This change to the definition of what constitutes ‘regulated advice’ presents a potentially huge opportunity for FCA regulated firms and their retail clients.
What is changing? At a glance
From 3 January 2018:
For FCA regulated firms, the UK definition of advising on investments is going to be narrowed and bought into line with the definition found in the Markets in Financial Instruments Directive (“MiFID”). For these firms, only providing ‘personal recommendations’ will constitute regulated advice.
For unregulated firms, the definition of advising on investments will remain unchanged. This aims to ensure that unregulated firms won’t be able to move in and occupy the space left behind as a result of the change, with the FCA potentially powerless to take action against them.
What could this mean?
This could result in a huge change in the way that regulated firms provide information, content and services to retail clients.
In particular, those firms that previously restricted the content of the information they provided to retail clients (so as to not be accused of providing advice) may now be able to go much further in terms of providing guidance, risk information and opinion, potentially resulting in retail clients being able to make more informed decisions and a closing of the ‘advice gap’.
Let’s go through the changes in a little more detail.
Where has this come from?
In August 2015, the FCA and HM Treasury launched the Financial Advice Market Review. FAMR was setup to look at whether financial advice was working effectively for consumers.
Just to cast your minds back, this review began in the context of changes to pension freedoms and some three years after the initial introduction of the Retail Distribution Review (“RDR”), which fundamentally changed the way regulated financial advisers were remunerated and how they could recommend investment products, in order to combat poor sales practices.
These changes resulted in an overall reduction in the number of retail investors seeking the services of a regulated financial adviser as a result of it becoming less economical to do so.
This created the ‘advice gap’ and the FAMR aimed to look at how this gap could be closed.
What causes the advice gap and why is this a problem?
In addition to issues around adviser fees, the advice gap is exacerbated by two main regulatory issues.
The first thing to be aware of is that the current UK definition of advising on investments found in Article 53 of the RAO is very broad.
I won’t reproduce the full definition here but, in a nutshell, advising an investor (or potential investor) on the merits of buying or selling an investment constitutes advising on investments.
In its perimeter guidance manual and in further guidance issued in January 2015, the FCA states that the inclusion of ‘an element of opinion or judgement’ on the part of the adviser, including an opinion on the pros and cons of whether to buy or sell an investment, results in a line being crossed between ‘information’ and ‘advice’.
Once this line is crossed, the firm in question would be undertaking the regulated activity of advising on investments and therefore require the appropriate permission from the regulator.
We can contrast this definition of regulated advice with that of the Markets in Financial Instruments Directive (“MiFID”).
At a high level, advice only becomes regulated under MiFID where there is a ‘personal recommendation’ – i.e. the recommendation is made or based on the investor’s circumstances and must be presented as suitable for that person. This is much more akin to what a traditional financial adviser does – they take their client’s specific circumstances into account and provide advice tailored to their client’s needs, attitude to risk and time horizon, among other considerations.
It is this focus on the investor’s circumstances, rather than on the general merits of buying and selling an investment, which results in the MiFID definition being much narrower.
The second thing to be aware of is that if an individual or firm produces content or provides a service for retail clients which crosses that line between ‘information’ and ‘investment advice’, then a whole host of detailed, complex and onerous compliance requirements potentially come into force. In particular, obligations for approved persons to hold specific qualifications are particularly burdensome.
Again, these rules were originally designed for the traditional financial adviser market, but the FCA Handbook doesn’t always differentiate between whether a firm is providing a personal recommendation or simply ‘an element of opinion’.
What was the net effect?
For the regulated firms, the existence of these onerous requirements resulted in a whole host of businesses, new and established alike, doing everything they could to stay as far outside the definition of advising on investments as possible, particularly in areas such as crowdfunding and other alternative investments. The costs simply outweighed the benefits, and understandably so.
By way of practical examples, this has traditionally included a reluctance to:
- Provide risk scores or put products into ‘risk buckets’, as this constitutes an opinion
- Classify products based on their time horizon and other investment objectives (e.g. income vs capital gain information)
- Filter investment opportunities based on either of the above
As the FCA confirmed in its finalised guidance in 2015, to do any of the above would constitute regulated advice, though not necessarily a personal recommendation.
In practice, this resulted in retail clients being faced with a stark choice. They either paid for the privilege of using a traditional financial adviser, which may be expensive and/or inappropriate for their circumstances, or be left having to make their own investment decisions on an ‘execution-only’ basis.
There was obviously a clear gap in between the two.
HM Treasury is proposing to change the scope of Article 53 of the RAO so that, for regulated firms, the definition of advising on investments matches the equivalent definition under MiFID.
This means that firms that are already regulated by the FCA, but do not provide personal recommendations, will be able to provide enhanced guidance and risk information to retail clients (potentially as detailed above) without needing to be authorised specifically to advise on investments for retail clients.
The FCA and HM Treasury hope that this will result in regulated firms moving in and close the advice gap.
It is worth remembering that all regulated firms have a requirement to ensure that anything they communicate is ‘fair, clear and not misleading’ with risks appropriately identified and presented in a balanced way, and this will continue to apply to firms that may decide to provide opinion and guidance. This should help, to some extent, mitigate against the danger of firms ‘cherry picking’ information.
When these changes come into effect, I would expect the FCA to focus a lot of monitoring activity in this area, to ensure that retail clients are still being given accurate information by regulated firms.
For unregulated firms, the definition of advising on investments will remain unchanged and providing ‘an element of opinion’ will continue to constitute regulated advice.
This twin track approach is designed to limit the maneuverability of fraudsters to move in and fill the advice gap, as to do so without being regulated by the FCA for another activity would be breaking the law (at this stage it isn’t clear whether there will be any specific regulated activities that a firm will be required to have authorisation to carry out, though one would assume this will involve authorisation for arranging deals in investments as a minimum).
There’s no question that January 2018 is going to be an exceptionally busy time for regulated firms, with an unprecedented amount of regulatory change happening all at once.
However, on the face of it at least, this piece of regulatory change seems an utterly sensible one and it will be fascinating to see how regulated firms adapt their products and services to reflect these new-found freedoms to provide enhanced guidance and opinion.
Joe is the co-founder of Enterprise Incubator & Consultancy LLP, a firm providing compliance support to regulated financial services firms in the UK and EEA.