Unit 1 IMC Passcards

Investment Management CertificateUnit 1 – The Investment EnvironmentSyllabus version 11

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Published November 2013

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Page iii

Welcome to BPP Learning Media’s Investment Management Certificate Unit 1 Passcards.

� Passcards save you time. Important topics are summarised for you.

� Passcards include diagrams to kick start your memory.

� Passcards follow the overall structure of the BPP Learning Media Study Texts, but Passcards are notjust a condensed book. Each card has been separately designed for clear presentation. Topics are selfcontained and can be grasped visually.

� Passcards are still just the right size for pockets, briefcases and bags.

� Passcards focus on the exam you will be facing.

Run through the complete set of Passcards as often as you can during your final revision period. The daybefore the exam, try to go through the Passcards again.You will then be well on your way to passing yourexams. Good luck!

ContentsPreface

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ContentsPreface

Page

1 Financial markets and institutions 1

2 Ethics and investment professionalism 27

3 Financial regulation 33

Page

4 Legal concepts 109

5 Client advice 119

6 Taxation 145

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1: Financial markets and institutions

Topic List

Financial institutions

Role of government

Financial markets

Listing & governance

International markets

The agency problem

The financial services industry plays a key role in theeconomic system. Here, we look at the institutions andmarkets within the industry. We also examine the roles of thenational Government, and the status of EU legislation.

The London Stock Exchange is a market place for tradingbonds and other securities. The creation of Multilateral TradingFacilities (MTFs) since MiFID is a challenge to the mainstreamexchanges, with MTFs taking a significant market share.

The FCA operates as the UK Listing Authority (UKLA) toregulate company listings on the Exchange.

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The agencyproblem

Internationalmarkets

Listing &governance

Financialmarkets

Role ofgovernment

Financial intermediaries bring together providersand users of finance, either as a broker facilitating atransaction, or in their own right, as principal.

Functions of financial intermediaries

� Source of funds for borrowers

� Aggregation of deposits (eg small savers) tolend on to borrowers (eg for mortgages)

� Maturity transformation: between for exampledepositors wanting instant access and borrowersneeding a 25-year loan

� Pooling of collective funds, giving smallinvestors access to diversified portfolios

� Banks� Building societies� Insurance companies, pension funds, collective

funds� National Savings & Investments (NS&I) – a

Government agency

UK financial intermediaries

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

� Capital markets – for raising and investinglargely long-term capital (eg the StockExchange)

� Money markets – for lending and borrowinglargely short-term capital (eg banks’ short-termlending)

Financialinstitutions


1: Financial markets and institutionsPage 3

The agencyproblem


Listing &governance

Financialmarkets

Role ofgovernment

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



The agencyproblem


Listing &governance

Financialmarkets

Role ofgovernment

UK financial services industry� Employs over 1 million people in the UK� Accounts for around 5% of national output

Banks� Clearing banks – operate the system for settling

payments� Retail banks – the ‘High Street’ banks� Wholesale banks – lend in large amounts, to

larger customers� Investment banks – serve institutional investors

and corporate customers� Central bank – Bank of England (for UK)

Building societies � Main assets: mortgages of their members� Main liabilities are to investor members

– mutual organisations


Monetary Policy Committee (MPC) aims to meetUK’s 2% (CPI) inflation target.

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

Functions of Bank of England

The central bank (BoE)

�



The agencyproblem


Listing &governance

Financialmarkets

Role ofgovernment



The agencyproblem


Listing &governance

Financialmarkets

Role ofgovernment

Banks and building societies

� Current accounts: non- or low interest� Deposit or savings accounts� Trend towards e-banking and ATMs� Overdrafts and personal loans� Mortgages, including ‘buy-to-let’� Trustee services� Portfolio management services� FInancial planning services

Life offices provide protection on death and disability,long-term savings and lump sum investments, through theissue of term assurances, whole life assurances,endowments, pensions, investment bonds, annuities.

Products are marketed by personal advice and byadvertisements.

Bancassurers are banks with their own life offices. Banksmay establish independent subsidiaries employingindependent financial advisers, who must advise on themost suitable product available in the whole market ormarket sector.

Friendly societies: mutual organisations offeringinvestment products.

Products and functions




The agencyproblem


Listing &governance

Financialmarkets

Role ofgovernment

� Individual clients� Corporate clients

� Portfolio management� Research and analysis

Brokers – buy and sell securities

Investment managers

� Services may include:

� Unit trusts and OEICs� Investment trust offers� ISAs� Discount share dealing� Internet dealing services

Functions may be combined indiscretionary portfolio management:

� Manager makes buy/sell decisions� Within parameters agreed with the client

Funds supermarkets offer:

� Various providers’ collective funds� ‘Mix and match’ facility to combine different providers’ funds in an ISA� Online dealing by credit or debit card � Online account tracking facilities

E-commerce has changed the industry, with:

� Internet banking & online share trading� Real-time share price information services� Marketing of products, with online completion of applications

E-commerce: transacting business via the internet




The agencyproblem


Listing &governance

Financialmarkets

Monetary policy

Legislation Fiscal policy

� Changes in the amount of money in circulation –the money supply – and

� Changes in the price of money – interest rates

These variables are linked with:� Inflation in prices generally� Exchange rates – the price of the domestic

currency in terms of other currencies

Government spending is an injection into theeconomy, adding to demand for goods andservices, whereas taxes are a withdrawal.

The UK has a mixed economy – market-based withsome State intervention

A government's fiscal stance may be neutral,expansionary or contractionary, according toits overall effect on national income.

is concerned with:

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

A government's fiscal policy concerns its plansfor Government spending, taxation andGovernment borrowing.

Role ofgovernment




The agencyproblem


Listing &governance

Financialmarkets

Easing of monetary policy Tightening of monetary policy

� Loans are cheaper, and so people borrow &spend more. Companies find borrowing cheaperwhile consumer demand may rise, both factorsboosting profits.

� Asset values rise. Eg, Government bonds (gilts)rise in price, since required returns are nowlower.

� Those dependant on income from cashdeposits will be worse off.

� Loans cost more, property prices may bedampened & consumer demand may fall.Company profits could reduce through higherborrowing costs & lower demand.

� Other asset prices may fall. Investors willrequire a higher return than before & so payless for fixed interest stocks (eg gilts).

� Those reliant on interest for income will bebetter off.

BoE reduces interest rates: BoE increases interest rates:

v

Role ofgovernment



The agencyproblem


Listing &governance

Financialmarkets

Exchange rate policy Changes in interest rates affect exchange rates:currencies with higher rates attract money inflow,and their values relative to other currencies rise.

The European UnionThe EU seeks to remove barriers to the freemovement of goods, persons, services and capital.

The European Central Bank is the central bank foreurozone countries – which use the euro as theircommon currency.

The Government can try to influence exchangerates by buying & selling currency, to the extentthat it has sufficient currency reserves.

EU law

� Regulations have the force of law in every EUstate without need of national legislation.

� Directives are issued to the governments of theEU member states requiring them within aspecified period (usually two years) to alter thenational laws of the state.

� Decisions of an administrative nature are madeby the European Commission in Brussels.

EU legislation takes three forms:

Role ofgovernment




The agencyproblem


Listing &governance

Role ofgovernment

Financialmarkets

Asset types� Tangible assets – eg, property, equipment,

commodities – are real assets. Claims on areturn such as interest or dividends arefinancial assets. Loans (debt) and shares(equity) represent the two main types offinancial security.

� Ordinary shares (equities) offer the prospect ofdividends and capital growth, if the companysucceeds. Fixed income securities (debt, forthe issuer) are often generally called bonds.Pooled or collective funds package securities,allowing diversification and index-tracking.

Sell side and buy sideTraders in financial markets can be categorisedbroadly into sell-side & buy-side.

� Sell-side firms comprise investment banks,brokers, & dealers who provide investmentproducts & transaction services

� Buy-side firms are mainly investment managers(including pension funds, mutual funds, hedgefunds & insurance companies) who purchaseinvestment products & transaction services

Many firms encompass market participants on thebuy-side as well as the sell-side.



The agencyproblem


Listing &governance

Role ofgovernment

Financialmarkets

Financial markets� .... Mobilise people’s savings and put them to use in enabling firms to grow, thus contributing to the

wealth of the economy� .... Enable the transfer of risk. Eg, derivatives markets enable investors, entrepreneurs and market

participants to hedge risks as well as to speculate on the prices for assets

Attributes of an effective & efficient securities market� Cost efficiency – electronic order systems lower costs (operational efficiency)

� Liquidity – the ability to enter or exit the market with reasonable price spread, on a transaction of areasonable size (promotes operational efficiency). Contributing factors: effective IT & settlementsystems, diverse membership & stock availability, stock lending facilities

� Price discovery – the process through which an equilibrium price for a financial instrument is revealedcontinuously through bid & offer prices, and trading (enabling informational efficiency)

� Transparency – investors knowing the price before, during & after a deal in order to be satisfied that theyhave a good deal (informational efficiency: prices reflect all relevant information)




The agencyproblem


Listing &governance

Role ofgovernment

Financialmarkets

Round trip (purchase / sale) transaction costs include: bid / offer spread, broker’s commissions, StampDuty Reserve Tax (CREST, dematerialised transactions) or stamp duty (non-CREST), Takeover Panel levy (£1,on transactions over £10k).

A less easily quantified element of transaction costs is the cost effect of the tendency for fluctuating ordersizes to move prices: this is market impact or price impact. For major stocks with deep liquidity, bid-askspread and potential price impact can be very low for typical transactions. Smaller issues may have highliquidity risk or marketability risk, which has to do with the ease with which an issue can be sold. This riskcan become acute at times of market stress, and is built into the price of securities.

Limit orders – only filled if price is better than the stated limit – compare with market orders, which are filledat the best available price when the order is placed.The opportunity cost of a limit order is that the price maymove against the trader before the order is filled.

More opaque (less transparent) markets will typically have larger bid-ask spreads because dealers will find itmore difficult to judge demand for stock, and so know the equilibrium price (price discovery). Real-time pre-trade & post-trade transparency are required for many securities (especially equities) under MiFID rules.Over-The-Counter markets are typically less transparent.



The agencyproblem


Listing &governance

Role ofgovernment

Order- v quote-driven markets� Order-driven: trading system matches willing

buyers & sellers automatically. Prices ofsecurities are driven by buyers & sellers.

� Quote-driven: market makers act as buyers &sellers to the market, quoting prices continuously.

London Stock Exchange plc

Stock Exchange members

� Initially, companies issue securities to investors –the primary market.

� LSE also provides a secondary market fortrading in already-issued securities.

LSE members are:

� Broker/dealers, who may act in dual capacity, iebroker a customer’s business (agent) or dealdirectly with them (principal)

or� Equity market makers / GEMMs, who quote

2-way prices

Exchange trading v OTC� Exchange-traded instruments: standardised in

respect of (eg) contract size and dates,facilitating a liquid market in the instrument

� ‘Over the counter’ instruments: generallynegotiated with a financial institution, to fit clientneeds

Financialmarkets




The agencyproblem


Listing &governance

Role ofgovernment

SETS SETSqx SEAQOrder-driven Combined order-

and quote-drivenQuote-driven

No market makers 1+ marketmakers per stock

2+ marketmakers per

stock‘Liquid’ listed stocks asclassified by MiFID, i.e.FTSE All Share stocks,ETFs, Exchange TradedCommodities & actively

traded Irish stocks

‘Illiquid’ stocksunder MiFID

No listedstocks

Most traded AIM stocks All AIM stocks inAIM EUROsectors not

traded on SETS

AllremainingAIM stocks

SETS (Stock Exchange Electronic Trading Service) iscalled ‘The Order Book’. LCH.Clearnet is the centralcounterparty, keeping trades anonymous. Brokers’ orders:

� Match automatically with an order currently displayed, or� May be matched later

SETSqx (‘SETS – quotes & crosses’):

� Market makers must quote buying & selling (two-way)prices up to Exchange Market Size (EMS)

� Also, periodic auctions, where anonymous limit ordersare placed

SEAQ (known as a quote display system): secondarysystem, used for fixed income securities and less frequentlytraded AIM stocks.

LSE trading platforms

Financialmarkets



The agencyproblem


Listing &governance

Role ofgovernment

Cum- and ex-divShares trade cum div (with right to receive next dividend)until 2 business days before books close date.

LSE determines

2 business days

Company determines

Ex-div date

Dividendannouncement

Books close

Dividendpayment

date

Cum div – buyer willreceive next dividend

Ex div – seller willreceive next dividend

Financialmarkets

Fixed interest: usually go ex-div 7 business daysbefore coupon dates.




The agencyproblem


Listing &governance

Role ofgovernment

Alternative trading venues

� ‘Dark pools’: electronic trading platforms whereneither price nor identity of trading firm isrevealed

� Multilateral Trading Facilities (MTFs):electronic trading platforms functioning similarlyto SETS, but generally cheaper than SETStrading

� Systematic Internalisers (SIs): Investmentbanks executing client orders by trading for theirown account, rather than with an exchange orMTF

Financialmarkets

Benefits� Improved liquidity & bid/ask spreads� Lower transaction costs� More efficient market pricing

Risks� HFT traders may squeeze unfair price

advantage� Technical glitches could lead to erroneous

orders & volatility (‘flash crashes’)� Possible market manipulation

Automated & high frequency trading (HFT)



The agencyproblem


Listing &governance

Role ofgovernment

Gilts marketGilts settle via Euroclear UK & Ireland (EUI).

� Gilt Edged Market Makers (GEMMs) mustquote firm two-way prices in all conventionalgilts and/or all index-linked gilts.

� Inter Dealer Brokers (IDBs) arrange matchedprincipal-to-principal anonymous tradesbetween GEMMs, allowing GEMMs to unwindpositions.

Order Book for Retail Bonds (ORB)� Electronic order-driven trading service for

selection of gilts & UK corporate bonds� Investors can enter orders directly, or via a

broker with Direct Market Access (DMA)

Financialmarkets

Settlement conventionsEquities T + 3

Gilts/ US ‘T’-Bonds T + 1

Eurobonds/ Corporate bonds T + 3

Currencies/ German equities T + 2

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


Large



The agencyproblem


Listing &governance

Role ofgovernment

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

New issue Tranche

Auction Tap

Competitive Non-competitive

� Pay bid price � Maximum bid is £0.5 millionnominal value

� Pay weighted average ofsuccessful bid prices incompetitive auction

If small (tranchette) orfailed auction, issuedinto secondary market

Financialmarkets



The agencyproblem


Financialmarkets

Role ofgovernment

Summary Main List AIM

Trading record 3 years* None

Percentage in public hands 25%* None

Minimum market value £700,000 forequity; £200,000

for debt

None

Free transferability Yes Yes

Prospectus requirement** Yes Yes***

Applicable rules UKLA LSE

*Not required for a Standard (non-Premium) listing. **Exemptions:qualified/larger investors; smaller offers/private placements. *** ForAIM, a simplified Admission Document.

AIM – Alternative Investment Market

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

ISDX (previously PLUS Markets)

� ISDX Growth Market: for growing small- andmedium-sized enterprises (SMEs)

� Rules for issuers include application &continuing obligations requirements

� Market makers Peel Hunt & Shore Capitalmake markets in ISDX's major stocks, ensuringits operation as a secondary & primary market

UKLA and AIM rules

Listing &governance




The agencyproblem


Financialmarkets

Role ofgovernment

Annual General Meeting (AGM)� Listed company: must hold within 6 months of

financial year end

� 21 days’ notice required (unless Articles specifylonger) – can be waived if all members agree

� Member attends/sends proxy, to exercisemember’s rights

� Private company (Ltd): AGM not required – mostdecisions can be made by written resolution

Other general meetings� 14 days’ notice required – can be waived if 95%

of members agree (90% for private company)

Resolutions� Ordinary resolution needs 50% majority /

14 days’ notice.

� Special resolution needs 75% majority /14 days’ notice.

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

Standard AGM tasks

Listing &governance



The agencyproblem


Financialmarkets

Role ofgovernment

Disclosure/transparency Corporate Governance CodeKey rules� Holders (including connected parties) of 3% of voting

rights, & where holdings cross a % point up or down,must notify company by T + 2 (two business days)

� Directors and senior executives (PDMRs) must getclearance to deal in own company shares /derivatives, & notify company of such transactions byT + 4

� Company informs the market via RegulatoryInformation Service (RIS)/ Primary InformationProvider (PIP) by T + 1

� Chairman/Chief Executive split� Non-executive directors balance� Re-election every 3 years� Audit & renumeration committees� Service contracts & notice periods� Review of internal controls� Disclosures in annual accounts� Encourages institutional shareholders to

use votes

Key points

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

Listing &governance




The agencyproblem

Listing &governance

Financialmarkets

Role ofgovernment

USA

France

� US Government bonds: issued by Dutch auction,a form of tender

� Market makers on NYSE: known as ‘specialists’

� Super Display Book System: the NYSE’s primaryorder processing system

Japan

� French bonds: longer dated OAT (T + 3) &shorter dated BTAN (T + 1)

� OATi: inflation-protected bond

� Bonds issued by Dutch auction

Germany� Government bonds are the Bund: stock

exchange-traded & also OTC

� Equities settle T + 2, where counterparties areboth German


� Japanese stocks settle at the JapaneseSecurities Depository Centre (JASDEC)

� Japanese Government bonds (JGBs): mostlytraded over-the-counter (OTC)

� JGBs settle at Bank of Japan



The agencyproblem

Listing &governance

Financialmarkets

Role ofgovernment


Emerging markets Central securities depositories (CSDs)

Rapid economic growthLow correlationsPotentially attractive valuationsInefficient pricing

Attractions

TransparencyVolatilityRegulationLiquidityTaxation

Possible drawbacks

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

International CSDs (ICSDs) – such as Euroclear &Clearstream – provide clearance, settlement &custody in Euromarkets & in international equities.





Listing &governance

Financialmarkets

Role ofgovernment

A small firm typically has a strong alignment between its ownership and its control. The enterprise will typicallybe run by owner-managers, who are perhaps within the same family. It is in the interests of the owner-managers for the company to succeed, and for shareholder wealth to be maximised. In larger companies,professional managers may be hired who may have little or no shareholding in the company. There is then aseparation of ownership & control.Agency theory sees employees of businesses, including managers, as individuals, each with their ownobjectives. Various people are involved as agents. The department of a business has its own departmentalobjectives. If achieving these various objectives leads also to achieving the organisation’s goals, there is goalcongruence. In practice, this may not occur. Managers who work for the company (as agents) may havedifferent objectives, such as gaining benefits (perks) for themselves, dealing on their own account (in afinancial firm), pursuing pet projects or ‘empire-building’.

Agency problems arise from the misalignment of goals, and this can make clients, including individuals, morereluctant to provide finance intermediaries in the investment industry: they might tend to prefer keeping theirassets as cash, for example. This will limit market liquidity and makes it more difficult for firms to grow,potentially hurting growth prospects in the economy.

The principal-agent problem

The agencyproblem




Listing &governance

Financialmarkets

Role ofgovernment

The agencyproblem

One strategy aiming to enhance goal congruenceand to mitigate the 'agency problem' is the use ofremuneration incentives.

Examples� Profit-related/economic value-added pay� Rewarding managers with shares� Executive Share Options PlansIn financial trading firms, the wrong remunerationstructures could encourage short-term risk-takingby traders, potentially putting the future of theenterprise in jeopardy, if risks turn bad.

Other measures� Separation of roles – one individual not to

have too much power

� Accounting standards – auditied accounts animportant source of 'post-decision' informationfor investors

� Corporate governance – a check onmanagement power

� Regulation – in the financial services industry,rules & principles aim to ensure that financialservices firms deal properly with conflicts ofinterest and treat customers fairly

Ways to reduce the agency problem


Topic List

Ethics and compliance

CFA Code of Ethics

2: Ethics and investment professionalism

Ethical conduct is a matter of continuing debate. Thereputation of individuals and firms is at stake when thereare shortcomings in professional behaviour. In business asin other areas of life, reputation must typically be built upover a long time, but it can be lost quickly.


CFA Code of Ethics

Ethics andcompliance

Ethics in organisations Senior management’s roleAs the regulator stated (CP10/12), promoting standardsof ethical behaviour improves outcomes for consumers& their perception of the financial services industry.

Beyond mere compliance with rules, firms must – throughtheir leaders – foster a corporate culture congruent withregulatory principles, if regulation is to work.

Firms must follow law and regulations.

Ethics in organisations relates to socialresponsibility & business practices.

� Personal ethics derive from a person's beliefs& opinions.

� Professional ethics – eg, the CFA’s Code ofEthics.

� Corporate culture – eg, 'Customer first'.

� Organisation systems. Ethics might becontained in a formal code. Possible problem:good ethics does not always save money, &there is a real cost to ethical decisions. Equally,there can be substantial risk, & costs, if poorethics results in loss of reputation.

Senior management must use their leadershippositions to move the culture of their firm in the desireddirection, with:� Communication of the principles at all levels of the

organisation, & possibly external stakeholder groups

� Leaders (senior management, and team leaders)setting an example

� Appropriate training of staff


2: Ethics and investment professionalismPage 29

RegulationsA set of rules designed to control the behaviour of

industries, firms, or individuals

EthicsA set of basic principles about how individuals andorganisations should behave, for the benefit of all

The rules or principles that regulate behaviour ofindividuals and businesses derive from:� The law� The requirements of rules & regulations� Regulatory guidance that is not mandatory

� Professional standards & codes of conduct

� Ethics & ethical values

The ethical environment refers to justice,respect for the law and a moral code. Theconduct of an organisation, its management andits employees will be measured against ethicalstandards by customers, suppliers & othermembers of the public.

CFA Code of Ethics


The FCA expects firms to consider properly if theirincentive schemes increase the risk of mis-selling.


CFA Code of Ethics


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

As we shall see in the next Chapter:

The first FCA/PRA Principle for Businesses is Integrity:

‘A firm must conduct its business with integrity.’

The first Statement of Principle for Approved Persons isalso Integrity:

‘An approved person must act with integrity incarrying out his accountable functions.’

&

� Honesty: the person will not deliberatelymislead another

� Reliability: the person can be relied upon tomaintain appropriate levels of competence &skill in practice

� Impartiality: treating different people fairly,where the people involved could becustomers, employees or others

� Openness: implying transparency, whereappropriate & where justified confidentiality is not breached

Attributes of professional integrity


2: Ethics and investment professionalismPage 31

Compliance-based approachA rules-based compliance approach seeks to ensurethat a firm acts within laws & regulations, & thatviolations are prevented, detected & punished.

Integrity-based approachAn integrity-based approach combines a concernfor the law with emphasis on managerialresponsibility for ethical behaviour.

Integrity strategies define companies' guiding values,aspirations & patterns of thought & conduct:

� To prevent damaging ethical lapses, while� Tapping into human impulses for moral thought &

action

Some organisations, faced with the legal consequencesof unethical behaviours, take legal precautions such as:

� Compliance procedures to detect misconduct� Audits of contracts� Systems for employees to report criminal

misconduct without fear of retribution� Disciplinary procedures to deal with transgressions

A compliance-based approach suggests thatbureaucratic control is necessary; an integrity-based orprinciples-based approach relies on cultural control.

This approach echoes the FCA’s principles-basedapproach to financial regulation – eg, the principles-based approach requires firms to act with integrityand to treat customers fairly. Unlike rules, suchprinciples require senior management to applyhigher-level professional values in their business.

CFA Code of Ethics



III. Duties to ClientsA. Loyalty, Prudence & CareB. Fair DealingC. SuitabilityD. Performance PresentationE. Preservation of Confidentiality

IV. Duties to EmployersA. LoyaltyB. Additional Compensation ArrangementsC. Responsibilities of Supervisors

V. Investment Analysis, Recommendations & ActionsA. Diligence & Reasonable BasisB. Communication with Clients & Prospective ClientsC. Record Retention

VI. Conflicts of InterestA. Disclosure of ConflictsB. Priority of TransactionsC. Referral Fees

VII. Responsibilities as a CFA Institute Member or CandidateD. Conduct as Members & Candidates in CFA programE. Reference to CFA Institute, designation & program

CFA Code of Ethics

CFA Code of Ethics


1. Act with integrity, competence, diligence and respect, & in an ethicalmanner with others

2. Place the integrity of the investment profession & the interest of clientabove personal interests

3. Use reasonable care & exercise independent professional judgement4. Practice & encourage others to practice in a professional & ethical

manner 5. Promote the integrity of, & uphold the rules governing, capital markets6. Maintain & improve their own, & others’, professional competence

Standards of Professional ConductI. Professionalism

A. Knowledge of the LawB. Independence & ObjectivityC. MisrepresentationD. Misconduct

II. Integrity of Capital MarketsA. Material Non-Public InformationB. Market Manipulation


3: Financial regulation

Topic List

Regulatory framework

FCA high level standards

Exchanges & markets

FCA business standards

Supervision & redress

Financial crime

The Financial Services Act 2012 (FSA 2012) amendedthe Financial Services and Markets Act 2000 (FSMA2000) to reform the system of regulation of the UKfinancial services industry.

Re-structuring of the UK regulatory framework with effectfrom 1 April 2013 has seen the establishment of the PRAand the FCA as twin regulators, to replace the FSA.


Financial crimeSupervision &redress

FCA businessstandards

Exchanges &markets

FCA high levelstandards

Regulatoryframework

Passporting

Home State/ host State

‘Passporting’ (under MiFID rules) enables firms to usetheir domestic authorisation to operate not only in theirhome state, but also in other host states within theEuropean Economic Area (EEA) (EU + Norway, Iceland& Liechtenstein).

For a passporting firm (home-State authorised):� Organisational matters regulated by the home

State: eg authorisation, fitness & propriety,capital adequacy, Principles for Businesses,senior management arrangements, systems &controls, client assets, conflicts of interest,personal account dealing, transaction reporting& transparency, compensation

� Operational matters, eg conduct of businessrules that are not ‘organisational matters’,regulated by:– The host State, for activities of a branch ‘within its territory’– The home State, for cross-border services

European regulatory frameworkThe aims of the EU’s Financial Services Action Plan(FSAP) have been to create a single wholesale market,an open and secure retail financial services market, andstate-of-the-art prudential rules and regulation. VariousEU Directives have been issued to further these aims.


3: Financial regulationPage 35



Exchanges &markets


MiFIDThe Markets in Financial Instruments Directive:

� Part of the FSAP, implemented November 2007

� Applies to all investment firms, eg investment &retail banks, brokers, asset managers, securities &futures firms, securities issuers & hedge funds

� Transferable securities, eg shares & bonds� Money market instruments� Units in collective investment undertakings� Derivatives of various types� Financial contracts for differences (CFDs)

Instruments covered by MiFID

European Securities & Markets Authority:

� 1 of 3 European Supervisory Authorities� To ensure integrity, transparency, efficiency, orderly

functioning of securities markets, and� Enhance consistent EU-wide investor protection.� Works on laws to develop single EU rulebook,

promoting equal competition, limiting regulatoryarbitrage

� Standard setting, promoting internationalsupervisory co-operation

� With ESRB, identifies & advises on systemic risks:short-, medium- and long-term

� Would co-ordinate emergency crisis measures� Able to prohibit products that threaten stability

Role of ESMA

Regulatoryframework




Exchanges &markets


Scope of MiFID MiFID applies to ‘core’ investment services and activities of:� Investment firms (which are also regulated for ‘non-core’ ancillary services)� Credit institutions including UK banks & building societies, for activities in MiFID’s scope

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

Investment services and activities

� Safekeeping & administration of financialinstruments

� Credit / loans to an investor in a transactioninvolving the firm

� Advice on capital structure, industrialstrategy, mergers & acquisitions

� Currency services connected withinvestments

� Investment research & financial analysis

Ancillary services

Regulatoryframework





Exchanges &markets


UCITS Directives EMIR – European Market Infrastructure Regulation

Undertakings for Collective Investment inTransferable Securities (UCITS) – collective investmentschemes (CISs) that can be marketed across the EEA.CIS must comply with marketing rules of host State &documentation requirements of Directive.

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

Permitted UCITS investments

EMIR sets standards for OTC derivatives, centralcounterparties (CCPs) & trade repositories:� Reporting obligations for OTC derivatives� Obligations for eligible OTC derivatives to be

cleared through CCPs� New risk mitigation requirements for all OTC

derivative trades that are not centrally cleared� Common rules for CCPs and for trade repositories� Rules on the establishment of interoperability

between CCPsUnder EMIR, all standardised OTC derivative contractsshould be traded on exchanges or electronic tradingplatforms, where appropriate, and cleared throughCCPs.

Regulatoryframework




Exchanges &markets


PRA & FCAThe late 2000s financial crisis brought into focusproblems of financial instability affecting some banksand other financial sector institutions.

In 2013, the UK's single-regulator system (under theold FSA) was abolished.

� The PRA was established to oversee the stabilityof 'prudentially significant' firms.

� Regulation of conduct across the sector,including retail consumer advice, became theresponsibility of the new FCA.

The Financial Services and Markets Act 2000(FSMA 2000) is amended by the Financial ServicesAct 2012 (FSA 2012), which established:

� The independent Financial Policy Committee(FPC) at the Bank of England (BoE), and

� The Prudential Regulation Authority (PRA) – asubsidiary of the BoE

The Financial Services Authority (FSA) legal entitybecame the Financial Conduct Authority (FCA).The BoE became supervisor of financial marketinfrastructure providers: regulated clearing houses(RCHs), payment systems & securities settlementsystems.

The UK regulatory structure

Regulatoryframework





Exchanges &markets


‘Twin peaks’ regulation: since 1 April 2013

Role to protect & enhance stabilityof UK financial system, working withother bodies.� Prudential regulator of

clearing houses, and settlement& payment systems

� Special Resolution Unit toresolve failing banks

� The Bank’s Financial PolicyCommittee monitors stability &resilience, risk – and advises /directs PRA & FCA asappropriate

PRA is a BoE subsidiary.� Objective: to promote safety

and soundness of firms� Prudential regulator of banks,

larger firms (Dual-regulated)� Makes prudential rules� Recovery & resolution plans� Authorisations, permissions,

supervision, enforcement

FCA is independent company.

� Objective: ensuring that therelevant markets function well

� Oversees FOS, FSCS, MoneyAdvice Service

� Conduct regulator of banks,larger firms (Dual-regulated)

� Conduct & prudentialregulator of smaller firms andproviders

� Powers over criminal marketabuse

� Acts as UK Listing Authority

Prudential Regulation Authority Bank of England Financial Conduct Authority

The ‘twin peaks’ are Prudential &Conduct regulation. Note the dualregulation of banks & other large‘Prudentially Significant Firms’.

Regulatoryframework




Exchanges &markets


The Minister with overall responsibility for the Treasury, the Chancellor of the Exchequer, is ultimately responsiblefor the regulatory system for financial services under FSMA 2000.

HM Treasury, to which the FCA is accountable, will judge the regulator against the requirements laid down in FSMA2000 which includes a requirement to ensure that the burdens imposed on the regulated community areproportionate to the benefits it will provide.

Accountability of the FCA to HM Treasury

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

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

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

HM Treasury

Regulatoryframework





Exchanges &markets


The FPC includes the FCA Chief Executive and representatives from HM Treasury. The FPC will also have someexternal representation and will meet four times annually and at times of crisis.

S9C Bank of England Act 1998 (as amended by FSA 2012) provides for the FPC to exercise its functions with aview to:� Contributing to the achievement of the BoE’s Financial Stability Objective (to protect and enhance the stability

of the financial system of the UK), and � Subject to that, supporting the economic policy of the Government, including its objectives for growth and

employment.The FPC will seek to identify, monitor, and remove or reduce, systemic risks, including:� Systemic risks due to structural features of financial markets, eg connections between financial institutions

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

� Unsustainable levels of leverage, debt or credit growth.

Financial Policy Committee (FPC)

Regulatoryframework




Exchanges &markets


Competition Commission

Statutory merger control

� Ultimate power to block a takeover and fine forfailure to comply with requests

� May take up to 24 weeks to investigate� Appeals to rejection of the bid can be made to the

Competition Appeal Tribunal

Office of Fair Trading� Investigates if combined entity > 25% market share

or target’s UK turnover > £70m� Refers matter to CC if ‘substantial lessening of

competition’� Will report to FCA/PRA, HMT and CC if it believes

that regulatory rules adversely impact competition

Office of Fair TradingLooks at current takeovers/mergers

to ascertain if there has been asubstantial lessening of competition

May clear (ie, bid can go ahead) orrefer the bid to CC

Competition CommissionCC investigates bid & recommendswhether there has been substantial

lessening of competition

Bid is blocked Bid is cleared

Regulatoryframework





Exchanges &markets


City Code – has statutory effect, under Companies Act 2006

The Takeover Panel administers the TakeoverCode (‘City Code’). The Panel:

� Regulates offers for shares in publiccompanies

� Is funded by a levy on share transactions

� Equal treatment for all shareholders of a particularclass

� Reasonable period for bid to be considered� Reduces defensive measures by target company� Mandatory bid if shareholder acquires =/> 30% voting

rights� Minimum offer price = highest price paid to acquire

shares in last 12 months� Offer must remain open for =/> 21 days� If =/> 90% acceptances, can compulsorily purchase

remaining 10%� Directors of target company should not deny

shareholders opportunity to consider bid

The Government’s Department for Business,Innovation & Skills (BIS) is responsible interalia for business regulation, company law &consumer affairs.

Regulatoryframework

Department for Business, Innovation & Skills

Takeover Panel




Exchanges &markets


Regulatoryframework

Eight DPA 1998 Principles – personal data must be:� 1: Processed lawfully and fairly� 2: Obtained only for specific and lawful purposes� 3: Adequate, relevant and not excessive� 4: Accurate and kept updated� 5: Not kept longer than necessary� 6: Processed in accordance with data subjects’ wishes� 7: Protected against unauthorised or unlawful access, and damage� 8: Not transferred outside the EEA unless to a territory with adequate data protections

Data Protection Act 1998Regulates the use of all personal data, placingobligations on the organisation, which may be taken toCourt for a breach.

The organisation must havea data protection policy.

Data Protection Register

Recording sensitive personal data requires explicit consent.

The DPA 1998 requires persons who processpersonal data to register (unless exempt) withthe Information Commissioner (who maintainsa public registry of data controllers).





Exchanges &markets


Regulatoryframework

General prohibitionFSMA 2000 establishes the authorisation of firms tocarry out regulated activities – and the generalprohibition: no person may carry on a regulated activityin the UK, unless they are either authorised or exempt.Sanctions may be civil and/or criminal.

Civil sanctions:� Contracts voidable� Compensation/damages� Restitution Orders� Regulator may seek injunctionsCriminal sanctions:� 6 month sentence and/or £5,000 fine� 2 year sentence and/or unlimited fine

FCA or PRA authorisation?Firm will apply to either FCA or PRA, depending onfirm type.

� Dual-regulated firms (banks & building societies,credit unions, insurers & some investment firms)are authorised by PRA but only with FCAapproval. In the process, FCA will focus onconduct issues, while PRA will focus on a firm’sfinancial soundness.

� FCA-only regulated firms (including independentfinancial advisers, investment exchanges,insurance brokers & fund managers) areauthorised by FCA.

Passporting under MiFID is another authorisationroute.




Exchanges &markets


Regulatoryframework

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

Exceptions

� Appointed (tied) representatives

� RIEs, ROIEs, RCHs, Lloyd’s members, Bank of England,National Savings & Investments, local government authorities

� Certain professions, eg lawyers, accountants, actuaries, fornon-mainstream investment business (regulated by DPBs)

Exempt persons

Is authorisation required?

Are regulated activities to beundertaken?

Covered by exceptions?

Covered by exemptions?� ‘Passported’ EEA firms are authorised in their home State

1

2

3

Authorisation by FCA/PRA givespermission (Part 4A, FSMA 2000) tocarry out regulated activities by way

of business relating to specifiedinvestments.





Exchanges &markets


Regulatoryframework

Including:

� Deposits and electronic money

� Contracts of insurance

� Shares, warrants, ADRs etc

� Debentures, loan stock, and govt/local authoritysecurities

� Units in collective investment schemes

� Options, futures, contracts for differences

� Lloyd’s syndicates

� Regulated mortgages

Specified investments

Including:

� Dealing in, arranging deals in, managing,advising on investments

� Establishing/operating collective investmentschemes, stakeholder pension schemes

� Safekeeping/administering investments

� Lloyd’s insurance business

� Carrying out contracts of insurance

� Accepting deposits

� Regulated mortgage business

� Operating a Multilateral Trading Facility (MTF)

Regulated activities




Exchanges &markets


Excluded activitiesThe following activities are specifically excluded from the requirement for authorisation.

� Dealing as principal where the person is not holding themselves out to the market as willing to deal. The requirementto seek authorisation does not apply to the personal dealings of unauthorised individuals for their own account

� Trustees, nominees and personal representatives, if they do not hold themselves out to the general public asproviding the service and are not separately remunerated for the regulated activity, are excluded from the authorisationrequirement

� Employee share schemes. This exclusion applies to activities which further an employee share scheme

� Media, eg TV, radio and newspapers. Authorisation is not required if investment advice is not the primary purpose ofthe publication.'Tip sheets' (written recommendations of investments) will however require authorisation

� Overseas persons – firms which do not carry on regulated activity from a permanent place within the UK. Thisexclusion covers: first, where the activity requires the direct involvement of an authorised or exempt firm; and, second,where the activity is carried on as a result of an unsolicited approach by a UK individual. Thus, if a UK individual asksa fund manager in Tokyo to buy a portfolio of Asian equities for them, the Japanese firm does not need to beauthorised under FSMA 2000

Regulatoryframework





Exchanges &markets


SYSC – in FCA/PRA Handbooks WhistleblowingPrinciple for Businesses 3: ‘A firm must take reasonablecare to organise its affairs responsibly & effectively, withadequate risk management systems.’ SYSC requires firms tomaintain Senior management arrangements, SYstems andControls: a ‘common platform’ of requirements for almost allregulated firms.

Employees concerned about something maycontact the regulator.

Whistleblowers are protected by the PublicInterest Disclosure Act 1998 if:� A response from their firm was lacking, or they

felt unable to raise the matter internally� They reasonably believe matters raised to be

substantially true

Whistleblowing provisions are detailed in SYSC.Contracts must not prevent employee ‘blowing thewhistle’: the legislation protects whistleblowingemployees from unfair dismissal.

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

SYSC common platform

Regulatoryframework




Exchanges &markets


Regulatoryframework

Pensions Act 2004Trustee Act 2000Does the trust deed offer investmentguidance?

� Yes Follow the deed

� No Follow TA 2000

� A statutory duty of skill and care� Functions may be delegated� Invest in any asset except land

overseas� Keep investments under review

Trustee Act 2000

� Pensions Regulator – regulatory body for work-based UK pensions:– Adopts pro-active, risk-focused approach– Has powers to intervene in scheme affairs

Occupational (work-based) schemes:� Must have member-nominated trustees (except one-member schemes)� Must have adequate liquidity� Pensions Protection Fund for where an employer running a scheme

becomes insolvent & unable to pay liabilities� PPF provides compensation up to 100% of benefits to existing

pensioners and 90% to those not yet retired, funded by charges onother DB pension schemes

� Trustees’ Statement of Investment Principles (SIP) gives membersinformation about investment of pension scheme’s funds & investmentreturns received

Work-based pension schemes may be definedbenefit (DB) or defined contribution (DC).





Exchanges &markets

Regulatoryframework


Financial Conduct Authority – objectivesThe FCA has a single statutory strategic objective(s1B(2) FSMA 2000) of:

� Ensuring that the relevant markets function well.

FCA also has 3 supporting operational objectives:

� Consumer protection objective: securing anappropriate degree of protection for consumers

� Integrity objective: protecting and enhancing theintegrity of the UK financial system

� Competition objective: promoting effectivecompetition in the interests of consumers in themarket for regulated financial services and forservices provided by a recognised investmentexchange

The ‘relevant markets’ are:

� The financial markets

� Markets for regulated financial services, and

� The markets for services that are provided by non-authorised persons in carrying on regulatedactivities without contravening the generalprohibition

The regulator aims to ensure that firms put consumersat the heart of their business. The FCA’s duties to pro-mote competition may involve analysing pricing.

The FCA also has duties to address financial crime(broadly, following the existing approach to tackling suchcrime).




Exchanges &markets

Regulatoryframework


FCA HandbookHigh Level StandardsPrinciples for Businesses (PRIN)Training & Competence (TC)Statements of Principle & Code of Practice forApproved Persons (APER)

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

Fit & Proper Test for Approved Persons (FIT)Prudential StandardsPrudential Sourcebooks for different types of firm

Specialist SourcebooksCover certain specialised sectors of the industry

Listing, Prospectus and Disclosure

Listing rules (LR)

Prospectus Rules (PR)

Disclosure Rules & Transparency Rules (DTR)

Business StandardsConduct of Business Sourcebooks (including COBS)

Client Assets (CASS)

Market Conduct (MAR)

Regulatory Processes RedressDecision Procedures &Penalties Manual (DEPP)

Dispute Resolution: Complaints(DISP)

Supervision (SUP) Compensation (COMP)





Exchanges &markets

Regulatoryframework


A firm must:1 Conduct its business with integrity2 Conduct its business with due skill, care and diligence3 Take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk

management systems (management and control)4 Maintain adequate financial resources (financial prudence)5 Observe proper standards of market conduct6 Pay due regard to customers’ interests & treat them fairly7 Pay due regard to information needs of clients: communications with clients must be clear, fair, not

misleading8 Manage conflicts of interest fairly9 Take reasonable care to ensure suitability of advice and discretionary decisions (customers:

relationships of trust)10 Arrange adequate protection for clients’ assets11 Deal with regulators openly & cooperatively, making appropriate disclosures (relations with regulators)

The Principles for Businesses

� Treating Customers Fairly isan important regulatory theme.




Exchanges &markets

Regulatoryframework


Scope of the Principles Principles-based regulationSome principles (eg, 10) refer to clients, while others(eg, 9) refer to customers.

This is regulation that is focused on the over-archingPrinciples, which firms must then apply. Theregulator’s focus is not so much on the principlesthemselves, but on the actual outcomes andconsequences of what firms do. Since the financialcrisis, there has also been a shift to a more‘intrusive’ style of regulation.

'Client' includes everyone from the smallest retailcustomer through to the largest investment firm(eligible counterparties, professional customers &retail customers).

'Customer' includes professional and retail clients butexcludes eligible counterparties. Principles 6, 8 and 9,& parts of Principle 7, apply only to customers.

Principle 3 would not be considered breached if thefirm failed to prevent unforeseeable risks.

Breaches of the Principles, and of rulesBreaching a Principle makes the firm liable toenforcement or disciplinary sanctions. A privateperson who suffers a loss from a rule breach may sueunder s150 FSMA 2000, but not in respect of breachof a Principle.





Exchanges &markets

Regulatoryframework


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

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

Section 59 FSMA 2000 says that a person (that is a member of staff at an authorised firm) cannot carry out a controlled function in a firm unless the

individual has been approved by the appropriate regulator

Approved persons




Exchanges &markets

Regulatoryframework


For all approved persons:

1 An approved person must act with integrity in carrying outhis accountable (ie, regulated) functions �

2 And with due skill, care and diligence �

3 Must observe proper standards of market conduct �

4 Must deal with regulators openly and co-operatively �

Senior management only:5 Must take reasonable steps to ensure business is

organised so it can be controlled effectively

6 Exercise due skill, care and diligence in managing thebusiness

7 Take reasonable steps to ensure compliance by businesswith regulatory requirements

Statements of Principles Examples of non-compliance� Misleading or attempting to mislead

customer/firm/regulator, eg about risks ofinvestment or by falsifying documents

� Failing to give information tocustomer/firm/auditor/actuary when youknow/should have known it should beprovided, eg failing to disclose charges orsurrender penalties

� Market abuse, eg trading on insiderinformation, trading to distort the market,spreading false stories (FCA can imposeunlimited fines under s123 FSMA 2000)

� Failure to report matters through internalreporting procedures

Code of Practice





Exchanges &markets

Threshold conditions (for attaining Part 4A permission)Before it grants permission under FSMA Part 4A (formerly ‘Part IV’), the regulator must be satisfied that the firm meets andcontinue to satisfy the 'threshold conditions' for the activity concerned in order to be deemed fit and proper.

General threshold conditions� One condition relates to the location of the offices of the applicant. If the applicant is a UK company, its head and

registered offices must be located in the UK. For an applicant that is not a company, if it has its head office in the UK,then it must carry on business in the UK.

� Firms will need to ensure that no impediment to their effective supervision arises from: the nature and complexity ofregulated activities undertaken, products offered, and the business organisation. This condition also covers the effectof close links of the applicant with other entities, eg other members of the same group, and whether these have aneffect on effective supervision by the regulator.

� An applicant for FCA authorisation must have adequate resources for the activities they seek to undertake. Suchresources would not only include capital, but also nonfinancial resources such as personnel

� Another threshold condition relates to the suitability of the applicant. The firm must be considered to be 'fit andproper', ie it must have integrity, be competent and have appropriate procedures in place to comply with regulations.The management and staff of the firm must also be competent.

Regulatoryframework





Exchanges &markets

Regulatoryframework

Threshold conditions (for attaining Part 4A permission)FCA’s Business Model Threshold Condition

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

PRA’s Business to be Conducted in a Prudent Manner Threshold Condition

� The PRA’s Business to be Conducted in a Prudent Manner Threshold Condition is closely equivalent to the FCA’sappropriate resources and business model conditions, which we have described above. PRA-authorised firms musthold appropriate financial and non-financial resources. Appropriate resources are evaluated by reference to complexityof activities, the liabilities of the firm, effective management, and the ability to reduce risks to the safety andsoundness of the firm.






Exchanges &markets

Regulatoryframework

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

� Governing functions (eg directors)

� Required functions (eg Money LaunderingReporting Officer)

� Systems and control functions (eg seniorinternal audit staff)

� Significant management function (eg headsof divisions in larger firms)

� Customer functions, including:– Investment advice– Customer trading and investment

management

Controlled functions

� Covers most personnel advising customers

HonestyIntegrity

Reputation

CompetenceCapability

Financialsoundness

‘Fit and proper’ assessment

� Employment record� Criminal record

� Experience� Training and exams

� Court judgements?� Bankruptcy?

� In dual-regulated firms, significant influence functions (ie,excluding customer functions) are divided between PRA andFCA.





Exchanges &markets

Regulatoryframework


Appropriate examinations

Recruitment Training Maintainingcompetence

Attainingcompetence

� For roles involving privatecustomers (eg investmentadvice):

� Take account of individual’sknowledge and skill

� Find out about individual’sprevious relevant activitiesand training

� Firm to determine training needs,and organise, monitor & recordappropriate training

� Exams and supervision

� Continuing ProfessionalDevelopment (CPD)

Training and competence

�

�

� �

Required for advising retail clients, eg on retail investment products,securities & derivatives & for some specialist roles (eg: advice onmortgages, equity release, long-term care insurance, pensionstransfers).

FCA’s T&C Sourcebook covers the retail sector.





Exchanges &markets

Regulatoryframework


“”

The firm’s commitment to training & competenceshould be that employees:

� Are competent

� Remain competent

� Are appropriately supervised

� Have competence reviewed regularly

� Have levels of competence appropriate to thebusiness

Rules on training and competence The competent employees rule is the main FCAHandbook requirement on employee competence,and applies to both MiFID and non-MiFID firms:Firms must employ personnel with the skills,knowledge and expertise necessary for thedischarge of the responsibilities allocated to them.

Retail advisers must complete 35 hours ofverifiable CPD annually, of which 21 hours must bestructured (ie, with a defined learning outcome).

Professionalism requirementsRetail investment advisers (RIAs) need to hold aStatement of Professional Standing (SPS) issuedby an accredited body to give independent adviceor restricted advice. The SPS shows customers thatthe RIA subscribes to a Code of Ethics, is qualified,and has up-to-date knowledge.





Regulatoryframework

Exchanges &markets

RIE requirements cover: Financial resources,Suitability, Systems & controls, Investorsafeguards, Issuer disclosures, Complaintsarrangements, Discipline, Member default.

Recognised Investment Exchanges (RIEs) (but not theirmembers) are exempt from regulatory authorisation.

RIEs: � ICE Futures Europe � LIFFE � London Stock Exchange� ISDX � London Metal Exchange

Recognised Clearing Houses (RCHs) may perform clearingand settlement for an exchange.

RCHs: � CME Clearing Europe Ltd � Euroclear UK &Ireland � European Central Counterparty Ltd � ICE

Clear Europe Limited

Designated Investment Exchange (DIE) statusof overseas exchanges gives some assuranceabout local regulation but does not exempt fromUK authorisation.

Recognised Overseas Investment Exchanges (ROIEs) operate inthe UK without FCA authorisation. ROIEs:

� Australian Securities Exchange Ltd � CBOT � Eurex� ICE Futures U.S., Inc � NASDAQ � NYMEX � NYSELiffe US � SIX Swiss Exchange AG � Chicago Mercantile

Exchange

RIEs

RCHs

ROIEs

DIEs

RCHs, along with recognised payments systems &securities settlement systems (collectively FinancialMarket Infrastructures (FMIs)) are supervised by the BoE.






Regulatoryframework

Exchanges &markets

USA

UK

In the USA, there are two key regulatory bodies:

� Securities and Exchange Commission (SEC) –regulates derivatives on securities

� Commodity Futures Trading Commissions (CFTC) –regulates derivatives on commodities

IAS 39 states: (non-hedge) derivatives must be recorded inbalance sheet at fair value.

� Changes in fair value (ie, gains or losses) can berecognised in the income statement

� For derivatives used as a hedge, gains and losses arerecognised in reserves

EMIR standards for OTC derivatives – covered in Chapter 1.

UK derivatives markets members areregulated under FSMA 2000.

MiFID applies to firms carrying out activities inrelation to various derivative instruments

� Financial and commodity derivatives

� Derivatives relating to credit risk

� Financial CfDs

� Derivatives relating to climate, freight,carbon emissions, inflation & othereconomic statistics

DerivativeA contract for differences (CfD), afuture or an option. (FCA definition)

(Main law: Commodity Futures Modernization Act 2000)





Regulatoryframework

LCH.ClearnetLCH.Clearnet:� Acts as guarantor in the derivatives market,

honouring contracts in the event of a partydefaulting

� Formerly, London Clearing House

� Owned by exchanges and their members

� Is central counterparty for all trades(‘novation’)

� Administers all margin cash flows

� Registers all matched trades for the market

Initial margin� Returnable ‘good faith’ deposit paid on

opening positions

� Based on maximum probable one-day loss

Variation margin� Cash settlement of daily profits or losses

based on closing price of each day

� Paid to or received from LCH.Clearnet thefollowing morning

Exchanges &markets






Regulatoryframework

Central Counterparty – novation

LCH.ClearnetShort – ‘seller to every buyer’ Long – ‘buyer to every seller’

Trade

Long oil @ $80 Novation Short oil @ $80

Novation eliminates counterparty risk

Exchanges &markets



Exchanges &markets


Regulatoryframework


Exclusion of liability

Firm may not exclude its duties orliabilities to customers under FSMA2000 or the regulatory system

ie

Customers cannot sign away theirrights under COBS

� Firms should ensure thatinducements do not conflict withduty to customers

Where? Activities in UK, andbusiness brought into UK

�

�

Communications byelectronic mediacount as writtencommunication

Communication must be clear, fairand not misleading (Principle 7)

� Who? All authorised firms, but notprofessional firms in respect of non-mainstream regulated activities

�

� Advising on investments� Dealing in investments

� What? Generally, designatedinvestment business

��

�

�

�

�

�

�

COBS

Designated investment business covers includes various regulatedactivities but excludes deposits, mortgages nor non-savings insurancecontracts.




Exchanges &markets


Regulatoryframework


*Only foreligible counterparty business:

� Receipt & transmission of orders� Execution of orders� Dealing on own account

Client

Eligible counterparty*

Per se Elective

Customer

Professionalclient

Retailclient

Authorised firms

Large undertakings

Electiveprofessional clients

Individuals

Small businesses

Elect

Elect



Exchanges &markets


Regulatoryframework

Retail clients (eg individuals, small businesses)

Client classificationsEligible counterparties(eg government, other firms)

Clients can opt up or down.

More protection More knowledge/size

COBS applies

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

A retail client is any client who is not aprofessional client or an eligiblecounterparty.

Retail clientsClient agreementsIf a firm carries on designated investment business,other than advising on investments, for a new retailclient (eg, a discretionary investment managementservice), the firm must enter into a basic agreementwith the client.

Professional clients(eg large businesses, experts)





Exchanges &markets


Regulatoryframework

Per se Professional clients� An entity requiring authorisation or regulation to

operate in financial markets, whether authorised inthe EEA of by a third country

� A large undertaking meeting conditions:

Per se Eligible counterparties� Insurance company, investment firm or credit

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

supranational organisation

For MiFID Business

2 out of three of:– €20m balance sheet total– €40m net turnover– €2m own funds

Non-MiFID Business

– £5m called-up share capital or net assets,

or 2 out of 3 of:

– €12.5m balance sheet total

– €25m net turnover

– 250 average employees in year

�




Exchanges &markets


Regulatoryframework

Elective Professional clients Qualitative test

Quantitative test – for MiFID business

To treat a retail client as an electiveprofessional client:

1

2

3

4

Client makes requests in writing

Firm carries out a ‘qualitative test’:& for MiFID business a ‘quantitative test’:

Firm gives a clear written warning ofprotections & investor compensationrights lost

Client states separately in writing thatthey are aware of consequences

Firm undertakes assessment of client’s knowledge,expertise and experience.

Assessment gives firm reasonable assurance that client iscapable of making their own investment decisions &understanding risks.

At least 2 of the following 3 must be satisfied:� Client has traded, in significant size, on relevant market at

average 10 times per quarter over previous 4 quarters� Financial instrument portfolio > €500,000� Client works/has worked in financial sector for at least 1

year in professional position requiring knowledge oftransactions/services

� �

�

�





Exchanges &markets


Regulatoryframework

Financial promotion (FP)An invitation or inducement to engage in investmentactivity communicated in the course of business(s21(1), FSMA 2000).

� Qualifying credit� Home purchase plans & home reversion

schemes� Personal quotations & illustrations� ‘One-off’ communication that is not a cold call� Generic promotions (eg, of Investment Trusts)� Communications to investment professionals� Overseas recipients� Deposits & insurance� Certified high net worth individuals� Sophisticated investors

Exemptions/exclusions

There is a general prohibition on FPs (s21, FSMA2000) unless issued or approved by an authorisedperson.

Means of communicating FPs:� Product brochures, mailshots

� General advertising

� Telemarketing

� Written correspondence

� Sales aids, presentations

� Tip sheets

� Other publications containing non-personalrecommendations




Exchanges &markets


Regulatoryframework

Financial promotionsA firm must ensure that a communication or FP is:

� Fair, clear & not misleading,

� Appropriate & proportionate

� Considering the means of communication & theinformation to be conveyed.

FP addressed to a retail client & falling within therules must be clearly identifiable as FP.

The FCA’s rules are:

� media-neutral (print/fax/email/internet/phone etc)

� mainly directed at regulated activities


Fair, clear and not misleading

GuidanceA firm should ensure:

� It is clear if a client’s capital is at risk

� Any yield figure quoted gives a balancedimpression of short/long term prospects

� Complex charging structures are explained

� The regulator is named

� A clear impression is given of any third partypackaged/ stakeholder product provider



Supervision &redress

Exchanges &markets


Regulatoryframework

Direct offer financial promotionsA direct offer FP is a FP:� Containing an offer or invitation� Which enables investors to purchase investments

directly 'off the page'� Without receiving further information.The promotion must include relevant disclosures forthe product.

Firms may only make cold (unsolicited) calls:� To a client having established relationship with the

firm justifying such calls, or� About a generally marketed packaged product (not

based on a high volatility fund), or� Relating to controlled activities by an authorised

person or exempt person, involving only readilyrealisable securities (not warrants)

Financial crime

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




Exchanges &markets


Regulatoryframework

Controls & approvals Communicating with retail clientsSYSC requires that a firm communicating or approving FPhas systems & controls or policies & procedures.

� Approval of FP by an authorised firm enables it to becommunicated by an unauthorised firm.

� Firm approving FP must confirm that it complies withthe FP rules.

� Promotion made during a personal visit, phoneconversation or other interactive dialogue cannot beapproved.

� Firm’s approval may be ‘limited’, eg to communicationsto professional clients or eligible counterparties.

� In communicating FP, firm can rely on another firm’sconfirmation of compliance. FP should only becommunicated to types of recipients for whom intended.

Requirements:

� Understandable by target group

� Fair & prominent indication of relevantrisks

� Key items not disguised, diminished,obscured

� Must include name of firm

� Investment comparisons should specifysources, key facts, assumptions

� Firm should consider if omissions willmake information insufficient, unclear,unfair or misleading





Exchanges &markets


Regulatoryframework

Financial Promotions PowerFCA has power (under FSA 2012) to ban misleadingfinancial promotions.

� The regulator can give (and publish) a direction tofirms requiring them immediately to withdraw or tomodify promotions which it deems to be misleading.

� The firm will be able to make representations to theFCA to challenge its decision. The FCA may thenamend or revoke its decision, or confirm its originaldecision.

� The FCA can then publish: (1) Its direction, (2) A copyof the promotion, and (3) The regulator's reasons forbanning it. The FCA may publish details even if it hasdecided to revoke its decision.

Record keeping

Distance contracts

Records of FPs must be kept:

� Indefinitely for pension transfers� 6 years for life policies & most pension

schemes� 5 years for MiFID business� Three years in other cases

Firms must give clear information before acontract is concluded, including:

� Identity & address of supplier� Product details (incl. price & fees)� Contract details (incl. cancellation rights)




Exchanges &markets


Regulatoryframework

Past, simulated past and future informationPast performance information

Past performance information should:

� Not normally be the most prominentfeature of the communication

� Include appropriate information covering at least the five precedingyears, or the whole period

� Be based on and must show complete 12-month periods

� State the reference period andsource of the information

� Contain a prominent warning thatthe figures refer to the past

� If denominated in a foreign currency,state the currency clearly

� If based on gross performance,disclose the effect of commissions

Future performance information

Future performance information must:

� Not be based on nor refer to simulated past performance

� Be based on reasonable assumptions supported by objectivedata

� If based on gross performance, disclose the effect of commissions,fees or other charges

� Contain a prominent warning thatsuch forecasts are not a reliableindicator of future performance

� Only be provided if objective datacan be obtained

Simulated past performanceinformation

Simulated past performance informationmust:

� Relate to an investment or a financial index

� Be based on actual pastperformance of investments/indiceswhich are the same as, or underlie,the investment concerned

� Contain a prominent warning thatfigures refer to simulated past performance and that past performance is not a reliable indicator of future performance





Exchanges &markets


Regulatoryframework

Ethical implications of misleading communicationsThe pressure for short-term gain in a firm could encourage the use of a misleading financialpromotion.

This could have undesirable longer-term ethical and professional consequences:

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

� Consumers coming to know about the firm’s actions, as well as those directly affected, maycome to view the firm as unethical, and damage may be done to the reputation of the firm

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




Exchanges &markets


Regulatoryframework

SuitabilityFirm recommending designated investments mustassess whether the recommendation is suitable forthe client, based on client’s:

� Knowledge & experience� Investment objectives� Financial situation

Suitability report (letter) required following personalrecommendation to retail client on:

� Life policy� Stakeholder pension scheme, & some other

pensions transactions� Regulated collective investment schemes

Appropriateness (for non-advised services)

For investment services other than: personalrecommendations & managing investments.

Assessing appropriatenessClient to provide information about relevantknowledge/ experience to enable firms to assessappropriateness.

� If the product/service is not appropriate, firm mustwarn the client

� If there is insufficient information to assessappropriateness, firm must notify the client





Exchanges &markets


Regulatoryframework

Best execution Order execution policyThe rules on best execution apply to retail &professional clients.

� When executing orders, a firm must takeall reasonable steps to obtain the bestpossible result for clients, taking intoaccount the execution factors

� A firm will satisfy this rule by executing aclient order in accordance with thespecific instructions of the client

Clients must give prior consent to execution policy.Information must be given on the policy.

For each class of financial instrument, policy should include:

� Information on different execution venues, &

� Factors affecting the choice of venue

� Execution factors are: price, costs, speed,likelihood of execution and settlement, size,nature or any other consideration relevantto the execution of an order.

For retail clients, the following information must be givenin advance:� Relative importance of the execution factors� List of execution venues

� Warning that specific instructions may prevent firmfrom following its policy to obtain the best possibleresult

�




Exchanges &markets


Regulatoryframework

Client order handlingRules cover retail & professional clients.� Procedures must provide for prompt & fair

execution of client orders� Comparable orders to be executed according to

time of receipt by the firm

Use of dealing commissionInvestment manager must be satisfied thatgoods/services purchased with commission:� Do not impair compliance with client’s best

interest rule� Relate to the execution of trades, or� Comprise the provision of research

Inducements

A firm must act honestly, fairly and professionally inthe best interests of their client (Client’s bestinterests rule.)

� Any fee, commission or non-monetary benefitpaid to or provided by a third party must bedesigned to enhance the quality of service to theclient

� A firm must disclose to the client any fees,commissions or non-monetary benefits insummary form





Exchanges &markets


Regulatoryframework

Personal account dealingFirms must have arrangements to:

� Prevent employees engaging in market abuse

� Ensure all relevant persons are aware ofrestrictions

� Ensure any deals are notified promptly to the firm

� Ensure adequate transaction records are kept

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

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

Churning and switching

Churning is prohibited: switching products in orderto make more commission or fees regardless of theclient’s interests.

Customers must not be advised to switch productsunless it is in their interests.





Regulatoryframework

Exchanges &markets

Advice must be either independent or restricted.

If an adviser declares themselves to offerindependent advice, they will need to consider abroader range of retail investment products (RIPs) –wider than the definition of ‘packaged products’.

Retail investment advice rules

Independent advice

� Covers all retail investment products

� Unbiased, based on comprehensive & fairanalysis of market

Advice that is not independent must be labelled asrestricted advice, for example as advice on a limitedrange of products or providers.

Retail investment advisers (RIAs) are still requiredto meet the regulator’s suitability requirements, even ifthey offer restricted advice.


Independent advice Restricted advice

Restricted advice

� Covers limited products or providers

� Includes basic advice (stakeholder products)

� Suitability requirements still apply




Exchanges &markets


Regulatoryframework


Retail investment products (RIPs)RIPs are defined to include:

� Life policies

� Units/shares in collectives: ITs, UTs, OEICs

� IT savings scheme investments

� Personal and stakeholder pension schemes

� Other packaged investments offering exposureto underlying financial assets

� Structured capital-at-risk products (SCARPs)

Packaged products definitionCollective Investment Schemes (regulated)

Life policies

Investment trust savings schemes

Personal pensions

Stakeholder pensions

Advice is paid for through an adviser charge.

� Adviser must not take any other benefit, even topass on to client

� Firm must account for any reasons for chargesvarying materially from its charging structure

Adviser charging



Exchanges &markets


Regulatoryframework

Referring to specialists

� Advisers should be able and willing to referto other specialists within the firm.

� Advisers may also need to refer tospecialists outside their business incertain areas & should explain to client whenit would be necessary.

If dealings with a client involve actions beyondadviser’s authority (because of firm’s orregulator’s rules), the adviser should seekauthority from an appropriate person.

The FCA’s product intervention power gives it the‘flexibility to intervene quickly and decisively’, normallyafter public consultation, where it considers that aproduct or product feature is likely to result in significantconsumer detriment.

The FCA may impose temporary product interventionrules (TPIRs) for up to 12 months without the usualconsultation process, eg where:

� Products involve inappropriate consumer targeting

� Product access is restricted to boost firms’ profit

� Significant consumer detriment could result

� Inherently flawed products, from which consumersunlikely to benefit

FCA’s product intervention power





Exchanges &markets


Regulatoryframework

Investment research Required disclosuresRules:

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

� Cover written & oral materialFirms must manage conflicts of interest:

� No personal or firm transactions in unpublishedresearch until clients have had a reasonableopportunity to act on it

� No personal transactions contrary to currentrecommendation

� No promises of favourable research

� No editorial control for subject of research

� No front running of trades by firm or itsemployees

Firms should take reasonable care to ensure fairpresentation of information:� Disclose identity of person responsible for

research

� Disclose relationships & circumstances whichmay impair objectivity

� Do not tie remuneration to specific transactionsor recommendations

� Fact should be distinguished from opinion,analysis, interpretation etc




Exchanges &markets


Regulatoryframework

Non-independent research Conflicts of interestInvestment research is research described as investmentresearch or in similar terms, or is otherwise presented asan objective or independent explanation of the matterscontained in the recommendation. Otherwise, research isnon-independent research.

Principle for Businesses 8: A firm mustmanage conflicts of interest fairly, both betweenitself & its customers & between a customer &another client.

Identify material conflicts that arise or may arisebetween:

� Firm & client � Clients SYSC provisions:

� Organisational & administrative arrangements� Written conflicts policy� Keeping records of the conflicts� Disclosure of potential conflicts is the measure

of last resort, if conflicts cannot be managed

Non-independent research must:

� Be clearly identified as a marketing communication� Contain a clear & prominent statement that it does

not follow the requirements of independent researchand is not subject to prohibitions on dealing ahead ofdissemination of research

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





Exchanges &markets


Regulatoryframework

From Principle 7 Communications with clients &Principle 9 Customers: relationships of trust comesa general obligation to disclose risks. Specificwarnings may be needed – eg, for warrants,derivatives, non-readily realisable investments.

Key Facts Document (KFD) must be given to aretail client when providing a recommendation on apackaged product, including:� Details on nature & complexity of the product� Complaints handling procedures� Compensation schemes� Cancellation rights

DisclosuresKey Investor Information (KII)Managers of authorised UCITS funds must prepareshort KII document, containing:� Identification of the scheme� The words ‘key investor information’� Investment objectives and policy� Past performance presentation / scenarios� Costs and charges� Investment risk/reward profile, with guidance &

risk warnings� How to get more information




Exchanges &markets

Regulatoryframework


Cancellation rights

The consumer must be informed of a right tocancel.

The cancellation date is the date of dispatch bythe consumer.

� Life policies & pensions (including stakeholder& personal) – 30 calendar days

� Other products – 14 calendar days

Immediately after executing a client order, aninvestment firm should record key details of thetransaction.

A firm must provide promptly in a durable medium theessential information on execution of orders toclients in the course of designated investment business(except where it is managing the investments ie, undera discretionary management agreement). Theinformation may be sent to an agent of the client,nominated by the client in writing.

For retail clients, a notice confirming execution (aconfirmation) must be sent as soon as possible andno later than the first business day following receipt ofconfirmation from the third party.

Information on client transactions





Exchanges &markets


Regulatoryframework

Periodic reporting

Record keeping periods� MiFID records – 5 years� Non-MiFID – general rule: as long as is relevant

for the purposes for which the records are made� Pension transfers & pension opt-outs – indefinitely

Firm managing investments must provide periodicreports showing:

� Name of the firm� Name / designation for a retail client’s account� Statement of contents & valuation of portfolio,

including details of:– Designated investments & their value– Cash balance at beginning & end of period– Performance of portfolio

� Total fees & charges, itemising managementfees & execution costs

� Comparison of period performance with anyagreed benchmark

� Dividends, interest & other payments received � Information about corporate actions

Progress reports for fundsManagers of authorised funds must report tounitholders:

� Short report (send to all holders) & longreport (available on request), half-annually &annually

� The reports must be available within 4 monthsof the year-end & within 2 months of the endof the half-year




Exchanges &markets


Regulatoryframework

Client assetsMake adequate arrangements to safeguard clients’ownership rights in event of:

� Insolvency of firm� Unauthorised use by the firm – client must give

prior consent to their use in security transactionssuch as stocklending

Firm should have adequate arrangements tominimise risk of loss or reduction of financialinstruments, misuse, fraud, poor administration,inadequate record keeping or negligence.

Custody reconciliations:� Reconcile internal records with third parties’

regularly � Correct any discrepancies promptly

Client moneyClient money is money the firm looks after which isnot its own. Client money must be held on trust.Client bank account should be separately identifiablefrom firm’s own account. Adequate records andprocedures must cover mandated accounts (egdirect debit mandates and credit card details held).

A firm must reconcile its internal records with thoseof third parties:� As regularly as necessary� As soon as reasonably practicable after

reconciliation date

Correct any discrepancies promptly:� If shortfall, top up account the same business day� If excess, remove the same business day

Notify the regulator of any breaches without delay.






Exchanges &markets


Regulatoryframework

� Granting authorisation & permission to firms (under Part 4A FSMA 2000) to undertake regulated activities � Approving individuals to perform controlled functions � Issuing rules which appear to be necessary or expedient to advance regulators’ objectives (Part 9A FSMA 2000) � Supervision of authorised firm to ensure that they continue to meet the regulators’ authorisation requirements &

that they comply with the regulatory rules and other obligations � Powers to take enforcement action against authorised firms and approved persons � Powers to discipline authorised firms & approved persons � The FCA & PRA jointly oversee the Financial Services Compensation Scheme (FSCS)

Powers of the new regulators (FCA and PRA)

Applications for variations or cancellations of permissions:� Dual-regulated firm will normally apply to PRA, which may determine an application to vary a permission only

with FCA consent, and to cancel a permission only after consulting the FCA.

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


Financial crimeFCA businessstandards

Exchanges &markets


Regulatoryframework

FCA supervisory approach

The FCA’s process for assessing conduct risks puts firms into categories C1 (larger firms with most con-sumer/market impact: most intensive supervision) to C4 (smaller firms). Firms are also put into prudentialcategories CP1 (firms whose failure has greatest impact) to CP3 (least impact).

The FCA’s supervision approach:

1 – Firm Systematic Framework (FSF): analysing firms’ business models to assess sustainability from con-duct perspective, and future risks; evaluating firm’s culture and ‘tone for the top’ regarding fair treatment ofcustomers and market integrity

2 – Event-driven work: covering emerging issues, eg mergers, spikes in complaints, whistleblowing allega-tions

3 – Issues and products: analysis by FCA’s sector teams





Exchanges &markets


Regulatoryframework

ComplaintsWhat is a complaint?

Any oral or written expression of dissatisfactionwhether justified or not, alleging loss, distressor inconvenience

Eligible complainants for Ombudsman purposes:� Consumers

� Enterprises with fewer than 10 employees andturnover or annual balance sheet notexceeding €2 million (‘micro-enterprises’)

� Charities with annual income < £1 million

� Trusts with net asset value < £1 million

Contact the provider firm, using the firm’s formalcomplaints procedures if necessary.

If complaint not resolved with the firm, use anindependent scheme, eg the Financial OmbudsmanService (FOS), or the courts.

1

2

To whom should customers complain?

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

� Complaints categories & product types� Numbers of complaints closed: within 4 weeks; within

4-8 weeks; & more than 8 weeks� Numbers of complaints: upheld; referred to & accepted

by Ombudsman; outstanding� Total amount of redress paid




Exchanges &markets


Regulatoryframework

� Effective and transparent complaintshandling procedures

� Allow complaints to be made by anyreasonable means

� Recognise complaints as requiring resolution

� Complaint must be:– Investigated competently, diligently,

impartially

– Assessed fairly, consistently, promptly

� Assessment must be explained in a fair,clear & not misleading way, & anyappropriate redress or remedial actionoffered

Financial Ombudsman Service (FOS)Complaints handling

For default/insolvency in respect of:

�� Investments & home finance: 100% of 1st £50,000� Deposits: 100% of 1st £85,000� Long-term insurance: 90% of claim� General insurance: 90% of claim, but 100% for

compulsory insurance

Financial Services Compensation Scheme


Firms must cooperate with FOS’s CompulsoryJurisdiction which applies to regulated activities:� Where complaint not resolved after 8 weeks� Max. FOS award: £150,000 (including any

compensation for suffering, damage to reputation,distress, inconvenience), plus interest & costs




Exchanges &markets


Regulatoryframework

� Receive complaint, within 6 years of event, or 3 yearsof when complainant should have been aware of it

� Promptly on receiving a complaint, acknowledge it,providing ‘early assurance’ that it is being dealt with

� By 8 weeks after receipt, send final response orholding response explaining why final responsecannot be made, stating when it is expected to bemade, and informing complainant of his right to go toOmbudsman

� Final response ‘starts the clock’ on ...

� ... 6 month limitation period on using FOS

Timeline

Procedures must be in place for complaintshandling by a firm, and a complaints log mustbe maintained.

Publish summary of procedure & refer eligiblecustomers to it at the point of sale.

An FOS decision is binding on the firm.

Records of the complaint and measures takenfor its resolution must be kept for three years,but five years for MiFID business.

Twice-yearly reports to regulator required.

Complaints





Exchanges &markets


Regulatoryframework

International Financial Action Task Force (FATF)

UK� Criminal Justice Act 1993

� POCA 2002 (updated CJA 1993)

� Anti-drug trafficking & counter-terrorismfinancing (CTF) legislation

International & UK action

Three aspects to AML:

� Deterrence

� Co-operation

� Detection

Anti-money laundering (AML) provisions Money laundering: conversion of money obtainedillegally into apparently legitimate funds.

Proceeds of Crime Act 2002� Makes it a criminal offence to facilitate

arrangements involving the proceeds ofany crime (including, eg, tax evasion)

Financial crime





Exchanges &markets


Regulatoryframework

Proceeds of Crime Act 2002Three main offences:

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

� Failure to report – If a person discovers information during the course of his employment that makes himbelieve or suspect money laundering is occurring, & he fails to make the report as soon as is reasonably practi-cable, he is committing a criminal offence

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

Money laundering: Sequence� Depositing funds in respectable investments (placement)� Multiple transactions to conceal origins of funds (layering)� Conversion of funds into a business (integration)

Financial crime



Exchanges &markets


Regulatoryframework

Money Laundering Regulations 2007

� Risk-sensitive policies and procedures required

� Customer due diligence (CDD) meansidentifying customer or beneficial owner, ifdifferent, and verifying identities

� Enhanced due diligence (EDD) applies forhigher-risk situations, such as non-UKpolitically exposed persons

� Simplified due diligence (SDD) means nothaving to apply the usual measures, eg forCTFs, listed companies and public authorities

Penalty – Failure to implement MLR 2007 is a crime:2 years imprisonment and/or fine

Joint Money Laundering Steering GroupGuidance Notes

Identity information may come from (in order ofpreference):

� Government department or Court

� Other public sector body

� Regulated financial services firms

� Other firms subject to MLR or similar regime

� Other organisations

Keep records for five years.

Anti-money laundering regulation


Financial crime





Exchanges &markets


Regulatoryframework

Money laundering: maximum penalties (POCA 2002)

14 years for knowingly assisting in laundering of criminalfunds

5 years for failing to report knowledge or suspicion ofmoney laundering

2 years for ‘tipping off’ a suspected launderer, in regulatedsector (s333A POCA 2002)

The suspected launderer must not be alerted!

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

Suspicionsof

laundering

NationalCrime

Agency

MoneyLaunderingReporting

Officer

report

to

may

report to

Identity checks are designed toprevent money laundering. To preventfinancial exclusion, there is someflexibility on the evidence necessary.

Criminal Justice Act 1993

Money laundering regulations(secondary legislation)

Joint MoneyLaundering

Steering Groupguidance

Financial crime



Exchanges &markets


Regulatoryframework

SYSC & financial crime� Systems & controls need to identify,

assess, monitor money launderingrisk – the risk that firm is used tofurther financial crime

� Systems & controls should becomprehensive & proportionate tothe nature, scale & complexity of thebusiness

SYSC requires firms to:

� Allocate to a senior manager (could be the MLRObut does not have to be) responsibility forestablishment & maintenance of AML systems andcontrols

� Provide appropriate training

� Appoint MLRO, who must provide a report at leastannually to the governing body/senior management

� Appropriately document ML risk profile/policy

� Ensure ML risk is considered in day-to-dayoperations

� Ensure identification procedures do notunreasonably deny access to services


Financial crime





Exchanges &markets


Regulatoryframework

TerrorismWhat is terrorism? – Terrorism 2000 Actdefinition encompasses violent actions designedto influence a government or intimidate the public.

� The duty to report – Terrorism Act 2000

� Regulated sector – Anti-Terrorism, Crime &Security Act 2001

� Failure to disclose – 5 years in jail and/or fine

� Protected disclosures – Not a breach of clientconfidentiality

How does terrorism financing differ from moneylaundering?

� Relatively small amounts may beinvolved

� Terrorists may be funded from legitimateincome

� Fund raising

� Use & possession

� Funding arrangements

� Money laundering

Terrorist offences

Law on Counter-Terrorism Financing (CTF)

Financial crime



Exchanges &markets


Regulatoryframework

FCA supervision& redress

Financial crime

Under CJA 1993, an insider is an individual who has information in her possession that she knows is inside information andknows is from an inside source – either directly from her own profession or indirectly from someone with access due to theirown profession.

Who is an insider? Insider

InsideInformation

Must not:Deal

EncourageDisclose

InsideSource

� Price-sensitive

� Unpublished

� Specific or precise

� Particular issuer orsecurity

� Company Director

� Employee

� Office or duties

� Direct or indirectsource

Insider dealing is a criminal offence under Part IV of the Criminal Justice Act 1993.





Exchanges &markets


Regulatoryframework

Where are insider dealing restrictions found? Insider dealing: Criminal Justice Act 1993Many rules and regulations:

� Financial Services & Markets Act 2000

� Criminal Justice Act

� Principles for Businesses

� Exchange rules

� Civil offence

� Individuals who are ‘insiders’

� Regulated market/ professionalintermediary

� Not all investments covered

� Various bodies involved

Defences

General defences� Did not expect to profit

� Believed on resonable grounds thatinformation was in public domain

� Would have dealt anyway

Special defences� Market maker

� Market information including bidfacilitation

� Price stabilisation rules

Financial crime



Exchanges &markets


Regulatoryframework

Market abuse Market abuse: due diligence defence

Insider dealing

Insider dealing

Improper disclosure

Misuse of information

Market manipulation

Manipulating devices

Manipulating transactions

Dissemination of false ormisleading information

Misleading behaviour &distortion

Section 123 FSMA 2000� Person believed on reasonable grounds

that he was not committing marketabuse, or

� Person took all reasonable precautionsand exercised due diligence to avoidcommitting market abuse

� No financial penalty

Behaviour by any personoccuring in relation toqualifying investments tradedon a prescribed market

FCA supervision& redress

Financial crime

Safe harbours – if acting within one of these safe harbours, a person is notcommitting market abuse:�� Regulators’ rules�� The Takeover Code�� Buy-back programmes and stabilisation�� Due diligence defence – see above





Exchanges &markets


Regulatoryframework

Market abuseoffences

(detail set out in the Codeof Market Conduct)

Insider dealing Misleading behaviour & distortion

Misuse of information .

Manipulating transactions

Dissemination

Manipulating devices

Where an insider deals, or attempts todeal, in a qualifying investment or related investment on the basis of inside information

Improper disclosure Where an insider discloses inside information to another person otherwisethan in the proper course of the exerciseof her employment, profession or duties

Where a transaction is based uponinformation not generally available, which aregular market user would regard asrelevant and would cause them view theperson’s behaviour as being below reasonablemarket standards

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

Where behaviour Is likely to give a regular marketuser a false or misleading impression as to thesupply of, demand for, or price or value of,qualifying investments; or cause a distortion of themarket

Dissemination of information which gives, oris likely to give, a false or misleadingimpression as to a qualifying investment bya person who knew it was false ormisleading

Effecting transactions or orders to trade whichemploy fictitious devices or any other form ofdeception

1

2

34

5

67

Financial crime




Exchanges &markets


Regulatoryframework

Enforcement of market abuse – The FCA may impose one or more of the following penalties on thosefound to have committed market abuse:� An unlimited fine� Issue a public statement� Apply to the court to seek an injunction or restitution order� Disciplinary proceedings, which could result in withdrawal of authorisation/approval where an authorised/approved

person is guilty of market abuse as they will also be guilty of a breach of the Principles for BusinessesNote that the regulator has criminal prosecution powers to enforce insider dealing and Part 7 Financial Services Act2012 (see below). The regulator has indicated that it will not pursue both the civil and criminal regime.

Financial crime

Part 7 Financial Services Act 2012 has created criminal offences relating to:

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

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





Exchanges &markets


Regulatoryframework

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

Bribery offencesThere are four main offences under BA 2010:� Section 1: Active bribery – Offering, promising or giving a bribe� Section 2: Passive bribery – Requesting, agreeing to receive or accepting a bribe (passive bribery)� Section 6: Bribing a foreign public official – A breach of this section may also breach s1 BA 2010, and prosecu-

tors will need to decide which is the more appropriate offence for the case� Section 7: Failure of firms to prevent bribery – Failure by a commercial organisation to prevent persons associat-

ed with it from bribing another person on its behalf.An organisation has a defence against the s7 offence (failure to prevent bribery) if it can prove that, despite a particularinstance of bribery having occurred, the organisation had adequate procedures in place to prevent persons associatedwith the organisation from committing bribery.

Bribery Act 2010

Financial crime


Notes


4: Legal concepts

Topic List

Legal persons

Power of attorney

Contracts & agency

Property

Bankruptcy & insolvency

Trusts & wills

Those working in the financial sector must operate withinvarious regulations, laws and statutes.

As in any business, the law of contract has a bearing,and the law on power of attorney, wills and trusts needsto be understood.


Legalpersons

Trusts & wills

Bankruptcy& insolvency

PropertyContracts& agency

Power ofattorney

CompaniesLegal personalityA company is a legal person. A creditor cannotdemand payment of company debts from itsshareholders. The company is liable without limit for itsown debts.

� An individual human being is a natural person

� A corporation (eg, a company) is an artificialperson

� A public company (plc) has a nominal sharecapital of at least £50,000 – & may be StockExchange-listed

� Others are private companies (Limited or ‘Ltd’) –not permitted to offer their securities to the public

Sole tradersFor a self-employed trader, there is no legaldistinction between individual & business. Thetrader is personally liable for debts of the business.

Legal persons can:� Enter into contracts� Sue & be sued� Incur debt� Own property

Legal persons include:� Companies� Nations� Co-operatives� Individuals


4: Legal conceptsPage 111

Legalpersons

Trusts & wills



Power ofattorney

Powers of attorneyPower of attorney: formal document made by ‘donor’which appoints ‘attorney’ or ‘donee’ to act for donor inlegal matters (eg, to sign documents).

� General power of attorney allows donee to actfor donor in all matters

� Power may be restricted to specific act, eg toexecute a specific document

Ordinary power of attorney:

� Valid while donor capable of giving instructions

� Revoked by death or bankruptcy of donor orattorney, or at choice of donor

Lasting power of attorneyA lasting power of attorney (LPA) under the MentalCapacity Act 2005 can take effect if the donorbecomes mentally incapable, and can cover PersonalWelfare as well as Property & Affairs.

Existing enduring powers of attorney (EPAs) arestill effective, but new EPAs cannot be set up.

To take effect, LPA must be registered with theOffice of the Public Guardian.

If no replacement attorney, LPA is cancelled if:

� Attorney cannot or will not act, or dies

� Married attorney & donor divorce

� For a Property & Affairs LPA, if attorney or donorbecome bankrupt


Legalpersons

Trusts & wills



Power ofattorney

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

� Offer � Acceptance� Intention to create legal relations �

� Consideration ��

� eg A life assurance proposal form constitutes an offer

Other factors affecting validity of a contract:

� Capacity. Some people have restricted capacity to enter into contracts, eg, minors (under 18)� Form. Some contracts must follow a particular form� Content. There may be some implied terms in a contract. Express terms may be unlawful� Genuine consent. There may be undue influence or duress, or misrepresentation or mistake� Legality. The courts will not enforce a contract which is illegal or contrary to public policyEffect of failure to satisfy the validity tests:

� Void contract. This is no contract� Voidable contract. This contract can be avoided by one party� Unenforceable contract. This contract is valid but performance by one party cannot be enforced



Ways in which a contract can come to an end:

� Breach� Performance� Agreement� Frustration

Contract discharge

� Performance & obedience

� Skill & accountability

� No conflict of interest

� Keep confidence

� Benefit only as agreed

Agent’s obligations

� Principal� Agent (eg broker, appointed representative)� Third party

Agency

A verbal contract is legally binding, except for sale ofproperty, and tenancy agreements.

Legalpersons

Trusts & wills



Power ofattorney

The agent-principal relationship forms a contractbetween the principal & a third party.


Legalpersons

Trusts & wills



Power ofattorney

Real property

Personal property

� Real property (also called 'realty') is land ownedin perpetuity – ie, freehold property.

� With leasehold property, the right of the rent-paying tenant (or lessee) to possession endseither by expiry of a fixed period or by notice.

� A lease is a form of contract. If granted for aterm of more than three years, it must generallybe in the form of a deed.

Co-ownership2+ persons may own land. (Applies to owningfreehold land outright, in spite of the word ‘tenant’.)

� Joint tenancy – a common form of ownership ofa house by a couple. The transfer does not statewhat share in the land each person has. Theland is 'held by X and Y'.

With a tenancy in common, each tenant canbequeath his interest.

If a joint tenant dies, his interest lapses & the landis owned wholly by the survivor(s).

� Tenants in common. A conveyance may statethat the land should go to 'P, Q and R equally' –each then owns one-third part of the interest.

In legal terminology, land includes buildings &anything else permanently attached to the land.

Personal property (‘personalty’) is anything thatis not real property (freehold land).



Legalpersons

Trusts & wills


Power ofattorney


BankruptcyBankruptcy: when an individual is no longer ableto pay debts and his or her financial affairs aretaken over by a court. The assets are transferredinto a trust.

Bankruptcy proceedings start with a BankruptcyOrder to the court.� Court will decide whether to declare the individual

bankrupt.� The Official Receiver takes control of assets, as

receiver & manager.

Receiver & manager protects bankrupt's propertyuntil trustee in bankruptcy is appointed to getpossession of bankrupt’s assets & realise their value.

If the debtor owns their own home, & lives alone,lives with a co-habitee or lives with adult children,interest in the home normally passes to the trustee.

Trustee is entitled to the excess income above whatis needed to support bankrupt and his/her family.

A bankruptcy order is normally dischargedautomatically one year after the date of the order,unless the bankrupt is culpable (Enterprise Act 2002).


Legalpersons

Trusts & wills



Power ofattorney

� Protect the creditors of the company

� Balance the interests of competing groups

� Control or punish directors responsible forcompany's financial collapse

� Encourage 'rescue' operations

Aims of insolvency law

Three types of corporate insolvency:

� Administration – to provide a better way ofrealising company's assets than could beachieved by liquidation or receivership

� Receivership – concerned principally withinterests of secured creditors who want totake control of charged assets

� Liquidation – mainly for the interests ofunsecured creditors and members(shareholders) of the company. The company isdissolved and its affairs 'wound up'.

Insolvency procedures

A voluntary liquidation cannot be initiated byshareholders if a company is insolvent.

If there was intent to defraud creditors or others,the court may decide that persons (usually, directors)who were knowingly parties to the fraud shall bepersonally responsible for debts and other liabilitiesof the company.



Trusts & wills


Legalpersons


Power ofattorney

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

Is there a valid will?Yes No

Executors carry out the terms of a will, to distribute estate inaccordance with testator’s wishes. A witness or their spousecannot be a beneficiary. Marriage invalidates a will, unless thewill states it is made in ‘contemplation of marriage’.

Administrators dealwith the estate.

Intestacy

Trusts

� Bare Trust

� Interest in Possession Trust

� Discretionary Trust

� Charitable Trust

Types of trust

Some uses of trusts: will trusts, life trusts, familysettlements, unincorporated associations, land gifted tochildren, protecting the identity of a beneficial owner

A trust is an equitable obligation in whichtrustees are bound to deal with propertythey control (as legal owners) for thebenefit of the trust beneficiaries.


Notes


Topic List

The retail consumer

Advising clients

Institutional funds

Client interaction

5: Client advice

A client’s life stage, employment status and current financialposition all influence the client’s needs in the financialplanning context. Just as important are the client’s futureprospects and aspirations. Planning is by definition forward-looking and it is what the client can make of their currentsituation that matters.

Different factors shape asset allocation for a client portfolioand for a fund. Accurate recording of information is ofcourse vital, to help the financial planning process as wellas to demonstrate compliance with regulatory provisions.


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

In DP 18 An Ethical Framework for FinancialServices (2002), the previous regulator (FSA)recognised that consumers increasinglyunderstand an ethical stance.

� Professional conduct & ethical behaviour couldstrengthen confidence in the industry, but

� If consumers have diminishing trust in thesector & in firms, they will hesitate to useproducts & services

Consumers’ perceptions

There is also pressure from consumers &government for the sector to ‘put somethingback’, eg combating social exclusion.

The FCA’s TCF initiative identifies 6 improved outcomes toachieve for retail customers.

Treating Customers Fairly (TCF)

1. Customer confident of receiving fair treatment (TCF is viewedas a matter of corporate culture)

2. Products/services designed to meet the needs of specificconsumer groups

3. Customers are provided with clear (ie, simple &understandable) information

4. Advice given to retail customers takes account of theircircumstances

5. Products perform as customers expect

6. No unreasonable post-sale barriers imposed by firms (eg,when switching provider, making a complaint, etc)

TCF outcomes


5: Client advicePage 121

The consumer must have every reason to trust afinancial adviser.

� Trust is gained through respect, through theway advisers deal with customers.

� The adviser must always treat personalinformation with the utmost confidentiality.

Trust and confidentiality

RDRThe Retail Distribution Review (RDR) set uparrangements (since end of 2012) to enhanceconsumers’ confidence in using financialservices.

The adviser’s fiduciary duty

Client interaction

Institutionalfunds

Advising clients

The retailconsumer

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

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

Firms’ obligations to consumers


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

� Obtain relevant information �� Establish & agree client’s financial objectives �� Process & analyse information – identify &

analyse client’s needs� Formulate recommendations in a plan �� Implement recommendations, as agreed with

client� Review & regularly update the plan

Stages in giving advice

� Regulation & compliance� Economic conditions� Taxation� State benefits� Savings & investments� Protection� Client’s attitude to & understanding of

risk

Factors in formulating recommendations

� Fact-find (questionnaire)

� Detailed in the fact-find

Analysing client circumstances, eg:

� Structure of liabilities might be re-arranged� Are protection arrangements adequate?� Consider changes in circumstances: house, job, children� Assess client’s disposable income – to determine

affordability of a recommended product

�



Two potential client requirements:

� To maximise returns, eg positive net worth individuals lookingfor a portfolio to match their risk/return preferences

� To match liabilities, eg pension funds, where aim is to matchassets & liabilities or to minimise a mismatch

Private clients could have objectives that mix liability matching (egto pay school fees) & returns maximisation (for other funds, say).

Client objectives

� Capital risk – potential variability ininvestment values

� Inflation risk – potential variabilityin inflation rates

� Interest rate risk – the risk ofchanges in bank base rates onasset returns

� Shortfall risk – the risk of a fundfailing to meet any specifiedliabilities

Types of investor risk

Liabilities can be nominal (eg bankloan) or real (eg living costs, whichwill rise with inflation).

Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Maximising returns. Given the choice, investors would elect forhigh performance with minimal risk. In practice, this is notachievable: a risk/reward trade-off applies.

Matching liabilities. Investments in government bonds can matchincome & capital inflows precisely with liabilities. Extending intomore risky assets means that liabilities might not be met.


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

� Personal details: ‘hard’ facts �

� Family details �

� Employment details �

� Advisers �

Financial details (‘hard’ facts)

� Assets �

� Liabilities �

Typical fact-find ‘Know your customer’: collect information using thefact-find.

� Name, address, date of birth, contact details, NInumber/tax referencemarital status, state of healthcountry of domicile

� Dependants,other immediate family

� Occupation, employertime with employer, previous employer

� Bank, accountant, stockbroker, solicitor

� Property, belongings, antiques,stocks and shares, unit trusts,savings accounts, cash, other assets

� Mortgages, other loans and debts

Get letter of authority for information needed from third parties.



� Income �

� Expenditure �

� Protection �

� Pensions �

� Wills and legacies �

Customer’s attitudes (‘soft’ facts)

� Customer’s views on savings/ �investment/protection

� Customer’s objectives �

� Pay, bonus, benefits profits, if self-employed,investment income, pensions

� Living expenses, mortgage payments,school fees, regular savings, life assurance

� Life cover, disability insurance details

� Occupational schemes, personal pension schemes,preserved benefits

� Current will – when last reviewed?gifts in last seven years, anticipated legacies

� Attitude to risk, ethical investments?perceived needs?

� Moving/children’s education/retirement plans?

Review client information each time he/she seeks advice

Typical fact-find

Client interaction

Institutionalfunds

Advising clients

The retailconsumer


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Clients’ typical life stages� Minors (under 18)

� Young and single

� Married or cohabiting

� Both working, no dependants

� One working, no dependants

� One working, with dependants

� Married or cohabiting, older children

� Children left home

� Retired

Clients’ employment status� Employed� Self-employed� Non-employed

� Protection of financial stability

� Protection against adverse events

� Provision for future financial needs

� Pension provision

� Maintenance of living standards

� Ability to pass wealth on

Client needs



Client interaction

Institutionalfunds

Advising clients

The retailconsumer

� Death �

� Illness �

� Incapacity �

� Redundancy �

Possible adverse events Protection needs

� If there aredependants

� State benefits arelimited

Emergency funds can act as a temporary cushion.

If the unexpected happens:

� What is the likely loss of earnings?

� What are the housing & mortgageimplications?

� For a self-employed person, what are thelikely effects for the business?

Financial stability

CAPITAL INCOME

Protection products help to protect financial stability fromthe potential adverse effects of common life events.

Protection products


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Typical protection needs at different ages

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

Age Death Sickness Redundancy

Under 18 None None None

18-25 If married or in debt If employed or self-employed If employed

25-40 Significant: marriage, children,mortgage

Significant Mortgage cover needed?

40-50 Less significant if children growingup

Increasing age increases risk Mortgage cover needed?

50-60 Less significant unless there is asecond family

Long-term care cover may beconsidered

If there is still mortgagedebt

60+ Protection of assets, IHT liabilities Health protection and long-term care

Not usually significant



Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Mortgages:Capital and interest (or ‘repayment’) mortgage

Investment-related (or ‘interest only’) mortgage

1Borrower’spayments

LenderInterest

Capital

2

Borrower’spayments

LenderInterest

SavingsvehicleCapital On

maturity

eg: ISAs, pension lump sum,endowment policy

� Banks

� Building societies

� Insurance companies

� Mortgage corporations

� Credit companies (mainly unsecured loans)

Lending sourcesloans secured on property.

Islamic mortgages avoid interest, since interest isagainst Islamic (Sharia) law. The homebuyer maypay rent to the bank, with part of it going towardsbuying out the bank’s share in the property.


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Planning for retirementWhat age am I now?

How much can I afford from income?

What investment returns can I expect?

Tax relief is available on pension provision

At what age will I retire?

What income do I want in retirement?

How will inflation erode the value of savings?

Pensions in payment are taxed

� Evaluate existing provision

� Consider PP or stakeholder

� Consider additional contributions

� Consider ISAs as alternative

Planning points

� State provision is limited

� Housing costs can be significant

� What are the client’s aspirations?

In retirement



Client interaction

Institutionalfunds

Advising clients

The retailconsumer

The adviser must:

� Understand investment risks �

� Ensure that the client understandsinvestment risks, before therecommendation or transaction

Information on risks is included in theKey Features Document.

� The investor risks:

Eg variable interest

Assets which rise or fall in value, eg shares

Loss of income

Loss of capital

RISK SAFETY

Risky investmentsInvestments with high potential return come with therisk of low or negative returns and loss of capital (eg:shares, collective investments, options, warrants).

Investments with low risk of loss of capital comewith lower potential returns (eg: bank deposits,NS&I).

Safe investments

Investment risks


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

� The general market (systematic) risk ofinvesting in shares or bonds

� The specific (non-systematic) risk of anyindividual investment

Diversification Attitude to riskA client’s attitude to risk may be influenced by:

Investment timescales. Eg: in managing a pension fund,attitude to risk may depend on how far out in time liabilities fall

Client’s risk tolerance. Standard fact-find approach: askclient to select a mix of, say, equities & bonds, to give an ideaof the normal mix (& hence risk) that the client wishes to face

Investment risk & rewardsThe trade-off between risk & potential reward:� Low-risk investments offer low returns, but low probability

of loss� High-risk investments offer the possibility of high returns,

with higher probability of loss

� Diversification by asset class – portfoliopossibly spread across: cash, fixed interest(bonds), equities, property, & other assets

� Diversification within asset classes – avariety of investments, possibly spreadacross different geographical markets

� Diversification by manager – to reducerisk from a manager performing poorly (asin 'manager of manager' and 'fund offund' structures)

– two sorts of risk:



Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Risk profilesRational

decision makingEmotional

decision makingHigh riskaversity

Methodical Cautious

Low riskaversity

Individualist Spontaneous

Cautious investors� Highly loss averse� Need for security� Want low-risk investments with safe capital� Typically do not like making decisions but do

not listen to others� Tend not to use advisers� Portfolios are low risk & with low turnover

Based on Bronson, Scanlan, Squire

Methodical investors� Analytical & factual� Make decisions slowly� Little emotional attachment to investments &

decisions� Tend to be conservative in investment approachSpontaneous investors� High portfolio turnover� Do not trust the advice of others� Some are successful investors, but most do less

well, given high transaction costs� Make decisions quickly & fearful of missing

opportunities

Individualist investors� Self-confident� Prepared to do analysis and & expect to achieve

their long-term goals


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Employees� An employer may meet some protection

needs� Is the remuneration package flexible?� On pensions, salary sacrifice, additional

contributions & stakeholder pensionsmight be considered

Self-employed� Spouse might be employed to use

personal allowance� No S2P (2nd State pension) entitlement� Own pension provision is necessary

Non-employed� Are all benefits due being claimed?� Can any expenses be met from capital?� Personal pension contributions can be up

to £3,600 p.a. for non-earners

Maintaining wealth Passing on wealth� What form of

investment is mosttax-efficient?

� Non-housing assetsmight be gifted toreduce IHT liabilities

� Life assurancepolicies (usuallywhole of life) can beused to cover an IHTliability

� Economic conditions affectvalues of shares and other assetsand investments

� Inflation erodes the real value ofassets expressed in money terms

� House price inflation boostsequity but it may need to remaintied up in housing

� Future inheritances may changea client’s position

Clients who have actively accumulated theirwealth typically have higher risk tolerance



AffordabilityAffordability of investments & protection policies tobe recommended for the client must be considered.

� The client's prospective disposable incomeshould be ascertained in order to assess theaffordability of regular contributions to policies& investment plans.

� Existing assets & policies, such as lifeassurance contracts & other savings need tobe taken into account in quantifying the sizesof investments needed to meet client needs.

Client reviewThe adviser is concerned with identifying andsatisfying client needs. This is not just a ‘one-off’process. Clients will have a continuing need forfinancial advice. Their circumstances will change, &there may need to be a review of whether productsinitially recommended continue to be suitable.

� Regular reviews of client circumstances willenable the adviser to make best use of futurebusiness opportunities with that client.

� For the client, there are benefits of advice arisingfrom the review.

Client interaction

Institutionalfunds

Advising clients

The retailconsumer


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Risk spectrum of investm

entsNegligiblerisk

Low risk

Low/

medium

risk

Medium

risk

Medium

/high risk

High risk

NS&I deposit products

Gilts (incom

e)G

ilts (redemption)

Bank depositsBuilding society depositsC

ash ISAsAnnuities

Venture capital trustsU

nlisted sharesW

arrantsFutures & options w

hen used to speculateEnterprise Investm

ent Scheme

Enterprise Zone Property

Unit-linked overseas

Unit trusts & O

EICs/IC

VCs (overseas funds)

UK single equities

Com

modities

Unit-linked m

anaged fundsU

nit trusts & OEIC

s/ICVC

s (UK funds)

Investment trusts (U

K)R

esidential and comm

ercial property

Gilts (pre-redem

ption capital)W

ith-profits funds



Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Objectives

Strategies Stock Selection

Establishinvestment

policy

Evaluationperformance

Approach to fund management Strategic asset allocation

� Past performance� Charges� Entry (initial) & exit charges, annual

management charges� Financial stability of provider� Stability, independence & standing of

trustees, auditors & fund custodians

Fund selection criteria

Allocation of the fund between various:

� Asset classes (shares/bonds etc)� Currencies

Based on:

� Objectives of fund & client� Assets available for investment

Concept: the objectives & constraints direct youtowards certain asset classes and away from others


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Active and passive management

Indexation

Fund review

cover a range of criteria to meetclient ethical preferences.

Fund performance should be reviewed at leastannually to evaluate whether fund is achieving itsobjectives.

� Client circumstances – any changes, whichmight require a change in strategy?

� Performance review – monitor against fund’sselected benchmark

� Portfolio rebalancing – consider potentialchanges to agreed asset allocations

�

�v

Passive investment management, on the other hand,establishes a strategy which, once established, shouldguarantee the appropriate level of return for the fund.

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

Ethical funds

The index fund manager selects an appropriateindex and builds a portfolio to mimic the index.

� Index funds typically based on a samplingapproach, and thus exhibit some tracking error.

� Transaction costs will typically be low, althoughthe portfolio must change to accommodatechanges in index constituents.



BenchmarksThree forms of analysis of a fund's performance:

� Comparison to relevant stock/index, eg a publishedmarket index

� Comparison to similar funds, ie performance of othersimilar fund managers, measuring:

– Short and long-term investment return

– Asset distribution of funds

– Performance against peer groups, market indices &medians

� Comparison with customised benchmark for fundswith a unique constraint, eg ethical funds that cannotinvest in arms/tobacco (standardised FTSE4Goodindices meeting ethical criteria are available)

Risk profile of fundsEach type of institutional fund has its ownparticular risk/reward profile stemming from:

� Its initial objectives, returnmaximising/liability matching

� The value and time horizons of theliabilities it has to meet (if any)

� The assets it can invest in

� The liquidity required within the fund

� The risk that can be tolerated

� Its tax status

� Legislation governing its powers

Client interaction

Institutionalfunds

Advising clients

The retailconsumer


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Pension funds – liability matching

A pension fund is a pool of money to beinvested now, to achieve either:

� A specific return based on theemployee's salary & number of years'service with the company – a definedbenefit (DB)/ final salary scheme, or

� A general increase in value of thecontributions paid on behalf of theemployee – a defined contribution(DC)/ money purchase scheme

Funds:Tax

Approved pension funds pay no UK tax oneither fund income or capital gains.

Life funds: all fund income & capital gains aretaxable, so the investment manager will tend toselect more tax-efficient investment vehicles.

General insurance: business profits are subjectto normal corporation tax rates.

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



Constraints on funds�

Client interaction

Institutionalfunds

Advising clients

The retailconsumer

The time horizon for the attainment of the return,or the matching of liabilities, will influence types ofinvestment selected. A fund with a long-term timehorizon can probably stand a higher risk: poorreturns in some years will tend to be cancelled byhigh returns in other years.

Pension funds & life assurance companies willhave statistical projections of their liabilities intothe future & the fund must attempt to achievethese.

Currency risk. A pension fund may have all itsliabilities denominated in sterling. If the fundwere to invest heavily in overseas assets, thiswould expose it to additional risk, other than therisk inherent in the assets themselves.

Asset allocationThe fund or portfolio manager has legal &professional duty to base the asset allocation onclient's wishes with particular regard to:

� Matching liabilities� Meeting any ethical considerations� Remaining within risk tolerances� Maximising fund performance

Risk aversion & risk tolerances. Therisk/reward trade-off impacts on ways in whichthe fund’s requirements can be achieved.

Liquidity needs. Within any fund, there needs tobe a degree of liquidity, to respond to changingevents.


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Constraints Young pension fund

Mature pension fund

Life assurances fund

General insurancefund

Time Long-term Short-term Long-term Short-term

Liability Real Real Nominal NominalLiquidity Very low High Low Very high

Risk tolerance High Low Medium/high Very lowTax status Gross fund, no tax on

income or gainsGross fund, no tax onincome or gains

Tax on income andgains

Tax on income andgains

Possible assetallocation

Equities 60% - 80% 20% - 30% 55% - 65% 0%

Property 5% - 10% 0% (illiquid) 0% - 5% 0%

Bonds 15% - 25% 55% - 65% 15% - 30% 100%

Cash 0% - 5% 15% - 25% 5% - 15% 100%

Asset and liability matching


Open questions give the client more opportunity to expressviews or feelings in a longer response.


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

Factual v evaluative statements Closed and open questionsFactual information is distinct from evaluative statementsabout someone’s hopes, wants, plans, opinions or feelings.

Closed questions ask for specific information, & typicallythe answer is very short, or is ‘Yes’ or ‘No’.

Factual information� Disregarding dividends, the fund has grown in value by

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

mortgage payments.

Non-factual statements� Graham thinks that he should invest more of his

portfolio in foreign stocks, in order to diversify risk.� Matilda was disappointed by the service provided by

her previous financial adviser.

Open questions� How do you feel about taking risks with your

investments?� What do you think are the most immediate financial

needs to be addressed?

Closed questions� Could you please tell me your address?� Do you have any ISAs?

Examples


Client interaction

Institutionalfunds

Advising clients

The retailconsumer

‘Know your customer’ (KYC) Written reports to clients

� Statement of client's objectives

� Summary of client's income & assets; otherrelevant circumstances/ problems

� Recommendations, including anyproposals for immediate action as well aslonger-term suggestions

� Appendices, if appropriate

Parts of a financial planningreport

The language in the report should be phrasedconcisely with explanations to suit capabilities ofclient, avoiding unnecessary jargon.

To know your customer – basic requirement of theregulatory regime and part of adviser’s fiduciary duty.

� Obtain sufficient information about a customer'spersonal & financial situation, before giving advice or(if applicable) before constructing a portfolio for thecustomer.

� Know the customer’s capabilities, adapting bothspoken & written communication to suit thecustomer. Such adaptation should cover technicalterminology & quantitative analysis presented.

� In presentations to clients, continually check (eg, byasking open questions) for indications that the clientunderstands, explaining points again & more simplyas necessary.


6: Taxation

Topic List

Income tax

National insurance

Capital gains tax

IHT & trusts

Other taxes

Tax on investments

In covering the tax element of the syllabus, we examinevarious aspects of the taxation of individuals. Differentproducts suit clients with different tax situations, and theremay be a financial advantage in careful tax planning.

Inheritance tax (IHT) is charged on lifetime gifts and on anindividual’s estate at death.

Same-sex civil partnerships established under the CivilPartnership Act 2004 follow the same tax treatment asmarried couples.


� A remittance basis charge may be payable ifclaiming remittance basis: £30,000 for ‘non-doms’ who were UK-resident for 7 of the last 9tax years; £50,000 if resident for 12 of last 14tax years.

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Residence If an individual ...

DomicileAn individual is domiciled in the country which ishis permanent home. Someone can only changedomicile by severing ties with old country &establishing a permanent life in a new one.

UK residents are taxable on worldwide income.Non-residents are taxable on UK-derived

income.

Non-UK domiciled UK residents are onlytaxable on overseas income if it is remitted to

the UK or if it is from employment.

*Counting days when person is in UK at midnight.

Satisfies automatic overseas test > then,non-resident

Satisfies automatic UK test (eg, spending183+* days of tax year in UK) > then, UK-resident

If neither, then a sufficient ties test isapplied.

1

3

2


Income tax rates (2013/14)

6: TaxationPage 147

UK income tax system� Pay as you earn (PAYE): tax on employment

earnings, deducted at source

� Self-assessment: where additional tax is payable

� Payments on account: 31 January & 31 July (ifself-employed or < 80% of last year’s tax paid atsource)

The fiscal year runs from 6 April to 5 April.

Tax avoidance v.Tax evasionTax avoidance: the taxpayer uses tax rules to his/heradvantageTax evasion: the taxpayer does not pay all tax due, egby under-reporting his/her income

Rate Taxableincome

Salary andinterest

Dividends

Basic £0 to£32,010

20% 10%

Higher £32,011 to£150,000

40% 32.5%

Additional >£150,000 45% 37.5%

There is also a 10% starting rate for savingsincome only, with a limit of £2,790 of taxableearnings. The starting rate is not available if taxablenon-savings income exceeds £2,790.

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Allowances (2013/14)� There is a personal allowance of £9,440*

� The personal allowance is reduced by £1 forevery £2 excess income above £100,000 (thusfalling to zero for incomes over £118,880)

� Those born before 6 April 1948 may get a higherpersonal allowance, subject to an income limit.

Pension contributions� Contributions to personal or stakeholder pension

plan are paid net of basic rate tax, even for eligiblenon-taxpayers. Higher/ additional rate taxpayerscan reclaim more, to get tax relief at marginal rate.

� Annual allowance cap on tax-relievablecontributions is the lower of 100% of income and£50,000 (2013/14), with carry forward rules. Low ornon-earners can make up to £3,600 grosscontributions and still get tax relief.

� Contributions to an occupational pension schemeare deductible from earnings for tax purposes.

Gross taxable income less� Personal allowance� Qualifying pension contributions� Allowable gifts to charity

equals Taxable income


6: TaxationPage 149

A basic principle of income tax is the aggregation of income. Income from all sources is aggregated in apersonal tax computation.

Include GROSS income incomputation

Do not include incomputation

� Tax credits on dividends can be offset to reduce tax but arenever repaid to taxpayer.Tax suffered on other taxed income canbe repaid.

Bank/building societyinterest: received net of 20%tax

Debenture interest: receivednet of 20% tax

Dividends: received net of10% tax credit

Income taxed at source

� Premium Bondprizes

� Returns on NS&ISavings Certs.

� Income in ISAs

� Betting/gamingwinnings

Exempt income

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Taxing income� Non-savings income is taxed first, then

savings (excl. dividend) income thendividend income is taxed last.

� Non-savings income is taxed at 20% (basicrate), then 40%, & 45%.

� Savings income starting rate of 10% (onlywhere savings income falls below startingrate limit), then 20% (in basic rate band),then 40%, & 45%.

� Dividend income is taxed at 10% (not20%) in basic rate tax band, at effectivetotal rate of 32.5% for higher rate, & 37.5%for additional rate taxpayers.


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

ChildrenIf parent gives income(or assets whichgenerate income) to achild, the income istreated as the parent’sif the child is under 18and unmarried.

Transfer assets?Transfer income yielding assets to thespouse with the lower marginal tax rate. Tobe effective, such transfers should beunfettered rights.Example

A higher rate taxpayer is paid a gross dividend of £400

He receives £360 after withholding tax (£40 collected at source)

He has to pay 25% of £360 = £90 further to meet his liability

Total tax paid = £130

(32.5% of £400 = £130)

� Does not applyif the income is£100 a year orless

� Does not applyto gifts fromgrandparents,uncles etc

Higher rate (40%) taxpayers’ liability for tax at 32.5% ondividends. This equates to:

10% of gross dividend + 25% of net dividend

Planning pointsDividends taxation

Additional rate (45%) taxpayers pay 37.5% on dividends.


6: TaxationPage 151

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Class National insurance contributions

1 Payable by employees on their earnings above the ‘primary threshold’

Amount payable depends on an individual’s income

1A Payable by employers on certain types of non-monetary benefits given toemployees (eg, a company car)

1B Payable by employers on an employee’s earnings

2 Payable by self-employed persons

If earnings below the small earnings exemption, no NICs payable

3 Voluntary – usually to fill gaps in contributions

4 Payable by self-employed, if profits exceed a threshold


Spouses / civil partners are taxed as separatepeople, each with an annual exemption.

Nationalinsurance

Capital gains tax

Tax oninvestments

Other taxes

IHT & trusts

Income tax

Capital Gains Tax: rates

For individuals, taxable gains are taxed at 18%, but at28% for gains (after the annual exemption) that fall inthe higher rate band.

� Disposal consideration (or market value)

Less disposal costs

Less costs of acquisition / enhancement

Equals� Capital gain

Capital gain calculation

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

Married couples / civil partnersDisposals between spouses / civil partners livingtogether do not give rise to gains or losses.1

2


6: TaxationPage 153

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Three elements are needed for a chargeable gain toarise.

A chargeable disposal: this includes sales,gifts and the destruction of assets.

A chargeable person: individuals.

A chargeable asset: most assets arechargeable, but see exempt list.

1

2

3

Chargeable persons, disposals and assetsExempt from capital gains tax:

� NS&I Savings Certificates & Premium Bonds

� Betting & lottery winnings

� Foreign currency, for private use

� Gilts (Government stocks)

� Qualifying corporate bonds

� Tangible movable property up to £6,000 per item

� Wasting assets (life of 50 years or less)

� Private cars

� Investments in ISAs, Enterprise InvestmentScheme & Seed EIS

� Own home (principal private residence)

Exempt assets


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

ExampleDonna has taxable income of £22,000. In 2013/14, shesold shares for £42,000 that she had bought five yearsago for £28,000. The annual CGT exemption is£10,900. What CGT must Donna pay?

Solution£42,000 – £28,000 = £14,000 net gain.

£14,000 – £10,900 = £3,100 taxable gain.

£22,000 [income] + £3,100 = £25,100, within the basicrate band.

Donna must pay CGT of 18% x £3,100 = £558.

Ways to mitigate extent of CGT liabilities:

� Spread ownership of assets among familymembers

� Phased encashments

� Realise paper loss

� Sell shares & repurchase other shares assubstitutes

� Use ISAs

CGT planning


6: TaxationPage 155

Deduct allowable capital losses from chargeable gains in the tax year in which they arise.

ExampleZoë made chargeable gains of £12,200 in2013/14. She had brought forward capital lossesof £7,000.

Brought forward capital losses of £12,200 –£10,900 = £1,300 will be set off in 2013/14. Theremaining losses will be carried forward to2014/15.

Disposals by individual shareholders are matched withacquisitions in the following order.

� Same day acquisitions� Acquisitions within the following 30 days �� Other shares: the ‘share pool’

Matching gains on shares

� Any loss which cannot be set off is carriedforward to set against future chargeable gains.

� Allowable losses brought forward are only setoff to reduce current year chargeable gains lesscurrent year allowable losses to the annualexempt amount.

� Stops ‘bed and breakfasting’

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Inheritance tax (IHT) is charged:(1) on death, (2) on gifts within 7 years ofdeath, (3) on chargeable lifetime transfers

Potentially Exempt TransfersPETs include lifetime transfers to individuals andto trusts for the disabled� PETs are initially assumed to be exempt� They are chargeable if the donor dies within

7 years

� Small gifts £250 or less per donee per tax year

� Annual exemption £3,000: 1 yr carry forward possible

� Normal expenditure out of income

� Marriage exemptions

� Transfers between spouses/ civil partners

� Transfers to charities, political parties or for nationalpurposes

� Transfers of land to housing associations

Exemptions for lifetime and death transfers

£5,000 from parent £2,500 from remoter ancestor£1,000 from anyone else

Exemptions for lifetime transfers only

Most lifetime transfers into trusts not covered by anexemption are immediately liable to IHT(chargeable lifetime transfers (CLTs)).


6: TaxationPage 157

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

IHT planningPotentially Exempt Transfers (PETs). Gift madeby individual in lifetime is potentially exempt IHTprovided not made in last 7 years of life

Gifts to trusts. Transfer to a discretionary trust willattract IHT rate of 20% if transfer not made in last7 years of life

Gifts with reservation of benefit (GWR) – A giftwith strings attached. Still considered part ofindividual’s estate for IHT purposes.

Nil rate band. Transfer of nil rate band betweenspouses / civil partners. Transfer is on percentagebasis, not on a cash basis (see Example).

Example: transfer of nil rate bandEric McMullan dies & leaves his entire estate to hiswife.

100% of his nil rate band has been unused. Thistransfers to his wife.

If the individual nil rate band is £350,000 when hiswife dies then her nil rate band will be:

= £350,000 + 100% of £350,000

= £350,000 + £350,000 = £700,000


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Inheritance tax on deathIHT on the estate is found by taking into account all transfers in 7 years before death.IHT on each lifetime transfer made in 7 years before death is found as follows:

Take into account all chargeable transfers (including PETs which have become chargeable) in 7 yearsbefore the transferFind the tax at full rates: £325,000 at 0% (2013/14); remainder at 40% – then deduct any taper relief (per-centage reduction in IHT charge given if transfer was made more than 3 years before death)Deduct any tax already paid on the transfer3

2

1

Trusts and beneficiaries: taxTax Non-dividend income Dividend income

1st £1,000 20% (‘basic rate’) 10% (dividend ordinary rate)

Income > £1,000 45% (‘trust rate’) 37.5% (dividend trust rate)

Beneficiary may be able toreclaim tax charged on incomereceived from a trust (if non-taxpayer or basic rate taxpayer)


Value (residential property) SDLT rateUp to £125,000 0%Over £125,000 up to £250,000 1%Over £250,000 up to £500,000 3%Over £500,000 up to £1,000,000 4%Over £1,000,000 up to £2,000,000 5%Over £2,000,000 7%

Value (non-residential property) SDLT rateUp to £250,000 * 1%Over £250,000 up to £500,000 3%Over £500,000 4%

6: TaxationPage 159

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Stamp Duty Land Tax Stamp duty reserve tax (SDRT)– payable on buying property

* SDLT is 0% on non-residential property up to£150,000 if it earns annual rent of less than £1,000.

½% rate of tax (rounded to nearest 1p)

Payable (in a paperless transaction) by buyer of:

� Shares in a UK company

� Shares in a foreign company with UK shareregister

� An option to buy shares

� Rights arising from shares already owned

� An interest in shares, ie an interest in themoney made from selling shares

Payments are made through CREST.

For unit trusts & OEICs, the fund manager paysSDRT when units are surrendered.


Companies with profits falling between £300k & £1.5m pay on asliding scale to give an effective rate between 20% and 23%.

Losses can be offset against:� This year’s profits� Last year’s profits, or� Future years’ profits from same trade

Corporation tax (FY 2013) Value Added Tax (VAT)

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Corporation tax is payable by:� Companies resident in the UK on worldwide profits� Overseas companies on UK-derived profitsCompanies pay main rate in quarterly instalments, based on theestimated corporation tax liability. Other companies pay wholeamount 9 months & 1 day after end of accounting period.

Chargeable on supply of goods & services in thecourse of business – a tax on turnover, not profits

VAT rates� 0% – eg, books & children’s clothing� 5% – energy services & products� 20% – ‘standard rate’ on most other goods

VAT on investment services� Commissions – exempt (not the same as 0%)� Advisory services – standard rate, if invoiced

separately (otherwise, exempt)� Nominee services – exempt� Portfolio management – standard rate

Company profits FY 2013 rate

Main rate > £1.5m 23%

Small profits rate < £300k 20%


6: TaxationPage 161

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Tax on investments Tax treatment of pension benefitsDirect investments are taxed based onrelevant income tax or CGT rate.

� Pension funds

� Individual Savings Accounts (ISAs)

� Existing Child Trust Funds (CTFs)

� Real Estate Investment Trusts (REITs)

� Collective Investment Schemes (CISs)& investment companies

� Life insurance funds

� Venture Capital Trusts (VCTs)

� Enterprise Investment Schemes (EISs)

Indirect investment

Key points� Tax-free lump sum (up to 25% of accumulated

funds) can be taken from age 55. Remainder usedto produce an income, subject to income tax.

� Lifetime limit of £1.5m (2013/14)

A lifetime allowance charge applies on any excess:

� 25% for funds taken as income

� 55% for funds taken as a lump sum


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

ISAs

Key points� Not an investment, but rather a tax ‘wrapper’

� Cash ISA or Stocks & Shares ISA

� Annual limit on how much can be invested in ISA(£11,520 for 2013/14)

� Up to 50% of this can be invested in a Cash ISA

� Investments within ISA not subject to income taxor CGT

� Tax paid at source (eg, 10% tax credit ondividends) is not recoverable

� Withdrawals allowed at any time

Junior ISAAvailable since 1 November 2011:

� Max. £3,720 can be invested for a child per taxyear in cash, stocks & shares (2013/14)

� Holdings are not subject to income tax or CGT

� Replaces the Child Trust Fund

Real Estate Investment Trusts (REITs)Rental income and capital gains exempt within fund, butREITs are required to distribute most rental income.

Investors are subject to income tax on distributions,which are subject to 20% withholding tax.

Investors are also subject to CGT.


6: TaxationPage 163

Collective investmentsInvestment trusts (ITs)Unit Trusts & OEICs

In general, an authorised unit trust is treated as an investmentcompany, with its units being treated as shares in the company &any distribution as a dividend. Basic principle: to make the unit trusteffectively transparent for tax purposes, with no additional tax bornesolely, because assets are held within a unit trust.

IncomeAuthorised and unauthorised unit trusts and OEICs pay corporationtax at 20%. Franked income is not subject to corporation tax.

Capital gainsAuthorised unit trusts & OEICs are exempt from CGT on disposals ofinvestments & are thus able to switch investments free of tax.

IncomeIncome for an investment trust isdivided into franked investment income(largely dividends received from otherUK companies) & unfranked income.Franked income is not chargeable tocorporation tax, while corporation taxis payable on unfranked income.

Capital gainsCapital gains are free from tax forHMRC-approved ITs.

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

DistributionsDividend distributions from a collectiveinvestment fund are treated like dividends for incometax purposes.

Interest distributions are taxed as yearly interest ofthe share or unit holder & tax is deducted for UKresidents.

On sale, the investor is subject to CGT (unless theholding is within a tax wrapper).

Life fundsProceeds from a qualifying life assurance policyare usually free of income tax & CGT.Requirements:

� Premiums paid for at least 10 years

� Premiums paid at least annually

One-off or regular payments from single premiumUK life assurance policy (or life assurance bond)usually lead to no income tax.

Up to 5% of original premium can be withdrawn peryear without incurring additional income tax liability.


6: TaxationPage 165

Enterprise Investment Scheme (EIS)Offers tax incentives to individuals toinvest in new & growing businesses

Certain unquotedshares & AIM shares

Gains on disposalsare not taxed (if held

for 3 years)

Income tax relief given at 30%of investment (£1,000,000 max.

investment – 2013/14)

Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Investor’s tax liability is reduced by 30%of the invested amount (subject to£200,000 investment maximum).

� If shares are not held for 5 years, therelief is clawed back

� Dividend income is tax-free� No CGT (both within VCT and for

investor)

Venture Capital Trusts


Tax oninvestments

Other taxes

IHT & trusts

Capital gains tax

Nationalinsurance

Income tax

Offshore funds

Reporting funds

Must notify HMRC annually ofreportable income as well as

distributed income

Income Income tax on their share of income* Income tax**

Gains 18%/28% CGT on realised gains Income tax on realised gains

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

* Even if not distributed ** When distributed

Non-reporting funds

A fund without ‘reporting’ status


Notes


Notes


Notes


Notes


Notes


Notes


Documents

Unit 1 IMC Passcards