Unit 1 IMC Passcards

(000)IMC1PC_v11_FP.
qxp
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Investment Management Certificate

Unit 1 The Investment Environment
Syllabus version 11
(000)IMC1PC_v11_FP.qxp
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7:23 PM
Published November 2013

ISBN 9781 4727 0410 8
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Page ii
The contents of this book are intended as a guide and not

professional advice. Although every effort has been made to
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BPP Learning Media Ltd

2013
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Page iii
Preface
Contents
Welcome to BPP Learning Medias Investment Management Certificate Unit 1 Passcards.

Passcards save you time. Important topics are summarised for you.
Passcards include diagrams to kick start your memory.
Passcards follow the overall structure of the BPP Learning Media Study Texts, but Passcards are not
just a condensed book. Each card has been separately designed for clear presentation. Topics are self
contained and can be grasped visually.
Passcards are still just the right size for pockets, briefcases and bags.
Passcards focus on the exam you will be facing.
Run through the complete set of Passcards as often as you can during your final revision period. The day
before the exam, try to go through the Passcards again. You will then be well on your way to passing your
exams. Good luck!
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Page iv
Preface
Page
1
Financial markets and institutions
2
3
Contents
Page
Legal concepts
109
Ethics and investment professionalism
27
Client advice
119
Financial regulation
33
Taxation
145
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Page 1
1: Financial markets and institutions
Topic List
Financial institutions
Role of government
Financial markets
Listing & governance
International markets
The agency problem
The financial services industry plays a key role in the

economic system. Here, we look at the institutions and
markets within the industry. We also examine the roles of the
national Government, and the status of EU legislation.
The London Stock Exchange is a market place for trading
bonds and other securities. The creation of Multilateral Trading
Facilities (MTFs) since MiFID is a challenge to the mainstream
exchanges, with MTFs taking a significant market share.
The FCA operates as the UK Listing Authority (UKLA) to
regulate company listings on the Exchange.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Functions of financial intermediaries

Financial intermediaries bring together providers
and users of finance, either as a broker facilitating a
transaction, or in their own right, as principal.
Source of funds for borrowers
Aggregation of deposits (eg small savers) to
lend on to borrowers (eg for mortgages)
Maturity transformation: between for example
depositors wanting instant access and borrowers
needing a 25-year loan
Pooling of collective funds, giving small
investors access to diversified portfolios
Page 2
Listing &
governance
International
markets
The agency
problem
UK financial intermediaries
Banks
Building societies
Insurance companies, pension funds, collective
funds
National Savings & Investments (NS&I) a
Government agency
Capital markets for raising and investing
largely long-term capital (eg the Stock
Exchange)
Money markets for lending and borrowing
largely short-term capital (eg banks short-term
lending)
As well as its domestic market in equities (company shares) & bonds (interest-bearing securities), the UK is
a major centre for the eurobond markets for debt denominated in non-domestic currencies.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 3
Listing &
governance
International
markets
The agency
problem
Flow of funds in an open economy, showing the role of financial intermediation

Page 3
Financial
institutions
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Role of
government
7:24 PM
Page 4
Financial
markets
UK financial services industry
Listing &
governance
Clearing banks operate the system for settling

payments
Retail banks the High Street banks
Wholesale banks lend in large amounts, to
larger customers
Investment banks serve institutional investors
and corporate customers
Central bank Bank of England (for UK)
Building societies mutual organisations

Main assets: mortgages of their members
Main liabilities are to investor members
The agency
problem
The central bank (BoE)
Employs over 1 million people in the UK

Accounts for around 5% of national output
Banks
International
markets
Functions of Bank of England

Banker to the central government

Banknote-issuing authority
Manager of the National Debt
Manager of UK's foreign currency reserves
Adviser to the government on monetary policy
Monetary policy control (through MPC)
Key role in prudential regulation (see Ch. 3)
Banker to the commercial banks
Lender of last resort to the banking system
Monetary Policy Committee (MPC) aims to meet

UKs 2% (CPI) inflation target.
Financial
institutions
Page 5
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Role of
government
7:24 PM
Financial
markets
Page 5
Listing &
governance
International
markets
The agency
problem
Financial
institutions
12/4/2013
Role of
government
Products and functions

Banks and building societies

Current accounts: non- or low interest

Deposit or savings accounts
Trend towards e-banking and ATMs
Overdrafts and personal loans
Mortgages, including buy-to-let
Trustee services
Portfolio management services
FInancial planning services
7:24 PM
Financial
markets
Page 6
Listing &
governance
International
markets
The agency
problem
Life offices provide protection on death and disability,

long-term savings and lump sum investments, through the
issue of term assurances, whole life assurances,
endowments, pensions, investment bonds, annuities.
Products are marketed by personal advice and by
advertisements.
Bancassurers are banks with their own life offices. Banks
may establish independent subsidiaries employing
independent financial advisers, who must advise on the
most suitable product available in the whole market or
market sector.
Friendly societies: mutual organisations offering
investment products.
Financial
institutions
12/4/2013
Role of
government
Financial
markets
Brokers buy and sell securities

Individual clients
Corporate clients
Services may include:

Page 7
Unit trusts and OEICs

Investment trust offers
ISAs
Discount share dealing
Internet dealing services
Page 7
Listing &
governance
International
markets
The agency
problem
Functions may be combined in

discretionary portfolio management:
Manager makes buy/sell decisions
Within parameters agreed with the client
Investment managers
Portfolio management
Research and analysis
7:24 PM
E-commerce: transacting business via the internet

E-commerce has changed the industry, with:
Internet banking & online share trading
Real-time share price information services
Marketing of products, with online completion of applications
Funds supermarkets offer:

Various providers collective funds

Mix and match facility to combine different providers funds in an ISA
Online dealing by credit or debit card
Online account tracking facilities
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 8
Listing &
governance
International
markets
The agency
problem
Legislation
Fiscal policy
EU law takes precedence over national laws, and UK lawmaking must follow the Treaty of Rome and EU Directives.
A government's fiscal policy concerns its plans

for Government spending, taxation and
Government borrowing.
The UK has a mixed economy market-based with

some State intervention
Monetary policy
is concerned with:
Changes in the amount of money in circulation

the money supply and
Changes in the price of money interest rates
These variables are linked with:
Inflation in prices generally
Exchange rates the price of the domestic
currency in terms of other currencies
Government spending is an injection into the

economy, adding to demand for goods and
services, whereas taxes are a withdrawal.
A government's fiscal stance may be neutral,

expansionary or contractionary, according to
its overall effect on national income.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Easing of monetary policy
BoE reduces interest rates:
Page 9
Listing &
governance
International
markets
The agency
problem
Tightening of monetary policy

BoE increases interest rates:
Loans are cheaper, and so people borrow &

spend more. Companies find borrowing cheaper
while consumer demand may rise, both factors
boosting profits.
Loans cost more, property prices may be

dampened & consumer demand may fall.
Company profits could reduce through higher
borrowing costs & lower demand.
Asset values rise. Eg, Government bonds (gilts)

rise in price, since required returns are now
lower.
Other asset prices may fall. Investors will

require a higher return than before & so pay
less for fixed interest stocks (eg gilts).
Those dependant on income from cash

deposits will be worse off.
Those reliant on interest for income will be

better off.
Page 9
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Exchange rate policy

The Government can try to influence exchange
rates by buying & selling currency, to the extent
that it has sufficient currency reserves.
Page 10
Listing &
governance
International
markets
The agency
problem
Changes in interest rates affect exchange rates:

currencies with higher rates attract money inflow,
and their values relative to other currencies rise.
The European Union
EU law
The EU seeks to remove barriers to the free

movement of goods, persons, services and capital.
EU legislation takes three forms:

Regulations have the force of law in every EU
state without need of national legislation.
Directives are issued to the governments of the
EU member states requiring them within a
specified period (usually two years) to alter the
national laws of the state.
Decisions of an administrative nature are made
by the European Commission in Brussels.
The European Central Bank is the central bank for

eurozone countries which use the euro as their
common currency.
Financial
institutions
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Role of
government
7:24 PM
Financial
markets
Asset types
Tangible assets eg, property, equipment,
commodities are real assets. Claims on a
return such as interest or dividends are
financial assets. Loans (debt) and shares
(equity) represent the two main types of
financial security.
Ordinary shares (equities) offer the prospect of
dividends and capital growth, if the company
succeeds. Fixed income securities (debt, for
the issuer) are often generally called bonds.
Pooled or collective funds package securities,
allowing diversification and index-tracking.
Page 11
Page 11
Listing &
governance
International
markets
The agency
problem
Sell side and buy side

Traders in financial markets can be categorised
broadly into sell-side & buy-side.
Sell-side firms comprise investment banks,
brokers, & dealers who provide investment
products & transaction services
Buy-side firms are mainly investment managers
(including pension funds, mutual funds, hedge
funds & insurance companies) who purchase
investment products & transaction services
Many firms encompass market participants on the
buy-side as well as the sell-side.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 12
Listing &
governance
International
markets
The agency
problem
Financial markets
.... Mobilise peoples savings and put them to use in enabling firms to grow, thus contributing to the
wealth of the economy
.... Enable the transfer of risk. Eg, derivatives markets enable investors, entrepreneurs and market
participants to hedge risks as well as to speculate on the prices for assets
Attributes of an effective & efficient securities market
Cost efficiency electronic order systems lower costs (operational efficiency)
Liquidity the ability to enter or exit the market with reasonable price spread, on a transaction of a
reasonable size (promotes operational efficiency). Contributing factors: effective IT & settlement
systems, diverse membership & stock availability, stock lending facilities
Price discovery the process through which an equilibrium price for a financial instrument is revealed
continuously through bid & offer prices, and trading (enabling informational efficiency)
Transparency investors knowing the price before, during & after a deal in order to be satisfied that they
have a good deal (informational efficiency: prices reflect all relevant information)
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 13
Listing &
governance
International
markets
The agency
problem
Round trip (purchase / sale) transaction costs include: bid / offer spread, brokers commissions, Stamp
Duty Reserve Tax (CREST, dematerialised transactions) or stamp duty (non-CREST), Takeover Panel levy (1,
on transactions over 10k).
A less easily quantified element of transaction costs is the cost effect of the tendency for fluctuating order
sizes to move prices: this is market impact or price impact. For major stocks with deep liquidity, bid-ask
spread and potential price impact can be very low for typical transactions. Smaller issues may have high
liquidity risk or marketability risk, which has to do with the ease with which an issue can be sold. This risk
can become acute at times of market stress, and is built into the price of securities.
Limit orders only filled if price is better than the stated limit compare with market orders, which are filled
at the best available price when the order is placed.The opportunity cost of a limit order is that the price may
move against the trader before the order is filled.
More opaque (less transparent) markets will typically have larger bid-ask spreads because dealers will find it
more difficult to judge demand for stock, and so know the equilibrium price (price discovery). Real-time pretrade & post-trade transparency are required for many securities (especially equities) under MiFID rules.
Over-The-Counter markets are typically less transparent.
Page 13
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Order- v quote-driven markets

Order-driven: trading system matches willing
buyers & sellers automatically. Prices of
securities are driven by buyers & sellers.
Quote-driven: market makers act as buyers &
sellers to the market, quoting prices continuously.
Exchange trading v OTC

Exchange-traded instruments: standardised in
respect of (eg) contract size and dates,
facilitating a liquid market in the instrument
Over the counter instruments: generally
negotiated with a financial institution, to fit client
needs
Page 14
Listing &
governance
International
markets
The agency
problem
London Stock Exchange plc

Initially, companies issue securities to investors
the primary market.
LSE also provides a secondary market for
trading in already-issued securities.
Stock Exchange members

LSE members are:
Broker/dealers, who may act in dual capacity, ie
broker a customers business (agent) or deal
directly with them (principal)
or
Equity market makers / GEMMs, who quote
2-way prices
Financial
institutions
12/4/2013
Role of
government
SETS
SETSqx
SEAQ
Combined order- Quoteand quote-driven driven

No market makers
1+ market
2+ market
makers per stock makers per
stock
Liquid listed stocks as Illiquid stocks No listed
classified by MiFID, i.e. under MiFID
stocks
FTSE All Share stocks,
ETFs, Exchange Traded
Commodities & actively
traded Irish stocks
Most traded AIM stocks All AIM stocks in
All
AIM EURO
remaining
sectors not
AIM stocks
traded on SETS
Page 15
Page 15
Listing &
governance
Financial
markets
LSE trading platforms

Order-driven
7:24 PM
International
markets
The agency
problem
SETS (Stock Exchange Electronic Trading Service) is

called The Order Book. LCH.Clearnet is the central
counterparty, keeping trades anonymous. Brokers orders:
Match automatically with an order currently displayed, or
May be matched later
SETSqx (SETS quotes & crosses):
Market makers must quote buying & selling (two-way)

prices up to Exchange Market Size (EMS)
Also, periodic auctions, where anonymous limit orders

are placed
SEAQ (known as a quote display system): secondary

system, used for fixed income securities and less frequently
traded AIM stocks.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Page 16
Listing &
governance
Financial
markets
International
markets
The agency
problem
Cum- and ex-div

Shares trade cum div (with right to receive next dividend)
until 2 business days before books close date.
Fixed interest: usually go ex-div 7 business days

before coupon dates.
Company determines
Dividend
announcement
LSE determines
Ex-div
date
Books
close
2 business days
Cum div buyer will

receive next dividend
Ex div seller will

receive next dividend
Dividend
payment
date
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Alternative trading venues

Dark pools: electronic trading platforms where
neither price nor identity of trading firm is

revealed
Multilateral Trading Facilities (MTFs):

electronic trading platforms functioning similarly
to SETS, but generally cheaper than SETS
trading
Systematic Internalisers (SIs): Investment

banks executing client orders by trading for their
own account, rather than with an exchange or
MTF
Page 17
Page 17
Listing &
governance
International
markets
The agency
problem
Automated & high frequency trading (HFT)

Benefits
Improved liquidity & bid/ask spreads
Lower transaction costs
More efficient market pricing
Risks
HFT traders may squeeze unfair price
advantage
Technical glitches could lead to erroneous
orders & volatility (flash crashes)
Possible market manipulation
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Settlement conventions
Equities
Gilts/ US T-Bonds
Eurobonds/ Corporate bonds
Currencies/ German equities
T+3
T+1
T+3
T+2
Dual listing
Corporations in different jurisdictions act as single
operating business. Consequences:
Access to a wider pool of investors
Increased liquidity may reduce bid/offer spreads
Greater compliance costs
Page 18
Listing &
governance
International
markets
The agency
problem
Gilts market
Gilts settle via Euroclear UK & Ireland (EUI).
Gilt Edged Market Makers (GEMMs) must
quote firm two-way prices in all conventional
gilts and/or all index-linked gilts.
Inter Dealer Brokers (IDBs) arrange matched
principal-to-principal anonymous trades
between GEMMs, allowing GEMMs to unwind
positions.
Order Book for Retail Bonds (ORB)

Electronic order-driven trading service for

selection of gilts & UK corporate bonds
Investors can enter orders directly, or via a
broker with Direct Market Access (DMA)
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 19
Listing &
governance
International
markets
The agency
problem
New gilts issues

Issuer: Debt Management Office (DMO), to fund Public Sector Net Cash Requirement (PSNCR)
New issue
Tranche
Large
Auction
Competitive
Page 19
Pay bid price
Non-competitive
Tap
If small (tranchette) or
failed auction, issued
into secondary market
Maximum bid is 0.5 million

nominal value
Pay weighted average of
successful bid prices in
competitive auction
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
UKLA and AIM rules

Summary
AIM
3 years*
None
25%*
None
700,000 for
equity; 200,000
for debt
None
Free transferability
Yes
Yes
Prospectus requirement**
Yes
Yes***
UKLA
LSE
Percentage in public hands

Minimum market value
Applicable rules
Listing &
governance
AIM
Main List
Trading record
Page 20
*Not required for a Standard (non-Premium) listing. **Exemptions:

qualified/larger investors; smaller offers/private placements. *** For
AIM, a simplified Admission Document.
International
markets
The agency
problem
Alternative Investment Market
Applicants must:
Appoint NOMAD (nominated adviser)
Produce Admission Document
ISDX (previously PLUS Markets)

ISDX Growth Market: for growing small- and
medium-sized enterprises (SMEs)
Rules for issuers include application &
continuing obligations requirements
Market makers Peel Hunt & Shore Capital
make markets in ISDX's major stocks, ensuring
its operation as a secondary & primary market
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 21
Annual General Meeting (AGM)

Listed company: must hold within 6 months of
financial year end
21 days notice required (unless Articles specify
longer) can be waived if all members agree
Member attends/sends proxy, to exercise
members rights
Private company (Ltd): AGM not required most
decisions can be made by written resolution
Other general meetings

14 days notice required can be waived if 95%
of members agree (90% for private company)
Page 21
International
markets
Listing &
governance
The agency
problem
Standard AGM tasks

Approve accounts
Approve dividend
(Re)appoint directors
(Re)appoint auditors
Resolutions
Ordinary resolution needs 50% majority /
14 days notice.
Special resolution needs 75% majority /
14 days notice.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Disclosure/transparency
Key rules
Holders (including connected parties) of 3% of voting
rights, & where holdings cross a % point up or down,
must notify company by T + 2 (two business days)
Directors and senior executives (PDMRs) must get
clearance to deal in own company shares /
derivatives, & notify company of such transactions by
T+4
Company informs the market via Regulatory
Information Service (RIS)/ Primary Information
Provider (PIP) by T + 1
Page 22
Listing &
governance
International
markets
The agency
problem
Corporate Governance Code

Key points

Chairman/Chief Executive split

Non-executive directors balance
Re-election every 3 years
Audit & renumeration committees
Service contracts & notice periods
Review of internal controls
Disclosures in annual accounts
Encourages institutional shareholders to
use votes
The 7 Principles of the FRCs 2010 Stewardship Code aim to make fund managers and institutional investors more
active and engaged in corporate governance, eg by monitoring investee companies and having clear voting policies.
Like the FRCs Corporate Governance Code, the code is based on a comply or explain principle.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
USA
US Government bonds: issued by Dutch auction,
a form of tender
Market makers on NYSE: known as specialists
Super Display Book System: the NYSEs primary
order processing system
France
French bonds: longer dated OAT (T + 3) &
shorter dated BTAN (T + 1)
OATi: inflation-protected bond
Bonds issued by Dutch auction
Page 23
Page 23
Listing &
governance
International
markets
The agency
problem
Japan
Japanese stocks settle at the Japanese
Securities Depository Centre (JASDEC)
Japanese Government bonds (JGBs): mostly
traded over-the-counter (OTC)
JGBs settle at Bank of Japan
Germany
Government bonds are the Bund: stock
exchange-traded & also OTC
Equities settle T + 2, where counterparties are
both German
Financial
institutions
12/4/2013
Role of
government
Emerging markets
Attractions
Rapid economic growth
Low correlations
Potentially attractive valuations
Inefficient pricing
7:24 PM
Financial
markets
Page 24
Listing &
governance
International
markets
The agency
problem
Central securities depositories (CSDs)

Most major markets have a CSD to hold securities,
which will be either
Immobilised (certificates held in depository), or
Dematerialised (no physical certificate)
Possible drawbacks
Transparency
Volatility
Regulation
Liquidity
Taxation
International CSDs (ICSDs) such as Euroclear &

Clearstream provide clearance, settlement &
custody in Euromarkets & in international equities.
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 25
Listing &
governance
International
markets
The agency
problem
The principal-agent problem

A small firm typically has a strong alignment between its ownership and its control. The enterprise will typically
be run by owner-managers, who are perhaps within the same family. It is in the interests of the ownermanagers for the company to succeed, and for shareholder wealth to be maximised. In larger companies,
professional managers may be hired who may have little or no shareholding in the company. There is then a
separation of ownership & control.
Agency theory sees employees of businesses, including managers, as individuals, each with their own
objectives. Various people are involved as agents. The department of a business has its own departmental
objectives. If achieving these various objectives leads also to achieving the organisations goals, there is goal
congruence. In practice, this may not occur. Managers who work for the company (as agents) may have
different objectives, such as gaining benefits (perks) for themselves, dealing on their own account (in a
financial firm), pursuing pet projects or empire-building.
Agency problems arise from the misalignment of goals, and this can make clients, including individuals, more
reluctant to provide finance intermediaries in the investment industry: they might tend to prefer keeping their
assets as cash, for example. This will limit market liquidity and makes it more difficult for firms to grow,
potentially hurting growth prospects in the economy.
Page 25
Financial
institutions
12/4/2013
Role of
government
7:24 PM
Financial
markets
Page 26
Listing &
governance
International
markets
The agency
problem
Ways to reduce the agency problem

One strategy aiming to enhance goal congruence
and to mitigate the 'agency problem' is the use of
remuneration incentives.
Examples
Profit-related/economic value-added pay
Rewarding managers with shares
Executive Share Options Plans
In financial trading firms, the wrong remuneration
structures could encourage short-term risk-taking
by traders, potentially putting the future of the
enterprise in jeopardy, if risks turn bad.
Other measures
Separation of roles one individual not to
have too much power
Accounting standards auditied accounts an
important source of 'post-decision' information
for investors
Corporate governance a check on
management power
Regulation in the financial services industry,
rules & principles aim to ensure that financial
services firms deal properly with conflicts of
interest and treat customers fairly
12/4/2013
7:24 PM
Page 27
2: Ethics and investment professionalism
Topic List
Ethics and compliance
CFA Code of Ethics
Ethical conduct is a matter of continuing debate. The

reputation of individuals and firms is at stake when there
are shortcomings in professional behaviour. In business as
in other areas of life, reputation must typically be built up
over a long time, but it can be lost quickly.
12/4/2013
7:24 PM
Page 28
Ethics and
compliance
Ethics in organisations
Firms must follow law and regulations.
Ethics in organisations relates to social
responsibility & business practices.
Personal ethics derive from a person's beliefs
& opinions.
Professional ethics eg, the CFAs Code of
Ethics.
Corporate culture eg, 'Customer first'.
Organisation systems. Ethics might be
contained in a formal code. Possible problem:
good ethics does not always save money, &
there is a real cost to ethical decisions. Equally,
there can be substantial risk, & costs, if poor
ethics results in loss of reputation.
CFA Code
of Ethics
Senior managements role

As the regulator stated (CP10/12), promoting standards
of ethical behaviour improves outcomes for consumers
& their perception of the financial services industry.
Beyond mere compliance with rules, firms must through
their leaders foster a corporate culture congruent with
regulatory principles, if regulation is to work.
Senior management must use their leadership
positions to move the culture of their firm in the desired
direction, with:
Communication of the principles at all levels of the
organisation, & possibly external stakeholder groups
Leaders (senior management, and team leaders)
setting an example
Appropriate training of staff
12/4/2013
7:24 PM
Page 29
Ethics and
compliance
CFA Code
of Ethics
Regulations
Ethics
A set of rules designed to control the behaviour of

industries, firms, or individuals
A set of basic principles about how individuals and

organisations should behave, for the benefit of all
The rules or principles that regulate behaviour of

individuals and businesses derive from:
The law
The requirements of rules & regulations
Regulatory guidance that is not mandatory
Professional standards & codes of conduct
Ethics & ethical values
The ethical environment refers to justice,

respect for the law and a moral code. The
conduct of an organisation, its management and
its employees will be measured against ethical
standards by customers, suppliers & other
members of the public.
Page 29
The FCA expects firms to consider properly if their

incentive schemes increase the risk of misselling.
12/4/2013
7:24 PM
Page 30
Ethics and
compliance
The principle of integrity

Financial services is an important industry, affecting
the lives of most people in some way. The industry
needs not simply to provide the necessary expertise,
but to do so with integrity and professionalism.
As we shall see in the next Chapter:

The first FCA/PRA Principle for Businesses is Integrity:
A firm must conduct its business with integrity.
&
The first Statement of Principle for Approved Persons is
also Integrity:
An approved person must act with integrity in
carrying out his accountable functions.
CFA Code
of Ethics
Attributes of professional
integrity
Honesty: the person will not deliberately
mislead another
Reliability: the person can be relied upon to
maintain appropriate levels of competence &
skill in practice
Impartiality: treating different people fairly,
where the people involved could be
customers, employees or others
Openness: implying transparency, where
appropriate & where justified confidentiality
is not breached
12/4/2013
7:24 PM
Page 31
Ethics and
compliance
Compliance-based approach
A rules-based compliance approach seeks to ensure
that a firm acts within laws & regulations, & that
violations are prevented, detected & punished.
Some organisations, faced with the legal consequences
of unethical behaviours, take legal precautions such as:
Compliance procedures to detect misconduct
Audits of contracts
Systems for employees to report criminal
misconduct without fear of retribution
Disciplinary procedures to deal with transgressions
A compliance-based approach suggests that
bureaucratic control is necessary; an integrity-based or
principles-based approach relies on cultural control.
Page 31
CFA Code
of Ethics
Integrity-based approach
An integrity-based approach combines a concern
for the law with emphasis on managerial
responsibility for ethical behaviour.
Integrity strategies define companies' guiding values,
aspirations & patterns of thought & conduct:
To prevent damaging ethical lapses, while
Tapping into human impulses for moral thought &
action
This approach echoes the FCAs principles-based
approach to financial regulation eg, the principlesbased approach requires firms to act with integrity
and to treat customers fairly. Unlike rules, such
principles require senior management to apply
higher-level professional values in their business.
12/4/2013
7:24 PM
Page 32
Ethics and
compliance
CFA Code of Ethics

1.
2.
3.
4.
5.
6.
III. Duties to Clients

A. Loyalty, Prudence & Care
B. Fair Dealing
Act with integrity, competence, diligence and respect, & in an ethical
C. Suitability
manner with others
D. Performance Presentation
Place the integrity of the investment profession & the interest of client
E. Preservation of Confidentiality
above personal interests
Use reasonable care & exercise independent professional judgement IV. Duties to Employers
A. Loyalty
Practice & encourage others to practice in a professional & ethical
B. Additional Compensation Arrangements
manner
C. Responsibilities of Supervisors
Promote the integrity of, & uphold the rules governing, capital markets
V. Investment Analysis, Recommendations & Actions
Maintain & improve their own, & others, professional competence
A. Diligence & Reasonable Basis
B. Communication with Clients & Prospective Clients
C. Record Retention
Professionalism
VI. Conflicts of Interest
A. Knowledge of the Law
A. Disclosure of Conflicts
B. Independence & Objectivity
B. Priority of Transactions
C. Misrepresentation
C. Referral Fees
D. Misconduct
VII. Responsibilities as a CFA Institute Member or Candidate
Integrity of Capital Markets
D. Conduct as Members & Candidates in CFA program
A. Material Non-Public Information
E. Reference to CFA Institute, designation & program
B. Market Manipulation
Standards of Professional Conduct

I.
II.
CFA Code
of Ethics
12/4/2013
7:25 PM
Page 33
3: Financial regulation
Topic List
Regulatory framework
FCA high level standards
Exchanges & markets
FCA business standards
Supervision & redress
Financial crime
The Financial Services Act 2012 (FSA 2012) amended

the Financial Services and Markets Act 2000 (FSMA
2000) to reform the system of regulation of the UK
financial services industry.
Re-structuring of the UK regulatory framework with effect
from 1 April 2013 has seen the establishment of the PRA
and the FCA as twin regulators, to replace the FSA.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 34
FCA business
standards
Supervision &
redress
Financial crime
European regulatory framework
Home State/ host State
The aims of the EUs Financial Services Action Plan

(FSAP) have been to create a single wholesale market,
an open and secure retail financial services market, and
state-of-the-art prudential rules and regulation. Various
EU Directives have been issued to further these aims.
For a passporting firm (home-State authorised):

Organisational matters regulated by the home
State: eg authorisation, fitness & propriety,
capital adequacy, Principles for Businesses,
senior management arrangements, systems &
controls, client assets, conflicts of interest,
personal account dealing, transaction reporting
& transparency, compensation
Operational matters, eg conduct of business
rules that are not organisational matters,
regulated by:
The host State, for activities of a branch
within its territory
The home State, for cross-border
services
Passporting
Passporting (under MiFID rules) enables firms to use
their domestic authorisation to operate not only in their
home state, but also in other host states within the
European Economic Area (EEA) (EU + Norway, Iceland
& Liechtenstein).
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Page 35
Exchanges &
markets
Role of ESMA
FCA business
standards
Supervision &
redress
Financial crime
MiFID
European Securities & Markets Authority:
The Markets in Financial Instruments Directive:

Part of the FSAP, implemented November 2007
Applies to all investment firms, eg investment &

retail banks, brokers, asset managers, securities &
futures firms, securities issuers & hedge funds
1 of 3 European Supervisory Authorities

To ensure integrity, transparency, efficiency, orderly
functioning of securities markets, and
Enhance consistent EU-wide investor protection.
Works on laws to develop single EU rulebook,
promoting equal competition, limiting regulatory
arbitrage
Standard setting, promoting international
supervisory co-operation
With ESRB, identifies & advises on systemic risks:
short-, medium- and long-term
Would co-ordinate emergency crisis measures
Able to prohibit products that threaten stability
Page 35
Instruments covered by MiFID

Transferable securities, eg shares & bonds

Money market instruments
Units in collective investment undertakings
Derivatives of various types
Financial contracts for differences (CFDs)
Regulatory
framework
Scope of MiFID
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 36
FCA business
standards
Financial crime
MiFID applies to core investment services and activities of:

Investment firms (which are also regulated for non-core ancillary services)
Credit institutions including UK banks & building societies, for activities in MiFIDs scope
Ancillary services
Investment services and activities

Supervision &
redress
Receiving & transmitting orders

Execution of orders on behalf of clients
Dealing on own account
Discretionary portfolio management
Investment advice
Underwriting financial instruments
Placing financial instruments
Operating MTF

Safekeeping & administration of financial

instruments
Credit / loans to an investor in a transaction
involving the firm
Advice on capital structure, industrial
strategy, mergers & acquisitions
Currency services connected with
investments
Investment research & financial analysis
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 37
FCA business
standards
Supervision &
redress
Financial crime
UCITS Directives
EMIR European Market Infrastructure Regulation
Undertakings for Collective Investment in

Transferable Securities (UCITS) collective investment
schemes (CISs) that can be marketed across the EEA.
CIS must comply with marketing rules of host State &
documentation requirements of Directive.
EMIR sets standards for OTC derivatives, central

counterparties (CCPs) & trade repositories:
Reporting obligations for OTC derivatives
Obligations for eligible OTC derivatives to be
cleared through CCPs
New risk mitigation requirements for all OTC
derivative trades that are not centrally cleared
Common rules for CCPs and for trade repositories
Rules on the establishment of interoperability
between CCPs
Under EMIR, all standardised OTC derivative contracts
should be traded on exchanges or electronic trading
platforms, where appropriate, and cleared through
CCPs.
Permitted UCITS investments

Transferable securities
Money market instruments
Forward contracts & financial derivatives
Deposits
Units in other CISs
[Not permitted: Commodity derivatives]
Page 37
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 38
FCA business
standards
Supervision &
redress
Financial crime
The UK regulatory structure

The Financial Services and Markets Act 2000
(FSMA 2000) is amended by the Financial Services
Act 2012 (FSA 2012), which established:
The independent Financial Policy Committee
(FPC) at the Bank of England (BoE), and
The Prudential Regulation Authority (PRA) a
subsidiary of the BoE
The Financial Services Authority (FSA) legal entity
became the Financial Conduct Authority (FCA).
The BoE became supervisor of financial market
infrastructure providers: regulated clearing houses
(RCHs), payment systems & securities settlement
systems.
PRA & FCA

The late 2000s financial crisis brought into focus
problems of financial instability affecting some banks
and other financial sector institutions.
In 2013, the UK's single-regulator system (under the
old FSA) was abolished.
The PRA was established to oversee the stability

of 'prudentially significant' firms.
Regulation of conduct across the sector,
including retail consumer advice, became the
responsibility of the new FCA.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 39
FCA business
standards
Twin peaks regulation: since 1 April 2013

Prudential Regulation Authority
Bank of England
PRA is a BoE subsidiary.
Objective: to promote safety
and soundness of firms
Prudential regulator of banks,
larger firms (Dual-regulated)
Makes prudential rules
Recovery & resolution plans
Authorisations, permissions,
supervision, enforcement
The twin peaks are Prudential &
Conduct regulation. Note the dual
regulation of banks & other large
Prudentially Significant Firms.
Page 39
Role to protect & enhance stability

of UK financial system, working with
other bodies.
Prudential regulator of
clearing houses, and settlement
& payment systems
Special Resolution Unit to
resolve failing banks
The Banks Financial Policy
Committee monitors stability &
resilience, risk and advises /
directs PRA & FCA as
appropriate
Supervision &
redress
Financial crime
Financial Conduct Authority

FCA is independent company.
Objective: ensuring that the

relevant markets function well
Oversees FOS, FSCS, Money
Advice Service
Conduct regulator of banks,
larger firms (Dual-regulated)
Conduct & prudential
regulator of smaller firms and
providers
Powers over criminal market
abuse
Acts as UK Listing Authority
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 40
FCA business
standards
Supervision &
redress
Financial crime
HM Treasury
The Minister with overall responsibility for the Treasury, the Chancellor of the Exchequer, is ultimately responsible
for the regulatory system for financial services under FSMA 2000.
HM Treasury, to which the FCA is accountable, will judge the regulator against the requirements laid down in FSMA
2000 which includes a requirement to ensure that the burdens imposed on the regulated community are
proportionate to the benefits it will provide.
Accountability of the FCA to HM Treasury
HM Treasury has the power to appoint or to dismiss the Board and Chairman of the FCA.
HM Treasury requires that the FCA submit an annual report covering such matters as the discharge of its
functions and the extent to which the regulatory objectives have been met.
HM Treasury also has powers to commission and publish an independent review of the economy, efficiency and
effectiveness of the FCA's use of resources and to commission official enquiries into serious regulatory failures.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 41
FCA business
standards
Supervision &
redress
Financial crime
Financial Policy Committee (FPC)

The FPC includes the FCA Chief Executive and representatives from HM Treasury. The FPC will also have some
external representation and will meet four times annually and at times of crisis.
S9C Bank of England Act 1998 (as amended by FSA 2012) provides for the FPC to exercise its functions with a
view to:
Contributing to the achievement of the BoEs Financial Stability Objective (to protect and enhance the stability
of the financial system of the UK), and
Subject to that, supporting the economic policy of the Government, including its objectives for growth and
employment.
The FPC will seek to identify, monitor, and remove or reduce, systemic risks, including:
Systemic risks due to structural features of financial markets, eg connections between financial institutions
Systemic risks attributable to the distribution of risk within the financial sector, and
Unsustainable levels of leverage, debt or credit growth.
Page 41
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Office of Fair Trading

Investigates if combined entity > 25% market share
or targets UK turnover > 70m
Refers matter to CC if substantial lessening of
competition
Will report to FCA/PRA, HMT and CC if it believes
that regulatory rules adversely impact competition
Competition Commission
Ultimate power to block a takeover and fine for
failure to comply with requests
May take up to 24 weeks to investigate
Appeals to rejection of the bid can be made to the
Competition Appeal Tribunal
Page 42
FCA business
standards
Supervision &
redress
Financial crime
Statutory merger control

Office of Fair Trading
Looks at current takeovers/mergers
to ascertain if there has been a
substantial lessening of competition
May clear (ie, bid can go ahead) or
refer the bid to CC
Competition Commission
CC investigates bid & recommends
whether there has been substantial
lessening of competition
Bid is blocked
Bid is cleared
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Takeover Panel
The Takeover Panel administers the Takeover
Code (City Code). The Panel:
Regulates offers for shares in public

companies
Is funded by a levy on share transactions
Department for Business, Innovation & Skills

The Governments Department for Business,
Innovation & Skills (BIS) is responsible inter
alia for business regulation, company law &
consumer affairs.
Page 43
Page 43
FCA business
standards
Supervision &
redress
Financial crime
City Code has statutory effect, under Companies Act 2006

Equal treatment for all shareholders of a particular
class
Reasonable period for bid to be considered
Reduces defensive measures by target company
Mandatory bid if shareholder acquires =/> 30% voting
rights
Minimum offer price = highest price paid to acquire
shares in last 12 months
Offer must remain open for =/> 21 days
If =/> 90% acceptances, can compulsorily purchase
remaining 10%
Directors of target company should not deny
shareholders opportunity to consider bid
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 44
FCA business
standards
Supervision &
redress
Financial crime
Data Protection Act 1998
Data Protection Register
Regulates the use of all personal data, placing

obligations on the organisation, which may be taken to
Court for a breach.
The DPA 1998 requires persons who process

personal data to register (unless exempt) with
the Information Commissioner (who maintains
a public registry of data controllers).
Eight DPA 1998 Principles personal data must be:

1: Processed lawfully and fairly
The organisation must have
2: Obtained only for specific and lawful purposes
a data protection policy.
3: Adequate, relevant and not excessive
4: Accurate and kept updated
5: Not kept longer than necessary
6: Processed in accordance with data subjects wishes
7: Protected against unauthorised or unlawful access, and damage
8: Not transferred outside the EEA unless to a territory with adequate data protections
Recording sensitive personal data requires explicit consent.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
General prohibition
FSMA 2000 establishes the authorisation of firms to
carry out regulated activities and the general
prohibition: no person may carry on a regulated activity
in the UK, unless they are either authorised or exempt.
Sanctions may be civil and/or criminal.
Civil sanctions:
Contracts voidable
Compensation/damages
Restitution Orders
Regulator may seek injunctions
Criminal sanctions:
6 month sentence and/or 5,000 fine
2 year sentence and/or unlimited fine
Page 45
Page 45
FCA business
standards
Supervision &
redress
Financial crime
FCA or PRA authorisation?

Firm will apply to either FCA or PRA, depending on
firm type.
Dual-regulated firms (banks & building societies,

credit unions, insurers & some investment firms)
are authorised by PRA but only with FCA
approval. In the process, FCA will focus on
conduct issues, while PRA will focus on a firms
financial soundness.
FCA-only regulated firms (including independent

financial advisers, investment exchanges,
insurance brokers & fund managers) are
authorised by FCA.
Passporting under MiFID is another authorisation

route.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Is authorisation required?
1
Are regulated activities to be

undertaken?
Covered by exceptions?
Covered by exemptions?
Page 46
FCA business
standards
Supervision &
redress
Financial crime
Exceptions

Dealing as principal (for yourself)

Newspapers/media (but not tipsheets)
Acting as an unremunerated trustee
Employee share schemes
Certain overseas persons, for UK business
Passported EEA firms are authorised in their home State

Exempt persons
Authorisation by FCA/PRA gives

permission (Part 4A, FSMA 2000) to
carry out regulated activities by way
of business relating to specified
investments.
Appointed (tied) representatives

RIEs, ROIEs, RCHs, Lloyds members, Bank of England,
National Savings & Investments, local government authorities
Certain professions, eg lawyers, accountants, actuaries, for
non-mainstream investment business (regulated by DPBs)
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 47
FCA business
standards
Establishing/operating collective investment

schemes, stakeholder pension schemes

Safekeeping/administering investments
Lloyds insurance business
Carrying out contracts of insurance
Accepting deposits
Regulated mortgage business
Operating a Multilateral Trading Facility (MTF)
Page 47
Financial crime
Specified investments
Regulated activities
Including:
Dealing in, arranging deals in, managing,
advising on investments
Supervision &
redress
Including:
Deposits and electronic money
Contracts of insurance
Shares, warrants, ADRs etc
Debentures, loan stock, and govt/local authority
securities

Units in collective investment schemes

Options, futures, contracts for differences
Lloyds syndicates
Regulated mortgages
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 48
FCA business
standards
Supervision &
redress
Financial crime
Excluded activities
The following activities are specifically excluded from the requirement for authorisation.
Dealing as principal where the person is not holding themselves out to the market as willing to deal. The requirement
to seek authorisation does not apply to the personal dealings of unauthorised individuals for their own account
Trustees, nominees and personal representatives, if they do not hold themselves out to the general public as
providing the service and are not separately remunerated for the regulated activity, are excluded from the authorisation
requirement
Employee share schemes. This exclusion applies to activities which further an employee share scheme
Media, eg TV, radio and newspapers. Authorisation is not required if investment advice is not the primary purpose of
the publication.
'Tip sheets' (written recommendations of investments) will however require authorisation
Overseas persons firms which do not carry on regulated activity from a permanent place within the UK. This
exclusion covers: first, where the activity requires the direct involvement of an authorised or exempt firm; and, second,
where the activity is carried on as a result of an unsolicited approach by a UK individual. Thus, if a UK individual asks
a fund manager in Tokyo to buy a portfolio of Asian equities for them, the Japanese firm does not need to be
authorised under FSMA 2000
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 49
FCA business
standards
Supervision &
redress
Financial crime
SYSC in FCA/PRA Handbooks
Whistleblowing
Principle for Businesses 3: A firm must take reasonable

care to organise its affairs responsibly & effectively, with
adequate risk management systems. SYSC requires firms to
maintain Senior management arrangements, SYstems and
Controls: a common platform of requirements for almost all
regulated firms.
Whistleblowers are protected by the Public

Interest Disclosure Act 1998 if:
A response from their firm was lacking, or they
felt unable to raise the matter internally
They reasonably believe matters raised to be
substantially true
SYSC common platform

Business structure & contingency planning

Training, competence & expertise
Compliance, internal audit & financial crime
Risk control
Outsourcing
Record keeping (5 years min., for MiFID business)
Conflicts of interest
Page 49
Whistleblowing provisions are detailed in SYSC.

Contracts must not prevent employee blowing the
whistle: the legislation protects whistleblowing
employees from unfair dismissal.
Employees concerned about something may
contact the regulator.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 50
FCA business
standards
Supervision &
redress
Financial crime
Trustee Act 2000
Pensions Act 2004
Does the trust deed offer investment

guidance?
Pensions Regulator regulatory body for work-based UK pensions:
Adopts pro-active, risk-focused approach
Has powers to intervene in scheme affairs
Yes
Follow the deed
No
Follow TA 2000
Trustee Act
2000
A statutory duty of skill and care

Functions may be delegated
Invest in any asset except land
overseas
Keep investments under review
Work-based pension schemes may be defined

benefit (DB) or defined contribution (DC).
Occupational (work-based) schemes:

Must have member-nominated trustees (except one-member schemes)

Must have adequate liquidity
Pensions Protection Fund for where an employer running a scheme
becomes insolvent & unable to pay liabilities
PPF provides compensation up to 100% of benefits to existing
pensioners and 90% to those not yet retired, funded by charges on
other DB pension schemes
Trustees Statement of Investment Principles (SIP) gives members
information about investment of pension schemes funds & investment
returns received
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Page 51
Exchanges &
markets
FCA business
standards
Supervision &
redress
Financial crime
Financial Conduct Authority objectives

The FCA has a single statutory strategic objective
(s1B(2) FSMA 2000) of:
The relevant markets are:

The financial markets
Markets for regulated financial services, and
The markets for services that are provided by nonauthorised persons in carrying on regulated
activities without contravening the general
prohibition
Ensuring that the relevant markets function well.
FCA also has 3 supporting operational objectives:

Consumer protection objective: securing an

appropriate degree of protection for consumers
Integrity objective: protecting and enhancing the
integrity of the UK financial system
Competition objective: promoting effective
competition in the interests of consumers in the
market for regulated financial services and for
services provided by a recognised investment
exchange
Page 51
The regulator aims to ensure that firms put consumers

at the heart of their business. The FCAs duties to promote competition may involve analysing pricing.
The FCA also has duties to address financial crime
(broadly, following the existing approach to tackling such
crime).
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 52
FCA business
standards
Supervision &
redress
Financial crime
FCA Handbook
High Level Standards
Principles for Businesses (PRIN)
Training & Competence (TC)
Statements of Principle & Code of Practice for
Approved Persons (APER)
Business Standards
Conduct of Business Sourcebooks (including COBS)
Client Assets (CASS)
Market Conduct (MAR)
Threshold Conditions (COND)

Senior Management Arrangements, Systems &
Controls (SYSC)
Financial Stability and Market Confidence (FINMAR)
Regulatory Processes
Decision Procedures &
Penalties Manual (DEPP)
Supervision (SUP)
Redress
Dispute Resolution: Complaints
(DISP)
Compensation (COMP)
Fit & Proper Test for Approved Persons (FIT)

Listing, Prospectus and Disclosure
Prudential Standards
Prudential Sourcebooks for different types of firm
Listing rules (LR)

Prospectus Rules (PR)
Disclosure Rules & Transparency Rules (DTR)
Specialist Sourcebooks
Cover certain specialised sectors of the industry
Regulatory
framework
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FCA high level

standards
7:25 PM
Exchanges &
markets
Page 53
FCA business
standards
Supervision &
redress
Financial crime
The Principles for Businesses

A firm must:
1
2
3
Conduct its business with integrity

Conduct its business with due skill, care and diligence
Take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk
management systems (management and control)
4 Maintain adequate financial resources (financial prudence)
Treating Customers Fairly is
5 Observe proper standards of market conduct
an important regulatory theme.
6 Pay due regard to customers interests & treat them fairly
7 Pay due regard to information needs of clients: communications with clients must be clear, fair, not
misleading
8 Manage conflicts of interest fairly
9 Take reasonable care to ensure suitability of advice and discretionary decisions (customers:
relationships of trust)
10 Arrange adequate protection for clients assets
11 Deal with regulators openly & cooperatively, making appropriate disclosures (relations with regulators)
Page 53
Regulatory
framework
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FCA high level

standards
7:25 PM
Exchanges &
markets
Page 54
FCA business
standards
Supervision &
redress
Financial crime
Scope of the Principles
Principles-based regulation
Some principles (eg, 10) refer to clients, while others

(eg, 9) refer to customers.
This is regulation that is focused on the over-arching

Principles, which firms must then apply. The
regulators focus is not so much on the principles
themselves, but on the actual outcomes and
consequences of what firms do. Since the financial
crisis, there has also been a shift to a more
intrusive style of regulation.
'Client' includes everyone from the smallest retail

customer through to the largest investment firm
(eligible counterparties, professional customers &
retail customers).
'Customer' includes professional and retail clients but
excludes eligible counterparties. Principles 6, 8 and 9,
& parts of Principle 7, apply only to customers.
Principle 3 would not be considered breached if the
firm failed to prevent unforeseeable risks.
Breaches of the Principles, and of rules

Breaching a Principle makes the firm liable to
enforcement or disciplinary sanctions. A private
person who suffers a loss from a rule breach may sue
under s150 FSMA 2000, but not in respect of breach
of a Principle.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 55
FCA business
standards
Supervision &
redress
Financial crime
Approved persons
Section 59 FSMA 2000
says that a person (that is a member of staff at an authorised firm) cannot carry out a controlled function in a firm unless the
individual has been approved by the appropriate regulator
If a person carries out a controlled function but they not approved, this is a
breach of statutory duty
Where such a breach of statutory duty occurs, a private person has the right to sue the
firm for damages if they have suffered loss, using s71 FSMA 2000
Page 55
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
FCA business
standards
For all approved persons:
2
3
4
An approved person must act with integrity in carrying out

his accountable (ie, regulated) functions

And with due skill, care and diligence

Must observe proper standards of market conduct
Supervision &
redress
Financial crime
Code of Practice
Examples of non-compliance
Statements of Principles
Page 56
Must deal with regulators openly and co-operatively

Senior management only:
5 Must take reasonable steps to ensure business is
organised so it can be controlled effectively
6 Exercise due skill, care and diligence in managing the
business
7 Take reasonable steps to ensure compliance by business
with regulatory requirements
Misleading or attempting to mislead

customer/firm/regulator, eg about risks of
investment or by falsifying documents
Failing to give information to
customer/firm/auditor/actuary when you
know/should have known it should be
provided, eg failing to disclose charges or
surrender penalties
Market abuse, eg trading on insider
information, trading to distort the market,
spreading false stories (FCA can impose
unlimited fines under s123 FSMA 2000)
Failure to report matters through internal
reporting procedures
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 57
FCA business
standards
Supervision &
redress
Financial crime
Threshold conditions (for attaining Part 4A permission)

Before it grants permission under FSMA Part 4A (formerly Part IV), the regulator must be satisfied that the firm meets and
continue to satisfy the 'threshold conditions' for the activity concerned in order to be deemed fit and proper.
General threshold conditions
One condition relates to the location of the offices of the applicant. If the applicant is a UK company, its head and
registered offices must be located in the UK. For an applicant that is not a company, if it has its head office in the UK,
then it must carry on business in the UK.
Firms will need to ensure that no impediment to their effective supervision arises from: the nature and complexity of
regulated activities undertaken, products offered, and the business organisation. This condition also covers the effect
of close links of the applicant with other entities, eg other members of the same group, and whether these have an
effect on effective supervision by the regulator.
An applicant for FCA authorisation must have adequate resources for the activities they seek to undertake. Such
resources would not only include capital, but also nonfinancial resources such as personnel
Another threshold condition relates to the suitability of the applicant. The firm must be considered to be 'fit and
proper', ie it must have integrity, be competent and have appropriate procedures in place to comply with regulations.
The management and staff of the firm must also be competent.
Page 57
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 58
FCA business
standards
Supervision &
redress
Financial crime
Threshold conditions (for attaining Part 4A permission)

FCAs Business Model Threshold Condition
The FCA will apply the Business Model Threshold Condition, which refers to the risk that might be posed for a firm, for
its customers and for the integrity of the UK financial system. The FCA has stated that this new threshold condition
demonstrates the importance that the FCA will place on a firms ability to put forward an appropriate, viable and
sustainable business model, given the nature and scale of business it intends to carry out. The regulator will expect
firms to demonstrate adequate contingency planning in their business models. Firms will be expected to make clear
how their business model meets the needs of clients and customers, not placing them at undue risk, or placing at risk
the integrity of the wider UK financial services industry.
PRAs Business to be Conducted in a Prudent Manner Threshold Condition

The PRAs Business to be Conducted in a Prudent Manner Threshold Condition is closely equivalent to the FCAs
appropriate resources and business model conditions, which we have described above. PRA-authorised firms must
hold appropriate financial and non-financial resources. Appropriate resources are evaluated by reference to complexity
of activities, the liabilities of the firm, effective management, and the ability to reduce risks to the safety and
soundness of the firm.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 59
FCA business
standards
Supervision &
redress
Financial crime
Individuals carrying out controlled functions must have regulatory approval as fit and proper persons.
Fit and proper assessment
Controlled functions
Governing functions (eg directors)
Required functions (eg Money Laundering
Reporting Officer)
Systems and control functions (eg senior
internal audit staff)
Honesty
Integrity
Reputation
Employment record
Criminal record
Competence
Capability
Experience
Training and exams
Financial
soundness
Court judgements?
Bankruptcy?
Significant management function (eg heads

of divisions in larger firms)
Customer functions, including:
Investment advice
Customer trading and investment
management

Page 59
Covers most personnel advising customers
In dual-regulated firms, significant influence functions (ie,

excluding customer functions) are divided between PRA and
FCA.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Training and competence
Page 60
FCA business
standards
For roles involving private

customers (eg investment
advice):
Take account of individuals
knowledge and skill
Find out about individuals
previous relevant activities
and training
Financial crime
FCAs T&C Sourcebook covers the retail sector.
Firm to determine training needs,

and organise, monitor & record
appropriate training
Recruitment
Supervision &
redress

Training
Appropriate examinations
Exams and supervision

Attaining
competence
Maintaining
competence
Continuing Professional
Development (CPD)
Required for advising retail clients, eg on retail investment products,

securities & derivatives & for some specialist roles (eg: advice on
mortgages, equity release, long-term care insurance, pensions
transfers).
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Page 61
Exchanges &
markets
FCA business
standards
Rules on training and competence

The firms commitment to training & competence
should be that employees:

Are competent
Remain competent
Are appropriately supervised
Have competence reviewed regularly
Have levels of competence appropriate to the
business
Retail advisers must complete 35 hours of

verifiable CPD annually, of which 21 hours must be
structured (ie, with a defined learning outcome).
Page 61
Supervision &
redress
Financial crime
The competent employees rule is the main FCA

Handbook requirement on employee competence,
and applies to both MiFID and non-MiFID firms:
Firms must employ personnel with the skills,
knowledge and expertise necessary for the
discharge of the responsibilities allocated to them.
Professionalism requirements
Retail investment advisers (RIAs) need to hold a

Statement of Professional Standing (SPS) issued
by an accredited body to give independent advice
or restricted advice. The SPS shows customers that
the RIA subscribes to a Code of Ethics, is qualified,
and has up-to-date knowledge.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Page 62
Exchanges &
markets
FCA business
standards
Supervision &
redress
Financial crime
Recognised Investment Exchanges (RIEs) (but not their

members) are exempt from regulatory authorisation.
Recognised Overseas Investment Exchanges (ROIEs) operate in

the UK without FCA authorisation. ROIEs:
RIEs: ICE Futures Europe LIFFE

London Stock Exchange
ISDX London Metal Exchange
Australian Securities Exchange Ltd CBOT Eurex

ICE Futures U.S., Inc NASDAQ NYMEX NYSE
Liffe US SIX Swiss Exchange AG Chicago Mercantile
Exchange
RIE requirements cover: Financial resources,

Suitability, Systems & controls, Investor
safeguards, Issuer disclosures, Complaints
arrangements, Discipline, Member default.
RIEs
ROIEs
RCHs
DIEs
Recognised Clearing Houses (RCHs) may perform clearing

and settlement for an exchange.
RCHs: CME Clearing Europe Ltd Euroclear UK &
Ireland European Central Counterparty Ltd ICE
Clear Europe Limited
Designated Investment Exchange (DIE) status

of overseas exchanges gives some assurance
about local regulation but does not exempt from
UK authorisation.
RCHs, along with recognised payments systems &

securities settlement systems (collectively Financial
Market Infrastructures (FMIs)) are supervised by the BoE.
Regulatory
framework
12/4/2013
FCA high level

standards
A contract for differences (CfD), a

future or an option. (FCA definition)
UK derivatives markets members are

regulated under FSMA 2000.
MiFID applies to firms carrying out activities in
relation to various derivative instruments
Financial and commodity derivatives
Derivatives relating to credit risk
Financial CfDs
Derivatives relating to climate, freight,
carbon emissions, inflation & other
economic statistics
Page 63
Page 63
FCA business
standards
Exchanges &
markets
Derivative
UK
7:25 PM
Supervision &
redress
Financial crime
IAS 39 states: (non-hedge) derivatives must be recorded in

balance sheet at fair value.
Changes in fair value (ie, gains or losses) can be

recognised in the income statement
For derivatives used as a hedge, gains and losses are

recognised in reserves
EMIR standards for OTC derivatives covered in Chapter 1.
USA
(Main law: Commodity Futures Modernization Act 2000)
In the USA, there are two key regulatory bodies:

Securities and Exchange Commission (SEC)

regulates derivatives on securities
Commodity Futures Trading Commissions (CFTC)

regulates derivatives on commodities
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 64
FCA business
standards
Supervision &
redress
Financial crime
LCH.Clearnet
LCH.Clearnet:
Acts as guarantor in the derivatives market,
honouring contracts in the event of a party
defaulting
Formerly, London Clearing House
Owned by exchanges and their members
Is central counterparty for all trades
(novation)
Administers all margin cash flows
Registers all matched trades for the market
Initial margin

Returnable good faith deposit paid on

opening positions
Based on maximum probable one-day loss
Variation margin

Cash settlement of daily profits or losses

based on closing price of each day
Paid to or received from LCH.Clearnet the
following morning
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 65
FCA business
standards
Supervision &
redress
Financial crime
Central Counterparty novation

Short seller to every buyer
LCH.Clearnet
Long buyer to every seller
Trade
Long oil @ $80
Novation
Short oil @ $80
Novation eliminates counterparty risk
Page 65
Regulatory
framework
12/4/2013
FCA high level

standards
Where? Activities in UK, and

business brought into UK
Exchanges &
markets
Page 66
FCA business
standards
Who? All authorised firms, but not

professional firms in respect of nonmainstream regulated activities
Supervision &
redress
Financial crime
Firms should ensure that

inducements do not conflict with
duty to customers

Communications by
electronic media
count as written
communication
7:25 PM
Exclusion of liability
COBS

Communication must be clear, fair
and not misleading (Principle 7)

Advising on investments
Dealing in investments

What? Generally, designated
investment business
Firm may not exclude its duties or

liabilities to customers under FSMA
2000 or the regulatory system
ie
Customers cannot sign away their
rights under COBS
Designated investment business covers includes various regulated

activities but excludes deposits, mortgages nor non-savings insurance
contracts.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 67
FCA business
standards
Supervision &
redress
Financial crime
Client
Customer
Eligible counterparty*
Per se
Elective
Elect
*Only for
eligible counterparty business:
Receipt & transmission of orders
Execution of orders
Dealing on own account
Page 67
Professional
client
Retail
client
Authorised firms
Large undertakings
Elective
professional clients
Individuals
Elect
Small
businesses
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Client classifications
Page 68
FCA business
standards
Supervision &
redress
Financial crime
Clients can opt up or down.

Professional clients
(eg large businesses, experts)
Retail clients
(eg individuals, small businesses)
Eligible counterparties
(eg government, other firms)
COBS applies
More protection
Firms must notify clients of:
Categorisation
Rights to request a different categorisation
Resulting limitations to client protection
Retail clients
A retail client is any client who is not a
professional client or an eligible
counterparty.
More knowledge/size
Client agreements
If a firm carries on designated investment business,
other than advising on investments, for a new retail
client (eg, a discretionary investment management
service), the firm must enter into a basic agreement
with the client.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 69
FCA business
standards
Supervision &
redress
Financial crime
For MiFID Business
An entity requiring authorisation or regulation to

operate in financial markets, whether authorised in
the EEA of by a third country
A large undertaking meeting conditions:
2 out of three of:

20m balance sheet total
40m net turnover
2m own funds
Per se Eligible counterparties
Non-MiFID Business
Per se Professional clients
Insurance company, investment firm or credit

institution
UCITS CIS or its management company
Pension fund or its management company
Another EEA-authorised financial institution
National government, central bank or
supranational organisation
Page 69
5m called-up share capital or net

assets,
or 2 out of 3 of:
12.5m balance sheet total

25m net turnover
250 average employees in year
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Page 70
Exchanges &
markets
Elective Professional clients
FCA business
standards
Firm carries out a qualitative test:

& for MiFID business a quantitative test:
Firm gives a clear written warning of

protections & investor compensation
rights lost
Client states separately in writing that

they are aware of consequences
Client makes requests in writing
Financial crime
Qualitative test
Firm undertakes assessment of clients knowledge,

expertise and experience.
Assessment gives firm reasonable assurance that client is
capable of making their own investment decisions &
understanding risks.
To treat a retail client as an elective

professional client:
Supervision &
redress
Quantitative test for MiFID business
At least 2 of the following 3 must be satisfied:

Client has traded, in significant size, on relevant market at
average 10 times per quarter over previous 4 quarters
Financial instrument portfolio > 500,000
Client works/has worked in financial sector for at least 1
year in professional position requiring knowledge of
transactions/services
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Financial promotion (FP)

An invitation or inducement to engage in investment
activity communicated in the course of business
(s21(1), FSMA 2000).
Means of communicating FPs:
Product brochures, mailshots
General advertising
Telemarketing
Written correspondence
Sales aids, presentations
Tip sheets
Other publications containing non-personal
recommendations
Page 71
Page 71
FCA business
standards
Supervision &
redress
Financial crime
There is a general prohibition on FPs (s21, FSMA

2000) unless issued or approved by an authorised
person.
Exemptions/exclusions
Qualifying credit
Home purchase plans & home reversion
schemes
Personal quotations & illustrations
One-off communication that is not a cold call
Generic promotions (eg, of Investment Trusts)
Communications to investment professionals
Overseas recipients
Deposits & insurance
Certified high net worth individuals
Sophisticated investors
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Financial promotions
Page 72
FCA business
standards
Supervision &
redress
Financial crime
Fair, clear and not misleading
A firm must ensure that a communication or FP is:
Fair, clear & not misleading,

Appropriate & proportionate
Considering the means of communication & the
information to be conveyed.
FP addressed to a retail client & falling within the

rules must be clearly identifiable as FP.
The FCAs rules are:
media-neutral (print/fax/email/internet/phone etc)
mainly directed at regulated activities
Guidance
A firm should ensure:
It is clear if a clients capital is at risk
Any yield figure quoted gives a balanced
impression of short/long term prospects
Complex charging structures are explained
The regulator is named
A clear impression is given of any third party
packaged/ stakeholder product provider
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 73
FCA business
standards
Supervision &
redress
Financial crime
Unwritten promotions and cold calling

Someone making an unwritten FP outside the firm's premises must:
Do so at an appropriate time of day
Identify self & firm, and make his purpose clear
Clarify if client wants to continue or terminate communication, and terminate on request
If appointment is arranged, gives a contact point
Direct offer financial promotions

A direct offer FP is a FP:
Containing an offer or invitation
Which enables investors to purchase investments
directly 'off the page'
Without receiving further information.
The promotion must include relevant disclosures for
the product.
Page 73
Firms may only make cold (unsolicited) calls:

To a client having established relationship with the
firm justifying such calls, or
About a generally marketed packaged product (not
based on a high volatility fund), or
Relating to controlled activities by an authorised
person or exempt person, involving only readily
realisable securities (not warrants)
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 74
FCA business
standards
Controls & approvals
Supervision &
redress
Financial crime
Communicating with retail clients
SYSC requires that a firm communicating or approving FP

has systems & controls or policies & procedures.
Requirements:
Approval of FP by an authorised firm enables it to be

communicated by an unauthorised firm.
Understandable by target group

Fair & prominent indication of relevant
risks
Firm approving FP must confirm that it complies with

the FP rules.
Promotion made during a personal visit, phone
conversation or other interactive dialogue cannot be
approved.
Firms approval may be limited, eg to communications
to professional clients or eligible counterparties.
In communicating FP, firm can rely on another firms
confirmation of compliance. FP should only be
communicated to types of recipients for whom intended.
Key items not disguised, diminished,

obscured
Must include name of firm
Investment comparisons should specify
sources, key facts, assumptions
Firm should consider if omissions will
make information insufficient, unclear,
unfair or misleading
Regulatory
framework
12/4/2013
FCA high level

standards
Exchanges &
markets
Record keeping
Records of FPs must be kept:
Indefinitely for pension transfers
6 years for life policies & most pension
schemes
5 years for MiFID business
Three years in other cases
Distance contracts
Firms must give clear information before a
contract is concluded, including:
Identity & address of supplier
Product details (incl. price & fees)
Contract details (incl. cancellation rights)
Page 75
7:25 PM
Page 75
FCA business
standards
Supervision &
redress
Financial crime
Financial Promotions Power

FCA has power (under FSA 2012) to ban misleading
financial promotions.
The regulator can give (and publish) a direction to
firms requiring them immediately to withdraw or to
modify promotions which it deems to be misleading.
The firm will be able to make representations to the
FCA to challenge its decision. The FCA may then
amend or revoke its decision, or confirm its original
decision.
The FCA can then publish: (1) Its direction, (2) A copy
of the promotion, and (3) The regulator's reasons for
banning it. The FCA may publish details even if it has
decided to revoke its decision.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 76
Supervision &
redress
FCA business
standards
Financial crime
Past, simulated past and future information

Past performance information
Simulated past performance

information
Past performance information should:
Simulated past performance information
Not normally be the most prominent must:
feature of the communication
Relate to an investment or a
Include appropriate information
financial index
covering at least the five preceding
Be based on actual past
years, or the whole period
performance of investments/indices
Be based on and must show
which are the same as, or underlie,
complete 12-month periods
the investment concerned
State the reference period and
Contain a prominent warning that
source of the information
figures refer to simulated past
performance and that past
the figures refer to the past
performance is not a reliable
If denominated in a foreign currency,
indicator of future performance
state the currency clearly
If based on gross performance,
disclose the effect of commissions
Future performance information

Future performance information must:

Not be based on nor refer to

simulated past performance
Be based on reasonable
assumptions supported by objective
data
If based on gross performance,
disclose the effect of commissions,
fees or other charges
such forecasts are not a reliable
indicator of future performance
Only be provided if objective data
can be obtained
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 77
FCA business
standards
Supervision &
redress
Financial crime
Ethical implications of misleading communications

The pressure for short-term gain in a firm could encourage the use of a misleading financial
promotion.
This could have undesirable longer-term ethical and professional consequences:
When the misleading nature of the promotion comes to light, it may be that customers have
lost money, while others may feel cheated. Many may feel aggrieved. Consumers may have
diminished financial prospects and may view the firm unfavourably
Consumers coming to know about the firms actions, as well as those directly affected, may
come to view the firm as unethical, and damage may be done to the reputation of the firm
Customers may become less loyal to the firm and the firm may find it more difficult to retain
and acquire customers
Page 77
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 78
FCA business
standards
Supervision &
redress
Financial crime
Suitability
Appropriateness (for non-advised services)
Firm recommending designated investments must

assess whether the recommendation is suitable for
the client, based on clients:
For investment services other than: personal

recommendations & managing investments.
Knowledge & experience

Investment objectives
Financial situation
Suitability report (letter) required following personal
recommendation to retail client on:
Assessing appropriateness
Client to provide information about relevant
knowledge/ experience to enable firms to assess
appropriateness.
Life policy
Stakeholder pension scheme, & some other
pensions transactions
Regulated collective investment schemes
If the product/service is not appropriate, firm must

warn the client
If there is insufficient information to assess
appropriateness, firm must notify the client
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 79
FCA business
standards
Supervision &
redress
Financial crime
Best execution
Order execution policy
The rules on best execution apply to retail &

professional clients.
Clients must give prior consent to execution policy.

Information must be given on the policy.
For each class of financial instrument, policy should include:
Information on different execution venues, &
Factors affecting the choice of venue
When executing orders, a firm must take

all reasonable steps to obtain the best
possible result for clients, taking into
account the execution factors
A firm will satisfy this rule by executing a
client order in accordance with the
specific instructions of the client
Execution factors are: price, costs, speed,
likelihood of execution and settlement, size,
nature or any other consideration relevant
to the execution of an order.
Page 79
For retail clients, the following information must be given

in advance:
Relative importance of the execution factors
List of execution venues
Warning that specific instructions may prevent firm
from following its policy to obtain the best possible
result
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 80
FCA business
standards
Supervision &
redress
Financial crime
Client order handling
Inducements
Rules cover retail & professional clients.

Procedures must provide for prompt & fair
execution of client orders
Comparable orders to be executed according to
time of receipt by the firm
A firm must act honestly, fairly and professionally in

the best interests of their client (Clients best
interests rule.)
Use of dealing commission

Investment manager must be satisfied that
goods/services purchased with commission:
Do not impair compliance with clients best
interest rule
Relate to the execution of trades, or
Comprise the provision of research
Any fee, commission or non-monetary benefit

paid to or provided by a third party must be
designed to enhance the quality of service to the
client
A firm must disclose to the client any fees,
commissions or non-monetary benefits in
summary form
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Churning and switching
Page 81
FCA business
standards
Supervision &
redress
Financial crime
Personal account dealing

Firms must have arrangements to:
Churning is prohibited: switching products in order

to make more commission or fees regardless of the
clients interests.
Customers must not be advised to switch products
unless it is in their interests.
Prevent employees engaging in market abuse

Ensure all relevant persons are aware of
restrictions
Ensure any deals are notified promptly to the firm
Ensure adequate transaction records are kept
A series of transactions that are each suitable when viewed in isolation may be unsuitable if the recommendations or the decisions to trade are made with a frequency that is not in the best interests of the client.
A firm should have regard to the client's agreed investment strategy in determining the frequency of transactions.
This would include, for example, the need to switch within or between packaged products.
Page 81
Regulatory
framework
12/4/2013
FCA high level

standards
Independent advice
7:25 PM
Exchanges &
markets
Page 82
FCA business
standards
Supervision &
redress
Financial crime
Retail investment advice rules

Restricted advice
Advice must be either independent or restricted.

If an adviser declares themselves to offer
independent advice, they will need to consider a
broader range of retail investment products (RIPs)
wider than the definition of packaged products.
Independent advice
Covers all retail investment products
Unbiased, based on comprehensive & fair
analysis of market
Advice that is not independent must be labelled as

restricted advice, for example as advice on a limited
range of products or providers.
Retail investment advisers (RIAs) are still required
to meet the regulators suitability requirements, even if
they offer restricted advice.
Restricted advice
Covers limited products or providers
Includes basic advice (stakeholder products)
Suitability requirements still apply
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Retail investment products (RIPs)
Page 83
FCA business
standards
Supervision &
redress
Financial crime
Packaged products definition
RIPs are defined to include:
Collective Investment Schemes (regulated)
Life policies
Life policies
Units/shares in collectives: ITs, UTs, OEICs
Investment trust savings schemes
IT savings scheme investments
Personal pensions
Personal and stakeholder pension schemes
Stakeholder pensions
Other packaged investments offering exposure

to underlying financial assets
Adviser charging
Structured capital-at-risk products (SCARPs)
Adviser must not take any other benefit, even to

pass on to client
Advice is paid for through an adviser charge.
Firm must account for any reasons for charges

varying materially from its charging structure
Page 83
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 84
FCA business
standards
Supervision &
redress
Financial crime
FCAs product intervention power
Referring to specialists
The FCAs product intervention power gives it the

flexibility to intervene quickly and decisively, normally
after public consultation, where it considers that a
product or product feature is likely to result in significant
consumer detriment.
If dealings with a client involve actions beyond

advisers authority (because of firms or
regulators rules), the adviser should seek
authority from an appropriate person.
The FCA may impose temporary product intervention

rules (TPIRs) for up to 12 months without the usual
consultation process, eg where:

Products involve inappropriate consumer targeting

Product access is restricted to boost firms profit
Significant consumer detriment could result
Inherently flawed products, from which consumers
unlikely to benefit
Advisers should be able and willing to refer

to other specialists within the firm.
Advisers may also need to refer to
specialists outside their business in
certain areas & should explain to client when
it would be necessary.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Investment research
Rules:
Apply to investment research which is intended/
likely to be disseminated to clients/public
Cover written & oral material
Firms must manage conflicts of interest:
No personal or firm transactions in unpublished
research until clients have had a reasonable
opportunity to act on it
No personal transactions contrary to current
recommendation
No promises of favourable research
No editorial control for subject of research
No front running of trades by firm or its
employees
Page 85
Page 85
FCA business
standards
Supervision &
redress
Financial crime
Required disclosures
Firms should take reasonable care to ensure fair
presentation of information:
Disclose identity of person responsible for
research
Disclose relationships & circumstances which
may impair objectivity
Do not tie remuneration to specific transactions
or recommendations
Fact should be distinguished from opinion,
analysis, interpretation etc
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 86
FCA business
standards
Supervision &
redress
Financial crime
Non-independent research
Conflicts of interest
Investment research is research described as investment

research or in similar terms, or is otherwise presented as
an objective or independent explanation of the matters
contained in the recommendation. Otherwise, research is
non-independent research.
Principle for Businesses 8: A firm must

manage conflicts of interest fairly, both between
itself & its customers & between a customer &
another client.
Non-independent research must:

Be clearly identified as a marketing communication
Contain a clear & prominent statement that it does
not follow the requirements of independent research
and is not subject to prohibitions on dealing ahead of
dissemination of research
Identify material conflicts that arise or may arise

between:
Firm & client
Clients
SYSC provisions:

Financial promotions (FP) rules apply to non-independent
research as if it were a marketing communication.
Organisational & administrative arrangements

Written conflicts policy
Keeping records of the conflicts
Disclosure of potential conflicts is the measure
of last resort, if conflicts cannot be managed
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 87
FCA business
standards
Supervision &
redress
Financial crime
Disclosures
From Principle 7 Communications with clients &
Principle 9 Customers: relationships of trust comes
a general obligation to disclose risks. Specific
warnings may be needed eg, for warrants,
derivatives, non-readily realisable investments.
Key Facts Document (KFD) must be given to a
retail client when providing a recommendation on a
packaged product, including:
Details on nature & complexity of the product
Complaints handling procedures
Compensation schemes
Cancellation rights
Page 87
Key Investor Information (KII)

Managers of authorised UCITS funds must prepare
short KII document, containing:
Identification of the scheme
The words key investor information
Investment objectives and policy
Past performance presentation / scenarios
Costs and charges
Investment risk/reward profile, with guidance &
risk warnings
How to get more information
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Information on client transactions

Immediately after executing a client order, an
investment firm should record key details of the
transaction.
A firm must provide promptly in a durable medium the
essential information on execution of orders to
clients in the course of designated investment business
(except where it is managing the investments ie, under
a discretionary management agreement). The
information may be sent to an agent of the client,
nominated by the client in writing.
For retail clients, a notice confirming execution (a
confirmation) must be sent as soon as possible and
no later than the first business day following receipt of
confirmation from the third party.
Page 88
FCA business
standards
Supervision &
redress
Financial crime
Cancellation rights
The consumer must be informed of a right to
cancel.
The cancellation date is the date of dispatch by
the consumer.
Life policies & pensions (including stakeholder
& personal) 30 calendar days
Other products 14 calendar days
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 89
FCA business
standards
Supervision &
redress
Financial crime
Periodic reporting
Progress reports for funds
Firm managing investments must provide periodic

reports showing:
Managers of authorised funds must report to

unitholders:
Name of the firm

Name / designation for a retail clients account
Statement of contents & valuation of portfolio,
including details of:
Designated investments & their value
Cash balance at beginning & end of period
Performance of portfolio
Total fees & charges, itemising management
fees & execution costs
Comparison of period performance with any
agreed benchmark
Dividends, interest & other payments received
Information about corporate actions
Page 89
Short report (send to all holders) & long

report (available on request), half-annually &
annually
The reports must be available within 4 months
of the year-end & within 2 months of the end
of the half-year
Record keeping periods

MiFID records 5 years
Non-MiFID general rule: as long as is relevant
for the purposes for which the records are made
Pension transfers & pension opt-outs indefinitely
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 90
FCA business
standards
Supervision &
redress
Financial crime
Client assets
Client money
Make adequate arrangements to safeguard clients

ownership rights in event of:
Client money is money the firm looks after which is

not its own. Client money must be held on trust.
Client bank account should be separately identifiable
from firms own account. Adequate records and
procedures must cover mandated accounts (eg
direct debit mandates and credit card details held).
A firm must reconcile its internal records with those
of third parties:
As regularly as necessary
As soon as reasonably practicable after
reconciliation date
Correct any discrepancies promptly:
If shortfall, top up account the same business day
If excess, remove the same business day
Insolvency of firm
Unauthorised use by the firm client must give
prior consent to their use in security transactions
such as stocklending
Firm should have adequate arrangements to
minimise risk of loss or reduction of financial
instruments, misuse, fraud, poor administration,
inadequate record keeping or negligence.
Custody reconciliations:
Reconcile internal records with third parties
regularly
Correct any discrepancies promptly
Notify the regulator of any breaches without delay.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 91
FCA business
standards
Supervision &
redress
Financial crime
Powers of the new regulators (FCA and PRA)

Granting authorisation & permission to firms (under Part 4A FSMA 2000) to undertake regulated activities
Approving individuals to perform controlled functions
Issuing rules which appear to be necessary or expedient to advance regulators objectives (Part 9A FSMA 2000)
Supervision of authorised firm to ensure that they continue to meet the regulators authorisation requirements &
that they comply with the regulatory rules and other obligations
Powers to take enforcement action against authorised firms and approved persons
Powers to discipline authorised firms & approved persons
The FCA & PRA jointly oversee the Financial Services Compensation Scheme (FSCS)
Applications for variations or cancellations of permissions:
Dual-regulated firm will normally apply to PRA, which may determine an application to vary a permission only
with FCA consent, and to cancel a permission only after consulting the FCA.
FCA-only regulated firm will apply to FCA. If the applicant firm is part of a group that includes a dual-regulated
firm, the FCA must consult the PRA in making its decision
Page 91
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 92
FCA business
standards
Supervision &
redress
Financial crime
FCA supervisory approach

The FCAs process for assessing conduct risks puts firms into categories C1 (larger firms with most consumer/market impact: most intensive supervision) to C4 (smaller firms). Firms are also put into prudential
categories CP1 (firms whose failure has greatest impact) to CP3 (least impact).
The FCAs supervision approach:
1 Firm Systematic Framework (FSF): analysing firms business models to assess sustainability from conduct perspective, and future risks; evaluating firms culture and tone for the top regarding fair treatment of
customers and market integrity
2 Event-driven work: covering emerging issues, eg mergers, spikes in complaints, whistleblowing allegations
3 Issues and products: analysis by FCAs sector teams
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Complaints
What is a complaint?
Any oral or written expression of dissatisfaction
whether justified or not, alleging loss, distress
or inconvenience
Eligible complainants for Ombudsman purposes:
Consumers
Enterprises with fewer than 10 employees and
turnover or annual balance sheet not
exceeding 2 million (micro-enterprises)
Charities with annual income < 1 million
Trusts with net asset value < 1 million
Page 93
Page 93
FCA business
standards
Supervision &
redress
Financial crime
Firms must report to the regulator twice-yearly, on:

Complaints categories & product types

Numbers of complaints closed: within 4 weeks; within
4-8 weeks; & more than 8 weeks
Numbers of complaints: upheld; referred to & accepted
by Ombudsman; outstanding
Total amount of redress paid
To whom should customers complain?

1
Contact the provider firm, using the firms formal

complaints procedures if necessary.
If complaint not resolved with the firm, use an

independent scheme, eg the Financial Ombudsman
Service (FOS), or the courts.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Complaints handling
Effective and transparent complaints
handling procedures
Allow complaints to be made by any
reasonable means
Recognise complaints as requiring resolution
Complaint must be:
Investigated competently, diligently,
impartially
Assessed fairly, consistently, promptly
Assessment must be explained in a fair,
clear & not misleading way, & any
appropriate redress or remedial action
offered
Page 94
FCA business
standards
Supervision &
redress
Financial crime
Financial Ombudsman Service (FOS)

Firms must cooperate with FOSs Compulsory
Jurisdiction which applies to regulated activities:
Where complaint not resolved after 8 weeks
Max. FOS award: 150,000 (including any
compensation for suffering, damage to reputation,
distress, inconvenience), plus interest & costs
Financial Services Compensation Scheme

For default/insolvency in respect of:
Investments & home finance: 100% of 1st 50,000
Deposits: 100% of 1st 85,000
Long-term insurance: 90% of claim
General insurance: 90% of claim, but 100% for
compulsory insurance
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Complaints
Procedures must be in place for complaints
handling by a firm, and a complaints log must
be maintained.
Publish summary of procedure & refer eligible
customers to it at the point of sale.
An FOS decision is binding on the firm.
FCA business
standards
Page 95
Financial crime
Supervision &
redress
Timeline
Receive complaint, within 6 years of event, or 3 years

of when complainant should have been aware of it
Promptly on receiving a complaint, acknowledge it,

providing early assurance that it is being dealt with
By 8 weeks after receipt, send final response or

holding response explaining why final response
cannot be made, stating when it is expected to be
made, and informing complainant of his right to go to
Ombudsman
Final response starts the clock on ...
... 6 month limitation period on using FOS
Records of the complaint and measures taken

for its resolution must be kept for three years,
but five years for MiFID business.
Twice-yearly reports to regulator required.
Page 95
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Anti-money laundering (AML) provisions

Three aspects to AML:
Page 96
FCA business
standards
Supervision &
redress
Financial crime
Money laundering: conversion of money obtained

illegally into apparently legitimate funds.
Deterrence
Co-operation
Detection
Proceeds of Crime Act 2002

Makes it a criminal offence to facilitate
arrangements involving the proceeds of
any crime (including, eg, tax evasion)
International & UK action
International
Financial Action Task Force (FATF)
UK
Criminal Justice Act 1993
POCA 2002 (updated CJA 1993)
Anti-drug trafficking & counter-terrorism
financing (CTF) legislation
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 97
FCA business
standards
Supervision &
redress
Financial crime
Proceeds of Crime Act 2002

Three main offences:
Assistance If any person knowingly helps another person to launder the proceeds of criminal conduct, he or
she will be committing an offence
Failure to report If a person discovers information during the course of his employment that makes him
believe or suspect money laundering is occurring, & he fails to make the report as soon as is reasonably practicable, he is committing a criminal offence
Tipping off (s333A) Even where suspicions are reported, the parties must generally be careful not to alert the
suspicions of the alleged launderer since, within the regulated sector, this is an offence
Money laundering: Sequence

Depositing funds in respectable investments (placement)
Multiple transactions to conceal origins of funds (layering)
Conversion of funds into a business (integration)
Page 97
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 98
FCA business
standards
Supervision &
redress
Financial crime
Anti-money laundering regulation

Money Laundering Regulations 2007
Risk-sensitive policies and procedures required
Customer due diligence (CDD) means
identifying customer or beneficial owner, if
different, and verifying identities
Enhanced due diligence (EDD) applies for
higher-risk situations, such as non-UK
politically exposed persons
Simplified due diligence (SDD) means not
having to apply the usual measures, eg for
CTFs, listed companies and public authorities
Penalty Failure to implement MLR 2007 is a crime:
2 years imprisonment and/or fine
Joint Money Laundering Steering Group

Guidance Notes
Identity information may come from (in order of
preference):
Government department or Court
Other public sector body
Regulated financial services firms
Other firms subject to MLR or similar regime
Other organisations
Keep records for five years.
Regulatory
framework
12/4/2013
FCA high level

standards
Criminal Justice Act 1993

Money laundering regulations
(secondary legislation)
Joint Money
Laundering
Steering Group
guidance
Identity checks are designed to
prevent money laundering. To prevent
financial exclusion, there is some
flexibility on the evidence necessary.
7:25 PM
Exchanges &
markets
Page 99
FCA business
standards
Financial crime
Supervision &
redress
Money laundering: maximum penalties (POCA 2002)

14 years for knowingly assisting in laundering of criminal
funds
5 years for failing to report knowledge or suspicion of
money laundering
2 years for tipping off a suspected launderer, in regulated
sector (s333A POCA 2002)
The suspected launderer must not be alerted!

Suspicions
of
laundering
report
to
Money
Laundering
Reporting
Officer
may
report to
National
Crime
Agency
The regulator requires annual reporting by MLRO to senior management and training of staff.
Page 99
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 100
FCA business
standards
Supervision &
redress
Financial crime
SYSC & financial crime
SYSC requires firms to:
Systems & controls need to identify,

assess, monitor money laundering
risk the risk that firm is used to
further financial crime
Allocate to a senior manager (could be the MLRO

but does not have to be) responsibility for
establishment & maintenance of AML systems and
controls
Systems & controls should be

comprehensive & proportionate to
the nature, scale & complexity of the
business
Provide appropriate training

Appoint MLRO, who must provide a report at least
annually to the governing body/senior management
Appropriately document ML risk profile/policy
Ensure ML risk is considered in day-to-day
operations
Ensure identification procedures do not
unreasonably deny access to services
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 101
FCA business
standards
Terrorism
What is terrorism? Terrorism 2000 Act
definition encompasses violent actions designed
to influence a government or intimidate the public.
How does terrorism financing differ from money
laundering?
Relatively small amounts may be

involved
Terrorists may be funded from legitimate
income
Page 101
Supervision &
redress
Financial crime
Terrorist offences

Fund raising
Use & possession
Funding arrangements
Money laundering
Law on Counter-Terrorism Financing (CTF)

The duty to report Terrorism Act 2000
Regulated sector Anti-Terrorism, Crime &
Security Act 2001
Failure to disclose 5 years in jail and/or fine
Protected disclosures Not a breach of client
confidentiality
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Who is an insider?
Page 102
FCA business
standards
FCA supervision
& redress
Financial crime
Insider
Inside
Source
Inside
Information

Price-sensitive
Unpublished
Specific or precise
Particular issuer or
security
Must not:
Deal
Encourage
Disclose

Company Director
Employee
Office or duties
Direct or indirect
source
Insider dealing is a criminal offence under Part IV of the Criminal Justice Act 1993.
Under CJA 1993, an insider is an individual who has information in her possession that she knows is inside information and
knows is from an inside source either directly from her own profession or indirectly from someone with access due to their
own profession.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 103
FCA business
standards
Financial crime
Supervision &
redress
Where are insider dealing restrictions found?
Insider dealing: Criminal Justice Act 1993
Many rules and regulations:
Individuals who are insiders

Regulated market/ professional
intermediary

Financial Services & Markets Act 2000

Criminal Justice Act
Principles for Businesses
Exchange rules
Civil offence
Not all investments covered

Various bodies involved
Special defences
General defences
Did not expect to profit
Believed on resonable grounds that
information was in public domain
Would have dealt anyway
Page 103
Defences
Market maker
Market information including bid
facilitation
Price stabilisation rules
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 104
FCA business
standards
FCA supervision
& redress
Financial crime
Market abuse
Market manipulation
Market abuse: due diligence defence
Behaviour by any person

occuring in relation to
qualifying investments traded
on a prescribed market
Manipulating devices
Section 123 FSMA 2000

Person believed on reasonable grounds
that he was not committing market
abuse, or
Insider dealing
Insider dealing
Improper disclosure
Misuse of information
Manipulating transactions
Dissemination of false or
misleading information
Misleading behaviour &
distortion
Person took all reasonable precautions

and exercised due diligence to avoid
committing market abuse
No financial penalty
Safe harbours if acting within one of these safe harbours, a person is not
committing market abuse:
Regulators rules
The Takeover Code
Buy-back programmes and stabilisation
Due diligence defence see above
Regulatory
framework
12/4/2013
FCA high level

standards
Insider dealing
Improper disclosure
Where an insider discloses inside

information to another person otherwise
than in the proper course of the exercise
of her employment, profession or duties
Misuse of information
Where a transaction is based upon

information not generally available, which a
.
regular market user would regard as
relevant and would cause them view the
persons behaviour as being below reasonable
market standards
Page 105
Exchanges &
markets
Page 105
FCA business
standards
Where behaviour Is likely to give a regular market

user a false or misleading impression as to the
supply of, demand for, or price or value of,
qualifying investments; or cause a distortion of the
market
Market abuse
offences
4
Dissemination
Dissemination of information which gives, or

is likely to give, a false or misleading
impression as to a qualifying investment by
a person who knew it was false or
misleading
(detail set out in the Code

of Market Conduct)
Financial crime
Supervision &
redress
7 Misleading behaviour & distortion
Where an insider deals, or attempts to

deal, in a qualifying investment or related
investment on the basis of inside
information
7:25 PM
Manipulating devices
Effecting transactions or orders to trade which

employ fictitious devices or any other form of
deception
Manipulating transactions
Where a transaction or orders to trade (are effected otherwise than for legitimate reasons
and in conformity with accepted market practices) which:
Give, or are likely to give a false or misleading impression as to the supply, demand or
price of one or more qualifying investments; or Secure the price of one or more such
investments at an abnormal or artificial level
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 106
FCA business
standards
Supervision &
redress
Financial crime
Enforcement of market abuse The FCA may impose one or more of the following penalties on those
found to have committed market abuse:
An unlimited fine
Issue a public statement
Apply to the court to seek an injunction or restitution order
Disciplinary proceedings, which could result in withdrawal of authorisation/approval where an authorised/approved
person is guilty of market abuse as they will also be guilty of a breach of the Principles for Businesses
Note that the regulator has criminal prosecution powers to enforce insider dealing and Part 7 Financial Services Act
2012 (see below). The regulator has indicated that it will not pursue both the civil and criminal regime.
Part 7 Financial Services Act 2012 has created criminal offences relating to:

Misleading statements
Misleading impressions, and
Misleading statements relating to benchmarks (including LIBOR)
There will also be new provisions relating to regulated activities that are connected with setting benchmarks.
Regulatory
framework
12/4/2013
FCA high level

standards
7:25 PM
Exchanges &
markets
Page 107
FCA business
standards
Supervision &
redress
Financial crime
Bribery Act 2010

The Bribery Act 2010 (BA 2010) replaces existing anti-corruption legislation and introduces a new offence for commercial
organisations of negligently failing to prevent bribery.
Bribery offences
There are four main offences under BA 2010:
Section 1: Active bribery Offering, promising or giving a bribe
Section 2: Passive bribery Requesting, agreeing to receive or accepting a bribe (passive bribery)
Section 6: Bribing a foreign public official A breach of this section may also breach s1 BA 2010, and prosecutors will need to decide which is the more appropriate offence for the case
Section 7: Failure of firms to prevent bribery Failure by a commercial organisation to prevent persons associated with it from bribing another person on its behalf.
An organisation has a defence against the s7 offence (failure to prevent bribery) if it can prove that, despite a particular
instance of bribery having occurred, the organisation had adequate procedures in place to prevent persons associated
with the organisation from committing bribery.
Page 107
12/4/2013
7:25 PM
Notes
Page 108
12/4/2013
7:25 PM
Page 109
4: Legal concepts
Topic List
Those working in the financial sector must operate within

various regulations, laws and statutes.
Legal persons
As in any business, the law of contract has a bearing,

and the law on power of attorney, wills and trusts needs
to be understood.
Power of attorney
Contracts & agency
Property
Bankruptcy & insolvency
Trusts & wills
Legal
persons
Power of
attorney
12/4/2013
7:25 PM
Contracts
& agency
Page 110
Property
Bankruptcy
& insolvency
Trusts &
wills
Legal personality
Companies
Legal persons include:
A company is a legal person. A creditor cannot

demand payment of company debts from its
shareholders. The company is liable without limit for its
own debts.

Companies
Nations
Co-operatives
Individuals
Legal persons can:

Enter into contracts
Sue & be sued
Incur debt
Own property
Sole traders
For a self-employed trader, there is no legal
distinction between individual & business. The
trader is personally liable for debts of the business.
An individual human being is a natural person

A corporation (eg, a company) is an artificial
person
A public company (plc) has a nominal share
capital of at least 50,000 & may be Stock
Exchange-listed
Others are private companies (Limited or Ltd)
not permitted to offer their securities to the public
Legal
persons
12/4/2013
Power of
attorney
7:25 PM
Contracts
& agency
Page 111
Property
Bankruptcy
& insolvency
Trusts &
wills
Powers of attorney
Lasting power of attorney
Power of attorney: formal document made by donor

which appoints attorney or donee to act for donor in
legal matters (eg, to sign documents).
A lasting power of attorney (LPA) under the Mental

Capacity Act 2005 can take effect if the donor
becomes mentally incapable, and can cover Personal
Welfare as well as Property & Affairs.
General power of attorney allows donee to act

for donor in all matters
Power may be restricted to specific act, eg to
execute a specific document
To take effect, LPA must be registered with the

Office of the Public Guardian.
Ordinary power of attorney:

Valid while donor capable of giving instructions
Revoked by death or bankruptcy of donor or
attorney, or at choice of donor
Existing enduring powers of attorney (EPAs) are
still effective, but new EPAs cannot be set up.
Page 111
If no replacement attorney, LPA is cancelled if:

Attorney cannot or will not act, or dies
Married attorney & donor divorce
For a Property & Affairs LPA, if attorney or donor
become bankrupt
4: Legal concepts
12/4/2013
Power of
attorney
Legal
persons
7:25 PM
Contracts
& agency
Page 112
Property
Bankruptcy
& insolvency
Trusts &
wills
Elements of a contract
A contract is a legally binding agreement between persons in any form (eg, inferred, written or oral).
Offer

Intention to create legal relations

Consideration
Acceptance
eg A life assurance proposal form constitutes an offer

Other factors affecting validity of a contract:
Capacity. Some people have restricted capacity to enter into contracts, eg, minors (under 18)
Form. Some contracts must follow a particular form
Content. There may be some implied terms in a contract. Express terms may be unlawful
Genuine consent. There may be undue influence or duress, or misrepresentation or mistake
Legality. The courts will not enforce a contract which is illegal or contrary to public policy
Effect of failure to satisfy the validity tests:
Void contract. This is no contract
Voidable contract. This contract can be avoided by one party
Unenforceable contract. This contract is valid but performance by one party cannot be enforced
Power of
attorney
Legal
persons
12/4/2013
7:25 PM
Page 113
Contracts
& agency
Property
Bankruptcy
& insolvency
Trusts &
wills
Agency
The agent-principal relationship forms a contract
between the principal & a third party.
Principal
Agent (eg broker, appointed representative)
Third party
Contract discharge
Agents obligations
Ways in which a contract can come to an end:

Breach
Performance
Agreement
Frustration
A verbal contract is legally binding, except for sale of

property, and tenancy agreements.
Page 113

Performance & obedience

Skill & accountability
No conflict of interest
Keep confidence
Benefit only as agreed
4: Legal concepts
Legal
persons
Power of
attorney
12/4/2013
7:25 PM
Contracts
& agency
Page 114
Property
Bankruptcy
& insolvency
Trusts &
wills
Real property
Co-ownership
In legal terminology, land includes buildings &

anything else permanently attached to the land.
Real property (also called 'realty') is land owned
in perpetuity ie, freehold property.
With leasehold property, the right of the rentpaying tenant (or lessee) to possession ends
either by expiry of a fixed period or by notice.
A lease is a form of contract. If granted for a
term of more than three years, it must generally
be in the form of a deed.
2+ persons may own land. (Applies to owning

freehold land outright, in spite of the word tenant.)
Joint tenancy a common form of ownership of
a house by a couple. The transfer does not state
what share in the land each person has. The
land is 'held by X and Y'.
Personal property
Personal property (personalty) is anything that
is not real property (freehold land).
If a joint tenant dies, his interest lapses & the land

is owned wholly by the survivor(s).
Tenants in common. A conveyance may state
that the land should go to 'P, Q and R equally'
each then owns one-third part of the interest.
With a tenancy in common, each tenant can
bequeath his interest.
Legal
persons
Power of
attorney
12/4/2013
7:25 PM
Contracts
& agency
Bankruptcy
Bankruptcy: when an individual is no longer able
to pay debts and his or her financial affairs are
taken over by a court. The assets are transferred
into a trust.
Bankruptcy proceedings start with a Bankruptcy
Order to the court.
Court will decide whether to declare the individual
bankrupt.
The Official Receiver takes control of assets, as
receiver & manager.
A bankruptcy order is normally discharged
automatically one year after the date of the order,
unless the bankrupt is culpable (Enterprise Act 2002).
Page 115
Page 115
Property
Bankruptcy
& insolvency
Trusts &
wills
Receiver & manager protects bankrupt's property

until trustee in bankruptcy is appointed to get
possession of bankrupts assets & realise their value.
Trustee is entitled to the excess income above what

is needed to support bankrupt and his/her family.
If the debtor owns their own home, & lives alone,

lives with a co-habitee or lives with adult children,
interest in the home normally passes to the trustee.
4: Legal concepts
Legal
persons
Power of
attorney
12/4/2013
7:25 PM
Contracts
& agency
Insolvency procedures
Three types of corporate insolvency:
Administration to provide a better way of
realising company's assets than could be
achieved by liquidation or receivership
Receivership concerned principally with
interests of secured creditors who want to
take control of charged assets
Liquidation mainly for the interests of
unsecured creditors and members
(shareholders) of the company. The company is
dissolved and its affairs 'wound up'.
A voluntary liquidation cannot be initiated by

shareholders if a company is insolvent.
Page 116
Property
Bankruptcy
& insolvency
Trusts &
wills
If there was intent to defraud creditors or others,

the court may decide that persons (usually, directors)
who were knowingly parties to the fraud shall be
personally responsible for debts and other liabilities
of the company.
Aims of insolvency law

Protect the creditors of the company
Balance the interests of competing groups
Control or punish directors responsible for
company's financial collapse
Encourage 'rescue' operations
Legal
persons
12/4/2013
Power of
attorney
7:25 PM
Page 117
Contracts
& agency
Property
Bankruptcy
& insolvency
Trusts &
wills
Valid will
Signed by testator
Witnessed by two people
Not made under pressure
Intestacy
Yes
Is there a valid will?
Administrators deal
with the estate.
No
Types of trust
Executors carry out the terms of a will, to distribute estate in
accordance with testators wishes. A witness or their spouse
cannot be a beneficiary. Marriage invalidates a will, unless the
will states it is made in contemplation of marriage.
Trusts
A trust is an equitable obligation in which
trustees are bound to deal with property
they control (as legal owners) for the
benefit of the trust beneficiaries.
Page 117
Bare Trust
Interest in Possession Trust
Discretionary Trust
Charitable Trust
Some uses of trusts: will trusts, life trusts, family

settlements, unincorporated associations, land gifted to
children, protecting the identity of a beneficial owner
4: Legal concepts
12/4/2013
7:25 PM
Notes
Page 118
12/4/2013
7:26 PM
Page 119
5: Client advice
Topic List
The retail consumer
Advising clients
Institutional funds
Client interaction
A clients life stage, employment status and current financial

position all influence the clients needs in the financial
planning context. Just as important are the clients future
prospects and aspirations. Planning is by definition forwardlooking and it is what the client can make of their current
situation that matters.
Different factors shape asset allocation for a client portfolio
and for a fund. Accurate recording of information is of
course vital, to help the financial planning process as well
as to demonstrate compliance with regulatory provisions.
12/4/2013
7:26 PM
The retail
consumer
Page 120
Advising
clients
Institutional
funds
Client
interaction
Consumers perceptions
Treating Customers Fairly (TCF)
In DP 18 An Ethical Framework for Financial

Services (2002), the previous regulator (FSA)
recognised that consumers increasingly
understand an ethical stance.
The FCAs TCF initiative identifies 6 improved outcomes to

achieve for retail customers.
Professional conduct & ethical behaviour could

strengthen confidence in the industry, but
If consumers have diminishing trust in the
sector & in firms, they will hesitate to use
products & services
1.
Customer confident of receiving fair treatment (TCF is viewed

as a matter of corporate culture)
2.
Products/services designed to meet the needs of specific

consumer groups
3.
Customers are provided with clear (ie, simple &

understandable) information
4.
Advice given to retail customers takes account of their

circumstances
5.
Products perform as customers expect
6.
No unreasonable post-sale barriers imposed by firms (eg,

when switching provider, making a complaint, etc)
There is also pressure from consumers &

government for the sector to put something
back, eg combating social exclusion.
TCF outcomes
12/4/2013
7:26 PM
The retail
consumer
Trust and confidentiality

The consumer must have every reason to trust a
financial adviser.
Trust is gained through respect, through the
way advisers deal with customers.
The adviser must always treat personal
information with the utmost confidentiality.
RDR
The Retail Distribution Review (RDR) set up
arrangements (since end of 2012) to enhance
consumers confidence in using financial
services.
Page 121
Page 121
Advising
clients
Institutional
funds
Client
interaction
The advisers fiduciary duty

An adviser's fiduciary responsibility implies that the
adviser (or firm) acts in the best interests of the client
(Clients Best Interests Rule), to the exclusion of his
or her own interests.
Firms obligations to consumers

Authorised firms have an obligation to abide by the
FCA Principles for Businesses and detailed rules,
as set out in the FCA Handbook, in their dealings
with consumers.
5: Client advice
12/4/2013
7:26 PM
Page 122
The retail
consumer
Advising
clients
Institutional
funds
Client
interaction
Stages in giving advice

Obtain relevant information

Establish & agree clients financial objectives
Process & analyse information identify &
analyse clients needs
Formulate recommendations in a plan

Implement recommendations, as agreed with
client
Review & regularly update the plan
Fact-find (questionnaire)
Detailed in the fact-find
Analysing client circumstances, eg:

Structure of liabilities might be re-arranged

Are protection arrangements adequate?
Consider changes in circumstances: house, job, children
Assess clients disposable income to determine
affordability of a recommended product

Factors in formulating
recommendations
Regulation & compliance

Economic conditions
Taxation
State benefits
Savings & investments
Protection
Clients attitude to & understanding of
risk
12/4/2013
7:26 PM
The retail
consumer
Page 123
Advising
clients
Client objectives
Two potential client requirements:
To maximise returns, eg positive net worth individuals looking
for a portfolio to match their risk/return preferences
To match liabilities, eg pension funds, where aim is to match
assets & liabilities or to minimise a mismatch
Private clients could have objectives that mix liability matching (eg
to pay school fees) & returns maximisation (for other funds, say).
Maximising returns. Given the choice, investors would elect for
high performance with minimal risk. In practice, this is not
achievable: a risk/reward trade-off applies.
Matching liabilities. Investments in government bonds can match
income & capital inflows precisely with liabilities. Extending into
more risky assets means that liabilities might not be met.
Page 123
Institutional
funds
Client
interaction
Types of investor risk
Capital risk potential variability in

investment values
Inflation risk potential variability
in inflation rates
Interest rate risk the risk of
changes in bank base rates on
asset returns
Shortfall risk the risk of a fund
failing to meet any specified
liabilities
Liabilities can be nominal (eg bank
loan) or real (eg living costs, which
will rise with inflation).
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Page 124
Advising
clients
Institutional
funds
Client
interaction
Know your customer: collect information using the

fact-find.
Typical fact-find
Personal details: hard facts
Family details
Employment details
Advisers
Financial details (hard facts)

Assets
Liabilities
Name, address, date of birth, contact details, NI

number/tax reference
marital status, state of health
country of domicile
Dependants,
other immediate family
Occupation, employer
time with employer, previous employer
Bank, accountant, stockbroker, solicitor
Property, belongings, antiques,
stocks and shares, unit trusts,
savings accounts, cash, other assets
Mortgages, other loans and debts
Get letter of authority for information needed from third parties.
12/4/2013
7:26 PM
The retail
consumer
Typical fact-find
Income
Expenditure
Protection
Pensions
Wills and legacies
Customers attitudes (soft facts)

Customers views on savings/
investment/protection
Customers objectives
Page 125
Advising
clients
Institutional
funds
Client
interaction
Pay, bonus, benefits profits, if self-employed,

investment income, pensions
Living expenses, mortgage payments,
school fees, regular savings, life assurance
Life cover, disability insurance details
Occupational schemes, personal pension schemes,
preserved benefits
Current will when last reviewed?
gifts in last seven years, anticipated legacies
Attitude to risk, ethical investments?
perceived needs?
Moving/childrens education/retirement plans?
Review client information each time he/she seeks advice

Page 125
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Clients typical life stages

Minors (under 18)
Young and single
Married or cohabiting
Page 126
Advising
clients
Institutional
funds
Client
interaction
Clients employment status

Employed
Self-employed
Non-employed
Both working, no dependants

One working, no dependants
One working, with dependants
Married or cohabiting, older children
Children left home
Retired
Client needs

Protection of financial stability

Protection against adverse events
Provision for future financial needs
Pension provision
Maintenance of living standards
Ability to pass wealth on
12/4/2013
7:26 PM
The retail
consumer
Page 127
Advising
clients
Institutional
funds
Client
interaction
Protection products
Protection products help to protect financial stability from
the potential adverse effects of common life events.
Possible adverse events
Death
Illness
Incapacity
Redundancy
Protection needs
If there are
dependants
State benefits are
limited
Emergency funds can act as a temporary cushion.
Page 127
CAPITAL
INCOME
Financial stability
If the unexpected happens:
What is the likely loss of earnings?
What are the housing & mortgage
implications?
For a self-employed person, what are the
likely effects for the business?
5: Client advice
12/4/2013
7:26 PM
Page 128
The retail
consumer
Advising
clients
Institutional
funds
Client
interaction
Typical protection needs at different ages

Age
Death
Sickness
Redundancy
Under 18
None
None
None
18-25
If married or in debt
If employed or self-employed
If employed
25-40
Significant: marriage, children,

mortgage
Significant
Mortgage cover needed?
40-50
Less significant if children growing

up
Increasing age increases risk Mortgage cover needed?
50-60
Less significant unless there is a

second family
Long-term care cover may be If there is still mortgage

considered
debt
60+
Protection of assets, IHT liabilities
Health protection and longterm care
Some possible needs are shown above, but every case is different.
Not usually significant
12/4/2013
7:26 PM
The retail
consumer
Page 129
Advising
clients
Institutional
funds
Client
interaction
Mortgages: loans secured on property.

Lending sources
Capital and interest (or repayment) mortgage

Borrowers
payments
Banks
Interest
Lender
Capital
Building societies
Insurance companies
Investment-related (or interest only) mortgage

Borrowers
payments
Capital
Interest
Lender
Savings
vehicle
On
maturity
eg: ISAs, pension lump sum,

endowment policy
Page 129
Mortgage corporations
Credit companies (mainly unsecured loans)
Islamic mortgages avoid interest, since interest is
against Islamic (Sharia) law. The homebuyer may
pay rent to the bank, with part of it going towards
buying out the banks share in the property.
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Page 130
Advising
clients
Institutional
funds
Client
interaction
Planning for retirement

What age am I now?
How much can I afford from income?
What investment returns can I expect?
Tax relief is available on pension provision
At what age will I retire?

What income do I want in retirement?
How will inflation erode the value of savings?
Pensions in payment are taxed
Planning points
In retirement
Evaluate existing provision
State provision is limited
Consider PP or stakeholder
Housing costs can be significant
Consider additional contributions
What are the clients aspirations?
Consider ISAs as alternative
12/4/2013
7:26 PM
Page 131
The retail
consumer
Investment risks
The adviser must:
Understand investment risks

Ensure that the client understands
investment risks, before the
recommendation or transaction
Advising
clients
Institutional
funds
Client
interaction
The investor risks:

Loss of income
Eg variable interest
Loss of capital
Assets which rise or fall in value, eg shares
Information on risks is included in the

Key Features Document.
RISK
SAFETY
Risky investments
Safe investments
Investments with high potential return come with the

risk of low or negative returns and loss of capital (eg:
shares, collective investments, options, warrants).
Investments with low risk of loss of capital come

with lower potential returns (eg: bank deposits,
NS&I).
Page 131
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Diversification
two sorts of risk:
Page 132
Advising
clients
Institutional
funds
Client
interaction
Attitude to risk
The general market (systematic) risk of

A clients attitude to risk may be influenced by:
investing in shares or bonds
Investment timescales. Eg: in managing a pension fund,
The specific (non-systematic) risk of any attitude to risk may depend on how far out in time liabilities fall
individual investment
Clients risk tolerance. Standard fact-find approach: ask
client to select a mix of, say, equities & bonds, to give an idea
Diversification by asset class portfolio of the normal mix (& hence risk) that the client wishes to face
possibly spread across: cash, fixed interest
(bonds), equities, property, & other assets
Diversification within asset classes a
variety of investments, possibly spread
The trade-off between risk & potential reward:
across different geographical markets
Low-risk investments offer low returns, but low probability
Diversification by manager to reduce
of loss
risk from a manager performing poorly (as
in 'manager of manager' and 'fund of
High-risk investments offer the possibility of high returns,
with higher probability of loss
fund' structures)
Investment risk & rewards
12/4/2013
7:26 PM
The retail
consumer
Risk profiles
Rational
Emotional
decision making decision making
High risk
Methodical
Cautious
aversity
Low risk
Individualist
Spontaneous
aversity
Based on Bronson, Scanlan, Squire
Cautious investors
Highly loss averse
Need for security
Want low-risk investments with safe capital
Typically do not like making decisions but do
not listen to others
Tend not to use advisers
Portfolios are low risk & with low turnover
Page 133
Page 133
Advising
clients
Institutional
funds
Client
interaction
Methodical investors
Analytical & factual
Make decisions slowly
Little emotional attachment to investments &
decisions
Tend to be conservative in investment approach
Spontaneous investors
High portfolio turnover
Do not trust the advice of others
Some are successful investors, but most do less
well, given high transaction costs
Make decisions quickly & fearful of missing
opportunities
Individualist investors
Self-confident
Prepared to do analysis and & expect to achieve
their long-term goals
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Page 134
Advising
clients
Maintaining wealth
Institutional
funds
Client
interaction
Passing on wealth
Employees
An employer may meet some protection
needs
Economic conditions affect
What form of
Is the remuneration package flexible?
values of shares and other assets
investment is most
On pensions, salary sacrifice, additional
and investments
tax-efficient?
contributions & stakeholder pensions
Inflation erodes the real value of
Non-housing assets
might be considered
assets expressed in money terms
might be gifted to
Self-employed
reduce IHT liabilities
House price inflation boosts
Spouse might be employed to use
equity but it may need to remain
Life assurance
personal allowance
policies (usually
tied up in housing
No S2P (2nd State pension) entitlement
whole of life) can be
Own pension provision is necessary
Future inheritances may change
used to cover an IHT
a clients position
Non-employed
liability
Are all benefits due being claimed?
Can any expenses be met from capital?
Personal pension contributions can be up
Clients who have actively accumulated their
to 3,600 p.a. for non-earners
wealth typically have higher risk tolerance
12/4/2013
7:26 PM
The retail
consumer
Page 135
Advising
clients
Institutional
funds
Client
interaction
Affordability
Client review
Affordability of investments & protection policies to

be recommended for the client must be considered.
The adviser is concerned with identifying and

satisfying client needs. This is not just a one-off
process. Clients will have a continuing need for
financial advice. Their circumstances will change, &
there may need to be a review of whether products
initially recommended continue to be suitable.
The client's prospective disposable income

should be ascertained in order to assess the
affordability of regular contributions to policies
& investment plans.
Existing assets & policies, such as life
assurance contracts & other savings need to
be taken into account in quantifying the sizes
of investments needed to meet client needs.
Page 135
Regular reviews of client circumstances will

enable the adviser to make best use of future
business opportunities with that client.
For the client, there are benefits of advice arising
from the review.
5: Client advice
Page 136
7:26 PM
12/4/2013
Client
interaction
Institutional
funds
Advising
clients
The retail
consumer
Risk spectrum of investments
Low/
medium
risk
Low risk
Gilts (pre-redemption capital)

With-profits funds
Bank deposits
Building society deposits
Cash ISAs
Annuities
Negligible NS&I deposit products

risk
Gilts (income)
Gilts (redemption)
Medium
risk
Unit-linked managed funds
Unit trusts & OEICs/ICVCs (UK funds)
Investment trusts (UK)
Residential and commercial property
Medium/ Unit-linked overseas

high risk Unit trusts & OEICs/ICVCs (overseas funds)
UK single equities
Commodities
High risk Venture capital trusts
Unlisted shares
Warrants
Futures & options when used to speculate
Enterprise Investment Scheme
Enterprise Zone Property
12/4/2013
7:26 PM
The retail
consumer
Approach to fund management

Evaluation
performance
Strategies
Advising
clients
Institutional
funds
Client
interaction
Strategic asset allocation
Objectives
Establish
investment
policy
Page 137
Stock Selection
Allocation of the fund between various:

Asset classes (shares/bonds etc)
Currencies
Based on:
Fund selection criteria

Past performance
Charges
Entry (initial) & exit charges, annual
management charges
Financial stability of provider
Stability, independence & standing of
trustees, auditors & fund custodians
Page 137
Objectives of fund & client

Assets available for investment
Concept: the objectives & constraints direct you

towards certain asset classes and away from others
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Active and passive management

An active investment manager tries to use individual
expertise to enhance the overall return of the fund.
Passive investment management, on the other hand,

establishes a strategy which, once established, should
guarantee the appropriate level of return for the fund.
Indexation
The index fund manager selects an appropriate
index and builds a portfolio to mimic the index.
Index funds typically based on a sampling
approach, and thus exhibit some tracking error.
Transaction costs will typically be low, although
the portfolio must change to accommodate
changes in index constituents.
Page 138
Advising
clients
Institutional
funds
Client
interaction
a range of criteria to meet

Ethical funds cover
client ethical preferences.
Fund review
Fund performance should be reviewed at least
annually to evaluate whether fund is achieving its
objectives.
Client circumstances any changes, which
might require a change in strategy?
Performance review monitor against funds
selected benchmark
Portfolio rebalancing consider potential
changes to agreed asset allocations
12/4/2013
7:26 PM
The retail
consumer
Page 139
Advising
clients
Institutional
funds
Client
interaction
Benchmarks
Risk profile of funds
Three forms of analysis of a fund's performance:
Each type of institutional fund has its own

particular risk/reward profile stemming from:
Comparison to relevant stock/index, eg a published

market index
Comparison to similar funds, ie performance of other
similar fund managers, measuring:
Short and long-term investment return
Asset distribution of funds
Performance against peer groups, market indices &
medians
Comparison with customised benchmark for funds
with a unique constraint, eg ethical funds that cannot
invest in arms/tobacco (standardised FTSE4Good
indices meeting ethical criteria are available)
Page 139
Its initial objectives, return

maximising/liability matching
The value and time horizons of the
liabilities it has to meet (if any)
The assets it can invest in
The liquidity required within the fund
The risk that can be tolerated
Its tax status
Legislation governing its powers
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Page 140
Advising
clients
Institutional
funds
Client
interaction
Pension funds liability matching
Funds:Tax
A pension fund is a pool of money to be

invested now, to achieve either:
Approved pension funds pay no UK tax on

either fund income or capital gains.
A specific return based on the

employee's salary & number of years'
service with the company a defined
benefit (DB)/ final salary scheme, or
A general increase in value of the
contributions paid on behalf of the
employee a defined contribution
(DC)/ money purchase scheme
Life funds: all fund income & capital gains are

taxable, so the investment manager will tend to
select more tax-efficient investment vehicles.
General insurance: business profits are subject

to normal corporation tax rates.
Reasons for decline in DB schemes and rise of DC schemes Pressure on DB schemes from:
Increased longevity Flling returns on scheme assets Poor financial position of schemes
Requirements to disclose scheme funding position in companys financial statements
12/4/2013
7:26 PM
Page 141
The retail
consumer
Advising
clients
The time horizon for the attainment of the return,

or the matching of liabilities, will influence types of
investment selected. A fund with a long-term time
horizon can probably stand a higher risk: poor
returns in some years will tend to be cancelled by
high returns in other years.
Pension funds & life assurance companies will
have statistical projections of their liabilities into
the future & the fund must attempt to achieve
these.
Currency risk. A pension fund may have all its
liabilities denominated in sterling. If the fund
were to invest heavily in overseas assets, this
would expose it to additional risk, other than the
risk inherent in the assets themselves.
Page 141
Institutional
funds
Client
interaction
Liquidity needs. Within any fund, there needs to

be a degree of liquidity, to respond to changing
events.
Risk aversion & risk tolerances. The
risk/reward trade-off impacts on ways in which
the funds requirements can be achieved.
Constraints on funds
Asset allocation
The fund or portfolio manager has legal &

professional duty to base the asset allocation on
client's wishes with particular regard to:

Matching liabilities
Meeting any ethical considerations
Remaining within risk tolerances
Maximising fund performance
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Page 142
Advising
clients
Institutional
funds
Client
interaction
Asset and liability matching

Constraints
Time
Young pension
fund
Long-term
Mature pension
fund
Short-term
Life assurances
fund
Long-term
General insurance
fund
Short-term
Liability
Liquidity
Real
Very low
Real
High
Nominal
Low
Nominal
Very high
Risk tolerance
Tax status
High
Low
Medium/high
Gross fund, no tax on Gross fund, no tax on Tax on income and
income or gains
income or gains
gains
Very low
Tax on income and
gains
Possible asset
allocation
Equities
Property
60% - 80%
5% - 10%
20% - 30%
0% (illiquid)
55% - 65%
0% - 5%
0%
0%
Bonds
15% - 25%
55% - 65%
15% - 30%
100%
Cash
0% - 5%
15% - 25%
5% - 15%
100%
12/4/2013
7:26 PM
Page 143
The retail
consumer
Advising
clients
Institutional
funds
Client
interaction
Factual v evaluative statements
Closed and open questions
Factual information is distinct from evaluative statements

about someones hopes, wants, plans, opinions or feelings.
Closed questions ask for specific information, & typically

the answer is very short, or is Yes or No.
Examples
Closed questions
Factual information

Disregarding dividends, the fund has grown in value by

more than the FTSE 100 index over the 3-year period.
Brenda has fallen into two months' arrears on her
mortgage payments.
Could you please tell me your address?

Do you have any ISAs?
Open questions give the client more opportunity to express
views or feelings in a longer response.
Non-factual statements

Graham thinks that he should invest more of his

portfolio in foreign stocks, in order to diversify risk.
Matilda was disappointed by the service provided by
her previous financial adviser.
Page 143
Open questions

How do you feel about taking risks with your

investments?
What do you think are the most immediate financial
needs to be addressed?
5: Client advice
12/4/2013
7:26 PM
The retail
consumer
Know your customer (KYC)

To know your customer basic requirement of the
regulatory regime and part of advisers fiduciary duty.
Page 144
Advising
clients
Institutional
funds
Client
interaction
Written reports to clients

Parts of a financial planning
report
Obtain sufficient information about a customer's

personal & financial situation, before giving advice or
(if applicable) before constructing a portfolio for the
customer.
Statement of client's objectives

Summary of client's income & assets; other
relevant circumstances/ problems
Know the customers capabilities, adapting both

spoken & written communication to suit the
customer. Such adaptation should cover technical
terminology & quantitative analysis presented.
Appendices, if appropriate
In presentations to clients, continually check (eg, by

asking open questions) for indications that the client
understands, explaining points again & more simply
as necessary.
Recommendations, including any

proposals for immediate action as well as
longer-term suggestions
The language in the report should be phrased

concisely with explanations to suit capabilities of
client, avoiding unnecessary jargon.
12/4/2013
7:26 PM
Page 145
6: Taxation
Topic List
Income tax
National insurance
Capital gains tax
IHT & trusts
Other taxes
Tax on investments
In covering the tax element of the syllabus, we examine

various aspects of the taxation of individuals. Different
products suit clients with different tax situations, and there
may be a financial advantage in careful tax planning.
Inheritance tax (IHT) is charged on lifetime gifts and on an
individuals estate at death.
Same-sex civil partnerships established under the Civil
Partnership Act 2004 follow the same tax treatment as
married couples.
Income
tax
12/4/2013
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insurance
7:26 PM
Capital gains
tax
Page 146
IHT &
trusts
Other
taxes
Tax on
investments
Residence If an individual ...

1
Satisfies automatic overseas test > then,

non-resident
Satisfies automatic UK test (eg, spending

183+* days of tax year in UK) > then, UKresident
If neither, then a sufficient ties test is

applied.
*Counting days when person is in UK at midnight.
Domicile
An individual is domiciled in the country which is
his permanent home. Someone can only change
domicile by severing ties with old country &
establishing a permanent life in a new one.
UK residents are taxable on worldwide income.

Non-residents are taxable on UK-derived
income.
A remittance basis charge may be payable if

claiming remittance basis: 30,000 for nondoms who were UK-resident for 7 of the last 9
tax years; 50,000 if resident for 12 of last 14
tax years.
Non-UK domiciled UK residents are only
taxable on overseas income if it is remitted to
the UK or if it is from employment.
Income
tax
National
insurance
12/4/2013
7:26 PM
Capital gains
tax
UK income tax system

Pay as you earn (PAYE): tax on employment
earnings, deducted at source
Self-assessment: where additional tax is payable
Payments on account: 31 January & 31 July (if
self-employed or < 80% of last years tax paid at
source)
The fiscal year runs from 6 April to 5 April.
Page 147
IHT &
trusts
Other
taxes
Tax on
investments
Income tax rates (2013/14)

Rate
Taxable
income
Salary and Dividends

interest
Basic
0 to
32,010
20%
10%
Higher
32,011 to
150,000
40%
32.5%
Additional
>150,000
45%
37.5%
Tax avoidance v.Tax evasion

Tax avoidance: the taxpayer uses tax rules to his/her
advantage
Tax evasion: the taxpayer does not pay all tax due, eg
by under-reporting his/her income
Page 147
There is also a 10% starting rate for savings

income only, with a limit of 2,790 of taxable
earnings. The starting rate is not available if taxable
non-savings income exceeds 2,790.
6: Taxation
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Gross taxable income less

Personal allowance
Qualifying pension contributions
Allowable gifts to charity
equals Taxable income
Allowances (2013/14)
There is a personal allowance of 9,440*
The personal allowance is reduced by 1 for
every 2 excess income above 100,000 (thus
falling to zero for incomes over 118,880)
Those born before 6 April 1948 may get a higher
personal allowance, subject to an income limit.
Page 148
IHT &
trusts
Other
taxes
Tax on
investments
Pension contributions
Contributions to personal or stakeholder pension
plan are paid net of basic rate tax, even for eligible
non-taxpayers. Higher/ additional rate taxpayers
can reclaim more, to get tax relief at marginal rate.
Annual allowance cap on tax-relievable
contributions is the lower of 100% of income and
50,000 (2013/14), with carry forward rules. Low or
non-earners can make up to 3,600 gross
contributions and still get tax relief.
Contributions to an occupational pension scheme
are deductible from earnings for tax purposes.
Income
tax
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insurance
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Capital gains
tax
Page 149
IHT &
trusts
Other
taxes
Tax on
investments
A basic principle of income tax is the aggregation of income. Income from all sources is aggregated in a
personal tax computation.
Income taxed at source
Exempt income
Taxing income
Non-savings income is taxed first, then

savings (excl. dividend) income then
dividend income is taxed last.
Non-savings income is taxed at 20% (basic
rate), then 40%, & 45%.
Savings income starting rate of 10% (only
where savings income falls below starting
rate limit), then 20% (in basic rate band),
then 40%, & 45%.
Dividend income is taxed at 10% (not
20%) in basic rate tax band, at effective
total rate of 32.5% for higher rate, & 37.5%
for additional rate taxpayers.
Page 149
Bank/building society
interest: received net of 20%
tax
Debenture interest: received
net of 20% tax
Dividends: received net of
10% tax credit
Include GROSS income in
computation
Premium Bond
prizes
Returns on NS&I
Savings Certs.
Income in ISAs
Betting/gaming
winnings
Do not include in
computation
Tax credits on dividends can be offset to reduce tax but are

never repaid to taxpayer.Tax suffered on other taxed income can
be repaid.
6: Taxation
Income
tax
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insurance
7:26 PM
Capital gains
tax
Page 150
IHT &
trusts
Other
taxes
Tax on
investments
Dividends taxation
Planning points
Higher rate (40%) taxpayers liability for tax at 32.5% on

dividends. This equates to:
10% of gross dividend + 25% of net dividend
Transfer assets?
Transfer income yielding assets to the
spouse with the lower marginal tax rate. To
be effective, such transfers should be
unfettered rights.
Example
A higher rate taxpayer is paid a gross dividend of 400
He receives 360 after withholding tax (40 collected at source)
He has to pay 25% of 360 = 90 further to meet his liability
Total tax paid = 130
(32.5% of 400 = 130)
Additional rate (45%) taxpayers pay 37.5% on dividends.
Children
If parent gives income
(or assets which
generate income) to a
child, the income is
treated as the parents
if the child is under 18
and unmarried.
Does not apply

if the income is
100 a year or
less
Does not apply
to gifts from
grandparents,
uncles etc
Income
tax
National
insurance
Class
Page 151
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7:26 PM
Capital gains
tax
Page 151
IHT &
trusts
Other
taxes
Tax on
investments
National insurance contributions
Payable by employees on their earnings above the primary threshold

Amount payable depends on an individuals income
1A
Payable by employers on certain types of non-monetary benefits given to

employees (eg, a company car)
1B
Payable by employers on an employees earnings
Payable by self-employed persons

If earnings below the small earnings exemption, no NICs payable
Voluntary usually to fill gaps in contributions
Payable by self-employed, if profits exceed a threshold
6: Taxation
Income
tax
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insurance
7:26 PM
Capital gains
tax
Page 152
IHT &
trusts
Other
taxes
Tax on
investments
Capital Gains Tax: rates

For individuals, taxable gains are taxed at 18%, but at
28% for gains (after the annual exemption) that fall in
the higher rate band.
Married couples / civil partners

1
Disposals between spouses / civil partners living

together do not give rise to gains or losses.
Spouses / civil partners are taxed as separate

people, each with an annual exemption.
Capital gain calculation

Disposal consideration (or market value)
Less disposal costs
Less costs of acquisition / enhancement
Equals
Capital gain
Annual CGT exemption of 10,900 (2013/14) is deducted when computing individuals total taxable gains.
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Chargeable persons, disposals and assets

Three elements are needed for a chargeable gain to
arise.
A chargeable disposal: this includes sales,

gifts and the destruction of assets.
A chargeable person: individuals.
A chargeable asset: most assets are

chargeable, but see exempt list.
Page 153
Page 153
IHT &
trusts
Other
taxes
Tax on
investments
Exempt assets
Exempt from capital gains tax:
NS&I Savings Certificates & Premium Bonds
Betting & lottery winnings
Foreign currency, for private use
Gilts (Government stocks)
Qualifying corporate bonds
Tangible movable property up to 6,000 per item
Wasting assets (life of 50 years or less)
Private cars
Investments in ISAs, Enterprise Investment
Scheme & Seed EIS
Own home (principal private residence)
6: Taxation
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Example
Donna has taxable income of 22,000. In 2013/14, she
sold shares for 42,000 that she had bought five years
ago for 28,000. The annual CGT exemption is
10,900. What CGT must Donna pay?
Solution
42,000 28,000 = 14,000 net gain.
14,000 10,900 = 3,100 taxable gain.
22,000 [income] + 3,100 = 25,100, within the basic
rate band.
Donna must pay CGT of 18% x 3,100 = 558.
Page 154
IHT &
trusts
Other
taxes
Tax on
investments
CGT planning
Ways to mitigate extent of CGT liabilities:
Spread ownership of assets among family
members
Phased encashments
Realise paper loss
Sell shares & repurchase other shares as
substitutes
Use ISAs
Income
tax
12/4/2013
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insurance
7:26 PM
Capital gains
tax
Page 155
IHT &
trusts
Other
taxes
Tax on
investments
Deduct allowable capital losses from chargeable gains in the tax year in which they arise.
Any loss which cannot be set off is carried
forward to set against future chargeable gains.
Allowable losses brought forward are only set
off to reduce current year chargeable gains less
current year allowable losses to the annual
exempt amount.
Example
Zo made chargeable gains of 12,200 in
2013/14. She had brought forward capital losses
of 7,000.
Matching gains on shares

Disposals by individual shareholders are matched with
acquisitions in the following order.
Same day acquisitions
Acquisitions within the following 30 days
Other shares: the share pool
Page 155
Brought forward capital losses of 12,200

10,900 = 1,300 will be set off in 2013/14. The
remaining losses will be carried forward to
2014/15.
Stops bed and breakfasting
6: Taxation
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Inheritance tax (IHT) is charged:

(1) on death, (2) on gifts within 7 years of
death, (3) on chargeable lifetime transfers
Page 156
IHT &
trusts
Other
taxes
Tax on
investments
Exemptions for lifetime transfers only

Small gifts 250 or less per donee per tax year
Annual exemption 3,000: 1 yr carry forward possible
Potentially Exempt Transfers
Normal expenditure out of income
PETs include lifetime transfers to individuals and

to trusts for the disabled
PETs are initially assumed to be exempt
They are chargeable if the donor dies within
7 years
Marriage exemptions
Most lifetime transfers into trusts not covered by an

exemption are immediately liable to IHT
(chargeable lifetime transfers (CLTs)).
5,000 from parent

2,500 from remoter ancestor
1,000 from anyone else
Exemptions for lifetime and death transfers

Transfers between spouses/ civil partners
Transfers to charities, political parties or for national
purposes
Transfers of land to housing associations
Income
tax
National
insurance
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7:26 PM
Capital gains
tax
Page 157
IHT &
trusts
Other
taxes
Tax on
investments
IHT planning
Potentially Exempt Transfers (PETs). Gift made
by individual in lifetime is potentially exempt IHT
provided not made in last 7 years of life
Gifts to trusts. Transfer to a discretionary trust will
attract IHT rate of 20% if transfer not made in last
7 years of life
Gifts with reservation of benefit (GWR) A gift
with strings attached. Still considered part of
individuals estate for IHT purposes.
Example: transfer of nil rate band

Eric McMullan dies & leaves his entire estate to his
wife.
100% of his nil rate band has been unused. This
transfers to his wife.
If the individual nil rate band is 350,000 when his
wife dies then her nil rate band will be:
= 350,000 + 100% of 350,000
= 350,000 + 350,000 = 700,000
Nil rate band. Transfer of nil rate band between

spouses / civil partners. Transfer is on percentage
basis, not on a cash basis (see Example).
Page 157
6: Taxation
Income
tax
12/4/2013
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insurance
7:26 PM
Capital gains
tax
Page 158
IHT &
trusts
Other
taxes
Tax on
investments
Inheritance tax on death
IHT on the estate is found by taking into account all transfers in 7 years before death.
IHT on each lifetime transfer made in 7 years before death is found as follows:
1 Take into account all chargeable transfers (including PETs which have become chargeable) in 7 years
before the transfer
2 Find the tax at full rates: 325,000 at 0% (2013/14); remainder at 40% then deduct any taper relief (percentage reduction in IHT charge given if transfer was made more than 3 years before death)
3 Deduct any tax already paid on the transfer
Trusts and beneficiaries: tax

Tax
Non-dividend income
Dividend income
1st 1,000
20% (basic rate)
10% (dividend ordinary rate)
Income > 1,000
45% (trust rate)
37.5% (dividend trust rate)
Beneficiary may be able to

reclaim tax charged on income
received from a trust (if nontaxpayer or basic rate taxpayer)
Income
tax
12/4/2013
National
insurance
Stamp Duty Land Tax
7:26 PM
Capital gains
tax
payable on buying property
Value (residential property)

Up to 125,000
Over 125,000 up to 250,000
Over 250,000 up to 500,000
Over 500,000 up to 1,000,000
Over 1,000,000 up to 2,000,000
Over 2,000,000
SDLT rate
0%
1%
3%
4%
5%
7%
Value (non-residential property)

Up to 250,000 *
Over 250,000 up to 500,000
Over 500,000
SDLT rate
1%
3%
4%
* SDLT is 0% on non-residential property up to

150,000 if it earns annual rent of less than 1,000.
Page 159
Page 159
IHT &
trusts
Other
taxes
Tax on
investments
Stamp duty reserve tax (SDRT)

% rate of tax (rounded to nearest 1p)
Payable (in a paperless transaction) by buyer of:
Shares in a UK company
Shares in a foreign company with UK share
register
An option to buy shares
Rights arising from shares already owned
An interest in shares, ie an interest in the
money made from selling shares
Payments are made through CREST.
For unit trusts & OEICs, the fund manager pays
SDRT when units are surrendered.
6: Taxation
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Corporation tax (FY 2013)
IHT &
trusts
Other
taxes
Tax on
investments
Value Added Tax (VAT)
Corporation tax is payable by:

Companies resident in the UK on worldwide profits
Overseas companies on UK-derived profits
Companies pay main rate in quarterly instalments, based on the
estimated corporation tax liability. Other companies pay whole
amount 9 months & 1 day after end of accounting period.
Main rate
Page 160
Company profits
FY 2013 rate
> 1.5m
23%
Chargeable on supply of goods & services in the

course of business a tax on turnover, not profits
VAT rates
0% eg, books & childrens clothing
5% energy services & products
20% standard rate on most other goods
Small profits rate
< 300k
20%
Companies with profits falling between 300k & 1.5m pay on a
sliding scale to give an effective rate between 20% and 23%.
Losses can be offset against:
This years profits
Last years profits, or
Future years profits from same trade
VAT on investment services

Commissions exempt (not the same as 0%)
Advisory services standard rate, if invoiced
separately (otherwise, exempt)
Nominee services exempt
Portfolio management standard rate
Income
tax
12/4/2013
National
insurance
Capital gains
tax
Tax on investments
Direct investments are taxed based on
relevant income tax or CGT rate.
Indirect investment

Pension funds
Individual Savings Accounts (ISAs)
Existing Child Trust Funds (CTFs)
Real Estate Investment Trusts (REITs)
Collective Investment Schemes (CISs)
& investment companies
Life insurance funds
Venture Capital Trusts (VCTs)
Enterprise Investment Schemes (EISs)
Page 161
7:26 PM
Page 161
IHT &
trusts
Other
taxes
Tax on
investments
Tax treatment of pension benefits

Key points
Tax-free lump sum (up to 25% of accumulated
funds) can be taken from age 55. Remainder used
to produce an income, subject to income tax.
Lifetime limit of 1.5m (2013/14)
A lifetime allowance charge applies on any excess:
25% for funds taken as income
55% for funds taken as a lump sum
6: Taxation
Income
tax
12/4/2013
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insurance
7:26 PM
Capital gains
tax
Page 162
IHT &
trusts
Other
taxes
Tax on
investments
ISAs
Junior ISA
Key points
Not an investment, but rather a tax wrapper
Cash ISA or Stocks & Shares ISA
Annual limit on how much can be invested in ISA
(11,520 for 2013/14)
Up to 50% of this can be invested in a Cash ISA
Investments within ISA not subject to income tax
or CGT
Tax paid at source (eg, 10% tax credit on
dividends) is not recoverable
Withdrawals allowed at any time
Available since 1 November 2011:

Max. 3,720 can be invested for a child per tax
year in cash, stocks & shares (2013/14)
Holdings are not subject to income tax or CGT
Replaces the Child Trust Fund
Real Estate Investment Trusts (REITs)

Rental income and capital gains exempt within fund, but
REITs are required to distribute most rental income.
Investors are subject to income tax on distributions,
which are subject to 20% withholding tax.
Investors are also subject to CGT.
Income
tax
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insurance
7:26 PM
Capital gains
tax
Page 163
IHT &
trusts
Other
taxes
Tax on
investments
Collective investments
Unit Trusts & OEICs
In general, an authorised unit trust is treated as an investment
company, with its units being treated as shares in the company &
any distribution as a dividend. Basic principle: to make the unit trust
effectively transparent for tax purposes, with no additional tax borne
solely, because assets are held within a unit trust.
Income
Authorised and unauthorised unit trusts and OEICs pay corporation
tax at 20%. Franked income is not subject to corporation tax.
Capital gains
Authorised unit trusts & OEICs are exempt from CGT on disposals of
investments & are thus able to switch investments free of tax.
Page 163
Investment trusts (ITs)

Income
Income for an investment trust is
divided into franked investment income
(largely dividends received from other
UK companies) & unfranked income.
Franked income is not chargeable to
corporation tax, while corporation tax
is payable on unfranked income.
Capital gains
Capital gains are free from tax for
HMRC-approved ITs.
6: Taxation
Income
tax
12/4/2013
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insurance
7:26 PM
Capital gains
tax
Page 164
IHT &
trusts
Other
taxes
Tax on
investments
Distributions
Life funds
Dividend distributions from a collective

investment fund are treated like dividends for income
tax purposes.
Interest distributions are taxed as yearly interest of
the share or unit holder & tax is deducted for UK
residents.
On sale, the investor is subject to CGT (unless the
holding is within a tax wrapper).
Proceeds from a qualifying life assurance policy

are usually free of income tax & CGT.
Requirements:
Premiums paid for at least 10 years
Premiums paid at least annually
One-off or regular payments from single premium
UK life assurance policy (or life assurance bond)
usually lead to no income tax.
Up to 5% of original premium can be withdrawn per
year without incurring additional income tax liability.
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Page 165
IHT &
trusts
Other
taxes
Tax on
investments
Enterprise Investment Scheme (EIS)

Venture Capital Trusts
Investors tax liability is reduced by 30%
of the invested amount (subject to
200,000 investment maximum).
If shares are not held for 5 years, the
relief is clawed back
Dividend income is tax-free
No CGT (both within VCT and for
investor)
Page 165
Offers tax incentives to individuals to

invest in new & growing businesses
Certain unquoted
shares & AIM shares
Gains on disposals
are not taxed (if held
for 3 years)
Income tax relief given at 30%

of investment (1,000,000 max.
investment 2013/14)
6: Taxation
Income
tax
12/4/2013
National
insurance
7:26 PM
Capital gains
tax
Page 166
IHT &
trusts
Other
taxes
Tax on
investments
Offshore funds
Reporting funds
Non-reporting funds
Must notify HMRC annually of

reportable income as well as
distributed income
A fund without reporting status
Income Income tax on their share of income*

Gains
18%/28% CGT on realised gains

* Even if not distributed
Income tax**
Income tax on realised gains
** When distributed
Like earlier rules they replace, the current Offshore Funds (Taxation) Regulations 2009 seek (as above) to:
Stop investors accumulating untaxed income offshore while only paying tax on realised capital gains
Apply income tax on gains by investors in funds that roll up income
12/4/2013
7:26 PM
Notes
Page 167
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Notes
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Notes
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Notes
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Notes
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Notes
Page 172

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(000)IMC1PC_v11_FP.

Investment Management Certificate

Published November 2013

Printed in the United

Your learning materials, published by BPP Learning

The contents of this book are intended as a guide and not

BPP Learning Media Ltd

Welcome to BPP Learning Medias Investment Management Certificate Unit 1 Passcards.

Financial markets and institutions

Ethics and investment professionalism

1: Financial markets and institutions

The financial services industry plays a key role in the

Functions of financial intermediaries

Flow of funds in an open economy, showing the role of financial intermediation

1: Financial markets and institutions

UK financial services industry

Clearing banks operate the system for settling

Building societies mutual organisations

The central bank (BoE)

Employs over 1 million people in the UK

Functions of Bank of England

Banker to the central government

Monetary Policy Committee (MPC) aims to meet

1: Financial markets and institutions

Products and functions

Current accounts: non- or low interest

Life offices provide protection on death and disability,

Brokers buy and sell securities

Services may include:

Unit trusts and OEICs

Functions may be combined in

E-commerce: transacting business via the internet

Various providers collective funds

A government's fiscal policy concerns its plans

The UK has a mixed economy market-based with

Changes in the amount of money in circulation

Government spending is an injection into the

A government's fiscal stance may be neutral,

Easing of monetary policy

BoE reduces interest rates:

Tightening of monetary policy

Loans are cheaper, and so people borrow &

Loans cost more, property prices may be

Asset values rise. Eg, Government bonds (gilts)

Other asset prices may fall. Investors will

Those dependant on income from cash

Those reliant on interest for income will be

1: Financial markets and institutions

Exchange rate policy

Changes in interest rates affect exchange rates:

The European Union

The EU seeks to remove barriers to the free

EU legislation takes three forms:

The European Central Bank is the central bank for

Sell side and buy side

1: Financial markets and institutions

1: Financial markets and institutions

Order- v quote-driven markets

Exchange trading v OTC

London Stock Exchange plc

Stock Exchange members

Combined order- Quoteand quote-driven driven

LSE trading platforms

SETS (Stock Exchange Electronic Trading Service) is