FSA Proposes New Rules Restricting the Retail Distribution of Unregulated Collective Investment Schemes and Other Non-mainstream Pooled Investments

UCIS are often higher risk, speculative investments in unusual assets which are difficult to value and may be highly illiquid. They are not subject to FSA rules on regulated CIS, which means they do not have to comply with rules governing investment and borrowing powers, conflicts of interest, a prudent spread of risk and other investor safeguards. A number of non-mainstream pooled investments have failed completely in recent years, leading to total investment loss for customers.

FSA rules currently restrict the promotion of UCIS, prohibiting their promotion to the general public and only allowing marketing of them where an exemption is available. However, following extensive work carried out in this area, the FSA has found that the current restrictions are poorly understood and widely misinterpreted. In a recent review, the FSA found that only one in every four advised sales of UCIS to retail customers was suitable. Many advisers are breaching the rules and some providers have actively encouraged promotion of UCIS to the general retail market, for example by offering high rates of commission to distributors. Ordinary investors are being exposed to a significant risk of detriment.

The FSA is therefore proposing new rules, restrictions and guidance to apply to the following products: UCIS; qualified investor schemes; securities issued by special purpose vehicles; and traded life policy investments (TLPIs). The inclusion of TLPIs follows on from guidance published by the FSA earlier this year strongly recommending that TLPIs should not reach the vast majority of retail investors in the UK.

The FSA’s proposed new measures are as follows:

• Changing the existing marketing restriction rules by removing certain categories of customer to whom UCIS may currently be promoted (for example, investors who are already participants in a UCIS or who have been in the last 30 months); and introducing a new provision to stop firms promoting the other products within scope to ordinary retail investors. This will, in effect, prevent firms from being able to promote these products to ordinary retail customers;
• New Handbook guidance to confirm that promotions in the context of advice are still financial promotions and therefore subject to the marketing restriction rules;
• A new rule requiring firms to document and maintain records of the basis on which they make promotions of UCIS and the other products within scope to retail clients; and requiring the individual responsible for a firm’s compliance oversight function (CF10) to confirm compliance of each financial promotion with the marketing restriction rules; and
• Updating the Handbook definition of “retail investment product” (which will come into force on 31 December 2012) to clarify the restrictions on the types of customer to whom UCIS and the other products stated above may be promoted. This is relevant to RDR independence requirements.

The new rules will only apply to direct retail access; however this includes investment through products such as ISAs, self-invested personal pension schemes and platform services. The rules will not apply to execution-only sales if there has been no financial promotion.

The new rules are found in an FSA consultation paper published on 22 August 2012, which is available here. Responses to the consultation paper are invited by 14 November 2012. As many UCIS are operated from outside the UK, the FSA invites feedback from overseas regulators, the European Commission and any other interested bodies. The FSA expects to issue a Policy Statement with finalised rules and guidance in the first quarter of 2013.

The FSA’s work in this area may be seen as a signal of its new regulatory approach moving forward to the new regime, favouring proactive intervention when problems are perceived to prevent consumer detriment occurring in the first place.