Restrictions on UCIS and ‘Close Substitutes’

The FCA has published policy statement PS13/3: “Restrictions on the retail distribution of unregulated collective investment schemes and close substitutes” and will be of interest to both discretionary portfolio managers as well as those that promote any of the investments covered by the policy statement.

For the avoidance of doubt, the new rules will only be relevant to firms with, or communicating to, retail customers (which will invariably include persons classified as ‘High Net Worth’ or ‘Sophisticated’ or where their status is unclear); the rules will have no impact upon persons correctly categorised as professional.

The publication has been long awaited – the original consultation paper featured in Regulatory Roundup 43 in August last year – and has prompted much debate and feedback from industry, being concerned with the implications of the original proposals. The FSA, and now the FCA, has listened – in part – which is reflected in the final rules.

Firms involved with the promotion of unregulated collective investment schemes (UCIS) will be familiar with COBS 4.12, and in particular the eight categories of person that such investments can be promoted to contained in table COBS 4.12.1(4).

The new regime expands the restrictions on promotion to ‘non-mainstream pooled investments’ (NMPIs), a term which captures:

  • UCIS
  • Qualified investor scheme
  • Traded life policy investment
  • A security issued by a special purpose vehicle (SPV) – but not an ‘excluded security’
  • Rights to or interests in investments that are any of the above

In the original consultation paper, SPV exclusions from the definition of a NMPI were fairly limited.

The definition of an excluded security now means that the following will not be captured under the NMPI heading (this is a summary and it is recommended that firms look at the precise definition of an excluded security contained in PS13/3).

  • Exchange traded products
  • Real Estate Investment Trusts
  • Venture capital trusts
  • Investment trusts
  • Non-EEA investment companies that would qualify as an investment trust if resident and listed in the UK
  • Covered bonds
  • Funds structured as SPVs which invest primarily in shares and/or bonds

The changes to COBS 4.12 are wide ranging. The familiar table of COBS 4.12.1 now includes 13 possible exemptions that firms can consider, including ‘US persons’ that are US for tax purposes or that own a US qualified retirement plan; Solicited advice (but subject to specific requirements) and the introduction of Certified high net worth/Certified sophisticated/Self-certified investors.

The last three categories above will be familiar to those firms that make use of the exemptions available under the Promotion of Collective Schemes (Exemptions) Order (PCIS) for UCIS or the Financial Promotion Order (FPO) for other investments, and indeed these will still remain available. However in terms of COBS 4.12 the FCA is changing the definitions where it is able. It obviously cannot change the definitions that are contained within either PCIS or the FPO – that is a matter for HMT and Parliament – but what they have done is to introduce alternative definitions.

By way of example, a firm wishing to consider the ‘certified sophisticated investor’ exemption will find that they can now look to article 23 of PCIS (or article 50 of the FPO if not a UCIS) or to the definition in COBS 4.12.7. Whilst e.g. PCIS requires that such an individual must not be certified by a firm that is the operator of the UCIS in question, and nor must the firm certifying ‘induce’ the individual to acquire units in the UCIS, this requirement is not in COBS 4.12.7.

However moving on to COBS 4.12.10 we find a warning to firms that may be considering this route for a retail client to make sure that it is in the client’s best interests and the need for a proper assessment. Firms will find a similar approach in respect of the certified high net worth and self-certified investor exemptions, effectively requiring a preliminary assessment of suitability (although not a full assessment as would be required under COBS 9) before promotion of NMPIs to clients.

Annex 4 contains a useful flow chart on the application of the new marketing restrictions.

The record keeping obligations in COBS 4.11 should not be overlooked. The CF10, or a delegate supervised by that individual, must record the exemption being relied upon – and the reason why it is applicable – when communicating or promoting a NMPI to a retail client, together with any relevant investor statements or certifications.

Changes will also be seen in COBS 9.3 (Guidance on assessing suitability).

It is the view of the FCA that the provision of advice or making a personal recommendation typically includes “an invitation or inducement to engage in investment activity” i.e. it will include an element of financial promotion. Therefore firms will need to satisfy themselves that an exemption is available in relation to the promotion of a NMPI before recommending the investment to a retail client.

Discretionary portfolio managers are advised to consider the revised table in COBS 4.12 before purchasing a NMPI in a client’s portfolio. Whilst the revised rules are concerned with ‘promotion’ and ‘communication’ – and so would not be associated with a purchase under a discretionary mandate – such firms are left in no doubt that they will need to satisfy themselves (and possibly any FCA thematic visit team) whether such a transaction would be suitable for the client if promotion of the same investment would not have been permitted.

The final rules, which take effect from 1 January 2014, can be found in Appendix 1 of PS13/3.

By way of encouragement, the FCA release reminds readers of the list of UCIS related Enforcement Notices that it maintains.

Although not specifically addressed in the policy statement, those firms which do not have ‘retail’ in their Part 4A permission should bear in mind that whilst the revised COBS 4.12 may permit communicating a financial promotion to a retail customer – which in itself is not a regulated activity – they are not allowed to undertake any regulated activities for such customers such as subsequent arranging of deals, advising etc.

Firms that are involved with NMPIs, whether by way of distribution, advising or discretionary portfolio management, should use the next 6 months or so to consider what changes, if any, will be needed to their systems and procedures to ensure that they will be compliant with the new rules.