Inducement Rules: FCA Reminds Firms Of Expectations

Key findings of thematic review into benefits received

Originally published in the July | August 2016 issue

On 18 April, the Financial Conduct Authority (FCA) published the key findings from its thematic review into benefits provided and received by (a) firms that conduct Markets in Financial Instruments Directive (MiFID) business and (b) those that carry out regulated activities in relation to retail investment products (Firms). The findings serve as a useful reminder that non-monetary client benefits, such as client hospitality, must be business-focused and comply with the FCA’s inducement rules.

Firms must comply with the FCA’s inducement rules, which include the requirement that any payment or benefit given to or received from clients is designed to enhance their quality of service.

Typically, after FCA conducts a thematic review of selected regulated firms, it will publish a report that sets out its findings and draws regulated firms’ attention to the lessons to be learned and to FCA’s expectations. However, on this occasion, FCA notes that its thematic report will form part of FCA’s planned MiFID II consultation paper, which will be published later this year, likely in September. However, because of the recent delay in implementing MiFID II to 3 January 2018, FCA published its findings earlier this year to remind firms of its expectations in relation to its inducement rules.

FCA’s key findings and expectations
FCA’s key findings centre on non-monetary benefits (such as client hospitality), recordkeeping, advisory firm profits, and the disclosure of information.

Key findings:

  • Hospitality that firms provided or received did not always appear to be designed to enhance quality of service. In a move likely to provoke industrywide concerns, FCA illustrates its point by describing social and sporting events that it had reviewed as benefits apparently incapable of enhancing the quality of service to clients.
  • Hospitality that was not designed to enhance the quality of service to clients was offered in connection with other benefits that did meet the requirements.
  • Hospitality registers did not always record relevant detail or were not well-maintained.
  • Product providers made payments to advisory firms in excess of the costs incurred by advisory firms when facilitating training or educational material supplied by product providers or collecting management information on behalf of a product provider.
  • MiFID firms did not indicate to clients the value of allowable benefits provided.

Nonmonetary benefits
FCA has made clear that it expects Firms to assess whether all aspects of their nonmonetary benefits are designed to enhance their quality of service to clients. In practical terms, this means that Firms should consider whether:

  • the benefit is business-focused,
  • it facilitates constructive business discussions, and
  • it may detract from ensuring that an enhanced quality of service is provided to clients.

In addition, FCA requires that each non-monetary benefit that Firms provide be considered in isolation. For example, where a Firm organises a conference followed by an evening dinner, the Firm must consider whether providing the conference enhances the quality of client service separately from its considerations in relation to the evening’s dinner. FCA explains that this does not mean that social events cannot provide clients with an enhanced quality of service, but it does mean that Firms should carefully consider the purpose of their benefit programmes and whether each benefit complies with the FCA rules.

FCA requires Firms to keep a record of the information and benefits provided to clients and others for five years from the date on which they were given. This includes recording the nature of a benefit, the identity of the intended recipient, and how that benefit is designed to enhance the quality of service to clients. Firms will need to review their recordkeeping policies to ensure that they are recording sufficiently detailed information in their hospitality registers, and Firms may wish to provide current employees with training on how to record disclosures of information and each benefit given.

Payments in excess of advisory firm costs
FCA has reminded Firms that payments to advisory or third-party organisations that facilitate training, educational materials, or other services supplied by product providers (such as setting up a webinar on an advisory firm’s systems) that exceed the costs of providing those services will likely be deemed inducements. Firms should review their agreements with advisory firms to establish whether they are overpaying for services.

In addition, FCA reminds MiFID firms to provide clients with an indication of the value of the benefits given so that a client is aware of the possible level of inducement and may then decide whether to proceed with the investment or seek more detailed information. MiFID firms should review the level of information disclosed to clients to ensure that they are in compliance.