businesses  (firms)  

1. Integrity  –  acting  without  dishonesty,  or  intentionally  misleading  customer  (1=I)  2. Skill  care  and  diligence  –  you  don’t  mislead  customer  through  lack  of  research  (2=Due-­‐

diligence)  3. Managements  and  control  –  CEO  has  sub  managers  and  they  have  team  managers  reporting  

to  them,  a  clear  tree  of  management  control  (3=tree)  4. Financial  prudence  –  businesses  does  not  overstretch  itself  (4=door=often  see  chancellor  

standing  outside  door  who  should  be  most  prudent  person)  5. Market  conduct  –  standards  of  conduct  differ  across  markets  (5=hive  –full  of  honey  and  

money  sells  on  market)  6. Customer  interests  –  TCF-­‐    always  act  in  customers  best  interest  (6-­‐fixed  (rate  of  

return/interest)  7. Communications  with  clients  –  clear  fair  and  not  misleading  –  (7=heaven,  clients  are  gods)  8. Conflicts  of  interest  –  recognises  and  manage  these  conflicts  (8=hate  of  conflict)  9. Customer  relationships  of  trust    -­‐  (9-­‐  wine,  trusting  relationship  have  a  dinner  and  rink  with  

customers)  10. Clients  assets  –  keep  client  assets  safe  and  warm  until  mature  into  cash  (10-­‐hen  (nurtures  

eggs)  11. Relations  with  regulators  (Open  and  honest  with  regulators  (11-­‐RR)  

 

Individuals  can  sue  firm  if  they  are  hurt  because  firms  breached  a  rule  

Hurt  Individual  cannot  sue  firm  for  breach  of  principle  

 

Regulation  of  investment  exchanged  

FCA  has  recognised  number  of  investment  exchanges  such  as:    

• LSE    • NYSE  Liffe  • London  metals  exchange  

Recognised  exchanged  are  required  to  deliver  a  high  standard  of  investor  protection  and  market  integrity    

• Exchanges  have  to  undergo  higher  level  of  checking  out  to  become  recognised  

 

Recognised  clearing  houses  that  used  to  be  recongised  yb  the  FCAs  predecessor  the  FSA,  but  are  now  regulated  by  the  Bank  of  England  

 

Off  exchange  derivatives  (OTC)    

• largely  unregulated  • but  settlement  and  clearing  now  subject  to  new  requirements*  such  as  clearing  through  

central  counterparty  risk  management  procedures  and  reporting.  

 

Regulation  of  derivatives  

MiFID  applies  to  firms  carrying  out  activities  in  relation  to  any  derivative  instrument  

UK  market  regulated  by  the  FCA  (only  in  relation  to  those  derivatives  covered  under  specified  investments)  

International  accounting  standards  states  that  (non-­‐hedge)  derivatives  must  be  rescored  in  the  balance  sheet  at  fair  value.    

• If  fair  value  changes  over  companies  accounting  year,  then  that  should  be  recognised  as  a  gain  or  loss  in  income  statement    

• Except  derivatives  used  a  hedge  where  gains  and  losses  are  recognised  in  reserves  

 

Approved  Persons  (individual)  

Within  an  authorised  firm,  people  carrying  out  ‘controlled  functions’  must  be  approved  

Must  satisfy  the  FCA  as  to  fitness  and  propriety  

1. Honest,  integrity  and  reputation  (going  to  jail  may  exclude  someone  from  this)  2. Competency  and  capability  (including  the  need  to  pass  approved  exams  and  an  internal  

assessment)  3. Financial  soundness  (if  ever  been  declared  personally  bankrupt  you  probably  cannot  look  

after  other  peoples  money)  

Key  issue  is  disclosure,  of  when  apply  you  do  not  disclose  any  relevant  details,  this  immediately  makes  you  dishonest.    

• Approved  persons  must  comply  with  FCAs  “Statements  of  Principle”  

 

Controlled  functions  

(SIF)    

Significant  influence  functions  -­‐  run  whole  departments,  have  influence  on  companies  direction,  policies  and  how  the  business  is  run  

Governing  functions  

• Directors,  partners  if  partnership  

Required  Functions  

• Compliance  oversight  (head  of  compliance)  officer  • Money  laundering  officer  

Systems  and  controls  -­‐  To  have  necessary  control  in  business  that  regulator  says  you  must  have  

• Finance  officer  (head  of  finance)  • Head  of  audit  • Head  of  risk  

Significant  management  

• Trading  company  -­‐  Heads  of  settlement  • Bonds-­‐  Head  of  bond  trading  

 

Majority  of  people  performing  controlled  function:  

Customer  function  -­‐  Anyone  who  has  influence  on  customer’s  wealth  

• Investment  advisor  • Trader  –  indirectly  by  trading  with  market  

 

Who  undertakes  approval:  

If  only  FCA  regulated  (majority  of  firms)  not  considered  systematic  risk  –  FCA  signs  of  any  individuals    

If  working  for  dual  regulated  firms,  PRA  approves  however  PRA  needs  consent  from  FCA  before  grants  approval  

• PRA  checks  individuals    will  handle  businesses  finance  in  right  way  • FCA  will  check  persons  follows  correct  conduct  rules  on  day  to  day  basis  

 

Statements  of  principle  (approved  persons)  –  distinguish  from  principle  of  business  

Apply  to  all  approved  persons  –  first  4  

1. Integrity  2. Skill,  care,  diligence  3. Proper  standard  of  market  conduct  4. Deal  with  regulator  in  open  way  

Apply  only  to  significant  influence  functions    -­‐  

5. Proper  organisation  of  business  –  must  run  area  of  business  responsible,  clear  organisational  structure,  clear  job  descriptions  communicated  clearly  

6. Skill  care  diligence  in  management    -­‐  delegating  is  not  abdication  of  responsibility,  must  understand  what  you  are  delegating  to  understand  if  person  delegating  to  is  doing  good  job  and  not  rogue  trading  

7. Comply  with  regulatory  requirements  –  must  be  proactive,  ensure  that  areas  of  business  you  are  responsible  for  respond  to  changes  in  regulatory  environment,  

The  code  of  practice  for  approved  persons  sets  out  descriptions  of  conduct  that  does  not  comply  with  the  above  principles.    

 

FCA  Handbook  

5  Main  books  

High  level  standards  

• Principle  for  business  • Statements  of  principles  • Threshold  conditions  • Fit  and  proper  test  • Training  and  competence  • Senior  manage  arrangements  • System  and  controls  

Business  standards  

• Conduct  of  business  • Client  assets  • Market  conduct  

Regulatory  processes  

• Supervision  • Decision  procedure  and  penalties  manual  

Redress    

• Complaints  handling  • Compensation  –  not  very  examinable  

Regulatory  guides  

• Enforcement  guides  

 

Knowledge  of  other  books  not  required  –  just  know  they  exist  should  be  enough  

(prudential  standards,  specialist  sourcebooks  and  listing,  prospectus  and  disclosure)  

 

Senior  manage  arrangements  system  and  controls  (SYSC)  

Purpose:  

• System  and  controls  are  appropriate  to  the  nature,  scale  and  complexity  of  the  firm  o Outcomes  based  so  different  companies  require  different  types  of  systems  

• Effective  compliance  systems  (especially  countering  financial  crime)  • Create  common  platform  of  requirements  for  firms  subject  to  CRD  and/or  MiFID  

o To  achieve  consistency  across  Europe  –  Common  platform  

Apportionment  of  senior  management  responsibilities  

• CEO  responsible  for  apportionment  • Knowing  and  recording  who  does  what  (recorded  kept  for  at  least  5  years  from  

organisational  structure  changes  –  MiFID)  

Training  competence  and  professionalism  

All  staff  (everyone)  employed  in  authorised  firms  must  be  competent  

If  dealing  with  retail  clients:  

• Employee  must  be  assessed  as  competent  • Employee  must  be  supervised  

 

Retail  distribution  review  –  new  requirements  from  Jan  2013  when  giving  retail  investment  sector:  

• Retail  investment  advisor  must  hold  statement  of  Professional  standing  –issued  by  an  accredited  body  such  as  the  CISI  

• The  SPS  confirms  that  the  advisors  hold  an  appropriate  level  4  qualification  and  has  completed  a  minimum  of  35  hours  CPD  per  year  /  21hours  must  be  structured  

In  addition  to  the  above  advisors  must  subscribe  to  a  code  of  ethics  

 

Takeover  Code  

Regulated  by  the  Takeover  Panel    

Takeover  panel  Funded  by  a  £1  levy  on  LSE  share  transactions    (buyer  and  sellers)  above  £10k  

Regulates  offers  for  shares  in  all  UK  public  limited  companies  (plcs)  that  are  listed  on  exchanges  

Key  points  

• Promote  fairness  (note:  the  code  does  not  consider  competition  issues  or  public  interest)  o Equal  treatment  for  all  shareholders  of  a  particular  class  o Allow  a  reasonable  period  for  the  bid  to  be  considered  

• Reduce  occurrence  of  defensive  measures  take  by  target  co.  Discourage  financial  structure  that  make  it  difficult  for  someone  to  launch  a  takeover  bid,  so  they  can  be  launched  so  the  investors  can  then  decide  whether  or  not  they  wish  to  go  forward    

• Mandatory  bid  is  required  if  shareholder  acquires  >  30%  of  the  voting  rights  of  a  company.  They  must  make  a  cash  offer  to  all  other  shareholders  at  the  highest  price  paid  in  12  months  before  the  offer  was  announced.  

o Below  30%  considered  minority  shareholder.    • Offer  must  remain  open  for  >21  days  • If  achieve  >90%  acceptance  –  can  compulsorily  purchase  remaining  10%  • Directors  of  target  company  should  not  deny  shareholders  the  opportunity  to  consider  the  

bid.  

The  competition  and  Markets  Authority  (CMA)  

The  CMA  was  established  under  the  Enterprise  and  Regulatory  reform  Act  2013.  

Will  investigate  all  mergers  if  :  

• Proposed  merger  where  turnover  of  company  is  at  least  >70  m  in  UK  • Or  when  combined  market  share  is  at  least  25%  of  total    

If  either  of  two  tests  are  breached  they  will  launch  a  Phase  1  Study  (takes  up  to  40  days)  

• To  determine  If  the  merger  results  in  substantial  lessening  of  competition    

Phase  2  Investigations  

Merger  may  be  approved,  prohibited  or  remedies/conditions  imposed  

• Statuary  time  of  12  weeks  following  phase  2  for  remedies  to  be  implemented.  

Fines  

CMA  is  empowered  to  impose  fines  up  to  5%  of  the  combined  worldwide  turnover  of  merging  companies  for  breach  of  an  order.    

They  can  also  impose  fines  for  failure  to  provide  requested  information.    

 

Data  Protection  Act  1998  

Data  protection  act  applies  when  processing  personal  data  

Data  controllers  must  register  with  the  Information  Commissions  officer  (ICO)  

If  in  contravention  of  data  protection,  commissioner  can  serve  enforcement  notice.  Failure  to  comply  with  enforcement  notice  could  lead  to  a  £500,000  fine  

Eight  principles  to  ensure  personal  information  is:  

• Fairly  and  lawfully  processed  • Processed  for  limited  purposes  • Adequate,  relevant  and  not  excessive  

o Required  to  keep  data  on  customers  to  satisfy  rules  (anti  money  laundering).  Data  protection  act  would  say  that  if  you  asks  for  information  that  is  not  required  for  regulatory  purposes  then  they  are  in  breach  

• Accurate  and  up  to  date  • Not  kept  for  longer  than  necessary    • Processed  in  line  with  an  individuals  rights  • Secure  • Not  transferred  to  other  countries  without  adequate  protection  

o If  data  moved  must  be  confident  that  data  protection  rules  in  that  country  are  adequate  enough  

• Person  whose  data  is  held  is  entitled  to  ask  for  access  to  that  information  (subject  access  request)  and  has  the  right  to  correct  where  appropriate.    

o They  can  be  charged  a  maximum  fee  of  £10  for  access  (max  fee  of  £2  for  credit  reference  agency  records)    

o The  person  entitles  to  be  told  the  source,  purpose  and  recipients  of  data.    o DPA  1998  requires  that  subject  access  requests  take  place  within  40  days  of  the  

request  (including  fees)  being  received.    

Breach  is  a  criminal  act  resulting  in  fines  but  not  jail  

 

Whistleblowing  procedure  

• Whistle-­‐blower  interests  stem  from  Public  interest  disclosure  Act  1998  -­‐  Law  • Law  is  detailed  in  SYSC  –  part  of  FCA  handbook  -­‐  regulation  • Process  whereby  a  worker  seeks  to  make  a  disclosure  to  a  regulator  or  law  enforcement  

agency  relating  to  criminal  offence  or  breach  of  rules  (e.g.  FCA  rules)  • No  contractual  restrictions  for  whistleblowing  • Should  be  no  discrimination  for  whistleblowing  

 

Trustee  Act  2000  

When  set  up  a  trust,  should  be  legal  trust  deed  behind  it  which  gives  clear  advice  of  how  any  money  should  be  invested  

If  no  trust  deed,  trust  act  2000  would  be  default  

Trustees  are  in  power  to  invest  in  any  appropriate  asset  and  must  review  investments  and  obtain  and  consider  advice.    

 

Pension  Act  2004  

Introduced  new  regulatory  authority  –  the  pensions  regulator    

• For  occupational  pensions  • Defined  benefit  Pensions  only  –  promise  certain  %  of  your  salary  when  you  retire  

New  Pensions  protection  fund  for  where  an  employer  who  runs  a  scheme  becomes  insolvent  and  unable  to  pay  liability    

PPF  provides  compensation  up  to  100%  of  benefits  to  existing  pensions  and  90%  to  those  not  yet  retired  (funded  by  charges  on  companies  that  run  these  pensions  on  other  defined  benefit  pension  schemes)  

Minimum  funding  requirement  replaced  by  scheme  specific  objectives:  

• Required  trustees  of  defined  benefit  schemes  to  prepare  a  statement  of  funding  principles  which  will  clearly  outline  how  necessary  funding  will  be  achieved  –  outlines  what  future  liabilities  will  be  and  how  much  companies  needs  to  put  in  to  attain  that  target  

• This  must  be  reviewed  every  3  years.  

 

Conducts  of  Business  Sourcebook  (COBS)  

Who?  

Applies  to  Authorised  firms  

What?  

Day  to  day  activity  rules  in  relation  to:  

• Client  categorisation  • Financial  promotions  • Investment  research  • Suitability  and  appropriateness  • Dealing  and  managing  • Client  assets  and  client  money  

Rules  on  Client  Assets  are  covered  by  a  separate  sourcebook  (CASS)  

 

Client  Categorisation  

Anyone  you  would  be  offering  financial  services  to  are  potential  clients  

Look  at  the  level  of  knowledge  of  financial  services  that  clients  have  

High  level    

• Eligible  counterparty  (other  authorised  firms)  • Level  of  protection  will  be  low  

Eligible  Counterparty  –  must  want  following  services:  

• Receipt  and  transmission  of  orders  • Execution  of  orders  • Dealing  on  own  account  

Per  se  eligible  counterparties    

Authorised  firms    

National,  central  banks,  international/supranational  intuitions  

Low  level    

• Retail  client  • Level  of  protection  will  be  high  

Retail  

• Individuals  and  persons    • Small  businesses  

Medium  Level  

• Professional  Client  • Medium  level  of  protection  

Professional  

• Authorised  firms  when  business  they  seek  when  business  they  is  not  in  eligible  counterparties  risk  

• Large  undertakings  in  non  finance  

Per  se  Professional  client  

Authorised  firms  who  are  not  eligible  counter  party  

National,  central  banks,  international/supranational  institutors  and  regional  government  

Institutional  investor  whose  main  activity  is  to  invest  in  financial  instruments    -­‐  SPV  

A  large  undertaking  which  meets  two  of  the  following  :  

If  subject  to  MiFID  • €20m  balance  sheet  total  • €40m  net  turnover  • €2m  own  funds  

 Non-­‐MiFID  

• €12.5m  balance  sheet  total  • €25m  turnover  • 250  average  employees  in  year    

 

or  (single  test  trumps  all  others:  

• £5m  share  capital/net  assets  

Clients  can  elect  to  opt  up,  subject  to  certain  criteria  

• Protection  costs  money,  so  may  end  up  with  cheaper  fees  

• Retail  clients  may  be  deemed  unable  to  handle  risk  of  certain  products  so  may  have  greater  access  to  products  

 

General  notification  

Firms  must  notify  clients  of  their  categorisation  

Prior  to  the  provision  of  services  firms  must  inform  the  client  

• Any  right  to  request  a  different  categorisation  and  • Any  limitations  to  the  level  of  client  protection  that  such  a  different  categorisation  would  

entail  

 

Elective  professional  Clients  

3  letters  in  this  process  

A  firm  can  treat  a  retail  client  as  an  elective  professional  client  if:  

• Firm  carries  out  a  Qualitative  test  and  for  MiFID  business  also  a  and  Quantitative  tests  • Clients  requests  this  in  writing  and  • Forms  gives  clear  written  warning  of  the  protections  and  investor  compensation  rights  lost  • clients  states  in  writing  in  a  separate  document  that  they  are  aware  of  the  consequences.    

 

Qualitative  and  Quantitative  tests  

Qualitative  test  

Firm  undertakes  adequate  assessment  of  KNEES  

• Knowledge  and  • Expertise  • Experience  of  the  clients  

 

This  assessment  hives  firms  reasonable  assurance  that  client  is  capable  of  making  their  own  investment  decision  and  understands  the  risks  involved  

Quantitative  test  –  only  if  MiFID  business  (3  Rs:  Regular,  Rich,  Resume)  

At  least  two  of  three  of  following:  

• Client  has  traded  in  significant  size  on  the  relevant  market    (that  they  are  seeking  business  with  you  in)  at  an  average  frequency  of  10  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  which  

requires  knowledge  of  transactions/services  

 

Financial  Promotions    

Must  follow  rules  appropriate  to  type  of  client  

Financial  Promotions    -­‐  Invitation  or  inducement  to  engage  in  investment  activity  

Written  promotions  (non-­‐real  time)    

• Adverts  • Letter    • Mailshots  • Websites  • Emails  

Non-­‐written  (real  time  promotions)  –  potentially  more  aggressive  

• Meetings  • Telephone  Calls  

 

FSMA  2000  

Financial  promotion  can  only  be  issues  by  an  authorised  financial  services  firm,  if  not  authorised  would  need  approval  by  authorised  financial  firm  

• e.g.  Overseas  financial  firm  not  authorised  would  may  seek  to  enter  UK  market    

 

COBS  Financial  Promotion  

Communication  and  financial  promotions  must  be  fair,  clear  and  not  misleading  

Guidance:  

A  firm  should  ensure:  

• It  is  clear  if  a  clients  capital  is  at  risk  • Any  yield  figure  quotes  gives  a  balanced  impression  of  short/long  term  prospects  

o If  1st  year  of  investment  gives  bonus  high  rate,  but  drops  in  subsequent  year  must  give  balanced  view  of  this  

• Complex  charging  structures  are  explained  • The  FCA  is  named  as  regulator  • A  clear  impression  is  given  of  any  3rd  party  packaged/stakeholders  product  provider  

 

Exceptions  

• Those  communicated  only  to  investment  professionals  (dragons  den  types)  or  eligible  counterparties    

• Excluded  communications  –  if  there  are  another  set  of  rules  that  apply  to  communications.  E.g.  takeover  rules  take  precedence  over  financial  promotions  rules  

• A  ‘one-­‐off’  promotions  (that  is  not  a  cold  call)  –  communicated  to  a  specific  client  or  to  one  group  of  recipients  -­‐  could  be  a  rich  individual  or  family  and  promotion  is  tailored  to  their  needs.    

Communications  with  retail  clients  

Requirements  for  communications  with  retail  clients  

• Must  be  likely  to  be  understood  by  an  average  member  of  the  target  group  • Fair  and  prominent  indication  of  relevant  risks  • Important  items  are  not  disguised,  diminished  or  obscured  • Must  include  the  name  of  the  firm  

 

Comparisons  of  investments/businesses  must  be  fair  

• Specify  information  sources,  key  facts  and  assumptions  o Comparisons  must  be  fair  –  e.g.  cant  compare  returns  on  bank  deposit  to  equity  

 

Past  performance  data  

Past  performance  data  should:  

• Not  be  the  most  prominent  feature  of  the  communication  • Contain  a  warning  that  pas  performance  is  not  a  reliable  indicator  of  future  results  • Cover  at  least  5  years  immediately  preceding  consecutive  12  months  • Include  reference  period  and  source  • Contain  a  currency  risk  warning  • Disclose  the  effect  of  charges  if  based  on  gross  performance  

 

Cold  calls/unsolicited  calls  

Investment  firms  must  not  make  a  cold  call  unless:  

• Existing  relationship  where  recipient  envisages  the  call  • It  relates  to  generally  marketable  packaged  product    

o We  are  allowed  to  sell  to  retail  public,  investment  itself  should  be  authorised  and  regulated  by  the  FCA.  Not  just  firms  that  are  regulated,  products  must  also  be  regulated  

• It  relates  to  a  controlled  activity/service  carried  out  by  an  authorised  firm/  or  exempt  person    o involving  readily  realisable  securities  (other  than  warrants)  o these  are  liquid  and  readily  tradable  

Definition  of  packaged  product  (CLIPS)  

• Collective  investment  schemes  (regulated)  • Life  policies  

• Investment  trust  savings  scheme  –  not  collective  investment  because  it  is  closed  ended,  finite  number  of  shares.  Like  a  company  with  shares  trading  on  the  market  although  all  it  does  is  own  shares  or  stakes  in  other  products.    

o ITSS  (savings  scheme)  You  invest  a  regular  sum  of  money  with  provider  each  month  who  n  turn  puts  money  into  investment  trust  

o Investment  directly  into  Investment  trust  is  not  a  packaged  product  • Personal  pensions  • Stakeholder  pensions  

o Personal  and  stakeholder  are  private  pensions.  Stakeholder  pensions  have  lower  costs  

 

Non-­‐written  financial  promotions  

A  firm  must  not  initiate  a  non-­‐written  financial  promotion  unless  the  persons  communicating  it:  

• Does  so  at  an  appropriate  time  of  day  (for  recipient)  (must  justify  appropriate  for  specific  person  

• Identifies  himself  and  the  firm  at  the  outset  and  makes  the  purpose  of  the  communication  clear  

• Terminates  the  communication  at  any  time  if  requested  to  do  so  • If  signed  up  for  communication;  A  contact  point  must  be  given,  so  that  a  future  meeting  if  

arranged  can  be  cancelled.    

 

Investment  adviser  charging/remuneration  

New  rules  since  Jan.  2013  prevents  firms  making  personal  recommendations  from  earning  commission  set  by  product  provider  

Applies  to  retail  investment  products  (broader  than  packaged  product)  

• Firms  offering  such  service  now  charge  for  the  advice  they  provide  • Charges  must  be  disclosed  in  writing  in  good  time  before  advice  given  using  clear  and  plain  

language  • Clients  have  the  option  of  paying  the  charge  upfront  or  may  have  it  deducted  from  their  

investment  • Advisors  can  no  longer  receive  commission  from  fund  managers  

Issues:  

• Transparency  • Conflict  of  Interest  

 

Independent  advice  and  restricted  investment  advice  

Independent  advice  –  you  must  cover  all  suitable  retail  investment  products,  relevant  to  the  client  base  from  relevant  providers    

• The  RDR  introduced  a  new  definition  of  independent  advice  –  which  consider  all  suitable  retail  investment  products  

Restricted  advice  

• Advice  which  is  not  independent  is  described  as  restricted  • Firms  must  disclose  the  nature  of  the  restrictions  (e.g.  limited  number  of  product  providers  

or  specific  types  of  product)  to  the  client  

 

Advising  on  packaged  product  

Advisers  can  choose  to:  

• Advise  on  the  whole  of  the  market  (independent  financial  advisor)  • Advise  on  limited  product  range  (restricted)  • Advise  on  a  single  providers  products      -­‐  Appointed  representative    (exempt  from  

authorisation)  

Key  Feature  Document  must  be  given  to  a  retail  client  when  providing  a  recommendation  on  a  packaged  product  including:  

• Details  on  nature  and  complexity  of  the  product  • Complaints  handling  procedure  • Compensations  schemes  (if  provider  goes  bust)  • Cancellation  rights  (if  client  invests  but  changes  their  mind)  

 

Suitability  and  suitability  reports  

• For  all  Retail  and  professional  clients:  • Applies  to  personal  recommendations  and  firms  managing  investments  • Reasonable  steps  must  be  taken  to  ensure  suitability    • In  order  to  do  this  firms  must  obtain  necessary  information  regarding  the  clients:  

o Relevant  knowledge  and  experience  o Financial  situation  o Investment  objectives  

• Retail  clients  must  be  sent  a  suitability  report  if  recommendation  related  to  an  investment  in  a  packaged  product.  

 

Appropriateness  obligations  

For  all  Retail  and  professional  clients:  

For  investment  services  other  than  managing  investments  and  personal  recommendations  (essentially  execution  only)  –  no  advised  service  

• No  need  to  assess  appropriateness  in  relation  to  noncomplex  financial  instruments  • Firms  to  assess  appropriateness  based  on  the  clients  relevant  knowledge/experience  

• If  the  product/service  is  not  considered  appropriate  you  must  warn  client  • Where  there  is  insufficient  information  to  assess  appropriateness  the  firm  must  notify  the  

client  that  we  cannot  do  appropriateness  check.  It’s  a  firm’s  discretion  whether  or  not  they  execute  order.  

 

Best  Execution  

Applies  to  retail  and  professional  clients  

• When  executing  order  a  firm  must  take  all  reasonable  steps  to  obtain  the  best  possible  results  for  its  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.  

Churning  and  switching  

Dealing  with  unjustified  frequency/overtrading  

Maybe  due  to  racking  up  commissions  

Firm  should  be  acting  in  firms  best  interest  

• Churning  –    relates  to  investments  in  general  (switching  between  securities/assets)  • Switching  –  if  managing  portfolio  of  packaged  products  (switching  between  funds)  

 

Order  Execution  Policy  

Clients  must  have  prior  consent  to  execution  policy  

For  each  class  of  financial  instrument  policy  should  include  

• Information  on  different  execution  venues  and    • Factors  affecting  the  choice  of  venue  

 

For  retail  clients,  the  following  information  must  be  given  in  advance  

• The  relative  importance  of  the  execution  factors  • A  list  of  execution  venues  • Warning  that  specific  instructions  may  prevent  firm  form  following  its  policy  to  obtain  the  

best  possible  results  

 

Clients  Order  Handling  

Retail  and  professional  clients  

• Firms  must  implement  procedures  and  arrangement  which  provide  for  the  prompt  fair  execution  of  client  orders  

• Comparable  orders  to  be  executed  in  accordance  with  the  time  of  receipt  by  the  firm  

 

Aggregation  and  Allocation  of  Orders  

• Could  potentially  aggregate  orders  as  long  as  you  believe  it  will  not  disadvantage  either  or  clients  and  you  disclose  to  clients  that  you  will  do  this  and  that  you  have  proper  allocation  policy  (our  systems  and  3rd  party  systems  clearly  know  about  the  allocations)  

 

Inducements  

A  firm  must  act  honestly,  fairly  and  in  best  interest  of  their  clients  

Any  fee  commission  or  non  monetary  benefit  paid  to  or  provided  by  a  3rd  party  must  be  designed  to  enhance  the  quality  of  service  to  the  client  

A  firm  must  disclose  too  the  client  any  fees  commissions  or  nonmonetary  benefits  in  summary  form.  

 

Use  of  Dealing  commission  (Unbundling)  

• Fund  manager  passes  business  to  broker  who  they  pay  commission  to  execute  the  order  • In  return  the  broker  executes  and  provides  research  +  other  goodies  (subscription  to  

Bloomberg,  invite  analysts  to  training  and  education  conference)  • Problem  is  that  fund  managers  customer  is  paying  the  commissions.  Anything  that  

commission  buys  should  give  a  benefit  to  the  customer.  • Rules  now  say  that  in  return  for  payment  of  commission,  no  other  goodies  are  acceptable.    

Commission  can  only  pay  for  execution  of  trades  and  research    • Unbundle  packages  of  returns  form  commission  to  make  more  transparent  what  customer  is  

paying  for.    

An  investment  manager  must  not  execute  customer  orders  through  a  broker  and  pass  on  charges  to  client  unless  the  manage  has  reasonable  ground  to  be  satisfies  that  the  goods  services  purchased  with  commission:  

• Relate  to  the  execution  of  trades  • Comprise  the  provision  of  research    • Will  assist  the  manager  in  providing  services  to  its  customers  • Do  not  impair  compliance  with  the  duty  to  act  in  clients  best  interest  

 

Conflicts  of  Interest    

Firms  must  identify  conflicts  of  interest  between    

• The  firms  and  its  clients  • One  client  and  another  

Maintain  effective  arrangements  to  manage  conflicts  

If  the  arrangements  are  not  sufficient,  and  cannot  manage  conflict  must  disclose  the  nature  of  conflicts  to  firms  and  clients  

Provide  retail  clients  with  a  copy  or  summary  of  policy  

Keep  record  of  any  conflicts  

 

Conflicts  of  Interest  Policy  

The  conflicts  of  interest’s  policy  must:  

Set  out  the  circumstances  which  gives  rise  to  a  conflict  

State  the  procedure  for  managing  conflicts,  which  could  include:  

• Information  barriers  such  as  ‘Chinese  walls’    -­‐  prevents  information’s  from  following  from  the  private    (M+A  advisory)  to  the  public  (advisors,  analysts).    

o Must  prevent  information  from  flowing  between  these  two  groups  • Remuneration  structures    -­‐  Avoid  pay  structures  that  create  conflicts  –  if  advisors  paid  by  

commission  they  may  not  be  working  in  best  interest  of  clients  • Independence    -­‐  analysts  are  independent  to  the  private  side.  Stop  one  side  from  influencing  

decision  or  research  of  the  other  (pressuring)  • Segregation  of  duties  –  having  a  senior  manager  in  charge  of  both  public  and  private  would  

be  bad.  Need  to  segregate  those  duties  

 

Investment  research  

Apply  to  investment  research  which  is  intended  to  be  disseminated  to  clients/public  

Covers  written  or  oral  material  

Firms  arrangements  must  manage  conflicts  of  interest  and  cover  

• No  personal  or  firm  transactions  in  unpublished  research  until  clients  have  had  reasonable  opportunity  to  act.  

• No  personal  transactions  contrary  to  their  current  recommendation  • No  promises  of  favourable  research  to  firm  subject  of  research  or  will  always  have  a  conflict  • No  editorial  control  for  the  subject  of  the  research  

If  significant  shareholder  of  company  we  wirte  share  on,  then  we  cannot  get  around  conflict.  In  such  cases:  

• Disclose  all  relationships  and  circumstances  which  may  impair  objectivity  of  recommendation    

Personal  Account  Dealing  –  requirements  

Firms  must  establish  implement  and  maintain  adequate  arrangements  to:  

• Prevent  employees  engaging  in  market  abuse  (insider  dealings  and  related  offenses)  • Ensure  all  relevant  persons  are  aware  of  restrictions  

• Ensure  any  deals  are  notified  promptly  to  the  firm:  post  trade  notification  • Ensure  adequate  transactions  record  are  kept:    

Exceptions:  discretionary  fund  management  and  nits  in  collective  investment  schemes  (one  information  in  one  security  held  in  fund  (which  generally  has  minimum  of  16  securities)  

 

Cancellation  Rights  

Life    policies  and  pensions  (stakeholder  or  personal)  –  you  have  30  days  to  cancel  without  being  charged  any  fees  or  commissions  

Other  products    -­‐  14  days  

• Consumer  must  be  informed  of  a  right  to  cancel  • Cancellation  date  is  the  date  of  dispatch  

Record  Keeping  

General  rule  

• MiFID  –  5  years  • Non-­‐MiFID-­‐  3  Years  

Records  relating  to  pensions  and  life  policies  must  be  kept  for  5  years.  

Those  relating  to  pension  transfers,  pension  opt-­‐outs  or  a  free  standing  AVC  must  be  kept  indefinitely.    

Record  keeping  re.  financial  promotions  relating  to  life  policies  and  pension  must  be  kept  for  6  years.    

 

Reporting  requirements  

Occasional  -­‐  If  executing  order  for  client  we  must  provide  (occasional)  reporting  

Retail  and  professional  clients  

Retail  clients  to  be  sent  an  order  confirmation  by  T+1  

• Except  when  managing  investments  

Periodic  –  applies  to  investment  managers  

• Must  provide  periodic  statements  that  gives  information  on  content,  value  and  performance  of  fund  at  regular  periodic  individual  

• Default  is  every  6  months  for  normal  securities  (shares,  bonds)  • 3  months  on  request  • If  provide  clients  with  order  confirmations,  the  you  only  need  to  send  report  eervy  12  

months  • If  portfolio  is  leveraged  (or  through  derivatives)  can  create  a  lot  of  volatility  in  value  of  fund.  

Because  of  this  extreme  volatility  must  report  back  to  client  on  monthly  basis  

 

Holding  of  Client  assets  and  client  money  

Make  adequate  arrangement  to  safeguard  client’s  ownership  rights  in  event  of:  

• Insolvency  of  a  firm  –  make  sure  that  clients  assets  and  money  is  separate  from  firms  assets  and  money  

• Unauthorised  use  by  the  firm  –  i.e.  client  must  give  prior  consent  to  their  use  in  security  transactions  such  as  stock  lending.    –  if  hedge  fund  want  to  take  short  position  (sell  something  they  don’t  won)  they  borrow.  Clients  may  not  like  their  stocks  lent  out  to  hedge  funds  

Have  an  adequate  organisation  arrangements  to  minimise  risk  of  loss  or  reduction  of  financial  instruments,  misuse,  fraud,  poor  administration,  inadequate  record  keeping  negligence.    

 

Custody  Reconciliations  

A  firm  must  reconcile  internal  records  with  those  of  3rd  parties  (such  as  custodian  –  who  would  have  definitive  record  of  firms  assets)  

• As  regularly  as  necessary  • As  soon  as  reasonably  practicable  after  the  reconciliation  date  

Correct  any  discrepancies’  promptly  

Notify  the  FCA  of  any  breaches  without  delay  

 

Client  money  

• Money  which  firm  is  looking  after  which  is  not  its  own  • Client  money  must  be  held  on  trust  • Client  bank  account  should  be  separately  identifiable  form  the  firms  own  account  • Main  purpose  of  rules  is  to  ensure  money  is  protected  in  the  event  of  insolvency.  

Pollution  of  trust  –  if  moneys  of  firms  and  clients  account  become  mixed.  Client’s  accounts  are  susceptible  to  be  taken  by  creditors  in  event  of  insolvency.    

 

A  firm  must  reconcile  its  internal  record  with  those  of  3rd  parties  (banks)  

As  regularly  as  necessary    

As  soon  as  reasonable  practical  after  the  reconciliation  date  

 

Correct  discrepancies  promptly    

• If  shortfall  in  client  account  top  up  account  –  not  pollution  • If  excess,  remove  immediately  –  this  is  pollution  of  account  

Notify  FCA  of  any  breaches  without  delay  

 

Offences  under  FSMA  2000  

FSMA  makes  it  an  offence  to  do  the  following:  

• Describe  oneself  as  authorised  or  exempt  if  one  is  not  authorised  or  exempt  • Contravene  section  21  –  financial  Promotion  • Make  false  or  misleading  statements  • Knowingly  or  recklessly  creating  a  false  impression  (for  the  purpose  of  personal  gain  

or  loss  to  another  person)  o Might  conduct  phantom  transactions  between  themselves  and  another  

counterparty  (washing)  to  make  market  for  a  security  look  more  liquid  • Contravene  section  91  (FSA  2012)  in  relation  to  benchmarks,  specifically  to  make  to  

another  person  a  false  or  misleading  statement  or  to  an  act  or  engage  in  any  course  of  conduct  that  creates  false  or  misleading  impression  

o Offense  to  deliberately  use  bench  mark  that  does  not  give  fair  comparison  (picking  one  that’s  easy  to  beat).  

Approaches  to  supervision:  FCA  

The  FCAs  supervision  model  is  based  on  three  pillars:  

• Firm  systematic  framework  (FSF)    o preventative  work  through  regular  structured  assessment  of  firm  conduct  

• Event-­‐driven  work    o dealing  with  emerging  issues  and  those  that  arise  outside  of  the  regular  cycle  

of  firm  assessment  • Issues  and  products  

o  fast  intensive  campaigns  on  particular  products  or  market  sectors  

Discipline  and  enforcement    

Discipline  

For  disciplining  firms  or  approved  individuals  

• Private  warning  • Public  censure  –  Published  on  website  of  regulator  and  picked  up  by  financial  press  

(reputational  damange)  • Unlimited  fines  

 

• Varying  or  cancelling  permission  –  cancel  authority  to  conduct  in  one  or  all  areas  • Withdrawal  of  approval  –  individuals  who  are  approved  

A  firm/individual  can  appeal  to  the  Upper  Tribunal  (not  part  of  the  FCA)  

• Part  of  Tax  and  Chancery  chamber,  witihin  of  justice  system  

FCA  has  power  to  invoke  ‘temporary  product  intervention  rules’  (TPIR)  allowing  a  product  to  be  restricted  or  banned  without  following  the  normal  disciplinary  process.  

Complaints  procedure  

Complaint-­‐  any  expression  of  dissatisfaction  in  any  form  

• Appropriate  and  effective  complaints  handling  procedures  • Publish  summary  of  procedures  and  refer  eligible  customers  to  it  at  point  of  sale  • Within  8  weeks  of  receiving  complaint  firm  must  either  have  sent  

o A  final  response;  or  • If  unable  to  resolve  issue  in  8  weeks:  

• A  letter  explaining  why  the  complaint  has  not  been  resolved  and  notification  that  complaint  can  be  referred  to  the  financial  ombudsman  service  

• Summary  report  to  the  FCA  every  6  months.  

Financial  ombudsman  service  (FOS)  

Independent  archer  between  complaining  client  and  firm  

Easy  cheap  and  quick  route,  low  publicity  to  resolution  rather  talking  complaint  to  court  

FOS  has  two  Jurisdiction  

• Compulsory  Jurisdiction  –  FCA  regulated  firms  • Voluntary  Jurisdiction  –  VJ  participants  

The  firm  must  cooperate  with  the  FOS  investigation:  

Must  complain  to  FOS:  

• Within  6  years  of  event  happening  or  • 3  years  of  customers  knowing  of  the  problem  or    • If  raised  complaint  with  firm,  then  you  have  6  months  of  the  firms  final  response  

Maximum  award  £150,000  +  expenses  

 

Financial  Service  Compensation  Scheme  

Final  safety  net  for  eligible  claimants  of  failed  UK  authorised  firm:  

• Claim  must  be  made  within  6  years  of  the  date  when  the  loss  occurred  • Maximum  pay-­‐out  is  £50,000  for  investment  business  –  for  funds  or  securities  • Maximum  pay-­‐out  is  £85,000  –  on  any  deposits  

 

Insider  dealing  –  Criminal  Justice  Act  1993  

Inside  Info    

• Unpublished    • Price  sensitive    • Specific/precise  

Inside  Source  

• Director  • Employee  • Shareholder  • Virtue  of  work  or  employment  elsewhere  (in  investment  bank)  • Direct/indirect  source  is  one  of  above  

Insider  

• Dealing  –  via  market/professional  intermediary  o If  done  privately  OTC,  probably  not  subject  to  insider  dealing  

• Encouraging  –  others  to  deal  • Disclosing    -­‐  Inside  information  (unless  proper)  

 

Note  that  Insider  dealing  covers  shares,  bonds,  warrants,  depositary  receipts  and  derivatives  (including  contracts  for  differences)  

Did  not  expect  it  to  lead  to  a  profit…  

General  Defences  

Dealing  

• Did  not  think  it  would  lead  to  profit  • Believed  it  to  be  already  widely  known  • Would  have  done  it  anyway  

Encouraging  

• Did  not  think  it  would  lead  to  profit  • Believe  it  to  be  already  widely  known  • Would  have  done  it  anyway  

Disclosing  

• Did  not  think  it  would  lead  to  profit  • Did  not  expect  it  to  lead  to  dealing  

 

Special  Defences  (for  certain  circumstances/actors)  

• Market  Maker  or  those  complying  with  stabilisation  rules    

o Stabilisation  rules  carried  out  during  IPOs,  prices  can  be  volatile  so  stabilisation  broker  can  buy  shares  to  stabilise  prices  

• Market  information  o Dawn  raids  –  if  company  thinking  about  takeover  and  buys  shares  in  the  

target  company  to  build  up  ownership  prior  to  formal  bid  

Penalties  and  enforcement  

Penalties  

• Summary  Conviction  (Magistrates’  Court)  o Max:  6  months  prison  and  £5,000  fine  

• (More  serious)  Indictment  (crown  court)  o Max:  7  years  prison  and  unlimited  fines  

Enforcement  

Her  Majesties  Treasury  legislation  –write  laws  on  insider  trading  

LSE  investigate  –  as  usually  occurs  on  exchange  

FCA  prosecutes  but  cannot  send  to  jail,  can  only  take  to  court  

 

Market  abuse  

• Covers  all  persons  • Seven  types  of  behaviour  that  can  constitute  market  abuse  • It  is  a  civil  offense  (so  no  jail)  • Sanctions  

o Unlimited  fines  o Public  censure  

 

Overview  of  Market  abuse  

Behaviour  occurring  in  relation  to  qualifying  investments  traded  on  prescribed  market.    –  any  European  economic  market  or  investment  traded  on  such  market.    

Focused  on  effect  not  intent.  

Insider  Dealing:    

• Insider  dealing  • Improper  disclosure  • Misuse  of  information  –  much  more  general  

Market  Manipulation  –  misleading  people  to  try  and  make  a  profit  

• Manipulating  transactions  • Manipulating  devices  • Dissemination  of  false  or  misleading  information  • Misleading  behaviour  and  distortion  

 

Money  Laundering  

Definition:  Process  by  which  criminals  seek  to  hide  the  true  origins  of  money  derived  from  activities  (whatever  they  may  occur)  considered  by  the  UK  to  be  criminal  conducts  e.g.  drugs,  terrorism,  tax  evasion,  minor  theft.  

Legislation  

• EU  Money  Laundering  Directive    • Proceeds  of  Crime  Act  2002  –focuses  on  individual  liability  • UK  Money  laundering  Regulations  2007  –  focuses  on  company  liability  • Senior  Management  Arrangements  Systems  and  Controls  (SYSC)  

The  3  stages  

Placements  -­‐>  laying  -­‐>  Integration  

• The  placement  stage  will  involve  retail  financial  entities:  banks  and  building  societies  as  cash  related.  

• The  layering  and  integration  stages  more  likely  to  involve  investment  management  business.    

Proceeds  of  Crime  Act  2002  

Individual  liability  

• Assistance    o 14  years  in  jail  and/or  unlimited  fine  

• Failure  to  report  knowledge/suspicion  or  reasonable  grounds  o 5  years  in  jail  and/or  unlimited  fine  

• Tipping  Off    o 2  years  in  jail  and/or  unlimited  fine  

UK  Money  Laundering  Regulations  2007  

Institutional  liability  applying  to  financial  institutions  and  other  relevant  business  e.g.  casinos  and  estate  agents  

Main  requirements:  

• Appoint  Money  Laundering  Reporting  Officers  (must  be  a  senior  employee)  • Identification  and  KYC-­‐  (know  normal  pattern  of  transactions)  

• Records  of  evidence  of  identity  and  all  customer  transactions  (5  years  from  when  customer  ceases  to  do  business  with  firm)  

• Training  on  recognising  suspicions  • Internal  procedures  for  reporting  suspicions  • Various  levels  of  ‘due  diligence’  –  CDD,  SDD,  or  EDD  for  PEPs)  • Failure  to  comply  penalty  –  2  years  in  jail  (senior  directors)  and/or  unlimited  fine  

Financial  Crime  Systems  and  Control’s  (SYSC)  

Part  of  FCA  Handbook  –  applies  to  authorised  firms  

• Requires  firms  to  have  systems  and  controls  to  manage  money  laundering  risk  • Firm  should  maintain  effective  and  proportionate  systems  in  order  to  manage  the  

money  laundering  risk  • Allocate  to  a  senior  manager  responsibility  for  the  establishment  and  maintenance  

of  AML  systems  and  controls  • Appoint  MLRO  and  ensure  MLRO  provides  a  report  at  least  annually  to  the  

governing  body/senior  management  • Provide  appropriate  training  for  employees  

 

‘JMLSG’  Guidance  Note  2007  

• The  guidance  notes  interpret  relevant  money  laundering/terrorist  financing  legislation  and  indicate  good  industry  practice  for  implementing  these  requirements  

• When  considering  whether  an  offence  or  breach  has  occurred  the  courts/FCA  will  take  into  account  compliance  with  guidance  notes  

UK  Bribery  Act  2010  

There  are  4  offences  under  the  UK  Bribery  Act  2010:  

• Paying  bribes  • Receiving  bribes  • Bribery  of  foreign  officials  • Failure  to  prevent  bribery  (commercial  organisations):  

o The  company  must  put  in  place  controls  to  prevent  bribery  being  committed  by  its  employees,  agents  and  external  3rd  parties.  

Penalties  

Individuals:  maximum  jail  sentence  =  10  years  

Institutions:  Unlimited  fines  

 

Financial  services  action  plan  (FSAP)  

EU  Issues  directives,  regulations  and  decisions  

FSAP  was  launched  in  1999,  

It  consists  of  42  measures,  including  24  EU  directives  to  be  adapted  into  law  of  each  member  state.  Main  ones  pertain  to:  

• Market  abuse  directive  • Prospectus  Directive  • Transparency  Directive  • MiFID  

The  FSAP  has  3  specific  objectives  

• To  create  a  single  EU  wholesale  market  • To  achieve  open  and  secure  retail  markets  –  allow  operators  throughout  Europe  to  

sell  throughout  Europe  • To  create  state-­‐of-­‐the-­‐art  prudential  rules  and  structures  of  supervision    

 

Direct  effect  

Principle  of  direct  effect  (or  immediate  applicability)  enables  individuals  or  firms  to  immediately  invoke  a  EU  provision  before  a  national  or  European  court.  E.g.  if  directive  not  fully  implemented  in  home  country  

Vertical  direct  –  Directive  takes  precedence  over  national  law  in  matters  between  member  state  and  firm/individual  

Horizontal  direct    -­‐  between  firms  and/or  individuals  this  does  not  apply.  However  courts  should  interpret  law  so  as  to  achieve  the  result  required  by  the  directive.  

 

European  Securities    and  Markets  Authority  (ESMA)  

ESMA  (much  like  FCA)  aims  to  ensure  integrity  transparency  efficiency  proper  functions  of  securities  markets  in  Europe    

Contributed  to  safeguarding  the  stability  of  the  European  Unions  financial  system  by:  

• Ensuring  Integrity,  Transparency,  Efficiency,  orderly  function  of  securities  markets,  and  

• Enhancing  investor  protection  

Developed  a  single  rule  book  in  Europe  with  2  purposes:  

• Ensure  consistent  treatment  of  investors  across  the  EU,  enabling  an  adequate  level  of  protection  of  investors  through  regulation  and  supervision  

• Promote  equal  conditions  of  competition  for  financial  service  providers.    

It  has  a  range  of  powers  to  meet  its  objectives:  

• consumer  protections  –  can  prohibit  financial  products  that  threaten  stability  • monitoring  systematic  risk  of  cross  border  financial  institutions  • emergency  powers  • on-­‐site  inspections  • Enter  into  administrative  arrangements  with  supervisory  bodies,  international  

organisations..  • Resolution  of  disagreements  between  national  authoirties,  

MIFID  MiFID  was  set  up  adopted  by  the  European  council  in  2004  and  is  part  of  the  Financial  services  action  plan.    

Passporting  Passporting  already  existed  under  the  old  (investment  services  directive)  but  MiFid  expanded  the  scope  by  including  more  activities.  

• Allows  European  firms  to  open  branches  and  cross  border  sell  through  out  the  EEA  without  the  need  for  licensing  in  each  separate  jurisdictions    

• Tied  agents  established  in  the  EEA  will  be  able  to  act  on  behalf  of  a  firm  instead  of  the  firm  needing  to  set  up  a  branch  (tied  agent,  similar  to  appointed  representative  and  so  does  not  require  authorization)  

 

MiFIDs  all  about  how  firms  set  up  and  operate  across  boarders.  

(Undertaking  for  collective  investments  in  transferable  securities  directives)  UCITS  -­‐  All  about  funds  and  how  they  can  be  sold  across  borders.    

 

MiFID  investment  services  and  activities  

Investment  Services  and  Activities  (wholesale  FCA  activities)  

• Operating  an  MTF  • Dealing  on  own  account  • Execution  on  behalf  of  clients  • Receipt  and  transmission  of  orders  • Investment  advice  • Managing  portfolios  • Underwriting/placing  financial  instruments  (process  when  shares  issued  for  first  

time)  (not  on  UK    wholesale  list)  

These  are  the  activities  you  may  passport  throughout  EEA  using  MiFID  

 

Ancillary  Services  (non-­‐core)  

• Safekeeping  and  administration  (custodianship;  collateral  and  cash,  management)  • Granting  credit/loans  • Corporate  finance  advice  • Foreign  exchange  services  • Investment  research  and  financial  analysis  

May  not  passport  these  under  MiFID  

 

Home  and  host  state  responsibilities  

Home  is  the  one  that  your  authorised  in.    

Host  is  the  non-­‐home  you  are  operating  in.  

Home  state  (deal  with  big  picture  of  overall  parent  organisation)  =  organisational  matters  including:  

• Compliance  arrangements  • Internal  systems  and  controls  • Management  of  conflicts  of  interest  • Certain  conflict  of  business  rules  (personal  account  dealing  and  investment  

research)  • Client  assets  (clients  protected  by  home  state  client  assets  rules)  

Host  state  =  operational  matters  including  

• Most  COBs  rules  

 

UCTITS  Directives  

Undertaking  for  collective  investment  in  transferrable  securities  

Facilitate  cross  border  sales  of  open-­‐ended  funds  throughout  the  EEA  

UCITS  III  Product  Directive    • Expanded  the  range  of  permitted  investments  that  UCITS  funds  can  invest  in.  • As  a  result  UTICs  schemes  can  now  invest  in:  

o Transferable  securities  o Money  Market  instruments  o Forward  contracts  and  financial  derivatives  o Deposits  o Units  in  other  collective  investment  schemes  o Commodity  derivatives  are  excluded  

 

• UCITS  III  ‘management  Directives’  increased  the  range  of  services  that  can  be  passported  under  the  UCITS  including  safekeeping  and  fund  administrations      UCITS  IV  Directive  introduced:  

o a  passport  for  management  companies  o a  procedure  for  fund  mergers  (cross  border)  o Key  investor  information  document  (replaced  simplified  prospectus)    o Master  feeder  structure  to  permit  asset  pooling  (different  fund  in  different  

EU  countries  that  all  feed  into  one  overall  fund)  

 

European  Market  Infrastructure  Regulation  (EMIR)  

EMIR  comprises  standards  of  regulation  of  OTC  derivatives,  central  counterparties  and  trade  repositories*  

Implemented  through  FSMA  2000  in  UK.  

Aims  for  all  standardised  OTC  derivatives  to  be  cleared  through  a  central  counterparty.    

Tries  to  clear  up  infrastructure  behind  derivatives  when  they  are  traded  privately.    

Structure  around  OTC  derivatives  (typically  traded  between  big  banks):  when  done  privately  there  is  no  clearing  house  and  all  the  settlement  and  paperwork  is  not  pushed  through  formal  process  so  some  of  the  paperwork  is  not  necessarily  been  processed  correctly.  This  creates  problems  with  risk  management.    

If  derivative  that  is  trade  with  bank,  it  may  have  been  traded  several  times  between  other  banks  and  so  may  not  know  who  created  the  derivate.  It  might  turn  out  to  be  a  bank  that  went  bust  and  no  longer  exists.    

EMIR  imposes  the  following  3  new  requirements:  

• To  clear  OTC  derivatives  through  CCP  • Put  in  place  a  risk  management  procedure  for  OTC  derivative  transactions  that  are  

not  cleared  • Report  derivatives  to  a  trade  repository.    

o Trade  repositories  is  an  entity  (an  electronic  platform)  that  centrally  collects  and  maintains  the  records  of  OTC  derivatives.    So  transparency  of  who  owns  what  in  OTC  derivative  market.    

 

 

 

 

 

Legal  Concepts  Legal  Persons    2  forms:  

• Natural  person  =  Individual  human  beings    • Artificial  persons  =  Corporations,  cooperatives  and  countries    

 Corporation  can  be  limited  liability.      An  unincorporated  association  (for  example,  a  partnership)  is  not  a  separate  legal  entity;  it  does  not  have  a  legal  identity  separate  from  that  of  its  members.      Legal  Persons  can:  

• Pay  Tax  • Sue  and  be  sued  • Enter  into  contracts  • Incur  debt  • Own  property  

 Power  of  Attorney  

• Power  to  make  decisions  on  behalf  of  another  • A  power  of  attorney  is  a  legal  document  made  by  a  person  (‘the  donor’)  which  appoints  

another  person    (‘the  attorney’  or  ‘the  donee’)  or  persons,  to  act  for  the  donor  in  legal  matters  

• The  power  of  attorney  may  be  a  general  power,  to  allow  the  donee  to  act  for  the  donor  in  all  matters,  or  restricted  to  a  specific  act  

 Enduring  power  of  Attorney  

• Pre  2007,    It  is  not  possible  to  make  any  changes  to  an  existing  EPA  or  make  a  new  one  (still  valid  if  created  prior  to  2007)  

• Does  not  need  to  be  registered,  can  be  a  contract  but  no  formal  registration  • Deals  with  looking  after  someone’s  affairs  usually  the  elderly  • Not  about  personal  health  

Lasting  power  of  Attorney  • Post  2007  • Must  be  registered  with  the  Office  of  the  Public  Guardian  (OPG)  • 2  types  of  LPA  

o Property  and  Affairs  LPA  –  right  to  make  decisions  about  business  affairs  and  property  

o Personal  Welfare  LPA  –  decisions  about  care  of  an  individual      Contracts  A  contract  is  a  legally  binding  agreement  between  mutually  consenting  two  parties  who  intend  to  enter  into  a  legal  relationship  

 Can  be  written  or  verbal.  Verbal  contracts  are  valid  in  most  situations  except  in  relation  to  property  and  tenancy  agreements.  (First  3)  Required  elements  of  a  contract  

• Offer  and  Acceptance  -­‐  To  determine  whether  or  not  an  agreement  has  been  reached,  the  courts  will  consider  whether  one  party  has  made  a  firm  offer  which  the  other  party  has  accepted  

• Consideration  –  must  be  some  form  of  payment  in  relation  to  service  being  done  • Intention  –  the  parties  intend  to  create  legal  relations.  What  matters  is  not  what  the  

parties  have  in  their  minds,  but  the  inferences  that  reasonable  people  would  draw  from  their  words  or  conduct.    

Other  requirements  • Legality  • Capacity  to  contract  is  the  legal  ability  to  enter  into  a  contract.  Cannot  enter  contract  if  

insane  or  under  18    Contract  discharge  -­‐  ways  in  which  a  contract  could  come  to  the  end  of  its  life  

• Breach  –  1  or  more  [parties  has  not  fulfilled  requirements  set  out  in  the  contract]  • Performance  –  If  standard  of  service  is  not  completed  in  accordance  with  

agreements,  so  obligations  not  met  • Agreement  –  both  parties  happy  to  end  contract  • Frustration  –  events  have  made  completion  of  contract  impossible,  whereby  

obligations  cannot  be  met  (e.g.  painter  cannot  paint  house  if  house  blows  away)    Utmost  good  faith    

• Requirement  to  disclose  all  relevant  information  is  fundamental  to  an  insurance  contract.  If  the  rule  is  not  observed  the  policy  can  be  treated  by  the  insurer  as  voidable.  The  requirement  is  termed  ‘utmost  good  faith  'or  uberrimae  fidei.    

 Agency  relationship  

• Agents'  are  engaged  by  'principals'  generally  in  order  to  perform  tasks  which  the  principals  cannot  or  do  not  wish  to  perform  themselves,    

• Agency  is  a  relationship  which  exists  between  two  legal  persons  (the  principal  and  the  agent)  in  which  the  function  of  the  agent  is  to  form  a  contract  between  his  principal  and  a  third  party  

 Obligations  of  Agents  

• Performance  and  obedience  -­‐  The  agent  must  perform  his  obligations,  following  his  principal's  instructions  with  obedience,  unless  to  do  so  would  involve  an  illegal  act  

• Skill  and  accountability  • No  conflict  of  interest  • Confidentiality  • Any  benefit  must  be  handed  over  to  the  principal  unless  he  agrees  that  the  agent  may  retain  

it.      Forms  of  co-­‐ownership  of  land  If  land  (and  the  property  built  on  it)  is  purchased  or  transferred  to  two  or  more  persons,  these  persons  become  either  joint  tenants  or  tenants  in  common  

• Joint  tenancy  is  where  two  or  more  people  acquire  land  but  no  words  of  'severance'  are  used.    

o This  means  that  the  transfer  does  not  state  what  share  in  the  land  each  person  has.  The  land  is  merely  'held  by  X  and  Y'.  e.g.  husband  and  wife  

o The  importance  of  the  distinction  is  that  if  a  joint  tenant  dies  his  interest  lapses  and  the  land  is  owned  wholly  by  the  survivor(s).  He  may  not  pass  his  interest  on  by  will.    

o The  advantage  is  that  only  a  limited  number  of  interests  can  exist.    o The  disadvantage  is  the  fact  that  survival  decides  ownership.  

 • Tenants  in  common  have  shares  in  the  land.    

o A  conveyance  may  state  that  the  land  should  go  to  'P,  Q  and  R  equally'  –  each  then  owns  one-­‐third  part  of  the  interest.  It  is  equitable  ownership.  If  P  subsequently  dies,  his  or  her  one-­‐third  share  goes  into  P’s  estate:  Q  and  R  still  own  a  one-­‐third  share  each  

o Each  tenant  can  bequeath  his  interest  which  means  that  a  house  owned  by  tenants  in  common  (A,  B  and  C  equally)  will,  if  C  dies  and  leaves  his  interest  to  D,  E,  F  and  G,  be  owned  by  A,  B,  (one-­‐third  part  each)  D,  E,  F  and  G  (one-­‐twelfth  part  each).  

o  While  perhaps  being  fairer,  this  can  be  cumbersome!      

Other  legal  terminology  Insolvency    

• State  of  being  • When  ones  liabilities  and  obligations/debt  exceed  ones  assets  +  cash  flow.    • The  company  will  need  to  take  action  to  generate  cash  and/or  re-­‐negotiate  terms  with  its  

creditors  • If  prolonged  the  company  declared  insolvent  and  trading  is  suspended  

 The  purpose  of  insolvency  law  is  to  govern  what  should  happen  to  the  property  of  a  company  that  is  insolvent.  The  basic  aims  of  company  insolvency  law  are  to:  

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

 There  are  three  types  of  corporate  insolvency  'officials',  depending  on  whether  a  company  goes  into  administration,  receivership  or  liquidation    Bankruptcy  –legal  matter  Bankruptcy  occurs  when  an  individual's  financial  affairs  are  taken  over  by  a  court.  The  individual’s  assets  are  transferred  into  a  trust  which  is  used  to  repay  as  much  debt  as  possible.    

• If  insolvency  persists  leads  to  bankruptcy  • Official  Receiver  takes  control  of  the  debtor's  assets,  as  receiver  and  manager,  selling  

assets  as  appropriate  • One  is  protected  against  further  creditors,  who  can  no  longer  chase  you  • Technically,  if  unable  to  pay  £750  you  can  be  taken  to  court  and  declared  bankrupt  • Lasts  for  period  of  1  year  

 Will  and  intestacy  

• A  will  appoints  the  persons  who  will  have  the  responsibility  for  dealing  with  the  estate  (the  executors,  also  called  personal  representatives)  and  gives  instructions  as  to  how  the  estate  should  be  distributed.    

 Conditions  for  a  will  to  be  valid  

• The  will  must  be  in  writing  • The  will  must  be  signed  and  witnessed  by  two  people    • The  person  making  the  will  must  be  at  least  18  years  of  age  • The  person  must  have  the  mental  capacity  to  understand  the  effect  of  making  a  will    • The  will  must  not  have  been  made  as  a  result  of  pressure  from  another  person.    

 A  witness  or  the  spouse  of  a  witness  cannot  benefit  from  a  will.  If  a  witness  or  the  spouse  of  a  witness  is  named  as  a  beneficiary,  the  will  is  not  made  invalid,  but  that  person  will  not  be  able  to  inherit  under  the  will.      Probate  

• Scenarios  following  death  of  individual  • Executers  of  estate  must  establish  financial  position/ownership  of  deceased  estate.  • The  workout  what  tax  (inheritance  is  owed  to  government  only  after  this  can  any  

money  be  given  to  heirs.    • The  executors  need  to  obtain  a  Grant  of  Probate  from  the  Probate  Registry  to  show  they  are  

entitled  to  administer  the  estate.  • Then  they  can  collect  the  assets  of  the  estate.  The  executors  are  responsible  for  settling  all  

liabilities  of  the  estate  before  paying  out  the  money  to  the  beneficiaries.      Intestate  Testate    

• Those  with  legal  will  determining  where  money  goes  after  they  die  Intestate  

• No  will,  no  one  person  can  determine  where  the  money  goes.    • There  is  a  strict  hierarchy  of  where  money  goes  determined  by  government  

 Types  of  Trust    A  trust  is  an  equitable  obligation  in  which  certain  persons  (the  trustees)  are  bound  to  deal  with  property  over  which  they  have  control  (the  trust  property)  for  the  benefit  of  certain  individuals  (the  beneficiaries)  

• The  trustees  may  also  be  beneficiaries  of  the  trust.  • An  individual  who  transfers  assets  into  a  trust  during  his  lifetime  is  known  as  a  settlor  and  

such  trusts  are  known  as  settlements.  • A  settlor  may  also  be  a  trustee  and/or  a  beneficiary.    • A  trust  may  also  be  set  up  in  a  will  and  is  then  usually  called  a  will  trust.  Where  the  trust  is  

set  down  in  writing,  this  document  is  called  the  'trust  instrument'.      Settlor  –  persons  who  sets  up  trust  and  whose  money  goes  into  trust  Trustees  –  manage  the  trust  and  take  responsibility  for  entire  trust  Beneficiaries  –  receives  money  from  the  trust  Life  trust  and  Remainder  man  –  associated  with  interest  in  possession  trust  

 Bare  Trust  (simple  trust)  

• Assets  of  trust  belong  to  named  sole  beneficiary  before  managed  by  trustees.  Typical  example  is  child  trust  

• The  beneficiary  of  the  trust  can  instruct  the  trustee  how  to  manage  the  trust  property,  and  has  the  right  to  take  actual  possession  of  the  trust  property  at  any  time.    

 Interest  in  Possession  Trust  

• Beneficiary,  known  as  an  'income  beneficiary'  or  a  'life  interest',  has  a  legal  right  to  the  income  or  other  benefit  derived  from  the  trust  property  as  it  arises.    

o For  example,  the  life  interest  may  have  the  right  to  occupy  a  house  during  his  or  her  lifetime,  or  an  income  beneficiary  the  right  to  receive  income  from  the  trust  property  for  a  specified  period  or  until  death.    

• On  the  death  of  the  life  interest/income  beneficiary,  the  assets  of  the  trust  will  be  held  for  the  benefit  of  the  second  class  of  beneficiary,  known  as  the  remainder  man  or  the  reversionary  interest.  

• Stops  trust  from  falling  into  hands  of  beneficiary  named  by  original  beneficiary  of  trust.  

• Life  tenant  is  primary  beneficiary,  Remainder  man  gets  what’s  left  and  can  be  given  remainder  in  will  by  life  tenant.  

 Discretionary  Trust  

• Setup  when  trustees  hold  assets  for  beneficiaries’.    • Trustees  exercise  their  discretion  as  to  which  beneficiaries  will  be  entitled  to  receive  income  

or  capital  from  the  trust.    • The  exact  rights  of  each  beneficiary  are  not  determined  in  advance.    • Original  settlors  may  not  know  who  benefits  are  going  to    • E.g.  university  trust  with  old  alum  settlor,  where  university  decides  beneficiaries  or  

Grandpa  for  kids  not  yet  born  Inheritance  tax  (IHT)    

• For  inheritance  tax  (IHT)  purposes,  there  is  a  chargeable  lifetime  transfer  (CLT)  when  a  discretionary  trust  or  an  interest  in  possession  trust  is  set  up.    

• The  trust  suffers  an  IHT  principal  charge  once  every  ten  years  and;  • An  exit  charge  when  property  leaves  the  trust  

 Charitable  Trust    

• Set  up  to  provide  for  a  charitable  activities  of  charity  in  question.    • Charity  must  be  registered  with  charity  commission  and  trust  would  provide  making  sure  

that  it  carried  out  work  as  specified  in  the  charitable  trust.  • Charitable  trusts  enable  the  settlor  to  give  some  degree  of  individuality  to  a  gift,  specifying  

how  it  may  be  used  and,  as  charities,  are  basically  free  from  tax.      

     

                       

Client  Advice  Investors  can  broadly  be  categorised  into  two  types:  

• Individuals  or  retail  investors  o classified  by  firms  according  to  their  wealth  

§ Retail    § High  net  worth  § Very  high  net  worth  

• institutional  invest  o Such  as  pension  funds  and  mutual  funds  (a  term  used  in  the  US  for  collective  

investment  funds),  hedge  funds,  charitable  and  philanthropic  trusts  employ  professional  fund  managers  who  manage  funds  on  a  large  scale.  

 Explain  the  obligations  of  a  firm  towards  retail  clients.      Authorised  firms  have  an  obligation  to  abide  by  the  regulators’  Principles  for  Businesses  and  detailed  rules,  as  set  out  in  the  relevant  regulatory  Handbook  (FCA  or  PRA),  in  their  dealings  with  consumers.    Over-­‐arching  principles  include:  

• Requirement  to  treat  customers  fairly  • Disclosures  to  be  made  to  customers.    

 Fiduciary  Responsibility  An  adviser's  fiduciary  responsibility  implies  that  the  adviser  ought  not  to  take  advantage  of  a  client's  trust  in  him  or  her.  The  adviser  (or  firm)  agrees  to  act  in  the  sole  interests  of  the  client,  to  the  exclusion  of  his  or  her  own  interests.      The  adviser's  fiduciary  duty  implies:  

• Avoidance  of  Conflict  of  interest  • To  always  act  in  client's  best  interests    • Full  and  fair  disclosure  of  material  facts,  particularly  where  there  may  be  a  conflict  of  

interest.    

 Principle  for  Businesses  6  states  that  a  firm  must  pay  due  regard  to  its  customers  and  treat  them  fairly  It  is  on  the  actual  consequences  of  what  firms  do.    

• By  adopting  a  'principles-­‐based  approach'  to  TCF  through  Principle  6,  the  regulator  puts  the  onus  on  firms  to  determine  what  is  fair  in  each  particular  set  of  circumstances.    

• The  emphasis  of  the  Authority's  philosophy  is  not  so  much  on  the  principles  themselves.  It  is  on  the  actual  consequences  of  what  firms  do.  Increasingly,  the  term  used  for  the  regulators’  recent  approach  has  been  outcomes-­‐focused  regulation.    

   With  regard  to  TCF,  the  FCA  specifically  expects  firms  to  focus  on  delivering  the  following  six  consumer  outcomes    

• Corporate  Culture  o consumers  can  be  confident  that  they  are  dealing  with  firms  where  the  fair  

treatments  of  customers  is  central  to  the  corporate  culture    

• Marketing  o products  and  services  marketed  and  sold  in  the  retail  market  are  designed  to  meet  

the  needs  of  identified  consumer  groups  and  are  targeted  accordingly  • Clear  information:  

o consumers  are  provided  with  clear  information  and  are  kept  appropriately  informed  before,  during  and  after  the  point  of  sale  ability  of  advice  

• Suitability  of  advice:  o  where  consumers  receive  advice,  the  advice  is  suitable  and  takes  account  of  their  

circumstance  product  expectations  • Fair  product  explanations:    

o consumers  are  provided  with  products  that  perform  as  firms  have  led  them  to  expect,  and  the  associated  service  is  both  of  an  acceptable  standard  and  also  as  they  have  been  led  to  expect.    

• Absence  of  post-­‐sale  barriers:    o consumers  do  not  face  unreasonable  post-­‐sale  barriers  imposed  by  firms  to  change  

product,  switch  provider,  submit  a  claim  or  make  a  complaint    

Investment  management  process  1) Plan  

a. Identify  and  prioritise  clients’  needs  and  objectives  b. Establish  the  clients  circumstances  (via  Data  collection):  suitability/needs  c. Analyse  different  options  to  meet  identified  shortcoming/needs  d. Meet  with  the  client  to  agree  strategic  asset  allocation  

2) Implement  a. Actually  invest  in  funds  and  products  

3) Review  a. Check  allocation  is  in  line  with  objectives  b. Circle  around  and  go  through  plan  stage  again  to  make  sure  nothing  has  changed  

and  everything  is  in  line    Investor  needs  and  objectives  Identify  3  key  factors  

• Time  horizon-­‐  how  long  investing  for  • Return  –  to  match  expectations  • Risk  tolerance    

 Return  Broadly  speaking,  the  requirements  of  clients  fall  into  one  of  two  categories:  

• To  maximise  returns,  eg  for  positive  net  worth  individuals  looking  for  a  portfolio  to  match  their  Risk/return  preferences    

• To  match  liabilities,  eg  in  the  case  of  pension  funds,  where  the  aim  is  to  match  assets  and  liabilities  or  minimise  any  mismatch.    

   Explain  the  importance  of  establishing  and  quantifying  a  client’s  objectives.      The  first  stage  is  to  determine  all  of  the  objectives  that  the  client  is  looking  to  meet  and  to  prioritise  those  objectives  and  to  quantify  them  in  financial  terms    

From  a  quantification  viewpoint,  the  requirements  of  a  client  portfolio  may  include  such  factors  as  school/college  fees,  loans,  dependent  pensions,  and  a  primary  consideration  here  will  be  whether  those  liabilities  are  nominal  or  real.      

• A  nominal  liability  is  one  that  is  fixed  in  monetary  terms  irrespective  of  future  inflation.    • In  contrast,  a  real  liability  is  one  which  changes  in  monetary  terms  as  we  experience  

inflation.    Whatever  the  liability,  assessment  can  involve  a  present  value  analysis  of  the  anticipated  future  liabilities  that  the  portfolio  is  aiming  to  meet.    

• For  example,  to  pay  a  pension  of  £20,000  pa  for  a  period  of  20  years  when  real  returns  (asset  returns  in  excess  of  inflation)  are  3%  will  require  a  fund  value  at  retirement  of  almost  £300,000,  and  so  we  would  be  looking  to  achieve  this  fund  value  at  the  retirement  date.    

 Objectives  

• Save  for  retirement  • Provide  financial  protection  • Repay  mortgage  • Insurance  against  disasters  • Future  liabilities  to  meet  (school  fees)  

Other  specific  needs  • Liquidity  –  time  horizon  may  need  funds  in  short  term  /  which  may  cause  short  term  losses  if  

SR  depreciation  in  asset  • Liabilities  –    • Tax  considerations  –  different  people,  different  tax  needs  • Regulatory  requirements  • Religious  and  ethical  considerations  –  socially  responsible  investing  

 Risks  

• Capital  risk  –  chance  of  asset  depreciating,  but  if  focus  solely  on  this  may  lead  to  bother  risks  

• Inflation  risk-­‐  risk  that  investment  appreciation  does  not  keep  up  with  inflation  • Interest  rate  risk  –  the  risk  of  changes  in  bank  base  rates  and  the  knock-­‐on  effect  that  this  

may  have  on  asset  returns    o To  avoid  capital  risk  may  invest  in  low  risk,  low  interest  investments.  But  if  IR  

increase  you  may  be  locked  into  relatively  low  yielding  asset.  • Shortfall  risk  –  failure  to  meet  investment  objectives.  If  don’t  want  to  risk  capital  then  you  

may  fail  to  meet  objectives    Diversification  Consider  an  Investment  in  shares  (equities).  Two  sorts  of  risk  can  be  distinguished:      

• The  general  market  risk  (or  ‘systematic’  risk)  of  investing  in  shares  or  bonds    • The  specific  risk  (or  ‘non-­‐systematic’  risk)  of  any  individual  investment.    

 Through  this  process  of  diversification,  investors  are  able  to  rid  themselves  of  the  specific  risk  of  a  stock.  It  is,  however,  impossible  to  remove  the  market  risk.    Different  types  of  diversification  

Diversification  by  asset  class.  • This  is  achieved  by  holding  a  combination  of  different  kinds  of  asset  within  a  portfolio,  

possibly  spread  across:  cash,  fixed  interest  securities,  equity  investments,  property-­‐based  investments,  and  other  assets  

 Diversification  within  asset  classes.    

• An  investor  can  diversify  a  portfolio  by  holding  a  variety  of  investments  within  the  particular  asset  types  that  he  holds.  This  may  be  achieved  by  holding  various  fixed  interest  securities,  by  holding  equities  in  a  number  of  different  companies,  by  spreading  investments  across  different  industry  sectors  and  geographical  markets,  and  by  holding  a  number  of  different  properties  or  property-­‐based  investments.    

   Diversification  by  manager.  

• Diversifying  risk  across  different  funds  with  different  managers  reduces  the  risks  from  a  manager  performing  poorly.  This  is  one  of  the  attractions  of  'manager  of  manager'  and  'fund  of  fund'  structures.    

   Timescales  A  client’s  attitude  to  risk  may  be  influenced  by  investment  timescales.    

• If  the  fund  is  a  young  scheme  with  30  or  40  years  to  client  retirement,  then  it  can  afford  to  take  a  reasonably  aggressive  attitude  to  capital  risk  and  invest  in  what  may  be  regarded  as  the  riskier  assets.  May  experience  some  poor  years  but  we  are  also  likely  to  experience  some  very  good  years.  The  effect  is  that  risk  averages  out.  

• If,  on  the  other  hand,  the  scheme  is  very  mature  and  retirement  is  imminent,  then  there  is  insufficient  time  for  this  averaging  effect  to  take  place  

 Risk  Tolerance  Two  approaches  to  gauging  risk  tolerance:  

• The  process  will  probably  start  with  a  review  of  the  client’s  current  investments  and  risks,  which  will  clearly  illustrate  the  client’s  historical  attitude  to  risk.  As  we  noted  above,  however,  risk  tolerance  changes  over  time,  so  this  historical  information,  whilst  a  very  useful  insight,  is  not  of  itself  sufficient  

• To  augment  this,  the  investment  adviser  will  also  undertake  the  fact-­‐find  soft  facts  review.  They  will  ask  the  client  to  select  a  mix  of,  say,  equities  and  bonds,  to  give  an  idea  of  the  normal  mix  (and  hence  risk)  that  the  client  wishes  to  face.  As  part  of  the  fact  find  process  the  investment  adviser  will  illustrate  various  possible  asset  allocations  and  discuss  in  detail  the  potential  returns  and  risks  of  each.  Such  targeted  discussions  should  enable  the  manager  to  get  an  understanding  of  the  clients  general  risk  tolerance.  

 Investment  and  product  selection  Approach  adopted  depends  on  the  investment  management  style  adopted,  ie  active  or  passive    Active  investment  manager  An  active  investment  manager  is  one  who  intervenes  with  the  portfolio  on  a  regular  basis,  attempting  to  use  individual  expertise  in  order  to  enhance  the  overall  return  of  the  fund.    

• There  are  costs  involved  with  all  transactions,  and  hence  limits  on  the  number  of  active  interventions  taking  place  are  likely  to  be  to  the  advantage  of  the  fund  holder.  

• AIMs  do  not  believe  that  the  securities  markets  are  always  efficient.  They  believe  that  securities  can  be  misvalued.  They  attempt  to  time  their  purchase  or  sale  on  the  basis  of  specific  stock  information,  market  information,  economic  factors  etc.  

• May  obtain  research  from  external  sources  such  as  investment  banks,  these  are  'sell-­‐side'  analysts.  They  may  establish  an  in-­‐house  research  department,  made  up  of  ‘buy-­‐side’  analysts.  The  benefit  of  generating  unbiased  internal  research  needs  weighed  against  the  costs  of  setting  up  the  department.      

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

• The  simplest  strategy  is  to  'buy  and  hold'.  However,  perhaps  the  most  common  form  of  passive  management  is  indexation.    

 Indexation  –  Indexor  tracker  fund  Fund  manager  selects  an  appropriate  index  quoted  in  the  market  place.  Having  established  the  index,  the  fund  manager  builds  a  portfolio  which  mimics  the  index,  hoping  that  this  portfolio  will  then  perform  in  line  with  the  index  numbers.  Likelihood  is  that  the  fund  will  underperform  the  index  for  a  number  of  reasons.  

• Firstly,  there  is  the  initial  cost  of  creating  the  portfolio.    • Secondly,  and  perhaps  more  importantly,  all  index  funds  tend  to  be  based  on  a  sampling  

approach  and  consequently  exhibit  a  degree  of  tracking  error      Hybrid  Seeking  to  out-­‐perform  indexes  requires  a  less  than  fully  passive,  and  more  interventionist,  approach  –  possibly  with  an  indexed  core  fund,  and  a  Peripheral  or  satellite  fund  which  is  more  actively  managed  and  could  involve  the  use  of  derivatives  in  order  to  establish  larger  trading  positions  than  the  fund  itself  can  obtain    Tilting  -­‐  Alternatively,  the  fund  manager  may  combine  both  active  and  passive  fund  management  methods  by  Tilting  the  fund.  Tilting  involves  holding  all  (or  a  representative  sample)  of  the  constituents  of  an  index  (like  a  passive  tracker  fund),  but  with  larger  proportions  in  areas  that  the  manager  favours.          Review  Portfolio  performance  should  be  reviewed  no  less  than  once  a  year,  or  more  regularly  for  short  term  funds,  and  will  look  to  achieve  a  number  of  objectives.      

• Client  circumstances  –  we  should  look  to  determine  whether  any  client  circumstances  have  altered  as  this  may  result  in  an  alteration  of  the  client’s  objectives.  Any  significant  changes  may  require  a  modification  to  the  investment  strategy.    

• Performance  review–  we  need  to  monitor  the  performance  of  the  portfolio  against  the  selected  benchmark  to  ensure  that  it  is  achieving  its  objectives  

• Portfolio  rebalancing–  following  on  from  the  performance  review  we  should  consider  whether  there  is  any  need  to  update  the  agreed  asset  allocations.  Care  needs  to  be  taken  here  in  respect  of  the  tax  liabilities  that  may  arise  from  the  effects  of  any  rebalancing.    

 Establish  client’s  circumstances  Data  Collection/  Fact  find  Hard  facts:  

• Definite  answer  • Close  ended  questions  

Soft  facts:  • Subjective  • Open  ended  questions  

 Letter  of  Authority  Should  factor  clients  other  investments  into  making  investment  decisions.  This  may  require  information  on  their  other  investments,  so  may  need  letter  of  Authority  which  would  allow  advisor  to  talk  to  other  product  provider  to  find  relevant  information.    Advice  and  recommendations  Having  established  client’s  financial  objectives  and  established  their  circumstances  the  advisor  would:  

• Analyse  a  range  of  options  (of  investments)  • Prepare  a  report  –  explains  options  when  giving  recommendation  • Implement  the  Plans  

o Strategic  Asset  Allocation  § Asset  classes  (shares/bonds)  –  based  on  objectives  of  the  fund  and  client  

• Important  decision  is  asset  class  • 80-­‐90%  of  differences  in  performance  between  investors  

performance  § Currencies  –  based  on  objectives  of  the  fund  and  client  § Asset  allocation  is  the  key  driver  of  investment  performance,  not  security  

selection  • Key  to  long  term  performance  

• Review  the  plan,  review  changing  circumstances  and  objectives  and  changed  market  conditions  

   Benchmarks  When  measuring  performance  of  a  portfolio,  it  is  important  to  establish  whether  the  performance  was  relatively  good,  or  bad,  and  so  a  performance  measure  is  required.      Three  main  forms  of  comparable  analysis  of  performance.  

• Comparison  to  relevant  stock/index,  o  eg  a  published  market  index  

• Comparison  to  similar  funds,    o ie  performance  of  other  managers  with  similar  objectives  and  constraints.  PPM  

consultants  maintain  extensive  databases  on  statistical  performance.  • Comparison  with  a  customised  benchmark  for  funds    

o that  have  a  unique  objective  or  constraint,  eg  ethical  funds  that  cannot  invest  in  arms/tobacco  (although  the  standardised  FTSE4Good  indices  meeting  ethical  criteria  are  available).    

 

Benchmark  indices  To  be  useful  in  this  context,  however,  the  index  must  be  comparable  over  the  period  being  considered,  and  great  efforts  must  be  made  to  ensure  that  any  index  is  both  relevant  and  comparable.  If  an  index  is  to  be  used  as  a  performance  yardstick  against  which  the  performance  of  a  portfolio  is  to  be  assessed,  it  must  provide  a  reasonable  comparison.    

Indices  may  be  used  for  a  variety  of  reasons.  Historically,  their  main  purpose  was  to  give  an  indication  of  the  mood  of  the  market.  More  frequently  now,  they  are  used  as  a  benchmark  for  performance  assessment.      To  be  appropriate  for  benchmarking  purposes,  an  index  must  be  indicative  of  the  performance  that  could  realistically  have  been  achieved.      The  characteristics  that  are  required  to  render  an  index  suitable  as  a  benchmark  are  therefore  that  it  is:  

• specified  and  unambiguous  • Appropriate  to  the  nature  of  the  fund  (eg,  a  UK  blue  chip  fund  may  utilise  the  FTSE  100  

Index)  • Appropriate  to  the  currency  of  the  fund  • Investable,  ie  composed  of  investments  that  could  conceivably  be  held  in  the  fund  • Measurable,  ie  the  return  can  be  calculated  on  a  frequent  basis  as  required  • Representative  of  achievable  performance,  ie  it  has  an  arithmetic  weighted  composition  

(remember  that  the  return  of  a  portfolio  is  an  arithmetic  weighted  average  of  the  individual  stock  returns)  

• Measures  the  relevant  component  of  performance,  ie  total  return  indices  for  total  return  performance  and  capital  value  indices  for  capital  growth  

 Source  of  wealth  Investors  may  have  acquired  their  wealth  actively  or  passively.    Passive  wealth  

• People  who  have  acquired  their  wealth  passively,  for  example,  through  inheritance,  or  those  who  have  acquired  savings  gradually  from  their  salaries  

• These  people  are  frequently  less  experienced  with  risk  and  do  not  believe  that  they  could  rebuild  their  wealth  were  they  to  lose  it.    

• They  have  a  greater  need  for  security  and  a  lower  tolerance  for  risk.    Active  wealth  

• People  who  have  earned  their  own  wealth,  often  by  risking  their  own  capital  in  the  process  • These  types  of  people  are  assumed  to  be  more  confident  and  familiar  with  risk.  • They  have  a  higher  tolerance  for  risk.  • They  dislike  losing  control  over  anything,  including  their  investments  

   Recommending  funds  Factors  in  fund  selection  process  

• Past  performance  –  no  guide  to  the  future  • Charges    

o Initial  charges  vs  annual  management  charges  • Financial  stability  of  the  provider  • Stability,  independence  and  standing  of  trustees,  auditors  and  fund  custodians  

• Compare  investment  performance  relative  to  the  unbiased  benchmark  (ideally  and  unbiased  benchmark  such  as  market  index  comprising  similar  investment  styles)  

 

Where  a  portfolio  is  too  small  to  be  efficiently  managed  or  the  client’s  objectives  are  too  specialised  to  be  handled  in-­‐house,  the  fund  management  may  be  outsourced.  The  decision  to  outsource  will  be  determined  when  the  overall  strategy  and  policy  are  developed,  towards  the  end  of  the  initial  investment  management  process.    

   Charges      Fund  charges  tend  to  come  in  one  of  two  forms  

• Entry  and  exit  charges  –  charges  made  when  funds  are  invested  or  when  funds  are  withdrawn  

• Annual  charges  –  generally  charged  as  a  percentage  of  the  value  of  funds  under  management,  though  they  may  include  a  performance  related  element    

 Financial  stability  

• For  many  funds  this  is  of  little  relevance,  however  it  is  key  to  'with  profits'  funds  run  by  life  assurance  companies  whose  performance  accumulates  over  many  years.    

• 'With  profits'  funds  aim  to  smooth  the  fund  returns  across  the  years  through  the  application  of  bonuses.    

• In  very  good  years  part  of  the  fund  return  will  be  retained  rather  than  being  allocated  as  an  annual  bonus.  In  poorer  years  these  retained  funds  can  be  called  on  to  continue  to  provide  the  annual  bonus.    

• For  this  process  to  function  requires  a  good  degree  of  financial  stability  within  the  provider.    

 Stability,  independence  and  standing  of  trustee,  fund  custodians  and  auditors    One  individual,  the  fund  manager,  has  control  of  potentially  quite  substantial  funds  owned  by  others,  the  investors.  As  a  result,  there  needs  to  be  controls  and  checks  in  place  to  ensure  that  neither  the  fund  manager  nor  anyone  else  involved  in  the  process  is  either  tempted  or  able  to  abuse  their  position.    Typically,  within  a  fund  where  a  trustee  is  involved:  

• The  fund  manager  controls  how  and  where  the  assets  are  invested  but  never  personally  has  access  to  them    

• Any  trades  are  transacted  by  a  broker  • The  funds  are  held  in  the  name  of  the  trustee  who  is  charged  with  the  task  of  ensuring  that  

the  fund  manager  operates  in  accordance  with  his  remit    • Periodically,  the  fund  accounts  are  checked  by  the  fund  auditor.  

 Any  action  taken  by  any  one  of  these  parties  is  immediately  transparent  to  the  others,  so  this  segregation  of  duties  should  ensure  the  safety  and  security  of  the  investor’s  funds  (except  in  the  case  of  collusion  between  all  of  the  parties  involved)    Written  reports  to  clients  Providing  a  written  report  to  clients  is  an  important  part  of  the  process  of  giving  financial  advice  The  parts  of  a  financial  planning  report  to  a  client  are  typically  as  follows  

• A  statement  of  the  client's  objectives  • A  summary  of  the  client's  income  and  assets  and  other  relevant  circumstances  or  problems  

• Recommendations,  including  any  proposals  for  immediate  action  as  well  as  longer-­‐term  suggestions  for  the  client  to  consider  in  the  future    

• Appendices,  including  any  data  that  is  best  presented  separately,  if  appropriate      Asset  and  liability  matching     Young  person’s  

pension  fund  (40  years  from  retirement)  

Mature  pension  fund  (Close  to  retirement  =close  to  pay-­‐out)  

Life  assurance  fund  (pay  out  on  death  of  policy  holder)  

General  insurance  fund  (never  know  when  may  have  to  cash  in)  

Time   Long  term     Short  tem     Long  term     Short  tem    Liability   Real   Real   Nominal   Nominal  Liquidity   Low   High   Low   Very  high  Risk  Tolerance   High   Low   High   Very  Low  Tax   Gross  fund  

No  tax  (may  include  index  linked  gilts  to  protect  against  inflation)  

Gross  fund  No  tax  (may  include  index  linked  gilts  to  protect  against  inflation)  

Tax  on  income  and  gains  

Tax  on  income  and  gains  

      Equity      more  bonds     Equity                Bond/cash/treasury  bills  Real  =  inflation  linked.  Liabilities  goes  up  with  inflation  if  real  this  means  that  investment  must  grow  with  inflation      Pension  funds  A  pension  fund  is  an  example  of  a  liability  matching  fund  or  a  return  maximising  fund.  It  represents  a  pool  of  money  to  be  invested  now,  to  achieve  either:    

• A  specific  return  based  on  the  employee's  salary  and  number  of  years'  service  with  the  company  –  a  defined  benefit  (DB)/final  salary  scheme,    

 o DB  pension  fund  must  ensure  that  the  present  value  of  liabilities  equals  the  

present  value  of  assets.  Future  pension  liabilities  is  predictable  by  actuaries.  This  suggests  that  it  is  desirable  to  ensure  the  future  cash  flows  from  assets  required  to  meet  those  pension  payments  are  also  reasonably  predictable.  This  suggests  that  bonds  should  play  a  significant  role  in  the  portfolios  of  pension  funds.    

o DB  pension  funds  need  to  consider  longevity  risk–  the  risk  that  liabilities  to  pay  pensions  will  increase  as  pensioners  live  longer.  It  could  be  difficult  to  meet  this  risk  through  investment  in  bonds.  

 • A  general  increase  in  value  of  the  contributions  paid  on  behalf  of  the  employee  –  a  defined  

contribution  (DC)/money  purchase  scheme    

o Personal  pension  plans,  set  up  by  an  individual  who  is,  perhaps,  self-­‐employed  or  is  not  a  member  of  an  occupational  scheme,  are  DC  pensions.    

 • Generally  speaking,  pension  funds  have  fairly  long-­‐term  horizons  and,  therefore,  are  

prepared  to  take  on  board  a  higher  degree  of  risk,  since  any  shortfall  in  the  fund  can  be  made  up  in  future  investment  performance.    

• This  investment  policy  depends  on  the  maturity  of  the  fund.  • If  the  fund  beneficiaries  are  close  to  retirement,  then  it  would  be  more  appropriate  to  select  

relatively  short-­‐term  safe  investments.      Pensions  -­‐  Inflations      Pension  funds  also  have  to  keep  control  over  the  real  rate  of  return  that  they  earn  since  their  liabilities,  potential  pension  payments,  expand  with  inflation.  So,  pension  funds  tend  to  invest  in  more  speculative  assets  referred  to  as  real  assets  (e.g.  equities,  property)  as  these  offer  protection  against  inflation.      They  keep  small  proportion  of  fund  in  fixed  interest  instruments,  particularly  index-­‐linked  stocks,  partly  because  these  guarantee  real  returns  over  a  period  of  time,  but  also  because  the  bonds  tend  to  have  fairly  high  durations  and  are  therefore  sensitive  to  movement  in  real  interest  rates.      Equally,  the  pension  fund  will  keep  some  assets  in  liquid  form.  Government  bond  markets  are  highly  liquid  market  place  in  which  to  invest  money  gaining  a  moderate,  risk-­‐free  return.        Discretionary  and  non-­‐discretionary  portfolio  management  

• Discretionary  portfolio  management  o the  investment  manager  makes  and  implements  decisions  to  buy  and  sell  

investments  in  the  portfolio  without  asking  the  client  each  time.    • Non-­‐discretionary  portfolio  manager    

o provides  advice  to  the  client  to  assist  the  client  in  making  their  own  investment  decisions.    

 Execution-­‐only  customers  

• Execution-­‐only  customers  are  those  who  are  not  given  any  advice  by  the  firm  when  they  make  investment  decisions.  The  only  responsibility  of  the  firm  to  such  customers  is  one  of  'best  execution':  to  implement  the  customer's  investment  decisions  at  the  best  price  available.    

   

Taxation    

• Income  tax  • Capital  gains  tax  • Inheritance  • Stamp  duty  • Corporation  • VAT  • Investor  tax  

   Income  Tax  UK  income  Tax  system      PAYE  

• Most  of  us  are  taxed  by  the  (PAYE)  pay  as  you  earn  system  • Most  tax  deducted  at  source  • Each  month  company  deducts  from  salary  the  relevant  amount  of  tax  

 If  you  have  extra  income  you  must  fill  out  the  Self  Assessment  form;  to  pay  additional  tax    Payment  on  Account  (if  self  employed  or  <80%  of  last  years  tax  paid  at  source)    National  insurance  is  extra  charge  on  earnings  

• Payment  contribute  towards  future  benefits  such  as  pensions      Income  tax  fiscal  years    Fiscal  years  refers  to  personal  income  tax  year  –  2014/15  tax  years  runs  from  6th  April    2014  to  5th  April    2015the  following  year.    Resident  and  domicile    Resident  Statutory  residence  introduced  in  2013  Status  determined  each  year    Residence  is  determined  by  where  you  live  in  tax  year  Possible  to  be  resident  in  more  than  one  place    Automatically  non-­‐resident  

• Resident  in  the  UK  for  1  or  more  of  previous  3  years.  Visit  UK  for  fewer  than  16  days  • Non-­‐resident  in  previous  3  tax  years  &  spends  fewer  than  46  days  during  the  year  • Work  fulltime  overseas  and  visit  UK  fewer  than  91  days  during  the  tax  year  

• Non-­‐residents  liable  to  income  tax  only  on  income  arising  in  the  UK    Automatically  UK  resident    If  non-­‐residency  does  not  apply:  

• In  UK  for  more  than  half  the  year  (183  days)  • Have  their  only  home  in  the  UK  (don’t  need  to  know  conditions)  • Carry  out  full  time  work  in  the  UK  

o There  is  a  365  day  period  when  the  taxpayer  works  an  average  of  35  hours  a  week  in  the  UK.    

o Within  that  365  day  period,  no  significant  breaks  of  more  than  30  days  when  he  does  not  work  in  the  UK  (excluding  annual  leave  and  sick  leave)  

o Within  that  365  day  period,  the  taxpayer  works  in  the  UK  on  at  least  75%  of  his  working  days.  

o At  least  one  day  in  the  tax  year  when  he  does  at  least  three  hours  work  in  the  UK  

• Residents  liable  to  UK  income  tax  on  UK  and  overseas    Sufficient  ties  test  

• If  you  don’t  pass  either  of  the  other  two  another  series  of  tests  related  to  circumstances  

• Determining  if  you  fall  into  residency  or  on  residency  • Don’t  need  to  know  this  for  exam  

 Domicile  Domicile  refers  to  the  country  you  call  home.  A  person  can  only  have  one  domicile.      

• Domicile:  If  UK  domiciled  you  pay  tax  on  UK  and  any  income  earned  overseas  • Non-­‐domiciled:  If  non-­‐dom  you  won’t  be  taxed  on  what  earned  overseas  if  you  don’t  

bring  it  back  to  UK    If  long  term  resident  then  may  have  to  pay  annual  remittance  basis  charged  to  avoid  income  tax  on  overseas  earnings  not  brought  back  to  the  UK:    

• £30,000  if  resident  for  at  least  7  years  of  the  last  9  years  or    • £50,000  if  resident  for  at  least  12  of  last  14  years  

   Income  tax  computation    Gross  taxable  income-­‐      income  from  all  sources    Some  income  gets  paid  net  of  tax,  so  you  must  back  out  what  actual  gross  amount  is:  May  have  to  do  this  for  exam  using  formula:  

• Gross  amount  =  net  /  100-­‐%  tax  rate    Less:  allowable  deduction  from  gross  income    Deductions  

• First  £10,000  is  deducted  • Any  money  paid  into  pension  up  to  £40,000  is  deducted  • Deeds  of  covenant  to  charity  (not  adhoc)  

 Charity  Payroll giving scheme  

• Under the payroll giving scheme, employees can authorise their employer to deduct charitable donations from their gross salary before calculating tax via the PAYE system.

Gift of certain shares and securities

• If an individual makes a gift of certain shares and securities to a charity, he can deduct the market value of the shares or securities at the date of the charitable gift, again giving the employee automatic tax relief at his marginal rate of tax.

Gift Aid

• All cash donations are treated as being paid net, ie after deduction of income tax at the basic rate (20%). So, a net donation of £800 is worth £1,000 (£800 × 100/80) as the charity can claim £200 (20% × £1,000) from Her Majesty’s Revenue & Customs (HMRC)

 Income  Tax  computation    Rate   Taxable  income     Salary  and  interest   Dividend  Basic   £0  to  £31,865   20%   10%  Higher   £31,866  to  £150,000   40%   32.5%  Additional   >£150,000   45%   37.5%    Must  work  out  in  correct  order:  

• Earnings  (Salary)  and  property  (Non-­‐savings)  • Interest  • Dividend  

 There  is  a  starting  rate  of  10%  for  the  first  £2,880  of  interest  Income  (2014/15).    This  only  applies  where  savings  income  falls  below  the  starting  rate  limit  of  £10,000    

• Dividends  falling  in  the  basic  rate  tax  band  are  taxed  at  10%.  As  they  come  with  a  10%  deemed  or  ‘notional’  tax  credit,  no  further  tax  is  payable  on  dividends  for  basic  rate  taxpayers.    

• Dividends  falling  into  the  higher  rate  tax  band  are  taxed  at  32.5%,  and  for  additional  rate  taxpayers  at  37.5%  

 If  you  earn  over  £100,000  for  every  2  pounds  you  earn  you  lose  1  pound  of  your  personal  allowance.  Up  to  120,000      Allowances  Certain  loan  interest  payments  can  be  deducted  from  total  income.    An  individual  who  pays  interest  in  a  tax  year  is  entitled  to  relief  in  that  year  if  the  loan  is  for  one  of  the  following  purposes.    

• Loan  to  buy  plant  or  machinery  for  partnership  use  (interest  allowed  for  three  years)    

• Loan  to  buy  plant  or  machinery  for  employment  use  (interest  allowed  for  three  years)  

• Loan  to  buy  interest  in  unquoted  employee  controlled  company  • Loan  to  invest  in  a  partnership    • Loan  to  invest  in  a  cooperative    

 Tax relief is given by deducting the interest from total income for the tax year in which the interest is paid. It is deducted from non-savings income first, then from savings income and lastly from dividend income    National  insurance  contributions    National insurance contributions (NICs)are payable by employees and their employers and also by self-employed individual  Class   Description  1   Payable  by  employees  on  their  earnings  

above  the  primary  threshold.  The  amount  payable  depends  on  an  individuals  income    

• Both  employees  and  employers  pay  Class  1  NICs,  in  amounts  that  are  related  to  the  employee's  earnings.    

• Primary  Class  1  NICs  are  paid  by  employees  under  the  State  Pension  Age,  on  part  of  their  earnings  through  a  deduction  from  their  pay.    

• The  employer  adds  their  own  contribution  (secondary  Class  1  NICs)  and  remits  the  total  to  HMRC  

1A   Payable  by  employers  on  certain  types  of  non-­‐monetary  benefits  (company  cars,  health  benefit  schemes)  

1B   Payable  by  employers  on  an  employee’s  earnings  if  they  have  entered  into  a  PAYE  settlement  agreements  (PSA)  

2   Payable  by  self  employed.  If  earnings  are  below  small  earnings  exception  then  no  NIC  is  payable    

• Contributions  are  payable  at  a  flat  rate  by  self-­‐employed  persons,  unless  annual  profits  are  below  the  small  earnings  exception  limit  

3   Voluntary  –  usually  to  fill  gaps  in  contributions  

4   Payable  by  self  employed,  if  profits  exceed  a  threshold  (based  on  the  level  of  their  taxable  business  profits).  

   Taxation  of  trusts  and  beneficiaries  Tax  Band   Non-­‐dividend  type  income  

(rent,  savings,  business  income)  

Dividend  type  

1st  1000  of  income  (standard  rate  band)  

20%  basic  rate   10%  dividend  ordinary  rate  

Income  over  1000   45%  trust  rate   37.5%  (dividend  trust  rate)    If  settlor  has  more  than  one  trust  the  standard  band  is  split  between  them  down  to  a  minimum  of  £200  A  beneficiary  may  be  able  to  reclaim  tax  charged  on  income  received  from  a  trust    Capital  gains  tax    Capital gains tax (CGT) is payable by:

o UK - Domiciled residents o on the chargeable disposal o of a chargeable asset

 • What  you  pay  when  you  make  a  gain  on  selling  asset  • You  must  be  chargeable  person  • A  person  resident  or  with  sufficient  ties  to  the  UK  

 Overseas  aspects  

Individuals with UK domicile are liable to CGT on the disposal of assets situated anywhere in the world if, for any part of the tax year in which the disposal occurs, they are resident in the UK    Chargeable  disposal  

• Sale  of  asset  • Gift  of  asset  • Received  proceeds  for  asset  

o e.g.  insurance  claim    Chargeable  asset  Everything  except:  

• Gilts  • Qualifying  Corporate  bonds  • Principal  private  resident  • Wasting  assets  (cars)  • NISA  • NS&I  products  • Gambling,  lottery  and  premium  bond  pay-­‐outs  

   Calculation  of  CGT           Scenario  A  (‘000)   Scenario  B  1st:  Total  capital  gains  in  fiscal  year  

37   8  

Total  capital  losses  in  fiscal  year  

(16)   (12)  

=net  gain  or  loss  in  current  fiscal  year  

21   (4)  

2nd:  losses  brought  forward  from  previous  years  (net  loss  from  previous  year)  

(5)    

3rd:  annual  exceptions   (11*)    4th:  chargeable  gain  or  loss   5   (4)  –  could  bring  forward  to  

offset  subsequent  gains  in  following  year  

   Pay  CGT  at  flat  rate  Salary  and  interest  of  18%  (28%  for  higher  rate  tax  payers)    Tax  Planning    Ways  to  mitigate  the  extent  of  CGT  liabilities’:  

• Spread  ownership  of  assets  amongst  family  members  (although  gifting  you  could  trigger  CGT)  

• Phased  encashment  –  only  sell  £11,000  each  year  to  take  advantage  of  allowance  • Realise  paper  loss  –  offset  against  gain  to  reduce  liability  • Sell  shares  and  repurchase  similar  different  shares  • Use  ISA  

 IHT  rates  Chargeable  estate  

o On  death  value  of  all  assets  added  together  that’s  what’s  determined  your  charitable  estate  

o There’s  no  exception  o The  first  325,000  at  0%  =  nil  banding  o Everything  above  325,000  taxed  at  40%  

 Death  bed  bequeathal    

• Potentially  exempt  (PET)      o any  gift  made  by  individual  in  lifetime  is  potentially  exempt  IHT  provided  not  

made  in  last  7  years.  o any  gifts  in  those  7  years  will  have  inheritance  tax  imposed  on  them  

• Gifts  to  trusts    o Assets  can  be  parked  in  a  trust  if  trust  isn’t  legal  property  it  isn’t  charged  to  

your  estate.    o a  transfer  to  a  discretionary  trust  will  attract  an  IHT  rate  of  20%  immediately  

• Gifts  with  reservation  of  benefit  (GWR)    o i.e.  gift  with  strings  attached.  Still  considered  part  of  an  individual  estate  for  

IHT  purposes  o Can  gift  your  house  to  children  on  condition  that  you  get  to  live  their  rent  

free,  which  means  that  it’s  not  a  true  gift.  Must  be  paying  rent  for  it  to  be  seen  as  true  gift.    

 Charity  –  reduction  of  10%  in  IHT  rate  (to  36%)  if  deceased  leaves  more  than  10%  of  their  estate  to  charity    Transfer  of  unused  nil  rate  band  

• An  individual  has  a  nil  rate  of  £325,000  • If  on  death  their  chargeable  estate  is  les  than  this  nil  rate  band  the  excess  can  be  

transferred  t  their  spouse  to  be  used  on  their  death      Property  can  move  between  spouses  with  no  tax    

• Nil  rate  bands  can  be  transferred    • Spouse  can  receive  100%  of  nil  rate  band  at  time  of  latter  spouses’  death  and  add  it  

to  her  own  nil  rate  band.    Transfer  is  on  percentage  basis  not  a  cash  basis    [This  calculation  will  come  up]    

 Stamp  Duty    Stamp  Duty  land  tax  –  paid  by  acquirer  of  land  and  property  in  UK    As  property  value  rises,  the  stamp  duty  land  tax  increases.    Should  know  bandings    Non-­‐residential  property   Residential   Rate    0-­‐150,000   0-­‐  125,000   0  150,001  –  250,000   125,001  –  250,000   1  250,001  –  500,000   250,001  –  500,000   3  Over  500,000   500,000  –  1,000,000   4  N/A   1,000,001  –  2,000,000   5  N/A   Over  2,000,000     7          For  non-­‐residential  property  or  land  with  a    value  up  to  250,000  the  SDLT  rate  is  1%  rising  to  3%  for  the  250,00-­‐500,000  range  and  4%  for  values  grater  than  500,000    Stamp  duty  reserve  tax    -­‐  on  purchase  on  assets,  not  property  but  on  shares  in  the  UK  (LSE  main  market)    ½%  rate  of  tax    (  of  value  of  transaction)    Payable  in  a  paperless  transaction  by  purchaser  of  :  Shares  in  a  UK  company  Shares  in  foreign  co  with  a  share  register  in  the  UK  An  option  to  buy  shares  Rights  arising  fro  shares  already  owned  An  interest  in  shares    Interest  in  shares    -­‐  interest  in  money  made  from  selling  shares      Payments  are  made  through  crest  (electronic  settlement  and  registration  system  administered  by  Euroclear)  For  funds  -­‐  Unit  Trusts  and  OEIC  the  fund  manager  pays  SDRT  when  each  individual  investors  units  are  sold    Corporation  tax  Corporation  tax  is  payable  buy  companies  resident  in  the  UK  on  their  worldwide  profits  (overseas  companies  on  their  UK  derived  profits)  -­‐    don’t  need  to  know  how  to  calculate    

• Main  rate  companies  pay  tax  in  4  quarterly  instalments  based  on  an  estimate  of  their  corporate  tax  liability  

• Other  companies  pay  whole  amount  nine  months  and  one  day  after  end  of  accounting  period  (financial  year  end)  

    Applies  to  co’s  with  profits  

of:  From  April  2014  

Main  rate   >1.5m   21%  Small  companies   <300k   20%  Companies  that  lie  between  pay  a  sliding  rate  somewhere  between  20%  and  21%    Losses  can  be  offset  against:  

• This  years  income  and  gains  • Last  years  income  and  gains  • Future  years  profits  from  the  same  trade  

 VAT  Chargeable  on  the  supply  of  goods  and  services  in  the  course  of  business  Tax  rates  

• 0%  Children  books  and  clothes  (not  exempt)  • 5%  energy  services  and  products  • 20%  most  other  goods  

 Investment  services  

• Commissions  –  exempt  (not  same  as  0%)  • Nominee  services  –  exempt  • Advisory  services  –  standard  rate,  if  invoiced  separately  (otherwise  exempt)  • Portfolio  management  –  stand  rate  (20%)  

   Taxation  of  Investments      Direct  investments  

• Taxed  based  on  relevant  income  or  capital  gains  tax  rate  • Examples  include  interest  income  form  banks  gilts  corporate  bonds,  income  part  of  

purchased  life  annuity,  dividend  income  rental  income  • Most  income  is  paid  net  of  20%  (basic  rate)  tax.    • Those  paid  gross  include  gilt  interest  (UK  gov  bonds)  interest  on  NS&I  accounts  

interest  paid  to  individual  investors  by  listed  UK  comps    Indirect  investments  

• Pension  funds  • ISA  • REIT  • CIS  • VCT  • EIC  

• Life  insurance  funds    Pensions    Limit  of  how  much  can  be  contributed  each  year  (£40,000)  Tax  relief  at  marginal  rate  :  if  under  75  Tax  free  lump  sum  (up  to  25%  of  accumulate  funds  )  can  be  taken  at  retirement.  Remainder  used  to  produce  an  income  subject  to  income  tax    Lifetime  limit  of  £1.25m  (2014/15)  Amounts  above  this  subject  to  tax  at  25%  if  the  excess  take  as  income  or  55%  if  excess  taken  as  lump  sum    ISA  

• Not  an  investment  but  rather  a  wrapper  • Two  types  of  ISA:  Cash  and  Stocks  and  shares  • Annual  limit  of  how  much  can  be  invested  in  ISA  (15000  for  14/15)  can  split  as  

desired  between  two  types  • Investments  within  ISA  not  subject  to  income  or  capital  gains  tax  • Tax  paid  at  source  is  not  recoverable  (10%  on  dividends  and  20%  on  interest  income  

–  on  stocks  and  shares  only  (Basic  rate))    Junior  ISA    Up  to  4000  can  be  invested  each  year  Can  be  split  between  stocks  shares  and  cash    REIT  Real  estate  investment  trust  Company  that  primary  business  is  to  invest  and  rent  out  property  If  company  turns  itself  into  reit,  rental  income  and  capital  against  exempt  within  the  fund,  but  requirement  to  distribute  most  rental  income  (90%)  as  dividend.  ,which  is  taxed.  Investors  subject  to  income  tax  on  distributions  (20%  basic  rate  tax  withheld  from  dividend)  Investors  also  subject  to  capital  gains  tax    Taxation  of  investment  vehicle     Authorised  UT/OEIC   Investment  Trst  co  Income  (non-­‐dividend)   >Corporation  tax  of  20   Corporation  tax    (rate  

depends  on  profitability  of  trust  

Capital  gains  (gains  within  the  fund)  

NL   NIL  

   Distributions  form  a  collective  investment  fund  treated  as  dividend  distribution  for  income  tax  purposes  

But,  if  fund  holds  >60  interest  bearing  securities,  distribution  is  treated  as  interest  income  for  income  tax  purposed  (20%)  On  sale  (including  switching  between  sub-­‐funds)  investor  subject  to  CGT    Taxation  of  investment  vehicle  Offshore  fund  classification  (no  run  in  UK)  Reporting  status  –  how  reports  income  to  tax  man  ,  income  taxed  by  income  tax,  gains  taxed  from  CGT  Non-­‐reporting  status  ‘roll  up  funds’  retains  most  of  its  money  to  make  more  investments  (buy  more  shares  increase  value  of  fund)    -­‐  gains  in  value  isn’t  about  capital  gains  its  about  reinvestment  –  they  pay  income  tax  on  any  capital  gains.  –  not  great  for  investors  as  they  miss  out  on  large  CG  allowance    Life  assurance  funds  Fund  insures  lfie  and  promises  investment  return  at  end  of  period  Process  form  qualifying  life  assurance  policy  free  of  income  and  capital  gains  tax  so  long  as:  Premium  paid  for  at  least  10  years  Premiums  paid  at  least  annually    20%  would  be  paid  by  higher  rate  taxpayers  (25%  for  additional  rate  tax  payers)  on  the  surplus  of  process  over  premiums  paid  if  the  above  is  not  satisfied    One  off  or  regular  payments  from  a  single  premium  UK  life  assurance  policy  usually  leads  to  no  income  tax  Max  withdrawal  of  5%  of  the  original  premium  can  be  withdrawn  without  incurring  additional  income  tax  liability.    Tax  relief  of  venture  capital  trust    Investor  tax  liability  is  rescued  by  30%  of  the  invested  amount  (max  investment  that  attracts  relief  is  200,000)  If  shares  not  held  for  5  years  the  relief  is  clawed  back    Dividend  income  is  tax  free  No  CGT  (both  within  the  VCT  and  for  investor,  irrespective  of  the  holding  period)    Enterprise  investment  scheme-­‐  tax  reducer  

• Offers  tax  incentives  to  individuals  to  invest  in  new  and  growing  businesses  • Certain  unquoted  shares  and  AIM  shares  • Income  tax  relief  given  at30%  of  investment  (maximum  investment  is  1m)  must  hold  

shares  for  3  years  • Gains  on  disposal  are  not  taxed    (so  long  as  held  for  3  years)  • If  shares  sold  at  a  loss  the  loss  can  be  set  against  the  investors  income.