Financial advice, what does it even mean?


Proposed changes

The root cause of the uncertainty is that UK firms currently face two definitions of regulated financial advice. The first of these definitions is contained in the RAO, which defines regulated financial advice widely, capturing advice that:

- relates to a relevant investment (which includes contracts of insurance);

- is given to a person in their capacity as an investor or a potential investor; and

- relates to the merits of buying, selling, subscribing or underwriting the investment.

The Markets in Financial Instruments Directive[2] (“MiFID”) contains a narrower definition of financial advice, with a key requirement that it must be a personal recommendation. Further FCA obligations, for example around suitability, attach solely to personal recommendations and not the wider definition of regulated financial advice.

FAMR found that the MiFID definition is both clearer for firms and enables firms to build the definition more easily into their compliance procedures. FAMR is therefore recommending the amendment of the definition of regulated financial advice in the RAO to bring it in line with the definition in MiFID.

While MiFID does not include contracts of insurance in its scope (although certain life insurance contracts are subject to FCA suitability requirements on personal recommendations), FAMR recommended that the amendment would also apply to the provision of advice relating to contracts of general insurance, which relies on the same definition in the RAO.

Effects on firms

Firms that provide both regulated financial advice as well as financial guidance would have to change their internal systems and processes, such as external communications, training, record-keeping and documentation. However, these firms would also benefit from the clearer definition of financial advice, which should enable them to give more tailored information and useful guidance to their customers without incurring additional regulatory costs.

The barriers to entry for new firms wanting to only provide financial guidance would be lowered considerably. Where these firms currently need to apply for a permission to advise on investments, this should not be necessary when the definition is changed (although they may still of course need other permissions depending on their activities).

Firms will, of course, also need to have systems and controls to ensure they do not provide personal recommendations. This should, however, be substantially easier than trying to avoid giving regulated financial advice under the existing, broad, definition.

Personal recommendations

The proposed amendment to the RAO would not alter the existing definition of a personal recommendation in the FCA Handbook, which already closely follows the MiFID definition of the same. In the FCA Handbook, and in the MiFID Implementing Directive[3], a personal recommendation is a recommendation that is presented as suitable for the person to whom it is made, or is based on a consideration of the circumstances of that person. The FCA and the Committee of European Securities Regulators (“CESR”) have published further guidance on what constitutes a personal recommendation[4].

However, a recommendation is not a personal recommendation if it is issued exclusively:

- through distribution channels; or

- to the public.

Under MiFID II, which is due to come into force on 3 January 2018, the exclusion for recommendations made through distribution channels, for example to all investors of a particular fund, will be removed. This is intended to clarify that a recommendation issued solely through a distribution channel could still qualify as a personal recommendation depending on how the recommendation is presented to the recipients[5].

Firms are currently under a requirement to take reasonable steps to ensure that a personal recommendation is suitable for a client, including when providing simplified advice[6]. There is no indication by FAMR that this requirement would change in any way.

Next steps

The consultation closes on 15 November 2016. Following this, the Treasury will provide its response. FCA will also produce new guidance on the topic.

[1] Financial Services and Markets Act 2000 (Regulated Activities) Order (SI 2001/544)

[2] 2004/39/EC

[3] Directive 2006/73/EC

[4] See in particular FG 15/1 and GC 14/3 published by the FCA and CESR/10-294 and CESR/09-665 by CESR.

[5] Background on the MiFID II change of the definition a personal recommendation can be found in ESMA /2014/1569, published by the European Securities and Markets Authority (which is the successor body to CESR), and CESR/10-859, published by CESR as well as recital (14) of the Commission Delegated Regulation of 25.4.2016.

[6] COBS 9.2.1R