The FCA Conduct of Business Sourcebook Queestions

Question 1

What are the COBS Rules?

Answer 1

The Conduct of Business Sourcebook (COBS) is contained within the business standards block for the FCA handbook. It implements the provisions of MiFID that relate to conducts of business. COBS provides rules and guidance for firms on how they manage their day-to-day interactions with clients

Firms are subject to COBS rules if they carry on any range of activities from an establishment maintained by them or their appointed representative in the UK, whether the firm is subject to MiFID or not. The activities are:

1) Accepting Deposits (Certain rules only)
2) DIB - Designated Investment Business
3) Long term insurance business in relation to life policies
4) Activities relating to the above

Question 2

When are some COBS rules modified or disapplied for specific circumstances?

Answer 2

COBS rules can be disapplied for specific types of activities

The following COBS rules are disapplied for firms carrying on eligible counterparty business

• A large part of COBS 2 - the conduct of business obligations
• Much of COBS 2 - communicating with clients (including financial promotions)
• COBS 6.1 - provision of information about the firm, its services and its renumeration
• Cobs 8 - client agreements
  -COBS 10 - appropriateness (for non-advised services)
• Parts of COBS 11 - best execution, client order handling and the use of dealing commision
  Parts of COBS 12 - labelling for non-independent research
  COBS 16 - reporting requirements to clients

Question 3

What is the purpose of the FCA’s corporate finance specialist regime?

Answer 3

The implementation of the MIFID reduced the ability of the FCA to grant concessions or modifications to those Conduct of Business Rules required to implement the MiFID. Those corporate finance firms which were carrying on MIFID business found themselves subject to the requirements of COBS, whereas those not carrying out MIFID business have the benefit of some exemptions from the rules.

Question 4

When is a firm expected to act honestly, fairly and professionally in accordance with the best interest of its client?

Answer 4

A firm must act honestly, fairly and professionally in accordance with the best interests of its client. This rule applies to DIB carried on

1) For a retail client and
2) In relation to MiFID or equivalent 3rd country business, for any client

A firm must also not, in any communication relating to DIB, seek to:

1) Exclude or restricted
2) Rely on any exclusion or restriction of

any duty or liability it may have to a client under the regulatory system

Question 5

What is the purpose of the Inducements Provisions?

Answer 5

The rules on inducements apply to firms carrying on MiFID, as well as non-MiFID, DIB. The rules only apply to dealings with professional clients and retail clients. Therefore, investment firms are not subject to the detailed inducement provisions when undertaking eligible counterparty business

The Inducement rules may be described as payments rules, as they prohibit any payment unless expressly permitted. In relation to MiFID business, firms are prohibited from paying or accepting any fees or commissions or providing or receiving non-monetary benefits, other than:

1) Fees, commissions or non-monetary benefits paid to or by the client, or someone on their behalf
2) Proper fees which are necessary for the provision of the service and which cannot, by their nature, give rise to conflicts
3) Fees, commissions or non-monetary benefits paid tp/by a third party which are permissible only if:
- they do not impair compliance with the firm’s duty to act in the cient’s best interests
- They are designed to enhance the quality of the service to the client
- They are disclosed in accordance with set standards prior to the provision of the service to the client

Firms can satisfy the disclosure obligations under the rules if they

1) disclose the essential arrangements for such payments/benefits in summary fir
2) Undertake to their client that further details will be disclosed on request
3) Provide details on the request

Firms must keep full records of suck payments/benefits made to other firms, for all MiFID business

Question 6

What is the purpose of the financial promotion rules?

Answer 6

The purpose of the financial promotion rules is to ensure that financial promotions are identified as such, and that they are fair, clear and not misleading.

The rules are consistent with principles 6 and 7 of the FCA’s Principles of Business:

Principle 6: a firm must pay due regard to the interests of its customers and treat them fairly

Principle 7: A firm must pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading

Section 21 of FSMA imposes a statutory restriction on the communication of financial promotions by unauthorised persons. A person must not communicate a financial promotion unless:

• They are an authorised person
• The content of the promotion is approved by an authorised person

Unless the financial promotion is subject to an exemption

The maximum penalty for a breach of section 21 of FSMA is 2 years in jail and / or an unlimited fine

Question 7

What is the definition of a client?

Answer 7

A client is defined as “someone to whom a firm provides, intends to provide, or has provided a service in the course of carrying on a regulated activity. In the case of MiFID or equivalent 3rd party business, this includes anything which is an ancillary service.

The term includes potential clients and people acting as agent for another person. In relation to financial promotion rules, it includes persons with whom the firm communicates, whether or not they are actually clients

Question 8

What is the purpose of the client categorisation requirements?

Answer 8

Clients may be categorised as

1) A retail client
2) A professional client
3) An eligible counterparty

The classification determines the level of protection the client receives. Retail clients receive the most and eligible counterparties receive the least.

A retail client is any client who is not a professional client or an eligible counter party

The term customer referees to both retail clients and professional clients.

Question 9

What customers are classified as professional clients?

Answer 9

Professional clients may either be elective professional clients or per see professional clients. An elective personal client is one who has chosen to be treated as such.

Per Se Professional clients are those who fall into the following categories unless they are eligible counterparties:

• Entities requires to be authorised or regulated to operate in the financial markets
• Institutional investors whose main business is an investment in financial instruments
• Governments, certain public bodies, central banks and international/subnational institutions
• Large undertakings (Companies whose balance sheer, turnover or own funds meet certain levels)

For MiFID and equivalent 3rd party business, this means undertakings that meet 2 of any of the following size requirements

• a balance sheet total of 20m euros
• A net turnover of 40m euros
• Own funds of 2m euros

For other non-MiFID business, large undertakings are:
1) Companies whose called up Share capital or net assets are, or have at any time in the past 2 years been, at least £5m (even if there holding / subsidies meet this test) or

2) Companies (or their holding or subsidiary companies) meet any 2 of the following criteria
- A balance sheet of over 12.5m Euros
- A Net turnover of 25m Euros
- An average of 250 employees during the year

3) Partnerships or unincorporated associations whose net assets are, or have at any time in the last two years been, at least £5m.
4) Trustees of a trust (other than specific pension schemes) which has, or has at any time in the past 2 years, had assets of at least £10m

5) Trustees of an occupational pension scheme or a small self-administered scheme, or the trustee/operator of a personal pension or stakeholder pension scheme if the scheme has or at any time in the previous 2 years has had:
- At least 50 members
- Assets under management of at least £10m

6) Local or public authorities

Question 10

What are Eligible counterparties on the COBS list?

Answer 10

Eligible counterparties are similar to professional clients. However, the ECP list is narrower as it does not include large undertakings.

A client can only be categorised as an EXP for the following 5 types of business

1) Executing orders and / or
2) Dealing on own account and / or
3) Receiving and transmitting orders and / or
4) Ancillary services relating to the above activities
5) Arranging

If a ECP wants to engage in other types of business with a firm, it will have to be classified by that firm as a professional client.

Many of the COBS rules don’t apply when the client is an ECP, so the ECP doesn’t benefit from the protection of those rules. An ECP can voluntarily ask to opt-down a client category and be classified as a professional client.

Question 11

What obligations has the MiFID 2 placed on firms when dealing with ECP’s

Answer 11

MiFID 2 has placed the following 4 obligations on firms when dealing with ECPs

1) Act honestly, fairly and professionally in their dealings with ECPs
2) Communicate in a way that is fair, clear and not misleading
3) Provide certain info to ECPs
4) PRovide certain reports to ECPs

Question 12

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

Answer 12

If a firm knows that someone to whom it is providing services (Person A) is acting as the agent of another person (Person B) then it should regard Person A as its client. The exception is when the firm has agreed, in wiring, with A that it should treat B as its client instead.

If the involvement of A in the arrangement is mainly for the purpose of reducing the firm’s duties to B, in this circumstance, B should be treated as the client.

Question 13

What is the purpose of providing a higher level of protection for clients?

Answer 13

Firms must allow professional clients and ECPs to request re-categorisation, so as to benefit from the higher protections afforded to retail or professional clients.

Firms can, at their own initiatives as well as at the client’s request:

1) Treat per see professional clients as retail clients
2) Treat per see ECPs as professional or retail clients

Recategorisation may be carried out for a client:

1) On a general basis
2) On more specific terms, e.g., in relation to a specific transaction

A firm can classify a client under different client classifications for different financial instruments that they may trade or undertake trades in, however this would be complex internal arrangements, so most firms only classify a client once.

Question 14

What notifications should new clients receive?

Answer 14

New Clients must be notified of how a firm has classified them. They must also, before services are provided, be advised of their rights to request recategorisation, and of any limits in their protections that will arise from this

Question 15

What is a corporate finance contract?

Answer 15

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 the purposes of the financial promotion rules. If a firm communicates or approves financial promotions that will be communicated to such a contact, it will have to treat this contract as a client, and will need to recategorise it.

In this case, non Mifid categorisations are relevant, and in categorising these contacts as elective professional clients, the quantitative test does not need to be satisfied

Question 16

How may a client become an elective professional client?

Answer 16

A retail client may be treated as an elective professional client if:

1) The firm has assessed their expertise and believes they can make their own investment decisions and understand the risks involved (This is the Qualitative test)
2) Any 2 of the following are true (The Quantative test)
- the client carried out, on average, ten significantly szed transactions on the relevant market in each of the past 4 quarters
- The size of the client’s financial portfolio exceeds £500,000
- The client works, or has worked, as a professional in the financial services sector for at least a year on a basis which required knowledge of the transaction envisaged

The firm must follow specific steps, including:

• giving a clear written warning to the client of the lost protections, the client must agree in writing
• The client must state in writing it wishes to be treated as a professional client either generally or in respect to a particular service or transaction

For MiFID business, a client may be treated as an elective professional client if it meet both the qualitative and quantitative test. IF the firm becomes aware a client no longer fulfils the conditions for categorisation as an elective professional client it must take action. If this means making the client a retail client, they must notify the client of the new categorisation.

It is up to the professional-client to keep the firm up to date with their circumstances

Question 17

How may a client become an Elective Eligible Counterparties?

Answer 17

A professional client may be treated as an elective ECP if it is a company and it is:

1) a per see professional client
2) Asks to be treated as an elective ECP and is already an elective professional client (but only for the services for which it could be treated as a professional client
3) It expressly agrees with the firm to be treated as an ECP

Question 18

What are the main considerations for Conflicts of Interest?

Answer 18

Common Platform firms (Those subject to either the CRD - capital requirements directive, or MiFID) must take all reasonable steps to identify conflicts of interest that may arise in the course of the firm providing regulated activities or ancillary activities,

For the purpose of identifying the types of conflicts of interest that may arise during service which poses a material risk to clients, the firm must take into account whether the firm, or a person directly or indirectly linked by control to the firm:

1) Is likely to make a financial gain, or avoid a financial loss, at the expense of a client
2) Has an interest in the outcome of a service provided to a client, or a transaction conducted on behalf of a client, which is different to the client’s interest
3) Has a financial or other incentives to favour the interest of another client
4) Carries on the same business as the client
5) 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 19

How are Non-MiFID affected by conflicts of interest?

Answer 19

For Non-MiFID platform firms, the above requirements must be taken as guidance rather than a rule, other then:

1) When a firm produces or arranges the production of, investment research - Cobs 12.2
2) When a firm produces or disseminates non-independent research - COBS 12.3

Question 20

What are the main conflicts of interest that will arise for a corporate finance firm?

Answer 20

When a firm is undertaking the service of management of a securities offering, a firm’s duty is to its corporate finance client, but its responsibilities to provide services to its investment challenges is unchanged.

This situation needs to be controlled to ensure that inside information in relation to the corporate finance client is not provided to investment clients and that the pricing of the securities offer and the allocation of securities are not influenced by the interests of the firm’s investment clients.

Question 21

What measures might a firm consider in drawing up its conflicts of interest policy in relation to the management of an offering of securities?

Answer 21

Measures that a firm might consider when drawing up its conflicts of interest policy in relation to the management of an offering of securities might include:

1) Agreeing with its corporate finance client relevant aspects of the offering process, such as the process the firm proposes to follow in order to determine what recommendations it will make about allocations for 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

2) Agreeing on allocation and pricing objectives with the corporate finance client
3) Inviting the corporate finance client to participate actively in the allocation process
4) Making the initial recommendation for allocation to retail clients of the firm as a single block and not on a ned basis
5) 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
6) Disclosing to the issuer details of the allocations made

An example of a conflict of interest would be a firm advising a client on an acquisition of a company which the same firm has a material interest in.

Question 22

What processes and procedures is a firm required to have in order to manage conflicts of interests?

Answer 22

A Chinese wall - arrangements made by a firm where one colleague in a part of the business has information which must be withheld from another colleague in a different part of the business

A firm has no requirement to implement a Chinese wall unless. However, the SYSC dictates that if a firm has and maintains a Chinese wall it must:

1) Withhold or not use the information held
2) For this purpose, permit employees in one part of the business to withhold information from employees in another, but only to the tent that one of the parts carries on regulated activities, ancillary activities or MiFID ancillary activities

Firms must also take reasonable steps to ensure the Chinese wall procedures remain up to date.

In order to manage conflicts of interest to ensure the fair treatment of clients, firms mat also use the additional processes and procedures

: 1) Infomation barriers such as:

• Reporting Lines
• Remuneration structures
• Segregation of duties
• Policies of independence

Question 23

What is the purpose of the personal accounting dealing rules?

Answer 23

The Personal account dealing rules apply to employees who are relevant persons and involved in activities that could lead to conflicts of interest, or who could have access to inside information or other confidential client information.

Relevant persons are: directors, managers, partners, appointed representatives or those carrying out regulated activities

Firms must have arrangements in place to stop these persons from:

1) Entering into a personal transaction that is contrary to MAR, involves misuse of improper disclosure of confidential information or conflicts with the firm’s duties to a customer

2) Improperly advising or pouring that anyone else enters into a transaction that would have fallen foul of the above, if conducted by the employee themselves
3) Improperly disclosing information or opinion if they know the person who has received the information is likely to transact

The relevant provisions are:

1) The rules on personal account transactions undertaken by financial analysts contained elsewhere in COBS (e.g. investment research)
2) The rules on the misuse of information relating to pending clients orders

Firms must keep records of all personal transactions notified to them, and of any authorisation or prohibition made in connection with them

Question 24

When is a firm required to undertake a suitability assessment?

Answer 24

The suitability rules exist to ensure that firms take reasonable steps to ensure that personal recommendations are suitable for clients’ needs.

When a firm makes a personal recommendation or is managing investments it should obtain the necessary information regarding a client’s:

1) Knowledge and experience in the investment field relevant to the specific type of designated investment business
2) Financial situation
3) Investment objectives

A firm must supply the client with a suitability report if it makes a personal recommendation to the client, if the client:

1) Acquires a holding in, or sells all or part of a holding in a:
- Regulated CIS

• An investment trust in which the shares have been, or are to be, acquired through an investment trust savings scheme
• An investment trust in which the shares are to be held in an ISA which has been promoted as the means for investing in one or more specific investment trusts
  2) Buys, sells, surrenders, converts or cancels rights under, or suspends contributions to, a persona pension scheme or stakeholder pension scheme
  3) Elects to make income withdrawals or purchase a short-term annuity

4) Enters into a pension transfer or pension opt-out
5) If it makes a personal recommendation in connection with a life assurance policy

Question 25

What are the exceptions, where a firm doesn’t need to provide a suitability report?

Answer 25

A firm isn’t required to provide a suitability report when:

1) When a firm, acting as an investment manager for a retail client, makes a personal recommendation in connection with a regulated CIS
2) When the client is habitually outside the EEA and is not present in the UK at the time of acknowledging consent to the proposal form to which the persona recommendation relates
3) When the personal recommendation is made bya friendly society in connection with a small life policy sold by it, with a premium not exceeding £50 a year or £1 a week
4) When the personal recommendation is to increase a regular premium to an existing contract
5) When the personal recommendation is to invest additional single premiums or single contributions to an existing packaged product to which a single premium or contribution has previously been made

Question 26

What are the timings and content of a suitability report?

Answer 26

For timing, a suitability report must be provided:

1) in connection with a life policy, before the contract is concluded (unless the necessary information is provided orally, or cover is required immidietly, in which case the report must be provided in a durable medium immediately after the contract is concluded)
2) in connection with a personal pension scheme or a stakeholder pension scheme when the cancellation rules apply, within 14 days of concluding the contract
3) In any other case, as soon as possible after the transaction is effected or executed

The report must:

1) Specify the client’s demands and needs
2) Explain any possible disadvantages of the transaction to the client
3) Explain why the firm has concluded that the recommendation transaction is suitable for the client

Question 27

What is the purpose of the best execution requirements?

Answer 27

Rules on best execution apply ot both MiFID and non-MiFID firms and businesses

The best execution rules require firms to execute orders on the terms that are most favourable to the client. They apply if a firm owes contractual or agency obligations to its client and is acting on behalf of that client

They require firms take all reasonable steps to obtain, when executing orders, the best possible result for their clients, taking into account all execution factors”

• Cost
• Speed
• Likelihood of execution
• Settlement
• Size
• Nature

whenever a firm receives a specific instruction from a client it must execute the order as instructed. IT will be deemed to have satisfied its obligation to secure the best results if it follows these instructions.

Question 28

What is the purpose of the client handling requirements?

Answer 28

Firms must apply procedures and arrangements which provide for the prompt, fair and expeditious execution of clients orders, relative to the other orders to the trading interests of the firm.

In particular, these should allow compatible client orders to be executed in the order in which they are received.

Firms should ensure that

1) Executed client order are promptly and accurately recorded and allocated
2) COmparable orders and executed sequentially and promptly unless this is impractical or client interests require otherwise
3) Retail clients are informed of any material difficulty in the prompt execution of their order, promptly on the firm becoming aware of this
4) When the firm is responsible for overseeing or arranging settlements, the assets or money are delivered promptly and correctly

Firms must not misuse information relating to client orders and must also take steps to prevent its abuse