Conduct of Business Sourcebook

Question 1

Who is the scope of COBS?

Answer 1

COBS applies to all authorised firms or their appointed representatives doing the following regulated activities in or into the UK:

Question 2

Who does ICOBS cover?

Answer 2

General Insurance

Question 3

Who does BCOBS cover?

Answer 3

Bank deposits

Question 4

Who does MCOBS cover?

Answer 4

Property finance

Question 5

What are the majority of COBS rules for?

Answer 5

Consumer protection

Question 6

How do some COBS rules change for corporate finance businesses?

Answer 6

Certain COBS rules do not apply

Question 7

What are three three types of client under COBS?

Answer 7

Eligible counterparty
Professional client
Retail client

Question 8

In terms of knowledge base, how do the three types of client covered by COBS relate?

Answer 8

Retail has most regulation and the lowest knowledge, while ECP has lowest regulation and the highest knowledge

Question 9

Under COBS, what is opting up?

Answer 9

Individuals and small businesses can ‘opt up’ to be treated as an elective professional client.

Question 10

What tests does someone have to complete when ‘opting up’ under COBS?

Answer 10

They need to pass two tests: one quantitative, one qualitative. They are assessed by the person providing the service to see if they are eligible and likely to understand the product they want to have professional service for. Qualitative is a ‘fit and proper’ examination.

Question 11

Under COBS, what is the difference between per se and elective?

Answer 11

Per se is default/automatic position, whereas elective is opted up.

Question 12

Can you change mind if you have opted up under COBS?

Answer 12

You can change mind; if you opted up before, you can opt down

Question 13

What is the difference between eligible counterparty and professional?

Answer 13

Business that they are engaging in.

Eligible counterparties are things like dealing and market making. Receiving or transmitting orders, execution of trades, arranging deals, dealing on own account. Summarised by market making or brokerage

Question 14

What is the definiton of a Per Se Professional client?

Answer 14

• An entity authorised to operate in financial markets.
• Includes:
  o National or regional governments, central banks, international;/supranational institutions, and any other institutional investors whose main activity is to invest in financial instruments

Question 15

What are the quantitative qualifications for both MiFID and non-MiFID businesses to meet COBS ‘per se professional client’?

Answer 15

Mifid Business qualfiications:
- €20m balance sheet total
- €40m net turnover
- €2m own funds
- Need to meet two out of three

Non-MiFID Business qualfications:
- €12.5m balance sheet total
- €25m turnover
- 250 average employees in year
- Any 2 of 3 of the above OR
- £5m share capital/net assets
- Non-MiFID: can also include ancillary investment services

Question 16

Under COBS, how can you define a retail client?

Answer 16

Retail Client:
- Any client which is not:
o A professional client
o An eligible counterparty
- OR the firm re-categorises (or the client requests) to treat an eligible counterparty or professional client as a retail client as unable to assess or manage risks

Question 17

How does one become an elective professional client?

Answer 17

Elective Professional client
- A firm may treat a retail client as an elective professional client on two tests:
o Qualitative test
 Based on knowledge, experience, and expertise
o Quantitative tets (2 out of 3):
 10+ significant transactions per quarter over past year
 Portfolio worth > €500,000
 Worked in sector for greater than one year

Question 18

When becoming an elective proffesional client, what protections are lost that are available to retail clients?

Answer 18

o Client agrees in writing with warning of protections lost
 Cant claim on financial ombudsmen act
 Neither Financial Services Compensation Scheme
 Neither financial promotion order

Question 19

What are the Obvious ECP only clients?

Answer 19

locals and insurance firms

Question 20

What are ‘locals’ in the context of ECPs?

Answer 20

Local: Own-account traders dealing in financial futures or options or other derivatives and on cash market for the sole purpose of hedging positions on derivates

Question 21

How can you be an elective eligible counterparty?

Answer 21

Elective eligible counterparty:
- A firm may treat the following as elective eligible counterparties:
o Per se professional clients (except institutional investors)
o An elective professional client on request for those areas it has elected up to

Question 22

How long should records be kept for MiFID and Non-MiFID firms?

Answer 22

• Records must be made of all notices and agreements on client categorisation for 5 years for MiFID and 3 years for non MiFID

Question 23

What is the application of COBS to corporate finance business?

Answer 23

A few rules are disapplied, but should be aware that financial promotions may still need to be enforced if the promotion could end up on a retail clients desk

Question 24

What is the rule of clients best interests?

Answer 24

Must act honesty, fairly, and professionally in accordance with the best interests of all its client. For non-MiFID business, this only applies to retail clients.

Question 25

How does the clients best interests rule apply to non-MiFID firms?

Answer 25

For non-MiFID business, this only applies to retail clients.

Question 26

In the context of payments for services, what are inducements?

Answer 26

Inducements: A firm must not pay/accept any fee/commission or provide/receive any non-monetary benefit other than:
- That paid by or provided to the client
- Proper fees which are necessary for the provision of business
- Paid by or provided to a third party if:
o They do not impair compliance with firms’s duty to act in client’s best interent
o They enhance the qulatiy of service to client – only applicable for MiFID business
o Disclosed to client prior to provision of service – only applicable for MiFID business

Question 27

When can a firm rely on the information provided by another party?

Answer 27

Reliance on others: Firm is required to obtain information, it is allowed to rely on written information from others if reasonable i.e.
- Other party is competent/professional
- Other party is not connected.

Question 28

What is a financial promotion?

Answer 28

Invitation or inducement to engage in investment activity communicated in the course of business

Question 29

What is covered by the FSMA Section 21?

Answer 29

Financial promotions must be issued or approved by an authorised firm. Penalty for breach is two years in jail and/or an unlimited fine.

Covered by FCA Principles for Businesses

Question 30

What are the three financial promotion order exemptions?

Answer 30

Financial promotion order exemptions:
- Those made only to investment professionals
- Those subject to the takeover code or corporate sales rules
- Communications made by journalists, governments, and central banks

Question 31

What financial services are covered by the financial promotion rules?

Answer 31

Financial promotion rules cover all non-exempt communications for any financial service/activity other than:
- Qualifying credit or home purchase/reversion plans
- Non-investment insurance contracts
- Unregulated CIS

Question 32

What are the situations for when firms can conduct cold calls?

Answer 32

A firm must not make a cold call unless:
- There is an existing relationship where recipient envisages the call
- It relates to a generally marketable packaged product
- It relates to a controlled activity carried out by an authorised firm / exempt person involving
o Readily realisable securities (other than warrants)

Question 33

Who do suitability tests apply to?

Answer 33

• Applies to all retail clients, professional clients (MiFID only) and pension fund management

Question 34

How do you ensure suitability of investment advice?

Answer 34

To ensure suitability of advice obtain necessary information regarding the client:
- Relevant knowledge and experience
- Financial situation and hence level of risk acceptable
- Investment objectives
Will have to decline if you cant obtain the information; suitability report may be required for a retail client

Question 35

What are common platform firms?

Answer 35

Another name for MiFID firms

Question 36

How do MiFID firms manage their conflict of interests?

Answer 36

MiFID firms must establish, implement and maintain an effective conflicts policy to identify and prevent conflicts damaging client interests.

Question 37

What things are included in a conflict of interest policy?

Answer 37

• In writing
• Appropriate to the size, nature, scale, and complexity of the business
• May manage conflicts by:
  o Information barriers (e.g. Chinese Walls)
  o Policy of Independence
  o Segregation of duties and supervision
  o Remuneration policy
• If conflict cannot be managed away, use disclosure as a last resort
• Soft commissions are prohibited (e.g. on research reports)

Question 38

Are chinese walls mandatory?

Answer 38

Chinese Walls: Not obligatory, but if you don’t have them you cant use them as a safe harbour

Question 39

How can chinese walls be used as a defence and safe harbour?

Answer 39

• Defence against ‘Misleading Statements and Impressions’ (FSA 2012 Part 7)
• Behaviour does not amount to market abuse
• Defence for firm against S 138D action

Question 40

What does best execution mean?

Answer 40

• When executing orders a firm must take account of all execution factors (price, costs, speed, likelihood of execution, size, and nature or order) to obtain the best possible result
• Importance of these factors depends on client categorisation and client orders; must execute according to specific client instructions, even if does not achieve the best possible result

Question 41

How should client orders be handled?

Answer 41

• Prompt, fair, and expeditious
• Comparable orders to be executed sequentially

Question 42

When does personal account dealing rules not apply in the context of discretionary managed funds?

Answer 42

Rules do not apply to discretionary managed funds if managed on your behalf with no input from yourself; no direct investments

Question 43

Why are there personal account dealing rules?

Answer 43

• Applies to employees who are involved in activities that could lead to conflicts of interest, or who have access to inside info, or other confidential client info

Question 44

How do the client categorisation rules apply when a person is acting as the agent of another person?

Answer 44

Treats the agent as the client, as long as there is no alternative agreement

You can provide services at the level of the agent, and assume that the agent can determine products suitability for a client

Question 45

What is a corporate finance contact?

Answer 45

For most purposes, a corporate finance or venture capital contact is not a client, because a firm does not provide a service to such a contact.
However, it will be considered a client for purposes of financial promotion

Question 46

Which one of the following is exempt from regulations covering financial promotions?

• Promotion to a company with net assets of £100,000
• Promotion to investment professionals only
• Promotion to a professional client in relation to MiFID business
• Promotion to a retail client

Answer 46

Promotion to investment professionals only

A financial promotion made only to investment professionals is given an exemption from financial promotion rules under the financial promotions order

Question 47

Under section 21 of FSMA, which requires a promotion in relation to securities to be issued or approved by an authorised firm, is an unregulated collective investment scheme exempt?

Answer 47

Yes, an unregulated CIS is exempt, but a regulated CIS is not.

Question 48

What does the POCA do?

Answer 48

Legislation that punishes those who assist, fail to report, or tip-off a money launderer.

Question 49

What is the JMLSG?

Answer 49

The Joint Money Laundering Steering Group issue guidance notes on preventing money laundering.

Question 50

Do the financial promotion rules apply to non-independent research?

Answer 50

Yes, although there is no need to disclose this fact on the document

Question 51

What are the criteria in the qualitative test for elective professional clients?

Answer 51

Experience, Expertise, and Knowledge

Question 52

Who takes the responsibility for financial promotion?

Answer 52

The authorised firm without exception

Question 53

Can an overseas individual who regularly deals off-exchange be classified as a per se eligible counterparts under the Client Categorisation Rules?

Answer 53

No - the overseas individual would need to be aurhtoised or regulated under the law of the EU or an EEA state.

Question 54

When writing to a retail client, what is the requirement that suggests the level of understanding for retail clients?

Answer 54

Should be likely to be understood by the average member of the group, NOT likely to be understood by every member

Question 55

When does the COBS rule on suitability apply?

Answer 55

When a firm makes a personal recommendation in relation to a designated investment

Question 56

Does a financial promotion need to be approved by the FCA?

Answer 56

No - the promotion needs to be approved by the firm itself, in accordance with FCA requirements, but the promotion does not need to be approved by the FCA itself.