2)5) Conflicts of Interest (SYSC 10, PRIN 2.1)

Question 1

5.1 When may a conflict of interest arise in respect of a corporate firm? (2)

the rules for conflicts of interest derive from MiFID which requires firms to act honestly, fairly and professionally in accordance with the best interest of their clients

Answer 1

• the firm has more than one interest in a txn
• the multiple interests may impact or appear to impact the firm’s ability to deliver independent financial advice

Question 2

5.1 What is a ‘common-platform’ firm?

Answer 2

Firms subject to either CRD and/or MiFID

Question 3

5.1 Who do the rules contained within SYSC on conflicts of interest apply to? (2)

Answer 3

Common-platform firms in respect of regulated business and of ancillary services which constitute MiFID business
Non-MiFID firms and businesses

Question 4

5.1 Which entities do the SYSC rules say firms should take all reasonable steps to identify conflicts of interest between? (2)

Answer 4

• the firm, including its managers, employees, appointed reps/tied agents and parties connected by wat of control and a client of the firm
• one client of the firm and another

Question 5

5.1 What are the expectations of firms under SYSC rules for conflicts of interest? (6)

The status of the client (retail, professional or ECP) is irrelevant to these rules, these are relevant when a service is provided by a firm to anyone

Answer 5

• maintain (and apply) effective organisational and administrative arrangements designed to prevent conflicts of interest from adversely affecting the interests of their clients
• for those producing externally facing investment research, have appropriate info controls and barriers to stop information from these research activities from flowing to the rest of the firm’s business (for example, this may include Chinese walls/info barriers)
• where a specific conflict cannot be managed away, ensure that the general or specific nature of it is disclosed (as appropriate to the circumstances). Note that disclosure should be used only as a last resort
• prepare, maintain and implement an effective conflicts policy
• provide retail clients and potential retail clients with a description of that policy
• keep records of those of its activities a conflict has arisen

Question 6

5.2 What factors must a firm take into account in order to identify the type of a conflict of interest? (5)

These are rules for common-platform firms, and guidance for non-common-platform firms, other than when the firm produces, or arranges the production of, investment research in accordance with COBS 12.2

Answer 6

The firm must take into account whether the firm, a person directly or indirectly linked by control to the firm:
- is likely to make a financial gain, or avoid a financial loss, at expense of a client
- has an interest in the outcome of a service provided to the client, or of a txn carried out on behalf of the client, which is different from the client’s interest in that outcome
- has a financial, or other, incentive to favour the interest of another client, or group of clients, over the interest of the client
- carries on the same business as the client
- receives, or will receive, from a person other than the client an inducement in relation to a service provided to the client, in the form of monies, goods or services other than the standard commission or fees for that service

Question 7

5.2 A firm undertaking the service of management of a securities offering will have a duty to its corporate finance client (the issuer or seller of the relevant securities), but it may till have responsibilities to provide services to its investment clients.
In order to avoid Market Abuse by insider trading, what measures may a firm want to consider within its conflicts of interest policy?

Answer 7

at an early stage, agreeing with the corp fin client on relevant aspects of the offering, such as:
- how the target investor group will be identified
- how recommendations on allocation and pricing will be prepared
- whether the firm may place securities with its investment clients or with its own proprietary book, or with an associate, and how conflicts arising might be managed

agreeing allocation and pricing objectives

inviting the corp fin client to participate actively in the allocation process

making the initial recommendation for allocation to retail clients of the firm as a single block and not on a named basis

having internal arrangements under which senior personnel responsible for providing services to retail clients make the initial allocation recommendations for allocation to retail clients of the firm

disclosing to the issuer details of the allocations actually made

Question 8

5.3.1 What processes and procedures will firms require in order to manage conflicts of interest to ensure fair treatment of clients? (4)

Answer 8

• info barriers, such as reporting lines
• remuneration structures
• segregation of duties
• policy of independence

Question 9

5.3.2 How and when must insufficient arrangements to manage potential conflicts of interest be disclosed to clients?

Answer 9

The firm must clearly disclose the general nature and/or source of conflicts of interest to the client before undertaking business for/on behalf of the client
Disclosure must be made in a durable medium and include sufficient detail, taking into account the nature of the client, so that the client may make an informed decision on this

FCA defines ‘durable medium’ as paper or any instrument which enables the recipient to store info addressed personally to them in a way which is accessible for future ref for a period of time adequate for the purposes of the info

Question 10

5.3.3 How should common and non-common platform firms record conflicts of interest?

Answer 10

Common-platform firms must keep and regularly update a record of the kinds of services or activities carried out by, or on behalf, of the firm in which a conflict of interest entailing a material risk of damage to the interest of one or more clients has arisen or, in the case of an ongoing service of activity, may arise

For non-common-platform firms, these are guidance rather than reqs, other than in the case of investment research in accordance with COBS 12.2

Question 11

5.4 What should a firm’s conflict of interest policy include?

Answer 11

Should record the circumstances which constitute, or may give rise to, a conflict of interest if they have been identified as having the potential to impact the firm’s business

Should detail how these are managed, specify the procedures that are to be followed, and outline the measures adopted in order to manage such conflicts

If the firm is the member of a group, the policy should take into account any potential conflicts arising from the structure/business activities of other members of that group

Question 12

5.4 How must the procedures and measures be designed?

Answer 12

to ensure that relevant persons engaged in different business activities involving a conflict of interest of the kind specified above carry on those activities at a level of independence appropriate to the size and activities of the common-platform firm and of the group to which it belongs, and to the materiality of the risk of damage to the interest of clients

Question 13

5.4 What must the procedures and measures provided for include?

Answer 13

the following, as necessary for the common-platform firm to ensure the requisite degree of independence:
- have effective procedures to prevent or control the exchange of information between relevant persons if the exchange of that info may harm the interest of one or more clients
- ensure the separate supervision of relevant persons whose principal functions involve carrying out activities and represent different interests that may conflict, including those of the firm
- remove any direct link between the remuneration of relevant persons principally engaged in one activity and the remuneration of, or revenues generate by, another activity
- include measures to prevent or limit any person from exercising inappropriate influence over the way in which a relevant person carries out services or activities
- have measures to prevent or control the simultaneous or sequential involvement of a relevant person in separate services or activities if such involvement may impair the proper management of conflicts of interest

Question 14

5.5 What are info barriers or Chinese walls?

Answer 14

Arrangements made by a firm to manage conflicts of interest where the info held by an employee in one part of the business must be withheld from (or if not possible, not used by) people working in another part of the business

Question 15

5.5 What does SYSC require firms who employ info barriers or Chinese walls to do?

Answer 15

• withhold or not use the info held
• for that purpose, permit its employees in one part of the business to withhold the info from those employed in another part of the business, but only to the extent that at least one of those parts of the business is carrying on regulated activities, or another activity carried on in connection with a regulated activity
• take reasonable steps to ensure that these arrangements remain effective and are adequately monitored

Question 16

5.5 Which additional processes and procedures may a firm use to manage conflicts of interest to ensure the fair treatment of clients (SYSC 10.2)? (4)

Answer 16

• info barriers such as reporting lines
• remuneration structures
• segregation of duties
• policy of independence

These must meet the reqs set out in section 5.4

Question 17

5.6.1 Which conditions should firms satisfy with their arrangement in place regarding conflicts of interest in relation to investment research and research recommendations?

Answer 17

Financial analysts and other relevant persons who know the likely timing/content of investment research which is not yet publicly available or available to clients and which cannot be inferred from info that is so available cannot undertake personal transactions, or trade for others, until the recipient of the investment research has had a reasonable opportunity to act on it. However, there are certain exceptions, such as the receipt of an instruction from an execution-only client or market maker acting in good faith

In cases not covered by the above, they cannot undertake personal account txns without prior approval from the firm’s compliance or legal dept, and then only in exceptional circumstances

A physical separation exists between the financial analysts involved in the production of investment research and other relevant persons whose responsibilities, or business interests, may conflict with the interests of the persons to whom the investment research is disseminated or, when considered not appropriate to the size and organisation of the firm as well as the nature, scale and complexity of its business, the establishment and implementation of appropriate alt info barriers

The firm and any person involved in the production of research must not accept inducements from those with a material interest in the subject matter of the research

The firm may not promise issuers favourable research coverage

Issuers, relevant persons other than financial analysts, or anyone else must not be allowed to review draft investment research which includes a recommendation or target price other than to verify compliance with the firm’s legal obligations

Question 18

5.6 When is a firm which disseminates investment research produced by another person to its clients exempt from the prior reqs? (4)

Answer 18

• the person (firm) that produces the investment research is not a member of the group to which the firm belongs
• the firm does not substantially alter the recommendation within the investment research
• the firm does not present the investment research as having been produced by itself
• the firm verifies that the producer of the investment research is itself subject to the reqs in relation to the production of investment research, or has established a policy setting such reqs

Question 19

5.6 How did MiFID II enhance the rules on the provision of investment research and potential conflicts of interest?

Answer 19

• investment firms may receive research without this constituting an inducement
• MiFID II prohibits the provision of research by third parties to investment firms providing portfolio management or providing investment advice to either professional clients or retail clients

(in-scope entities must pay for research - either themselves or by setting up a research payment account and charging their clients for the research that they purchase)

Question 20

5.6 What changes did the FCA make to the prohibition on in-scope fund managers having to pay for research related to FICC (fixed income, currency and commodity) financial instruments?

Answer 20

Fund managers could receive this research as a non-monetary benefit
They would still have to pay for ‘macro-economic’ and equity based research

Question 21

5.6 What is the total amount of research charges allowed to be received under Research Payments Account (RPA)?

Answer 21

Not exceeding the research budget set by the investment firm for the purpose of establishing the need of third-party research

Question 22

5.6 What info must a firm making use of the Research Payments Account (RPA) provide to clients?

Answer 22

• before the provision of an investment service to clients, info about the budgeted amount for research and the amount of the estimated research charge for each of them
• annual information on the total costs that each of them has incurred for third-party research

Question 23

5.6.2 What are the obligations contained in Article 3 of UK MAR relating to the objective presentation of information and disclosure of conflicts of interest? (5)

Answer 23

• facts are clearly distinguished from interpretations, estimates, opinions and other types of non-factual info
• all substantially material sources of info are clearly and prominently indicated
• all sources of info are reliable or, where there is any doubt as to whether a source is reliable, this is clearly indicated
• all projections, forecasts and price targets are clearly and prominently labelled as such, and the material assumptions made in producing or using them are indicated
• the date and time when the production of the recommendation was completed are clearly and prominently indicated

If the info is provided in a form that is non-written, there must be information on where the client can access the information directly and easily, free of charge

Persons producing recommendations shall substantiate any recommendation they have made to the FCA upon request