UK financial services and regulation

After studying this module, you will be able to:

• state the main aims of the Financial Services Authority (FSA) and its approach to ethical conduct by firms and individuals;

• describe the FSA’s approach to regulating firms and individuals;

• explain how the FSA’s Conduct of Business rules affect the control structures of firms and their relationship with the FSA;

• explain how the FSA’s Conduct of Business rules apply to the process of advising customers;

• explain how the anti-money laundering rules apply to dealings with private and intermediate customers;

• explain the main features of the rules for dealing with complaints;

• explain how the Data Protection Act 1998 affects the provision of financial advice and the conduct of firms generally;

• state how other law and regulations impact on firms and the process of advising clients.

Section 1

The Financial Services Authority

The latter part of the 20th century saw a strong assertion, in Western societies, of the rights of the consumer. Many people believe that, as commercial organisations have become larger and larger through mergers and acquisitions, they have become more remote from their customers and more concerned with their own financial results than with the satisfaction of their customers. This is reflected in the emergence of both government-sponsored organisations, such as the Office of Fair Trading and the Competition Commission, and openly consumerist bodies such as the Consumers’ Association, publishers of ‘Which’ and ‘Money Which’ magazines.

Although some people believe that this trend to consumerism – notably in the USA – has gone too far, there is a general acceptance that protection for the consumer is both necessary and appropriate.

One of the primary objectives pursued by most modern governments is the establishment of an economic and legal environment in which a balance is established between the need for businesses to make a profit and the rights of customers to receive a fair deal. This has led to the regulation, to some degree, of most industries in the UK, but at the same time, the government recognises the right of companies to make a profit. Indeed, it recognises that it is essential that companies be permitted to make a reasonable profit; otherwise it would be impossible to attract the investment that sustains the industries on which the economy depends.

These twin objectives of a free market for business enterprise and the protection of the consumer are among the principles on which the European Union is based, and it is not surprising to discover that the furtherance of these objectives has been promoted largely through European legislation – most of which impacts, either directly or indirectly, on the UK. The force of European law can be seen in most of the recent major developments in the regulation of UK financial institutions.

Perhaps because it deals with money – a vital common denominator both in the lives of individuals and in the national economy – the financial services industry has become one of the most regulated business sectors of all. Following the establishment by the UK government in 1998 of the Financial Services Authority (FSA) as the single regulator of the financial services industry and the passing of the Financial Services and Markets Act 2000, there is no sign of a slowing down in the trend to greater supervision of the industry. Details of the nature and scope of the FSA as the regulator of the UK financial services industry are included later in this section.

Although governments try to foresee problems and to introduce legislation as a means of ‘prevention rather than cure’, it remains true that most regulatory legislation in the past has been reactive rather than proactive, in other words it has been passed in response to problems, rather than being designed to foresee and prevent problems. Legislation has often resulted from:

Now, however, there is a strong move towards a culture of recognising and preventing problems before they arise, where possible, rather than simply picking up the pieces afterwards and allocating blame and punishment (although the ability to do the latter has not been discarded). This approach is clearly illustrated by the Financial Services Authority’s stated objective of moving to a more proactive stance, and in particular its plans to base regulation on an assessment of the risk posed to consumers and to the economy by financial organisations and their products.

Government policy on the regulation of the financial services industry in the UK has, since the late 1970s, displayed what appears to be something of a paradox. There have been specific moves in what seem to be two opposite directions: in some areas, deregulation has been a key development; at the same time, many aspects of the industry have become more closely regulated. This is not, however, the contradiction it may seem to be, because the aims of both developments have been to benefit the consumer through greater choice, better service and stronger protection.

Deregulation was experienced mainly in the worlds of banking and building societies. Traditionally, banks had not been active in the mortgage market because government credit controls had severely restricted their lending activities, whereas building societies – operating under legislation, which dated in some cases from as far back as the 19th century – were restricted to lending on mortgages and to offering simple personal savings products. But the world had moved on: the increase in home ownership was creating a huge demand for mortgages and customers were demanding a much wider range of products and services from their chosen financial providers.

The deregulation introduced in the 1980s was designed to remove these barriers, enabling institutions to broaden their services and to move into new markets. The relevant changes were introduced largely through the Building Societies Act 1986 and the Banking Act 1987. The increased competition was beneficial for customers, who, in addition to having a much wider choice of both products and providers, saw a reduction in the cost of many products. The increased size and complexity of the financial marketplace, however, quickly revealed the inadequate protection afforded to customers by existing legislation. Many existing laws, such as the Prevention of Fraud (Investments) Act, were quite inadequate to deal with what was now a much more sophisticated and competitive industry.

One consequence of the circumstances described in the previous paragraph was the introduction, in the 1980s and 1990s, of a number of pieces of regulatory legislation, including the Financial Services Act 1986 which included an element of self-regulation.

By the mid-1990s, however, it was becoming clear that the self-regulation aspects of the system had not been wholly successful, and also that the overall structure of regulation was too fragmented for the increasingly integrated world of financial services. For example, many large banking groups – now providing a wide range of financial products and services – were regulated by the Bank of England and also by several other organisations in relation to fund management, investments and marketing. This led at times to confusion as to where the regulatory responsibility lay. For example, the collapse of Barings Bank in 1992 highlighted many of the anomalies, with both the Bank of England and the body then regulating stock market organisations (the Securities and Futures Authority) being criticised.

These events led to the establishment of a single regulator, the Financial Services Authority (FSA). The first major step in the development of a new regulatory regime came in June 1998, when responsibility for the regulation of the UK banking sector was transferred from the Bank of England to the FSA.

The next stage was achieved in December 2001, with the FSA then assuming regulatory responsibility for virtually the whole of the financial services industry, with effect from December 2001. A wide-ranging new Act, the Financial Services and Markets Act 2000, gave effect to the new regulatory regime, which the FSA oversees. This Act provides the legislative framework through which the FSA is able to regulate the professional and business behaviour of all parts of the industry, from the largest institutions (including around 800 insurance companies and 600 banks) to individual employees and sole traders. It covers a wide range of matters, including solvency, capital adequacy, sales and marketing practices, prevention of crime, competence of managers and sales staff, complaints and compensation. These topics are covered in subsequent Sections of these notes.

Two sectors of the industry that did not come under the wing of the FSA in 2001 were mortgages and general insurance. Regulation of mortgage sales continued on a voluntary basis, overseen by the Mortgage Code Compliance Board (MCCB). Similarly, general insurance continued to be the responsibility of the General Insurance Standards Council (GISC). These two areas, however, also came under the umbrella of the FSA with effect from October 2004 (mortgages), and from January 2005 (general insurance).

The role of the FSA is to oversee the regulation of the financial services industry in the UK. To carry out this role – so easily defined in that one sentence – requires a staff of well over 2,000 and an annual budget of over £200m. It involves the publication of a Handbook so large that, as the Director of Policy of the Association of Independent Financial Advisers pointed out, a paper version would take up the entire shelf space in most financial advisers’ offices.

The FSA is not a government department – in fact it is a limited company – but it does have statutory powers, given to it under the Banking Act 1987, the Financial Services and Markets Act 2000, and other legislation. The FSA’s Board, which makes its policy decisions, is however appointed by the Treasury, which has the overall responsibility for the UK financial services industry.

The FSA has also been given the following statutory objectives.

The performance of the FSA in regulating the industry will be judged against a set of ‘principles of good regulation’. For instance, it must be seen to be:

The FSA carries out its role by setting standards, developing rules and regulations, supervising their implementation, authorising firms and individuals, and providing guidance and training. These and other areas of FSA activity are covered in a range of Sourcebooks, which make up the Handbook. The Handbook is broadly divided into five sections.

The third section of the Handbook covers regulatory processes, including rules and guidance for firms wishing to seek authorisation, and the FSA’s enforcement powers. It also includes the Supervision Manual that sets out the way the FSA will regulate and monitor the compliance of authorised firms.

The two remaining sections of the Handbook cover:

The Handbook consists mainly of ‘rules’ and ‘guidance’, and it is important to understand the difference between them.

It would be impossible in these notes to explore every area that is covered by the FSA Handbook. The sections that follow will, however, attempt to cover the areas of greatest interest to financial advisers and mortgage advisers, in sufficient detail to enable them to carry out their activities in an efficient, safe and well-regulated manner.

The FSA's regulatory regime is based on a set of 11 Principles for Business, from which all the more precise rules and regulations follow. They apply to the behaviour of firms and of the individuals who carry out the firm’s activities. The 11 principles are:

In addition, there are seven statements of principle for members of staff who are approved persons and are carrying out controlled functions (see Section 1.13 for a definition of approved persons and controlled functions). These principles specifically stress that approved persons must, while carrying out controlled functions:

These principles are taken straight from the list of Principles for Business. In addition to these, there are three principles that apply to persons who are in positions of significant influence in a firm (ie those who carry out senior or supervisory functions). Such persons must:

In order to ensure that the principles described above are translated into a practical, properly controlled regulatory regime, the FSA has established a very large body of rules, many of which are found in the sourcebooks listed in Section 1.3.2. A selection of the important rules affecting financial advisers and mortgage advisers is included below, from Section 1.5 onwards.

The establishment of rules and regulations can, however, carry with it one very serious drawback, which is that people and organisations make it their aim to comply with the letter of the law rather than to operate according to its spirit. There is also the danger that it is sometimes possible for firms to ‘hide behind’ the rules, using loopholes or technicalities to their own advantage.

The FSA quickly became aware of this potential drawback to their complex system of rules, and has introduced an initiative known as Treating Customers Fairly (commonly referred to as TCF). The aim of the scheme, which is being treated very seriously by the FSA, is to develop a more ethical ‘frame of mind’ within the industry, leading to more ethical behaviour at every stage of firms’ and individuals’ relationships with their customers.

What exactly is meant by ‘treating customers fairly’? Clearly, it depends on the definition of ‘fair’, but the FSA has declined to supply a definition, claiming that fairness is a concept that is ‘flexible and dynamic’ and that it can ‘vary with particular circumstances’. Instead, firms will have to decide for themselves exactly what TCF means within their own context. What is clear is that the FSA intends that TCF will apply at every stage throughout the lifecycle of financial products, beginning with product design. All the stages that follow, including sales and marketing, advice and selling, administration, must also be carried out with TCF in mind – and this carries through into all post-sales activities such as claims-handling and, where necessary, dealing with complaints. The FSA has stressed that firms and employees must ‘embed the principle of treating customers fairly into the firm’s culture and day-to-day operations’.

Despite not really wishing to specify what ‘fairness’ entails, the FSA has given some guidance as to the types of behaviour it would wish to see, and has suggested a number of areas that firms should consider; these include: considering specific target markets when developing products; ensuring that communications are clear and do not mislead; honouring promises and commitments they have made; and identifying and eradicating root causes of complaints.

Responsibility for the introduction of TCF lies with a firm’s senior management, which is required to ensure that TCF is ‘built consistently into the operating model and culture of all aspects of the business’.

Individuals who wish to get to grips with this new FSA initiative, and to demonstrate their commitment to the principles of TCF, can take an appropriate examination such as the Certificate in Regulated Customer Care (CeRCC) from the ifs.

Senior managers must take responsibility for a firm’s compliance with FSA regulations and there are three particular ways in which they are required to achieve this. The exact nature of the systems and controls used by a firm to achieve this is left to the individual firm but it must be able to demonstrate that they are appropriate. The three responsibility areas that senior managers must address are as follows.

Senior managers will be held personally responsible for the firm’s activities but in many large firms it is not realistic for them to do everything themselves. They must therefore identify specific individuals within the firm to take responsibility for specific areas of activity. These individuals must be made aware of their areas of responsibility and records must be kept showing the chain of responsibility.

A firm must implement systems and controls that are ‘appropriate to its business’. These systems and controls must be clearly documented and regularly reviewed. They will relate to a wide range of the firm’s activities, including:

Firms should have procedures in place to enable employees to report serious inappropriate circumstances or behaviour within the firm, which they believe are not being addressed. Workers who wish to report their knowledge or suspicions regarding, for example, a failure by the firm to comply with legislation, have a right to protection under the Public Interest Disclosure Act 1998. The firm’s procedures should assist staff and not hinder them in the whistle-blowing process.

The FSA has established a set of criteria for determining whether an individual is a ‘fit and proper’ person to be approved to undertake a controlled function. This refers to the need for individuals to be authorised under the terms of the Financial Services and Markets Act 2000 before they can undertake certain specified jobs or activities within the financial services industry; this is described in more detail in Section 1.13.

The criteria relate to a person’s:

The FSA is committed to reducing financial crime of all kinds, in particular:

Any financial services organisation carrying on business in the UK must be authorised by the FSA if it carries out regulated activities in relation to regulated investments. Regulated activities and regulated investments are defined in Section 1.8.1.1. Similarly, individuals who carry out certain specified controlled functions also have to be authorised. This is described in Section 1.13.

The activities for which firms must be authorised were first listed in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, often referred to simply as the Regulated Activities Order, or RAO. They include:

Permission is given in the form of a list of regulated activities that the firm is allowed to carry out; it also shows the regulated investments, which the firm is allowed to deal with. The relevant section of the FSMA 2000 under which permission is granted is Part IV – as a result, this form of permission is often referred to as Part IV permission.

The RAO (see above) also defines regulated investments. They include:

The FSA defines two key categories of regulated investments: securities (such as shares, debentures and gilts), and contractually based investments (including life policies, personal pensions, options and futures).

A vital element of the work of any industry regulator is to ensure that the firms operating in the industry are prudently managed. The aim is to protect the firms themselves, their customers, and the economy, by establishing rules and principles that should ensure the continuation of a safe and efficient market, able to withstand any foreseeable problems.

One of the key areas of prudential control for financial institutions relates to their capital adequacy. There are different rules for deposit takers (eg banks and building societies), for investment firms and for life assurance companies.

Regulations about capital adequacy broadly state that institutions must have sufficient capital to make it very unlikely that deposits will be placed at risk. The meaning of ‘capital’ in this context is perhaps best illustrated by the fact that it is also sometimes referred to as ‘own funds’, that is to say the bank’s own capital base, obtained from shareholders and related sources, as distinct from funds deposited by customers.

Although generally a bank’s lending is financed by deposits, any losses made (for instance if a loan is written off because repayment cannot be obtained) should be borne by shareholders rather than by depositors. Minimum requirements for capital adequacy are therefore set, in order to protect a bank's depositors. This provides a ‘cushion’ so that depositors (whom the law seeks to protect) do not lose, whereas shareholders are expected to take risks.

The Basel Committee on Banking Supervision, a multinational body acting under the auspices of the Bank for International Settlements, first established an international framework for deposit-takers (ie principally banks) in 1988. This agreement, which – among other things – set out minimum capital requirements for banks, was commonly referred to as the Basel Accord. This has now been superseded by a new expanded Accord, commonly known as Basel II (see below).

These capital requirements are specified in terms of a bank’s solvency ratio, which means that the capital required is denominated as a proportion of the bank’s assets, with appropriate allowances made for the perceived risk level of different assets.

The solvency ratio is defined as the own funds of the institution as a percentage of the risk-adjusted value of its assets. (This reflects the very reasonable principle, mentioned earlier, that any losses made on traditional banking business – such as debts written off when borrowers default – should be carried by the institution’s shareholders and not by the investors whose deposits provide the funds which the institution lends out.) Current regulations require credit institutions to keep a solvency ratio of at least 8%. This means that their ‘own funds’ must amount to at least 8% of their risk-weighted assets (which are calculated as described below). In practice, institutions normally keep more than the required 8%.

The ‘risk weighting’ of assets is a process which is largely self-explanatory. Since the solvency ratio is designed, broadly speaking, to calculate how much an institution must hold to cover the risk of loss on its lending (its credit risk), each asset is categorised according to risk and the contribution of the less risky assets to the risk-weighted total is less than the contribution of the more risky assets. The following list of examples of percentage contributions – based on the figures specified in the Directive – should make this clear.

Under the New Basel Accord, or Basel II, the minimum capital requirements for credit risk remain broadly as described above, although there is more flexibility for the approach to reflect the business of individual institutions.

Capital requirements for operational risk are included for the first time in Basel II. Operational risk is the risk of losses from failed or inadequate internal processes, people and systems, or external events: this could include computer failure, a serious earthquake, or staff fraud. The basic approach to calculating the capital required is to multiply the institution’s gross annual income (averaged over the past three years) by 0.15. Insurance held against the events happening cannot be offset against this. For large organisations with different business lines, a more sophisticated system (called the standardised approach) can be applied, using different multiplying factors for each line.

In additional to the traditional ‘capital requirements’ approaches, Basel II introduced a more robust system of supervision. This includes the requirement for banks to carry out ‘stress tests’ to ascertain the extent to which they would have sufficient capital if certain unexpected adverse economic conditions prevailed. These supervisory processes are backed by a set of disclosure requirements to ensure that banks publish sufficient information to enable market participants to assess a bank’s risk profile and the extent of its capitalisation.

In the early 1990s, it was recognised that investment firms which are not credit institutions should have the same freedom to provide services across the frontiers of the EU as is available to banks and other credit institutions. In order to achieve fair competition on investments, a new European Directive ‘on investment services in the securities field’ was issued in 1993 and came into force in 1996. It is commonly known as the Investment Services Directive (ISD). Under the ISD, firms based in one EU state can provide investment services in other states but are generally subject to conduct of business rules imposed in the states where the business is transacted.

The ISD does not cover all investment firms or all investment services. For instance it does not apply to:

The types of investment activity covered by the ISD include:

The specified investments covered by the ISD are:

The ISD was repealed in 2004 and replaced by a new directive, generally known as ISD2. This gives investment firms the right to operate throughout the EU on the basis of a single authorisation in its home state. The aim of the directive is to make life simpler by imposing a single set of rules across the EU.

In conjunction with the Investment Services Directive described above, a second Directive was issued, setting out the requirements for capital adequacy of investment firms. Not surprisingly, it is commonly known as the Capital Adequacy Directive (CAD). The CAD established minimum capital requirements to cover market risks arising from debt, equity and related derivatives in the trading books of those credit institutions and investment companies that are subject to the provisions of the ISD.

Minimum initial capital requirements are split into two categories:

The authorities may sometimes permit firms in the first category, who only carry out transactions on behalf of clients, to temporarily hold investments on their own account, provided that the situation arises from a failure to match a client’s order precisely.

The practical applications of the ISD and the CAD were implemented in the UK through the Investment Services Regulations 1995 and through amendments to existing financial services legislation and the working practices of the regulatory bodies. The regulations continue to be applied following the passing of the Financial Services and Markets Act 2000 and the establishment of the Financial Services Authority.

Determining whether a life assurance company is solvent is a more complex process than determining solvency for most other companies – more complex even than for other financial services companies such as credit institutions. This is because the liabilities of a life assurance company relate to payments that the company may or may not have to make at unknown dates in the future, eg the death claims on life assurance policies. Determination of the current value of these future liabilities, based on estimates of future mortality rates and future interest rates, is the province of actuaries. Although the valuation liabilities (known in Life Directive, issued by the EU in 2002, as mathematical provisions) must continue to be assessed according to the professional judgment of the actuarial profession, the Directive sets out principles designed to harmonise the sometimes very technical methods and calculations used.

The Directive requires that life assurance companies must maintain an ‘adequate’ solvency margin at all times in respect of its entire business. The solvency margin is the excess of the company’s assets over its mathematical provisions (the discounted current value of its liabilities).

An ‘adequate’ solvency margin means a margin which is at least equal to that prescribed in the Directive. The regulations are complex and the detail is beyond the scope of these notes, but the basic rule is that for policies which carry an investment risk (such as endowment assurances), the required minimum solvency margin is 4% of the mathematical provisions – in other words, the value of a life company’s assets must be at least 104% of the value of its liabilities. For policies with no investment risks (such as term assurance), the percentages are less. This reflects the fact that actuaries can be more confident about future mortality rates than about future yields on investments.

The ‘competent authorities’ in individual EU states (eg the FSA in the UK) can, in extreme circumstances, relax the rules on a temporary basis if they feel it is appropriate to do so. In early 2003, in the wake of a deep and continuing fall in the value of stock market securities, the FSA indicated that it would not take action against life assurance companies which had become, or were in danger of becoming, technically insolvent under the 4% rule, provided that they could show that they were taking steps to rectify the situation. This would normally mean taking action to reduce their prospective liabilities, for instance by reducing the levels of their annual bonuses and terminal bonuses on with-profits policies.

The Directive also sets out the types of assets that can be used to represent a company’s solvency margin, including:

The FSA has made it clear that its approach will be radically different from that of earlier regulators. In particular, it will:

It also recognises that regulation has to be built on realistic aims, and has stated that it will not aim to prevent all failure. It stresses not only the responsibilities of firms' own managements in this regard, but also the need for consumers to take some responsibility for their own decisions. This appears to be a tacit admission that there is a danger in the 21st century of consumerism going too far and eventually acting to the detriment both of providers and of consumers themselves.

The FSA claims that its new approach will ‘integrate and simplify’ the different approaches employed by its predecessors. These are early days, and it remains to be seen whether regulation of the different sectors of the industry can actually be achieved under an integrated system. Many practitioners and commentators, however, feel that simplicity has not been – and is unlikely to be – achieved.

The integrated approach is based on systems and controls that reflect the risk factors involved rather than the business sector from which the firm comes – reflecting the fact that many firms now operate across a wide range of product areas.

The FSA has listed the main risks that financial services consumers face as follows.

The FSA aims to reduce prudential and bad faith risks, and possibly some aspects of complexity/unsuitability risk, but is not responsible for protecting consumers from performance risk. This is reflected in the fact that the industry’s consumer protection schemes do not, for example, protect investors who have lost money because of a fall in stock market prices. The FSA will, however, aim to educate consumers about opportunities, risks and potential rewards.

The FSA's risk-based approach seeks to identify risks, which may prevent it from achieving its objectives, to assess those risks, and to prioritise them. The risks may arise from a number of different areas, for instance firm-specific risks, product-specific risks, and macro-economic risks.

Assessment of risks is a complex process, but the following illustration may help to clarify the FSA's approach (which is set out in more detail in its booklet ‘A new regulator for the new millennium’). Consider a firm-specific risk, for instance the risk of a particular firm collapsing. The overall level of risk is defined by the FSA as being a combination of probability factors and impact factors. This reflects the fact that the seriousness of a problem depends both on the chance of it happening and on the effects of it happening.

This risk assessment process will be applied to all firms and will determine how closely supervised each firm will be. The FSA allocates each institution to one of four ‘impact’ bands: category A is high risk, categories B and C are medium risk, and D is low risk. Initial investigations suggest that less than 1% of institutions fall into category A (high risk), whereas the great majority are category D. It has been estimated that – not surprisingly – high impact firms have on average about 65% of market share; the collapse of a large organisation clearly has greater overall impact than the collapse of a small one.

Although the FSA has said that it aims to be proactive rather than reactive in its activities, there will undoubtedly be occasions when it needs to investigate situations in which it believes that the regulations have been broken, and possibly to discipline organisations or individuals.

The FSA is empowered to undertake general investigations into the business of authorised persons by looking at the business as a whole or at particular aspects of that business.

The FSA is also empowered to undertake specific investigations if they have specific suspicions about the activities or behaviour of an authorised person. The circumstances under which this might occur cover a wide range of situations. They might, for example, include suspicion of:

The person who is appointed to carry out the investigation on their behalf has the power to:

If there are reasonable grounds for believing that someone has not complied with the requirement to provide information or documents, the FSA can apply to a Justice of the Peace for a search warrant to enter a property and seize documents or take copies.

If the FSA is satisfied that it has discovered a contravention of its rules, it has a number of steps that it can take, depending on its view of the nature and/or the severity of the contravention. Some of these are described below.

The Conduct of Business Sourcebook is part of the FSA Handbook. It draws on the principles established in the FSA’s Principles for Business (and elsewhere), and sets out in more detail the rules by which approved persons must operate when carrying out their controlled functions.

There is a very wide range of rules covered in this Sourcebook (and in others). In the remainder of this section we will look at some rules that have particular relevance to advisers.

Any person working in an authorised firm who carries out a controlled function, must be approved by the FSA. Approved persons are always approved to carry out a specific controlled function or functions.

The concept of approved persons is designed to cover all areas of financial services and all types of functions, so some controlled functions will not apply in all areas. Nevertheless, for completeness, the full list of controlled functions is set out below. They are sub-divided into five categories.

These are the people who run the business, even those who do not necessarily do so on a day-to-day basis such as non-executive directors and sleeping partners:

These functions, and the significant management functions (see below) are often carried out by people who also carry out governing functions – if so, they do not require separate approval for systems and control functions:

These are split into the management of:

These are in essence the roles that involve giving advice to clients:

A financial promotion is defined as an ‘invitation or inducement to engage in investment activity’. This includes:

Financial promotions can be ‘communicated’ only if they have been prepared, or approved, by an authorised person.

There is a distinction between:

Examples of the rules applying to advertisements and other financial promotions are as follows.

There are particular rules about unsolicited real time promotions, for instance:

The maintenance of clear and readily accessible records is vital at all stages of the relationships between financial services professionals, their clients and the FSA, from details of advertisements to information collected in factfinds to the reasons for advice given and beyond. Record-keeping requirements for the different stages can be found at appropriate points within the Conduct of Business Sourcebook, with details of what must be kept and the minimum period for which it must be retained. Details of record-keeping requirements are given where relevant in other sections of these notes; for example, details of training and competence records are included in Section 1.16 below.

There are many business reasons for maintaining good records. From a regulatory point of view, the most important reason is to be able to demonstrate compliance with the regulations.

Records can be kept in any appropriate format, which, of course, includes storage on computer, although the rules say that records stored on computer must be ‘capable of being reproduced on paper in English’. Firms are expected to take reasonable steps to protect their records from destruction, unauthorised access and alteration.

The FSA’s philosophy of regulation is to be proactive rather than reactive; in other words – as far as possible – to prevent problems from arising rather than simply to deal with problems which have arisen. There is little doubt that one of the major steps towards the achievement of this objective lies in the attainment of high levels of knowledge and ability among financial services staff, and this is reflected in the importance, which the FSA places on training and competence.

The FSA has published a Training and Competence Sourcebook (as part of its overall Handbook). The Sourcebook requires firms to make certain commitments regarding the competence of all persons who are employed in controlled functions (see Section 1.13) but is particularly prescriptive in relation to three types of employees, for whom it sets out detailed training and competence rules. These are:

These training and competence rules fall into the following categories.

Firms must check that individuals being recruited for a particular post have the knowledge, skills and examination passes appropriate to that particular post. This means, for instance, that firms, as well as researching the applicant’s background, must also have a clear job description for the post, specifying the knowledge, skills and examination achievement required for the job.

If a new recruit has no industry background, then full training must be given. If on the other hand, he has been assessed as competent by a recent previous employer, there are transition rules allowing recognition of this prior competence; this means that he can be initially assessed as competent by his new employer on the basis of his existing skills and experience, provided that he will be carrying out substantially the same role as before.

Firms must, at appropriate intervals, determine each employee’s training needs, and must organise training, which is appropriate and timely. The success of the training in achieving its objectives must be evaluated.

Employees must not be allowed to engage in carrying out any of the activities covered by these rules unless they have been assessed as competent in that activity. A firm that permits an employee to engage in an activity with or for a private customer under supervision must ensure that:

(b) the firm has satisfied itself that the employee has an adequate level of knowledge and skills to act with or for private customers while under supervision.

Approved persons who carry out certain controlled functions are required to achieve a pass in an ‘appropriate examination’ as part of the demonstration of their competence to carry out the function. Lists of appropriate examinations for different functions are held by the Financial Services Skills Council (FSSC). The FSSC sets the standards for appropriate examinations; awarding bodies submit proposals for particular examinations. When these are accredited, they are added to the lists.

The Certificate for Financial Advisers (CeFA^®), the Certificate in Mortgage Advice and Practice (CeMAP^®) are examples of appropriate examinations for financial advisers and for mortgage advisers respectively.

As well as ensuring that employees become competent, firms must have definite arrangements in place for ensuring that they remain competent. Although there is no specified minimum for the time that should be spent on continuing professional development (CPD), employees should take steps to refresh and expand their knowledge and skills levels. Some practitioners suggest that around 50 hours per annum may be appropriate. Methods used may include training courses, private study, conferences or any other activity, which is appropriate to the role and the needs of the employee.

Firms must maintain records showing how and when employees’ competence has been and is being assessed. All records relating to training and competence of individual employees must be retained for at least three years after they leave the firm. For pensions transfer specialists, records must be kept indefinitely.

Typical records might include some or all of the following:

The FSA’s Conduct of Business Sourcebook covers a variety of aspects of business behaviour within the financial services industry, but one particular section of the Sourcebook is of special relevance to financial advisers. This is Part 5, which relates to advising and selling.

It covers the relationship between the adviser and the client, the independence (or not) of the adviser, the collecting of information, the requirement to give suitable advice and to clearly describe the nature of the products, the opportunity to withdraw from the contract, and the question of the adviser’s remuneration.

These topics are dealt with in Section 1.18.

All advisers are required to have a written agreement with the client, which sets out the basis of their business relationship. In most cases this takes the form of a terms of business letter, issued separately or included as part of an Initial Disclosure Document (IDD see – Section 1.20.3).

All new clients must be informed of the terms of business before any information is sought or advice given. If the business transaction results from an off-the-page advertisement, the terms of business can be sent with the first response.

A terms of business letter is not required if:

The terms of business will typically address the following key issues:

A client agreement extends the terms of business by including additional elements. It is required when the service to be provided by the firm includes higher risk investment business such as discretionary investment management services (see below) and transactions in certain types of financial derivatives (futures and options). A client agreement would not usually be required for advisory services involving life policies, pensions and unit trusts.

The agreement reflects the fact that the customer is placing an increased reliance on the adviser’s advice and service. Issues that it addresses may include:

This agreement is necessary when a client allows the adviser discretion over investment choice, for instance where the adviser is handling a portfolio of investments and can change or switch them without the client’s individual agreement to every separate transaction.

It is a customer agreement with additional features. In particular, it must specify the limits of discretion within which the adviser can operate in his capacity as investment manager.

One of the significant concepts introduced by the Financial Services Act 1986 was polarisation, which meant that all advisers have to be either independent or tied, and that they must make their status clear to clients before giving any advice.

By the end of the 1990s, however, it was becoming clear that the polarisation regime was no longer the ideal way of protecting the customer against the danger of ‘commission bias’ (ie the tendency of advisers to recommend products which pay larger commissions).

In January 2002, the FSA issued a consultation paper (‘Reforming Polarisation – Making the Market Work for the Consumer’) that effectively signalled the end of polarisation by proposing that the status of advisers should simply be a matter of disclosure to the customer. A broader range of types of status would be permitted, provided that customers are made aware of precisely what products are available, where they are being sourced from, exactly how the adviser will be remunerated and what the level of that remuneration might be.

The new regime, known as depolarisation, came into effect on 1 December 2004, and will be fully operative from 1 June 2005. The two major innovations of the new system are:

• the change from two to three basic types of status for advisers (described below);
• a new way of determining and explaining the way in which clients pay for advice (see Section 1.20.2).

Under the new rules, advisers are permitted to operate in one of three categories:

• fully independent advisers, who offer products from across the whole of the market. In practice – because of the huge size of the marketplace – independent advisers will be allowed to select from a smaller ‘panel’ of product providers; this panel must, however, include a range of providers sufficient to reflect the spread of products available across the market.
• advisers who offer products from a limited range of specified providers. This system is commonly known as ‘multi-tie’.
• advisers who are tied to only one provider (or a linked group of providers known as a ‘marketing group’ – normally all subsidiaries of one organisation). They will offer only products from that company or group.

Advisers are obliged to specify to their clients, before any business is discussed, the category in which they operate.

The FSA claims that the new system will increase the range of products available to consumers and make the process of buying financial products clearer – though it has to be said that initial reactions from consumer bodies suggests that they believe customers will not find the process to be any clearer than before.

Customers will receive two important disclosure documents that the FSA have ‘branded’ as keyfacts documents. The first, ‘keyfacts about our services’, is the initial disclosure document described earlier, and tells the customer about the type of advice offered and the range of products available. The second document, ‘keyfacts about the cost of our services’ is commonly known as the ‘menu’, and is described in Section 1.20.2 below.

All advisers must give to clients a document entitled ‘Key facts about the cost of our services’ at the beginning of any consultation, which may result in the giving of advice. The guide will include information explaining:

Advisers who class themselves as independent will have to be a whole of market firm (ie offer advice across the whole market or a specified sector of the market) and will have to offer (but not necessarily insist on) a fee-based option.

The ‘menu document’ described above will be provided to customers alongside an Initial Disclosure Document, which will set out the key facts about the firm and its services in a standard format. The information contained in this document will include:

An adviser must not give investment advice to a client unless he has fully ascertained the client’s personal and financial circumstances that are relevant to the services that the adviser has agreed to provide.

This process is carried out by the completion of a confidential client information questionnaire, commonly known as a factfind. There is no prescribed format for this document. The information gathered normally includes the following details about the client, spouse, children and other dependants.

The ‘know your customer’ rules specifically require advisers to take all reasonable steps to ensure that the client understands the nature of any risks implicit in the product proposed. Examples are: whether or not the customer’s capital will be returned in full; or whether or not the level of life cover is sustainable for the duration of the term without an increase in premiums. These requirements must take due regard of the investor’s experience and knowledge of the type of investment under consideration.

Advisers must also determine the customer’s risk profile: in other words, how much risk, if any, is the customer willing to take with his capital?

The information obtained must be retained for a specified period of time, depending on the nature of the product recommended. These periods are:

In practice’ advisers will wish to retain the information in all cases for as long as they believe they may be required to justify the advice and recommendations given.

Advisers must recommend the product or service, which is most suitable for the client, based on the information supplied by the client and on anything else about the client that the adviser should reasonably be aware of. The recommendation must be solely in the best interests of the client and it goes without saying that, for instance, no account should be taken of the commission that might be payable to the adviser.

A suitability letter explains why the particular product recommended is suitable for the client based on his particular personal and financial circumstances, his needs and priorities as identified through the fact-finding process, and his attitude to risk (both in general terms and in relation to the specific recommendation made). It should be clear and concise and written in plain English, and must be signed by a person who is authorised to advise on the type of product recommended.

Suitability letters are required for:

A suitability letter should be provided as soon as possible after the transaction has been effected, and no later than the date when the cancellation notice is issued to the client (see below).

Some transactions with some customers may be carried out on an execution-only basis, which means that, rather than wanting an adviser to make recommendations, the customer instructs him to effect a specific transaction on his behalf, detailing in full the nature of the product required.

For an execution-only transaction, the adviser’s duty of care to fully explain the nature of the transaction and risks involved does not apply. The customer is acting entirely on his own responsibility.

Advisers who deal with this type of client are required to obtain the client’s signature confirming that the transaction is execution-only. Moreover, where a non-execution-only client wishes to effect a transaction that contravenes any advice given, the adviser will commonly require the client to sign to that effect.

It is expected that only a very small proportion of any adviser’s cases would be on an execution-only basis.

The rules specifically require that charges to clients must not be excessive. In determining what constitutes excessive charges, advisers should consider:

When an adviser transacts designated investment business for a client, the basis or amount of the charges must be disclosed in writing before the business is transacted. This is normally done in the terms of business letter.

If the product being recommended is a life policy, the adviser must disclose in cash terms the amount of commission that would be received.

Advisers who advise on or sell packaged products (eg life policies, pension policies, unit trusts and investment trusts) must provide clients with written details of the key features of a product, before the sale is concluded. Although it is the adviser’s responsibility to provide the documents, the product providers usually prepare the papers. It is a requirement that key features documents should be of the same quality as the materials used for marketing purposes.

The format for supplying the information is specified by the FSA and cannot normally be changed. The rules on what must be included are very detailed, but as a broad guide, a key features document will cover the following issues:

Sometimes known as a cooling-off notice, the statutory cancellation notice reminds clients of their right to withdraw from the contract within a specified period of receiving the notice. This time period is most commonly 14 days and runs from the date on which the client received the cancellation notice. The notice must be sent by post direct from the product provider to the client.

The customer can withdraw from the contract at any time during the cooling-off period, without any commitment or loss, by returning the signed cancellation notice to the product provider.

Generally the customer will receive a full refund of any premiums paid if they cancel the contract during this period. The exception to this is where the customer cancels a lump sum unit-linked investment where the money has been invested and the value of the investment has fallen. Under these circumstances the customer is entitled to a refund of the reduced investment; no charges can be taken but an adjustment can be made to reflect the fact that the value of the lump sum has fallen. This risk should be explained to the customer before the contract is effected.

In 2001, the government asked Ron Sandler to:

His report suggested that there were three main reasons why the industry seemed to be failing to serve large sections of the population who have urgent and genuine financial needs that they are failing to satisfy. The government are, of course, particularly concerned about the so-called savings gap, that is the failure of many people to provide for themselves adequate funds for their retirement. The report mentioned:

Sandler suggested the development of a suite of simple, low-cost, risk-controlled products that would appeal to a target audience comprising the less financially sophisticated. The phrase ‘stakeholder’ was coined to describe such products – indeed it had already been introduced with the concept of stakeholder pensions (see Section 3.6.3 of Unit 1), although they are more commonly referred to, for obvious reasons, as ‘Sandler’ products.

It was felt that a simpler sales regime would require less complex regulation, thereby reducing costs. In addition to this, more direct cost-reducing measures were suggested, including a cap on charges. After considerable heated debate about the appropriate level for charges, the maximum permitted annual charge for the investment products was set at 1.5%.

The suite of stakeholder products includes five types of product, namely:

• a cash deposit, similar to a cash ISA. The interest rate will be within 1% of the Bank of England base rate, and the minimum deposit is not more than £10;
• a medium term investment product, related to collective investment schemes such as unit trusts and OEICs;
• a smoothed investment fund;
• the stakeholder pension;
• the child trust fund.

Controlling the risk is also an important part of the process of attracting investors who may have been put off by the large stock market falls of recent years. This is achieved by limiting the proportion of shares in the stakeholder unit-linked and with-profits products to 60% of the funds. The remainder must be invested in fixed interest securities and cash.

A simplified selling model will apply to these products, with the exception of the smoothed investment fund. The rules for this simplified selling process are included in a new chapter (5A) in the Conduct of Business Sourcebook, and can be summarised as follows.

• The adviser should explain the nature of stakeholder (‘Sandler suite’) products, and that only basic advice will be given.
• The sales process will be based on a series of short scripted questions in plain language.
• The assessment as to whether a stakeholder product is suitable will be based only on information disclosed by the questions, and will not involve a detailed assessment of the customer’s needs. However:

• the customer’s savings and investment objectives should be ascertained (eg saving for retirement, specific sum required, early access required);
• the customer’s willingness to accept risk should be ascertained, as this may determine which product might be suitable.

• The process should be terminated at any stage if (i) the customer requests it, (ii) the adviser believes there is no likelihood of any stakeholder product being suitable or (iii) it appears that the customer is unlikely to be able to afford a stakeholder product.
• An assessment should be made of the customer’s other financial needs and priorities (eg family protection or the need to reduce a debt) – and if necessary the customer should be clearly informed of the desirability of meeting the other priorities first.

• If the customer appears to be ‘significantly’ in debt (eg unsecured debt repayments exceed 20% of gross income), a stronger warning of the desirability of addressing the debt should be given.

• Additional rules apply to stakeholder pensions, which should not be recommended if the adviser believes there are better options for the customer (eg he could contribute to an occupational scheme).

The FSA took over the regulation of mortgage advice and sales with effect from 31 October 2004.

Prior to that date, regulation was on a voluntary basis under the terms of the Mortgage Code, a code of practice established by the Council of Mortgage Lenders (CML) and overseen by the Mortgage Code Compliance Board.

The FSA’s rules relate to loans taken out by individuals or trustees, which are subject to a first charge on the borrower’s property. This will include not only mortgages but also other loans where the security is a first charge on residential property.

Second mortgages and other second-charge loans are not covered. The property must be in the UK and it must be residential to the extent that the borrower or their immediate family must occupy at least 40% of the property. This means the new regime will cover home improvement loans, debt consolidation loans and equity release schemes such as home income plans, but that buy-to-let mortgages will not normally be covered.

The rules cover lending, administration, advice and the arranging of loans. Banks, building societies, specialist lenders and mortgage intermediaries will need authorisation.

The sales process must distinguish – as it did under the Mortgage Code – between on the one hand cases where advice is given; and on the other hand those where only information is given and a series of pre-determined questions is used as a ‘filter’ through which a client can narrow down the selection of mortgages. In the latter case, sales staff would have to ensure they did not stray into the area of giving advice.

Where advice is given, it must be based not only on a consideration of which mortgage best suits the client’s needs, but also on the affordability of the scheme for that client. This might include, for instance, recognising the impact of any possible increase in interest rates on a variable rate mortgage. Determination of the suitability of a mortgage involves three stages:

There is no requirement to issue a suitability letter to the client, but advisers may do so if they wish. It is important for advisers to keep their own record of why a recommendation made meets the FSA’s suitability requirements.

The FSA’s detailed rules for mortgage regulation are contained in the Mortgage Conduct of Business (MCOB) rulebook. A brief summary of the contents of the MCOB rules is given below.

Information about mortgages will have to be set out clearly and in a prescribed format to enable clients not only to understand the terms of the mortgage but also to compare it with other mortgages.

• An initial disclosure document (IDD) must be given out on first meeting the client. This describes the services that the adviser offers, and also covers other factors, as described in Section 1.20.3.
• A personalised key facts illustration (KFI) must be given to a client before the client completes the mortgage application form. This document sets out product information in a standardised format, making it easier for clients to compare and contrast different mortgages. This format is prescribed by the FSA and includes the following sections:

• confirmation that all lenders are required to provide such an illustration;
• details of the service being provided: advice, or merely information;
• summary of information provided by the prospective borrower;
• description of the mortgage;
• total costs of the mortgage, and monthly repayments;
• information about the risks, eg what happens if interest rates rise;
• fees payable;
• compulsory or optional insurance;
• early repayment charges;
• additional features such as overpayment/underpayment/linked accounts;
• contact points and sources of additional information.

KFIs will also be issued if the client asks for a further advance or for the addition or removal of a party to the mortgage. For other variations to the mortgage (eg changing the term), certain specified items of key information must be given out, but not necessarily in a standard KFI format.

For lifetime mortgages (the FSA’s new name for home income plans), there are additional elements in the sales process, designed to ensure that the client understands the nature of the product and the additional risks it entails: for example, an adviser must consider whether taking out a lifetime mortgage would adversely affect a customer’s entitlement to means-tested benefits, or to age-related personal allowances. The adviser must also check whether a customer has plans to leave his property to his family.

The rules will also contain other elements designed to protect the client from unfair practices such as excessive charges and misleading advertising:

• cold calling, by visit, telephone call or other interactive means, will not be permitted for mortgage sales unless the customer has stated that he is willing to receive unsolicited calls. Such calls can only be made between 9.00am and 9.00pm Monday to Saturday;
• excessive fees for advising on or arranging mortgages are not permitted;
• payments by way of fees or commission must be declared in the key facts illustration;
• any fees for advising on or arranging the mortgage must be included in the calculation of APR.

There are detailed rules for non-real time promotions (ie by letter, e-mail or in advertisements in the press, on the Internet, or on television or radio). They must be clear, fair and not misleading. If they include comparisons with competitors, they must show a realistic like-for-like comparison and must not create confusion or denigrate the competitor.

Advisers must meet the FSA’s normal training and competence requirements (see Section 1.16). These are found in the Training and Competence Sourcebook rather than the MCOB rules, but they apply equally to mortgage advisers. Firms must ensure that their employees are competent for the work they do, and that they remain competent.

Advisers who met the training and competence requirements of the Mortgage Code Compliance Board under the previous voluntary regulatory regime are permitted to continue advising on standard mortgages under the new FSA rules.

For advisers dealing with lifetime mortgages, there are additional training and competence requirements.

Mortgage advisers, arrangers and lenders will come under the scope of the Financial Ombudsman Service (see Section 3.2) and the Financial Services Compensation Scheme (see Section 3.3).

With effect from January 2005, the FSA has responsibility for regulating activities relating to general insurance and other protection products. This move was prompted, in part, by the need to implement the terms of the EU Directive on insurance mediation, which was designed to open and standardise the market for insurance intermediaries throughout the European Union. The new regulatory regime does, however, apply to product providers (insurance companies) as well as intermediaries.

The new regulatory regime will be similar to the existing regulation of long-term insurance contracts (ie life policies). Firms and individuals working in the areas of general insurance, protection, critical illness, long term care and permanent health insurance will have to be authorised through the same processes of permission and approval as apply to the remainder of the industry.

Rules applicable to intermediaries who sell, administer or advise on general insurance are contained in a new FSA rulebook known as the Insurance Conduct of Business (ICOB) Sourcebook. The ICOB rules are split into a number of sections; the contents of the main sections are summarised below:

ICOB 1: The scope of the rules. This explains which firms the rules apply to and what types of activities are covered. The rules cover intermediaries who deal with retail customers and commercial customers for the sale of ‘non-investment’ insurance contracts (eg endowment policies are excluded).

ICOB 2: General rules. This section covers rules on communications, which must be clear, fair and not misleading, and on inducements and record-keeping.

ICOB 3: Financial promotions. Advertisements must be clear, fair and not misleading. This means, amongst other things, that: expressions of opinion should be fair representations, and it should be clear if the person quoted has a connection with the firm; it should be made clear if price quotations are estimates only and not precise figures; any mention of reduced premiums should make it clear in what circumstances the reduction is available, and what limitations are involved.

ICOB 4: Advising and selling standards. This is a particularly important section, dealing in some detail with the initial and ongoing relationship with the customer. The main elements are:

Information on status: This includes details of the firm’s regulatory status (ie authorised and regulated by the FSA); whether products are offered from the whole market, a range of providers, or just one provider; details of how to complain, and details of compensation arrangements. This information can be provided in an Initial Disclosure Document (IDD). If both mortgage and insurance products are offered, information about both can be included in a Combined Initial Disclosure Document (CIDD).

Fees: Details of any fees charged by the intermediary must be disclosed before the contract begins, including any fees that may be charged later in the term of the contract.

Suitability of advice: When a personal recommendation is made, the contract recommended must be suitable for the customer’s demands and needs. This must be confirmed by issuing a demands and needs statement that details the customers demands and needs and explains why the particular product recommendation has been made.

Excessive charges: Charges must not be excessive in relation to charges for similar services offered by others in the market.

Unsolicited services: Automatic renewal of contracts on behalf of customers must not be carried out unless the customer has given prior consent to this.

ICOB 5: Product disclosure. This covers the content of product information and when it must be provided. It is the intermediary’s responsibility to provide product information to customers, but insurance companies regulated by the FSA must provide the intermediary with adequate information to enable the intermediary to do so. Details are included of the information that must be given to customers, particularly before and after a sale and on renewal. This includes information about the terms of a contract, price, cancellation rights and claims handling.

A policy summary must be given to all customers. It must include the ‘keyfacts’ logo, the main features of the policy, and any significant exclusions or limitations.

ICOB 6: Cancellation. This section sets out the cancellation rights of retail customers. The cancellation rights themselves are offered by the product provider, but intermediaries must be aware of them as it is their responsibility to inform customers of their cancellation rights. For general insurance, the cancellation period is 14 days, whilst for pure protection contracts (eg critical illness cover) the period is 30 days.

If a customer cancels, the insurance company must return any sums paid to it within 30 days of cancellation. For general insurance contracts, the company can deduct any reasonable and genuinely incurred costs including a charge for time on risk, but the company must not make a profit and the amount retained must not be capable of being interpreted as a penalty.

ICOB 7: Claims handling: If the intermediary acts on behalf of the insurance company in handling a claim on their behalf, the insurance company is responsible for ensuring that the rules are complied with. If the intermediary were to act on behalf of both the insurance company and the customer for whom he arranged the policy that would be construed as a conflict of interest. In the event of a conflict of interest, it is necessary for the intermediary to tell the customer and ask for their consent to continue acting for them. If this is not possible, or the consent is not given, then the intermediary must withdraw from acting for one of the parties.

Section 2

Money laundering

The prevention of the use of financial systems for money laundering purposes has, for many years, been a key objective of most national, European and international communities. In 1987, the Financial Action Task Force on Money Laundering (FATF) was created as a major international body dedicated to the fight against criminal money. The FATF has over 30 members including the European Commission and many of the EU member states.

One indication of the scale of the problem is that the number of suspicious transactions reported by UK companies to the National Criminal Intelligence Service (NCIS) is currently around 50,000 per annum.

Because money laundering is such a high profile issue, it will be dealt with in some detail in the following sections.

The UK’s laws and regulations about money laundering were developed in a number of Acts and Amendments over a period of more than 15 years before they were consolidated in the Proceeds of Crime Act 2002. The 2002 Act no longer separates the proceeds of drug-related crimes from others, and deals with the laundering of the proceeds of all forms of crime. In particular, in relation to report suspicions about money laundering, the new Act extends this to laundering the proceeds of all forms of crime, where previously it had been restricted to drugs or terrorism offences.

Important elements of this legislation are described in more detail in the following sections.

Money laundering can be defined as the process of filtering the proceeds of criminal activity through a series of accounts or other financial products in order to give it apparent legitimacy or to make its origins difficult to trace.

In 1991, the European Union issued a Directive on the prevention of money laundering. In that Directive, money laundering is defined in some detail. It is said to comprise ‘the following conduct when committed intentionally’:

Two more important definitions were included, in order to clarify the definition of money laundering given above. They are:

The Directive makes the point that money laundering within the EU will still be treated under EU money laundering rules, even when the activities that generated the property to be laundered took place in a non-EU country.

Under the Proceeds of Crime Act 2002 there are three principal money laundering offences:

These definitions lead to a number of practical procedures designed to ensure that persons working in the financial services industry do not become ‘involved’ in money laundering. The rules require that all authorised firms must:

Contravention of any of the money laundering rules is a criminal offence.

Two areas of particular concern to financial advisers are failure to disclose and tipping off.

All suspicions of money laundering must be reported to the authorities. The Proceeds of Crime Act 2002 introduced the requirement for a person to disclose information about money laundering if he has ‘reasonable grounds’ for knowing or suspecting that someone is engaged in money laundering. The FSA will determine this on the basis of whether a reasonable professional should have known – so the importance of good quality appropriate training of staff is obvious.

It is also an offence to disclose to a person who is suspected of money laundering that an investigation is being, or may be, carried out.

When assessing a firm’s compliance with its money laundering requirements, the FSA will take into account the extent to which the firm has followed:

One of the most important elements in the financial service industry’s action against money laundering is the process of confirming the identity of customers.

Evidence of identification is required in the following cases:

Evidence of identification must be obtained in every case where there is suspicion of money laundering. If there is suspicion that the applicant may not be acting on his own behalf, reasonable measures must be taken to identify the person on whose behalf the applicant is acting.

If a client is introduced to the firm by a financial intermediary or other authorised firm, it is permissible to accept the written assurance of the intermediary that he has obtained sufficient evidence of identity. This is clearly important to, for instance, financial advisers and mortgage advisers. Many will use a standard format for giving the required confirmation, such as that developed by the Association of Independent Financial Advisers.

The definition of what constitutes satisfactory evidence of identity is rather vague – it requires that it should be reasonably capable of establishing that the applicant is the person that he claims to be, to the satisfaction of the person who obtains the evidence. Acceptable forms of identification include:

The FSA’s own guidance on ‘financial exclusion’ is mentioned above. This guidance helps firms to ensure that, where people cannot reasonably be expected to produce detailed evidence of identity, they are not denied access to appropriate financial services. The FSA cites the example of a person who does not have a passport or driving licence, and whose name does not appear on utility bills. In such circumstances, the FSA considers that a firm may accept, as evidence of the customer’s identification, a letter or statement from a person in a position of responsibility (such as a solicitor, doctor, or minister of religion) who knows the client.

Institutions must keep appropriate records for use as evidence in any investigation into money laundering. This means that:

Each firm must appoint a Money Laundering Reporting Officer (MLRO), a person of ‘appropriate seniority’ who will co-ordinate all the firm’s anti-money laundering activities.

All members of staff must make a report to the MLRO if they know or suspect that a client is engaged in money laundering. The MLRO will then determine whether to report this to the National Criminal Intelligence Service (NCIS), using known information about the financial circumstances of the client and the nature of the business being transacted.

At least once in each calendar year senior management of the firm must requisition a report from the Money Laundering Reporting Office. This report must:

A firm’s senior management must consider this report and must take any action necessary to solve any problems identified in it.

Firms are required to:

In particular, staff should be made aware of the following aspects:

Training should be given on a regular basis throughout the time when the individual handles transactions that could lead to money laundering.

The FSA can discipline firms and individuals for breaches of its money laundering rules, as described in Section 1.11. It also has the power to prosecute anyone who breaks the Money Laundering Regulations established under UK law to give effect to the EU Money Laundering Directives.

The penalties are severe. Anyone convicted of concealing, arranging or acquiring (see Section 2.4) could be sentenced to up to 14 years’ imprisonment or an unlimited fine, or both. The offence of failing to disclose or of tipping off carries a prison sentence of up to five years or an unlimited fine, or both.

Section 3

Complaints and compensation

The Financial Services and Markets Act 2000, consolidating and enhancing the arrangements under the previous regulatory regime, introduced new rules on complaint-handling arrangements. The rules require firms to deal properly and promptly with consumer complaints. The key requirements for firms' complaints procedures are that firms must:

Complaints may be received orally (in person or by telephone) or in writing. In either case, the complaint should be acknowledged in writing within five working days. Complaints covered by the FSA rules are those that are received from eligible complainants, which means:

It is also necessary to distinguish between soft and hard complaints. Hard complaints are those involving ‘an allegation that the complainant has suffered financial loss, material distress or material inconvenience’. The other (soft) complaints are, for the most part, subject to the same rules as hard complaints – the only difference is that they are not subject to the usual deadlines, and they do not have to be reported to the FSA.

All complaints must be promptly and thoroughly investigated by a person of sufficient competence who, wherever possible, was not directly involved in the matter under complaint. The overall aim should be to ensure that any specific problem identified by the complainant is remedied.

The firm’s response to the complainant is in the form of a final response letter, which must ‘adequately address the subject matter of the complaint’. It must also inform the complainant that, if he is not satisfied, he can refer his complaint to the Financial Ombudsman Service within six months of the date of the letter.

If the final response letter cannot be issued within four weeks of receiving the complaint, an interim letter must be sent explaining the cause of the delay. If after eight weeks, a final response still cannot be given, a further letter must be sent, this time also telling the client that he can refer the matter to the Financial Ombudsman Service if he is dissatisfied with the delay.

Records of hard complaints have to be retained for at least three years.

Six-monthly reports about hard complaints are required, showing how many complaints were satisfactorily concluded within four weeks, between four and eight weeks, and after more than eight weeks.

The FSMA 2000 provides for a mechanism under which ‘certain disputes may be resolved quickly and with the minimum of formality by an independent person’. The concept of an ombudsman, as a person or organisation providing an independent facility for the resolution of complaints and disputes relating to public bodies and commercial organisations, has, of course, been with us for many years. Indeed, in the past, a number of separate ombudsman bureaux have operated in the financial services marketplace, each of them dealing with problems arising in a particular sector. These included the Banking Ombudsman, the Building Societies Ombudsman, and many more relating to insurance, investment, pensions and other areas.

The FSA recognised that such a fragmented system was neither helpful nor efficient, and the framework for an integrated body, the Financial Ombudsman Service (FOS), was established by the FSMA 2000.

The FOS took over from the existing financial services ombudsman schemes in December 2001, with the aim of having a single organisation with a consistent set of rules to deal with complaints and disputes arising from virtually any aspect of financial services. Note that the rules mentioned here are rules about dealing with complaints – the FOS stresses that it does not make the rules under which firms are authorised, nor can it give advice about financial matters or debt problems.

Although now a single organisation, the FOS does acknowledge that different types of problems may arise from different areas, so it has established three different divisions within the service, namely:

The FOS has not, however, taken over the responsibilities of the Pensions Ombudsman, which deals with complaints about occupational pension schemes (see Section 3.4).

The Financial Ombudsman Service is free to customers and is open to all private individuals and small businesses. It is funded by the firms who are members of the FOS and membership is compulsory for all firms authorised under the FSMA 2000.

Complainants must first complain to the firm itself, and the FOS will become involved only when a firm's internal complaints procedures have been exhausted without the customer obtaining satisfaction. Complaints to the FOS must be made within six years of the event that gives rise to the complaint, or within three years of the time when the complainant should have become aware that he had cause for complaint, whichever is the later. The FOS will not usually consider any complaint that is the subject of a court case.

The FOS can make awards of up to £100,000, plus the complainant’s reasonable costs, which are binding on the firm but not on the complainant, who is free to pursue the matter in the courts if he wishes. The award is not intended to punish the firm, but to put the complainant back into the same financial position that he would have been in if the event complained about had not taken place.

Compensation arrangements for customers who have lost money through the insolvency of an authorised firm have been co-ordinated under a single scheme with effect from December 2001. The Financial Services Compensation Scheme is made up of a number of sub-schemes relating to different default situations, as follows:

• claims against firms involved in mortgage advice and arranging: 100% of the first £30,000, plus 90% of the next £20,000 (ie a maximum of £48,000).

Claims cannot be made against the Financial Services Compensation Scheme for other losses – for instance, losses due to negligence, poor advice, or simply due to a fall in stock market values. In some cases, however, the customer may be able to sue for compensation through the civil courts.

The Pensions Ombudsman was created by the Social Security Act 1990 to deal with complaints relating to occupational pension schemes and certain aspects of personal pension schemes. The Secretary of State for Work and Pensions appoints the Ombudsman.

The Pensions Ombudsman can decide about complaints and disputes relating to the running of pension schemes. He does not deal with complaints about the sales and marketing of pension schemes – these are the province of the Financial Ombudsman Service (see Section 3.2) – or with complaints about state pensions.

Complaints and disputes can be made by a wide range of people: individuals, managers, trustees or employers. They are commonly made by:

Complaints or disputes should first be addressed to the pension scheme’s managers or trustees. If this does not result in agreement, the next point of reference should be to the Office of the Pensions Advisory Service (OPAS), who try to resolve the dispute through conciliation and mediation. OPAS decisions are not legally binding, and cases that cannot be agreed are normally then referred to the Pensions Ombudsman.

Complaints and disputes must be communicated to the Ombudsman in writing within three years of the event being complained about. Any time spent trying to resolve the matter using the scheme’s internal complaints procedures, or through OPAS, is normally excluded from this time period.

The Ombudsman’s decision is binding on all parties, and can be enforced in the courts.

Section 4

Data protection

The Data Protection Act 1998 replaced an earlier Act (the Data Protection Act 1984) when it became necessary for UK law in this area to be updated in order to comply with a new EU data protection Directive issued in 1995. The 1998 Act is much wider in its scope than the earlier Act; in particular, it extends the regulations to cover not only computerised data (as in the 1984 Act) but also data held in manual filing systems.

The purpose of the legislation is, broadly speaking, to give private individuals control over the use of personal data about themselves, which is held by organisations. It does so by establishing a series of data protection principles, together with enforcement processes.

The Data Protection Act uses a number of words and phrases that have precise meanings within the terms of the Act. These include:

The basis of the Data Protection Act is a set of eight data protection principles. These are described below; they all relate to the processing of personal data (as defined above).

The Information Commissioner oversees the application of the Data Protection Act. The Commissioner’s responsibilities are:

The Commissioner can issue one of two types of notice to a data controller if he believes that there has been an infringement of the terms of the Act:

The enforcement powers of the Information Commissioner include the power to prosecute a data controller who fails to comply with an information notice or enforcement notice. This is a criminal offence, and there are two other criminal offences under the Act:

The maximum penalty for these offences is £5,000, unless the case goes to the Crown Court, in which case there is no limit on the possible fine.

Section 5

Other laws and regulations relevant to advising clients

In addition to the legislation already described, the interests of financial services customers are safeguarded by aspects of a range of other laws and regulations. Some of these relate closely to financial services, whereas others are aimed more broadly at the rights of consumers in general.

The purpose of the Consumer Credit Act 1974 is to regulate, supervise and control certain types of lending to individuals, and to provide borrowers with protection from unscrupulous lenders. The provisions of the Act are regulated by the Office of Fair Trading (not the FSA).

There are many types of lender in the market for financial services, ranging from large multinational banks to individual moneylenders. The Act sets out standards by which all lenders must conduct their business. It includes a number of safeguards under which potential borrowers must be made aware of the nature and conditions of a loan, and of their rights and of their obligations.

The Act affects most aspects of bank lending activities, including personal loans and revolving credit such as credit cards. Not all loans are covered by the Act:

The main elements of the Act's provisions are:

One of the Act's most significant innovations was a system for comparing the price of lending. This is the annual percentage rate (APR), which must be quoted for all regulated loans. The APR represents a measure of the total cost of borrowing, and its aim is to allow a fair comparison, between different lenders, of the overall cost of borrowing.

The calculation of APR is specified under the terms of the Consumer Credit Act 1974 and it takes account of two main factors:

The result is that the APR is higher than the actual rate being charged on the loan.

The government has carried out a three-year review of consumer credit law, which led to the decision to reform the Consumer Credit Act 1974 in order to better protect consumers and to create a fairer and more competitive credit market. It aims to make improvements in three broad areas, described as follows by the Department of Trade and Industry:

• to enhance consumer rights and redress. Consumers will be able to challenge unfair lending and will have access to more effective options for resolving disputes;
• to improve the regulation of consumer credit businesses by ensuring fair practices and through ‘targeted action to drive out rogues’;
• to make regulation more appropriate for all kinds of consumer credit transaction. The plan is to extend protection to all consumer credit and to create a fairer regime for business.

This reform is being implemented through primary and secondary legislation. The primary legislation is a new Consumer Credit Bill, introduced into the House of Commons in May 2005. Prior to that, however, a number of pieces of secondary legislation came into force. These are as follows.

• The Consumer Credit (Advertisements) Regulations 2004. These relate to the form and content of advertisements for credit. They replace the old distinction between simple, intermediate and full-credit advertisements, and establish a single list of items of information that must be included in all credit advertisements. They also introduce new provisions relating to the calculation and presentation of APR in advertisements, including a requirement to display the APR more prominently than other financial information.
• The Consumer Credit (Agreements) (Amendments) Regulations 2004. These seek to make the agreements signed by customers clearer and easier to understand, by making some changes to content and layout.
• The Consumer Credit (Disclosure of Information) Regulations 2004. These specify what information must be disclosed to prospective borrowers, and the way in which it must be disclosed.
• The Consumer Credit (Early Settlement) Regulations 2004. These regulations confirm the entitlement of borrowers under regulated credit agreements to a rebate when all or part of the debt is repaid earlier than when it is due; they also change the calculation method for such rebates.

The Supply of Goods and Services Act applies to all contracts (except those entered into before 1995) involving the supply of services, including those for the supply of financial services. Its terms mean that, in the absence of anything specific, the following provisions are automatically deemed to be included in all such contracts:

These regulations apply to any term in a contract between a supplier of goods and services and a consumer, where the supplier is acting on the behalf of their business and the contract has not been negotiated on an individual basis. The Office of Fair Trading is responsible for considering any complaint brought about because of the regulations.

A contract that has been drafted in advance and does not offer the consumer an opportunity to influence the terms of the contract is regarded as one that has not been individually negotiated and will therefore fall under the terms of the regulations. Contracts for the sale of land, tenancy agreements and mortgages can fall under the remit of the regulations where the supplier is not an individual and is acting in the course of business. Therefore a person selling his own home would be excluded from the regulations but they would cover a builder selling new houses.

The main areas covered by the regulations are as follows.

The main requirements are that all terms in regulated contracts should:

The written terms of a contract should be expressed in clear, easily understood language. If there is any doubt about the meaning of a written term, then the interpretation most favourable to the customer will be adopted.

A term that causes a significant imbalance between the rights and obligations of the various parties to the contract to the detriment of the consumer will be deemed to be in breach of good faith.

It should be noted that any part of a contract that defines the main subject matter of the contract does not fall under the regulations, as long as it meets the plain language requirement. So, for instance, in the case of house purchase, the regulations could not be used to determine whether the price being charged for a property was fair.

Examples of unfair terms would be:

If an element of a contract is found to be unfair, the whole contract is not necessarily invalidated. The contract may be allowed to continue if it is capable of doing so without the unfair term. The term that is deemed to be unfair will not be binding on the consumer.

The regulation of occupational pension schemes remains quite separate from the regulation of other financial services, separate even from the regulation of private pension arrangements such as personal pensions and stakeholder pensions. Nevertheless, it is clearly advantageous for financial advisers to have a good knowledge of matters relating to occupational schemes, in order to be able to advise, for instance, individuals who are members of such schemes or employers who may be considering establishing a scheme.

An earlier Act, the Pensions Act 1995, introduced changes to several aspects of pension provision and supervision, not least of which related to concern about the security of occupational pensions. Public confidence in occupational pension scheme security had been severely dented by the Maxwell affair, where pensioners' funds were used to meet the companies' general obligations. The government sought to restore confidence with measures designed to prevent fraud and to improve the administration of occupational schemes.

The Pensions Act 2004 incorporated many of the proposals of two Green Papers in 2002 and 2003, issued in response the worsening pensions crisis in the UK. Two particularly important elements of the 2004 Act are the establishment of the Pension Protection Fund (see Section 5.3.2) and the transfer of regulatory responsibility for occupational pension schemes from the Occupational Pensions Regulatory Authority (OPRA) to the newly created Pensions Regulator.

The Pension Regulator has wider powers than its predecessor and will take a proactive and risk-focused approach to regulation. Its mission statement is that it will work ‘to improve confidence in work-based pensions by protecting the benefits of scheme members and encouraging high standards and good practice in running pension schemes’.

Like the FSA, the Pensions Regulator has a set of statutory objectives. These are:

• to protect the benefits of members of work-based pension schemes. By ‘work-based’ schemes they mean all occupational schemes, and also any stakeholder and personal pension schemes where employees have direct payment arrangements;
• to promote good administration of work-based pension schemes;
• to reduce the risk of situations arising that may lead to claims for compensation from the Pension Protection Fund.

The Pensions Regulator will aim to identify and prevent potential problems rather than deal with problems that have arisen. It will do so by assessing the risks that can occur and may prevent them from meeting their statutory objectives. These risks might include inadequate funding, inaccurate record-keeping, lack of knowledge or understanding by the trustees, or even dishonesty or fraud. They will consider the combined effect of two factors related to each risk: the likelihood of the event occurring, and the impact of the event on the scheme and its members. Schemes that are judged to have a higher risk profile will be more closely monitored than those with lower risk.

The Regulator does, however, also have a range of powers that will enable it to put things right that have gone wrong.

The regulator’s powers fall broadly into three categories.

• Investigating schemes in order to identify and monitor risks. All schemes must make regular returns to the regulator. In addition, trustees or scheme managers must give notification of any changes to important information, such as the types of benefits being provided by the scheme. The regulator also demands to be quickly informed if the scheme discovers that it cannot meet the funding requirements, so that remedial action can be taken at an early stage.
• Putting things right. The Pension Regulator has a range of actions that it can take to protect the security of members’ benefits. These include:

• requiring specific action to be taken to improve matters within a certain time;
• recovering unpaid contributions from an employer who does not pay them to the scheme within the required period (by the 19th of the month following the month in which they were deducted from salary);
• disqualifying trustees who are not considered fit and proper persons to be trustees;
• imposing fines or even prosecuting certain offences in the criminal courts.

• Acting against avoidance. This means preventing employers from deliberately attempting to avoid their pensions obligations and thereby leaving the Pension Protection Fund to cover their pension liabilities. The main actions they can take are the issuing of:

• contribution notices requiring the employer to make good the amount of the debt either to the scheme or to the Pension Protection Fund; or
• financial support directions which require financial support to be put in place for an underfunded scheme.

The Pensions Act 2004 requires the Pension Regulator to issue voluntary codes of practice on a range of subjects. The codes provide practical guidelines for trustees, employers, administrators and others on complying with pensions legislation, and set out the expected standards of conduct.

The Act also introduces new requirements for trustees to have a sufficient knowledge and understanding of pension and trust law, and scheme funding and investment. Trustees also have to be familiar with the trust deed and other important documents such as the scheme rules and the statement of investment principles. These requirements come into force in April 2006.

The Pensions Act 2004 established the Pension Protection Fund (PPF) to protect members of private sector final salary (defined benefit) pension schemes whose firms become insolvent with insufficient funds in their pension scheme to maintain full benefits for all the members.

In addition to this responsibility, the PPF will also take over the existing responsibilities of the Pensions Compensation Board, which compensates members of both defined benefit and defined contribution (money purchase) schemes in cases of fraud and misappropriation.

The PPF will ensure that where a company with an eligible defined benefit scheme becomes insolvent, with an insufficiently funded scheme, members of that scheme will still receive the core of the benefits to which they are entitled. The PPF will provide compensation of:

• 100% for existing pensioners including ill-health retirement and survivors’ benefits;
• 90% for pre-retirement members, subject to an overall benefit cap.

To ensure that PPF compensation retains its value over time, pensions in payment will be increased in line with the retail price index (RPI) up to a maximum of 2.5%.

Compensation will be funded in two ways: firstly by taking over the assets of pension schemes with insolvent employers, and secondly by means of a levy on all private sector defined benefit schemes and the defined benefit element of hybrid schemes.

The levy is split into five parts:

• a pension protection levy based on risk factors (including under-funding, credit rating and investment strategy). Eventually, this is expected to constitute at least 80% of the total amount collected by the Fund;
• a pension protection levy based on scheme factors such as the numbers of active and retired members;
• an administration levy, covering set-up cost and ongoing costs of the PPF;
• a PPF Ombudsman levy, covering the costs of the PPF Ombudsman; and
• a fraud compensation levy, replacing the Pensions Compensation Board levy.

As mentioned in Section 1.1, Directives issued by the European Union are binding, as to the result to be achieved, upon each member state to which they are addressed. What this means is that the objectives of the Directive have to be achieved, but the choice as to exactly how they are achieved is left to national authorities in each state. As a result, much of the UK regulation about financial services can be seen as derived from European Directives. Some examples are given below.

A significant EU Directive issued in March 2000 (known as the Second Banking Directive) consolidated the earlier Directives that gave institutions the freedom to establish and pursue the business of credit institutions (banks, building societies and similar organisations) throughout the European Union. It describes:

Credit institutions (see Section 5.4.1) also provide investment services, in direct competition with firms whose primary business is investment. In 1993, the EU recognised that ‘in order to guarantee fair competition, it must be ensured that investment firms that are not credit institutions have the same freedom to create branches and provide services across frontiers’ as is provided by the Second Banking Directive.

In order to achieve fair competition on investments, the 1993 Directive on Investment Services in the Securities Field, commonly known as the Investment Services Directive (ISD), came into force at the beginning of 1996. Its aim was to enable investment firms to operate in different European states in much the same way as other Directives have broadened the markets for banks and for the insurance industry (see below), by providing direct access to well-regulated markets across the EU.

In the same way as with credit institutions, firms that provide certain specified investment services must first be authorised in their own home state. They can then operate in the other member states without requiring further authorisation from the authorities in those other states.

The ISD does not cover all investment firms or all investment services. In particular, it does not apply to insurance and reinsurance companies.

The types of investment activity covered by the ISD include:

The ‘specified’ investments covered by the ISD are:

In order to obtain and retain authorisation in their home state, investment firms must comply with certain prudential rules drawn up by the authorities in the home state. The general nature of these prudential rules is specified in the ISD; it states that the authorities in each member state (eg the FSA in the UK) must require that investment firms take the following steps:

The regulatory authorities are also required to draw up a code of conduct which investment firms and their employees must observe. This code of conduct must, as a minimum standard, include the following obligations, ie that the firm will:

Many of these requirements will be recognised as elements of the FSA’s regulatory regime in the UK.

The two main (and linked) objectives of a European single market for insurance are:

In setting out to achieve these objectives, the EU has always dealt with life assurance and non-life insurance separately – in order to take account of their different characteristics, and also in acknowledgement of the close ties which life assurance has with the long-term savings industry.

The first Directive relevant specifically to life assurance was adopted in 1979 with the aim of setting out how the right of establishment included in the Treaty of Rome might be put into effect for life assurance companies. It defined life assurance as including the following categories:

The Second Life Directive, issued in 1990, laid down special rules relating to the freedom to provide cross-frontier services in the life assurance field. It covers individual policies and group life, but not group pension funds.

Arrangements for regulation and supervision of the insurance fall into two categories, depending on the reason why the applicant is taking out the policy:

In 1992 the Third Life Directive – sometimes also known as the Life Framework Directive – was adopted. Like all EU Directives, its provisions had to be incorporated into the legislation of all the member states. In the UK, for example, they were incorporated into the insurance legislation (based largely on the Insurance Companies Act 1982) through the Insurance Companies (Third Insurance Directive) Regulations 1994. In order to obtain authorisation a company must:

The financial supervision of the insurers is the responsibility of their home state; this supervision includes valuation of assets and liabilities, and the consequent verification of solvency. Local legislation may apply, in the states where the insurance is sold, in relation to advertising, marketing and contract matters; similarly any premium taxes applied are those of the state in which the insurance is sold (at present in the UK, insurance premium tax applies to general insurance but not to life assurance).

The Directive requires the harmonisation of national laws where this is necessary for the Directive’s principles to work smoothly throughout the EU. These principles include:

Policyholders must be able to withdraw from the contract within a ‘cooling-off’ period of between 14 and 30 days from the time when they are informed that the contract has been made. This rule is reflected in the UK through the issuing, by the insurance company, of a statutory cancellation notice to customers – who then have 14 days in which to return it to the company to cancel the policy with a refund of any premium paid.

Policyholders must also be provided with clear and accurate information about the essential characteristics of the products offered to them, to assist them in choosing an appropriate product. This requirement is met in the UK by the issue of a key features document (see Section 1.25).

In 2002, a fourth Life Directive was issued. The previous three Life Directives (and certain other Directives) were repealed and replaced by a single Directive that covers all aspects of life assurance. It is largely a consolidation Directive, bringing together the provisions of earlier Directives, not just concerning the concept of a single licence but also concerning the harmonisation of local rules on authorisation and regulation which is required to make the single licence system work.

In 1988, the Second Non-Life Directive laid down rules for cross-frontier non-life insurance, which balance the needs of freedom of service and consumer protection. This allowed companies to supply insurance in another member state without having to establish a branch or subsidiary in the other state.

The Third Non-Life Directive, issued in 1992, completed the process and now any insurance company whose head office is in one of the member states can establish branches, and carry on non-life insurance business, in any other state under the supervision of the competent authorities of the member state in which its head office is situated.

Authorisation to carry out insurance business under the terms of this Directive is granted for a particular class or classes of insurance (or even sometimes for some of the risks relating to a particular class). Companies can, of course, be authorised for two or more classes. The classification of the risks is the same as that given in the first Directive in 1973.

(1) Accident

(2) Sickness

(3) Land vehicles

(4) Railway rolling stock

(5) Aircraft

(6) Ships

(7) Goods in transit

(8) Fire and natural forces

(9) Damage to property

(10) Motor vehicle liability

(11) Aircraft liability

(12) Liability for ships

(13) General liability

(14) Credit

(15) Suretyship

(16) Miscellaneous financial loss

(17) Legal expenses

In some cases, authorisation can be given for more than one class together; for instance Classes 1 and 2 can be authorised as ‘Accident and Health Insurance’, and Classes 10–13 inclusive as ‘Liability Insurance’.

There are specific rules on compulsory insurances against accidents at work, such as Employers’ Liability Insurance in the UK.

As well as ensuring that insurance companies can operate throughout the community, the EU also wants to ensure that retail markets in insurance are accessible and secure. To this end, a Directive on insurance mediation came into force in January 2003, the purpose of which is to establish the freedom for insurance intermediaries to provide services in all states throughout the EU. It was felt that, prior to the development of this Directive, the liberalisation of the insurance sector had benefited the wholesale market (large industrial and commercial risks) to the detriment of the retail market (insurance for private individuals). The 2003 Directive replaces an earlier (1977) Directive that first introduced plans to give insurance brokers and agents the freedom to operate across the community and a 1992 recommendation from the European Commission about qualifications to be required of insurance intermediaries. It is now the sole European statute governing insurance intermediaries.

Insurance mediation is defined in the Directive as ‘the activities of introducing, proposing or carrying out other work preparatory to the conclusion of contracts of insurance, or of concluding such contracts, or of assisting in the administration and performance of such contracts, in particular in the event of a claim’. When an employee of the insurance company, or someone acting under the responsibility of the insurance company (tied agents), carries out such activities they are not included in the definition of insurance mediation.

The Directive establishes a system of registration for all independent insurance (and reinsurance) intermediaries. They must be registered with a competent authority in their home state – so, for instance, independent financial advisers based in the UK who are selling life assurance have to be registered with the FSA, but tied agents are authorised by the company to which they are tied and do not have to be directly authorised by the FSA.

Registration is subject to strict requirements as regards professionalism and competence; intermediaries must have the necessary general, commercial and professional knowledge and skills. Exactly what this means depends on the relevant national authority, but it will almost certainly include a requirement for appropriate training and a specified level of qualification, and possibly a programme of continuing professional development – in the UK, the FSA have set out their requirements in considerable detail in their Training and Competence Sourcebook.

Insurance intermediaries are also required to be ‘of good repute’. Again, local interpretations of this may vary, but minimum requirements are that an intermediary must not have been:

The Directive also requires that insurance intermediaries should hold professional indemnity insurance of at least €1m per case and €1.5m in total per annum. The whole question of professional indemnity insurance in the UK has become very difficult in recent years; problems such as the so-called ‘pension mis-selling scandal’, and the failure of some mortgage-related endowments to provide sufficient funds to repay policyholders’ loans, have made professional indemnity insurance more difficult to obtain and more expensive.

Rules are also included to protect clients’ funds, including the requirement to keep client money in strictly segregated accounts. This is backed up by a requirement for intermediaries to have financial capacity of an amount equal to at least 4% of premiums received per annum, subject to a minimum of €15,000.

The regulations specify in some detail what information an intermediary must give to a customer. In relation to the intermediary, the following information must be supplied:

In relation to the advice offered and products recommended:

All information provided by an intermediary to a customer must be set out in a clear and accurate manner, and must be comprehensible to the customer.

Again, it will be seen that the requirements of the Directive are closely reflected by rules in the FSA’s Conduct of Business Sourcebook.

The government has for some time been concerned that many financial products are:

They have tried to counteract this by introducing a set of standards (known as charges, access and terms, or CAT, standards), intended to help less knowledgeable investors choose a suitable deal.

As mentioned in Section 3.2.4 of Unit 1, following the introduction of the ‘Sandler suite’ of simplified products, CAT standards for new ISA’s have been withdrawn. However, CAT standards for mortgages remain in force. These are standards that can be applied to mortgage products, although lenders do not have to offer CAT standard mortgages, and there is no guarantee by either the government or the lender that a CAT standard mortgage will be the most suitable product for a particular borrower.

CAT standard mortgages are likely to appeal to borrowers who wish to have clearly stated limits on charges. Examples of the limits set on charges and other costs are:

Other rules relating to access and terms include:

The CAT standards for ISAs have been described in Section 3.2.4. They are repeated here, for convenience.

Specific additional CAT standards apply to the different ISA components, for example:

It is not compulsory for ISAs to meet the specified CAT standards, but those that do meet the standards will be CAT-marked. The government has stressed that the CAT mark is not a seal of approval, and it seems likely that many ISAs, particularly those investing in the stocks and shares component, will be marketed without being CAT-marked. This is because the cost restrictions are so tight that they may preclude schemes that allow for the cost of giving advice to potential investors (for instance through commission payments to advisers).

In addition to abiding by the rules laid down in industry-specific regulations, advertisements for financial services and financial products have to meet the standards laid down in the British Code of Advertising under the supervision of the Advertising Standards Authority (ASA).

The ASA was set up in 1962 and is an independent self-regulatory body, which administers the British Codes of Advertising and Sales Promotion.

It covers all non-broadcast advertisements, ie those that appear in:

The ASA can take action against individuals and organisations whose advertising contravenes the Code. The first step is usually to discuss the offending advertisement with the advertiser, and – if an acceptable explanation is not given – to require the advertisement to be changed or withdrawn.

A number of sanctions are used against offenders, ranging from the adverse publicity generated by its adjudications to legal proceedings in the case of persistent or deliberate offenders. This legal action is available through a referral of the advertiser, agency or publisher to the Office of Fair Trading.

The Advertising Code requires that advertisements should be prepared with a sense of responsibility to consumers and society, and should respect the generally accepted principles of fair competition in business. Specifically the Code requires that all advertisements should be:

Advertisers are permitted to express opinions, including opinions about the desirability of their products, provided that it is clear that it is opinion and not a statement of fact. Assertions or comparisons that go beyond subjective opinion must be capable of being objectively substantiated.

This Act made it unlawful to discriminate against disabled people in relation to:

The Act affects the financial services industry in relation to both employment practices and the provision of products and services. Important issues include:

The Code relates to dealings with personal customers, which covers private individuals, executors and trustees, but not clubs, societies, companies, sole traders or partnerships. A separate Business Banking Code covers small businesses with a turnover of up to £1m. Both Codes are reviewed every two years by an independent body, the Banking Code Standards Board, and updated versions of the Codes came into force on 1 March 2005. The Banking Code Standards Board also checks on compliance with the Code, and if it receives complaints about non-compliance, it takes the matter up with the bank or building society concerned.

The Banking Code covers the following products and services:

The standards of the Code are set out in a series of key commitments that apply to the conduct of business for banking products and services. These commitments specify that banks and other organisations that subscribe to the Code will:

The Banking Code covers the following areas of business operations.

Some of the requirements described in the Code are open to interpretation – for instance different banks may give different meanings to certain technical terminology. The Code suggests that a ‘common sense’ approach should be applied in cases of doubt.