New Restrictions on UCIS

Regular Readers of Regulatory Roundup will be aware of both the FSA’s continuing concerns on the promotion of unregulated collective investment schemes (UCIS) and its readiness to take relevant regulatory action against both firms and individuals where transgressions have occurred – see link to UCIS Enforcement Notices for further details.

The FSA’s Conduct Risk Outlook 2012 that was published in March (see Regulatory Roundup 39) listed 15 broad risk categories: UCIS were included under ‘complexity in retail investment products and services’. Whilst it was acknowledged that the majority of UCIS are designed for institutional investors the Regulator was finding that more of these schemes were being sold to retail investors “for whom this product is unsuitable”. We were put on warning that the Regulator was intending to conduct a review of the rules relating to UCIS to improve consumer protection so the publication of CP12/19 “Restrictions on the retail distribution of unregulated collective investment schemes and close subjects” will not come as a surprise. Arguably this is an example of the new regulatory approach under which the Regulator will intervene at an earlier stage.

Strictly speaking, and in keeping with the paper’s title, CP12/19 concerns itself with the distribution of ‘non-mainstream pooled investments’ so not only includes UCIS but also includes traded life policy investments, securities issued by special purpose vehicles and qualified investor schemes. The latter are, of course, authorised funds governed by COLL 8.

The current restrictions on the promotion of UCIS can be found in COBS 4.12. Under this, it is a requirement that a potential investor/scheme participant must fall into one of the eight categories listed therein before a UCIS can be promoted to them. It is proposed to remove three of those categories: category 1 (existing participants in a UCIS); category 2 (where a firm has deemed the UCIS as being suitable for them); and category 8 (where an adequate assessment has been made, written warnings provided and the necessary statement made). The purpose of these changes is not to discourage the promotion of UCIS per se but rather to restrict their promotion to ‘ordinary retail investors’ (see glossary on page 6 of CP12/19). The remaining five categories in COBS 4.12 continue, including category 7 which permits promotion to persons that are a professional client or an eligible counterparty.

The category 8 exemption was of use to firms that were intending to promote a UCIS to a retail client i.e. an investor that did not fall into category 7. Although this category will be lost, firms can still make use of exemptions in the CIS Exemptions Order e.g. certified sophisticated investors (article 23). However it must be remembered that for MiFID business a firm must still follow the MiFID communication provisions as implemented in COBS 4 even if COBS 4.12 exemptions are not being used.

SPVs are of concern to the FSA as they can be used as a means to pool investments but, because of their structure, would not be subject to the current protections under the UCIS regime: there will be a carve out for investment trusts and covered bonds. The FSA will consider waiver requests from providers under certain circumstances – see 3.28 of CP12/19.

In a similar manner to the possible use of the CIS Exemption Order (see above), firms can also consider the use of the Financial Promotions Order where the non-mainstream pooled investment is not a UCIS. Note the obligation placed upon the CF10 (COBS 4.11.4) and the need for a firm to make and retain a record of why it is satisfied that a particular exemption applies (COBS 4.11.5).

For the avoidance of doubt, the table in COBS 4.12.1 that we are all currently familiar with still relates to the promotion of UCIS. Restrictions on the promotion to retail clients of other investments, apart from UCIS, that will be classified as non-mainstream pooled investments, will be addressed by way of expansion of COBS 4.12. The guidance on the classification of investors as ‘sophisticated’ or ‘high net worth’ can be read as a warning to firms that such classification must be done with due care and even then to carefully consider whether such a promotion would be appropriate – note the use of “the firm should consider” and “for example” in (2) in each of COBS 4.12.7G to COBS 4.12.9G inclusive. For good measure firms are also reminded of their obligations under the Principles and the ‘client’s best interest rule’ (COBS 2.1.1).

The proposed changes to the Handbook, including enhanced record keeping requirements (COBS 4.11); the restrictions on the promotion of UCIS and non-mainstream pooled investments (COBS 4.12); and suitability guidance (COBS 9.3) can be found in Appendix 1 of CP12/19.

The consultation period finishes on 14 November 2012 and, interestingly, the FSA invites feedback from overseas regulators, the EU Commission and any other interested regulatory bodies.

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