Topic 1 Flashcards

Question

Who is responsible for administering Sonia? a) The FCA. b) The Bank of England. c) The Monetary Policy Committee. d) The Prudential Regulation Authority.

Answer 1

The Bank of England is the administrator for Sonia. The FCA used to regulate the Wholesale Markets Brokers’ Association as the calculation and publication agent. In April 2018, the Bank of England assumed calculation and publication duties.

Answer 2

Price stability – involves a low and controlled rate of inflation. It does not mean, however, that zero inflation is desirable and there is a body of economic opinion that believes that moderate inflation can stimulate investment, which is good for the economy. Low unemployment – involves expanding the economy so that there is more demand for labour, land and capital. Balance of payments equilibrium – a situation in which expenditure on imports of goods and services and investment income going abroad is equal to (ie in equilibrium with) the income received from exports of goods and services and the return on overseas investments. The exchange rate of the country’s currency is linked to the balance of payments, and most governments aim to keep the price of currency stable at a level that is not so high that exports will be discouraged but not so low as to increase inflation. Satisfactory economic growth – the output of the economy is growing in real terms over time and standards of living are getting higher.

Answer 3

policies to reduce unemployment will also boost growth; measures to reduce inflation will also help to improve the balance of payments. Governments generally have to trade off objectives against each other, ie they want price stability but know that the price of getting rid of inflation altogether would be very high unemployment, so they accept a low inflation rate to avoid pushing the economy into recession.

Answer 4

Recovery and expansion: Interest rates, inflation and unemployment are low. Consumers have money to spend. Demand for goods and services rises, pushing prices up. Share prices improve as businesses flourish. Boom: to prevent the economy from overheating, the Bank of England may intervene by putting up interest rates to control consumer spending and dampen inflation. Contraction or slowdown: Once the interest rate rises start to bite, consumer spending falls. Demand for goods and services falls, profits fall (as do share prices) and unemployment rises. Inflation slows down. Recession: As the economy heads towards its lowest level of activity, the Bank of England may intervene to reduce interest rates in a bid to stimulate demand and set the economy on the path back to recovery.

Answer 5

A measure of the change in price of a ‘basket’ of consumer goods and services over a period. Items to be included in the ‘basket’ are reviewed regularly to ensure it provides an accurate reflection of consumer spending. It is the equivalent of the Harmonised Index of Consumer Prices (HICP) used within the eurozone.

Answer 6

Measures taken to control the supply of money in the economy (eg by raising or lowering interest rates) in order to manage inflation.

Answer 7

Interest rates are set by the Bank of England’s Monetary Policy Committee (MPC). Each member of the MPC has expertise in the field of economics and monetary policy. The MPC usually meets eight times a year over three days to set the interest rate that it judges will enable the inflation target to be met. The minutes of the meetings are published simultaneously with the interest rate decision. To help produce its projections, the MPC uses a model of the economy that provides a framework to organise thinking on how the economy works and how different economic developments might affect future inflation. Every quarter, the Bank publishes its Inflation Report, which gives an analysis of the UK economy and the factors influencing policy decisions.

Answer 8

If the MPC decides to change the Bank rate, the banks and similar deposit-takers follow suit. Whether lending or taking deposits, a bank will apply a margin between the rate at which it borrows money and the rate at which it lends the money out, in order to cover costs and generate a profit.

Answer 9

The adjustment of levels of taxation and public spending in a way that is intended to achieve the government’s macroeconomic objectives. Because the public sector is responsible for taking a large amount of money from the private sector and for making large amounts of expenditure on its behalf, any changes have a significant effect on the economy as a whole.

Answer 10

Each year the Chancellor of the Exchequer makes a Budget statement to the House of Commons outlining the state of the economy and the government’s proposals for changes to taxation. The House of Commons debates the Budget and scrutinises the subsequent Finance Bill, which enacts the Chancellor’s proposals. The Budget also includes forecasts for the economy, which are provided by the Office for Budget Responsibility (OBR).

Answer 11

A government that has a deficit must borrow to finance it. The public sector net cash requirement (PSNCR) is a cash measure of the public sector’s short-term net financing requirement.

Answer 12

Increased general taxation reduces the amount of money available for investment or to fund loan repayments. Tightening of the taxation regime in relation to particular products or activities makes them less attractive to investors. For example, in April 2016 a stamp duty land tax supplement was introduced in respect of the purchase of second properties. This followed concern that first-time buyers were being priced out of the housing market as a result of demand from buy-to-let landlords.

Answer 13

On 23 June 2016, the British public voted in a referendum for the UK to leave the European Union (referred to as Brexit). The UK stopped being a member of the European Union (EU) on 31 January 2020. During a transition period that ran until 31 December 2020, the UK continued to follow all the EU’s rules and its trading relationship remained the same (BBC, 2020). As the UK onshored aspects of the EU’s financial regulatory framework (ie retained certain EU laws and regulations in UK statue), legislation and wider issues relating to the UK, and its legacy of membership of the EU covered in this text, remain important areas within the syllabus for this qualification. The Retained EU Law (Revocation and Reform) Bill was introduced in the House of Commons in September 2022. The Bill provided the government with the required provisions to allow for the amendment of retained EU law and removal of most of the special features it had in the UK legal system via a sunset clause by the end of 2023.

Answer 14

Post-Brexit, when the EU changes a regulation or introduces new regulation, the UK considers whether to adopt the new regulation or develop an alternative approach; and, in the case of reformed EU regulation, whether it wishes to amend the legislation it onshored before Brexit. Examples of EU directives include the following. The EU Mortgage Credit Directive (MCD) aimed to harmonise regulation of the EU mortgage credit market and promote competition. You will find out more about the FCA’s regulations in relation to mortgage advice and product sales in Topic 21. The deposit protection limits under the FSCS are set in reference to the European Deposit Guarantee Schemes Directive. This directive requires that the sterling scheme is revalued every five years to make sure that the level of protection remains in line with the €100,000 provided for under the EU-wide scheme.

Answer 15

The UK’s financial services regulators – the Prudential Regulation Authority and Financial Conduct Authority – are not formally part of the ESFS (European system of financial supervision) post-Brexit. However, the ESAs (European supervisory authority) still retain some jurisdiction over UK financial institutions as third-country institutions where they are providing service to clients in an EU member state. As such, the ESFS remains an important area within the syllabus for this qualification.

Answer 16

The Single Supervisory Mechanism (SSM) is the name for the mechanism by which the European Central Bank holds responsibility for the supervision and monitoring of banks in EU member states. The SSM provides a common approach to banking supervision. The ECB ( European central bank) is supported by national regulators and it is the ECB that has the final decision on supervisory matters.

Answer 17

c) The UK should consider whether it adopts a new regulation or develops its own alternative approach; and, in the case of reformed EU regulation, whether it wishes to amend the legislation it onshored before Brexit.

Answer 18

c) is bound by the regulation in its entirety regardless of existing legislation.

Answer 19

1) Acts of Parliament that set out what can and cannot be done, including any onshored EU legislation. 2) Regulatory bodies that monitor the regulations and issue rules about how the requirements of the legislation are to be met in practice. The main regulatory bodies in the UK are the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). 3) Policies and practices of the financial institutions themselves and the internal departments that ensure they operate legally and competently, eg the compliance department of a life assurance company. 4) Arbitration schemes to which consumers’ complaints can be referred. In most cases, this is the Financial Ombudsman Service.

Answer 20

1) An objective that relates to the economy as a whole, rather than to a specific sector or individual company.

Answer 21

2) Price stability, low unemployment, a balance of payments equilibrium and satisfactory economic growth

Answer 22

3) Measures taken to expand the economy (eg reducing interest rates and taxation) increase the demand for goods and services, which is likely to result in a rise in inflation.

Answer 23

4) False. They aim to keep prices stable, but seeking to reduce inflation to zero is likely to increase unemployment.

Answer 24

5) The UK government’s inflation target is 2 per cent with a maximum divergence either side of 1 per cent. It is measured by the Consumer Prices Index

Answer 25

6) c) Prices are rising but more slowly than previously.

Answer 26

7) Paul and Amanda must have a variable‑rate mortgage, so the amount they pay each month is likely to rise and fall broadly in line with changes in the Bank rate.

Answer 27

8) b) Increasing public spending. To achieve a budget surplus a government must cut public spending, raise taxes, or both.

Answer 28

9) A regulation. Member states have flexibility in the way they introduce directives.

Answer 29

10) The Bank of England for the UK and the European Systemic Risk Board (ESRB) for the EU.

Answer 30

Residence mainly affects income tax and CGT. Any person who is present in the UK for at least 183 days in a given tax year is regarded as automatically UK resident for tax purposes.

Answer 31

Domicile is best described as the country that an individual treats as their home, even if they were to live for a time in another country. Everyone acquires a domicile of origin at birth. This is the domicile of their father on the date of their birth (or the domicile of the mother if the parents are not married). A person can change to a different domicile (known as domicile of choice) by going to live in a different country, intending to stay there permanently and showing that intent by generally ‘putting down roots’ in the new country and severing connections with the former country. There is no specific process for this.

Answer 32

Domicile mainly affects liability to IHT. If a person is domiciled in the UK, IHT (inheritance tax) is chargeable on assets anywhere in the world, whereas for persons not domiciled in the UK, tax is due only on assets in the UK. People who are not UK‑domiciled but have been resident in the UK for tax purposes in at least 15 of the previous 20 tax years are deemed to be UK‑domiciled for IHT purposes.

Answer 33

1) b) Antoine. Answer c) is not correct because three months of Max’s contract are in one tax year and the rest in the following year. He will not spend 183 days in either tax year in the UK.

Answer 34

2) c) As Helena is not UK domiciled she will not pay IHT on overseas assets.

Answer 35

It is treated as the parents’ income for tax purposes. In this situation, the child’s unused allowances cannot be set against this income

Answer 36

c) Any earned income that exceeds their personal allowance. The settlement from their parents (answer d) will be taxed as the parents’ income, the educational grant (answer b) is tax‑free, and they would not pay tax on all of their earned income (answer a), only that which exceeds their personal allowance.

Answer 37

All UK residents, including children, may be subject to income tax, depending on the type and amount of income they receive.

Answer 38

Personal allowance – the personal allowance threshold usually determines the rate above which income tax is charged. Individuals whose annual income exceeds an upper threshold have their personal allowance reduced, sometimes to zero, depending how much their earnings exceed the threshold. Marriage allowance – it is possible for an individual to transfer part of their personal allowance to their spouse or civil partner, providing the transferor is not liable to income tax at all and the recipient is not liable to income tax at the higher or additional rate. Married couple’s allowance – this allowance is available if one partner in a marriage or civil partnership was born before 6 April 1935. The allowance is provided as a tax reduction and is limited to a percentage of the applicable allowance amount. Blind person’s allowance – this allowance is available to those registered as blind with a local authority. If the allowance cannot be used by the individual, it can be transferred to their spouse or civil partner. Personal savings allowance (PSA) – is a tax-free allowance that enables savers to earn interest on savings without paying tax on that interest. The allowance depends on the individual’s income tax band. There is no PSA for additional-rate taxpayers. Dividend allowance (DA) – individuals receive a dividend allowance each year. Any dividend income above the DA is taxable, but special rates apply. Dividends on any shares held in an ISA are also tax-free. Allowances for property and trading income – so‑called ‘micro‑entrepreneurs’ who supplement their main income with property or trading income are entitled to an additional allowance. There are two separate allowances, one for trading income and one for property income. The allowances apply to those who, for example, make small amounts of money by selling on eBay or by renting a room in their house or a parking space. If trading/property income is less than the allowance, then no tax is payable on that income; if it is more than the allowance, then the individual has the choice to either deduct the allowance from trading/property income or calculate profit in the usual way and deduct allowable expenses

Answer 39

certain pension contributions (within specified limits) – for example, a scheme set up by an employer; certain charitable contributions; allowable expenses – such as costs incurred in carrying out one’s employment.

Answer 40

allowable expenses can only be incurred “wholly and exclusively for the purpose of trade”, while for employed persons they must be incurred “wholly, exclusively and necessarily” while doing the job. When all the relevant deductions have been made from a person’s gross income, what remains is their taxable income. This is the amount to which the appropriate tax rate(s) is applied in order to calculate the tax due.

Answer 41

1) First, tax is calculated on non‑savings income, such as earned income, self‑employed net profits, pension income and rent received. 2) Second, it is applied to savings income, ie interest received. 3) Third, income tax is calculated on dividends. 4) Finally, any chargeable gains on non‑qualifying life assurance policies are brought into the calculation.

Answer 42

In some cases, HMRC collects income tax at source, ie from the person who makes the payment, not the recipient. An example of where tax is deducted at source is PAYE. Employers deduct tax weekly or monthly (as appropriate) from wages and salaries, which are then paid to the employee net of tax. Some other types of income are taxed at source, such as income from certain trusts.

Answer 43

Tax‑free – including income from ISAs and some National Savings and Investments accounts. Paid gross without deduction of tax but subject to tax in the hands of the individual – including interest from bank and building society accounts – if in excess of the personal savings allowance.

Answer 44

1) Work out the total income. 2) Make appropriate deductions, eg allowable expenses or certain pension contributions. 3) Deduct the personal allowance and other reliefs (eg blind person’s allowance) to arrive at the taxable income. 4) Apply tax at the current rates to the appropriate bands of income.

Answer 45

When a gift is made using Gift Aid, the charity can recover the basic‑rate tax (20 per cent) that is assumed to have been paid on the amount of the gift, increasing the value of the net gift. For example, a gift of £80 from an individual who pays income tax is treated as a gift of £100: the donor pays £80 and the charity reclaims £20 from HMRC. Effectively, this is an uplift of 25 per cent (as £20 is 25 per cent of £80). In addition, the donor making the gift has their basic‑ and higher‑rate tax thresholds extended by the value of the gross gift.

Answer 46

This enables employees to make tax‑efficient gifts by having a charitable gift deducted from their salary before income tax is charged. By making a gift in this way, tax relief is granted on the value of the gift at the individual’s highest rate of income tax.

Answer 47

Paid by employees at a percentage on earnings between certain levels, known as the primary threshold and the upper earnings limit with a reduced percentage payable on earnings above the upper limit. They are also paid by employers on most employees’ earnings above a lower limit called the secondary threshold – but with no upper limit. No employer NICs are paid in respect of employees and apprentices under a certain age on earnings between the primary threshold and the upper earnings limit.

Answer 48

Flat‑rate contributions paid by the self‑employed if their annual profits exceed the small profits threshold or deemed paid if their annual profits exceed the small profits threshold but are below the lower profits threshold. They are quoted as a weekly amount. They are collected through self‑assessment in a single lump sum.

Answer 49

Voluntary contributions that can be paid by people who would not otherwise be entitled to the full state pension or sickness benefits. This can occur because a person has, for instance, taken a career break or spent some time working overseas. They are flat‑rate contributions.

Answer 50

Additional contributions payable by self‑employed people on their annual profits between specified minimum and maximum levels, with a reduced rate payable above the upper limit, as for Class 1. They are paid to HMRC in half‑yearly instalments by self‑assessment.

Answer 51

In order to deduct the right amount of tax, the employer is supplied with a tax code for each employee: the tax code relates to the amount that the employee can earn without paying tax. The employer then supplies it to the employee.

Answer 52

People who are self‑employed pay income tax directly to HMRC on the basis of a declaration of net profits. For a self‑employed person, net profits are broadly the equivalent of the gross income of an employee, ie they are the amount on which income tax is based. They are calculated by taking the total income of the business and deducting allowable business expenses and capital allowances.Many taxpayers calculate their own liability and submit their figures online to HMRC for approval. HMRC will perform the tax calculation for those sending in their figures on paper, although the submission deadline for this is earlier. This process is called self‑assessment. Some self‑employed people use an accountant to prepare their accounts and to deal with HMRC on their behalf. Self‑employed people pay their income tax and Class 4 NICs in two equal parts. The first payment is due on 31 January of the tax year in which their business year ends; the second is due on 31 July, six months later. Any under or overpayment is then rectified on the 31 January following the end of the tax year. Class 2 NICs are also due in one lump sum on this date.

Answer 53

Personal savings allowance (PSA) – is a tax-free allowance that enables savers to earn interest on savings without paying tax on that interest. The allowance depends on the individual’s income tax band. There is no PSA for additional-rate taxpayers.

Answer 54

1) False. They are liable for income tax on income generated anywhere in the world, but the UK has reciprocal tax treaties (double taxation agreements) with many countries to ensure that people are not taxed twice on the same income.

Answer 55

2) True, as long as their actions indicate that their change of residence is permanent and they have severed links with their original country of domicile.

Answer 56

3) c) Lottery prizes.

Answer 57

4) Non‑savings income, then savings income, then dividend income.

Answer 58

5) True. Blind person’s allowance can be transferred to a spouse/civil partner if the original recipient does not pay tax or use all their allowance.

Answer 59

6) Class 3.

Answer 60

7) On earnings: £22,000 – £12,570 (personal allowance) = £9,430 £9,430 × 20% = £1,886 There is no tax to pay on savings income because, as a basic‑rate taxpayer, Mike has a personal savings allowance of £1,000.

Answer 61

8) Total income is £39,570 Salary falls within personal allowance of £12,570 so no tax is paid on this.£2,000 of dividend income is taxable at 0 per cent. The remaining £25,000 all falls within the basic rate tax band and is taxed at 8.75 per cent. Total tax is £2,187.50 (£25,000 × 8.75%).

Answer 62

9) Income tax: £20,000 Gross profit (£2,500) Allowable expenses (£12,570) Personal allowance (£2,870) Blind person’s allowance Taxable income: £2,060 Tax: £2,060 × 20% = £412 Class 4 NICs: £20,000 – £2,500 = £17,500 taxable profit £17,500 – £12,570 × 9% = £443.70

Answer 63

10) Tax on earned income: £75,000 Income (£12,570) Personal allowance £62,430 taxable earned income £37,700 × 20% = £7,540 £62,430 – £37,700 = £24,730 × 40% = £9,892 Savings interest: £500 (PSA) × 0% = £0 £150 × 40% = £60 Dividend income: £2,000 (DA) × 0% = £0 £5,000 × 33.75% = £1,687.50

Answer 64

Interest on deposits is paid gross to all customers, and individuals have to advise HMRC to deduct tax via their tax code or pay via self‑assessment. For those on low incomes a starting rate of 0 per cent applies to the first £5,000 of savings income. The starting-rate band reduces as taxable non‑savings income is received, and the starting rate does not apply at all where income received exceeds an individual’s personal allowance plus the starting‑rate band. Additionally, there is a personal savings allowance (PSA) for basic‑rate taxpayers and a lower allowance for higher‑rate taxpayers: savings income falling within these limits is subject to 0 per cent tax. In calculating eligibility for the PSA, all of an individual’s income is taken into account in assessing whether they are a basic‑ or higher‑rate taxpayer.

Answer 65

One issue with CGT is that it becomes due on the whole gain in the year it is realised, even where the gain has been made over a longer period. Only one annual exempt amount can be set against what may be many years’ worth of gain. Historically, holders of shares and unit trusts could minimise the effect of this by ‘bed and breakfasting’: selling their holding each year and repurchasing it the following day, thus realising a smaller gain that could be covered by that year’s allowance. Nowadays, any shares and unit trusts that are sold and repurchased within a 30‑day period are treated, for CGT purposes, as if those two related transactions had not taken place, rendering this loophole ineffective.

Answer 66

CGT applies to gains made since 6 April 2015 by individuals or trustees who are not UK resident on residential property located in the UK. Gains made during ownership prior to this date are ignored. Gains that accrue to non‑UK residents on non‑residential property have been subject to tax since 6 April 2019. A non‑resident individual might still be able to claim private residence relief if they live in the property for at least 90 days during a tax year.

Answer 67

the loss can be offset against gains made elsewhere. It must be offset first against gains in the year the loss occurred. Residual losses may then be carried forward to future years. A capital loss cannot be carried back to a previous year. Given that capital losses can be carried forward but the annual exempt amount cannot, capital losses brought forward are used only to the extent necessary to reduce gains to the level of the annual exempt amount. Residual losses are then carried forward.

Answer 68

1) Calculate the amount of the gain. 2) Deduct the CGT annual exempt amount (if this has not been used against other gains in the same tax year). 3) Deduct any losses that can be offset against the gain. 4) What remains is the taxable gain. 5) Add taxable gain to taxable income to establish what rate(s) of CGT should be paid. 6) Apply tax at appropriate rates. There may be different rates for taxable gains that fall in the basic‑rate income tax band and those that fall outside it. There may also be a surcharge where the gain results from the sale of property not subject to private residence relief.

Answer 69

This is available when someone sells the property they have lived in as their main or only residence. The ‘main residence’ does not have to be a house or flat – it could be a houseboat, or a fixed caravan. If someone has more than one property and shares their time between each, they may nominate the property on which they want to claim private residence relief. There are rules relating to how long an individual may spend away from the property and still be eligible for the full relief. For example, if someone owns a house but spends part of the year living away in accommodation provided with their job, the house is treated as their main residence for private residence relief purposes. There are also rules relating to the use of the property for business purposes and to the size of the garden on which full relief can be claimed.

Answer 70

Business owners are required to pay capital gains tax when they sell (dispose of) trading businesses or assets used in those businesses and from certain disposals of shares in trading companies. However, they may be able to pay a lower rate of tax on gains on qualifying assets if they meet certain conditions. This is commonly known as business asset disposal relief (previously entrepreneurs’ relief) and is available to both sole traders and limited companies. For owners of limited companies, eligibility depends on holding at least 5 per cent of the ordinary share capital of the business, which enables them to exercise at least 5 per cent of the voting rights in that company. In addition, they must also be entitled to at least 5 per cent of the distributable profits and net assets of the company. Most property letting businesses do not qualify for this relief. Business asset disposal relief also applies to gains resulting from investment into unlisted companies.

Answer 71

roll‑over relief may be claimed if the assets disposed of are replaced by other business assets. This means that, instead of CGT falling due on the original disposal, it is deferred until a final disposal is made. The replacement asset must be bought within a period of one year before and three years after the sale of the original asset. Relief can be claimed up to the lower of either the gain or the amount reinvested.

Answer 72

CGT on any gain arising on the gift of certain assets can normally be deferred until the recipient disposes of it. Gains may be wholly or partly passed on to the recipient in the case of gifts (or sale at under value) of the following broad categories of assets: assets used by the donor in their trade or the trade of their personal company or group; shares in the transferor’s personal company or in an unlisted trading company; agricultural property that would attract relief from inheritance tax; assets on which there is an immediate charge to inheritance tax.

Answer 73

If part of the estate includes a residence that is being left to children or other direct descendants an additional residence nil‑rate band (RNRB) applies. When calculating IHT due on the estate, the RNRB is deducted from the estate’s value on death. Where the RNRB is unused, in full or in part on death, the unused balance can be carried forward for use upon the death of a surviving spouse or civil partner. the unused percentage is carried forward rather than the unused value. This means that the maximum amount exempt from IHT between married couples or civil partners is effectively £1m (ie £175,000 × 2 RNRB and £325,000 × 2 NRB).

Answer 74

IHT is also payable in certain circumstances when assets are transferred from a person’s estate during their lifetime (usually in the form of gifts). Most gifts made during a person’s lifetime are potentially exempt transfers (PETs) and are not subject to IHT at the time of the transfer. If the donor survives for seven years after making the gift, these transactions become fully exempt and no IHT is payable.

Answer 75

b) £6,000. The gift uses the available nil‑rate band of £325,000, leaving an excess of £25,000 above the nil‑rate band. Joan died between four and five years after the gift, so the £25,000 excess is liable for IHT at 60 per cent of the full rate (ie 40% × 60%).

Answer 76

Some lifetime gifts – notably those to companies, other organisations and certain trusts – are not PETs but chargeable lifetime transfers, on which IHT at a reduced rate is immediately due. The reduced rate of IHT is only applied to the excess over the nil‑rate band. As with PETs, the full amount of IHT is due if the donor dies within seven years (subject to the same taper relief).

Answer 77

transfers between spouses and between civil partners both during their lifetime and on death, provided that the receiving spouse/civil partner is UK domiciled; small gifts of up to £250 (cash or value) per recipient in each tax year; donations to charity, to political parties and to the nation; wedding/civil partnership gifts of up to £1,000 (increased to £5,000 for gifts from parents or £2,500 from grandparents, or from one spouse/civil partner to the other); gifts that are made on a regular basis out of income and which do not affect the donor’s standard of living; up to £3,000 per tax year for gifts not covered by other exemptions. Any part of the £3,000 that is not used in a given tax year can be carried forward for one tax year, but no further.

Answer 78

the firm’s goods or services are more expensive to customers (by the amount of the VAT that the firm must charge); the additional administration involved in collecting, accounting for and paying VAT.

Answer 79

Stamp duty is payable on paper documents that transfer the ownership of financial assets, such as shares and bearer instruments over a certain amount. Stamp duty reserve tax (SDRT) is charged on transfers that are completed electronically. If the transaction is carried out through CREST, which is an electronic settlement and registration system, SDRT is deducted automatically and passed to HMRC.

Answer 80

First‑time buyers can claim a discount (relief), which is tapered depending on the price of the residential property. For properties below a certain amount, first-time buyers will not be liable for any SDLT and for properties in excess of a certain amount, the relief is not applicable. The relief was extended to qualifying shared-ownership property purchasers in the 2018 Budget.

Answer 81

The phrase ‘withholding tax’ refers to any tax on income that is levied at source before that income is received. So, technically, income tax paid by UK employees is a withholding tax. However, the phrase is normally understood to apply to tax that is levied in a particular country on income received in that country by those who are non‑resident in that country (eg non‑resident entertainers and professional sportspeople); this could be earned income or investment income. The aim is to ensure that the income does not leave the country without being taxed. The UK has reciprocal tax treaties (double taxation agreements) with over 100 other countries to prevent the same income from being taxed twice.

Answer 82

1) False. Gains made on ‘chattels’ (movable objects such as jewellery, antiques and paintings) are exempt from CGT if their value is £6,000 or less.

Answer 83

2) The CGT annual exempt amount cannot be carried forward at all.

Answer 84

3) False. Assets must be replaced within three years after the date of disposal.

Answer 85

4) b) Inheritance tax would be payable on the total value of the estate above the available nil‑rate band.

Answer 86

5) c) Immediately, at a reduced rate of 20 per cent.

Answer 87

6) Stamp duty reserve tax.

Answer 88

7) Gain: £25,400 – £11,300 = £14,100 Taxable gain: £14,100 – £6,000 = £8,100 Capital gains tax payable: £8,100 × 10% = £810

Answer 89

8) Gain on flat £47,600 Less cost of renovations (£14,000) Less cost of disposal (commission) (£3,500) Less carried‑forward loss from 2018/19 (£4,900) Less annual exempt amount (£6,000) Taxable gain = £19,200 × 18% = £3,456 capital gains tax

Answer 90

9) c) In this instance, we do not have enough information to decide if the gain is eligible for private residence relief. For example, the gain may not be eligible for private residence relief if: Luis has spent money renovating the house and is now selling it to release a profit; Luis sold some or all of the grounds that originally came with the house after he sold the house; any part of the house has been used exclusively for business purposes while Luis has owned it.

Answer 91

10) Nine months after the end of the relevant accounting period.

Answer 92

1) State benefits can affect the need for financial protection. The amount of additional cover needed by a client can be quantified as the difference between the level of income or capital required and the level of cover already existing. Existing provision includes not only any private insurance that the client already has, but also any state benefits to which they or their dependants would be entitled. 2) Financial circumstances can affect entitlement to benefits. Certain benefits are means‑tested – in other words, the amount of benefit is reduced if the individual’s (or sometimes the household’s) income or savings exceed specified levels. This might mean, for example, that a financial plan that increased a person’s income or the value of their assets might be less attractive than it seemed at first sight, if it also had the effect of reducing entitlement to, for instance, Universal Credit.

Answer 93

Universal Credit is not specifically an ‘in work’ or ‘out of work’ benefit; it is one benefit for people whatever their employment status. The intention is that people will not need to keep transferring from one type of benefit to another as their circumstances change. The structure is intended to be much simpler than that of the current system, where separate benefits (which often overlap) are administered by different agencies, with different methods of means testing. From April 2013, Universal Credit began to replace the following benefits: Income Support; Income‑based Jobseeker’s Allowance; Income‑related Employment and Support Allowance; Working Tax Credit and Child Tax Credit; Housing Benefit. The amount of Universal Credit awarded to claimants depends on their income and personal and financial circumstances. There is a basic allowance with different rates for single claimants and couples (and a lower rate for younger people), and additional amounts available for those with a disability, caring responsibilities, housing costs, and children and/or childcare costs. There is an ‘earnings disregard’, which is based on the claimant’s needs. There is also a maximum cap amount you can receive for specific benefits. The benefits that remain outside of Universal Credit include: Carer’s Allowance; new style Jobseeker’s Allowance and new style Employment and Support Allowance; Disability Living Allowance/Personal Independence Payment; Child Benefit; Statutory Sick Pay; Statutory Maternity Pay; Maternity Allowance; Attendance Allowance

Answer 94

Working Tax Credit is designed to top up the earnings of employed or self‑employed people who are on low incomes; this includes those who do not have children. There are extra amounts for: working households in which someone has a disability; and the costs of qualifying childcare. Working Tax Credit has now been replaced by Universal Credit and new claims can only be made for those already receiving Child Tax Credit.

Answer 95

Income Support is a tax‑free benefit which was designed to help people aged between 16 and state pension age whose income was below a certain level and who were working less than 16 hours per week (if they had a partner, their partner must work less than 24 hours per week). It was available to people with no income at all or it could be used to top up other benefits or part‑time earnings. Existing claims continue for those who continue to meet the eligibility requirements. New claims for Income Support can no longer be made, but those on low incomes can apply for Universal Credit.

Answer 96

Jobseeker’s Allowance (JSA) is a benefit for people who are unemployed or working less than 16 hours and actively seeking work. There are two forms of JSA: new style and income‑based. Income‑based JSA is being replaced by Universal Credit. People are eligible for new style JSA only if they have paid sufficient Class 1 National Insurance contributions. It is paid at a fixed rate, irrespective of savings or partner’s earnings, for a maximum of six months. Payments are made gross but are taxable. Claimants are usually credited with National Insurance contributions (NICs) for every week that they receive JSA.

Answer 97

Those in receipt of Income Support, Jobseeker’s Allowance, Universal Credit or Pension Credit can apply for assistance to pay the interest on their mortgage. Support for Mortgage Interest (SMI) was a pure state benefit until April 2018 but now takes the form of a loan that must be repaid. For eligible claimants, SMI will pay interest on a mortgage up to an upper threshold (with a lower threshold if a claim is being made for Pension Credit). SMI does not pay for associated mortgage costs, such as the repayment of capital, insurance premiums or mortgage arrears. Payment is made direct to the mortgage lender at a standard mortgage rate that may be more or less than the actual rate on the mortgage. The SMI loan is secured on the property by way of a second charge and is subject to interest. The loan is repaid when the property is sold or ownership of the property is transferred.

Answer 98

An often‑voiced complaint about the benefits system is that people can be better off out of work (by claiming state benefits) than in work. In response to this, a cap on the maximum weekly income that can be received from benefits was introduced in 2013. In broad terms, the intention is to limit the maximum paid to the level of the average UK wage. The following benefits are subject to the cap. Employment and Support Allowance Income Support Jobseeker’s Allowance Housing Benefit Maternity Allowance Child Benefit Child Tax Credit Bereavement Allowance Incapacity Benefit Severe Disablement Allowance Universal Credit (unless deemed unfit for work) Widowed Parent’s Allowance

Answer 99

Women who become pregnant while employed may receive Statutory Maternity Pay (SMP) from their employer, providing that: their average weekly earnings are above a certain threshold; they have been working for their employer continuously for 26 weeks prior to their ‘qualifying week’, which is the 15th week before the week in which their baby is due. SMP is payable for a maximum of 39 weeks. The earliest it can begin is 11 weeks before the baby is due and the latest is when the baby is born. There are two rates of SMP: for an initial period, the amount paid is equal to a percentage of the employee’s average weekly earnings; after that, the remaining payments are at a standard flat rate or set percentage of the employee’s average weekly earnings, whichever is the lower. SMP is taxable and NICs are due on the amount paid.

Answer 100

Some women who become pregnant are not able to claim SMP, including those who are self‑employed or have recently changed jobs or stopped working. They might be able to claim an alternative benefit called Maternity Allowance. This is paid by the Department for Work and Pensions (DWP) and not by employers.Maternity Allowance is not a benefit available to all women who become pregnant; an individual must meet the relevant eligibility criteria in order to claim. Maternity Allowance is paid at a lower rate than SMP but it is not subject to tax or NICs on the amount paid. Like SMP, it is payable for a maximum of 39 weeks. The earliest it can begin is 11 weeks before the baby is due and the latest is when the baby is born.

Answer 101

Child Benefit is a tax‑free benefit available to parents and others who are responsible for bringing up a child. It does not depend on having paid NICs. It is not affected by receipt of any other benefits. Child Benefit is available for each child under age 16. It can continue up to and including age 19 if the child is in full‑time education or on an approved training programme. A higher rate is paid in respect of the eldest child and a lower rate in respect of every other child. Child Benefit is means‑tested in the form of an income tax charge if either of a couple has individual adjusted net annual income over the threshold. If both have adjusted net income above the threshold, it is assessed on the higher of the two incomes. The tax charge is collected through self-assessment and is applied at a rate such that, where adjusted net income reaches a specified level above the threshold, the tax charge equals the Child Benefit paid.

Answer 102

Child Tax Credit is designed to provide financial assistance to people who are responsible for bringing up children and are on low incomes. A claim may be made by an individual who is responsible for: a child aged under 16; a child under 20 in eligible education or training. Child Tax Credit is made up of a number of different payments called ‘elements’. How much is received depends on an individual’s income, the number of children, and whether any of the children are disabled. Child Tax Credit is being replaced by Universal Credit and is not open to new claims except for individuals who are already claiming Working Tax Credit.

Answer 103

1) c) Tax is charged through self-assessment for any income above the threshold, offsetting the amount of Child Benefit received.

Answer 104

Statutory Sick Pay (SSP) is paid by employers to employees who are off work due to sickness or disability for four days or longer, providing their average weekly earnings are above the level at which Class 1 NICs are payable. SSP is paid for a maximum number of weeks in any spell of sickness. Spells of sickness with less than a minimum number of weeks between them count as one spell. Amounts paid as SSP are liable to income tax and to Class 1 NICs, just as normal earnings would be.

Answer 105

People who are ill or disabled may be able to claim Employment and Support Allowance (ESA). There are two forms of ESA. For new style ESA, eligibility depends on a person’s NIC record. New style ESA is not means‑tested and the payments are taxable. In contrast, income‑based ESA does not depend on NICs and is means‑tested but not taxable. A key feature of ESA is the work capability assessment, which looks at the impact that a claimant’s health condition has on their ability to work. As a result of the assessment, people are put in either a work‑related activity group or a support group. Those in the former group are deemed capable of working in some capacity and required to take steps to help them move into employment. For those in the support group, it is recognised that their health condition severely limits their capacity to work. Different rates of benefit are payable to the two groups; there is also a lower rate during the initial assessment period.

Answer 106

Attendance Allowance is a benefit for people who have reached state pension age and need help with personal care as a result of sickness or disability. This benefit is not means‑tested and it does not depend on NICs. There are two levels of benefit: a lower rate for people who need help with personal care by day or by night and a higher rate for those who need help both by day and by night. Some other state benefits (ie Pension Credit, Housing Benefit and Council Tax Reduction) are paid at a higher rate if the claimant is also receiving Attendance Allowance.

Answer 107

Disability Living Allowance (DLA) is a tax‑free benefit for people who need help with personal care and/or need help getting around. It is currently replaced by Personal Independence Payment (PIP) for people aged between 16 and state pension age. People born on or before 8 April 1948 can continue to claim DLA, but those born after that date will need to apply for PIP or Attendance Allowance depending on their age. There are two components to both benefits, and people may be eligible for either or both: Care component: this component is for people who need help in carrying out activities of daily living such as washing, dressing, using the toilet or cooking a meal. Mobility component: this component applies if a person has difficulty in walking or cannot walk at all.

Answer 108

Carer’s Allowance (CA) is a benefit for people who are caring for a sick or disabled person; they do not have to be a relative of the person they are caring for in order to qualify. The right to receive CA does not depend on having paid NICs. It is taxable and must be declared on tax returns. It is important to be aware that claiming CA can affect the other benefits the claimant receives, as well as the benefits the person they are caring for receives.

Answer 109

When people are in hospital, some of the needs normally met by state benefits or pensions are instead met by the NHS. In general terms, state benefits that were being claimed will continue to be paid when someone goes into hospital.

Answer 110

2) The correct answer is b). Income‑based ESA is means‑tested; new style ESA is based on National Insurance contribution record so is not means‑tested.

Answer 111

State pensions are payable from state pension age (SPA). The SPA is subject to a system of regular reviews based on changes in life expectancy. The basis of the reviews is the principle that people should spend one‑third of their adult life (regarded for these purposes as beginning at age 20) in retirement. The first review was published in March 2017 and recommended that state pension age be increased from age 67 to age 68 between 2037 and 2039. The system of state pension benefits changed from April 2016 with the introduction of the new state pension. Before this date, state pension provision consisted of a basic state pension with an additional earnings‑related element for those who were employed. The new state pension has no earnings‑related element. Those reaching SPA before 6 April 2016 have their state pension benefits paid under the system of basic + additional state pensions. Those reaching SPA on or after 6 April 2016 receive the new state pension, 9 with an adjustment paid to compensate them if they would have been better off under the previous system. State pensions are designed to provide a basic standard of living in retirement. The system operates on a pay‑as‑you‑go basis, with National Insurance contributions from the current working population being used to pay pensions to those entitled to receive them. It is readily apparent that, with the number of pensioners increasing and the numbers in employment decreasing, there is little scope for making generous increases to state pensions.

Answer 112

Originally, the basic state pension was paid only to employed people on their retirement and was not related to their earnings. It was later extended to include self‑employed people and others who have made sufficient National Insurance contributions – which means that they have contributed for at least 30 years. Benefits are scaled down for lower contribution rates. Those who had not made enough NI contributions of their own to qualify for a full basic state pension might be in receipt of a ‘Category B’ pension based on their spouse or civil partner’s pension entitlement.

Answer 113

Some employees who reached state pension age before 6 April 2016 are entitled to an additional state pension, on top of their basic state pension. The first earnings‑related state pension scheme was the graduated pension scheme that operated from 1961 until 1975. It was replaced by the state earnings‑related pension scheme (SERPS), which came into operation in 1978. SERPS was itself replaced in 2002 by the state second pension (S2P). These schemes are now collectively referred to as the ‘additional state pension’. Unlike the basic state pension, additional state pension was available only to employed people who paid Class 1 National Insurance contributions. Self‑employed people could not build entitlement to additional state pension benefits. Employed people had the option to ‘contract‑out’ of SERPS/S2P and have the NICs that would have been used to provide SERPS/S2P reduced or redirected to an alternative form of pension.

Answer 114

Pension Credit is made up of two elements: Guarantee Credit – this tops up an individual’s weekly income to a specified minimum amount. Savings Credit – this is an additional payment for some people who reached state pension age before 6 April 2016 who have saved some money towards their retirement. Pension Credit is not taxable.

Answer 115

The complexity of the state pension system led to the introduction of a simplified state pension for those reaching retirement age on or after 6 April 2016. There is a single level of benefit with no additional earnings‑related element. Pension benefits are determined by a person’s NIC record. To be eligible for the maximum pension, an individual needs to have made or been credited with 35 years’ NICs; those with under 10 years’ NICs are not usually eligible for any state pension. Carers are credited with NICs. One of the features of the new state pension is that it is based solely on an individual’s personal National Insurance record.

Answer 116

Once in payment, both the basic state pension and the new state pension are guaranteed to increase each year by the higher of: earnings (measured by the Average Weekly Earnings Index); inflation (as measured by the Consumer Prices Index); or 2.5 per cent. This is referred to as the ‘triple lock guarantee’.

Answer 117

3) The correct answer is c). With the basic state pension it is possible to claim a Category B pension based on the NICs of a spouse or civil partner, but this is not possible with the new state pension.

Answer 118

1) Financial advisers need to understand what state benefits a person is entitled to or already claiming in order to give appropriate financial advice. For instance, when working out the level of life assurance cover that a family needs, the income that would be available from state benefits if a family wage earner were to die has to be taken into account.

Answer 119

2) False. Universal Credit will eventually replace Child Tax Credit, not Child Benefit.

Answer 120

3) b) New style Jobseeker’s Allowance (JSA) is paid irrespective of savings or partner’s earnings.

Answer 121

4) c) New style Jobseeker’s Allowance.

Answer 122

5) d) Maternity Allowance. She is not entitled to Statutory Maternity Pay because she will not have been with her employer for 26 weeks by her qualifying week.

Answer 123

6) Eleven weeks before the baby is due.

Answer 124

7) c) Employment and Support Allowance. He cannot claim Statutory Sick Pay because he is self-employed.

Answer 125

8) b) All three: they will be able to claim for Ethan up until his twentieth birthday while he remains in approved education.

Answer 126

9) d) Yes. Although 35 years’ NICs are needed to be eligible for the full new state pension, Ian would have been credited with NICs for the three years that he was a carer.

Answer 127

10) False. The state second pension was available only to those who reached state pension age before 6 April 2016. Lydia’s National Insurance contributions will build entitlement to the new state pension, which has no additional earnings‑related element, therefore it is not possible for Lydia to choose to contract out.

Answer 128

Property, cash (money held in deposit accounts), fixed interest securities (gilts and corporate bonds), equities(shares), alternative investments(antiques)

Answer 129

Security of capital – However, inflation could reduce the value of the savings. There is also the risk of loss of capital if the institution becomes insolvent. Convenience – banks and building societies are readily accessible.

Answer 130

A basic bank account is a simplified current account designed to encourage people who have not previously had an account to open one. These accounts are aimed at people (typically those on low income or receiving state benefits) who might not otherwise be able to open a current account. Cash can be obtained with a card from ATMs and in-branch over the counter. Payments can be made by direct debit but no cheque books are issued on these accounts and there is no overdraft facility.

Answer 131

A packaged current account offers the holder a range of ancillary benefits such as breakdown cover, mobile phone insurance and travel insurance in return for a monthly or annual fee. A packaged current account may also enable the holder to open other accounts that offer preferential rates of interest.

Answer 132

Savings in UK bank and building society accounts are protected by the FSCS, up to a level of £85,000 per investor per financial services provider.

Answer 133

Interest on deposits is paid gross to all customers, and individuals have to advise HMRC to deduct tax via their tax code or pay via self‑assessment. For those on low incomes a starting rate of 0 per cent applies to the first £5,000 of savings income. The starting-rate band reduces as taxable non‑savings income is received, and the starting rate does not apply at all where income received exceeds an individual’s personal allowance plus the starting‑rate band. Additionally, there is a personal savings allowance (PSA) for basic‑rate taxpayers and a lower allowance for higher‑rate taxpayers: savings income falling within these limits is subject to 0 per cent tax. In calculating eligibility for the PSA, all of an individual’s income is taken into account in assessing whether they are a basic‑ or higher‑rate taxpayer.

Answer 134

National Savings and Investments (NS&I) are a range of saving and investment products backed by the government. The risk associated with the products is very low because the government guarantees the return of capital invested.

Answer 135

Individual savings accounts (ISAs) are a form of tax‑free personal savings scheme. One form of ISA is cash (also known as a cash ISA): it is a means of obtaining tax‑free interest on a bank or building society deposit account, subject to certain limits and regulations.

Answer 136

Offshore accounts are often perceived as a vehicle to hold monies that are not declared to the tax authorities. Under legislation introduced to support implementation of the US Foreign Account Tax Compliance Act, and effective from 2016, British Crown dependencies and overseas territories exchange financial information with HMRC. This includes the names and financial details of those holding accounts.

Answer 137

REDEMPTION DATE The date on which the government must redeem the gilt by paying back its original issue value or par value, normally quoted as a nominal £100. This works in the same way as redeeming an interest‑only mortgage. COUPON The interest rate payable on the par value of a gilt. It is a fixed rate, paid half‑yearly, gross but taxable.

Answer 138

Index‑linked gilts are gilts where the interest payments and the capital value move in line with inflation. For the investor, this means that the purchasing power of their capital and interest received remain constant, unlike all other fixed‑interest investments where inflation erodes the purchasing power of fixed‑interest payments.

Answer 139

She pays 80000 for her stock She pays no capital gains tax

Answer 140

Rising interest rates Robert owns £10,000 of gilts with a coupon of 3 per cent. This means that he receives £300 per year interest. He wants to sell the gilts, which have six years to run until their redemption date. However, interest rates have risen since he bought them and new six‑year gilts are now being offered with a coupon of 5 per cent. Carmen offers to buy Robert’s gilts from him, but she won’t offer him £10,000 for them because she can buy new six‑year gilts for £10,000 that gives her a coupon of £500 per year, instead of the £300 that Robert’s pay. She offers him in the region of £9,000 for his gilts. The effect of rising interest rates is that the price on Robert’s gilts has fallen. Although a price of £9,000 would reflect a return of 3.33 per cent (ie £300 interest on £9,000 invested) in terms of the income provided by the gilts, it is important to remember that if Carmen buys the gilts and holds them until redemption she will also make a capital gain of £1,000 as £10,000 is returned on redemption. Falling interest rates Imagine if, instead of rising, interest rates have fallen and new 6‑year gilts are only paying a coupon of 2 per cent. An investment of £10,000 would only return £200 per year, compared with the £300 per year that Robert’s gilts are paying. Carmen may therefore pay Robert substantially more than £10,000, in which case Robert will make a profit (which is exempt from capital gains tax). Carmen will need to bear in mind that if she pays more than £10,000 she will make a loss if she holds the gilts to redemption.

Answer 141

CALCULATE Mark is considering buying gilts and is attracted to 5% Treasury 2025. He finds that this gilt is currently trading at a price of £130.73. Mark understands that, should he buy this gilt, he will get income of £5 per year (par value of £100 x 5%) every year to 2025. He also understands that, should he hold the gilt until redemption date, he will suffer a loss of £30.73 on each one as only £100 will be paid on redemption. To understand whether the income offered is a good rate it is necessary to calculate the running yield as follows. Running yield = coupon ÷ price paid £5 ÷ £130.73 = 3.82% The 3.82% rate of income looks reasonably attractive, based on current interest rates, but it should be remembered that if the gilt is held to redemption it will lose £30.73 of capital value, which reduces the overall return.

Answer 142

Like the government (gilts) , local authorities can borrow money by issuing stocks or bonds, which are fixed‑term, fixed‑interest securities. They are secured on local authority assets and offer a guaranteed rate of interest, paid half‑yearly. The bonds are not negotiable and have a fixed return at maturity. Return of capital on maturity is promised, but these are not quite as secure as gilts since there is no government guarantee.

Answer 143

Permanent interest‑bearing shares (PIBS) were once issued by building societies to raise capital. They pay a fixed rate of interest on a half‑yearly basis. Interest is paid gross, although it is taxable as savings income according to the investor’s tax status. Investors should note that PIBS rank below ordinary accounts in priority of payment, should a building society become insolvent. As a result, they are higher risk, because depositors will be paid before shareholders. If a building society converts to a bank by ‘demutualising’, the PIBS it has issued are converted to perpetual subordinated bonds (PSBs). Perpetual subordinated bonds have similar characteristics to PIBS in that they have no redemption or maturity date and will provide a fixed income stream.

Answer 144

Generally, a company will seek to finance its activities by using its profits, but there are situations in which profits, even if retained over many years, will not be sufficient to meet the company’s requirements and it has to seek other sources of finance. The two main ways in which a company might seek to raise additional money are by issuing shares and/or by borrowing. It can, of course, borrow from banks or other lenders. It can also issue corporate bonds to meet its long‑term financing needs, or commercial paper if funds are needed over a shorter period. Corporate bonds are similar to gilts issued by the government. The bond is issued with the promise to pay a fixed rate of interest until redemption date, with the loan repaid in full at redemption date. The borrowing is usually over the longer term, which helps the company to make long‑term business plans. The bonds can be bought by institutional investors (such as life companies and pension funds) and by private investors. A bond may be secured or unsecured. If it is secured, a charge is made on company assets. This means these assets could be taken by the creditor and sold in the event that the company defaults on interest payments or repayment at redemption date. A bond that is backed by security is typically referred to as a debenture. The security is provided by a charge over company assets. A bond that is not backed by security is generally referred to as loan stock. Some corporate bonds are convertible, giving the holder the right to convert the loan into ordinary shares of the issuing company. There is no obligation to do so and if the option is not exercised, the loan continues unchanged. Interest, rather than dividends, is payable and the company is obliged to pay the interest promised, whether or not sufficient profit has been made by the company. Whether the bond is secured or not, the holder is a creditor of the company so, in the event of the company being wound up, would have priority over shareholders. If the lending is unsecured, the bondholder ranks with ordinary creditors. The risks associated with corporate bonds relate to the viability of the issuing company, its prospects and financial strength. Corporate bonds are riskier than gilts because gilts are backed by the government. Corporate bonds will therefore pay higher rates of interest than similar gilts. A bond that is unsecured presents a greater level of risk to the investor than one that is secured.

Answer 145

Corporate bonds pay higher rates of interest than similar gilts because of the relationship between risk and reward – the riskier the investment is considered to be, the greater the reward the investor expects.

Answer 146

A Eurobond is a bond issued or traded in a country that uses a currency other than the one in which the bond is denominated. This means that the bond operates outside the jurisdiction of the central bank that issues that currency. Eurobonds are a form of borrowing used by multinational organisations and governments. For example, a UK company might issue a Eurobond in Germany, denominating it in US dollars. It is important to note that the term has nothing to do with the euro currency, and the prefix ‘euro’ is used more generally to refer to deposits outside the jurisdiction of the domestic central bank.

Answer 147

Local authority bonds, corporate bonds, PIBS and Eurobonds pay interest gross (without deduction of tax). The interest paid is classed as savings income so would be free of tax if it fell within an individual’s starting‑rate band for savings income or their personal savings allowance (see Topic 3, section 3.4.4). If the gross interest, when added to other savings income, falls outside the starting‑rate band for savings and exceeds an individual’s personal savings allowance it will be taxed at 20 per cent, 40 per cent or 45 per cent with the actual rate determined by the individual’s gross income.

Answer 148

The return from a bank account is generally in the form of interest and linked to general interest rates. With a structured deposit, the return paid is linked to the performance of an index measuring the performance of equities, such as the FTSE 100. The investment is normally arranged over a fixed term, five years for example. Unlike a traditional fixed‑rate savings account, the return generated through a structured deposit is variable because it is linked to the performance of a particular stock market index or indices. The benefit of using structured deposits is access to equity‑based returns with a promise that, regardless of stock market performance, depositors will always get back their initial investment. This reduction in risk is offset by the lowered potential for reward, meaning investors probably will not receive the full benefit of any index rise and they will not receive dividend payments. Structured deposits are complex and are normally purchased via a financial adviser.

Answer 149

Alternative finance refers to any form of financial activity or lending that takes place outside of the traditional banking system. A prime example of this is crowdfunding. Crowdfunding is a way that individuals, charities and businesses (including start-ups) can raise money from the public. Crowdfunding can be donation-based (contributors do not expect anything in return) or reward-based (contributors expect a reward, for example a free trial of the product or service being developed). Neither of these types of crowdfunding are regulated by the FCA. In contrast, both loan-based crowdfunding (more commonly known as peer- to-peer [P2P] lending) and investment-based crowdfunding are regulated. Due to the risks involved, firms are only allowed to promote these to experienced or sophisticated investors, or to ordinary investors who confirm that they will not invest more than 10% of their net investable assets.

Answer 150

P2P lending involves a saver placing their money with a P2P lender who will then lend the money out to businesses that are seeking funding. This type of lending is usually arranged via loan-based crowdfunding platforms. P2P lending is not a deposit proposition but has a number of elements in common with deposit‑based savings, notably that funds are aggregated and distributed, normally for a return, and it is possible to arrange both on an easy access and fixed‑rate basis over an agreed term. P2P lenders are regulated by the FCA. In some cases, returns can be very competitive compared with traditional deposits but there are more risks. While the lender will perform due diligence on the businesses to which funds are being lent, there is a risk that loan repayments might be missed, in which case the returns to the saver would reduce. Importantly, P2P lenders are not covered by the Financial Services Compensation Scheme (see Topic 25).

Answer 151

With investment-based crowdfunding, contributors invest money typically in exchange for a share of a company or a return on their investment. Investment- based crowdfunding platforms enable lots of small investors to pool their funds in one or more start-up companies. On its website, the FCA advises that these investors are very likely to lose their investment given the significant risk of a start-up company going bust and the shares becoming worthless.

Answer 152

True. Deposit accounts allow instant access to funds and they are low risk because savings are protected by the Financial Services Compensation Scheme up to a limit of £85,000.

Answer 153

3) False, interest is paid gross but is taxable.

Answer 154

4) If the investment is held in a currency other than sterling, its value might be affected by adverse exchange rates if it has to be converted to sterling. Accounts held offshore might not be covered by investor protection schemes to the same extent as onshore UK investments.

Answer 155

5) The coupon is the interest rate payable on the par value of a gilt.

Answer 156

6) a) The gilts will have a redemption date within the next seven years.

Answer 157

7) The running yield is £3 (coupon) ÷ £107 (price paid) = 2.8%. Running yield = coupon ÷ price paid

Answer 158

8) d) Corporate bonds are considered to be higher‑risk investments.

Answer 159

9) b) A debenture is usually secured on the assets of the company.

Answer 160

10) False. A Eurobond is a bond issued or traded in a country that uses a currency other than the one in which the bond is denominated, and they can be issued by large companies, not just governments.

Answer 161

11) c) A basic bank account.

Answer 162

Company profitability, strength of the market sector, strength of the UK and global economy and supply and demand for shares and other investments

Answer 163

The London Stock Exchange (LSE). Shares, issued by UK and overseas companies, gilts, corporate bonds and options are all traded on this market. There are two markets for shares: the main market (for which full listing is required) and the Alternative Investment Market.

Answer 164

To be listed on the main market, companies must conform to the stringent requirements of the Listing Rules laid down by the Financial Conduct Authority (FCA).For a full listing, a considerable amount of accurate financial and other information must be disclosed. In addition: the applicant company must have been trading for at least three years; at least 25 per cent of its issued share capital must be in the hands of the public. The LSE, like most stock markets, is both a primary and secondary market. The primary market is where companies and financial organisations can raise finance by selling securities to investors. They will either be coming to the market for the first time, through the process of ‘going public’ or ‘flotation’, or issuing more shares to the market. The main advantages of listing include greater ease with which shares can be bought or sold, and the greater ease with which companies can raise additional funds. The secondary market is where investors buy and sell existing securities. It is much bigger than the primary market in terms of the number of securities traded each day.

Answer 165

The Alternative Investment Market (AIM) is mainly intended for new, small companies with the potential for growth. In addition to shares companies will enjoy a wider public audience and enhance their profiles by joining the AIM. Rules for joining the AIM are fewer and less rigorous than those for joining the official list (the main market) and were designed with smaller companies in mind.

Answer 166

It is possible to measure the overall performance of shares by using one or more of the various indices that are produced. These include the following: FTSE 100 Index (commonly known as the Footsie) – this is an index of the top 100 companies in capitalisation terms; each company is weighted according to its market value. FTSE 250 Index – the next 250 companies by market capitalisation after the FTSE 100. FTSE 350 Index – the FTSE 100 and FTSE 250 companies combined. FTSE All‑Share Index – this is an index of around 600 shares, split into sectors. It measures price movements and shows a variety of yields and ratios as well as a total return on the shares.

Answer 167

OTC trading is not very common between individual private investors, but is common between institutions. They trade large blocks of securities with little publicity about the price paid or the company (or companies) whose shares are being traded. This form of trading is sometimes called ‘dark pools’. MiFID II introduced stricter requirements for all trading venues to ensure the fair and orderly functioning of financial markets. New reporting requirements have increased the amount of information available and are expected to reduce the use of dark pools and OTC trading.

Answer 168

Shareholders in a limited liability company do not have a liability for the debts of the company. The company is, legally, a separate entity from its owners and is liable for its own debts. Shareholders do, however, run the risk that the value of their investment in the company could go down; if the company goes into liquidation they could lose their investment altogether. So, given that those who invest in equities run the risk of potentially losing all their investment, we might expect that they would also expect to receive higher returns than they could get from investing in deposit‑based investments, where their capital is protected. It is certainly true that, on average and over the longer term, equity markets have generally outpaced the returns available on secure deposit‑based investments.

Answer 169

Dividends are usually paid half‑yearly. Because of the administration involved in ensuring that all shareholders receive their dividends on time, the payment process has to begin some weeks before the dividend dates. A ‘snapshot’ of the list of shareholders is made at that point, and anyone who purchases shares between then and the dividend date will not receive the next dividend (which will be paid to the previous owner of the shares). Once the date has passed when the administrative process of paying the dividend starts, the shares are said to be ex‑dividend (or xd). The share price would normally be expected to fall by approximately the dividend amount on the day it becomes xd. Alternatively, a share may be paid cum‑dividend, which means that it is purchased before it goes xd, and the purchaser receives the next dividend payment.

Answer 170

Earnings per share (EPS) = post‑tax net profit ÷ number of shares Dividend cover = how much of company profits are paid as dividends P/E ratio = share price ÷ earnings per share

Answer 171

Sophie has taxable earned income of £31,700 and receives dividend payments of £9,000 in the current tax year. The tax payable is worked out in a set order of priority: 1) Earned income. 2) Dividend income. Let’s assume higher‑rate income tax is paid on taxable income above £37,700, that dividend income is taxed at 8.75% for basic- rate taxpayers and 33.75% for higher-rate taxpayers, and that the DA is £1,000. Sophie’s tax is calculated as follows. (Remember that taxable income is after the personal allowance has been deducted.) Her earned taxable income all falls within the basic‑rate tax band and there is £6,000 of the basic‑rate tax band remaining (£37,700 – £31,700 = £6,000). So, the first £6,000 of her dividend income falls in the basic‑rate tax band. However, the first £1,000 is covered by the DA, so no tax is payable on that amount. The remaining £5,000 within the basic‑rate band is taxed at 8.75 per cent = £437.50. This leaves £3,000 in the higher‑rate tax band, which is taxed at 33.75 per cent = £1,012.50. The total tax payable on Sophie’s dividend income is £1,450. Note that the dividend income falling within the basic‑rate band, even where covered by the DA and not taxed, does use up a portion of the basic‑rate band. Therefore, in the example, £3,000 is subject to higher‑rate tax rather than a further £1,000 of Sophie’s dividend income being taxed at the basic rate. %

Answer 172

to raise further capital by issuing more shares, those shares must first be offered to the existing shareholders. This is done by means of a rights issue offering, for example, one new share per three shares already held, generally at a discount to the price at which the new shares are expected to commence trading Shareholders who do not wish to take up this right can sell the right to someone else, in which case the sale proceeds from selling the rights compensate for any fall in value of their existing shares (due to the dilution of their holding as a proportion of the total shareholding).

Answer 173

A scrip issue is an issue of additional shares, free of charge, to existing shareholders. No additional capital is raised by this action – it is achieved by transferring reserves into the company’s share account. The effect is to increase the number of shares and to reduce the share price proportionately.

Answer 174

As with ordinary shares, holders of preference shares are entitled to dividends payable from the company’s profits. They differ from ordinary shares in that they are generally paid at a fixed rate, and holders of preference shares are eligible for any dividend payout ahead of ordinary shareholders. Many preference shares are cumulative preference shares, which means that if dividends are not paid, entitlement to dividends is accumulated until such a time as they can be paid. Preference shares do not normally carry voting rights, although in some cases holders may acquire voting rights if their dividends have been delayed. If a company has to be wound up, there would generally be only a limited amount of money available to repay debts and shareholders. In this situation, the claims of creditors are repaid in a set order of priority. Shareholders rank lowest in the order of priority and are therefore most at risk of receiving nothing at all; however, holders of preference shares have a higher claim than holders of ordinary shares.

Answer 175

Convertibles are securities that carry the right to be converted at some later date to ordinary shares of the issuing company. Traditionally they were issued as corporate bonds (with a lower rate of interest than conventional corporate bonds because of the right to convert to equity).

Answer 176

Warrants give the holder the right to buy shares at a fixed price at an agreed future date. The attraction is that they give the holder rights at a fraction of the cost of the shares themselves. At the date when the warrant can be exercised, it will be exercised if the share price is above the price at which the shares can be bought under the terms of the warrant. If the share price is at or below the terms offered by the warrant, it will not be worth exercising the warrant and it will lapse.

Answer 177

Property investment can have benefits, including the following: Property is a very acceptable form of security for borrowing purposes. The UK property market is highly developed and operates efficiently and professionally.On the other hand, there are a number of pitfalls of which inexperienced investors in particular should be made aware, including the following: Location is of paramount importance and a badly sited development may prove a problem. The property market is affected by overall economic conditions – in times of recession, letting properties may be difficult and property prices may fall. Property is a less liquid form of investment than most others. As with direct investment in shares, direct investment in property can be risky for the small investor, although buy‑to‑let mortgages (see section 7.6) have made it easier. For those with smaller amounts of capital and those who wish to spread the risk, property bonds might be appropriate: the underlying fund is invested in a range of properties and shares in property companies. The purchase of property is subject to stamp duty land tax and a premium applies where the property is not the only one owned. Income from property, after deduction of allowable expenses, is subject to income tax. It is treated as non‑savings income for tax purposes. On the disposal of investment property, any gain is liable to CGT, but any capital expenditure on enhancement of the property’s value can be offset against taxable gains.

Answer 178

Regular and increasing revenue streams to hedge against inflation, easy access to BTL mortgages, well developed market, easy access to ancillary services such as property management services. Accessing the market can be difficult, as investment costs are high and there are additional costs associated with arranging a mortgage, legal fees and stamp duty land tax. Property is an illiquid investment, meaning that it may be difficult to access funds if they are required at short notice. There may be void periods when the property is untenanted, meaning that income is reduced or ceases. There is the risk that tenants may damage the property, leading to additional costs. Legal fees may be incurred to remove unsatisfactory tenants. The property will require ongoing management and maintenance; these services can be outsourced but the costs would reduce overall yield.

Answer 179

Tax relief – previously, a BTL landlord could deduct the full cost of mortgage interest from their BTL income when calculating profits. This effectively gave tax relief at the landlord’s highest marginal income tax rate in respect of the interest costs. Tax relief is now limited to a tax credit at the basic rate only. Wear and tear – the annual wear‑and‑tear allowance on the cost of furnishings in the property has been replaced by a furniture replacement relief that only allows the actual cost of replacing furnishings to be offset against profits. Stamp duty land tax – as mentioned in section 7.5, second properties are now subject to an SDLT surcharge purchase.

Answer 180

Commercial property tends to provide reasonably high rental income together with, in general, steady growth in capital value. The main advantages are: regular rent reviews, with typically no more than five years between each; longer leases than for residential property; more stable and longer‑term tenants; typically lower initial refurbishment costs. Drawbacks may include the following: the higher average value means that spreading the risk is more difficult; commercial property does not generally show the spectacular growth in value that can sometimes be achieved in residential property; if the investment is to be funded by borrowing, interest rates may be higher than for residential loans.

Answer 181

quality of the land and property; reputation of builders, architects and other professionals involved; suitability of likely tenants.

Answer 182

A further category of property investment is agricultural property – farmland. An investor may buy the land and run the farm themselves to generate income or let out all or some of the land to a third party, thus providing rental income. There is the prospect of capital growth but the market for agricultural land is highly specialised and demand limited; liquidity is therefore a major concern. One of the benefits of owning agricultural property is agricultural relief for inheritance tax. This relief applies to the land, growing crops and farm buildings. Relief is available for up to 100 per cent of the inheritance tax liability for owner‑occupied farms, or 50 per cent where the owner has let out the land.

Answer 183

Treasury bills are short‑term redeemable securities issued by the Debt Management Office (DMO) of the Treasury. Like gilts, they are fundraising instruments used by the UK government, but they differ from gilts in a number of ways. Two major differences are: Treasury bills are short term, normally being issued for a period of 91 days, whereas gilts can be long term or even undated; Treasury bills are zero‑coupon securities, ie they do not pay interest. Instead, they are issued at a discount to their face value or par value (the amount that will be repaid on their redemption date). As with gilts, Treasury bills are considered to be very low‑risk securities, the risk of default by the borrower (the UK government) being so low as to be effectively zero. For example, a Treasury bill may be issued for £9,850 with a ‘par value’ of £10,000. The investor makes a guaranteed £150 on their £9,850 investment over 91 days, representing just over 6 per cent pa return, with no risk (£150 ÷ £9,850 x 100 = 1.52% over three months). Because they are such short‑term securities, changes in market rates of interest have little impact on the day‑to‑day prices of Treasury bills unless the changes are significantly large. Throughout their term, Treasury bills can be bought and sold, and there is a strong secondary market, provided mainly by financial institutions as there is no centralised marketplace. The price tends to rise steadily from the issue price to the redemption value over the 91‑day period, but prices can also be affected by significant interest rate changes, or by supply and demand. Treasury bills are purchased in large amounts, and they are not, therefore, generally of interest to small, private investors. They are held in the main by large organisations (particularly financial institutions) seeking secure short‑term investment for cash that is temporarily surplus to requirements.

Answer 184

Certificates of deposits (CDs) are issued by banks and building societies. They are in effect a receipt to confirm that a deposit has been made with the institution for a specified period at a fixed rate of interest. The interest is paid with the return of the capital at the end of the term. Terms are typically three months or six months, although depositors who require a longer term can often obtain CDs that can be ‘rolled over’ for a further three or six months on specified terms. The amounts deposited are typically £50,000 or more. There are significant penalties for withdrawals before the end of the term. However, because certificates of deposit are bearer securities, they can be sold to a third party if the depositor needs the funds before the end of the term. Banks may also hold CDs issued by other banks, and they can issue and hold CDs to balance their liquidity positions. For example, a bank would issue CDs maturing at a time of expected liquidity surplus, and hold CDs maturing at a time of expected deficit.

Answer 185

Businesses need to borrow for a variety of purposes. When they need funds for investment in their longer‑term business plans, they may issue corporate bonds. When they wish to borrow for working capital purposes, however, they can issue commercial paper. The transactions are for very large amounts, with most purchasers being institutions such as pension funds and insurance companies. Commercial paper can be placed directly with the investors, or through intermediaries. The commercial paper market offers cheaper borrowing opportunities for companies that have good credit ratings, but even companies with lower credit ratings can issue commercial paper if it is backed by a letter of credit from a bank that guarantees (for a fee) to make repayment if the issuer defaults.

Answer 186

1) False. Direct investment in shares is regarded as high risk because if the company fails, the entire investment is at risk. It is difficult for most investors to spread the risk effectively between a large number of companies and sectors.

Answer 187

2) Factors include company profitability, the strength of the global and UK economy, the strength of the market sector and the supply of and demand for shares.

Answer 188

3) They will not be eligible for a dividend payment in the first dividend distribution following their acquisition of the shares. The previous owner of the shares will receive this dividend payment.

Answer 189

4) False. A low P/E ratio indicates that the share is not in high demand and it is likely to be less expensive than other shares.

Answer 190

5) a) 4 – the profit is four times the dividend paid out.

Answer 191

6) A rights issue involves offering existing shareholders the opportunity to buy additional shares in order to raise additional capital. A scrip issue involves issuing additional shares to shareholders free of charge, the effect being to increase the number of shares in issue and reduce the share price proportionately; no additional funds are raised.

Answer 192

7)  Suitable tenants may be hard to find. Properties must be in desirable locations (eg good transport links, access to local amenities, etc). In times of recession, letting properties may be difficult and property prices may fall. Property is less easy to realise than most other forms of investment. Investment costs tend to be high and can include management fees, legal charges and stamp duty. Government measures to discourage BTL have made the tax position less advantageous.

Answer 193

8) They are allowed a furniture replacement relief, which allows the actual cost of replacing furnishings to be offset against profits.

Answer 194

9) They do not pay interest; instead they are issued at a discount to their par value.

Answer 195

10) False. Commercial paper is generally issued for between 5 and 45 days, with 30–35 days being typical. Certificates of deposit are generally issued for between three and six months.

Answer 196

Most commercial paper is issued for periods of between 5 and 45 days, with an average of around 30 to 35 days. Firms that need to retain funds for longer than this regularly roll over their commercial paper – the advantages of this are: flexibility; and the fact that the rate of interest is not fixed for a long period.

Answer 197

The services of a skilled investment manager are obtained at a cost that is shared among the investors. Individual investors do not need to research particular companies – nor do they need to understand and deal with the decision‑making and administrative work arising from events such as rights issues. Investment risk can be reduced because the investment manager spreads the fund by investing in a large number of different companies; thus if one company fails, the investor loses only a small part of their investment, rather than all of it. This is referred to as ‘diversification’. Such a spread of investments could not normally be achieved with small investment amounts. Fund managers handling investments of millions of pounds can negotiate reduced dealing costs. There is a wide choice of investment funds, catering for all investment strategies, preferences and risk profiles. Collective investment schemes enable investors to gain exposure to assets they would not otherwise be able to access due to minimum lot/investment size (eg corporate bonds)

Answer 198

Diversification is an important concept for investors. It involves creating a portfolio of investments that are spread across different geographical areas, asset classes and sectors of the economy. The aim is to spread risk, in the hope that poor performance of one investment will be offset by better performance in another. It is the opposite of ‘putting all your eggs in one basket’. For example, if you only hold shares in a company that sells sunscreen, you are likely to make more money in a hot summer. If you only hold shares in a company making umbrellas, you will make more money if it rains. By diversifying to hold shares in both companies, you would have the opportunity to make money whatever the weather.

Answer 199

location, eg UK, Europe, America, Far East; industry, eg technology, energy; type of investment, eg shares, gilts, fixed interest, property; other forms of specialisation, eg recovery stocks, ethical investments. Many funds are based on more than one categorisation; for example, a UK equity fund is categorised by both location and type of investment. A further categorisation is possible: funds that aim to produce a high level of income (perhaps with modest capital growth); those that aim for capital growth at the expense of income; and those that seek a balance between growth and income. Funds can also be categorised according to their management style: Actively managed funds (sometimes referred to simply as ‘managed funds’) use the services of a fund manager(s) to make decisions on asset selection and when holdings should be bought or sold. Passively managed or tracker funds will seek to replicate the performance of a particular stock market index, such as the FTSE All‑Share. A manager may be used but it is also possible that asset selection is computerised.

Answer 200

The term ‘managed’ fund can also be used as a marketing term to describe a fund that is comprised of holdings allocated across some or all of the other funds a company offers. Most companies offer one or more managed funds – for example, ‘managed growth’ or ‘managed income’. In this context the manager’s role in a company’s managed fund tends to involve deciding on the way fund investments should be allocated between the company’s other funds.

Answer 201

A unit trust is a pooled investment created under trust deed. They can invest a lump sum in the unit trust, make regular contributions, or a mixture of both. A unit trust is categorised as an equity trust where the underlying assets are mainly shares, or as a fixed‑income trust where investment is mainly in interest‑yielding assets. An equity trust pays a dividend, while a fixed‑income trust pays interest. A unit trust is divided into units, with each unit representing a fraction of the trust’s total assets. It is ‘open‑ended’, so if lots of investors want to buy units in it, the trust manager can create more units. Unit trusts may offer the following types of unit: Accumulation units automatically reinvest any income generated by the underlying assets. This would suit someone looking for capital growth. Distribution or income units split off any income received and distribute it to unit holders. The units may also increase in value in line with the value of the underlying assets. The unit trust aims to produce a return by selecting investments that will grow in value and/or generate income. If this happens, the unit price will increase, meaning that the investment, when encashed, will be worth more than it was at outset. A key role of the manager is to select investments that will achieve the trust’s objectives in terms of income and/or growth.

Answer 202

In general law, a trust is an arrangement whereby one person gives assets to another (the trustees) to be looked after in accordance with a set of rules (specified in the trust deed). A unit trust is similar in that the trust deed details the investment rules and objectives of the scheme. The investor effectively gives their money to the trustees who will in turn allow the fund manager to use it to meet the trust’s objectives. The trustees will ensure that the manager is fulfilling their obligations under the trust deed.

Answer 203

To price the fund, the manager will calculate the total value of trust assets, allowing for an appropriate level of costs, and then divide this by the number of units that have been issued. On a daily basis, managers calculate the prices at which units may be bought and sold, using a method specified in the trust deed. Unit prices are directly related to the value of the underlying securities that make up the fund. There are four important prices in relation to unit trust transactions: The creation price is the price at which the unit trust manager creates units. The offer price is the price at which investors buy units from the managers. The bid price is the price at which the managers will buy back units from investors who wish to cash in all, or part, of their unit holding. The cancellation price is the minimum permitted bid price, taking into account the full costs of buying and selling. At times when there are both buyers and sellers of units, the bid price is generally above this minimum level, since costs are reduced because underlying assets do not need to be traded.

Answer 204

Some unit trusts use bid and offer prices, with the difference between them (known as the bid–offer spread) being between 3 per cent and 5 per cent.

Answer 205

In a single-price system the price is arrived at through consideration of the net flows of the fund – in other words whether, on a net basis, more subscriptions are being made into the fund or whether more redemptions are being taken from the fund. Where the value of subscriptions is greater than redemptions, the fund is said to be in net inflow. Similarly, where redemptions are greater than subscriptions, the fund is said to be in net outflow. The net flow of the fund is relevant in determining the single price because a fund that has a net inflow will need to purchase assets with the net subscription proceeds and so will be priced closer to the offer price to reflect the cost of purchasing these assets. Similarly, where the fund has a net outflow, the single price will tend towards the bid price to reflect the cost of the fund selling assets in its portfolio to generate cash, which can be used to pay redemption proceeds. In cases where the value of subscriptions and redemptions is similar and the fund is receiving neither significant inflows or outflows, the single price will tend towards the mid-price. Although rare, they may impose an exit charge if units are sold within, for instance, three or five years of purchase.

Answer 206

The purchase of units in a unit trust is not an instant process as application forms need to be completed, sent off or emailed, and then administered before the investment is made. Units are generally priced on a forward pricing basis. Under forward pricing, clients buy or sell in each dealing period at a price that will be determined at the end of the dealing period. The prices published in the financial press are therefore only a guide to investors, who do not know the actual price at which their deal will be made. Before forward pricing became standard practice there was a system of historic pricing: the price of units was determined by the closing price at the end of the previous dealing period. Fund managers are still permitted to use historic pricing if they wish, subject to the proviso that they must switch to forward pricing if an underlying market in which the trust is invested has moved by more than 2 per cent in either direction since the last valuation.

Answer 207

Unit trust managers are obliged to buy back units when investors wish to sell them. There is consequently no need for a secondary market in units and they are not traded on the Stock Exchange. This adds to the appeal as the buying and selling of units is a relatively simple process. Units can be bought direct from the managers or through intermediaries. They can be purchased in writing, by telephone or online: all calls to the managers’ dealing desks are recorded as confirmation that a contract has been established. Purchasers may receive two important documents from the managers: The contract note – this specifies the fund, the number of units, the unit price and the amount paid. It is important because it gives the purchase price, which will be needed for capital gains tax (CGT) purposes when the units are sold. The unit certificate – this specifies the fund and the number of units held, and is the proof of ownership of the units. In cases where investors subscribe to a unit trust through an intermediary, their holdings may be confirmed on a non‑certificated basis. Instead, investors will receive a regular statement outlining the number of units held and their current value from the intermediary (eg a fund supermarket) rather than directly from the unit trust manager. In order to sell units, the holder signs the form of renunciation on the reverse of the unit certificate and returns it to the managers. If only part of the holding is to be sold, a new certificate for the remaining units is issued. If the holding is non‑certificated, the investor may be asked to sign a separate form of renunciation.

Answer 208

In the UK, unit trusts are primarily regulated under the terms of the Financial Services and Markets Act 2000, and must be authorised by the Financial Conduct Authority (FCA) if marketed to retail investors. The FCA specifies rules aimed at reducing the risks associated with unit trusts. The rules require that a unit trust fund is suitably diversified and specify that the fund cannot borrow an amount of more than 10 per cent of the fund’s net asset value and, even then, only for a temporary period. The trust deed places obligations on both the manager and the trustees. The manager aims to generate profit for the unit trust provider from the annual management charge and dealing in units. The trustees’ overall role is to ensure investors are protected and that the manager is complying with the terms of the trust deed. The role of trustee is usually carried out by an institution such as a clearing bank or life company. Manager’s responsibilities — Managing the trust fund in line with the trust deed — Valuing the assets of the fund — Fixing the price of units — Offering units for sale — Buying back units from unit holders Trustees’ responsibilities — Setting out the trust’s investment directives — Holding and controlling the trust’s assets — Ensuring that adequate investor protection procedures are in place — Approving proposed advertisements and marketing material — Collecting and distributing income from the trust’s assets — Issuing unit certificates (if used) to investors — Supervising the maintenance of the register of unit holders

Answer 209

The initial charge covers the costs of purchasing fund assets. The initial charge is typically covered by the bid– offer spread. The annual management charge is the fee paid for the use of the professional investment manager. The charge varies but is typically between 0.5 per cent and 1.5 per cent of fund value. Although it is an annual fee, it is commonly deducted on a monthly or daily basis.

Answer 210

Authorised unit trusts fall into two main categories: If more than 60% of the underlying investments within a unit trust are cash or fixed-interest securities, such as UK gilts or corporate bonds, the fund will be classed as a fixed-income or non-equity fund and all income distributions will be treated as interest payments. If less than 60% of the underlying investments are cash or fixed-interest securities, the fund will be classed as an equity fund and all income distributions will be treated as dividends. In both cases there is no tax on gains within the fund, meaning that the investor may be liable to capital gains tax if they make a gain when encashing the investment. Equity‑based funds For equity‑based unit trust funds, the tax treatment is the same as for shares. Income is paid without deduction of tax. Where an investor’s total dividend in a tax year is less than the dividend allowance (DA), there is no income tax on the dividend. Where dividend income is in excess of the DA, then the income is taxed at different rates based on which tax band it falls into. Fixed-income (or non-equity) funds Interest from a fixed‑income fund is classed as savings income. The income is paid gross, without deduction of tax. Where the interest is received by a non‑taxpayer, falls within the starting‑rate band for savings, or falls within the PSA of a basic‑ or higher‑rate taxpayer, then no tax is payable. Taxpayers who have used their PSA are taxed on the excess income and are required to declare the income to HMRC through self‑assessment.

Answer 211

The legal constitution of a unit trust helps to mitigate risk of fraud because the trustees have a responsibility to ensure there is proper management. The risks involved in investing in a unit trust are lower than those for an individual investing directly into equities on their own behalf because a unit trust is a pooled investment. The wide range of choice means that there are unit trusts to match most investors’ risk profiles. A cash fund will carry similar risks to a deposit account, while specialist funds that invest in emerging markets, for instance, are high risk by their very nature. Overseas funds carry the added risk of currency fluctuations. Unit trusts provide no guarantee that the initial capital investment will be returned in full or that a particular level of income will be paid.

Answer 212

Investment trusts are collective investments that are not unitised funds. they are not trusts. They are public limited companies whose business is investing (in most cases) in the stocks and shares of other companies. As a company, an investment trust is established under company law and operates as a listed plc; its shares are listed on the stock exchange. An investment trust, by contrast, must meet FCA requirements to gain a stock market listing, and it is governed by rules in its memorandum and articles of association. As with all companies, shares are sold to investors. The number of shares available remains constant – the company does not create more just because investors want them – so an investment trust is said to be ‘closed‑ended’ (in contrast to the open‑ended nature of unit trusts and OEICs).

Answer 213

Investing in an investment trust involves purchasing shares in the investment trust through: a stockbroker; a financial adviser; or direct from the investment trust manager. Similarly, to cash in the investment, it is necessary to sell these shares, via a stockbroker or back to the investment trust manager directly. The shares trade at a single price but dealing fees are added to any purchase and deducted from any sale. An annual management charge is also payable, typically between 0.5 per cent and 1.5 per cent. The share price of an investment trust depends to some extent on the value of the underlying investments, but not so directly as in the case of a unit trust: the price can also depend on a number of other factors that affect supply and demand. The share price of an investment trust may be more or less than the net asset value (NAV) per share. Where the share price is less than the NAV the trust is said to be trading at a discount, and this suggests a lack of demand for the shares. Where the share price is higher than the NAV, the investment trust is said to trade at a premium, indicating demand for the shares.

Answer 214

Total value of the investment fund’s assets less its liabilities, divided by the number of shares issued.

Answer 215

The level of debt as a percentage of a company’s equity. It is a way of measuring the extent to which a company’s operations are funded by borrowing rather than by shareholder capital.

Answer 216

Because investment trusts are constituted as companies, they can borrow money to take advantage of investment opportunities – this is known as gearing. This facility is not open to unit trusts or OEICs, which are only permitted to borrow money over the short term and against known future cash inflows. Gearing enables investment trusts to enhance the growth potential of a rising market, but investors should be aware that it can equally accentuate losses in a falling market. The ability to ‘gear up’ is one of the reasons why investment trusts are viewed as being riskier than a similar unit trust or OEIC. Some investment trusts are described as being ‘highly geared’ or ‘highly leveraged’, which means they have a high level of borrowing relative to the assets they hold; the investment trust will be pursuing high returns but there is the risk of being unable to service interest and/or repayments on borrowings.

Answer 217

At least 85 per cent of the income received by the fund managers of investment trusts must be distributed as dividends to shareholders. As it is constituted as a company, an investment trust pays income in the form of dividends. The taxation situation is the same as that described for equity unit trusts. As with unit trusts, fund managers are exempt from tax on capital gains. Investors are potentially liable to CGT on the sale of their investment trust shares, in the event that their gain, when added to the value of their other gains realised in a tax year, exceeds the CGT annual exempt amount.

Answer 218

Sometimes known as split‑level trusts or simply as splits, split‑capital investment trusts are fixed‑term investment trusts offering two or more different types of share. The most common forms of share offered are: income shares – these receive the whole of the income generated by the portfolio but no capital growth; capital shares – these receive no income but, when the trust is wound up at the end of the fixed term, share all the capital growth remaining after fixed capital requirements have been met. Most companies will also offer shares with differing balances of income and growth, so as to meet different investor objective

Answer 219

Real estate investment trusts (REITs) are tax‑efficient property investment vehicles that allow private investors to invest in property while avoiding many of the disadvantages of direct property investment. One particular advantage is that stamp duty reserve tax is charged at 0.5 per cent on purchase; the rates of stamp duty for direct property purchase are much higher. In the UK, REITs pay no cooperation tax on income or growth for the property rental potion of there investments. They have to meet the requirements of reits.

Answer 220

R: • At least 75 per cent of their gross income must be derived from property rent. • The remainder can come from development or other services but corporation tax is charged on income and gains made here. E: • At least 90 per cent of their profits must be distributed to their shareholders net of basic-rate tax. Higher- and additional-rate shareholders will have to pay additional income tax. • Dividends can be paid in cash or as stock dividends (ie the allocation of further shares) and are taxable at dividend rates. I:No individual shareholder can hold more than 10 per cent of the shares. T: Single-property REITs are only allowed in special cases – such as, for example, a shopping centre with a large number of tenants. S:They can be held in ISAs, Junior ISAs, Child Trust Funds and self-invested personal pensions.

Answer 221

A unit trust is constituted as a trust; an investment trust is actually a company. A unit trust is subject to FCA rules on diversification; an investment trust is not. A unit trust issues units to customers and these represent the customers’ holdings of the assets in the pooled fund. An investment trust issues shares in a fund. Units must be bought back by the fund manager so no secondary market is needed; shares in an investment trust must generally be sold via a stockbroker. An investment trust can borrow funds to take advantage of investment opportunities whereas a unit trust cannot. Unit trusts are open‑ended (ie the unit trust manager can create more units to meet demand); an investment trust is closed‑ended (ie the number of shares available is fixed). A unit trust can be established as an equity trust paying dividends or a fixed‑interest trust paying interest. As an investment trust is a company, it only issues shares and pays income as dividends.

Answer 222

An OEIC is an ‘open‑ended investment company’ – a limited liability company that pools the funds of its investors to buy and sell the shares of other companies and deal in other investments. To invest in an OEIC, the investor buys shares in the company; there is no limit to the number of shares that can be issued, which is why it is described as ‘open‑ended’. The open‑ended nature of an OEIC means that the fund can expand or contract, depending on whether new shares are being issued in response to demand, or being redeemed if investors wish to sell. The value of the shares varies according to the market value of the company’s underlying investments. An OEIC may be structured as an ‘umbrella’ company that is made up of several sub‑funds. Different types of share can be made available within each sub‑fund. OEICs share a number of characteristics with unit trusts and investment trusts. For instance, as with unit trust and investment trusts, investments can be made by lump sum, regular contribution or a combination of both. One difference to note, however, is that while both investment trusts and OEICs operate as companies, an investment trust can borrow money to finance its activities but an OEIC can only borrow for short‑term purposes.

Answer 223

An OEIC is established as a limited liability company under a structural framework set by HM Treasury (not under trust) under the Open-Ended Investment Companies Regulation 2001 (as amended) and associated FCA rules. Unlike an investment trust (unless it is self-managed), OEICs must be authorised by the FCA; there is a great deal of common ground between the FCA’s regulations for OEICs and those that apply to unit trusts The role of overseeing the operation of the company and ensuring that it complies with the requirements for investor protection is carried out by a depositary, who is authorised by the FCA. The role of the depositary is similar to that of the trustee of a unit trust. An authorised corporate director, whose role is much the same as the manager of a unit trust, manages the OEIC. The role of the corporate director is to: manage the investments; buy and sell OEIC shares as required by investors; ensure that the share price reflects the underlying net asset value of the OEIC’s investments.

Answer 224

The share price of an OEIC is established by dividing the total value of its assets by the number of shares currently in issue. This is, essentially, the same approach as that used to establish the unit price of a unit trust. In many unit trusts, the units have a different bid and offer price. Shares in an OEIC are single priced. Some OEICs opt to use ‘swing pricing’, which is a method through which the single quoted price of an OEIC ‘swings’ towards a de facto bid or offer price. The swinging of the price takes account of the transaction costs the OEIC incurs buying assets when there are net inflows (ie net subscriptions into the OEIC) or net outflows (ie net redemptions from the OEIC). The bid price takes account of the cost of the OEIC selling assets to generate cash to pay redemptions, whereas the offer price takes account of the cost of the OEIC buying assets with subscription cash. You might recall from your reading on unit trusts that some of these now offer single pricing, too.

Answer 225

In addition to the cost of buying the shares, the OEIC will levy: an initial or buying charge – which is added to the unit price and is normally in the region of 3 per cent to 5 per cent of the value of the individual’s investment; annual management charges based on the value of the fund – the range of annual management charges is typically between 0.5 per cent for indexed funds and 1.5 per cent for more actively managed funds; a dilution levy – this may be added to the unit price on purchase of shares or deducted from the price on sale of shares in situations where there are large flows of funds into or out of the OEIC. Other administration costs may also be deducted from the income that is generated.

Answer 226

The tax treatment of UK‑based OEICs is exactly the same as that for unit trusts. In terms of income, an OEIC will be classified as either fixed‑income or equity‑based. If it is fixed‑income, the interest is paid without deduction of tax but is subject to income tax as savings. There will be a liability to income tax for basic‑ and higher‑rate taxpayers if total savings income exceeds the investor’s starting-rate band for savings income (where available) and personal savings allowance. Additional-rate taxpayers will be liable to income tax on the full amount paid. If an OEIC is equity‑based, a dividend is paid, again without deduction of tax. There will be a further liability for income tax for basic‑, higher‑ and additional‑rate taxpayers if total dividend income exceeds the investor’s dividend allowance. Fund managers are not subject to tax on capital gains, although individual investors may be liable to pay CGT when their shares in the UK OEIC are encashed.

Answer 227

Where a fund, whether a unit trust or an OEIC, is based offshore, a UK resident investor will still be liable for taxation on income and gains. If the offshore fund reports all the annual income attributable to an investor, whether the income is distributed or not, it is referred to as a ‘reporting fund’. The tax treatment is as above: the investor will be liable for income tax on the income and CGT on any gain on disposal. If the offshore fund does not report the attributable income, it is referred to as a ‘non‑reporting fund’ and the investor will pay income tax, rather than CGT, on any gain on disposal.

Answer 228

The risks associated with investing in an OEIC are similar to those of investing in a unit trust: An OEIC is subject to the same FCA rules on diversification and fund borrowing as apply to unit trusts, and these rules help to reduce risk. As an OEIC is a pooled investment employing the services of professional investment managers, the degree of risk is lower than it would be for an individual investing directly in equities. Risk is also mitigated by the spread that can be achieved for a relatively small investment. There is, however, no guarantee that the value of the original capital investment will be maintained, nor is there any guarantee as to the level of income that will be generated.

Answer 229

Endowments are a type of investment based on life assurance. They combine life assurance and regular savings. A lump sum is either paid if the life assured dies during the term or, if they survive to the end of the term, it is paid at maturity. The introduction of schemes such as ISAs has reduced their popularity but some plans remain in existence. Endowments vary according to the nature of the underlying investment structure, and common types are with‑profits and unit‑linked. As long as premium payments are maintained, with‑profits endowments are comparatively low risk as they offer the guarantee of at least a minimum value at maturity. Unit‑linked plans do not carry such a guarantee and the value at maturity depends on how the underlying investments perform.

Answer 230

Friendly societies date from the eighteenth century when they were established as mutual self‑help organisations. Over time they have evolved, with many now offering a range of financial services. A friendly society is able to market a tax‑exempt savings plan, effectively an endowment with tax benefits, because the friendly society pays no corporation tax on its investment returns. This can be compared with a conventional endowment on which the life assurance company would pay corporation tax on some income and gains within the fund. As there is preferential tax treatment, the amount that can be saved is limited to £270 per year (as a lump sum),£25 per month or £75 per quarter. The plan is set up over an initial ten‑year term and there is no tax upon encashment. Friendly society plans are often marketed as savings plans that enable parents and grandparents to save on behalf of their children and grandchildren

Answer 231

Investment bonds are collective investment vehicles based on unitised funds; although they often appear similar to unit trusts because of their unitised structure, they are actually very different. Investment bonds are available from life assurance companies and are set up as single‑premium, whole‑of‑life assurance policies. An individual who wants to invest does so by paying a single (lump sum) premium to the life company. If an investment bond is unit‑linked, the investor then receives a policy document showing that the premium has purchased (at the offer price) a certain number of units in a chosen fund, and that those units have been allocated to the policy. To cash in the investment, the policyholder accepts the surrender value of the policy, which is equal to the value of all the units allocated, based on the bid price on the day when it is surrendered. Investment bonds are attractive to investors because of the: relative ease of investment and surrender; simplicity of the documentation; and ease of switching from one fund to another – companies generally permit switches between their own funds without charging the difference between bid and offer prices. The range of available funds is similar to those offered by unit trusts and investment trusts. investment a with‑profits bond is cashed in within a specified period after commencement (typically five years), the amount received is likely to be less than the value of the units. In the event of the death of the life assured, the policy ceases and a slightly enhanced value (often 101 per cent of the bid value on the date of death) is paid out.

Answer 232

The funds in which the premiums are invested are an insurance company’s life funds and their tax treatment is different from that of unit trusts. In particular, they attract internal tax at 20 per cent on capital gains (whereas unit trust funds are exempt) and this tax is not recoverable by investors even if they themselves would not pay capital gains tax. The taxation system for policy proceeds in the hands of the policyholder is complex. Policies may be qualifying or non-qualifying with tax consequences, particularly for higher- and additional-rate taxpayers as 20 per cent tax is deemed to have already been paid within the fund. Investment bonds are non‑qualifying policies.

Answer 233

Life assurance policies are designated as ‘qualifying’ or ‘non‑qualifying’ policies for tax purposes. The benefit of a qualifying policy is that there is no tax liability on the proceeds of the plan on death or maturity; a non‑qualifying plan may result in a tax liability for higher‑ and additional‑rate taxpayers. The criteria for qualifying policies is summarised in Figure 8.5.

Answer 234

4) To be a qualifying policy for income tax purposes, premiums would have to be paid annually, half‑yearly, quarterly or monthly over a period of at least ten years. Investment bonds involve making a single lump sum payment at the outset. As regular premiums are not made, an investment bond will be non‑qualifying.

Answer 235

Broadly speaking, a higher-rate taxpayer will pay an additional 20 per cent income tax on their gain and an additional-rate taxpayer an extra 25 per cent. The gain is the surrender value plus any withdrawals previously made that have not already been taxed, less the original investment. Top slicing, which enables the gain to be averaged over the term of the policy, is used to facilitate use of the personal savings allowance (where available). Top slicing is also used where the gain takes a basic-rate taxpayer into a higher tax band. Where top slicing results in the gain remaining in the basic-rate tax band, no further income tax is payable as the liability of a basic-rate taxpayer is deemed to have been met at source. Unlike investment trusts and unit trusts, investment bonds do not normally provide income in the form of dividends or distributions, but it is possible to derive a form of ‘income’ from them by making small regular withdrawals of capital (ie by cashing in some of the units allocated to the policy). Investors can withdraw up to 5 per cent of the original investment each year without incurring an immediate tax liability, regardless of whether the investor is a basic‑, higher‑ or additional‑rate taxpayer. This 5 per cent allowance can, if not used, be carried forward and accumulated, up to an amount of 100 per cent of the original investment. Please see qualifying criteria for tax purposes below:

Answer 236

Collective investment schemes may only be sold to the general public in the UK if they adhere to regulations relating to investment and promotion set out in the FCA Handbook. Schemes that do not fulfil the criteria for regulated collective investment schemes are classified as non‑mainstream pooled investments (NMPIs). The FCA Handbook defines an NMPI as: a unit in an unregulated collective investment scheme (UCIS); a unit in a qualified investor scheme; a security issued by a special vehicle, unless an excluded security; a traded life policy; rights or interest in any of the investments listed above. NMPIs may invest in non‑traditional assets. Such investments carry a higher risk. Also, if the provider is based abroad, an investor may have limited recourse to the Financial Ombudsman Scheme and the Financial Services Compensation Scheme. For these reasons, NMPIs are only considered suitable for a very small group of high‑net‑worth individuals. The FCA does not generally permit the marketing of NMPIs to retail customers

Answer 237

The defining characteristic of structured products is that they offer some protection of the capital invested (up to 100 per cent in some cases), while enabling investment in underlying assets that have the potential for higher returns but are also higher risk (such as ordinary shares).

Answer 238

A SCARP is defined as a product other than a derivative that provides an agreed level of income or growth over a specified investment period and displays the following characteristics: a) The customer is exposed to a range of outcomes in respect of the return of initial capital invested. b) The return of initial capital invested at the end of the investment period is linked by a pre‑set formula to the performance of an index, a combination of indices, a ‘basket’ of selected stocks (typically from an index or indices), or other factor or combination of factors. c) If the performance in b) is within specified limits, repayment of initial capital invested occurs. If it is not, the customer could lose some or all of the initial capital invested.

Answer 239

A non‑SCARP investment is one that promises to provide a minimum return of 100 per cent of the initial capital invested as long as the issuer(s) of the financial instrument(s) underlying the product remain(s) solvent. This repayment of initial capital is not affected by the market risk factors.

Answer 240

There are a number of risks associated with structured products including: counterparty risk; market risk; inflation risk. The products are also complex, with terms varying widely between providers. Before investing in a structured product, an individual should ensure they understand the risks involved and how the product works, particularly in terms of the returns offered and the conditions that need to apply for specific returns to be provided.

Answer 241

The basic premise of a ‘wrap’ account is that one provider sets up an internet‑based platform to hold all of the investor’s investments within one framework, enabling the investor to see all relevant information in one place. The wrap account allows the investor to analyse and quantify the holdings according to value, tax treatment and product type. Wraps are generally offered by independent financial advisers, who levy charges in addition to any individual fund management charges that apply to the investments held in the framework. Most wraps are able to hold any class of asset or fund on behalf of the investor. A fund supermarket is designed to provide access to a wide range of funds, such as OEICS, unit trusts and ISAs, but not investment trusts. The investor has a ‘general investment account’, which is exposed to the UK tax regime (apart from any ISAs that are included, as they are tax‑free). The investors pay a charge for the service: either a flat fee or a percentage of funds held – this is how the fund supermarket makes its money. Both wraps and fund supermarkets are often referred to as ‘platforms’, but they are different. A wrap offers all the same investments as a fund supermarket, plus a range of other investments, such as investment trusts, offshore investments and direct equities (shares).

Answer 242

The terms ‘sustainable finance’, ‘socially responsible investing’, ‘ethical investing’ and ‘green investments’ appear frequently in the media and are often used interchangeably. In short, sustainable finance is about taking into account environmental, social and governance (ESG) material factors when making investment decisions. A material factor is one that is likely to affect the profitability of a firm. For example: A material environmental factor could be paper recycling for a publishing house. Material social factors could relate to how a firm treats its employees. Are they an inclusive employer? Do they pay a fair salary? Governance factors relate to how a firm is run. Does it pay its fair share of taxes? Does it have an ethics code? Is it transparent in its communications?

Answer 243

The FCA has concerns that firms are making exaggerated or misleading sustainability-related claims about their investment products (known as greenwashing). CP22/20 introduces a package of measures to clamp down on this, including sustainable investment labels, disclosure requirements and restrictions on the use of sustainability- related terms in product naming and marketing.

Answer 244

Transactions are recorded using distributed ledger technology (DLT). Distributed networks eliminate the need for a central authority to check for invalid transactions. Participants around the world, connected through a peer- to-peer network, compete to solve complex puzzles to validate transactions. All verified transactions are recorded on an electronic ledger. Blockchain is the most widely known DLT network. It comprises transaction entries called ‘blocks’ that confirm and record users’ transactions. Each block is cryptographically connected to the previous block in the blockchain through a ‘hash’ (a digital fingerprint). This creates an auditable trail of the transaction. Blockchains are generally publicly available and transparent. Transactions are time-stamped on the blockchain and mathematically related to the previous ones; they are irreversible and impossible to alter.

Answer 245

While the FCA has oversight to check that cryptoasset firms have effective anti-money-laundering (AML) and terrorist financing procedures, generally cryptoassets are not regulated by the FCA. The FCA has confirmed that some cryptoassets, such as security tokens, may fall within its regulatory remit depending on how they are structured. The UK Cryptoassets Taskforce (CATF) report identified three different categories of cryptoasset: Exchange tokens – these are not issued or backed by any central authority and are intended and designed to be used as a means of exchange. They tend to be a decentralised tool for buying and selling goods and services without traditional intermediaries. These tokens are usually outside the regulatory perimeter. Utility tokens – these tokens grant holders access to a current or prospective product or service but do not grant holders rights that are the same as those granted by specified investments. Although utility tokens are not specified investments, they might meet the definition of e-money in some circumstances (as could other tokens). In this case, activities involving them may be regulated. Security tokens – these are tokens with specific characteristics that mean they provide rights and obligations akin to specified investments, like a share or a debt instrument as set out in the Regulated Activities Order (RAO). These tokens are within the regulatory perimeter. (FCA, 2019) Cryptoassets are considered very high-risk, speculative investments and the FCA has banned the sale of crypto-derivatives to retail customers due to concerns surrounding the volatility and valuation of the underlying cryptoassets.

Answer 246

1) b) The fund manager can create an unlimited amount of units according to demand.

Answer 247

2) False. They are owned and controlled by the trustees.

Answer 248

3) a) The unit holder.

Answer 249

4) c) A company that invests in the shares of other companies.

Answer 250

5) b) By purchasing shares of the investment trust company on the stock exchange.

Answer 251

6) An investment trust can borrow in order to take advantage of investment opportunities. Unit trusts and OEICs cannot do this.

Answer 252

7) c) There is one price, based on the value of the assets divided by the number of shares.

Answer 253

8) c) 20 per cent is deemed to have been taken within the investment with a potential further liability of 20 per cent for higher‑rate taxpayers or 25 per cent for additional‑rate taxpayers.

Answer 254

9) False. The investor may withdraw up to 5 per cent of the value of the original investment per annum without paying tax at the time of withdrawal but a tax liability may arise when the bond matures, on encashment of the bond or on death of the bondholder.

Answer 255

10) d) Noah could choose any of the above. The fact that he is a higher‑rate taxpayer has no bearing on his decision – they are all taxed in the same way.

Answer 256

TAX WRAPPERS In considering the different types of investment that can be held, either directly or indirectly, through collective investments, the tax treatment is an important factor. Tax can be charged at two stages in an investment’s life: while the funds are invested; when funds are drawn or income is paid out. The main taxes that affect investments are income tax and capital gains tax (CGT). Using a tax wrapper, such as an ISA, changes the way the investor is taxed on income and gains from the underlying investment.

Answer 257

A stocks and shares ISA can include: — shares and corporate bonds issued by companies listed on a recognised stock exchange anywhere in the world, including Alternative Investment Market (AIM) shares; — gilt‑edged securities and similar stocks issued by governments of countries in the EEA; — UK‑authorised unit trusts and OEICs; — UK‑listed investment trusts; — life assurance policies on the sole life of the ISA investor; — units in a stakeholder medium‑term investment product; — shares acquired in the previous 90 days from an all‑employee savings‑related share option scheme (SAYE). A cash ISA can include: — bank and building society deposit accounts; — units or shares in UK‑authorised unit trusts and OEICs that are money‑market schemes; — stakeholder cash deposit products. An innovative finance ISA involves investing via a peer‑to‑peer (P2P) lender (P2P lending was discussed in Topic 6). A Help-to-Buy ISA (now closed for new applications) was to help those saving for their first UK home by adding a bonus to any savings they make. A Lifetime ISA can be used to buy a first home

Answer 258

ELIGIBILITY RULES FOR ISAS The minimum age for investing in a stocks and shares ISA, innovative finance ISA or Lifetime ISA is 18 years (Lifetime ISAs also have a maximum age of 40); a cash ISA can be opened by anyone aged 16 or over. An ISA investor must be generally resident in the UK for tax purposes. An ISA can only be held in a single name, ie joint accounts are not permitted.

Answer 259

The purpose of granting tax benefits on investments held within an ISA is to encourage people who might not otherwise have saved funds to do so. To ensure that the tax benefits meet that objective, there are limits on the maximum amount that may be saved each tax year. The limit means that those who already have adequate savings cannot benefit further by switching their savings into ISAs to gain greater tax benefits. Provided the overall annual subscription limit is not exceeded, an individual investor can choose to invest the full annual amount into a stocks and shares ISA, or a cash ISA or an innovative finance ISA, or split their investment in any proportion they wish.

Answer 260

On death of an investor on or after 6 April 2018, ISA holdings are designated as a “continuing account of a deceased investor” and remain so until the earlier of the: administration of the estate; closure of the account; or third anniversary of the death of the account holder. While no further funds can be added, the holding continues to benefit from the tax advantages of an ISA. An ‘additional permitted subscription’ (APS) allowance applies when an individual’s spouse or civil partner dies. The purpose of the APS is to protect the tax benefits around savings held within an ISA. It allows the surviving spouse/civil partner to make an additional ISA subscription to the value of the deceased’s ISA holdings. The right to make a cash APS applies for three years from the date that the person died, or 180 days after administration of the estate is complete, whichever is later. For stocks and shares, the time limit is simply 180 days after administration of the estate is complete. The additional subscription can be made with the manager who held the deceased’s ISA or with another manager who agrees to accept the subscriptions. Its value can either be the value of the deceased’s ISA at the date of their death or at the point the ISA ceased to be a continuing account of a deceased investor.

Answer 261

ISA providers have the option to offer flexibility, allowing funds withdrawn from a cash or innovative finance ISA, or the cash element of a stocks and shares ISA, to be replenished during a tax year. However, providers are not obliged to offer this flexibility. Many ISA providers allow no‑notice withdrawals to be made, although there are some fixed‑rate cash ISAs that do not permit withdrawals during the fixed‑rate period. Funds may be transferred between different types of ISA without contravening the ISA limits. ISAs can be transferred between providers.

Answer 262

Investors are exempt from income tax and CGT on their ISA investments. As a comparison, an investment held in a unit trust is potentially liable to CGT on encashment. If the unit trust is held within an ISA there is no liability to CGT.

Answer 263

It was designed to help those saving for their first UK home by adding a bonus to any savings they make. The scheme was open to those aged 16 or over, and joint purchasers were able to open individual accounts that each earn a bonus payment. Anyone who opened an account by 30 November 2019 will be able to use the funds invested and the bonus payment towards the purchase of a first home by 1 December 2030. Account holders could make an initial deposit of up to £1,200. Monthly savings of between £1 and £200 can be made until 30 November 2029. Each £200 paid in attracts a bonus payment of £50, subject to the ISA being worth at least £1,600 when funds are withdrawn for home purchase. The minimum bonus size is £400 and the maximum £3,000. The bonus is available on purchases of up to £450,000 in London and £250,000 elsewhere in the UK and is paid when the home purchase is completed. Savings into a Help‑to‑Buy ISA form part of the annual ISA allowance, rather than being in addition to it.

Answer 264

A Lifetime ISA was introduced from 6 April 2017, with the aim of encouraging younger people to save for their first home in the UK, to a value of up to £450,000, and/or for their retirement. The main rules are as follows: A Lifetime ISA can be opened by those aged between 18 and 40. Savings made before the age of 50 attract a bonus of 25 per cent (paid by the government). The bonus is paid monthly, which enables interest to be earned on the bonus. A maximum of £4,000 may be saved per tax year; there is no monthly savings limit. The underlying investment choices are the same as those in the cash and stocks and shares ISAs. Savings into a Lifetime ISA form part of the annual ISA allowance, rather than being in addition to it. Savings can be used to purchase a first home and/or retained to provide benefits in retirement from the age of 60. Savings, including the bonus, can also be withdrawn when the accountholder is terminally ill. A 25 per cent penalty is applied if funds are withdrawn for reasons other than the purchase of a first home, the holder reaching age 60 or the holder suffering a terminal illness. An individual may contribute to both a Help‑to‑Buy ISA and a Lifetime ISA, but the bonus payment from only one of these ISAs can be used towards the purchase of a first home.

Answer 265

Junior ISAs (JISAs) became available in November 2011 when their predecessor the Child Trust Fund (CTF) scheme closed. Children cannot have both a JISA and a CTF, but CTFs can be transferred into JISAs on request. JISAs confer the same tax benefits as an adult ISA. Stocks and shares and cash JISAs are available, and investment can be made into one type or split between each. As with other ISAs, there is a maximum annual investment limit. Where a child is aged under 16, a JISA can only be opened and managed by the child’s parent (or another adult with legal responsibility for the child). An eligible child aged 16 or over can open and manage a JISA on their own behalf; if a JISA has already been opened for them, they become responsible for managing it. Funds cannot be accessed until the child reaches 18; once the child is 18, the account becomes a conventional adult ISA.

Answer 266

Child Trust Funds (CTFs) are no longer available to new savers, although existing CTFs can continue to receive subscriptions up to the annual limit. Alternatively, as already mentioned, a CTF may be transferred into a Junior ISA (see section 9.2). A CTF remains in force until the child’s 18th birthday. At this point, no further contributions can be made but the account keeps its tax-exempt status until it is closed. A maturing CTF can be transferred into an ISA without affecting the child’s ISA subscription limit. There is no access to money in the account before the child’s 18th birthday. There were three general types of CTF: deposit‑type savings accounts; share accounts; and stakeholder CTF accounts. Stakeholder CTF accounts invest in a range of company shares, subject to certain government rules designed to reduce the risk. The maximum annual charge permitted on a stakeholder CTF is 1.5 per cent.

Answer 267

Investment Scheme Newly established companies, particularly those not listed on a stock exchange, can find it difficult to raise the funds they need to grow. To encourage private investors to provide funds to such companies, the government offers various schemes that incentivise investment through the award of tax benefits. The two main types of scheme are Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS). The main difference between the two types of scheme is that a VCT is an investment in its own right, a collective investment, whereas the EIS is a system of tax reliefs that an individual company applies for; if a company is eligible for the EIS an investor in the company can claim the available tax reliefs.

Answer 268

A Venture Capital Trust (VCT) is a company whose shares are listed (and can therefore be traded) on the stock exchange; it is run by an investment manager. The VCT normally spreads the monies raised from investors over a range of different companies. Investment into a VCT is normally viewed as high risk, so income tax reliefs are granted to make the proposition more attractive: Income tax relief at up to 30 per cent is given on an investment of up to £200,000 per tax year. Any dividends paid by the VCT from the £200,000 permitted maximum investment are tax free. Any capital gains are exempt from CGT. A VCT must be approved by HMRC and must meet certain conditions to gain approval.

Answer 269

In a similar way to a VCT, the Enterprise Investment Scheme (EIS) is designed to encourage investment in certain smaller, high risk companies by the provision of tax relief. The main difference is that whereas a VCT is a listed company that undertakes the investment on the behalf of the investor, the EIS involves direct investment in a company that is eligible for the scheme. As with VCTs, EIS investment is seen as high‑risk so tax reliefs are offered: Income tax relief at up to 30 per cent is given on an investment of up to £1,000,000 (£2,000,000 if the amount invested in excess of £1,000,000 is made in knowledge‑intensive companies) per tax year. The CGT on any capital gains that are reinvested is deferred. Capital gains from investment in the EIS are exempt from CGT, provided that the EIS shares have been held for at least three years. As with the VCT, there are a number of conditions that must be met for the tax reliefs to be granted. There is also the Seed Enterprise Investment Scheme (SEIS), which offers even higher tax reliefs than the EIS, as it is targeted at raising funds for small start‑up companies.

Answer 270

1) Yes, she can transfer money between different ISAs without contravening the maximum subscription limit.

Answer 271

2) An APS is allowed for someone who has died: the spouse/civil partner of the deceased is able to make an additional ISA contribution to the value of the ISA holdings of the deceased.

Answer 272

3) d) The right to make a cash APS lasts for three years from date of death, or 180 days from grant of administration, whichever is later. For stocks and shares, the time limit is simply 180 days after administration of the estate is complete.

Answer 273

4) a) The withdrawn amount counts towards Jane’s ISA allowance because her provider does not offer a flexible investment facility, so she could invest a further £10,000 (£20,000 less the £10,000 initially invested).

Answer 274

5) Investments held within an ISA are free from income tax and capital gains tax.

Answer 275

6) d) Customers who owned Help-to-Buy ISAs before 30 November 2019, can save a maximum of £200 per month until 30 November 2029.

Answer 276

7) The Lifetime ISA aims to encourage people to save for the purchase of their first home and/or for their retirement.

Answer 277

8) False. The annual investment limits for Lifetime and Help‑to‑Buy ISAs count towards the overall annual ISA investment limit; they are not in addition to it.

Answer 278

8) False. The annual investment limits for Lifetime and Help‑to‑Buy ISAs count towards the overall annual ISA investment limit; they are not in addition to it.

Answer 279

9) False. Aaron’s mother can transfer the Child Trust Fund into a Junior ISA. However, it is true that Aaron cannot hold both types of account concurrently.

Answer 280

10) A Venture Capital Trust would normally represent a higher risk to the investor than an investment trust because VCTs invest in newly established companies, which tend to be higher risk.

Answer 281

Threshold income is calculated through the following steps: Calculate total net income for the tax year. Deduct any gross pension contributions that benefited from relief at source (but excluding any employer contributions). Deduct any lump sum death benefits from registered pension schemes. Add any reduction of employed income for pension provision through salary sacrifice schemes and flexible remuneration arrangements made after 8 July 2015. Adjusted income is calculated through the following steps: Calculate total net income for the tax year. Add claims made for tax relief on pension savings paid before tax relief was given. Add pension savings made to pension schemes where tax relief was given. Add any tax relief claims on pension savings made to overseas pension schemes (for non-domicile individuals). Add employer pension contributions. Deduct any lump sum death benefits received from registered pension schemes.

Answer 282

An individual can carry forward any unused annual allowance from the previous three tax years to the current tax year. The unused allowance is added to the current year’s annual allowance and only if pension contributions exceed this amount is the annual allowance charge payable.

Answer 283

Two further allowances are important: Lifetime allowance – if the total value of an individual’s pension benefits exceeds the lifetime allowance at the point when benefits are taken, there is a lifetime allowance tax charge. The pension provider will deduct the tax before any benefits are issued. There are different tax rates charged depending on how the money is paid out, with lump sums attracting a higher charge than funds taken as income or withdrawals. Money purchase annual allowance (MPAA) – this applies where a pension scheme member draws benefits from their pension using flexi‑access drawdown income or takes an uncrystallised funds pension lump sum (UFPLS). Reading: In respect of contributions to personal pensions, tax relief is given at source at the basic rate with any higher‑/additional‑rate relief claimed via an individual’s self‑assessment tax return. Relief at the individual’s highest rate is given at source on contributions to occupational pensions as any pension contribution is deducted from gross, pre‑tax, income. Within a pension fund there is no tax on gains or on savings or dividend income.

Answer 284

A person’s highest marginal rate of tax is the highest rate that they pay on their income. For example, a person whose taxable income falls within the higher-rate band would pay 20 per cent on their income up to the basic-rate threshold and 40 per cent on any income that lies above that. As they only pay higher‑rate income tax on part of their earnings, they would only receive tax relief at the highest rate (40 per cent) on that amount of their pension contributions (eg if £5,000 of income was within the higher-rate band, then £5,000 of pension contributions would be eligible for an additional 20 per cent tax relief). Any contribution in excess of that amount would receive tax relief at the basic rate.

Answer 285

There is a demand for a third type of scheme, which can provide more predictability for scheme members than defined contribution, without the cost volatility for employers associated with defined benefit. The Pension Schemes Act 2021 provides a framework for the UK’s operation and regulation of collective money-purchase schemes (commonly known as collective defined‑contribution pensions). The new collective defined-contribution (CDC) pension will see both the employer and employee pay into a joint fund, with pensions paid out from this shared pot. The benefits of the new scheme include that it offers predictable costs for the employer and is more resilient against economic shocks. The Royal Mail and Communication Workers Union will be the UK’s first CDC scheme and a case study will be done on how UK workers receive the new scheme and how successful these schemes can be in practice.

Answer 286

As people are now living longer and spending a longer period in retirement, employers are finding defined‑benefit schemes increasingly expensive to run. As a result, many are reducing their commitment and transferring responsibility for pension provision to individuals. Many people may therefore wish to supplement their retirement income by contributing more to their occupational schemes, or contributing to private arrangements. The following are tax‑efficient pension arrangements: additional voluntary contributions (AVCs); free‑standing additional voluntary contributions (FSAVCs); personal/stakeholder pension plans. AVCs and FSAVCs are available to employees who are members of occupational schemes. Personal/stakeholder pensions are generally available to anyone under the age of 75. Funds do not pay tax on income or gains.

Answer 287

AVCs are additional contributions to an occupational scheme. Sometimes, such contributions purchase additional years’ service in a final salary scheme. However, most AVCs operate as defined-contribution arrangements and the employee will only have a limited choice of funds. The employer will usually cover some or all of the administration and fund management costs. Contributions to AVCs are deducted from gross salary and the employee therefore receives full tax relief at the same time.

Answer 288

As an alternative to an AVC, an individual might choose to contribute to an FSAVCs defined-contribution fund provided by a separate pension provider. FSAVCs are available from a range of financial institutions, including insurance companies, banks and building societies. Contributions to FSAVCs are made from taxed income. Tax relief at the basic rate of 20 per cent is claimed by the pension provider and added to the individual’s pension fund. Higher‑ and additional‑rate taxpayers need to claim additional relief separately through their income tax self‑assessment. Up until 2006, FSAVCs were potentially attractive to employees who wished to keep their financial arrangements independent from their employer and because they offer a wider range of investment funds than AVCs. Their drawback is that they tend to be more expensive than AVCs because the employer is not bearing the costs. Once personal/stakeholder pensions became available to all employees in April 2006, FSAVCs became much less popular.

Answer 289

Successive UK governments have been concerned that people are not saving enough for retirement. In 2009, for example, only 50 per cent of UK employees were members of their employer’s pension scheme, and not all employers offered a pension scheme. Workplace pensions and auto‑enrolment, introduced in 2012, are an attempt to address this problem. Under auto‑enrolment, employers must enrol ‘eligible’ workers in a qualifying workplace pension and contribute a specified minimum amount to the scheme. Many existing occupational pensions already qualified as a suitable pension scheme for this purpose; those employers who did not have a scheme already could set one up, or enrol their employees in the National Employment Savings Trust (Nest).

Answer 290

NEST As an alternative to setting up or using their own pension scheme, employers can meet their obligations by enrolling their employees in Nest. Nest is a trust‑based occupational pension scheme established to support workplace pension provisions; it can be used by an employer either alongside or instead of its own occupational pension scheme. Nest offers a range of investment funds from which the member can choose, and there are default fund selections for members who do not wish to make their own choice. Charges are capped. Benefits can be taken from age 55 and must be taken no later than age 75.

Answer 291

The criteria for auto‑enrolment are that the employee: is not already in a pension at work; is aged 22 or over; is under state pension age; earns more than £10,000; works in the UK. Reading An employee can choose to opt out of the scheme, but only after they have automatically been made a member. A minimum of 8 per cent of an employee’s earnings have to be paid into the scheme, made up of an employer contribution of 3 per cent, an employee contribution of 4 per cent and tax relief of 1 per cent.

Answer 292

He then worked for ten years at Brooks Bakery until his retirement and paid into their 1/60th scheme. His final salary with Brooks was £25,000. 10/60ths of £25,000 = 10/60 x £25,000 = £4,166.67

Answer 293

2) c) £47,250 (35 ÷ 60 × £81,000). Answer a) is not correct because £54,000 represents 40/60ths of his final salary, which is what Pat could have earned under the scheme had he worked for Telephonics for 40 years, not 35. Answer b) is not correct because £28,350 represents 35 per cent of his final salary, not 35/60ths. Answer d) is not correct because, although he can pay in to his pension a maximum of 100 per cent of his UK earnings, his pensionable service does not justify that level of pension.

Answer 294

All forms of non‑occupational pensions are arranged on a defined‑contribution basis. Personal pensions are individual arrangements provided by financial services companies such as life assurance companies, banks and building societies. Contributions receive basic‑rate tax relief at source, even for non‑taxpayers. A higher‑ or additional‑rate taxpayer needs to claim additional relief separately through self‑assessment.

Answer 295

Providing an occupational pension is expensive and may be unaffordable for a small or medium‑sized employer that lacks the financial resources to set up and run a scheme. An alternative is to arrange a group personal pension: a collection of individual personal pension plans all administered by an insurance company on behalf of a single employer. The arrangement is very much the same as each employee arranging a personal pension individually with access to the insurance company’s range of pension funds. Each member has their own plan, which they can take with them if they leave the employer. However, as there are a number of members, the insurance company normally offers a discount on the set‑up and management charges, meaning each employee gets better value than setting up a scheme on an individual basis. It is also possible that the employer will enter into a ‘direct pay’ arrangement whereby they collect pension contributions from each employee’s gross salary and pay them over in bulk to the pension provider.

Answer 296

A SIPP is a personal pension arrangement that gives access to a wider range of investment options than would be available through a conventional personal pension. For example, it may be possible to hold a direct shareholding or commercial property within a SIPP. While access to a wide range of investments is permitted, a SIPP will also allow a scheme member to use the provider’s range of conventional pension funds. A SIPP may appeal to someone who has the confidence to make their own investment decisions.

Answer 297

The stakeholder pension has been available since 6 April 2001 and is a type of personal pension. The government’s aim in introducing it was to encourage more individuals to contribute to their own pension arrangement, particularly those at lower earnings levels, who traditionally did not have pension provision and relied on the state pension. Stakeholder pensions were designed to be simple, low‑cost options. Key standards that a product must meet in order to be designated a stakeholder pension are as follows: Charges cannot exceed 1.5 per cent of the fund value per annum for the first ten years of the term and cannot exceed 1 per cent after that time. Entry and exit charges are not permitted. The minimum contribution required cannot be more than £20. The restriction on the level of charges meant that advisers generally found it uneconomic to give advice on stakeholder pensions. To overcome the lack of access to advice, the government prepared a set of decision‑making flowcharts, known as decision trees, which people can use to determine whether stakeholder pensions are appropriate to their own circumstances. It was partly because of the failure of stakeholder pensions to achieve a large‑scale take‑up that auto‑enrolment into qualifying workplace pensions was introduced in 2012.

Answer 298

Retirement planning has two phases: an accumulation phase when savings are made into a pension to build up a fund; a decumulation phase when benefits are drawn. The way in which pension contributions are invested during the accumulation phase very much depends on the type of scheme.

Answer 299

Retirement planning has two phases: an accumulation phase when savings are made into a pension to build up a fund; a decumulation phase when benefits are drawn. The way in which pension contributions are invested during the accumulation phase very much depends on the type of scheme.

Answer 300

In respect of a defined‑benefit scheme there is, generally, a pension fund operated by or on behalf of the employer into which contributions are paid. Investment decisions are taken at scheme level, with the objective being to ensure that the scheme can continue to pay pension benefits already in payment and the benefits of current members who will reach retirement age/ draw benefits in future. The scheme will usually be invested in a mixture of equities, gilts, corporate bonds and cash; individual members are unable to make decisions on how their contributions are invested but have the reassurance of the promise of a certain level of pension benefits.

Answer 301

Within defined‑contribution arrangements, the scheme member has much more choice and control over how their contributions are invested. The pension provider usually offers a wide range of investment funds from which the member can select, and pension benefits depend, in part, on the value of the fund when benefits are taken. When an individual is many years from taking benefits they may choose investment funds aimed at maximising growth, such as equity funds; as retirement approaches the preference may be for lower‑risk funds such as cash or fixed interest. The member is able to choose a mix of funds to meet their needs, objectives and circumstances. If the pension is an individual arrangement, such as a personal pension, a financial adviser can guide on fund choice. Where a defined‑contribution pension is an occupational scheme there may be a more limited range of funds to choose from, with the employer selecting what they believe to be the most suitable funds.

Answer 302

These schemes are operated by the government and most of them are ‘unfunded’. There is no pension fund as such and contributions form part of general government revenues. The schemes do provide a promise in terms of pension benefits and this is provided by the government out of its funds.

Answer 303

Up to 25% tax-free Annuity Uncrystallised funds pension lump sum Flexi-access drawdown

Answer 304

Annuity purchase involves the payment of a lump sum from the pension fund in exchange for an income. The benefit of an annuity is certainty: the annuity provider promises a guaranteed rate of income – an annuity rate – based on the annuitant’s circumstances. It is not necessary to buy the annuity from the company used during the accumulation phase: pension providers must inform their clients that they can ‘shop around’ for the most appropriate benefits structures and/ or higher annuity rates. This is known as the open‑market option. Once an annuity has been purchased, investment risk is removed but there is no longer any prospect of further investment growth.

Answer 305

Flexi‑access drawdown (FAD) involves drawing the pension fund, after any PCLS has been taken, and reinvesting it into a fund to provide income. The fund remains invested so there is potential for further growth but there is also the risk that the fund value might fall and, consequently, income levels may not be maintained. The withdrawals can be structured however the member wishes: as smaller, regular payments to provide an income, or as larger, perhaps one‑off payments. As any payment beyond the PCLS is taxable, care must be taken not to trigger a large tax charge.

Answer 306

lump sum Opting for a UFPLS means the pension fund remains invested. Unlike FAD, none of the fund is drawn or reinvested and no PCLS is drawn. The member is able to use their pension fund to draw a series of lump sum payments to meet their income/capital needs.

Answer 307

Pensions are almost unique as an investment because of the tax relief they offer on contributions: tax relief that is provided to encourage people to save for retirement. With the ability to draw sums from a defined‑contribution (ie money‑purchase) pension via FAD or UFPLS, there is a risk that those who already have adequate retirement income draw funds and then reinvest them into a defined-contribution pension to benefit from tax relief, effectively getting two lots of tax relief. To limit the extent to which people can do this, a lower annual allowance applies once an individual has started to access their funds via FAD income or UFPLS. Instead of being able to receive tax relief on pension contributions up to the full annual allowance, they have an MPAA. The MPAA only applies to contributions to defined‑contribution schemes: a member can still pay up to the full annual allowance into a defined‑benefit pension scheme (although that total is reduced by the amount of any contribution into a defined‑contribution scheme).

Answer 308

Capped drawdown was an option for those who reached pension age before 6 April 2015. Income benefits were drawn direct from a designated drawdown fund, with an upper limit (ie a cap), on the amount that could be drawn. Capped drawdown is no longer available for those reaching minimum pension age, but those already using a capped drawdown arrangement can add further pension funds. Alternatively, they can convert to FAD. Flexible drawdown was another option available until 6 April 2015. This form of drawdown allowed unlimited withdrawals. All flexible drawdown arrangements have been converted to FAD.

Answer 309

Pensions can provide a range of benefits when a member dies, with the options available depending on the type of scheme and whether death occurred before or after retirement. When seeking to understand the nature of death benefits provided, it is always important to check the scheme rules.

Answer 310

If a member dies before retirement age, referred to as death in service, a lump sum death benefit is usually available. This can be a multiple of earnings or a fixed sum. Additionally, there might be a spouse’s and/or dependant’s pension, paid from the scheme to the spouse, civil partner or dependants of the deceased. This can be a proportion of the member’s pension rights. On death after retirement, a defined‑benefit scheme may: continue to pay the pension income for a period of time, a ‘guaranteed period’; or pay a spouse’s/dependant’s pension as a proportion of the pension that was being paid to the member.

Answer 311

On death before crystallisation, the pension fund can be used to provide income and/or lump sum benefits. On death after retirement, there are a range of ways in which a defined‑contribution scheme will be able to provide benefits to the spouse/ civil partner or dependants of the deceased: continuing scheme pension; lifetime annuity continuing for an agreed period post‑death; lifetime annuity paying an annuity protection lump sum – this would be the balance of the funds used to buy the annuity as compared with how much had already been paid out as income at date of death; or continuing drawdown income.

Answer 312

While pensions confer a number of tax benefits, there are limitations in terms of the benefits not being accessible until age 55 and only 25 per cent of the fund value being available as a tax‑free PCLS. The large sums of money invested in pensions have proved attractive to criminals who attempt to ‘scam’ people out of their pensions. An approach will often be made via a cold call or text message on the pretext of an offer to transfer the pension to a scheme that will enable all funds to be drawn immediately as a tax‑free lump sum. The reality is that no such type of scheme exists and the intention is to take control of the pension. Pensions are by no means the only area in which attempts will be made to scam people out of money. Criminals are also active in promoting investment schemes that promise high rates of return, the sale of shares that in reality do not exist and in taking fees to arrange consumer credit which is never provided. An adviser’s role is to be aware of such schemes and to advise a customer considering one to be mindful of the potential risk. The general rule is that, if it looks too good to be true, it probably is.

Answer 313

PENSIONS DASHBOARDS The government is working to introduce pensions dashboards that will allow consumers to see the current value of their pensions, administrative details about their pots, and their estimated income in retirement, all in one place for all pensions that are not yet being paid. This will include their state pension entitlement, workplace pensions and personal pensions from all providers. The aim is to make it easier for people to plan for their retirement and ensure they have enough money to support them in later life. The implementation date of pensions dashboards has suffered several setbacks, so you should keep an eye on developments in this area.

Answer 314

1) d) Marta’s scheme is a defined‑contribution scheme, which could be either an occupational or a personal pension.

Answer 315

2) The lifetime allowance is the total amount that an individual may hold in retirement benefits at the point where the benefits are crystallised without incurring a tax charge.

Answer 316

3) a) Basic, higher or additional rate depending upon the contributor’s marginal rate of tax.

Answer 317

5) c) Individuals must earn in excess of £10,000 per year to be auto‑enrolled into a workplace pension scheme.

Answer 318

6) False. Pension providers are not obliged to offer this facility, although scheme members are free to move to a different provider if they wish to access their funds in this way.

Answer 319

7) b) There must not be any entry or exit charges.

Answer 320

9) Flexible drawdown arrangements were all converted to FAD on 6 April 2015.

Answer 321

10) An annuity provides a guaranteed income and there is no investment risk, so this would be a suitable option for Nicky.

Answer 322

KEY FEATURES OF TERM ASSURANCE The sum assured is payable only if the death of the life assured occurs within a specified period of time (the term). The term can be anything from a few months to, say, 40 years or more. If the life assured survives the term, the cover ceases and there is no return of premiums. There is no cash‑in value or surrender value at any time. If premiums are not paid within a certain period after the due date (normally 30 days), cover ceases and the policy lapses with no value. Most companies will allow reinstatement within 12 months provided all outstanding premiums are paid and evidence of continued good health is provided. Premiums are normally paid monthly or annually, although single premiums (one payment to cover the whole term) are allowed. Premiums are normally level (the same amount each month or year), even if the sum assured varies from year to year.

Answer 323

The sum payable by the insurance company to the policyholder if the policyholder chooses to terminate the policy before the end of the term, or before the insured event occurs.

Answer 324

The sum payable by the insurance company to the policyholder if the policyholder chooses to terminate the policy before the end of the term, or before the insured event occurs.

Answer 325

With level term assurance, the sum assured remains constant throughout the term. Premiums are normally paid monthly or annually throughout the term, although single premiums can be paid. Level term assurance is often used when a fixed amount would be needed on death to repay a constant fixed‑term debt such as a bank loan. It can also be used to provide family cover; in these circumstances, the term might run until the children are expected to have completed their full‑time education, for example. If it is used for this purpose, the policyholder should bear in mind that the amount of cover in real terms would be eroded by the effect of inflation. With decreasing term assurance, the sum assured reduces to nothing over the term of the policy. Premiums may be payable throughout the term, or may be limited to a shorter period such as two‑thirds of the term. This policy could be used to cover the outstanding capital on a decreasing debt. The most common use of decreasing term assurance is to cover the amount outstanding on a repayment mortgage. It is usually known as a mortgage protection policy, or mortgage protection assurance. The sum assured is calculated in such a way that it is always equal to the amount outstanding on a repayment mortgage of the same term, based on a specified rate of interest. The sum assured (like the mortgage) decreases more slowly at the start of the term than towards the end.

Answer 326

Gift inter vivos cover is a term assurance policy designed to cover certain inheritance tax liabilities. Gifts inter vivos are gifts made during a person’s lifetime, as opposed to on death. If a person makes an outright gift during their lifetime that, either on its own or when added to gifts made in the previous seven years, exceeds the current nil‑rate band for inheritance tax, provision needs to be made for the tax that may become due if the donor does not survive for seven more years. Using a gift inter vivos policy, the sum assured is set at the outset as the amount of tax that is due. It remains level for three years and then reduces in line with the tapering relief on taxation of gifts; seven years after the gift has been made it becomes exempt from tax and so the cover ceases. Additional cover should also be arranged to protect the remainder of the estate.

Answer 327

Convertible term assurance includes an option to convert the policy into a whole‑of‑life or endowment assurance, at normal premium rates, without the life assured having to provide evidence of their state of health at the time of conversion. The cost is an addition of, typically, around 10 per cent of the premium. Certain rules and restrictions apply to the conversion option: The conversion is normally carried out by cancelling the term assurance and issuing a new whole‑of‑life or endowment policy. A new endowment can extend beyond the end of the original convertible term policy. The option can only be exercised while the convertible term assurance is in force. The sum assured on the new policy cannot exceed the sum assured of the original convertible term assurance: if a higher level of cover is required after conversion, the additional sum assured will be subject to normal underwriting. The premium for the new policy is the current standard premium for the new term and for the life assured’s age at the conversion date.

Answer 328

Some companies offer increasing term assurance where the sum assured increases each year by a fixed amount or a percentage of the original sum assured. This type of policy can be used where temporary cover of a fixed amount is required but where the cover needs to increase to take some account of the effects of inflation on purchasing power. Renewable term assurance includes an option to renew the policy at the end of the initial term for the same sum assured, without the need to provide further medical evidence. The new term is of the same length as the initial term and the new policy itself includes a further renewal option. However, there is a maximum age, usually around 65, after which the option is no longer available. The premium for the new policy is based on the life assured’s age at the date when the renewal option is exercised. Renewable and increasing term assurance is similar to the renewable policy, with the added option to increase the sum assured by a specified amount on renewal. The increase is often either 50 per cent or 100 per cent of the previous sum assured, and again no further evidence of the life assured’s state of health is required. Some companies offer renewable, increasing and convertible term assurances, combining all three of the options described above.

Answer 329

Often, when people are seeking to protect their family finances, taking out life assurance that provides a lump sum on death of a wage earner might not be ideal. Such a sum might quickly be spent, or it might have to be invested and managed to provide an income. A more useful solution might be a product that is designed to provide a regular income to replace the income lost on death. Family income benefit (FIB) policies are designed to meet this need. Usually, these policies pay a tax‑free regular income (monthly or quarterly) from the date of death of the life assured until the end of the chosen term. As an alternative to regular income payments, beneficiaries may choose to receive a lump sum payment, which is calculated as a discounted value of the outstanding regular instalments due. Since, usually, the cover reduces as time passes, this policy can be described as a form of decreasing term assurance. However, policies can be arranged with escalating instalments, to combat the effects of inflation; the premiums for these policies are higher, to reflect the higher level of cover provided.

Answer 330

Whole‑of‑life assurance is designed, as the name implies, to cover the life assured for the whole of their lifetime. It will pay out the amount of the life cover in the event of the death of the life assured, whenever that death occurs, provided that the policy remains in force. Like all protection policies, therefore, the overall benefit of this type of assurance is that it provides peace of mind. It can be used in personal and business situations, and for certain taxation purposes. Examples include to: protect dependants against loss of financial support in the event of the death of a breadwinner; provide a tax‑free legacy; cover expenses on death; provide funds for the payment of inheritance tax. Premiums may be: payable throughout life (ie for the full term of the policy, whatever that turns out to be); or limited to a fixed term (eg 20 years) or to a specified age (such as 60 or 65). If limited premiums are chosen, the minimum term is normally ten years. Because whole‑of‑life assurance (unlike term assurance) will definitely pay out sooner or later, life companies build up a reserve to enable them to pay out when the life assured dies. This enables companies to offer surrender values on whole‑of‑life policies if the client cancels them during their lifetime. These surrender values are, however, generally small in relation to the sum assured. In fact, in the early years of a policy, the surrender value will be less than the premiums paid. This emphasises the fact that whole‑of‑life policies are protection policies and not investment plans, even though they have often been used for investment purposes.

Answer 331

When a whole‑of‑life policy is used to provide the funds likely to be needed to pay inheritance tax on the death of a married couple or civil partners, it is normal to use a policy that will pay out when the second spouse or partner dies. These types of whole‑of‑life policies are known as ‘joint‑life second‑death’ or ‘last survivor’ policies. The reason for this is that, in most families, the estate of the first spouse/partner to die passes to the surviving spouse/partner (free of IHT), and the IHT becomes due only when the surviving spouse/ partner dies and the estate passes to the family or to others. These policies are ‘written under trust’: ownership passes to the trustees to ensure that the proceeds of the policy are used to meet the IHT liability and do not pass into the value of the estate, thus becoming liable for IHT in their own right.

Answer 332

The key to flexibility is the method of paying for the life cover by cashing in units at the bid price: The policyholder pays premiums of an amount that they wish to pay – or feel that they can afford to pay. The premiums are used to buy units in the chosen fund or funds, and these units are allocated to the policy. The policyholder selects the level of benefits that they wish to have: — If a high level of life cover is required, a larger number of units will be cashed each month, and a correspondingly lower number will remain attaching to the policy. This means that the investment element of the policy (which depends on the number of units) is also lower. — Conversely, a low level of life cover means fewer units are cancelled and hence the policy offers a higher level of investment. Other options are often available. These include an option to take income, indexation of benefits (for automatic adjustment of death benefits) and the ability to add another life assured.

Answer 333

11.4 Universal whole‑of‑life assurance The flexibility of unit‑linked whole‑of‑life assurance is sometimes extended further by adding a range of other benefits and options to the policy. When that is done, the policy is usually referred to as universal whole‑of‑life assurance. Most of the additional benefits will be at extra cost, the additional cost being met by cashing more units.

Answer 334

11.5 Endowment policies Endowment policies combine life assurance and savings. In the past they were often used as savings plans and were very popular as a method of funding interest‑only mortgages because the savings element can be used to build a fund to repay the mortgage, while the life cover provides a lump sum if the borrower dies during the mortgage term. There are various types of endowment, with the plans varying according to the underlying investment structure. The range of investment structures is similar to those for a whole‑of‑life plan; the difference between an endowment and a whole‑of‑life plan is that an endowment runs over an agreed term. If death occurs during the term, the sum assured is paid out, while if the plan runs for the full term and ‘matures’ an investment value is paid out. During the term, the policyholder undertakes to maintain payment of regular premiums.

Answer 335

A non‑profit endowment has a fixed sum assured, which is payable on maturity (ie at the end of the policy term) or on earlier death; premiums are fixed for the term. Because the return is fixed and guaranteed, the policyholder is shielded from losses due to adverse stock market movements; on the other hand, they are equally unable to share in any profits the company might make over and above those allowed for in calculating the premium rate (hence the name, non‑profit). For that reason, non‑profit policies are rarely used today.

Answer 336

Like its non‑profit equivalent, a with‑profits endowment has a fixed basic sum assured and a fixed regular premium. The premium, however, is higher than that for a non‑profit policy of the same sum assured, and the additional premium (sometimes called a bonus loading) entitles the policyholder to share in the profits of the life assurance company. The company distributes its profits among policyholders by declaring bonuses that increase the value of the policy and are payable at the same time and in the same circumstances as the sum assured. There are two types of bonus. Reversionary bonuses – these are normally declared each year and, once they have been allocated to a policy, they cannot be removed by the company, provided that the policy is held until the end of the term or earlier death. Some companies declare a simple bonus, where each annual bonus is calculated as a percentage of the sum assured; others declare a compound bonus, with the new bonus being based on the total of the sum assured and previously declared bonuses. Most companies set their reversionary bonuses at a level that they hope to be able to maintain for some time, in order to smooth out the short‑term variations of the stock markets. Terminal bonuses – these are bonuses that may be added when a death or maturity claim becomes payable. Unlike reversionary bonuses, a terminal bonus does not become part of the policy benefits until the point of a death or maturity claim, thus allowing the company to change the terminal bonus rate – or even remove the terminal bonus altogether. Terminal bonuses are intended to reflect the level of investment gains that the company has made over the term of the policy, so the rate of bonus often varies according to the length of time that the policy has been in force. The term ‘with‑profits’ is used generally to describe a policy that pays bonuses to the plan. In the context of mortgages, a full with‑profits policy describes a policy set up with an initial sum assured equal to the mortgage debt. On death or at the end of the term, the worst‑case scenario is that the mortgage is repaid in full. If bonuses are added then these will generate an additional sum over and above the mortgage when the policy pays out.

Answer 337

The FCA requires life companies that carry out with‑profits business to publish a document called Principles and Practices of Financial Management (PPFM). This sets out how a firm manages its with‑profits business. Each year, the insurance company has to certify to the FCA that its with‑profits funds have been managed in accordance with the PPFM.

Answer 338

The guarantees offered by a full with‑profits policy mean that it has high premiums. A low‑cost endowment overcomes this by having a sum assured that is payable on death, whenever it occurs, that is made up of two elements: with‑profits; and decreasing term assurance. The policy offers a guaranteed death benefit equal to the mortgage, ensuring that it is fully protected on death. The basic with‑profits sum assured is lower than the overall level of mortgage to be funded, meaning that full repayment is not guaranteed at maturity. Bonuses are added over time with the aim of building a sum equal to the mortgage by the end of the term. Until the with‑profits sum assured plus the bonuses are equal to the mortgage amount, any shortfall on death of the life assured is made up by a decreasing term assurance. Once the basic sum assured plus bonuses increases beyond the mortgage amount, the decreasing term assurance element ceases. This policy is suitable for anyone seeking a with‑profits plan but finding that the costs associated with the full with‑profits plan are prohibitive.

Answer 339

The policy will pay out a minimum of £100,000 on death. It is not until the value of the with‑profits element part of the policy reaches £100,000 with bonuses that this figure starts to grow (whereas with a full with‑profits policy, the £100,000 would increase after one year).

Answer 340

Mis‑selling of endowment policies linked to interest‑only mortgages was a significant problem for the financial services industry, particularly in the 1980s and 1990s. The following problems recurred: The inherent risks of this type of policy were not adequately explained. The plans were sold to people with a low/cautious attitude to risk. Prospective investment returns were overstated and/or customers were promised that the plans were guaranteed to repay their mortgage in full. Many customers complained, and insurance companies were required to contact all endowment customers and advise them whether or not their endowment was on target to repay their mortgage. If it was not, they were required to outline corrective action that could be taken. Where mis‑selling was proven, the customer could claim compensation from the insurance company. If the total of sum assured plus bonuses is not equal to the amount of the loan at the end of the term, it is, of course, the borrower’s responsibility to fund the difference. Life companies help their policyholders to avoid this situation by including regular progress reviews of mortgage‑related endowments, to check whether the policy is on target to reach the required amount by the end of the term. If the policy does not seem to be on target, the company may either recommend an increase in premium, possibly without further medical evidence being required, or suggest other ways of addressing the problem. On the other hand, if the total benefit at maturity, including bonuses, proves greater than the amount required to repay the loan, the surplus will provide a tax‑free windfall for the borrower.

Answer 341

Unit‑linked endowments work on the basis that, when a premium is paid, the amount of the premium – less any deductions for expenses – is applied to the purchase of units in a chosen fund. A pool of units gradually builds up and, at the maturity date, the policyholder receives an amount equal to the total value of all units then allocated to the policy. Most unit‑linked endowments also provide a fixed benefit on death before the end of the term. The cost of providing this life cover is taken from the policy each month by cashing in sufficient units from the pool of units. The value of the plan is determined by the value of the underlying units; this in turn depends on the investment returns produced by the fund. Each unit‑linked fund is run by a fund manager whose role it is to select investments and invest the policyholders’ premiums. Unit‑linked policies have the potential to produce higher returns than with‑profits policies as the manager can be more adventurous when selecting investments. Unlike with‑profits endowments, however, unit‑linked policies do not provide any guaranteed minimum return at maturity; they are, therefore, a good illustration of the maxim that greater potential return generally goes hand‑in‑hand with the acceptance of greater risk. When a unit‑linked endowment policy is to be used for mortgage purposes, the premium required is calculated as the amount that will prove sufficient to repay the loan at the end of the term if unit prices increase at a specified rate of growth. This rate of growth is usually set at quite a conservative level and features on illustrations provided at the point of sale. Policyholders can choose which fund or funds to use for their investment. Should the life insured die before the end of the term, the full amount of the mortgage is protected. This is normally achieved by building in a variable term assurance plan which adjusts in line with the value of the underlying units. The growth rate is not guaranteed, and it is the borrower’s responsibility to ensure that the policy will provide sufficient funds to repay the loan. The life company will review the policy’s progress at regular intervals and inform the borrower of the need to increase the premiums (or make other provisions) if the policy is not on target. Most companies also provide the facility to switch to a cash fund, or similar, to protect the policy value from sudden market falls towards the end of the term. One potential advantage of the unit‑linked policy as a mortgage repayment vehicle is that, in a strongly rising market, the value of the policy may reach the required amount before the end of the term. In that event, the policy can be surrendered and the loan repaid early – thus saving on future interest, and freeing the repayment amounts for the borrower to use for other purposes.

Answer 342

A variable term assurance works by the value falling and rising to compensate for changing investment values. For example, if a customer has a £100,000 mortgage and the investment value of the unit‑linked endowment is £30,000, then the variable term assurance is £70,000. If, a month later, the plan value is £29,900, then the variable term assurance increases to £70,100 to ensure the full value of the debt is always protected on death.

Answer 343

Unitised with‑profits endowments were introduced to combine the security of the with‑profits policy with the greater potential for reward offered by the unit‑linked approach. As with unit‑linking, premiums are used to purchase units in a fund, and the benefits paid out on a claim depend on the number of units allocated and the then‑current price of units. The difference from a standard unit‑linked policy lies in the fact that unit prices increase by the addition of bonuses which, like the reversionary bonuses on a with‑profits policy, cannot be taken away once they have been added. This means that unit prices cannot fall and the value of the policy, if it is held until death or maturity, is guaranteed. If the policy is surrendered (ie cashed in before its maturity date), however, a deduction is made from the value of the units. This deduction, the size of which depends on market conditions at the time of the surrender, is known as a market value reduction (MVR).

Answer 344

One feature of life policies, such as endowments, is that they can be legally assigned to a third party, who effectively becomes the owner of the policy and is entitled to receive the benefits in the event of a claim. If an endowment is being used as the repayment vehicle for an interest‑only mortgage (see Topic 13), some lenders require the endowment to be assigned to them as part of the mortgage deal; others may simply require that the policy document be passed into their possession, without a formal assignment.

Answer 345

1) True – term assurances have no investment element so proceeds are paid tax‑free.

Answer 346

1) True – term assurances have no investment element so proceeds are paid tax‑free.

Answer 347

2) A convertible term assurance allows conversion of some or all of the plan to a different type of plan, at a later date, without the life assured having to provide evidence of their state of health.

Answer 348

3) a) A decreasing term assurance will pay benefits only if the insured dies within the policy term.

Answer 349

4) a) It is designed to provide protection rather than investment.

Answer 350

5) d) Transfers between husband and wife are free of IHT so any liability generally arises on second death. A plan being set up to provide the funds to pay IHT would be set up on a joint‑life second‑death basis.

Answer 351

6) d) ‘Ring‑fence’ the proceeds outside the individual’s estate.

Answer 352

7) a) A with‑profits whole‑of‑life plan has a certain level of life cover at outset that can then be increased as bonuses are added during the term.

Answer 353

8) b) A low‑cost whole‑of‑life plan combines with‑profits with a decreasing term assurance.

Answer 354

9) c) Waiver of premium cover means that premiums are not payable (ie they are waived) in the event that the insured is unable to work due to accident or sickness.

Answer 355

10) The answer is d). The policy is not guaranteed to repay the mortgage in full at the end of the term.

Answer 356

Life assurance can mitigate the financial impact of someone dying, but serious illness can also create a significant financial burden. Critical illness cover provides a tax‑free lump sum to meet the additional costs that someone may face if they find themselves in this situation. The illness need not be terminal. The range of illnesses and conditions covered can vary from one insurer to another but would typically include the following: most forms of cancer; heart attack; stroke; coronary artery disease requiring surgery; major organ transplant; multiple sclerosis; kidney failure. Other conditions that are sometimes covered are: paralysis; blindness; loss of limb(s). Many policies also make provision for payment of the sum assured in the event of total and permanent disability. Again, the definition of total and permanent disability varies between companies. Some providers define it as being a total and permanent disability that prevents the policyholder from doing any job to which they are suited by virtue of status, education or experience. Other companies employ a tighter definition that requires that the disability prevents the person from doing any job at all.

Answer 357

Income protection insurance (IPI) pays an income when accident or illness prevents someone from earning a living by carrying out their normal occupation. Many insurers also offer IPI to people whose main responsibilities are in the family home, for example looking after children, rather than earning money outside it. This is because, although they may not actually earn an income, costs may be incurred if they are ill or injured – for example, childcare fees or payment for housekeeping services.

Answer 358

A major factor in determining the premium to be charged is the occupation of the life insured. Table 12.1 provides an example of a typical classification of occupations by an IPI provider. TABLE 12.1 EXAMPLE OF OCCUPATION CLASSIFICATION FOR IPI PURPOSES Class 1 Lowest risk, covering those in clerical, professional or administrative roles, eg accountants and civil servants Class 2 Occupations carrying a low risk of an accident, eg hairdressers, pharmacists Class 3 Occupations carrying a moderate risk of an accident, eg farmers, electricians Class 4 Occupations with highest risk of a claim because of risk of health problems or accident, eg manual labourers, industrial chemists Certain occupations will be excluded from IPI cover altogether on the basis that they represent too great a risk. The occupation class that a person is deemed to fall within will determine the level of premium (Class 1 occupations get the cheapest rates) and may also influence the terms on which cover is offered. Other factors that will influence the premium rate are: the age of the life insured; the amount of benefit; current state of health; past medical history; the length of the deferred period (see section 12.2.3).

Answer 359

There are two types of income protection premiums available – reviewable and guaranteed. Reviewable premiums – a reviewable premium means that premiums may start off relatively low, but will be reviewed in the future and may go up every few years or so. In some cases, the premium may be reviewable every year, or every five years, to take into account changing circumstances. Guaranteed premiums – the nature of guaranteed premiums means that these tend to be more expensive at outset than reviewable premiums, but the premiums are guaranteed for the life of the policy, which may be 25 years or even longer. It is the insurer’s choice as to what premium charging methodology is used. Some may only offer one type. A waiver of premium option may also be provided whereby premiums for the IPI policy are not paid while benefits are being paid from the policy, but the policy cover continues as normal. The premiums are ‘waived’.

Answer 360

A period of time, called the deferred period, must elapse between the onset of the illness/injury and the point at which benefits begin to be paid. Typical deferred periods are 4, 13, 26, 52 and 104 weeks. The minimum four‑week deferred period is to prevent multiple claims for minor ailments such as colds. A self‑employed person, who typically would suffer a loss of income after a very short period of illness, should opt for a short deferred period. Conversely, an employed person may wish to opt for a long deferred period if they have sickness benefits paid by their employer. If this is the case, the deferred period should be set to match the date on which the employer’s sick pay ceases. The longer the deferred period chosen, the cheaper the premium will be. Benefit levels are set so that the claimant is unable to receive a higher income when they are not working than they could from working. The maximum benefit payable from an IPI policy varies between providers, but is normally in the range of 50 per cent to 65 per cent (individual policies) or 75 per cent (group policies) of pre‑disability earnings. If the provider allows a benefit level towards the top end of this range, they are more likely to make a deduction to allow for any state benefits to which the claimant may be entitled. These limits apply to total benefits from all IPI contracts held by the individual. Where the policy includes a ‘proportionate benefit’ feature, benefits are paid pro‑rata if a person can return to work but are earning less than they did before they suffered the illness/disability. For example, they might be able to work only part‑time, or in a lower‑paid job. Cover is permanent in the sense that the insurer cannot cancel the cover simply because the policyholder makes numerous claims; in fact IPI used to be known as ‘permanent health insurance’. The policy can be cancelled, however, if the customer fails to keep up their premium payments or takes up a hazardous job or pastime. Some policies will allow benefits to be index‑linked either before or during a claim. The rate of increase may be at a fixed rate, perhaps 3 per cent to 7 per cent, or based on a published measure of inflation. Benefits are normally paid until death, return to work (or, in the case of proportionate benefits, return to their original role on the same basis as before their incapacity), retirement or the end of the policy, whichever event occurs first. IPI is available as a standalone policy, usually as a pure protection plan or occasionally on a unit‑linked basis. Additionally, IPI can be available as an option on a universal whole‑of‑life plan.

Answer 361

Where income protection insurance (IPI) is taken out on an individual basis the benefits are tax‑free. IPI can be arranged by an employer on a group basis and in this case the income is taxable as earned income. The employer pays the premium, which is a tax‑deductible business expense. From the employee’s point of view, the premium paid by the employer is not taxable as a benefit in kind, ie they do not have to pay income tax on the premium paid, provided that the employer has discretion as to whether to pay the proceeds to the employee. In practice, the employer does have such discretion and pays the proceeds to the member concerned. The scheme member pays income tax and National Insurance on the proceeds.

Answer 362

Accident, sickness and unemployment insurance (ASU) plans are a type of general insurance that may be considered as an alternative to income protection insurance (IPI). ASU insurance is typically used to cover mortgage repayments if illness, accident or loss of employment prevents the policyholder from earning a living. A level of income equal to monthly mortgage repayments is paid for a limited period, usually a maximum of two years. Additional cover can sometimes be included to cover other essential outgoings. As with IPI, there will be a deferred period, normally one month, which must elapse before benefit payments can commence. Lump sums may be paid in certain situations (death, disablement, and loss of a limb). In contrast to IPI, these plans should be viewed as short term to protect mortgage repayments rather than as providing total protection of earned income. It would be more accurate to describe these policies as accident, sickness and redundancy insurance, as they do not offer protection from unemployment when the insured is dismissed, or resigns voluntarily. The policy will often include the following restrictions. The proposer must have been actively and continuously employed for a specified minimum period prior to starting the plan. Any redundancy that the proposer had reason to believe was pending when they took out the policy will be excluded. No benefit will be payable if redundancy occurs within a specified period of the cover starting. A person may have to have been employed for a minimum period either before they can take out this type of plan or before the unemployment cover becomes valid. ASU policies are renewable annually at the discretion of the insurer. This means that the insurer could increase premiums if a policyholder makes a large number of claims, or might even withdraw the cover offered. This is a major difference from IPI.

Answer 363

All benefits are tax‑free. There is no tax relief on contributions to an ASU plan when it is arranged on a personal basis. If the scheme is set up on a group basis, any employer contribution will be allowed as an expense against corporation tax. Any employer contribution will be classed as a benefit in kind.

Answer 364

Private medical insurance (PMI) is a pure protection plan designed to provide cover for the cost of private medical treatment, thus eliminating the need to be totally dependent on the NHS. The range of cover normally provided includes reimbursement of: in‑patient charges including nursing fees, accommodation, operating fees, drugs, and the cost of a private ambulance; surgical and medical fees including surgeon’s fees, anaesthetist’s fees, pathology, and radiology; out‑patient charges including consultations, pathology, radiology, and home nursing fees. Some policies offer additional benefits such as the payment of a daily rate if treatment is delivered within an NHS hospital and involves an overnight stay. Plans can be arranged on an individual basis or as part of a group scheme established by an employer. Employer‑sponsored schemes currently account for the vast majority of PMI provision in the UK. The way in which benefits are paid varies between providers. Some will offer a full refund of charges with payment direct to the healthcare provider. Other plans impose an upper limit on the amount that can be reclaimed in any one year.

Answer 365

Premium rates depend on a number of factors, including: location – this is mainly because the cost of medical care varies throughout the country (costs are particularly high in London); type of hospital to which the individual is allowed access under the terms of the plan – again, treatment in the postgraduate teaching hospitals in London is more expensive and is reflected in higher premiums; standard of accommodation available to the patient under the terms of the plan. A major factor will be the type of scheme that is taken out. For example, many providers offer a budget scheme, which may limit the patient’s choice of hospital or require treatment on the NHS if the waiting list does not exceed a maximum period, eg six weeks. Any limit on the range of cover provided will reduce the premium payable. The limit may take the form of a financial limit on the amount of benefit that is provided or limits on the range of treatment covered. One other significant factor is the age of the person applying for cover. The morbidity (likelihood of illness) risk increases with age and consequently so does the probability of a claim being made under the terms of the plan.

Answer 366

PMI cover will not be provided for any pre‑existing medical conditions. Other general exclusions are the costs of: routine optical care (such as the provision of glasses or contact lenses); routine dental treatment; routine maternity care; chiropody; the treatment of ailments that are self‑inflicted, for example, the consequences of drug abuse and alcohol; cosmetic surgery; alternative medicine.

Answer 367

Premiums are subject to insurance premium tax but the benefits are paid out tax‑free. Employers who contribute to PMI on behalf of their employees are able to claim the cost as an allowable deduction against corporation tax. Contributions paid by an employer are regarded as a benefit in kind as far as the employee is concerned and are taxable.

Answer 368

The purpose of long‑term care insurance (LTC) is to provide the funds to meet the costs of care that may arise in later life, when a person is no longer able to perform competently some of the basic activities involved in looking after themselves each day. The need for this cover has increased because: families are less able to take care of elderly relatives than they were in earlier generations (eg because they live further away from each other, there are competing pressures on their time, or because their accommodation is unsuitable); people are living longer; expectations in relation to quality of life in later years are higher; some people are concerned about the standard of care that the state and the NHS can realistically be relied upon to provide.

Answer 369

The amount of benefit paid from an LTC plan depends on the degree of care required by the insured. This is established by ascertaining the person’s ability to carry out a number of activities of daily living (ADLs). Typical ADLs would be: washing; dressing; feeding; using the toilet; moving from room to room; preparing food. Each LTC insurer has its own definitions of what constitutes an inability to carry out an ADL. Many follow the definitions laid down by the Association of British Insurers. The greater the number of ADLs that cannot be performed without assistance, the greater the amount of care required and, therefore, the higher the level of benefit paid. It is normal for insurers to require that the person must be incapable of performing at least two or three of the ADLs before a claim can be accepted. A person need not be in a nursing home to receive LTC benefits: for example, they might need help with dressing and with preparing and eating meals. In this situation, the support they would need might be limited to a person coming in at certain points during the day to help with those specific activities.

Answer 370

If an annuity is purchased for immediate long‑term care needs benefits will be tax free if paid direct to the care provider. Furthermore, the annuity must have qualified as an immediate needs annuity when it was taken out. In other words, the benefits from an ordinary purchased life annuity cannot be paid tax‑free just because they are being used to fund long‑term care. If an annuity does not qualify as an immediate needs annuity, ie if its benefits can be paid to the policyholder, only the interest element is taxable as savings income. Tax rates applicable are as follows: Tax at a rate of 20 per cent is deducted at source. Non‑taxpayers or individuals not liable to tax on their savings income can reclaim any overpaid tax. Higher‑rate taxpayers having a further liability of 20 per cent. Additional‑rate taxpayers have a further liability of 25 per cent. Where an immediate needs annuity is established on a ‘life of another’ basis, the benefits can still be paid tax‑free, provided that they are paid direct to the care provider and are used solely for the care of the person protected under the policy. If any part of the annuity benefits are paid to anyone other than the care provider, or for any purpose other than for the care of the person protected under the policy (including payments that may be due on the death of the protected person), the interest element of that portion of the benefits is taxable. Benefits are also tax‑free if the long‑term care policy is prefunded, ie where there is no annuity but, instead, premiums are paid to an insurance company (out of tax‑paid income) to insure against a possible future event. For prefunded long‑term care policies, it does not matter whether the benefits are paid direct to the care provider or to the protected person.

Answer 371

1) The correct answer is c) income protection insurance. Answer a) is incorrect because ASU cover is usually designed to cover only mortgage repayments and usually for a maximum of two years. Answer b) is incorrect because critical illness cover is restricted to specific conditions and is usually paid as a lump sum, which may not cover outgoings over a prolonged period of time. Answer d) is incorrect because PMI only covers costs directly associated with medical treatment.

Answer 372

The types of loss that are covered by general insurance can be categorised in five broad bands. The first two relate to both personal and commercial situations: property loss – loss, theft or damage to static and moveable assets (from diamond rings to houses to supertankers); liability loss – resulting from a legal liability to third parties, eg personal injury or damage to property. The remaining three are restricted to commercial situations. They are: personnel loss (due to injury, sickness or death of employees); pecuniary loss (as a result of defaulting creditors); interruption loss (when a business is unable to operate due to one of the other losses occurring, eg because its premises have suffered fire damage). Some policies may combine protection against two or more types of risk. Comprehensive motor policies, for example, cover damage to the policyholder’s property and to third parties’ property.

Answer 373

General insurance policies are contracts of indemnity. The principle of indemnity is that: in the event of a claim, insured persons should be restored to the same financial position after a loss that they were in immediately before the loss occurred. In particular, this means that an insured person should not be able to benefit from the event that caused the loss. Life and personal accident policies, on the other hand, are not contracts of indemnity. They are benefit policies since it is much more difficult to measure accurately in financial terms the impact of a loss of life or of a serious injury. It is usually up to the insurer to determine how to restore the claimant to the financial position they were in before the loss occurred. There are four main methods: cash (normally by cheque or electronic transfer); repair (used very commonly with motor insurance); replacement – this can be a cost‑effective option for the insurer as it has greater purchasing power than an individual consumer and so can negotiate better prices; reinstatement – for instance, where the insurance company arranges for a damaged building to be restored to its former condition. AVERAGE It is not uncommon for policyholders to underinsure: in other words, to insure for a smaller amount than is actually required to replace or repair the lost or damaged property. This may be because: they are unaware of the appropriate figure; inflation has increased the amount required; they are deliberately understating the figure in order to keep the premium down. In the event of a complete loss, eg where a whole house is destroyed by fire, the amount paid out would be limited to the sum insured, even if the actual cost were considerably more. Many losses are only partial, however. In these circumstances, it would be unfair if a policyholder who had paid less premium than was really appropriate were indemnified in full, even if the actual amount claimed were less than the overall sum insured. In such cases, the principle of average is applied, which means that the claim is scaled down in the same proportion that the premium actually paid bears to the premium that should have been paid for the full appropriate sum insured. So, for example, a policyholder who insured contents for £10,000, when their true insurance value was £15,000, would find that if they claimed £300 for a damaged carpet, the insurer would pay only £200. EXCESS Many general insurance policies are subject to an excess: in other words, a deduction is made from any claim payment. For instance, a homeowner might have an excess of £100 on claims for accidental damage under their contents insurance policy. For the insurer, this avoids the high administrative costs of dealing with a lot of small claims, since there is no point in a policyholder claiming for an amount less than the excess. Sometimes, an excess is a compulsory element of the policy; policyholders might also choose a voluntary excess or an excess above the compulsory level in exchange for a reduction in premium.

Answer 374

Buildings are defined as “anything on the premises that would normally be left behind if the property were sold”. This generally includes sheds, swimming pools, walls, fitted furniture and all fittings and decorations. Cover is normally provided against: fire and lightning strikes; explosions, subsidence and earthquakes; storms and floods; damage by vehicles and aircraft, and even by animals; damage by falling trees/branches or television aerials Policies normally also cover the costs of alternative accommodation during repairs. Some types of cover are subject to the property not being left unoccupied for more than a specified period, typically 30 or 60 days. These include cover against damage caused by: riot, civil commotion and vandalism; theft or attempted theft; burst water pipes or oil leakages. Most policies also cover property owners’ liability.

Answer 375

Harry insured his property for £100,000 when he bought it in 2000. He has never increased his insurance. In 2019, his house is completely destroyed in a fire. The ‘reinstatement value’ of his property is £150,000. However, the maximum that the insurance company will pay out is £100,000. (Note that if the property had a mortgage on it, the lender would have required adequate buildings insurance.) If a smaller claim were made, the claim would be averaged. If Harry were to lose roof tiles in a storm and claim £1,000 for the cost of replacing them, then the claim would be reduced as follows. The value of the insurance cover taken out is divided by the actual value: £100,000 ÷ £150,000 = 66.67% This calculation shows that Harry’s property is only insured for 66.67 per cent of its true value and so Harry’s premiums are less than they should be. The insurance company would only pay 66.7 per cent of his claim, ie £667.

Answer 376

Contents can be defined as “anything you would normally take with you if the property were sold”. Cover would typically be provided against the same events and circumstances as described above for buildings insurance. Additional cover might include: accidental damage to goods while being removed by professional removers; extended contents cover for specified personal property outside the home; damage to freezer contents due to electricity failure.

Answer 377

The aim of an all‑risks policy (sometimes known as extended contents cover) is to indemnify the policyholder for loss, damage or theft of items that are regularly taken out of the home. Cover is normally split into two categories: unspecified items – these need not be specifically named but each item must have a value below a specified amount; specified items – these items are above the single‑item value limit and are individually listed. Both of the above categories require the policyholder to take reasonable care of the property.

Answer 378

2) The insurance value is divided by the actual value, then multiplied by the value of the claim: (£25,000 ÷ £50,000) × £2,000 = £1,000 (less the ‘excess’ under the policy).

Answer 379

Third party, third party fire and theft, comprehensive

Answer 380

The Road Traffic Act 1988 makes it unlawful to use a motor vehicle on a public road unless there is in force a policy of insurance in respect of third‑party risks. Third‑party‑only policies typically provide cover for: death or bodily injury to third parties, including passengers in the car – hospital charges and emergency medical treatment charges are also covered; damage to property; legal costs incurred in the defence of a claim. Death, injury and damage cover is extended to include occasions when the policyholder is using another vehicle, and also to other drivers using the policyholder’s car with permission.

Answer 381

Motor insurance differs from other personal insurances in that a policy of motor insurance is of no effect unless a certificate of insurance is given to the policyholder. The certificate is what provides evidence of the existence of the contract of insurance and, as third‑party motor insurance is compulsory, this is very important.

Answer 382

In addition to third party cover, a third party, fire and theft policy provides cover against: fire, lightning or explosion damage to the vehicle; theft of the vehicle, including damage caused during theft or attempted theft.

Answer 383

In addition to the third party, fire and theft cover, a typical comprehensive policy would include some or all of the following: accidental damage to the vehicle on an all‑risks basis; loss of or damage to personal items in the vehicle; personal accident benefits; windscreen damage. The private motor insurance market is large and extremely competitive, and many other extensions to the cover are offered in order to attract business. These may include: roadside breakdown assistance; legal protection services; provision of a courtesy vehicle while repairs are carried out; out‑of‑pocket expenses resulting from an accident.

Answer 384

12.10 What cover does travel insurance provide? Travel insurance is available for individual journeys (typically from five days to one month) or on an annual basis. A typical policy might include cover against the following: cancellation due to illness or injury of the policyholder or a close relative; missed flights or sailings due to transport failure; delayed departures; medical expenses; personal accident; loss of personal possessions or of a passport; personal liability; legal expenses. Because of the increased risk of injury, cover for winter sports holidays is usually more expensive.

Answer 385

Some general insurance premiums payable in the UK are subject to insurance premium tax (IPT). The standard rate of IPT is charged at a percentage of the premium on most general insurance that relate to risks for which the period of cover begins on or after that date. Travel insurance premiums are taxed at the higher rate of IPT. There is no premium tax at present in respect of long‑term insurance such as life assurance and income protection insurance. IPT is paid by the policyholder as part of the premium; it is collected by the insurer and passed on to the tax authorities. Check the GOV.UK website for current rates and further information: www.gov.uk/government/publications/rates- and-allowances-insurance-premium-tax/insurance-premium- tax-rates.

Answer 386

Payment protection insurance (PPI) can cover monthly loan repayments if the policyholder’s salary is reduced due to accident, sickness or unemployment. The policy will pay out only for a fixed period of time, usually 12 months. This insurance is linked to the repayments of a specific lending product and may be offered at the same time as the loan itself. PPI can be extremely useful, although many PPI policies have been mis‑sold alongside loans, credit cards and mortgages over the years to people who did not need it, were ineligible to claim its benefits, or did not even realise it had been included as part of their loan repayments. Some lenders developed sales scripts for their customer services advisers that included a statement that the loan was ‘protected’, without mentioning the fact that this protection was in the form of an insurance policy – a policy that the customer should have been given the opportunity to opt out of taking. A number of companies, including high‑street lenders, have incurred fines for mis‑selling this product; compensation for customers runs into billions of pounds. Many customers have been encouraged (mainly through TV advertising campaigns or cold‑calling) to make a claim against their lender if they feel they were wrongly sold this product. People whose claims are successful are not only given back the insurance premiums they have paid, they are also able to claim the interest that this money would have earned had it been in a savings account. A deadline of 29 August 2019 was applied to PPI claims against companies that are still trading. However, customers may still be eligible to claim compensation with the Financial Services Compensation Scheme (FSCS) for financial firms that have failed. The FSCS can only accept a PPI claim if the advice was received on or after 14 January 2005. Read more on this area at: www.fscs.org.uk/what-we-cover/ppi/.

Answer 387

1) c) Critical illness insurance. Private medical insurance covers costs associated with treatment while income protection insurance pays a regular income rather than a lump sum. Long‑term care insurance is designed to meet the costs of care in later life.

Answer 388

1) c) Critical illness insurance. Private medical insurance covers costs associated with treatment while income protection insurance pays a regular income rather than a lump sum. Long‑term care insurance is designed to meet the costs of care in later life.

Answer 389

2) True. Marco’s income will reduce very rapidly if he is unable to work. He should opt for a short deferred period rather than a long one.

Answer 390

3) b) Marco’s policy will be arranged on an individual basis whereas Lydia’s policy has been arranged as part of a group scheme

Answer 391

4) d) Proportionate benefits would be paid until retirement, death or the end of the policy.

Answer 392

5) c) Private medical insurance, to cover the cost of treatment. Critical illness cover would not cover a hip replacement, while accident, sickness and unemployment insurance and income protection insurance provide cover for people who are working.

Answer 393

6) False. ASU benefits are not available to policyholders who resign voluntarily.

Answer 394

7) False. With an immediate needs annuity, the benefits are paid directly to the care provider but they are tax‑free.

Answer 395

8) True. This is the principle of indemnity.

Answer 396

9) (£25,000 ÷ £32,000) × £6,000 = £4,687.50 (less any excess).

Answer 397

9) (£25,000 ÷ £32,000) × £6,000 = £4,687.50 (less any excess).

Answer 398

10) False. It is a legal requirement to have third‑party motor insurance, which covers injury to other people and their property.

Answer 399

Lending is ‘secured’ when the borrower gives the lender the right to take possession of a specific asset if they (ie the borrower) fail to keep up repayments on a loan. In the event that repayments are missed and the matter cannot be resolved in any other way, the lender can then sell the asset to recoup the money it is owed. Security for a loan does not always take the form of a property. With commercial loans, the loan might be secured on business premises or equipment. It could also be a financial asset such as shares or other investments. With unsecured borrowing, the lender does not have the reassurance of an asset that they can sell to recoup the loan if the borrower fails to repay it. The lender has to rely on the borrower’s agreement to repay. For this reason, unsecured borrowing represents a greater risk to the lender, and thus interest rates on unsecured loans tend to be higher than those for secured loans.

Answer 400

The amount of the loan in relation to the value of the asset used for security, expressed as a percentage. For a mortgage loan of £80,000 on a property valued at £100,000, the LTV is 80 per cent.

Answer 401

A mortgage indemnity guarantee (MIG) is an insurance policy that protects the lender in situations where the loan has a high loan‑to‑value ratio (generally over 75–80 per cent). If the borrower defaults on repayments and the property is sold, the lender might not get back the full amount that it lent. The insurance is designed to make up any shortfall in these circumstances. Although the lender is the beneficiary of the policy, it is the borrower who pays the premium; it can either be a one‑off payment when the loan is taken out or can be added to the amount borrowed. Note that, even if the lender fully recoups the money owed by claiming under the MIG, the insurance company (MIG insurer) is still entitled to pursue the borrower for the shortfall arising from the default. ‘Higher lending charge’ is the term the FCA requires providers to use in explaining a MIG to a customer, but the term is not exclusive to MIGs. Some lenders will, for example, make a higher lending charge but, rather than arrange a MIG, simply place the money into a fund that can be drawn upon if required.

Answer 402

With a repayment mortgage, the borrower makes monthly repayments to the lender. Each monthly amount consists partly of capital repayment (ie the original amount borrowed) and partly of interest on the amount borrowed. The higher the interest rate (for any given mortgage amount and term), the higher the monthly repayment. The repayment is calculated in such a way that it is evenly spread throughout the term of the mortgage. Thus if interest rates do not change over the whole term, the repayment will be the same each month. However, if interest rates do go up or down, then the monthly repayment increases or decreases, or alternatively the mortgage term can be extended or shortened. The relative proportions of capital and interest vary throughout the term. At the beginning, when most of the original amount borrowed has yet to be repaid, most of the monthly repayment is just paying the interest on the loan. Later in the term, when more of the capital has been repaid, the interest proportion of the repayment decreases and a larger proportion of the repayment goes towards repaying the capital. Providing that all the repayments have been made when due, and that the repayments have been adjusted to reflect changes in the interest rate, the mortgage will be repaid at the end of the term. If the borrower dies before the end of the mortgage term, the repayments still have to be made or the loan has to be repaid in full. Borrowers need to take out life assurance cover to make sure these conditions can be met.

Answer 403

A lender’s security depends on the property being maintained in an acceptable condition. For that reason, borrowers have to covenant (ie promise under the terms of the mortgage deed) to maintain the property in good condition. They also have to covenant to insure the property adequately. A lender is permitted by law to: insist that a property subject to a mortgage is continuously insured by means of a policy that is acceptable to the lender; have its interest as mortgagee noted on the policy; secure a right over the proceeds of any claim and to insist that the proceeds be applied to remedy the subject of the claim or to reduce the mortgage debt.

Answer 404

With an interest‑only mortgage, the monthly payments made to the lender are solely to pay interest on the loan. The capital amount outstanding therefore does not reduce at all. For this reason, the monthly payments are lower than those for a repayment mortgage. However, the borrower still has to repay the original amount borrowed at the end of the term. The FCA’s Mortgages and Home Finance: Conduct of Business (MCOB) Sourcebook rules relating to interest‑only mortgages changed in April 2014, following the Mortgage Market Review, which was a major investigation into the mortgage market by regulators. New rules were introduced following concerns that, among other issues, people were being encouraged to borrow more than they could afford and borrowers were able to arrange an interest‑only mortgage without being required to make arrangements to fund repayment. An interest‑only mortgage can now only be arranged if the lender has obtained evidence that the borrower has a credible repayment strategy in place. A credible repayment strategy could be, for instance, a cash or stocks and shares ISA, a pension, an investment bond, shares, unit trusts or regular savings plans. In addition, lenders must contact the borrower at least once during the term of the mortgage to establish whether the repayment strategy remains in place and still has the potential to repay the capital. In response to these changes, many lenders stopped offering interest‑only mortgages to new borrowers. More recently, lenders have started offering interest‑only mortgages again, and there are many borrowers who have interest‑only mortgages that were taken out before the MCOB rules changed. When an interest‑only mortgage is taken out, the two main issues to be addressed are: putting in place a funding mechanism to repay the debt at the end of the term; and ensuring there is sufficient protection to enable the debt to be repaid should the mortgagor die before the end of the term. Level term assurance is a popular way of providing protection in the event that a borrower dies during the mortgage term.

Answer 405

One of the benefits of a personal pension plan or stakeholder pension is that up to 25 per cent of the accumulated fund can be taken as a tax‑free pension commencement lump sum (PCLS). Depending on the rules of the pension provider, it may also be possible for holders of a personal or stakeholder pension plan to draw an additional amount, over and above the 25 per cent PCLS, as a taxable sum. The availability of a lump sum from normal minimum pension age means that these pension plans have the potential to be used as mortgage repayment vehicles. The plans have other financial benefits in comparison with endowment policies: Pension contributions qualify for tax relief at a person’s highest rate of tax, up to the annual maximum contribution limit. There is no tax relief on endowment policy premiums. The fund in which the contributions are invested is not subject to tax on income or capital gains, meaning that it should grow faster than an equivalent endowment policy fund, which is taxed on both income and capital gains. On the other hand, there are a number of factors a borrower might feel are possible drawbacks to the use of a pension plan for mortgage repayment purposes. Lifetime allowance – this is the maximum tax‑privileged pension investments an individual is able to accrue during their lifetime. It effectively limits the amount of tax‑free PCLS that can be taken to 25 per cent of the lifetime allowance. For example, if the lifetime allowance was £1,000,000, the maximum tax‑free cash that could be taken would be £250,000. Therefore, someone who wanted to use a pension plan for mortgage repayment must either restrict themselves to a capital repayment of no more than £250,000, or be prepared to take a further taxable lump sum beyond the 25 per cent from their pension. Minimum pension age – in most cases, the minimum age at which benefits can be taken from a pension is 55, but this will increase to 57 in 2028 and may increase further in the future. This means that the term of the mortgage must run until the mortgagor reaches minimum pension age and the mortgage cannot be paid off earlier, even if the fund has grown to a sufficient value. A longer mortgage term will add to the total cost of the mortgage as a result of the additional interest payments incurred. Provider restrictions – not all providers offer the facility to take a taxable lump sum in excess of the tax‑free PCLS (although it is possible to switch to a provider that does). If only 25 per cent of the fund can be taken as a tax‑free PCLS, a fund of four times the loan value must be built up. This may mean that total contributions are more than the borrower can afford or more than are permitted by the pension scheme regulations. Impact on income in retirement – using a portion of the pension fund to repay a mortgage means there is less money available to provide an income in retirement. Need for separate life assurance – a personal pension or stakeholder pension, unlike an endowment assurance, does not automatically carry with it any life assurance, so a separate policy will be required to cover the repayment of the loan in the event of death during the term. Assignment – as with all pension contracts, personal pensions and stakeholder pensions cannot be assigned to a third party as security for a loan or for any other purpose. The lender cannot, therefore, take possession of the plan or become entitled to receive benefits directly from it, as it can with an endowment policy. This is a potential disadvantage to a lender but has not, in practice, prevented the majority of them from moving into the pension mortgages market.

Answer 406

In order to use an ISA as a mortgage repayment vehicle, ISA managers calculate the amount of regular investment that would be required to produce the necessary lump sum at the end of the mortgage term, based on an assumed growth rate and on specified levels of costs and charges. All managers allow investments to be made on a regular monthly basis, provided, of course, that the overall annual limits are not exceeded. The main benefits of using an ISA as a mortgage repayment vehicle are that the: funds grow free of tax on income and capital gains, thus reducing the cost of repaying the mortgage; mortgage can be repaid early if the fund’s rate of growth exceeds that assumed in the initial calculations. If, on the other hand, growth rates do not match the initial assumptions, the final lump sum will fall short of the mortgage amount. Performance needs to be monitored and adjustments made to the amount of regular investment if necessary. Another drawback of using an ISA is that, should the borrower die during the mortgage term, the value of the ISA investment is unlikely to be sufficient to repay the loan. Additional life assurance cover is required to meet this eventuality. The limits on annual contributions can make it difficult to build a sum sufficient to pay back a large loan or one with a short term. This is less of an issue for couples, as each individual has an ISA allowance. Also, as we saw in Topic 9, the government has introduced schemes such as the Help-to-Buy ISAs (no longer available for new applications) and Lifetime ISAs, which are intended to help those looking to purchase a property to fund their deposit.

Answer 407

A distinction can be made between the way a lender charges interest to the mortgage account and the different interest rate options that can be applied to the mortgage. For both repayment and interest‑only mortgages, there is a variety of ways in which interest can be charged to the mortgage account. For instance, some lenders charge interest on an annual basis, some on a monthly basis, and some on a daily basis. It is the lender who decides how interest is charged, and this can vary between different mortgage products with the same lender. Lenders will generally offer a range of different interest rate options or ‘mortgage products’ such as fixed or variable rates, and the ability to defer interest or take an interest payment ‘holiday’.

Answer 408

Cashback is a relatively common incentive offered by many lenders. A lump sum is paid to the borrower immediately after completion of their mortgage, either as a fixed amount or as a percentage of the advance. Generally, the lower the loan‑to‑value ratio (LTV), the higher the cashback, as the risk of the lender losing money is reduced and a lower LTV makes the borrower a more attractive proposition for the lender. It is usually a condition of the mortgage that some or all of the cashback must be repaid if the loan is repaid within a specified period. Discounted rates and cashbacks are sometimes used by lenders either to tempt borrowers away from competitors or as a loyalty bonus to persuade them to stay. Payment of legal fees is another offer that is commonly made to encourage switching of the loan between lenders while incurring minimum costs.

Answer 409

The flexible mortgage gives the borrower some scope to alter their monthly payments to suit their ability to pay, as well as the opportunity to pay off the loan more quickly. Although there is no precise definition of a flexible mortgage, it is generally considered that such a product should offer the following basic features: interest calculated on a daily basis; the facility to make overpayments at any time without incurring an early repayment charge; the facility to underpay, but only within certain parameters set out by the lender when the mortgage was arranged; the facility to take a payment holiday, again within certain parameters laid down at the outset. Two key benefits of these features are as follows: The combination of a daily interest calculation and occasional, or regular, overpayments will result in considerably less interest being paid overall and the mortgage term being reduced The ability to reduce monthly payments, or suspend them entirely, for a limited period will benefit a borrower who is experiencing temporary financial difficulties. If required, a borrower in this situation can borrow back overpayments made earlier in the term. Many lenders now offer flexible mortgages with a fixed, discounted or capped rate for an initial period. Early repayment charges do not normally apply to these products but an arrangement fee may be payable and, in some cases, it may be a condition of the loan that a particular insurance product is purchased from the lender. Most flexible mortgages allow the borrower to draw down further funds as and when required, although the lender will have set a limit on total borrowing at the outset. Flexible mortgages involve a much easier administrative process than is usual when dealing with further advances. The wording of the mortgage deed generally used for flexible mortgages is such that all additional funds withdrawn, within the limit on total borrowing, will automatically take priority over any other subsequent charges registered against the property.

Answer 410

An increasingly popular version of the flexible mortgage is the current account mortgage. This enables the borrower to carry out all of their personal financial transactions within a single account. The account is able to receive salary credits and pay standing orders and direct debits in exactly the same way as a conventional current account. The borrower will be provided with a cheque book and a debit/credit guarantee card. The combination of salary credits and the calculation of interest on a daily basis considerably reduces the amount of interest payable and consequently also the mortgage term. A more recent development is the offset mortgage. This requires the borrower to have savings or other accounts with the lender and enables the interest payable on such accounts to be offset against the mortgage interest charged. For example, if a borrower has an offset interest‑only mortgage for £80,000 and £25,000 in a savings account with the lender, they can opt to waive payment of interest on their savings, enabling interest to be charged on a net loan of £55,000. This calculation is repeated on a daily basis.

Answer 411

Shared‑ownership schemes are designed to help people on relatively low incomes to become owner‑occupiers, even though they cannot afford a conventional mortgage. These schemes are usually arranged by housing associations. Shared‑ownership schemes enable a borrower to buy a stake in the property and pay rent on the remainder. For example, a borrower can purchase a 25 per cent stake in the property, funded by a mortgage, with the option of buying further 25 per cent shares in the future. As the borrower increases their share in the property, the mortgage element increases and the rental element reduces. This process of increasing the mortgage element is sometimes called staircasing. Note that not all lenders offer mortgages for shared‑ownership arrangements.

Answer 412

In a mortgage context, ‘equity’ is the excess of the market value of a property over the outstanding amount of any loan or loans secured against it. Equity release plans are designed to enable older homeowners with limited pension income who typically do not have a mortgage on their property to release some of the equity in order to provide capital or supplement their income. A homeowner with a small mortgage may also be eligible; the existing mortgage would have to be paid off as part of the arrangement. Most of the schemes are available only to property owners over the age of 60, and many have a minimum age of 70.

Answer 413

The Equity Release Council represents all participants in the equity release market including product providers, advisers, lawyers and surveyors. Its Standards Board formerly existed as a body called SHIP – Safe Home Incomes Plans, which was incorporated into the Equity Release Council. The Council’s role is to ensure that equity release products are safe and reliable for customers. Members sign up to its Statement of Principles, which sets out standards of conduct, particularly in relation to product standards and the information provided to customers, and to its Rules and Guidance.

Answer 414

For a lifetime mortgage, a lender will usually be prepared to lend up to a maximum of 55 per cent of the property value, depending on the borrower’s age. The majority of lifetime mortgages are on a fixed‑rate basis and take into account the fact that, unlike with a standard mortgage product, the term of the loan is unknown. Interest is charged at the lender’s lifetime mortgage rate, but generally no regular payments of capital or interest are made. Instead, the interest is added to the loan (rolled up). When the borrower dies or moves into long-term care, the property is sold and the mortgage loan plus rolled‑up interest is repaid to the lender. If any of the sale proceeds remain once the loan has been repaid, the borrower, or their estate, receives the balance. If the property is owned jointly, the mortgage continues until the second death or vacation of the property. Most lenders provide a ‘no‑negative‑equity’ promise, which means that the borrower cannot owe more than the value of the property when the loan is due to be repaid. A lifetime mortgage can be arranged on a drawdown basis. The lender agrees a maximum lending limit and the borrower can borrow an initial minimum loan and subsequently draw down lump sums as they wish, subject to a minimum withdrawal, typically £2,000 to £5,000. Interest is charged on the amount outstanding, but is rolled up rather than paid each month. The benefit of this type of loan over a standard lifetime mortgage is that interest only accrues on the amount actually borrowed, so the borrower has a degree of control and the debt will not increase as rapidly. It will allow the borrower to provide an annual ‘income’ while maintaining control over the speed at which the debt builds up.

Answer 415

Home reversion plans involve the homeowner selling a percentage or all of their property to the scheme provider. The customer(s) retains the right to live in the house, rent‑free (or for a nominal or partial rent), until their death(s) or until they move into permanent residential care. At that point the property is sold and the provider receives a share of the proceeds equivalent to their share of ownership. Thus if they owned 40 per cent of the property, they would receive 40 per cent of the sale proceeds.

Answer 416

Equity release schemes, defined as lifetime mortgages and home reversion plans, are regulated by the FCA under the Mortgages and Home Finance: Conduct of Business (MCOB) rules. MCOB 8 and 9 are the sections of MCOB specifically directed at equity release and lifetime mortgages, although the general MCOB rules regarding suitability and affordability also apply. Anyone who advises on or arranges equity release must hold a specialist qualification. The requirements are detailed in the FCA Training and Competence sourcebook.

Answer 417

Retirement interest-only mortgages are similar to equity release schemes insofar as the outstanding debt is repaid from the proceeds of the sale of the property when the borrower dies or moves into long-term care. The main difference is that the borrower must repay the interest during the term of the mortgage and must be able to prove to the lender that they can afford to do so. Retirement interest-only mortgages are available from traditional mortgage lenders and, as the name suggests, are generally aimed at older borrowers.

Answer 418

With all secured loans, the borrower offers something of value as security for the loan so that, in the event of default, the lender can take and sell that asset (or, in financial services terminology, ‘realise the security’) and be repaid out of the proceeds. The most common form of secured personal lending is, of course, the mortgage loan for house purchase, the security being a first charge on the borrower’s private residence. When property values increase significantly, it is common for people to borrow against the increased equity in their property. For instance, they might take out a further loan from their existing mortgage lender (ie a further advance), arrange a second mortgage from a different lender or remortgage for a larger amount. They then use the loan to fund purchases that are not related to the house purchase but which improve their lifestyle in other ways. Sometimes, bridging finance is required to enable a homeowner to bridge the funding gap that arises when they complete on the purchase of a property before they have received the funds from the sale of their existing property. Most secured lending, therefore, is secured on ‘bricks and mortar’, even where its purpose is not directly – or even indirectly – related to house purchase or improvement.

Answer 419

BRIDGING FINANCE Can be used by those arranging a loan to finance a new purchase before they have sold their existing property in order to ‘bridge’ the finance gap. FIRST CHARGE A legal right to have ‘first call’ on a property if a borrower defaults on repayment of the mortgage loan. SECOND CHARGE A legal call on a property after all the liabilities to the holder of the first charge have been settled.

Answer 420

A second mortgage is one that is created when the borrower offers the property for a second time as security while the first lender still has a mortgage secured on the property. The new lender takes a second charge on the property; the original lender’s charge takes precedence over subsequent charges. This means that, in the event of a sale due to default, the original lender’s claim will first be met in full (if possible) and, if sufficient surplus then remains, the second mortgagee’s charge will be met. Lenders will, of course, only offer a second mortgage if there is sufficient equity in the property and, since second mortgages represent a higher risk to lenders, they are likely to be offered at higher rates of interest than first mortgages. Second charge mortgages have been regulated by the FCA under MCOB since 21 March 2016; prior to that date they were regulated under the Consumer Credit Acts.

Answer 421

Bridging finance may be required when a borrower wishes to move house but has not managed to sell their existing property, or the funds from the sale will not be available at the time completion of the new purchase is due. It is short‑term lending that is repaid when the original property is sold and the owner is able to secure a mortgage on their new home. There are two types of bridging finance: Closed bridging – the borrower has a feasible plan for repaying the loan within an agreed timescale. Typically, this is through the sale of the existing property and requires the borrower to have a firm buyer. Open bridging – the borrower needs finance to buy the new property, but does not yet have a firm buyer for their existing property. Open bridging represents a higher risk to the lender than closed bridging. Interest rates for open bridging are therefore higher than those for closed bridging

Answer 422

There is an extensive market for what might be called commercial lending, ie loans to businesses of all sizes, from sole traders and partnerships to family companies to multinational traders. Loans may be required to start up or expand businesses, to purchase shops, factories or hotels, or to refurbish premises. All the high‑street retail banks have departments operating in this field, and there is also a wide range of companies that specialise in commercial lending. Such lending is normally secured on the company’s property or other assets, with the interest rate set at a specified margin above the lender’s base rate. The exact interest rate will depend on the risk that the lender believes is involved in lending to the particular company; this will be assessed by looking at the company’s past performance (where applicable), business plans, projected profits and management quality, as well as the business sector in which it operates.

Answer 423

In contrast to secured loans, an unsecured loan relies on the personal promise, or covenant, of the borrower to repay. Unsecured loans are, therefore, generally higher risk than secured lending, with the consequence that they are subject to higher rates of interest and are normally available only for much shorter terms. For example, while a mortgage secured on a property will be available for 25 years or even longer, a personal loan is rarely offered over much more than six or seven years. Unsecured personal lending takes a number of forms, the most common of which are described below

Answer 424

Personal loans are offered by banks, building societies and some finance houses. They are normally for a term of one to five years; the interest rate is generally fixed at the outset and remains unchanged throughout the term. Many of the larger lenders assess loan applications on a centralised basis, using a form of credit scoring to assess the suitability of the borrower. A customer can use a personal loan for any (legal) purpose: typically, it might be used to purchase a car, fund a holiday, or consolidate existing higher‑cost borrowing such as a credit card balance. The purpose of the loan determines whether it is regulated under the terms of the FCA’s Consumer Credit (CONC) rules. Most loans are regulated under CONC unless they are for house purchase or home improvement, and therefore subject to FCA regulation under MCOB rules

Answer 425

An overdraft is a current account facility that enables the customer to continue to use the account in the normal way, even though its funds have been exhausted (although the provider does set a limit on the amount by which the account may be overdrawn). It is a convenient form of short‑term temporary borrowing, with interest calculated on a daily basis, and its purpose is to assist the customer over a period in which expenditure exceeds income – for instance, to pay for a holiday or to fund the purchase of Christmas gifts. Overdrafts are offered by all banks and some building societies. Because it is essentially a short‑term facility, the agreement is usually for a fixed period, after which it must be renegotiated or the funds repaid. Overdrafts that have been agreed in advance with the provider are known as arranged overdrafts. Where an arranged overdraft limit is exceeded, or not agreed in the first place, the resultant overdraft is unarranged. Previously, unarranged overdrafts were liable to higher rates of interest than arranged overdrafts. However, since April 2020, banks and building societies can only charge overdraft users a single annual interest rate. As a result, many now only offer arranged overdrafts.

Answer 426

Credit cards enable customers to shop without using cash or debit cards in any establishment that is a member of the credit card company’s scheme. Most retailers have terminals linked directly to the credit card companies’ computers, enabling online credit limit checking and authorisation of transactions. As well as providing cash‑free purchasing convenience, credit cards are a source of revolving credit. The customer has a credit limit and can use the card for purchases or other transactions up to that amount, providing that at least a specified minimum amount (usually 3 per cent of the outstanding balance) is repaid each month. The customer receives a monthly statement, detailing recent transactions and showing the outstanding balance. If the balance is repaid in full within a certain period (usually 25 days or so), no interest is charged; if a smaller amount is paid, the remainder is carried forward and interest is charged at the company’s current rate. Credit cards are an expensive way to borrow, with rates of interest considerably higher than most other lending products. There is also normally a charge if the card is used to obtain cash either over the counter or from an ATM, or if the card is used overseas. Credit card companies charge a fee to retailers for their service. This is deducted as a percentage (typically around 3 per cent) of the value of transactions when the credit card company makes settlement to the retailer. Despite the fee, credit cards offer a number of advantages to retailers: the retailer might achieve more sales if the convenience of payment by credit card is available to customers (and facilities to accept card payments of some kind are of course essential for most online retailers); payment is guaranteed if the card has been accepted in accordance with the credit card company’s rules; the retailer can reduce their own bank charges because the credit card vouchers paid into a bank account are treated as cash.

Answer 427

An arrangement whereby the customer can continue to borrow further amounts while repaying existing debt.

Answer 428

Although a charge card is used by the customer in the same way as a credit card to make purchases, the outstanding balance on a charge card must be paid in full each month. The best‑known examples are American Express and Diners Club. Thus a charge card is a form of unsecured lending only in a very limited sense. Like credit cards, debit cards can be used to make payments for goods and services, and to withdraw cash from ATMs. They are operated in the same way: a cardholder makes a payment by inserting the card into a card‑reader and entering a PIN (alternatively, most debit cards can be read by contactless card‑readers for transactions below a threshold). However, a debit card is not a credit facility. The effect of the transaction is that funds equal to the amount spent are transferred electronically from the cardholder’s current account to the account of the retailer. This is known as EFTPOS (electronic fund transfer at point of sale).

Answer 429

1) The mortgagor is the borrower and the mortgagee is the lender.

Answer 430

2) b) Life cover is not built in, therefore a separate life assurance policy would be needed to ensure that the mortgage could be repaid if the borrower were to die before the end of the mortgage term.

Answer 431

3) An ISA has an annual investment limit which might make it difficult to fund a large mortgage and/or one arranged over a short term.

Answer 432

4) False – MCOB rules require the lender to confirm at the outset that a credible repayment strategy is in place and then reconfirm this at least once during the mortgage term.

Answer 433

5) Not yet, because Chris cannot access his pension funds until he is at least 55.

Answer 434

7) a) If interest rates go up, the mortgage interest rate will not exceed a pre‑arranged limit, in other words, the ‘cap’.

Answer 435

8) Home reversion plans involve the homeowner selling a percentage or all of their property to the scheme provider. The customer(s) retains the right to live in the house, rent‑free (or for a nominal or partial rent), until their death(s) or until they move into permanent residential care. At that point the property is sold and the provider receives a share of the proceeds equivalent to their share of ownership.

Answer 436

9) The personal loan – interest rates on unsecured borrowing are generally higher than on secured borrowing because it represents a greater risk to the lender.

Answer 437

10) A facility that allows you to borrow more before you have paid off the initial amount borrowed. Credit card borrowing is the most common example.

Answer 438

14.1 Beginning the process Providing appropriate, ethical financial advice is not simply a matter of understanding the features of all the products that we have studied so far in this course – although product knowledge is important. An understanding of the regulatory and legal duties imposed on financial advisers is critical too: later in your studies, we will look at contract law and agency law (Topic 16), data protection (Topic 24) and consumer protection (Topic 25). The regulation of firms, individuals and the advice process is covered in Topics 18, 20 and 21. The precise financial needs of clients vary from person to person, but it is possible to identify financial needs that are typically associated with the life stage that an individual is in, and from there to establish the type of products that might be relevant to them. Demonstrating an understanding of the situations in which clients might find themselves over the course of their life, and the real or perceived financial needs that they might have as a result, is an important factor in developing the client’s trust. Maintaining confidentiality is another. There is a well‑established pattern to the way in which most savers and investors build up and hold their assets (summarised in Figure 14.2). It begins with savers’ attitudes to the need for liquidity and safety and then, as income and savings grow, moves gradually away from liquidity and towards an acceptance of greater risk. The first stage in the saving pattern is cash; after that, a current account with a debit card is virtually as good as cash. People do not generally hold any other form of asset until their cash requirements are met. The next stage is secure, short‑term investment such as instant access (or short‑notice) bank and building society deposits. With a sufficient balance in short‑term savings, investors look next at products with less flexibility but a greater return, such as fixed‑term bonds. Further down the line, individuals may be attracted to products that offer greater long‑term potential but at the risk of short‑term loss. Shares and other equity‑linked investments, such as unit trusts, are good examples. In times of stock market volatility, however, these investments may prove considerably less popular. Similar patterns can be recognised in relation to other types of financial products, though perhaps to a less pronounced extent: for example, the first type of bank account that most people open is a personal current account, often out of necessity to enable receipt of their wages or salary. It is only later, as their financial situation improves, that they begin to use a wider range of accounts and other banking products; similarly with insurance products, where the first experience is often of compulsory cover, particularly for motor insurance, and of travel insurance. In terms of borrowing, many people begin with short‑term unsecured borrowing, by way of credit cards or personal loans, to pay for holidays or a car.

Answer 439

Advisers must take reasonable steps to ensure that any advice offered is suitable for the client, based on the client’s circumstances, relevant knowledge and experience, financial situation and objectives. This is a requirement under FCA rules (COBS 9.2.2R). Advisers build a clear picture of a client’s circumstances, experience, needs and objectives by obtaining personal and financial information about the client through a fact-finding process. FCA rules do not prescribe the method by which advisers obtain information from clients. Firms design a process which meets the FCA’s requirements for assessing suitability, taking account of the market in which they transact business. Advisers record the information they obtain from the client through factfinding in a document often referred to as a factfind. Fees for services that the adviser intends to provide to the client are usually disclosed and agreed prior to the factfind. To gather appropriate information, it is necessary to ask questions in respect of the client’s: financial situation; existing and future needs; ability to provide for them; attitude towards providing for them; objectives; knowledge and experience of investment (where relevant to the service the adviser will provide). This will support an assessment of the client’s ability to understand and accept investment risks. This means, in practice, that any factfind should look at both the client’s circumstances and their preferences.

Answer 440

14.3 Establishing the customer’s situation The following basic information is needed. 14.3.1 Personal and family details Full name, postal and email addresses and telephone number(s). Date and place of birth – dates of birth for all those included in the factfind. The client’s place of birth may be important for underwriting or to establish domicile. Relationship status – single, married, civil partners, cohabiting, divorced, widowed, etc. It is usually preferable to have both partners of a relationship involved in the financial planning process, since the decisions made will often affect both partners. Some couples, however, prefer to keep their financial affairs separate. Family details – the client’s family details are important for a number of reasons: — there may be family members who are, or will be, financially dependent on the client; — the client may become the beneficiary of gifts or trusts; — the client may wish to become a donor, now or in the future; — from a marketing viewpoint, there may be an opportunity for referrals to family members. The most important group of family members is usually the children. In order to give appropriate advice about protection against death and disability, as well as about savings for school or university fees for example, it is necessary to know how old the children are. This may include children from previous relationships.

Answer 441

Employment status – is the client employed, self‑employed, unemployed or retired? If the client is a director or a partner, it may be necessary to delve deeper and establish basic information about their business arrangements. It also helps to know whether their status is part‑time or full‑time, temporary or permanent, as well as gaining details of the client’s profession or trade. Income and benefits – it is often useful to establish an exact breakdown of income by its component parts, eg basic, commission, bonus and overtime, together with the average level of overall earnings (net profits in the case of self‑employed clients). Similarly, an adviser must establish the exact nature of benefits provided, eg private medical insurance, company cars, pension and/or death‑in‑service details, subsidised loans, etc. Previous and/or additional employment – details of previous employment (especially if the client has preserved pension entitlement), share‑option schemes, profit‑related pay schemes, details of additional employment. It may be helpful to obtain copies of payslips, P60s, tax returns and notices of tax coding. Income and expenditure – analysing a client’s income and expenditure makes it possible to identify more easily the implications of, for instance, premature death on the family income and spending patterns. It is also possible to identify any surplus income that could be used to fund the purchase of any additional products recommended.Calculating a household’s income is usually relatively straightforward. Analysis of clients’ expenditure can be more difficult. Certain items are easily determined, ie those paid by standing order, such as rent and some household bills. It is usually more difficult to pin down how much is spent on, for example, food and drink, holidays or cars.

Answer 442

The adviser should obtain details of all the client’s assets, from their home (if they own it) to all their various bank accounts. Depending on the type of asset, the following details are required: ownership, ie single ownership or jointly owned; purpose of the investment; type of investment, eg property, deposit in a bank account, pension policy or fund; size of original investment and date; current value and/or projected future value; rate of return (if any); type of return, eg capital growth or income, and whether that return is fixed, guaranteed or variable; tax status of the investment or other asset; options available and/or penalties; sum assured and/or lives assured and maturity dates; name of the institution providing the asset. Liabilities The following information should be obtained in relation to the client’s borrowing: lender; amount of loan; balance outstanding; original term and term remaining; type of loan, eg secured, unsecured (and if secured, on what); amount of monthly or other periodic payment; rate of interest; repayment method; protection of capital or payments. Clients are often unaware of the details of any arrangements that they have. It is an adviser’s responsibility to try to obtain this information, and clients should be asked to bring full details with them.

Answer 443

Completing the first two sections of the factfind – the personal and family details and the financial situation – involves gathering hard facts, ie about tangible items and people. The client’s plans and objectives tend to be more intangible; here the aim is to find out “why?”, “how?” or “do you feel that?”; in other words, to discover the client’s feelings about what they have, what they want and where they want to go from a financial point of view. These are known as soft facts. Figure 14.3 summarises the soft facts that the adviser needs to establish for each area. Knowing the client’s feelings about their situation, their aspirations for the future and their existing arrangements will help build understanding in a number of ways: Discovering the reasons behind the client’s existing arrangements may in turn indicate the client’s level of understanding of their finances. Determining the level of the client’s interest in their situation will indicate their motivation to improve their situation and the likelihood of their taking action. Ascertaining the client’s views on a number of possible alternative solutions will help in constructing acceptable recommendations. To find out how a person feels about improving their financial situation, the adviser needs to ask questions like these:

Answer 444

It is essential to establish the client’s attitude to risk when making recommendations. The client must understand what the risk involved in a proposal is. This may involve providing explanations to distinguish between the degrees of risk – for example, whether there is a risk to the capital that is invested, the fact that the value of an investment may fall as well as rise, and that the amount of income or capital growth may not be guaranteed. Historically, many so‑called low‑risk investments, such as bank or building society accounts, have provided a safe haven and a relatively stable level of income, but the adviser must make sure the client is aware that inflation will cause the value of the investment to fall and explore their attitude towards this risk. A client’s attitude to risk is often assessed by psychometric testing (a questionnaire, typically online, designed to uncover a client’s risk tolerance), with a risk score being allocated from the answers given. Another important factor, linked to risk, is a client’s ‘capacity for loss’. The FCA describes this as “the client’s ability to absorb falls in the value of their investment”. If any loss of capital would have a materially detrimental effect on the client’s standard of living, this should be taken into account in assessing the risk that they are able to take. It is important to take note of a client’s stated preferences, but advisers have a duty of care: this means recognising that, while a client may have a clear view on what they want to do, their appreciation of what they ought to do can be less than clear. This means that an adviser may have an educational role in helping a client to explore their own financial circumstances and make the right choices. As environmental considerations become more important to people, it may also be pertinent to find out their sustainability preferences, ie to what extent they would like to invest in environmentally sustainable products.

Answer 445

Clients often have a range of financial needs, even when they approach an adviser with one particular need in mind. To give the most appropriate advice, advisers must be aware of the broad range of needs that clients might have – and must be able to recognise those needs even where clients themselves are not aware of them.Every client is different but, in general terms, an adviser should first seek to ensure that there is adequate protection of their lifestyle in the event of death or illness. Retirement planning would then be the next priority as it is effectively protecting income for a time when a person either does not want to or is no longer capable of working. Once the client’s current and future positions are protected, attention can then be made to enhancements through savings and investment planning. In seeking to assess any of these areas, an adviser should look for examples of typical things that clients either do wrong or fail to do at all. This might include the following: A young family, with little or no savings, relying solely on mortgage protection cover as their only form of life assurance. It would repay the mortgage but is not designed to meet the ongoing costs of running the house and bringing up the family. A low level of life assurance premiums being paid, suggesting that cover might need to be increased for the required protection to be adequate. Unnecessarily large amounts being held on deposit in bank and building society accounts over the long term and so not gaining access to better returns available elsewhere. Substantial taxable savings/dividend income, in excess of allowances, being received by an individual who pays higher‑rate income tax. A non‑taxpayer holding investments where tax is taken while funds are invested and where the tax deducted cannot be reclaimed. A client with many small holdings of shares over a wide range of companies, causing administration and monitoring difficulties. A married couple owning most of their assets in an individual’s sole name and paying more tax as a result. A client not making any pension contributions, or making only very small pension contributions as a percentage of total earnings, which will mean being dependent upon state benefits unless action is taken. People who have not made a valid will, whose assets on death may, therefore, not be distributed as desired. The adviser’s role is to define the client’s needs and objectives accurately, to enable the client to see the key issues facing them and to recommend and discuss a priority order for action.

Answer 446

Failing to establish a priority order with the client can result in a client ignoring an adviser’s recommendations. The client’s priorities may well differ from those that the adviser feels appropriate, and so the process is one of discussion and agreement rather than straightforward selection by any single person. In the end, however, deciding a plan of action and agreeing its priority order remains the client’s decision, assisted by the adviser’s recommendations.

Answer 447

Once an adviser has gathered all of the necessary information about the client’s circumstances and preferences, has a clear appreciation of their ability to pay, and has obtained agreement on priorities, then the process of matching solutions to requirements can begin. The advisor objectives are first put the right amount of money, second in the right form, third in the right hands, fourth at the right time. In practice, these four aims mean that advisers will look in detail at a number of specific areas: State benefits – the nature and level of state benefits to which a client may be entitled. Existing arrangements – there is no point in recommending products that satisfy needs already met by the client’s existing arrangements or by state provision. Affordability – any recommendations made must not, in terms of total cost, jeopardise the client’s current and likely future financial situation. Taxation – one purpose of the recommendations may be to mitigate tax but it is also important to ensure that any course of action recommended does not unnecessarily add to or create a tax burden. Risk – there must be a close correlation between the risk inherent in the product recommended and the client’s risk profile and capacity for loss. Timescale – the product recommended should meet the client’s needs within a defined timescale. Flexibility – recommendations should display the flexibility to deal with possible changes in the client’s circumstances. It is a good idea to have a clear plan for how to present each recommendation to the client, not least because some details may be mandatory under the Financial Services and Markets Act 2000 and related FCA rules. Explanations that should always be included are: the purpose of the product and the client’s needs that the product will address; the benefits that the client will enjoy; the risks and limitations inherent in the product; any options that exist within the product that may be appropriate to the client; a summary of reasons why the product is being recommended. For each product, part of the presentation should involve a features and benefits analysis. This means going through the product and identifying each of its features, and then putting into simple terms what specific benefits these features provide to the client. The adviser should check that the client understands, perhaps by asking a few simple questions.

Answer 448

Obtaining a commitment from the client in the form of a completed application form will depend on how effectively all of the earlier stages of the sales process have been carried out. Attempting to close a sale too early is clearly not sensible, and deciding when to close a sale is determined by two factors: the reaction of the client; and their understanding of the proposal. Closing the sale simply involves asking the client if they are happy to complete the application. Sometimes the client may expect the adviser to complete the form on their behalf. It is permissible to do this, but only with the client’s permission. If the adviser does complete the proposal form, the client must read it thoroughly, checking what has been written before signing it. In particular, the client must be made aware of the consequences of deliberate or reckless misrepresentation. If the contract is later made void because of information that the client misrepresented then the client may not be protected and could also incur a loss of premiums. A key features document (or key information document ‘KID’ or key investor information document ‘KIID’, depending on the product sold), together with a key features illustration (for some products), must be given to the client before the sale is closed. These documents provide the client with all the information they need in order to make a decision. The client should also be provided with a product brochure explaining product details and features in full. The adviser must also explain the cancellation notice, which sets out the client’s right to withdraw from any arrangements within a defined period. The adviser should provide the client with their business card during the meeting. This gives the client a clear route back to the adviser should there be any queries later on.

Answer 449

The first point in handling an objection is to qualify it. This means finding out whether it is a genuine statement of concern about the recommendation or whether it is masking another issue that is on the client’s mind. For example, if a client states “that is too expensive”, is that the real issue or is it that the adviser has not really explained the need or the benefits of the recommendation? If an objection is made, it is essential to understand how important it is. This can be done by trying to understand the objection as specifically as possible, ie by clarifying exactly what the client means by what they are saying. A good way of doing this is by paraphrasing what the client has said: “So what you’re saying is . . .?” Once the nature of the objection and its importance are clear, then an attempt can be made to solve the problem. If the problem lies in the client’s understanding or interpretation of what they have heard, then it should be straightforward to solve. If the problem lies in something specific and the client is not willing to move, then the obstacle should be put into perspective and other compensating factors stressed. The handling of objections or queries is another step in helping the client to buy something for which they have seen a clear need and of which they can now see the full benefit.

Answer 450

Once the arrangements have been put in place there is a regulatory requirement to keep records to demonstrate what advice and information was given and why. Product type Retention period Life policies, pension contracts 5 years Pension transfers, opt‑outs, FSAVCs Indefinite MiFID‑related business 5 years Other eg mortgage related contracts 3 years These retention periods relate to the FCA’s conduct of business requirements, which we cover in more detail in Topic 20. There are other retention rules relating to the prevention of money laundering and to complaints handling – we look at these in Topics 23 and 25 respectively.

Answer 451

Providing a professional service means more than selling a product to meet needs: it means ensuring that proper after‑sales care is given and that reviews are carried out. This will include ensuring that, where the acceptance procedure involves any delay, the client is kept fully informed. It will also mean dealing with other related matters such as direct debits, policy delivery, cancellation notices, standard reviews and any requests to alter the plan. After these general areas, client servicing falls into two categories: proactive and reactive servicing.

Answer 452

Proactive servicing involves instigating action by contacting the client to discuss further needs. This might be on a matter previously agreed, such as the next salary review, a job change, or even the taking up of recommendations of which the client was unable to take advantage originally. Even where there is no known future event or requirement, it is a good idea to agree a time to review the client’s position. At a review, an adviser can find out if there have been any changes to the client’s circumstances and can update the appropriate records. By doing this, an adviser is in a strong position to identify opportunities to recommend new products appropriate to the client’s needs, or to recommend changes to existing products.

Answer 453

Reactive servicing happens as the result of a request from the client, for example a request to discuss the recommendation after comments made in the media or by competitors. The client’s circumstances might change unexpectedly, resulting in a request for advice. The request might not be received directly from the client: it might be notification of non‑payment of premiums or a request by the next of kin to sort out a death claim. In order to be fully prepared for all eventualities, clear and concise records must be maintained. Keeping appropriate records will not only comply with the requirements of the Financial Services and Markets Act 2000, but may also lead to more business.

Answer 454

1) b) Income protection, to ensure that they can continue to make their mortgage repayments if they are unable to earn an income. An emergency fund would be useful but, at least at the beginning, would be unlikely to be big enough to cover mortgage repayments except in the very short term.

Answer 455

2) It is important to establish the client’s domicile for tax purposes and it may be a factor in underwriting decisions.

Answer 456

3) b) An emergency fund. Once people have enough cash to cover their day‑to‑day needs, the usual approach is to build up savings in an easy‑access deposit account.

Answer 457

4) c) Attitude to risk.

Answer 458

5) c) Generating income. It is not a) pension accumulation as this would take place before retirement.

Answer 459

6) ‘Capacity for loss’ is “the client’s ability to absorb falls in the value of their investment”, ie the extent to which the client would be adversely affected should they make a loss on their investments. This must also be taken into account when assessing attitude to risk.

Answer 460

7) Eligibility for state benefit; existing arrangements; affordability; taxation; attitude to risk; capacity for loss; anticipated changes in circumstances; timescale; flexibility.

Answer 461

8) The purpose of the product and the needs that it will address; the benefits to the client; risks and limitations inherent in the product; any product options that might be appropriate; a summary of reasons for recommending that product.

Answer 462

9) Indefinitely.

Answer 463

10) Proactive servicing is instigated by the adviser, perhaps on the basis of information obtained during the factfind about a forthcoming promotion or inheritance. Reactive servicing is instigated by the client in order to address a need, or by the client’s representatives, eg the executors of an estate.

Answer 464

The need to budget underpins all other forms of financial planning. At its simplest, it reflects the need to have sufficient funds to purchase the necessities of daily living. It also enables people to determine how much they can spend on other items, for instance large‑scale purchases, leisure pursuits and holidays, and provision for a secure retirement. Many savings products can be used to help people budget for future expenditure, whether this is for a major purchase or to provide regular income. However, advisers must be careful not to put pressure on the client’s current and future income when selling products paid for out of that income. An increase in mortgage interest rates, for example, could push a family’s expenditure beyond its means. It might be argued that the need to balance the budget on a weekly/monthly basis is not as great as it once was, as a result of the easy availability of credit. Nevertheless, all borrowing must be repaid at some point, and advisers should exercise caution when considering clients’ likely future income and expenditure levels.

Answer 465

Life involves exposure to many risks and it is not possible to avoid all the dangers and difficulties that it can bring. It is, on the other hand, possible to take sensible precautions against the impact of the risks that affect people, their lives, their health, their possessions, their finances, their businesses, and their inheritances. Many people, however, make little or no provision for minimising the financial consequences of death or serious illness. This may be because they are not aware of the size of the risk or because they believe that they cannot afford to provide the cover, not realising how cheap it can be, especially if taken out when young.

Answer 466

For most families, it is income rather than savings that enables them to enjoy their standard of living. Loss of that income on the death of an earner usually causes a reduction in a family’s standard of living. State benefits may be available but they generally do little more than sustain a very basic lifestyle, and increasing pressure on funding means that they are more likely to reduce than increase in real terms in the future. The surviving spouse/partner may, therefore, have to increase their income, for instance by working full‑time instead of part‑time. If they have young children, they may have to fund the cost of childcare. Another consequence of the death of an earner is that surviving family members may no longer be able to maintain loan repayments, particularly mortgage repayments. If the mortgage cannot be serviced, the property might have to be sold and the family rehoused in less suitable circumstances. It is equally important for the life of a financially dependent spouse/partner to be insured, even though they are not in paid employment. In the event of their death, the surviving spouse/partner may have to give up work in order to look after any young children, or may have to pay the cost of full‑time childcare. There might also be additional housekeeping costs.

Answer 467

1) In relation to the protection of debts, term assurance (level term for an interest‑only mortgage; decreasing term for a repayment mortgage) would provide a lump sum to pay off the outstanding mortgage loan. Family income benefit could provide a monthly income to replace that lost or to cover additional expenditure; alternatively the benefit from this type of policy could be taken as a lump sum. A level term assurance can also be used to protect living standards but would pay a lump sum which would then have to be invested in order to provide the required income.

Answer 468

Many of the arguments for protection against the adverse financial consequences of death apply equally to the need for protection against the impact of long‑term illness. In fact, there may be an even stronger argument for protection against financial loss as a result of sickness, not just because the likelihood of suffering a long‑term illness is greater than that of premature death, but also because the financial impact on a family of long‑term sickness can be even more severe than that resulting from a death. Protection against the impact of sickness may fall into a number of categories: an income to replace lost income (for instance when the main earner suffers a long‑term illness); an income to pay for someone to carry out the tasks normally undertaken by a person who is ill; an income to pay for continuing medical attention or nursing care during an illness or after an accident; a lump sum to pay for private medical treatment; a lump sum to pay for changes to lifestyle or environment, such as alterations to a house or a move to a more convenient house. As in the case of protection against death, there may be a requirement to cover not just a main breadwinner, but also a dependent spouse. The problems resulting from unemployment/redundancy are, in many ways, similar to those caused by illness, but it is much more difficult for insurers to predict statistically the likelihood of loss of employment than it is to predict loss of health or loss of life. Unemployment cover is, consequently, much more difficult to obtain as a stand‑alone insurance and, when it is available (normally only in conjunction with sickness cover and often only in relation to covering mortgage repayments), it is usually subject to a number of restrictions.

Answer 469

Loss of a colleague as a result of death, injury or long‑term sickness can have severe implications for the financial health of a business. Life or sickness insurance can be used to mitigate the financial loss that may result. Some of the more common circumstances are described below. The death of an important employee, particularly in a small company, can have a devastating effect on a business’s profits. Key personnel can be found at all levels of a business, not just within senior management. For example, they might be a: managing director with a strong or charismatic personality; research scientist with specialised knowledge; skilled engineer with detailed understanding of the company’s machinery; salesperson with a wide range of personal contacts. Determining the level of cover that is required can be difficult. A simple method is to use a multiple of the key person’s salary, say five or ten times. Another method is to relate the cover to an estimate of the key person’s contribution to the business’s profits. This contribution can be calculated by multiplying the amount of current annual profit by the ratio of the key person’s salary to the business’s overall wage bill. This estimate of the key person’s contribution is then multiplied by the length of time that the business would take to recover from the loss, often assumed to be five years. The business would then take out a term assurance on the life of the employee, for the period during which the employee is expected to be a key person. This may be until retirement, or until the end of a contract or a particular project. If a term assurance of five years or less is chosen, the premiums are likely to be allowed as a business expense, which the business can set against corporation tax. In the event of a claim, however, the policy proceeds will then be taxed as a business receipt and subject to corporation tax.

Answer 470

Goran is the production director of a firm whose last published gross profits were £4m. Goran is paid £50,000 pa. The firm’s total wage bill is £2m. The length of time that the business would take to recover from the loss of Goran is assumed to be five years. The sum assured for a policy on Goran’s life could be calculated as: (£50,000 ÷ £2,000,000) × £4,000,000 × 5 = £500,000.

Answer 471

A partnership is defined in the Partnership Act 1890 as “the relationship that exists between persons carrying on a business in common with a view to profit”. Groups of professionals such as solicitors and accountants normally work together as partners. In the absence of any formal partnership agreement, the Act stipulates that a partnership is dissolved upon the death of a partner, with the business assets realised and distributed to the remaining partners and the beneficiaries of the deceased partner’s estate. The surviving partners might want to carry on the business but might find that they lack the funds to do so, particularly if much of the business’s value is in the form of goodwill. The solution is to put in place an arrangement that specifies what should happen to each partner’s share of the business on death. The arrangement needs to be supported by an appropriate level of life insurance, to provide the required funds, and a suitable trust detailing distribution of the proceeds from the life assurance (see Topic 16 for more information about trusts). There are three main types of scheme that are used for this purpose. Automatic accrual method – all partners enter into an agreement under which, on the death of a partner, their share is divided among the remaining partners in agreed proportions. The deceased partner’s family is compensated by the proceeds of a life policy written in trust for their benefit. Where automatic accrual is used there is normally 100 per cent business relief for inheritance tax in respect of the deceased partner’s share of the business. Buy‑and‑sell method – all partners enter into an agreement under which, on the death of a partner, the deceased’s legal representatives are obliged to sell the partner’s share to the other partners, who are obliged to buy it. To enable them to do so, each partner takes out a life policy on their own life in trust for the other partners. One problem is that the person who inherits the share is deemed to receive cash rather than business assets, so in that situation business relief from inheritance tax is not available. Cross‑option method – this is basically the same as the buy‑and‑sell method, except that the agreement specifies that the deceased partner’s estate has the option to sell their business share to the remaining partners, who have the option of buying it. There will almost always be an agreement for the deceased’s estate to sell the business share and the remaining partners to buy it but because there is no legal obligation to do so, those who inherit are deemed to receive business assets, and relief from inheritance tax may be available.

Answer 472

Small businesses are often run as private limited companies with a small number of shareholders, who are often family members or friends. In the same way that partners may wish to buy out the share of a deceased partner, surviving shareholders in a small business will probably want to buy the shares of a deceased shareholder to prevent the shares from going out of the close circle of existing shareholders. The same types of scheme available for partnerships can be used for shareholder protection.

Answer 473

If sickness prevents a key employee from working, the effect on profits can be just as serious as in the case of that employee’s death. The company may need funds with which to recruit and pay the salary of a replacement who can supply the skills and attributes lost through sickness. A critical illness cover plan can be used.

Answer 474

If a partner falls ill, they may be able to continue to draw income from the partnership for some time, even if not contributing their skills to the partnership’s earning capacity. There will be a need to provide a replacement income to avoid the partner becoming a drain on the partnership’s resources. This need could be met by income protection insurance. In the event of the partner being unable to return to work, the remaining partners may even wish to buy the sick partner’s share of the business. Depending on the nature of the illness, critical illness cover could be used to generate the lump sum required.

Answer 475

Although sole traders may employ others to work for them, they often do much of the key work themselves, including accounting and decision‑making. If a sole trader ceases working, their income is likely to stop very quickly. Worse still, their customers may be lost to competitors, causing the business to collapse. The pressure and anxiety resulting from such a situation is likely to hinder recovery from the very illness by which it was caused. For a sole trader, income protection with a short deferred period can ensure that an income continues to be received.

Answer 476

House purchase is, for the majority of people, the largest financial transaction of their lives and, since most people are not able to fund the price of a house out of their own capital, a loan from a bank, building society or other source is normally required. Since a mortgage is such a large and long‑term commitment, the consequences of making a mistake can be very serious. It is therefore particularly important for an adviser to choose wisely and to match the products chosen to the client’s needs. The regulations relating to mortgage advice are contained in the FCA’s Mortgages and Home Finance: Conduct of Business (MCOB) Sourcebook, and we look at them in more detail in Topic 21. The primary consideration is that the mortgage is affordable. If a borrower fails to maintain payments on a loan secured on their property then they risk the lender taking possession of the property and losing their home. The MCOB rules make clear that the affordability of the mortgage is a key element in determining whether the product recommended is suitable. Nor is it enough to establish that a mortgage is affordable in the client’s current circumstances: mortgage payments must be stress tested over at least five years to ensure their ongoing affordability in light of expected interest rate changes. Beyond ensuring that the mortgage is affordable, there are further considerations. Choosing the wrong lender or the wrong interest scheme could lead to the borrower paying more than is necessary for the loan. Choosing the wrong investment product as a vehicle for repaying an interest‑only mortgage can lead, at worst, to the mortgage not being repaid in full at the end of the term. At best, it might mean that the client misses out on possible surplus funds. The exact nature of what constitutes good advice in a particular case will depend on a variety of factors, including the term for which a loan is required and the tax situation of the borrower. Failing to protect the outstanding capital or the repayments against sickness, death or redundancy can leave a client’s family destitute or lead to them having to leave their home. Many clients are unaware of the magnitude of the risk or of the ease with which it can normally be mitigated. A low level of interest rates coupled with strong house price inflation has led to a large increase in individual and family indebtedness in the UK, with many people increasing the proportion of their net income that they spend on mortgage and other loan repayments. Any increase in interest rates or reduction in income can leave people unable to service the high levels of debt that they have taken on. A number of products and services are available to assist people who can no longer afford their loan repayments. A consolidation loan usually takes the form of a remortgage for an increased amount, the new loan incorporating the existing mortgage plus the individual’s unsecured loans, such as personal loans and credit card balances. The advantage of this is that the overall monthly repayments are reduced, because the unsecured loans are now subject to a lower rate of interest and a longer repayment term. There is, however, a serious downside to the arrangement, which is that the formerly unsecured loans are now secured against the property, adding to the borrower’s problems if the borrower defaults on the repayments of the consolidated loan. In addition, this approach may cost more in the long term due to interest being paid over a longer period than originally planned. An arrangement fee may also be payable. Various options are available for clients who are unable to maintain payments in respect of their liabilities, including debt relief orders (DROs), individual voluntary arrangements (IVAs) or, in extreme circumstances, bankruptcy. Advice on dealing with debt is available from a number of agencies, and clients should be advised to consult a specialist in this area, such as Citizens Advice or StepChange Debt Charity. Further information on the legal aspects of IVAs and bankruptcy is outlined in Topic 16. Citizens Advice The stated aim of Citizens Advice is “to provide the advice people need for the problems they face, and improve policies and practices that affect people’s lives”. Citizens Advice gives advice on a wide range of different matters, the most relevant to financial services being state benefits, debt and money, and consumer law. Advice is provided online, over the phone and through an extensive branch network. More information is available online at: www. citizensadvice.org.uk/.

Answer 477

Broadly speaking, there are two reasons why people invest: to provide income (either now or in the future); or to provide a capital sum. Saving and investment needs change over the course of a lifetime, as explained in Topic 14. The financial services industry provides a very extensive range of savings and investment products to meet the needs of a wide spectrum of customers, and these products can be categorised in a number of different ways. Some of the categories are outlined here.

Answer 478

Most people build up their savings by small regular amounts from their disposable income. They may use regular savings schemes such as deposit accounts, ISAs or unit trusts, pay regular premiums to endowment policies, or make contributions to pension plans. The need to invest a lump sum may arise from the receipt of a legacy or other windfall, or it may result from the desire to move money from one form of investment to another.

Answer 479

The level of risk ranges from products where there is virtually no risk to the capital, such as bank deposit accounts, to those where the customer accepts the risk of loss of some or all of the capital in the hope of achieving higher returns. Most stock‑market‑related investments fall into the latter category to some degree. The relationship between risk and reward is very important. As a general rule, products that carry a greater risk also have a greater potential for higher returns.

Answer 480

Many deposit accounts offer instant access or require only short notice of withdrawal. At the other end of the scale, some investments are not directly accessible until a fixed maturity date: most gilt‑edged securities fall into this category, although they can be sold prior to their redemption date (but without any guarantee of the price that may be obtained). Shares and some gilt‑edged stocks (and other investments) are irredeemable, ie they have no maturity or redemption date. Where an investment is irredeemable, an investor who requires access to their money must sell the securities to an investor who wishes to buy.

Answer 481

The main UK taxes affecting investors are income tax and capital gains tax. With many investments, tax is payable by investors both on the income received and on any capital gain made on eventual sale. Shares and unit trusts fall into this category. Some investments, eg gilt‑edged securities, are taxed on income but are exempt from capital gains tax. It is important to consider the tax regime of the product in conjunction with the tax position of the investor: for instance, an investor who does not pay income tax will not benefit from the tax advantages of taking out an ISA, but a taxpayer wil

Answer 482

One of the factors that is least understood by clients is the impact of inflation on investment returns. As long as there is inflation, the purchasing power of a given amount of money will fall. For example, the purchasing power of £1,000 after 10 years of 3 per cent inflation will have fallen to under £750. Before an investment can grow in real terms it must first increase in line with inflation: the aim of any investment should be to provide a real return. Over the long term, equity‑linked and property‑based investments have proved most likely to offer growth rates over and above the rate of inflation. It is important that advisers educate customers about the impact of low and high levels of inflation on potential returns from investments. The significant measure for an investment is the real rate of return, which reflects the extent to which the purchasing power of invested funds is maintained. The real rate of return can be approximated by subtracting the rate of inflation from the interest/growth rate obtained on the investment: an investment paying 4 per cent interest at a time when inflation is 3 per cent is providing a real rate of return of only about 1 per cent. If the rate of interest is less than the rate of inflation, the real rate of return will be negative and the purchasing power of the invested funds will fall in real terms. Low inflation and low interest rates tend to go together, and one effect of this is that people tend to suffer from the so‑called money illusion, ie they tend to think of interest rates in terms of the headline rate only and fail to adjust their thinking to allow for inflation. Both savers and borrowers can be affected. Savers Savers often feel that the low interest rates paid on savings are a poor return for their money. They may, therefore, react to lower inflation by putting their money into riskier assets in order to seek higher returns. But if people on average incomes lose money as a result of riskier investments, it may have a very detrimental impact on their financial security – retirement planning, for example. If large numbers of people find themselves in this position, it may have adverse effects on the wider economy and society. Borrowers When interest rates are low, borrowers (particularly those repaying mortgage loans) may feel that they are gaining from the lower monthly repayments that have resulted from interest rate falls. This may persuade them to take out a larger mortgage since they feel they can more easily afford the monthly repayments. This is a misconception as, although less cash flows out in interest payments at the start of the mortgage term, a higher proportion of cash flow will be necessary to repay the capital. Again, problems may be stored up for the future as people take on debt they cannot afford, especially if interest rates then rise. In the meantime, an increased demand for houses can push up house prices and threaten price stability.

Answer 483

If £1,000 is invested in a savings account and the interest rate is 5 per cent, the interest will be £50. The account will have £1,050 in it at the end of 12 months. If, before the money was invested, £1,000 would buy a three‑piece suite, but after one year, the same three‑piece suite costs £1,100, then the money hasn’t increased in real terms. It has increased in ‘actual’ terms by £50 to £1,050 but it is actually worth less in ‘real’ terms because the effects of inflation have eroded its purchasing power.

Answer 484

Nominal interest/growth rate minus inflation rate.

Answer 485

Changes in the demographic structure of the population make it increasingly difficult for the state to provide pensions at the level needed to maintain people’s lifestyles but at a realistic and acceptable cost to the taxpayer. Encouraging people to save more for their retirement is one of the great challenges facing the UK government in the early twenty‑first century. State pension – set at about one quarter of the level of national average earnings – is clearly inadequate for anything more than subsistence living, yet many people are continuing to reach retirement age with little or no pension provision apart from a state pension. This is particularly – although by no means exclusively – true of people at the lower end of the earnings scale. There is an added risk that they are financially unsophisticated and unaware of products such as stakeholder pensions that could be used to boost their pension. Even when they are aware of retirement solutions, people in the lower earnings brackets generally have more immediate demands on their income and, moreover, may have been put off by talk of high charges or product mis‑selling. The inability of many people in the UK to make adequate provision for their retirement has been referred to as a ‘pensions crisis’. The problem has been increased by the accelerating trend for employers to move away from final salary schemes (also known as defined‑benefit schemes) and towards money‑purchase (or defined‑contribution) schemes, where the size of the individual’s pension pot is based on the performance of the assets in which the pension funds are invested. Successive governments have introduced measures to attempt to address the savings gap, for example, with the introduction of stakeholder pensions and the rules requiring that certain employees are automatically enrolled in a workplace pension.

Answer 486

There are two main questions to consider in advising on estate planning: Has the client made a (valid) will? Has the client taken steps to mitigate inheritance tax liabilities? Financial advisers should not generally become involved in writing a will, but should strongly advise that the client consult a legal adviser to ensure that a will is in place. If necessary, the financial adviser can provide a document explaining any financial objectives that the will should help to achieve. In relation to inheritance tax, there are basically two approaches that people can take: try to avoid having to pay it; or make provision for paying it when it is due. To avoid paying IHT, it is necessary to reduce the value of the estate to below the nil‑rate thresholds. This can be done by making use of the various exemptions described in Topic 4 to make tax‑free, or potentially exempt, gifts during one’s lifetime. Another method is to place assets in trust, since trust property no longer forms part of the settlor’s estate. The largest component of most people’s wealth is the property in which they live. It is usually not possible to avoid IHT by giving the property away while continuing to live in it, as this is highly likely to be caught by HMRC’s gift with reservation (GWR) rules. In simple terms, the GWR rules prevent assets (eg a property) that are gifted to non-exempt beneficiaries from being treated as potentially exempt transfers (PETs) if the transferor continues to receive a benefit from the asset (eg by continuing to live in the property). In the past, many people avoided this restriction by the device of placing their property (known technically as a pre‑owned asset) in a trust. The tax authorities closed this loophole by means of Schedule 15 of the Finance Act 2004, which introduced rules for the taxation of pre‑owned assets that came into force from 6 April 2005. Under these rules, people are liable to an income tax charge each year on the benefit of occupying or using any asset previously owned but disposed of after 17 March 1986. The tax charge is based on a realistic annual rental for the property they occupy, although if the deemed rental amount is less than a de minimis amount then no tax charge may be levied. Some people may decide that cancelling their schemes (with the loss of the benefits and some, or all, of the set‑up costs) is better than paying the future tax bills. Married couples and civil partners are now able to use the whole of both their nil‑rate bands to pass property tax‑free to their relatives or others. The percentage of nil‑rate band unused on the first death can be carried forward and used to increase the nil‑rate band on second death. The residence nil‑rate band, introduced on 6 April 2017, also helps to further mitigate the impact of IHT if the property is passed down to lineal descendants. If avoiding the tax is not a realistic option, a life assurance policy for the anticipated amount of the IHT should be taken out. To avoid the policy proceeds becoming part of the deceased’s estate – and therefore themselves subject to IHT – the policy should be written in trust for the benefit of the beneficiaries of the will.

Answer 487

The recommendation of a financial product should always take account of the product’s impact on the client’s tax situation, but not in isolation: it should be considered in context, in conjunction with other features of the product. For instance, contributions to a pension arrangement are often the most tax‑efficient way for an individual to invest, but this should never be the main reason for recommending a pension product. Just as it is wise to leave the writing of wills to solicitors, complex tax‑planning schemes should be left to taxation experts. However, it is important to be able to choose appropriate products that can complement and improve a client’s current tax situation: Clients should normally consider the use of ISAs, pensions and friendly society policies to maximise the advantage of tax‑free income or growth. Clients who are non‑taxpayers may consider investing in funds such as offshore bonds, which are free from UK tax. Clients who expect to exceed their CGT annual exempt amount might consider investments that are CGT‑free, such as gilts. Advisers should be aware of circumstances where tax that has been paid (in effect on behalf of the investor) cannot be reclaimed even if the investor is not a taxpayer. An example of this would be an endowment policy or a UK investment bond, where gains made within the life company’s funds are taxed at 20 per cent: a policyholder who is not a taxpayer cannot reclaim this deduction. An offshore bond (which is free from UK tax on its fund) may be more attractive to a non‑taxpayer.Unit trust managers are not taxed on gains within their funds; holders of units are liable for CGT if they sell their units at a profit but they may be able to avoid this by use of their CGT annual exempt amount.

Answer 488

Where an individual is either leaving the UK (emigrating) or coming to live in the UK (immigrating), consideration should be given as to whether existing investments should be encashed before the move or retained. The decision could be driven in part by which option results in the more favourable tax treatment.

Answer 489

At any given time, one or more of the advice areas described above might be the most significant for a particular client. However, circumstances can change very quickly and the financial needs of a client and their family may change dramatically. Births, marriages, divorces, deaths, moving home, changing jobs, losing a job and many other events can change people’s attitudes and objectives, as well as their assets and liabilities. Advisers should take account of this by allowing (as far as possible) flexibility in the products recommended and also by making plans to review the client’s situation at regular intervals.

Answer 490

1) The extent of any sickness benefit from an employer; the nature and amount of available state benefits; the number and ages of the children; and the availability of any help from family and friends with childcare and housekeeping.

Answer 491

2) To mitigate the adverse impact on a business’s profits caused by the death or long‑term illness of an important member of staff.

Answer 492

3) (£47,000 ÷ £400,000) × £1,500,000 × 5 = £881,250

Answer 493

4) It comprises an option to purchase the deceased partner’s share rather than a binding contract; as a consequence, the deceased’s family or heirs are deemed to receive business assets rather than cash, so business relief from inheritance tax can be claimed.

Answer 494

5) d) Nigel – a fixed‑rate mortgage is most suitable for ensuring that, over a specific period, repayments do not increase as a result of interest‑rate rises.

Answer 495

6) a) The sum assured on a full with‑profits endowment is set at a level equal to the mortgage debt so, as long as payments are maintained, it will guarantee to repay the mortgage at the end of the term.

Answer 496

7) b) To protect money against the effects of inflation.

Answer 497

8) c) 5.5% Real rate of return = nominal interest/growth rate – inflation 3% (real rate of return) = x% (nominal interest/growth rate) – 2.5% (rate of inflation) Therefore: 3% + 2.5% = 5.5%

Answer 498

9) b) £202.50. The £162 is the ‘net’ contribution. To work out the ‘gross’ contribution, divide the net contribution by 80 and multiply by 100 (do not add 20 per cent to the net contribution). £162 ÷ 80 × 100 = £202.50

Answer 499

10) If a donor receives any benefit from a gifted asset, the asset is treated for IHT purposes as remaining in the donor’s estate.

Answer 500

A ‘legal person’ is a body that has a legal existence and can, therefore, enter into contracts, sue or be sued in a court of law. It is important to remember that this includes not just an individual acting in a personal/private capacity but also an individual acting in a formal capacity such as that of executor, as well as groups of individuals such as trustees. It also includes bodies such as limited companies.

Answer 501

As a sole trader, the owner is not considered a separate legal person from the business, meaning that they are personally liable for their business’s debts. This also means that they are entitled to keep all of the profits generated by the business, after income tax and National Insurance contributions have been paid.

Answer 502

As noted in section 16.1, a company is a legal person (although, often, the term ‘legal entity’ is used instead). In other words, the company is legally separate from its shareholders and its individual employees. The certificate of incorporation provides evidence of the company’s formation, and details about the company are held on the central registry at Companies House. The information held includes the shareholding and shareholders, as well as listing the names and addresses of the directors and company secretary. The nature of the company, and the rules about what it can and cannot do, are set out in its memorandum and articles of association. For example, the memorandum normally includes the power to borrow, but may place limits or restrictions on that power in terms of amounts or purpose. Such limits will be significant if the company is considering taking out a mortgage or other form of loan. When entering into a contract with a company, it is prudent to check that the persons entering into the contract are authorised and empowered to do so. For example, when a company director is seeking to raise funds for the company, it would be advisable to check that the company is able to borrow and also that the director in question is able to arrange a loan on the company’s behalf. Shareholders of a limited liability company cannot be held personally responsible for the debts of the company, the limit of their liability being the amount that they have invested in company shares. This is the most they could lose if the company were to become insolvent.

Answer 503

A partnership is an arrangement between people who are carrying on a business together for profit. Unlike a company, a partnership is not a separate legal entity and the partners jointly own the assets. They are jointly and severally responsible for the liabilities of the partnership. This means that each partner is liable by themselves to pay back the entire amount owed to any creditor. Partnerships should have a written agreement that sets out in detail the relationship between the partners, including proportions in which they share the partnership’s profits and what will happen when a partner leaves, retires or dies.

Answer 504

A limited liability partnership (LLP) is one where partners have a limited personal liability if the business should collapse: their liability is limited to the amount that they have invested in the partnership, together with any personal guarantees they have given – for example, to a bank that has made a loan to the business. As with companies, LLPs have to be registered with Companies House; they are clearly more like companies than they are standard partnerships, but the taxation of LLPs is not the corporation tax regime that applies to companies. LLPs are taxed in the same way as other partnerships: each partner is taxed on a self‑employed basis, with their individual share of the profits being treated as their own personal income and subject to income tax.

Answer 505

Most business agreements, particularly in the world of financial services, are established as legally binding contracts. Some are made orally, some in writing and some by deed. Not all contracts can be made orally but all contracts generally are subject to certain basic requirements for them to be binding. Figure 16.1 summarises these, and an explanation of the terms is provided. Offer and acceptance – there must be an offer made by one party (the offeror) and there must be an unqualified acceptance by the other. This acceptance must be communicated to the other party. In practice there may be a number of counter‑offers before agreement is reached. Consideration – the subject of the contract (often a promise to do something or supply something) must be matched by a consideration (which is frequently, but not necessarily, the payment of money). A promise to pay is valid consideration. Capacity to contract – each of the parties to the contract must have the legal capacity, or power, to enter into the contract. Certain parties have only limited powers to enter into a contract, for example, minors (under 18s) and those who are deemed to lack the mental capacity to safely make their own decisions. For financial institutions such as insurance companies, capacity to contract depends on being authorised by the FCA/PRA. Contract terms – these must be certain, complete and free from doubt. For example, when a customer engages an independent financial adviser (IFA), the IFA’s commitments are detailed in a terms of service agreement. Intention to create a legal relationship – as distinct from a merely informal arrangement. Legality of object – contracts cannot be made for illegal or immoral purposes. Misrepresentation, duress or undue influence – if any of these factors are involved in leading someone to enter into a contract, the contract is not binding.

Answer 506

Note that all agreements for the sale of land must be made in writing and conveyances of land (the actual transfer of ownership) must be performed by deed.

Answer 507

Generally, there is no duty of disclosure between parties to a contract; most contracts are based on the principle of caveat emptor (‘let the buyer beware’). In other words, it is the responsibility of each prospective party to the contract to satisfy themselves that they have all the information they need on which to base their decision to enter into that contract. However, there are exceptions. For example, insurance contracts were, for many years, based on the principle of ‘utmost good faith’ (uberrima fides), whereby all material facts had to be disclosed by both parties. For an insurance policy, this meant that the person applying for the policy was required to supply all the facts that a prudent underwriter would need to decide the terms on which the policy could be issued. Non‑disclosure by the customer rendered the contract voidable at the option of the insurance company. From 2000 onwards there was growing concern from regulators and consumer groups that some insurers were rejecting claims on the basis that the policyholder failed to disclose information that they should have realised was relevant and important, even though no direct question asked for the information. The problem was exacerbated by a growing tendency for insurers to reduce the level of pre‑application underwriting and effectively ask medical underwriting questions when a claim was made, at which point problems might arise. The situation regarding rejection of claims eventually led to the Consumer Insurance (Disclosure and Representations) Act 2012, which came into force on 6 April 2013. In simple terms the Act more clearly defines the responsibilities of insurance customers. It abolishes the duty of consumers to volunteer material facts when applying for insurance and instead requires them to take reasonable care to answer the insurer’s questions fully and accurately. If they do volunteer information, they must take reasonable care to ensure that the information is not misleading or misrepresented. For example, section 2(2) of the Act states that “it is the duty of the consumer to take reasonable care not to make a misrepresentation to the insurer”. The representations will be based on responses to specific insurer questions, because there is no duty on the consumer to volunteer information that is not asked for. The Act defines, as far as possible, the meaning of “reasonable” in this context, which depends on a number of factors including, “how clear, and how specific, the insurer’s questions were”. Section 2.3 states that “a failure by the consumer to comply with the insurer’s request to confirm or amend particulars previously given is capable of being a misrepresentation”. In the case of misrepresentation, the Act also indicates what actions the insurer may take: If the consumer has taken reasonable care, and the misrepresentation was honest and reasonable, the insurer has no right to refuse a later claim. In the case of misrepresentation due to carelessness, detailed rules allow the insurer to apply a ‘compensatory remedy’ to the claim, based on what the insurer would have done had the applicant answered all questions completely and accurately. So, for example, if the insurer would have refused cover completely if it had been in full possession of all the facts, the claim could be rejected; if it would have excluded certain illnesses, then claims relating to those illnesses would not be met. If the claim is rejected, then the insurer must refund the premiums paid. If careless misrepresentation is identified in situations other than a claim, the insurer and the policyholder have the right to terminate the contract with reasonable notice. The exception to this is a policy that wholly or mainly relates to life insurance where the insurer may advise the consumer of their rights to terminate the contract by giving reasonable notice and stating that they may receive a refund of premiums paid for the terminated cover in respect of the balance of the contract term (if any). In the case of deliberate or reckless misrepresentation, the insurer may reject the claim completely as if the contract never existed and is not required to refund premiums paid, unless there is a good reason to do so.

Answer 508

Many of the cases in which insurance companies rejected claims on grounds of non‑disclosure involved critical illness policies where applicants failed to disclose a condition for which they had previously visited a doctor. In many cases the doctor had confirmed that there was not a problem, or had diagnosed a minor problem that was successfully treated. On later suffering from a specified critical illness, the policyholder’s claim was declined due to the non‑disclosure at the application stage, even when the condition not disclosed was unconnected to the illness that prompted the claim. In many cases, the Financial Ombudsman determined that the insurance company’s rejection was unreasonable and found in favour of the policyholder. One major issue was the reliance on the applicant to decide what was relevant to disclose. Typical questions on the application form would be along the lines of: “Have you ever visited a doctor or suffered from a medical condition requiring treatment?” This required the applicant to remember all such occasions and decide which, if any, to include

Answer 509

Breach of contract occurs when a party fails to perform its side of the contract and does not have a legal justification for doing so. Several court remedies are available in these circumstances; the most common ones are as follows: Damages – the injured party seeks to obtain financial compensation for their loss. The intention is to put them in the position they would have been in had the contract not been breached by the other party, insofar as it is possible to do so with money. Order for specific performance – such an order compels the other party to complete the contract. Injunction – this is a court order preventing someone from doing something. Of these, by far the most frequently sought is damages.

Answer 510

An agent is a person who acts on behalf of another, who is called the principal. The agent can conclude contracts on behalf of the principal. In law, the acts of the agent are treated as being those of the principal. In the context of financial services, an IFA is an agent of their client and given specific powers under the terms of engagement. Another example is an estate agent, who is the agent of a person looking to sell their property. In any kind of agent–principal relationship, it is important to ascertain how much power and authority has been granted to the agent, just as it is important that the agent is fully aware of what they can and cannot do. Some agents are given very wide authority while some are severely restricted. For example, an IFA may only be required to give advice, on which their client can choose whether or not to act; alternatively, they may be given discretionary investment powers to buy and sell investments on the client’s behalf. An agent should only act within the authority given to them by their principal. This should be strictly observed, because, if an agent exceeds their power, it could result in their principal being liable on the contract. This happens when, although the agent acts outside of their actual authority, they act within what is known as their apparent authority. Another result is that the agent may be made liable. This protects the third party to the agreement, who – if they are unable to rely on the agent’s claim to have authority – must be able to hold the agent personally responsible. It would otherwise be unfair to the third party, who would have entered in good faith into the contract only to find themselves without recourse either to the principal (if there is no apparent authority) or the agent. If the agent does exceed their authority, the principal can, if they choose, agree after the event to what the agent has done. This is called ratification. This very brief introduction cannot cover all the detail of agency law but serves to illustrate how important it is for advisers to know, understand and act within the extent of their authority. Key terms AGENT Acts on behalf of the principal, within specific boundaries, to conclude contracts. APPARENT AUTHORITY Something either done or said by the principal that leads to the impression that they have authorised the agent’s actions. PRINCIPAL The party granting permission to the agent to act on their behalf. RATIFICATION A retrospective agreement by the principal to actions taken by the agent that exceed the latter’s authority.

Answer 511

1) There is no cut‑and‑dried answer to this question. Martin certainly didn’t have ‘actual authority’ to make that decision, but he might have had ‘apparent authority’. Would it be reasonable to assume that in saying “do whatever is necessary” Joanne accepted that this might include creating a tenancy and accepting an offer that is £15,000 less than the asking price? If the property had been on the market for a long time, Joanne might decide to ratify Martin’s decision. If, on the other hand, this was the first offer, or she had already rejected an offer around £285,000, she might feel differently about the way Martin acted.

Answer 512

The law of England and Wales defines two distinct types of property; in this context, the word ‘property’ is used to refer to all types of asset, rather than its narrower sense of ‘land and buildings’. The two types are as follows: Realty – property is deemed to be real if a court will restore it to a dispossessed owner and not merely provide compensation for loss. Real property tends to be distinguished by being immovable, eg land and what is attached to it, also known as real estate. Personalty – all other property is called personalty. In relation to joint ownership of property, there are two types: Joint tenants – each joint owner owns 100 per cent of the property – there is no division of the property. On the death of any joint owner, the surviving joint owner(s) will take over legal ownership of the property. The transfer is automatic and cannot be overridden by any provisions made by a joint tenant in a will or through the laws of intestacy. Tenants in common – the joint legal owners are regarded as one single owner but are trustees of the land. However, each legal owner is also the beneficial (or equitable) owner of a defined interest (share) of the equity in the property, as agreed between them. If one owner dies, their share of the property passes to whoever is entitled to inherit it under the terms of their will or the law of intestacy.

Answer 513

Banks, building societies and other commercial lenders usually insist that joint mortgages are written on a joint and several liability basis, which means that all parties are equally responsible for carrying out the full terms of the agreement. Therefore, whether a jointly owned property is held as joint tenants or tenants in common, each owner is responsible for the mortgage, so if one person cannot make their payment, it is the responsibility of the other(s) to make up the shortfall.

Answer 514

An attorney is a person who is given the legal responsibility to act on behalf of another person. Examples of situations in which the need for an attorney might arise include: a person who, while currently in good health, is concerned about how their affairs will be run should they become unable to manage their own finances (for instance if they develop an illness such as dementia); or someone with affairs in the UK who is moving abroad. A person who does not have the legal capacity to enter into a contract (eg a minor or a mentally incapacitated person) cannot appoint someone else as their attorney.

Answer 515

An ordinary power of attorney automatically ceases if a person becomes mentally incapacitated. This can create problems for those responsible for managing the individual’s affairs. An enduring power of attorney (EPA) can continue if the donor becomes mentally incapacitated, although it has to be registered with the Office of the Public Guardian (OPG) if the attorney believes that the donor is losing mental capacity. An EPA can be revoked only with the consent of the Court of Protection. Key terms DONOR Person who makes a power of attorney. DONEE Person who is given power of attorney. Often, they are simply referred to as the attorney.

Answer 516

From 1 October 2007, under the provisions of the Mental Capacity Act 2005, enduring powers of attorney were replaced by lasting powers of attorney (LPAs). EPAs made before that date can remain in force, but all new arrangements must be lasting powers of attorney. There are two types of LPA: Health and welfare – this gives the attorney power to make decisions over issues such as medical care or moving into residential care. It can only be used once the donor can no longer make decisions for themselves. Property and financial affairs – this gives the attorney power to manage the donor’s bank accounts, collect benefits and sell property. It can be used even if the donor has mental capacity, as long as the donor gives permission. In both cases, the LPA must be registered with the OPG before it can come into effect.

Answer 517

The Mental Capacity Act 2005 supports and protects individuals who lack the capacity to make their own decisions. It promotes supported decision‑making, which is the process of providing support to those who need help making their own decisions. It also makes provision for substituted decision‑making, where decisions are made on behalf of the individual in their best interests (for instance, by a court-appointed deputy). If a person loses mental capacity and does not have a valid LPA or EPA in place, the Court of Protection can appoint a deputy. This process can take some time and a deputy’s powers are much more restricted when compared to those of an attorney. It is for these two reasons that all clients should be encouraged to draw up an LPA if they have not done so already.

Answer 518

A will is a written declaration of an individual’s wishes regarding what they want to happen after they have died. Although primarily concerned with how the person wishes to dispose of their assets, a will can also deal with other matters, such as giving instructions about burial. In the UK, approximately seven out of ten people die intestate, meaning that they die without leaving a valid will. Writing a will is the first step in gaining control over an estate and is, therefore, a vital part of financial planning. it is important that clients understand the benefits of a valid will and the risks of not having one. If the client has no will, the financial adviser should recommend that they seek professional advice from a solicitor; the adviser should not become involved in writing the will themselves. To make a valid will, two formalities must be followed: the will must be in writing; the will must be properly executed. The minimum age for making a valid will under English law is 18. The will should be a clear and unambiguous statement of the deceased’s wishes in respect of their estate, and must be signed by the testator in the presence of two witnesses. It is important that the witnesses chosen must not be beneficiaries under the will (or the spouses of beneficiaries). If a beneficiary were to be a witness, they would not be able to inherit under the terms of the will. The terms of a will only take effect on the death of the testator, the person who made the will. Before then, the testator can revoke (cancel) or modify the will at any time. Modifications are recorded in a document known as a codicil. In the event of marriage, remarriage or entering into a civil partnership, a will is automatically revoked, unless specifically written in contemplation of the change of status. Key terms TESTATOR Person who makes the will. BENEFICIARY A person or organisation that receives benefits under the terms of a will. CODICIL Document that formally amends a will.

Answer 519

The people who carry out the procedures necessary to distribute the estate of someone who has died are known as the deceased person’s legal personal representatives. The exact procedure depends on whether or not there is a valid will. The following comments apply to the law of England and Wales (Scottish law differs both in the procedures involved and in the terminology used). If there is a valid will, it will name the person or people the testator has chosen to be executors. The role of the executors is to ensure that the actions specified in the will are carried out. The duties of an executor can be time‑consuming and onerous and it is not uncommon for executors to appoint a solicitor to carry out all or part of their duties. Note that an executor can also be a beneficiary of the will. Before they are able to distribute the estate, the executor(s) must apply for a grant of probate. This gives them legal authority to carry out the testator’s instructions, as set out in the will. If there is no will (or the will is invalid), an appropriate person (such as a spouse or other close relative) acts as an administrator and applies for the grant of letters of administration, rather than probate. The administrator’s responsibility is to deal with the estate as prescribed by the rules of intestacy (see section 16.8.2). In certain circumstances it may be advantageous, following the death of the testator, for the beneficiaries under a will to vary the way the estate has been allocated. This can be achieved by executing a deed of variation. All those who would be affected by the deed must be over 18 years of age and must be in agreement on the terms of such a variation. A deed of variation is often executed for tax purposes: a change in beneficiaries or in the relative shares received that could reduce the inheritance tax liability, for example. To be effective for tax purposes, the deed of variation must be executed within two years of the death, and HMRC must be informed within six months of its execution. The variation must not be entered into for any consideration of money or money’s worth. Key terms EXECUTOR Person named by the testator as being responsible for carrying out the wishes expressed in a valid will. GRANT OF PROBATE Legal authority for executors to distribute an estate according to the terms of a valid will. DEED OF VARIATION Legal agreement by the beneficiaries to alter the terms of a will, after the death of the testator. MONEY’S WORTH Provision of goods/services in lieu of a cash payment.

Answer 520

A person who has died without having made a valid will is said to have died intestate. This includes the situation where the deceased has left a will that turns out to be invalid. If a will makes valid provision for the distribution of some of the assets of the estate, but not of others, this is referred to as partial intestacy. The distribution of the estate of a person who has died intestate is determined by a complex set of rules known as the rules of intestacy. They are very specific and there is no flexibility or discretion for their variation by the person dealing with the estate. In many cases – especially if the estate is a large one – the distribution of the assets may not be as the deceased would have wished. In particular, it is not necessarily true – as many people believe – that a surviving spouse or civil partner will receive the whole estate. The main rules are as follows. Please note that for the purpose of these rules, the word ‘spouse’ includes civil partner and ‘children’ includes more distant descendants, eg grandchildren or great‑grandchildren, and so on. If the deceased leaves a spouse but no children – the spouse inherits the deceased’s entire estate. If there is both a spouse and children – the spouse inherits the deceased’s personal chattels, plus the first £270,000, plus half of the residue above £270,000 absolutely; the other half of the residue in excess of £270,000 is divided equally between the children. If there are children but no spouse – the estate is shared equally among the children. If there is neither spouse nor children – the estate goes to the parents of the deceased, or (if they are dead) to the deceased’s brothers and sisters. This is just a summary of the main rules (Figure 16.2 provides further details) and, ultimately, if no blood relative can be found, the estate will pass to the Crown. Key terms INTESTATE Having died without leaving a valid will. ADMINISTRATOR Person given the role of distributing the estate according to the rules of intestacy. LETTERS OF ADMINISTRATION Legal authority to distribute the estate of a person who has died without leaving a valid will.

Answer 521

2) a) Marian’s husband inherited her entire estate. Parents only inherit if there is no spouse or children. b) Ian’s wife inherited £310,000 (ie the first £270,000 plus half the excess above that figure); Ian’s children inherited £20,000 each (ie the remaining £40,000 of the estate shared between them).

Answer 522

16.10 Trusts and trustees A trust (also known as a settlement) is a method by which the owner of an asset (the settlor) can distribute or use that asset for the benefit of another person or persons (the beneficiaries) without allowing them to exert control over the asset while it remains in trust. Depending on the nature of the trust, the beneficiaries may eventually become the absolute owners of the asset. The settlor is the person who creates the trust and who originally owned the assets placed in the trust (the trust property). Once it is placed in trust, the asset is no longer owned by the settlor (unless the settlor is also a trustee – see below). The beneficiaries are the people or organisations that will benefit from the trust property. They may be named individually or referred to as a group, eg “all my children”. The trustees are the people, appointed by the settlor, who take legal ownership of the trust property and administer the property under the terms of the trust deed. The trustees, who can include the settlor, are named in the trust deed. Trustees must be aged 18 or over and have mental capacity. If a trustee dies, the remaining trustees, or their legal personal representatives, can appoint a new trustee. Trustees have a number of duties: They must act in accordance with the terms of the trust deed. If the trust deed gives them discretion to exercise their powers (eg discretion over which beneficiaries shall receive the trust benefits), the agreement of all the trustees is required before a course of action can be taken. They must act in the best interests of the beneficiaries, balancing fairly the rights of different beneficiaries if these should conflict. For example, some trusts provide income to certain beneficiaries and, later, distribution of capital to other beneficiaries; in such a situation the chosen investment must preserve a fair balance between income levels and capital guarantee/capital growth. Under the Trustee Act 2000, trustees who exercise investment powers are required to: be aware of the need for suitability and diversification of assets; obtain and consider proper advice when making or reviewing investments; keep investments under review. Key terms SETTLOR The person who creates the trust and originally owned the assets held within it. TRUST DEED Document that sets out how the trust is to be managed, by whom and for whose benefit. TRUSTEE Person named in the trust deed as legal owner of the trust property, with responsibility to look after and distribute the trust property in line with provisions in the trust deed.

Answer 523

George is 65 years old. He has two grandchildren, Chloe aged seven and Mark aged five. He puts £500,000 in trust for his grandchildren’s education. Once the money has been put into the trust, it no longer belongs to him – he has made a gift. He names his daughter Sue and his friend Bob as trustees. The money has got to last a long time (16 years until Mark finishes university) so it must be invested and used wisely. Sue and Bob will decide how to invest the money (shares, property, gilts, accounts, etc) and what it is spent on (school fees, uniform, books, school trips, etc). They must agree all their decisions together.

Answer 524

Insolvency arises when: a person’s liabilities exceed their assets; or a person cannot meet their financial obligations within a reasonable time of them falling due. Bankruptcy takes the position a stage further and arises when a person’s state of being insolvent is formalised under the terms of a bankruptcy order. The primary UK legislation on insolvency is the Insolvency Act 1986, but this has been subject to amendments over the years.

Answer 525

A person can apply to have themselves declared bankrupt, or a creditor may petition to have someone else declared bankrupt if they owe (or are owed jointly with other creditors) £5,000 or more. Most bankruptcy orders remain in force for 12 months, during which time the person is said to be an undischarged bankrupt. If individuals do not comply with the terms of the bankruptcy order it may remain in place until the official receiver or insolvency practitioner is satisfied that their requirements have been met. During the period of bankruptcy, the individual’s possessions are, in effect, surrendered to an official receiver, who can dispose of them and use the money raised to pay off the creditors. The only exceptions are clothing, household items and work‑related items. Although bankruptcy cancels most kinds of debt and allows people to make a fresh financial start, it comes at a price: it normally makes it more difficult to obtain credit in the future and it can affect employment prospects. Bankrupts are unable to borrow, other than nominal amounts, during the period that the order is in force. An undischarged bankrupt will be unable to open a current account, but may be able to open a basic bank account. Even after the end of the period, the person must, by law, disclose the existence of a previous bankruptcy when applying for a mortgage. This may mean that it will be more difficult for them to obtain a loan or that they may be charged a higher rate of interest to cover the greater perceived risk.

Answer 526

An individual voluntary arrangement (IVA) is an alternative to bankruptcy, under which the debtor arranges with the creditors to reschedule the repayment of the debts over a specified period. An IVA can be set up only if creditors who represent at least 75 per cent of the debt agree to the arrangement. The scheme must be supervised by an insolvency practitioner. In recent years, a large market has arisen for firms that assist individuals with significant personal debts to enter into IVAs. In most cases they are able to arrange for interest to be frozen, for a reduction in the amount of the debt, and for legal protection from creditors if the terms of the IVA are met. The firms are generally able to persuade lenders to write off part of the debt in exchange for a reasonable guarantee of receiving repayment of the remainder. In many cases this is better for the lender than simply writing off the debt or selling it to a debt recovery firm. An individual with an IVA will find it difficult to obtain credit while the IVA is in place, and creditworthiness is likely to be impaired even after the end of the arrangement.

Answer 527

The company equivalent of an IVA is the company voluntary arrangement (CVA). Under the terms of the Insolvency Act 1986, a company that is in temporary financial difficulties (but which its directors believe to have a viable long‑term future) can make a binding agreement with its creditors – including HM Revenue & Customs – about how its debt and liabilities will be dealt with. In this way, the directors retain control of the company and it can continue to trade. A CVA can be proposed by the directors of the company, or by a liquidator if one has been appointed, but not by the creditors. However, many creditors may feel that it will be to their advantage for the company not to go nto administration. As with IVAs, creditors representing 75 per cent of the company’s debt must agree to the CVA being set up.

Answer 528

As mentioned in Topic 10, an adviser’s role in relation to scams is to be aware of such schemes and to advise a customer to be mindful of the potential risk. The FCA operates ScamSmart, a website designed to help consumers protect themselves against pension and investment scams. In addition to providing information on how to spot a scam, the website informs consumers how to avoid them. If a consumer is unsure as to whether a pension or investment opportunity is a scam or not, they can complete a short questionnaire on the website. The questionnaire asks them about the type of opportunity they are considering, how they found out about it and whether the promoter mentions money from their pension pot. On submitting their answers, the FCA will then confirm whether or not the opportunity is regulated or not and whether or not they suspect it is a scam. The consumer can then check if the promoter is in the list of firms to avoid. Consumers can also report a scam or an unauthorised firm via the website.In the past, where a victim of a scam had been deemed to have been negligent by their bank or pension provider, perhaps because they had been tricked into providing their personal details by what appeared to be a genuine employee and then had their money taken from them, or because they transferred their pension into what they believed was an FCA‑regulated pension fund, it was very unlikely they would see their money again. However, the Financial Ombudsman has recently raised the bar on what it views as negligence to counteract increasingly sophisticated banking scams. This means it will be harder for banks and building societies to reject complaints and may mean refunds for many who have lost money in the past. Now, if a scam victim has been tricked into handing over details that enabled someone else to take money from their account, the financial institution needs to be able to demonstrate that the victim was ‘grossly negligent’ in doing so in order to refuse a refund. This is a much higher standard than simply being careless or negligent. If they cannot prove this, then the victim must be refunded with interest. For pension transfers, The Pensions Ombudsman is now likely to side with the victim if the firm that transferred the pension did not have sufficient warnings and checks in place to protect the member from such scams.

Answer 529

1) False. There is no information here to suggest that the partnership is a limited liability partnership (LLP) so Jagdeep has unlimited personal liability.

Answer 530

2) None. As a limited company, Allenton Engineering Ltd is a separate legal entity and shareholders would not be liable for its debts.

Answer 531

3) a) There must be payment or a promise to provide payment. In a contract, one party provides goods or services, the other makes payment or a promise to pay.

Answer 532

4) No. Contracts for sale of land must always be in writing and the transfer effected by deed.

Answer 533

5) c) They act as agents of their client.

Answer 534

6) Mortgage lenders usually insist that joint mortgages are written on a joint and several liability basis because this means that all parties are equally responsible for carrying out the full terms of the agreement. Therefore, whether a jointly owned property is held as joint tenants or tenants in common, each owner is responsible for the mortgage, so if one person cannot make their payment, it is the responsibility of the other(s) to make up the shortfall.

Answer 535

c) A witness cannot inherit.

Answer 536

8) a) An administrator. (An executor distributes the estate of a person who has made a valid will.)

Answer 537

9) d) Enduring powers of attorney can only be revoked with the consent of the Court of Protection. They must be registered with the Office of the Public Guardian.

Answer 538

10) a) They are only able to borrow nominal amounts of money.

Answer 539

Although governments try to foresee problems and to introduce legislation as a means of ‘prevention rather than cure’, most regulatory legislation in the past has been reactive rather than proactive, ie it has been passed in response to problems, rather than designed to foresee and prevent them. Legislation has often resulted from: Particular scandals or crises – for example, the events leading up to the credit crisis from 2007. This showed the need for more diligent financial regulation of banks and for tighter rules on lending activities. An increase in consumers’ financial awareness and a demand for a more customer‑focused business approach – demands for a ‘one‑stop shop’ approach to financial services sales were instrumental in the deregulation of banks and building societies. The need to respond to changes in lifestyle – more relaxed attitudes to marriage and divorce have led to a strengthening of the rights of divorcees to share in former spouses’ pension benefits; the introduction of marriage for same‑sex couples and civil partnerships has extended the scope of some tax benefits and other financial and state benefits. Developments in business methods – technological advance in particular has transformed business processes at every level of the sector; for instance, many customers of banks and building societies now carry out many of their transactions electronically and rarely visit a branch office. Innovation in product design – rapid expansion has been seen in the ranges of certain products, particularly in mortgage business and, more recently, in the pensions arena in response to freedoms introduced in 2015. This has made it more important than ever that a consumer should be provided with sufficient clear information about the features and benefits of the products they are buying. The increasing number and complexity of financial products has made it necessary to provide customers with more information and advice.

Answer 540

Many people believe that, as commercial organisations have grown through mergers and acquisitions, they have become more remote from their customers and more concerned with their own financial results than with customer satisfaction. This belief is reflected in the emergence of government‑sponsored organisations, such as the Competition and Markets Authority (CMA), consumer bodies such as Which?, and websites such as Money Saving Expert. One of the primary objectives pursued by most modern governments is 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. At the same time, the government recognises the right of companies to make a profit and does not want rules and regulations to become a burden that prevents this. Indeed, the government recognises that it is essential that companies be permitted to make a reasonable profit; it would otherwise be impossible to attract the investment that sustains the industries on which the UK 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 are promoted largely through European legislation – most of which impacts, either directly or indirectly, on the UK. Despite Brexit, the force of European law can be seen in most recent major developments in the regulation of UK financial institutions. Because the financial services industry deals with money – vital both to individuals and to the national economy – it has become one of the most regulated sectors of all. In the context of financial services, key aims of regulation include: ensuring that those businesses operating in the industry are authorised to do so and conduct their business in a manner that ensures the fair treatment of their customers; ensuring that businesses have the necessary financial arrangements in place to minimise the risk of loss to their customers; establishing and understanding accountability at a senior level within financial service organisations; ensuring that individuals carrying out defined regulated activities have the competence and capability to do so; the ongoing development of the skills and knowledge of individuals working in the industry; ongoing supervision to ensure that regulatory requirements are adhered to and to try to prevent problems; actions to be taken when problems arise.

Answer 541

The financial crisis of 2007‑09 was essentially caused by a failure of prudential regulation. A number of firms were found to have inadequate management systems and financial safeguards. Events leading up to and after the crisis led to concerns about the effectiveness of the industry’s regulator, the Financial Services Authority (FSA), and its ability to prevent and then deal with a similar situation in the future. In the years following the financial crisis there have been a number of issues related to the conduct of firms in the financial services sector, including the mis‑selling of payment protection, the Libor rate‑fixing scandal and the sale of interest rate hedging products to corporates. These concerns resulted in the Financial Services Act 2012, which modified the Financial Services and Markets Act 2000 to enable changes to the regulatory system to be made under existing legislation. The Act saw the creation of a number of new regulatory bodies and the abolition of the FSA, with many of its powers handed to the Bank of England. Most of these changes came into effect on 1 April 2013. In 2016, the Bank of England and Financial Services Act 2016 made further changes to the regulatory architecture by strengthening the governance and accountability of the Bank, ending the subsidiary status of the PRA and establishing a new Prudential Regulation Committee (PRC), which makes the PRA’s most important micro-prudential decisions. These changes also include allowing the National Audit Office to undertake value-for-money reviews of the Bank for the first time. The Bank of England is responsible for protecting and enhancing monetary and financial stability, aiming to maintain economic stability. The Bank has a central role in the regulation of financial services in the UK. It was also responsible for payment systems, settlement systems and clearing oversight, but from April 2015 these responsibilities passed to the Payment Systems Regulator. The Financial Policy Committee (FPC) is a committee of the Bank of England. The FPC looks at the economy in broad terms to identify and address risks that may threaten the stability of the whole (or large parts of the) economy. The FPC has no direct regulatory responsibility for particular sectors of the financial services industry, but has various powers to take action where it sees threats to economic stability. The Prudential Regulation Authority (PRA) has sole responsibility for the day‑to‑day prudential (financial) supervision of banks and other financial institutions. The PRA sits within the Bank of England, although it is operationally independent. The PRA authorises large, systemically important providers of financial services such as banks, insurance companies and building societies. The powers of the PRA are exercised by the Prudential Regulation Committee (PRC) which is also within the Bank of England. The PRA’s primary objective is to promote the safety and soundness of the firms it regulates. It has further objectives to secure an appropriate degree of protection for insurance policyholders and to facilitate effective competition. The Financial Conduct Authority (FCA) has responsibility for the conduct of all retail and wholesale financial firms. The FCA also undertakes prudential supervision of firms that are not regulated by the PRA. The FCA is a quasi‑government department with statutory powers given to it under The powers of the PRA are exercised by the Prudential Regulation Committee (PRC) which is also within the Bank of England. The PRA’s primary objective is to promote the safety and soundness of the firms it regulates. It has further objectives to secure an appropriate degree of protection for insurance policyholders and to facilitate effective competition. The Financial Conduct Authority (FCA) has responsibility for the conduct of all retail and wholesale financial firms. The FCA also undertakes prudential supervision of firms that are not regulated by the PRA. The FCA is a quasi‑government department with statutory powers given to it under The powers of the PRA are exercised by the Prudential Regulation Committee (PRC) which is also within the Bank of England. The PRA’s primary objective is to promote the safety and soundness of the firms it regulates. It has further objectives to secure an appropriate degree of protection for insurance policyholders and to facilitate effective competition. The Financial Conduct Authority (FCA) has responsibility for the conduct of all retail and wholesale financial firms. The FCA also undertakes prudential supervision of firms that are not regulated by the PRA. The FCA is a quasi‑government department with statutory powers given to it under The powers of the PRA are exercised by the Prudential Regulation Committee (PRC) which is also within the Bank of England. The PRA’s primary objective is to promote the safety and soundness of the firms it regulates. It has further objectives to secure an appropriate degree of protection for insurance policyholders and to facilitate effective competition. The Financial Conduct Authority (FCA) has responsibility for the conduct of all retail and wholesale financial firms. The FCA also undertakes prudential supervision of firms that are not regulated by the PRA. The FCA is a quasi‑government department with statutory powers given to it under the Banking Act 1987, the Financial Services and Markets Act 2000, and the Financial Services Act 2012 (the Act that created the FCA). Key terms CONDUCT REGULATION Regulation requiring firms that provide products and services to consumers to ensure that those products and services meet the consumer’s needs, and to act appropriately and to deal fairly with consumers. PRUDENTIAL REGULATION Regulation aimed at ensuring that a business is established and run on a sound financial basis. This aims to limit the risk of that business failing and, if a failure does occur, to limit any adverse impact on consumers and the wider economy. SYSTEMICALLY IMPORTANT PROVIDERS Providers whose failure would have a significant adverse impact on the national or global financial system. Generally these would be providers with a large customer base.

Answer 542

The FCA is an independent financial regulator that reports to the Treasury and Parliament. The FCA and PRA oversee the regulation of the financial services industry in the UK. As noted above, the FCA is responsible for conduct regulation of all firms, and also for the prudential regulation of firms that are not considered to be systemically important. Thus some firms are regulated solely by the FCA, in relation to both prudential and conduct matters, while others are regulated by the PRA in respect of prudential matters and the FCA in respect of conduct. The FCA’s strategic objective is to make sure relevant markets function well so that consumers get a fair deal In seeking to promote competition, the FCA uses its powers to ensure that: there are no undue barriers to entry – in other words, to ensure that the required regulatory standards are not set so high that new providers are unable to enter the market; consumers are empowered to engage in such a way as to drive competition – for instance, by being able to switch providers easily if a product they hold becomes uncompetitive; no single firm or small group of firms dominates the market; and firms focus on consumers’ genuine needs and ensure that recommendations made are suitable.

Answer 543

The FCA works closely with the PRA to exchange information that is relevant to each regulator’s objectives, but acts as a separate entity when engaging with firms. A memorandum of understanding sets out two key principles for co‑operation between the two regulators, which are that: each regulator’s supervisory judgements will be based on all relevant information; and supervisory activity will not usually be conducted jointly. One example where the co‑operation between the FCA and the PRA is particularly important is in the supervision of insurers with with‑profits business, because the returns from such investments are not well defined and impact on, or depend on, prudential as well as performance criteria. As part of its continuous assessment of an insurer’s financial soundness, the PRA ensures that any discretionary benefit allocations (such as discretionary bonuses) are compatible with the firm’s continued safety and soundness. The FCA monitors whether the proposed allocations are consistent with the insurer’s previous communications to policyholders; that conduct in communicating and administering such payments is in line with the FCA’s conduct rules; and that the insurer’s overriding obligation to fair treatment of customers (see section 17.8.1) is maintained.

Answer 544

1) With‑profits business relates to certain life policies issued by life assurance companies. In addition to the sum assured under the policy, the policyholder receives a share of the profits of the life company, payable either during the term (reversionary bonuses) or at maturity or on death of the life assured (terminal bonuses).

Answer 545

2) d) A financial provider of this nature would be regarded as systemically important. It would be regulated by the PRA in relation to its prudential status and the FCA in relation to its conduct of business.

Answer 546

The FCA has powers to enforce the prohibitions in the Competition Act 1998 on anti‑competitive behaviour in relation to the provision of financial services. It also has powers under the Enterprise Act 2002 to carry out market studies and make market investigation referrals to the CMA relating to market studies. The competition powers held by the FCA in respect of financial services are the same as those held by the CMA, so the FCA and the CMA are concurrent regulators. The FCA has product intervention powers, which means that it is able to act quickly to ban or impose restrictions on financial products if it thinks that they are not in the best interests of consumers because of their complexity or suitability. It can disclose details of warning notices issued in relation to disciplinary action. It can take formal action in response to misleading financial promotions and publicise the fact that it has done so. In discharging its powers, the FCA adopts a “proportionate” approach, focusing its resources on those areas of the industry and firms that pose the greatest risk to its objectives. The PRA and the FCA are jointly responsible for the Financial Services Compensation Scheme (FSCS), and the FCA is responsible for the Financial Ombudsman Service (FOS).

Answer 547

Like the FCA, the CMA aims to promote competition for the benefit of consumers. It is responsible for investigating mergers that could restrict competition, carrying out investigations into markets where competition may not be working effectively and enforcing consumer protection legislation. It has powers to impose financial penalties and, in the case of cartels, is able to bring criminal proceedings.

Answer 548

The FCA Handbook details the FCA’s requirements of firms that operate in the financial services industry and consists mainly of rules and guidance: Rules – most of the rules in the Handbook create binding obligations on authorised firms. If a firm contravenes a rule, it may be subject to enforcement action and, in certain circumstances, to an action for damages. Guidance – the purpose of guidance is to explain the rules and to indicate ways of complying with them. The guidance is not binding, however, and a firm cannot be subject to disciplinary action simply because it has ignored the guidance; compliance with the rules is the key consideration, and firms have discretion as to how they achieve this. The FCA Handbook also contains evidential provisions. These are rules that are not binding in their own right but relate to a binding rule. Compliance with an evidential provision may be relied on (when it says so) as ‘tending to establish compliance’ with the rule to which it relates. Non-compliance with an evidential provision may be relied on (again, when it says so) as ‘tending to establish contravention’ of the rule to which it relates. Evidential provisions are used, for example in the Code of Market Conduct, which specifies: descriptions of behaviour that we consider amounts to markets abuse; and factors that we will take into account when determining whether or not behaviour amounts to market abuse. In this text, we cover the areas of the FCA Handbook of greatest interest to financial advisers and mortgage advisers, to enable advisers to carry out their activities in an efficient, safe and well‑regulated manner.

Answer 549

For those firms regulated solely by the FCA, prudential standards are detailed in the prudential sourcebooks. They deal with the financial soundness and management of firms, and cover issues such as the valuation of a firm’s assets and liabilities, its reserves, and financial reporting. The PRA establishes and monitors prudential requirements for dual‑regulated firms; we look at the role of the PRA in more detail in Topic 19.

Answer 550

Business standards are described in the following sourcebooks: Conduct of Business sourcebooks comprising the: — Conduct of Business Sourcebook (COBS), which sets general conduct standards; — Banking: Conduct of Business sourcebook (BCOBS); — Insurance: Conduct of Business sourcebook (ICOBS); — Mortgages and Home Finance: Conduct of Business sourcebook (MCOB). These individual sourcebooks set out the standards that apply to the marketing and sale of financial services products. We look at them in greater detail in Topic 21. Market Conduct sourcebook – this concerns investment markets and is therefore primarily of interest to investment firms. It covers such issues as insider dealing. Client Assets sourcebook – contains the requirements relating to holding client assets and safe custody of client assets.

Answer 551

This section of the Handbook covers regulatory processes, including rules and guidance for firms wishing to seek authorisation. It also includes the Supervision manual, which sets out the way that the FCA regulates and monitors the compliance of authorised firms. 17.5.5 Redress/specialist sourcebooks

Answer 552

The two remaining sections of the Handbook cover: redress – including regulatory standards for dealing with complaints and the provision of compensation; and specialist sourcebooks – including arrangements for credit unions, professional firms such as solicitors and accountants, collective investments (COLL), consumer credit (CONC), investment funds, recognised investment exchanges and regulated covered bonds.

Answer 553

3) a) High‑Level Standards. b) Business standards – specifically, the Mortgages and Home Finance: Conduct of Business Sourcebook (MCOB). c) Business standards – specifically, Conduct of Business Sourcebook (COBS). d) Specialist sourcebooks – specifically, the Consumer Credit sourcebook (CONC). e) Redress.

Answer 554

The FCA’s regulatory regime is based on a set of 12 ‘Principles for Businesses’ (including the addition of the Consumer Duty), from which all of 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 Principles, which are set out in the PRIN subsection of the High‑Level Standards in the FCA Handbook, are shown in Figure 17.5. 3 Key terms SENIOR MANAGEMENT FUNCTIONS Key individuals within a firm who perform significant roles. Individuals must be pre‑approved by the FCA/PRA before they are appointed. CERTIFICATION FUNCTIONS Individuals who must be certified as fit and proper to carry out their role. Also known as significant harm functions, this includes mortgage and investment advisers. firm must conduct its business with integrity 1. Integrity A firm must conduct its business with due skill, care and diligence 2. Skill, care and diligence A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems 3. Management and control A firm must maintain adequate fi nancial resources 4. Financial prudence A firm must observe proper standards of market conduct 5. Market conduct A firm must pay due regard to the interests of its customers, and treat them fairly 6. Customers’ interests A firm must pay due regard to the information needs of its clients and communicate information to them in a way that is clear, fair and not misleading 7. Communications with clients A firm must manage confl icts of interest fairly, both between itself and its customers and between one customer and another 8. Conflicts of interest A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely on its judgement 9. Customers: relationships of trust A firm must arrange adequate protection for clients’ assets when it is responsible for them 10. Clients’ assets A firm must deal with its regulators in an open and co-operative way, and must disclose anything of which the FCA or PRA would reasonably expect notice 11. Relations with regulators A firm must act to deliver good outcomes for retail customers 12. Consumer Duty There is a set of conduct rules that apply to all individuals working in the financial services industry, except for those in certain ‘ancillary’ roles. There is also a set of senior management conduct rules for those who carry out a senior management function. We look at the Senior Managers and Certification Regime and the codes of conduct in more detail in Topic 18.

Answer 555

To further protect consumers from bad conduct, the FCA has implemented the new Consumer Duty. The rules and guidance come into force on a phased basis: For new and existing products or services that are open to sale or renewal, Consumer Duty is effective on 31 July 2023. For closed products or services, Consumer Duty is effective on 31 July 2024. The Consumer Duty goes beyond the existing framework relating to the fair treatment of customers and adds Principle 12 to the Principles for Businesses: “A firm must act to deliver good outcomes for retail customers”. The Duty applies to products and services offered to retail customers and applies to firms forming part of the distribution chain, whether there is a direct relationship with the buyer or not. It does not apply to institutional investors, professional clients or eligible counterparties. Principles 6 (Customers’ interests) and 7 (Communication with clients) do not apply where the Consumer Duty Principle 12 applies. However, the FCA has retained Handbook and non‑Handbook material linked to Principles 6 and 7 as it continues to apply to firms and business activities outside the scope of the Duty and may help firms in considering their obligations where the Duty does apply. Principle 12 is intended to improve consumer protection by ensuring that firms place customer interests at the heart of everything they do. The FCA has identified four outcomes for the key elements of the firm–consumer relationship: products and services; price and value; consumer understanding; consumer support. In addition, three cross-cutting rules require firms to: act in good faith; avoid causing foreseeable harm; and enable and support retail customers to pursue their financial objectives.

Answer 556

In order to ensure that regulatory principles are translated into a practical, properly controlled regulatory regime, the FCA has established a very large body of rules, many of which are found in the sourcebooks listed in section 17.7. The establishment of rules and regulations can, however, have serious drawbacks. People and organisations may 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 firms might be able to hide behind the rules, using loopholes or technicalities to their own advantage. The former regulator, the FSA, was aware of these potential drawbacks, so it introduced an initiative known as treating customers fairly (TCF), which the FCA has continued to pursue. Among the FCA’s Principles, Principle 6 states that “a firm must pay due regard to the interests of consumers and treat them fairly”. The FCA expects that all firms must be able to show consistently that the fair treatment of consumers is at the heart of their business, as spotlighted by the new Principle 12.

Answer 557

The FCA does not provide a definition of ‘fair’; its view is that fairness is a concept that is “flexible and dynamic”, which can “vary with particular circumstances”. Firms must decide for themselves what fair treatment means within the context of their own business. What is clear is that the FCA intends fair treatment to apply at every stage throughout the life cycle of financial products, such as: product design; sales and marketing; advice and selling; administration; and post‑sales activities, including claims handling and dealing with complaints. The FCA provides some guidance on the types of behaviour it wishes to see and suggests a number of areas that a firm should consider. These include: considering specific target markets when developing products; ensuring that communications are clear and do not mislead; honouring promises and commitments that it has made; identifying and eradicating root causes of complaints. Responsibility for the fair treatment of consumers lies with a firm’s senior management, which is required to ensure that fair treatment is “built consistently into the operating model and culture of all aspects of the business”.

Answer 558

Firms are expected to be clear about the services they offer and about the true cost to the customer. Information must be provided to customers in a way that is clear, fair and not misleading. Firms should always consider the ways that the customer will assess their product against others in the market, and ensure that a fair comparison can be made. This means not only that product literature should be clear and appropriate to the target customer group’s expected financial sophistication, but also that the advice given should be of a sufficiently high quality to reduce the risk of mis‑selling.

Answer 559

FAIR TREATMENT OF CUSTOMERS Due regard for the fair treatment of customers must apply at every stage of a product’s life cycle. Information provided to customers must be clear, fair and not misleading. Firms should honour promises and commitments they make. Root causes of complaints should be analysed and eradicated. Senior managers are responsible for ensuring that fair treatment of customers is built into the operations and culture of the firm. Firms should seek to achieve the six outcomes for customers, as set out by the FCA. Firms must demonstrate to the FCA (eg through use of MI) that they are consistently treating customers fairly.

Answer 560

The FCA has an operational objective to enhance the integrity of the financial system and is therefore committed to reducing financial crime of all kinds, in particular: market abuse, which is separated into two aspects: — insider dealing, where a person who has information not available to other investors (eg a director with knowledge of a takeover bid) makes use of that information for personal gain; — market manipulation, where a person knowingly gives out false or misleading information (for instance about a company’s financial circumstances) in order to influence the price of a share for personal gain; money laundering, which is dealt with in Topic 23.

Answer 561

Firms should have whistleblowing 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 whistleblowing process.

Answer 562

1) b) The weaknesses exposed by the 2007–09 financial crisis and a number of major mis‑selling scandals drove the changes to regulatory bodies in 2013.

Answer 563

2) False. This is the key role of the FPC, the Financial Policy Committee.

Answer 564

3) a) Conduct regulation requires firms to ensure that products and services they supply to consumers meet the consumers’ needs, and to act appropriately and deal fairly with consumers. b) Prudential regulation aims to ensure that businesses are established and run on a sound financial basis, to limit the risk of a business failing and to minimise the impact on consumers and the wider economy if a business does fail. c) ‘Systemically important’ refers to financial institutions that play a key role in the national and global economy. If they were to fail, it would have a significant adverse impact on the national or global financial system.

Answer 565

4) i) Protecting consumers from bad conduct by securing an appropriate degree of protection; ii) Protecting financial markets, by protecting and enhancing the integrity of the UK financial system; iii) Promoting effective competition by promoting effective competition in the interests of consumers.

Answer 566

5) Rules impose binding obligations and firms can face sanctions for not complying with them. Guidance explains the rules and indicates ways in which firms can comply but is not binding and firms are not required to follow it.

Answer 567

6) Competition powers; product intervention powers; power of disclosure; power to take formal action against misleading financial promotions.

Answer 568

7) c) The FCA principles do not specifically require a firm to maintain an independent compliance function.

Answer 569

8) d) The redress sourcebook is concerned with complaints and compensation.

Answer 570

9) b) Information must be clear, fair and not misleading.

Answer 571

10) The FCA’s four outcomes for the key elements of the firm–consumer relationship are: products and services; price and value; consumer understanding; consumer support.

Answer 572

Any financial services business that carries out a regulated activity in the UK must be authorised, unless they are exempt. Firms have to apply to the FCA (or, if dual regulated, to the PRA) for authorisation. The FCA describes two categories of regulated investment: securities (such as shares, debentures and gilts); and contractually based investments (including life policies, personal pensions, options and futures).

Answer 573

Section 19 of the Financial Services and Markets Act 2000 (FSMA) states that a person (which includes a corporate body) must not carry on a regulated activity or purport to do so unless they are an authorised or exempt person. This is known as the general prohibition. Carrying on a regulated activity in breach of the general prohibition is a criminal offence under the FSMA.

Answer 574

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 as the Regulated Activities Order (RAO). The section of the FSMA 2000 under which permission may be granted to a firm to carry out regulated activities is Part 4A – so this form of permission is often known as Part 4A permission. Permission is granted in the form of a list of regulated activities that the firm is allowed to carry out; it also shows the regulated investments with which the firm is allowed to deal. The range of regulated activities covered by FSMA 2000 changes periodically as new activities fall under FCA and/or PRA regulation. Detailed guidance on the scope of regulated activities, investments and exemptions is contained in FCA Perimeter Guidance manual (PERG): www.handbook.fca.org.uk/ handbook/PERG/2/?view=chapter.

Answer 575

In addition to regulating the activities of firms, the FCA also regulates the appointment and activities of individuals within the firm. The rules relating to this aspect of its work are set out in the High Level Standards section of the FCA Handbook. Two particular issues the regulators had to address in the aftermath of the 2007–09 financial crisis were criticism of its approved persons regime and difficulties in identifying which individual or individuals are responsible for a business’s failings. In response, the FCA and PRA introduced a Senior Managers and Certification Regime (SM&CR) for banks, building societies and credit unions. This framework establishes an individual accountability framework and regulates individual conduct and standards in the financial services industry. The FCA extended the SM&CR regime to FCA solo‑regulated financial services firms. This excludes appointed representatives who continue to be subject to the approved persons regime.

Answer 576

An appointed representative (AR) is a firm or person who runs regulated activities and acts as an agent for a firm, which is known as the AR’s ‘principal’. The principal firm is the regulated entity, not the AR, and the principal takes full responsibility for ensuring that the AR complies with FCA rules.

Answer 577

There are three tiers under the SM&CR: Core – firms in this tier have to comply with the baseline requirements outlined in the rest of this section. Enhanced – only the firms representing the greatest risk to consumers or markets are classed as enhanced firms. These firms have additional requirements. Limited scope – this applies to firms that are already exempt under the approved persons regime. They are exempt from some baseline requirements and generally have fewer senior management functions. The core regime applies to the majority of these firms, and consists of three key elements: The Senior Managers Regime. Certification Regime. Code of Conduct.

Answer 578

The SMR focuses on individuals in key roles in relevant firms. The FCA has a number of designated senior management functions for core SM&CR firms (see Table 18.1). These are the functions the regulator feels pose the greatest risk to either customers or market integrity if the person conducting them is not fit to do so. There is also a range of prescribed responsibilities that must be allocated among the senior management of a business. Where an individual applies for a senior management role or moves to a different senior manager role that is materially different from their current one, they must be pre‑approved by the regulator. Their application must be accompanied by a “statement of responsibilities”, detailing the aspects of the business for which they will take responsibility. The regulator can then compare the personal capabilities of the individual with the nature of the role they will be performing. Once an individual is appointed, firms must have robust procedures to equip the senior manager to carry out their role effectively. Firms are also required to ensure the ongoing fitness and propriety of their senior managers. Enhanced firms have two additional requirements in which they must: maintain a “responsibilities map”, which details the way responsibilities are allocated between the senior management should problems arise, the “responsibilities map” enables the regulator to more easily identify which person is responsible. ensure that each activity, business area and management function is allocated a senior manager with overall responsibility. There is a statutory duty for senior managers to take “reasonable steps” to prevent regulatory breaches in their area of responsibility. If a breach occurs, then, in order to take action against an individual, the regulator must be able to prove that the senior manager failed to take reasonable steps to prevent the breach occurring. The penalties for senior managers are wide and potentially severe. The FCA is empowered to instigate criminal proceedings against a senior manager whose action or inaction has led their business to fail, through “reckless misconduct”. If an individual is found guilty, the maximum punishment is a prison sentence of up to seven years and/or an unlimited fine. TABLE 18.1 FCA‑DESIGNATED SENIOR MANAGEM

Answer 579

The regulator recognises that the actions of those in more junior roles, below senior management level, could still cause major damage to a business and its customers. The FCA therefore defines a number of “certified” functions. A certified function is one involving aspects of the firm’s business where there is a potential risk of significant harm to the firm or its customers. Individuals in certified functions are subject to the Certification Regime (CR): they are not required to secure direct approval from the FCA but the firm, in effect, certifies their fitness and propriety to carry out the role. Each firm must take reasonable care to ensure that no employee carries out a role for which certification is required until they have been assessed as “fit and proper”. Their continued fitness and propriety must be assessed on an ongoing basis, at least annually. The FCA certification regime applies to the following functions: Significant management function. Proprietary traders. CASS operational oversight functions. Functions subject to qualification requirements, eg mortgage advisers, retail investment advisers and pension transfer specialists. Client dealing function, eg financial advisers and investment managers. Anyone supervising or managing a certified function who is not themselves a senior manager. Material risk takers. Those with responsibility for algorithmic trading. A designated senior manager must be responsible for each firm’s certification regime.

Answer 580

Under SM&CR, the regulator has the power to make rules of conduct that apply to senior managers, certified persons and other employees. Conduct rules set expectations about standards of behaviour for those employed in firms covered by the Senior Managers Regime, other than ancillary staff (ie those performing a role that is not specific to financial services, such as security staff, IT support, etc). The tier one individual conduct rules are: CR1 – you must act with integrity. CR2 – you must act with due skill, care and diligence. CR3 – you must be open and co‑operative with the FCA, PRA and other regulators. CR4 – you must pay due regard to the interests of customers and treat them fairly. CR5 – you must observe proper standards of market conduct. The tier two conduct rules for senior managers are as follows: SM1 – you must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively. SM2 – you must take reasonable steps to ensure that the business of the firm for which you are responsible complies with the relevant requirements and standards of the regulatory system. SM3 – you must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively. SM4 – you must disclose appropriately any information of which the FCA or PRA would reasonably expect notice. Firms must: make individuals who are subject to the rules aware that this is the case, and provide training on how the rules apply to them; take effective action where staff fall below required standards. 18.2.4.1 Reporting The FCA requires firms to report to it within seven days if they take disciplinary action against a senior manager as a result of a breach of one or more rules of conduct. For all other staff, an annual report suffices. The FCA itself may take disciplinary action against an individual found to be in breach of the conduct rules; however, it is only likely to do so in extremely serious cases.

Answer 581

An individual subject to the SM&CR must be deemed “fit and proper” to carry out such a role. The FCA sets out the following criteria. Honesty, integrity and reputation – these can be judged from a number of factors, including: — criminal record; — disciplinary proceedings; — known contravention of FCA (or other) regulations or involvement with companies that have contravened regulations; — complaints received, particularly about regulated activities; — insolvency, or management of companies that have become insolvent; — dismissal from a position of trust or disqualification as a director. Competence or capability – in terms of meeting the FCA’s training and competence requirements (these are discussed in section 18.8). Financial soundness – as indicated by: — current financial position; — previous bankruptcy or an adverse credit rating. In addition to the requirements detailed above, the FCA requires that, when assessing whether a person is fit and proper to perform a senior management function, particular consideration must be given to whether that individual: has obtained a relevant qualification; has undergone or is undergoing training; possesses a relevant degree of competence; has the personal characteristics required by the FCA. Despite the FCA’s emphasis on fitness and propriety there is a risk that an individual with a poor conduct/disciplinary record could gain continued employment in the financial services industry by moving from firm to firm if each new employer remained unaware of past issues. To counter the risk, the FCA requires that before an individual can be appointed to a senior manager role: they must be verified as being “fit and proper” to exercise their duties; the prospective employer carries out checks in respect of any criminal record and a credit check; references are provided from the individual’s current and former employers covering the last six years. The reference should include details of any disciplinary action taken against the individual over the last six years due to breaches of the conduct rules and any findings that the person was not fit and proper. Any other information relevant to assessing whether they are fit and proper covering the previous six years should also be provided. Prior to being appointed to a certificated function an individual must also be verified as fit and proper, have their last six years’ references checked, and have a certificate for their function. There is, however, no requirement for a criminal record check.

Answer 582

The Financial Services Register is a public record of firms, individuals and other bodies that are, or have been, regulated by the PRA and/or FCA. Under SM&CR, the FCA publishes and maintains a directory of certified and assessed persons on the Financial Services Register so consumers and professionals can check the details of key individuals working in financial services. Firms are responsible for submitting and maintaining a person’s data using the FCA’s Connect system. You can find out more at the following link: www.fca.org.uk/firms/directory-persons.

Answer 583

Senior managers must take responsibility for a firm’s compliance with FCA regulations and produce relevant management information (MI). This is to demonstrate that their advisers give quality advice and treat customers fairly, and there are three particular ways in which they are required to achieve this. They must ensure that: the firm embodies a compliance culture, with senior managers using MI to drive forward the firm’s fair treatment of customers and the quality of their advice process; all staff have clearly defined responsibilities and are monitored appropriately; monitoring and compliance procedures are regularly reviewed and updated.

Answer 584

A firm must implement systems and controls that are “appropriate to its business”, and it must be able to demonstrate that such systems and controls are appropriate. Systems and controls must be clearly documented and regularly reviewed. They will relate to a wide range of the firm’s activities, including: the establishment of clear chains of responsibility, delegation and reporting; compliance; assessment and reporting of risk; reporting of other management information; competence and honesty of staff, particularly those who are subject to the SM&CR, with senior management applying the ‘competent employee’ rule, ie employees must have the necessary skills to carry out the job for which they are employed; a strategy for controlling business risks and for recovering from serious problems such as fire or computer failure; adequate and readily accessible records (with backup) of systems and controls must be securely kept; an audit of the systems and controls must be made independently of the persons who normally operate them.

Answer 585

The FCA seeks to ensure that firms are complying with regulatory requirements through a programme of supervision, based on eight principles (see Figure 18.3). FIGURE 18.3 EIGHT FCA PRINCIPLES FOR SUPERVISION Source: FCA (2022) Being forward-looking and pre-emptive – addressing poor conduct to avoid risk and serious harm Focusing on FCA strategy and fi rms’ business models – identifying emerging risks and ensuring the FCA’s supervisory activity mitigates these risks Focusing on firms’ culture and governance – examining a firm’s purpose and the effectiveness of governance strategies used to identify and mitigate risks Emphasis on individual accountability Taking a proportionate and risk-based approach, ie targeting fi rms that could cause the most harm or have the most signifi cant misconduct Encouraging two-way communication – engaging with consumers, industry and fi rms, and being transparent about FCA priorities and work Ensuring messages provided are co-ordinated and consistent, working closely with other regulatory bodies Fixing systemic harm, preventing it from occurring again and ensuring consumers are compensated

Answer 586

We saw in Topic 17 that the FCA adopts a “proportionate” approach to supervision, focusing its resources on those areas of the industry and firms that pose the greatest risk to its objectives. Firms are categorised according to their potential impact on the FCA’s objectives. The category in which the FCA places a firm determines the style of supervision carried out (see Figure 18.4). The FCA’s system of categorising firms uses a combination of factors with reference to the number of customers a firm has and the likely impact of a firm’s failure on the financial services sector and the economy as a whole. ‘Fixed portfolio’ firms are a relatively small number of firms that, based on size, customer numbers and market presence require the highest level of supervisory attention. The vast majority of firms present a lower level of risk and are classed as ‘flexible portfolio’ firms. These firms are supervised through a mixture of targeted supervisory work depending on the markets they operate in and programmes of communication and education. Figure 18.4 summarises the categories and levels of supervision.

Answer 587

2) Fixed portfolio firms are those that have the greatest impact on consumers and the financial services marketplace, therefore the FCA directs most of its resources to supervising these firms.

Answer 588

The FCA’s supervision model is based on the three pillars, as illustrated in Figure 18.5). These pillars draw on the FCA’s ongoing analysis of each industry sector and the risks that sector poses to the FCA’s objectives. FIGURE 18.5 FCA SUPERVISION MODEL: THREE PILLARS Source: FCA (2022) As well as focusing regulatory resources on those businesses posing the greatest risk to its objectives, the FCA focuses its supervision on the areas that have the greatest impact on consumers and market integrity. It examines different parts of a business’s operations, and will be in direct contact with a number of people within the business in order to understand how it is run. Areas of particular interest include the following: Business model and strategy – the FCA is aware that business strategy can drive behaviours that lead to poor customer outcomes. It seeks to ensure that a business has assessed and mitigated any risks to customers arising from its strategy, as part of its objective to ensure customers get products and services that meet their needs from providers they trust. Culture – culture underpins everything a business does and an appropriate culture will ensure the fair treatment of customers. The FCA will want to understand: — the way business is conducted; 3 Pillar 1 Proactive firm or group supervision Pre-emptive identification of harm through review and assessment of firms and portfolios: this includes business model analysis and reviewing the drivers of culture Pillar 2 Event‑driven, reactive supervision Dealing with issues that are emerging or have happened to prevent harm growing Pillar 3 Issues and products Wider diagnostic or remedy work where there is actual or potential harm across a number of firms As well as focusing regulatory resources on those businesses posing the greatest risk to its objectives, the FCA focuses its supervision on the areas that have the greatest impact on consumers and market integrity. It examines different parts of a business’s operations, and will be in direct contact with a number of people within the business in order to understand how it is run. Areas of particular interest include the following: Business model and strategy – the FCA is aware that business strategy can drive behaviours that lead to poor customer outcomes. It seeks to ensure that a business has assessed and mitigated any risks to customers arising from its strategy, as part of its objective to ensure customers get products and services that meet their needs from providers they trust. Culture – culture underpins everything a business does and an appropriate culture will ensure the fair treatment of customers. The FCA will want to understand: — the way business is conducted; — expectations of staff; and — attitude to customers. Frontline business processes – this involves understanding the extent to which business processes are designed to give customers what they need and meet their expectations. Systems and controls – this aspect of supervision focuses on the extent to which culture is reinforced by effective systems and controls designed to identify and deal with risks in areas such as conduct and financial crime. Governance – the FCA expects senior management and the board within a firm to understand and be able to explain the conduct risks in their strategies. It pays particular attention to the way the governance of a business implements consumer‑ and market‑focused strategies.

Answer 589

The FCA aims to be proactive rather than reactive, preventing problems from arising rather than simply dealing with them when they do. Ensuring high levels of knowledge and ability among financial services staff is key to achieving this objective. Consequently, the FCA places high importance on training and competence. The FCA’s Training and Competence (TC) sourcebook requires firms to make certain commitments regarding the competence of anyone within the remit of the SM&CR. It is particularly prescriptive in relation to three types of employee: financial advisers and those who deal in, or manage, investments; supervisors of those advisers, dealers or fund managers; supervisors who oversee certain ‘back‑office’ administrative functions, particularly within a product provider (eg supervisors of the underwriting or claims functions in a life assurance company). At the start of 2011, the TC sourcebook was moved into the High Level Standards part of the Handbook to reflect its increased importance. TC rules cover the following areas. Note that they do not apply to firms transacting wholesale business with non‑retail clients.

Answer 590

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

Answer 591

Investment advisers must not be allowed to commence activities until the employer is satisfied that an adviser has: achieved an adequate level of knowledge and skill to operate under supervision; and passed the regulatory module of an appropriate qualification for investment advisers at RQF Level 4 (such as the Financial Services Regulation and Ethics unit as part of the Diploma for Financial Advisers). Individuals must work under close (direct) supervision until they have been assessed as competent to work under indirect supervision. Individuals must not be assessed as competent until they have: passed all modules of an appropriate examination (such as the Advanced Financial Advice unit as part of the Diploma for Financial Advisers); and demonstrated a consistent ability to act competently under minimum supervision. Supervisors should have coaching and assessment skills as well as technical knowledge. For investment advisers, the regulatory module of an appropriate qualification must be achieved prior to commencing the activity and the remaining modules must be achieved within 48 months of commencing the activity. There are different examination standards for those in different roles: mortgage advisers must achieve an appropriate qualification in mortgages at RQF Level 3, such as the Certificate in Mortgage Advice and Practice (CeMAP®). There are no formal requirements for those working as overseers.

Answer 592

The role of investment adviser comes within the remit of the SM&CR, and investment advisers are required to pass an appropriate examination as demonstration of their competence.

Answer 593

As well as ensuring that employees become competent, firms must have definite arrangements in place for ensuring that they maintain that competence. A review must take place on a regular and frequent basis to assess the employee’s competence, and appropriate action must be taken to ensure that they remain competent for their role. Matters that must be taken into account include: technical knowledge and its application; skills and expertise; changes in the market and to products, legislation and regulation. A retail investment adviser who has been assessed as competent must complete a minimum of 35 hours of appropriate continuing professional development (CPD) in each 12‑month period; 21 hours of that CPD must be ‘structured CPD’. Examples of structured CPD include attending courses, seminars, lectures, conferences, workshops or e‑learning activities which entail a contribution of 30 minutes or more. Unstructured CPD includes conducting research as part of the adviser’s role, reading industry or other relevant material, and participating in coaching or mentoring sessions. Under the terms of the Insurance Distribution Directive, which took effect from 1 October 2018 (see section 24.4), advisers selling protection policies (if they are not subject to the FCA Training and Competence Regime) are required to undertake a minimum of 15 hours’ CPD each year. Advisers must obtain a Statement of Professional Standing (SPS) each year from an FCA accredited body. To receive an SPS, an adviser must meet the professional standards of the professional body and declare that they adhere to its code of ethics. They must also confirm that they hold the required qualifications to give retail investment advice.

Answer 594

Firms must maintain records showing how and when employees’ competence is being assessed. All records relating to the training and competence of individual employees must be retained for specific minimum periods of time after the person ceases to carry out the activity or leaves the company. The time limits are: at least three years for individuals carrying out non‑MiFID business; at least five years for individuals carrying out MiFID business; indefinitely for individuals carrying out pensions transfer business. Typical records might include some, or all, of the examples shown in Figure 18.6.

Answer 595

The FCA takes action when it considers that particular aspects of a firm’s business model or culture (such as products, training, recruitment procedures or remuneration policies) are likely to harm consumers. It places emphasis on securing redress for consumers who have suffered harm. The circumstances that may lead to an investigation cover a wide range of situations including, for example, suspicion that an authorised person is: contravening regulations; providing false information; falsifying documents; acting outside the scope of their Part 4A permission; participating in money laundering; allowing persons who are not approved or certified to carry out functions within the remit of the SM&CR; falsely claiming to be authorised; undertaking insider dealing or market manipulation. The person appointed to carry out the investigation on the FCA’s behalf has the power to demand that: the person being investigated or anyone connected with them answer questions and provide information; any person (whether or not they are being investigated or are connected with the person under investigation) provide documents and, in the case of a specific investigation, answer questions or provide information. If the FCA is satisfied that it has discovered a contravention of its rules, there are 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 in Figure 18.7. FIGURE 18.7 FCA ENFORCEMENT POWERS This may involve removal of one of the fi rm’s permitted regulated activities or a narrowing of the description of a particular activity. Variation of a fi rm’s permissions The FCA might withdraw or suspend a person’s approval or certifi cation to carry out some or all of their role. Withdrawal of approval If a person has benefi ted from a contravention of a regulation, the FCA can ask the court for an order requiring that person to forfeit to the FCA any profi t made from the activity. Restitution The FCA can announce that it has begun disciplinary action against a fi rm, although it must consult the recipient of the warning notice before making such an announcement. Disclosure If a person has contravened a regulation, the FCA can apply for an injunction to prevent that person from benefi ting from the action, for instance by selling assets that they have misappropriated. Injunction • If it can be shown that losses have been made by identifi able customers as a result of the contravention of a rule, the FCA may be able to obtain a court order requiring such losses to be made good. • However, there may be more appropriate ways for that customer to pursue such claims, such as through the Financial Ombudsman Service or the Financial Services Compensation Scheme (see Topic 25). Redress If an approved person or an authorised fi rm is judged to be guilty of misconduct, the FCA has a range of options regarding the sanctions it might apply. These are to: • issue a ‘warning notice’; • publish a statement of misconduct; • impose a fi nancial penalty. Disciplinary action • This is an intensive supervisory regime designed to deal with issues in fi rms that are considered to have serious governance failings. • The FCA can enforce a range of actions, which include requiring the fi rm’s board to commit to specifi c remedial action, the progress on which will then be reviewed. • As an alternative, the FCA can impose binding requirements on a fi rm in respect of certain actions it must take. Before taking action against a dual‑regulated firm, the FCA will consult with the PRA. If the decision is relevant to both regulators, they will decide whether it is best to pursue a joint investigation or for one of them to act alone, keeping the other informed of developments and findings.

Answer 596

Please see 18.7

Answer 597

1) Permission under Part 4A of the Financial Services and Markets Act 2000 to carry out specified regulated activities.

Answer 598

2) False. Investment in shares is a regulated investment.

Answer 599

3) d) There is no need to pay attention to how long someone has worked in the industry; an individual may have worked in the industry for many years but have a poor track record, while an individual who is new to the industry may have good credentials.

Answer 600

4) d) Yvette. The ‘fit and proper’ requirements include a check of financial soundness, and missing mortgage repayments would have adversely affected Yvette’s credit rating.

Answer 601

5) The regime was introduced in order to clarify responsibilities within a firm, thus making it easier to hold individuals to account for a particular failing. Prior to its introduction, the FCA and PRA had found it difficult to determine individual responsibility when seeking to take action against firms in the financial services industry.

Answer 602

6) The employee’s: technical knowledge and application; skills and expertise; understanding of changes in the market and to products, legislation and regulation.

Answer 603

7) A ‘fixed portfolio’ firm is one that has a large number of customers and the potential to have a major impact on the market; it receives the highest level of supervision, involving continuous assessment and a designated individual supervisor.

Answer 604

8) a) The firm may no longer be able to carry out one or more of its regulated activities.

Answer 605

9) Restitution refers to the FCA’s power, with a court order, to require a person or firm to forfeit any profit made as a result of contravening an FCA rule. Redress applies to a situation in which an identifiable customer has made a loss as a result of a contravention of an FCA rule; the FCA, with a court order, can require that the loss be made good.

Answer 606

10) Pillar 1: proactive firm or group supervision. Pillar 2: event-driven, reactive supervision. Pillar 3: issues and products.

Answer 607

A vital element of the work of the industry regulators is to ensure that firms have adequate risk management systems in place, particularly in relation to financial risks. This is referred to as prudential management. The majority of the prudential rules are the remit of the PRA; it is responsible for the prudential regulation of all deposit-takers, insurers and significant investment firms. The FCA is responsible for the prudential regulation of firms for which it is the sole regulator, typically smaller businesses. The FCA’s general approach to prudential supervision is to manage failure when it happens, rather than focusing valuable resources on reducing its probability. Remember that, in respect of prudential regulation, the FCA regulates smaller firms. Therefore the FCA’s approach has to be seen in context, that the failure of a smaller firm would generally not present a risk to the integrity of the whole financial system. There are exceptions, and where failure of a particular firm is likely to have a wider impact, the FCA will focus on reducing the impact on customers and the integrity of the financial system.

Answer 608

It is important to understand that the UK’s regulators do not operate in isolation; their work is driven by regulatory requirements at an international level. Trade is conducted on a worldwide basis, and the economies of many different countries are highly interconnected: problems in one economy or with a single large financial services provider can cause problems across the world. Such problems were seen following the collapse of Lehman Brothers in the United States in 2008, an event widely believed to have triggered the ensuing financial crisis. The Basel Committee on Banking Supervision sets standards for the prudential regulation of banks globally. The EU sets out detailed requirements for banks, building societies and investment firms within the member states. We will look at standards set by the Basel Committee in section 19.5 and the EU requirements in section 19.6

Answer 609

The Basel Committee is a multinational body acting under the auspices of the Bank for International Settlements, and is based in Basel, Switzerland. Its role is to strengthen the regulation, supervision and activities of banks to enhance financial stability; many of the people who work for it are on secondment from central banks and national regulatory bodies. It first established an international framework for deposit-takers (ie principally banks) in 1988. This framework, which – among other things – set out minimum capital requirements for banks, was known as the Basel Accord. It was superseded by the expanded Basel II, itself superseded by Basel III in 2010.

Answer 610

One of the key areas of prudential control for financial institutions relates to their capital adequacy. There are different rules for deposit-takers (such as banks and building societies), investment firms and life assurance companies. Regulations about capital adequacy broadly state that, should a business run into difficulties, the business must have sufficient capital to make it very unlikely that deposits will be placed at risk. Capital in this context is often referred to as the own funds of a business, ie those obtained from shareholders and related sources, as distinct from funds deposited by customers. The business aims to make a profit for its shareholders, and it is the shareholders who are expected to bear the risks in pursuit of the financial reward. Thus although a bank’s lending is generally financed by deposits, any losses made (for instance if a loan is written off because the borrower does not repay it) should be borne by shareholders rather than by depositors. Minimum requirements for capital adequacy are set to protect a bank’s depositors so that they do not lose money. The minimum capital that a business must hold is expressed in the form of a solvency ratio: that is, capital as a proportion of the value of the bank’s assets (ie mainly its loans). The solvency ratio takes account of the fact that some assets represent more of a risk to the bank than others, because the level of capital that must be held reflects the perceived risk level of the different assets.

Answer 611

Liquidity can be defined as the ease and speed with which an asset can be converted into cash – and thus into real goods and services – without significant loss of capital value. It must not be confused with solvency, or with capital adequacy, which are different issues. In relation to banks, the definition of liquidity is a measure of a bank’s ability to acquire funds immediately at a reasonable price in order to meet demand for cash outflows. The regulators define liquidity risk as the risk that a firm, though solvent, does not have sufficient financial resources available to enable it to meet its obligations as they fall due. Problems could, for example, arise when a bank that has committed a large volume of its assets to long-term mortgage advances is faced with an unexpectedly high number of its savings account holders wanting to withdraw funds; the bank may have the assets to enable the withdrawals but the mortgage loans are too illiquid. In assessing liquidity risks that they may face, banks need to consider the timing of both their assets and their liabilities, and endeavour to match them as far as possible. A firm’s assets can provide liquidity in three main ways: by being sold for cash, by reaching their maturity date, and by providing security for borrowing. Asset concentrations, where a large number of receipts from assets are likely to occur around the same time, should be avoided. Similarly, banks try to avoid liability concentrations, where a single factor or a single decision could result in a sudden significant claim. A wide spread of maturity dates is one obvious way to achieve this.

Answer 612

The situation of the UK bank Northern Rock in 2007 illustrates liquidity problems that can arise. The bank had a business plan that involved borrowing money short term on the money markets on a regular basis to fund a proportion of its (much longer-term) mortgage lending. The success of the plan depended on the continuing availability of short-term interbank lending. When this dried up as a result of escalating economic problems in the USA, the bank’s liquidity quickly disappeared. It was forced to approach the Bank of England for assistance. At that point, a different aspect of liquidity risk appeared. When concerns about the stability of the bank became widely known, large numbers of depositors sought to withdraw their savings (a so-called ‘run on the bank’). Banks do not retain all the funds deposited with them in a readily accessible form – as we have already learned, most of their deposits are lent to customers who wish to borrow. Only a small proportion is kept in cash or assets convertible into cash. If a run on the bank occurs, its liquidity can quickly be used up. In the case of Northern Rock, the government stepped in to guarantee deposits, which halted the bank run.

Answer 613

1) The main functions of the Bank of England are: issuer of banknotes; banker to the government; banker to other banks; adviser to the government; manager of the UK’s gold and foreign currency reserves; lender of last resort. The main reason why Northern Rock approached the Bank for assistance was because of the Bank’s role as lender of last resort; Northern Rock could not obtain the funds it urgently needed on the interbank market so it had to ask for emergency funding from the Bank.

Answer 614

The way in which a business is run and managed is another area in which prudential risk can arise. Operational risk is the risk of loss as a result of failed or inadequate internal processes, people and systems (eg staff fraud, or a computer failure), or as a result of external events, such as a natural disaster. 9 Capital requirements for operational risk were included for the first time in Basel II (see section 19.5.1). 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 institutions with different business lines, a more sophisticated system (called the standardised approach) can be applied, using different multiplying factors for each line.

Answer 615

Even before Basel II had been fully implemented, the events of the 2007–09 financial crisis highlighted the need for additional regulation. Basel III was agreed by members of the Basel Committee in 2010–11 and implementation was phased in up to 31 March 2019. Basel III covers two main areas: regulatory capital; asset and liability management. Regulatory capital Basel III requires banks to reach a minimum solvency ratio of 10.5 per cent. Regulatory capital is the amount of capital that a bank is required to hold in order to meet regulatory requirements. There are precise definitions as to what can be counted as regulatory capital and there are two broad classes of capital: Tier 1 capital, which includes share capital and disclosed reserves (ie profits retained in the business rather than being paid as dividends); Tier 2 capital, which is known as supplementary capital. The value of a bank’s assets is adjusted to take account of the risk that those assets present. So, for example, loans to governments (such as a bank holding UK government gilts) have a risk weighting of zero as they are considered to be very secure; personal loans, conversely, are unsecured lending so carry a risk weighting of 100 per cent. A general theme is that the higher the risk presented by the business a bank is carrying out, the higher the level of capital it is required to hold. In practice, institutions normally keep more than the minimum solvency ratio required by Basel III. Basel III also introduced a minimum leverage ratio, which is a bank’s Tier 1 capital divided by its average total consolidated assets. Banks are expected to maintain a leverage ratio in excess of 3 per cent. Asset and liability management Basel III introduced two new ratios that banks must comply with in respect of asset and liability management: liquidity coverage ratio (LCR); net stable funding ratio (NSFR). The LCR requires that high-quality liquid assets available to the bank exceed the net cash outflows expected over the next 30 days. In assessing a bank’s ability to meet the LCR, different weightings are attached to different types of asset according to their liquidity. The LCR was phased in between January 2015 and January 2019. While the LCR is aimed at ensuring a bank’s short-term liquidity, the NSFR aims to protect its longer-term position. The NSFR requires that long-term financial resources exceed long-term commitments; long term in this context is taken as being more than one year. NSFR requirements had to be met from 2018.

Answer 616

In the EU the requirements of Basel I, II and III are implemented by the Capital Requirements Directives (CRDs). CRD IV, which implements Basel III, came into effect on 1 January 2014, with the capital requirements being phased in over a number of years. The CRDs establish a supervisory framework that aims to minimise the effects of a firm failing. They do this by ensuring that firms hold sufficient financial resources to cover the risks that their business activities present. CRD IV builds on existing rules and introduces new prudential requirements. Notably, the quality of capital that firms are required to hold has been improved and new capital buffers have been introduced for some firms. CRD IV applies to banks, building societies and investment firms. CRD V came into effect on 28 December 2020 and introduced new rules governing the remuneration of staff, including the basis for identifying so- called ‘material risk takers’ – staff who are subject to the strictest remuneration rules. The reforms to the rules governing remuneration in CRD V include changes to deferral periods for performance-related pay and proportionality thresholds above which the requirements apply. As CRD V came into effect just before the end of the Brexit transition period, under the terms of the UK’s Withdrawal Agreement with the EU the UK was required to ‘onshore’ the CRD V rules.

Answer 617

There are additional capital requirements for banks deemed systemically important or too big to fail. The Financial Stability Board (FSB), an international organisation consisting of national regulators and central banks, issued a minimum total loss-absorbing capacity (TLAC) standard on 9 November 2015 for 30 banks identified as global systemically important banks (G-Sibs) that the Basel Committee on Banking Supervision (BCBS) deems at risk from being too big to fail. The TLAC requirements aim to bolster G-Sibs’ capital and leverage ratios, ensuring these banks are equipped to continue critical functions without threatening financial market stability or requiring further taxpayer support. The minimum TLAC requirement is in addition to minimum regulatory capital requirements, but qualifying capital may count towards both requirements, subject to conditions. Since 1 January 2022, the minimum TLAC requirement for G-Sibs has been at least 18 per cent of the resolution group’s risk-weighted assets (RWAs).

Answer 618

The failure of an insurance company presents a number of risks for consumers and, as with the banks, there are rules relating to the amount of capital a business must hold to mitigate the risk of insolvency. In the EU, a Directive that focused on the capital adequacy of insurers was introduced in the early 1970s; this is now referred to as Solvency I. A new Directive, Solvency II, came into effect on 1 January 2016. At an international level, the European Insurance and Occupational Pensions Authority (EIOPA) is responsible for its implementation. Within EU member states, national supervisory authorities will implement the requirements of the Directive. The main aims of Solvency II are to: reduce the risk of an insurance company being unable to meet its claims; reduce losses suffered by policyholders should an insurer be unable to meet all claims in full; establish a system of information disclosure that makes regulators aware of potential problems at an early stage; promote confidence in the financial stability of the insurance sector. Solvency II aims to harmonise regulation of the EU insurance industry and is primarily focused on the amount of capital an insurer must hold to reduce the risk of insolvency. It is based on three main ‘pillars’ (see Figure 19.3). Pillar 1 Capital requirements and the valuation of assets Pillar two Governance and risk-management requirements Pillar 3 Disclosure and transparency rules The capital requirement is expressed in terms of a solvency capital requirement (SCR) which comprises a basic SCR, plus an allowance for operational risk, less an amount for adjustments. Insurers are required to complete and submit an Own Risk & Solvency Assessment (ORSA). The PRA has made changes to its Handbook to reflect the new requirements. The regime applies to almost all EU insurance firms; some insurance firms are not subject to Solvency II requirements, depending on the amount of premiums they write, the value of technical provision or the type of business written. The UK government retained all core aspects of Solvency II in UK law following Brexit; however, it has since indicated plans to reform Solvency II.

Answer 619

The FCA and PRA are responsible for establishing rules that translate EU legislation into practical standards that apply to regulated financial services providers. The FCA Handbook’s ‘Prudential Standards’ section details prudential requirements. This section is made up of several subsections that detail requirements for different types of firm. The FCA has implemented a new prudential regime for investment firms, including the development of the Prudential Sourcebook for Investment Firms (MIFIDPRU).

Answer 620

Most larger firms are now subject to the FCA’s Investment Firms Prudential Regime (IFPR), whose rules can be found in the MIFIDPRU sourcebook. IFPR reflects the FCA’s approach to capital requirements following Brexit. The regime came into force on 1 January 2022. MIFIDPRU contains rules on own funds, concentration risk, basic liquid assets requirements, governance and risk management, and disclosure and reporting. The sourcebook also covers firms acting as clearing members and indirect clearing firms. Further details can be found here: www.handbook.fca.org.uk/ handbook/MIFIDPRU/

Answer 621

1) b) Prudential Regulation Authority.

Answer 622

2) The FCA is the prudential supervisor for smaller firms that, in general, would not present a risk to the wider financial system if a particular one were to fail. Therefore, the regulator concentrates its resources on managing a firm’s failure in an orderly way to mitigate the impact on its customers.

Answer 623

3) d) Capital adequacy requirements are based on the principle that shareholders, not depositors, should bear any loss.

Answer 624

4) Capital as a percentage of the risk‑adjusted value of assets.

Answer 625

5) Under Basel II, instead of simply calculating their capital requirement as a percentage of the total value of their assets, firms were required to categorise each asset according to the risk it represented and hold more capital in relation to the riskier assets.

Answer 626

6) a) 10.5 per cent.

Answer 627

7) b) The net stable funding ratio.

Answer 628

8) To reduce the risk of an insurance company being unable to meet its claims; to reduce losses suffered by policyholders should an insurer be unable to meet all claims in full; to establish a system of information disclosure that makes regulators aware of potential problems at an early stage; and to promote confidence in the financial stability of the insurance sector.

Answer 629

9) d) MIFIDPRU details the prudential requirements for MiFID investment firms.

Answer 630

Regulations relating to the way in which advisers interact with clients are set out in the Business Standards section of the FCA Handbook. Within this section, there are a number of sourcebooks detailing the rules governing advice in specific areas. Figure 20.1 summarises the sourcebooks we will be considering. The remainder of this topic addresses the provisions of COBS, with Topic 21 considering BCOBS, MCOB and ICOBS. BCOBS Banking: Conduct of Business Sourcebook Rules governing deposit- takers, eg banks and building societies MCOB Mortgages and Home Finance: Conduct of Business Sourcebook Rules governing the provision of advice relating to mortgages and home fi nance, including equity release ICOBS Insurance: Conduct of Business Sourcebook Rules governing the provision of advice on general insurance and protection products The FCA Handbook also contains a conduct of business sourcebook for claims management companies called CMCOB.

Answer 631

COBS sets out three types of client: eligible counterparties; professional clients; retail clients. Different rules apply to dealings with each of these client groups.

Answer 632

This category includes governments, central banks and financial institutions – the latter including firms such as banks, insurance companies, investment firms and collective investment funds. The eligible counterparty definition only applies to eligible counterparty business, which would include situations such as straightforward execution of transactions received or the purchase of shares, by a firm, for onward sale to the firm’s clients. Due to the assumed level of knowledge and experience, clients in this category receive the lowest level of investor protection.

Answer 633

This category includes all the bodies that would otherwise be eligible counterparties, except for the fact that they require a higher level of service than would apply to ‘eligible counterparty business’ – for example, they require advice, in addition to execution of transactions. It also includes other types of large client, particularly institutional investors whose main activity is investing in financial instruments. When dealing with professional clients, advisers can assume an adequate level of experience and knowledge and an ability to accept financial risks. Clients can either be considered as professional clients on a de facto basis (ie they qualify by meeting various tests) or they opt to be treated as professional clients, in which case they are referred to as ‘elective professional clients’.

Answer 634

This category provides the highest level of investor protection and comprises customers who do not fall into either of the previous two categories – especially customers who might be described as ‘the person in the street’ and who cannot be expected to have anything more than a basic general understanding of financial services. It is expected that most financial services customers will fall into this category. Increasing knowledge and experience ➡️ retail clients, professional clients, eligible counter parties ⬅️ increasing investor protection

Answer 635

Advisers are grouped into one of two categories: independent advisers and restricted advisers. In order to inform a client that it provides independent advice, a firm must assess a sufficient range of relevant products available on the market that must: be sufficiently diverse with regard to their type and issuers, or product providers, to ensure that the client’s investment objectives can be suitably met; and not be limited to relevant products issued or provided by the firm itself or by entities having close links with the firm, or other entities with which the firm has such close legal or economic relationships, including contractual relationships, as to present a risk of impairing the independent basis of the advice given. Source: FCA (no date) Any firm or adviser that does not meet the requirements to be ‘independent’ will, by default, be providing advice that is ‘restricted’. This is designed to reflect the idea of genuinely independent advice being free from any restrictions that could impact on the ability to recommend whatever is best for the customer. The restrictions may relate either to the range of product providers that an adviser can recommend, or the range of individual products.

Answer 636

Independent advisers offer advice on a wide range of financial products and providers. An advice firm can call itself independent even if it only offers advice on a certain area. For example, a firm could call itself independent while only offering advice on pensions. The firm would have to be able to advise on all pension product types and “would need to consider a sufficient range of pension products which were sufficiently diverse, in terms of their type and provider, to suitably meet the client’s objectives”. The FCA Glossary defines a ‘personal recommendation’ as advice on investments, advice on conversion or transfer of pension benefits, or on a home finance transaction that is presented as suitable for the person for whom it is made, or is based on consideration of the circumstances of that person. The use of panels The rules do not prohibit, or even restrict, the use of panels by firms wishing to operate as ‘independent’, but any panel should be sufficiently broad in its composition to enable the firm to make personal recommendations based on an assessment of a sufficient range of diverse and relevant products on the market. Any panel should be reviewed regularly and updated as necessary. The use of a panel must not materially disadvantage any client. The firm must recognise that there may be clients for whom the panel does not work. It should therefore be possible for ‘off‑panel’ advice to be available where a different product or product provider would provide a more suitable outcome for that client. The role of specialists The rules relating to independent advice apply both at the level of the firm and of the personal recommendation. Every adviser working in a firm that describes its advice as independent needs to ensure that each personal recommendation meets the definition of independence. This does not, however, prohibit firms from having advisers that specialise in certain areas, for example, investments, pension transfers or long‑term care.

Answer 637

Firms that advise retail clients on any retail investment products are subject to the FCA rules that apply to those operating in a particular area of financial services. For instance, a firm that only advised on mortgages would fall under the FCA’s COBS and MCOB rules. If the firm decided to start advising on protection products that could be used in conjunction with mortgages, they would also be subject to ICOBS rules, and their sales processes would need to be amended.

Answer 638

A firm providing independent advice has three advisers, each with their own specialist area. The IHT specialist has a client for whom a personal pension might be appropriate. They consult the pension expert to seek their advice and guidance. The personal recommendation provided to the client by the IHT expert would meet the independence rule provided that the recommendation of the pension expert would also meet the independence rule, as defined in section 20.3.

Answer 639

Restricted advice could be summarised as anything that is not independent advice or basic advice. Restricted advisers generally focus on a limited selection of products or providers.

Answer 640

The subject of pension and investment scams is detailed in section 10. One of the ways an individual can seek to protect themselves against a possible scam is to seek qualified financial advice from a financial adviser, whether independent or restricted. An accomplished financial adviser would be able to identify the warning signs of a scam and advise accordingly.

Answer 641

The FCA expects that the majority of retail customers will receive qualified investment advice, involving a recommendation based on analysis of their needs and circumstances. There are situations where a customer may feel equipped to make their own investment decisions and proceed without advice – to proceed on an execution‑only basis. Execution‑only involves the customer telling the firm what they wish to do and the firm executing their wishes; no advice is given. The FCA defines execution‑only business as “a transaction executed by a firm upon the specific instruction of a client where the firm does not give advice on investments relating to the merits of the transaction and in relation to which the rules on the assessment of appropriateness do not apply”. This can be contrasted with: qualified investment advice – where an adviser makes a recommendation based on a full analysis of a customer’s needs and circumstances; and simplified advice – where a streamlined or automated process is used to gather the personal and financial information on which advice is given. Where investment business is undertaken on an execution‑only basis, the customer instructs the adviser to effect a specific transaction on their 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 entirely responsible for their own choice. It is expected that only a small proportion of any adviser’s cases would be on an execution‑only basis. A different situation arises where an adviser provides advice to a client, but the client wishes to carry out a transaction that contravenes the advice given (sometimes referred to as an ‘insistent’ customer). In this situation, the adviser should require the client to sign to confirm that they are acting against the advice provided.

Answer 642

The Financial Ombudsman Service (FOS) has highlighted that complaints relating to execution‑only business often result from the customer believing they had received advice and not realising they have taken out an investment on an execution‑only basis. The FOS has indicated that it expects firms to be able to provide ‘clear and credible’ evidence that a transaction was conducted on an execution‑only basis. This would involve obtaining a signed statement from the customer confirming that: they are aware that business is being transacted on an execution‑only basis; they have not asked for or received advice; the decision to take out the investment is theirs alone; the adviser (and/or the firm they represent) takes no responsibility for the suitability of the investment.

Answer 643

A financial promotion is defined in COBS as an “invitation or inducement to engage in investment activity”. This includes: advertisements in all forms of media; telephone calls; marketing during personal visits to clients; presentations to groups. Financial promotions can be ‘communicated’ only if they have been prepared, or approved, by an authorised person. There is a distinction between: real‑time financial promotions (non‑written financial promotions), such as personal visits and telephone conversations; and non‑real‑time financial promotions (written financial promotions), such as newspaper advertisements and those on internet sites. The overall principle is that financial promotions to retail clients and professional clients must give a clear and adequate description of the product or service and be clear, fair and not misleading. In the case of retail clients, this means specifically that information supplied must: be accurate, including the requirement not to emphasise potential benefits without giving a fair and prominent indication of the risks; be understandable by an ‘average’ member of the group it is aimed at; not disguise or obscure important terms or warnings; contain the name of the conduct regulator (the FCA) in the case of direct offer advertisements. Figure 20.3 sets out the rules relating to financial promotions. Comparisons • Comparisons with other products must be meaningful, and presented in a fair and balanced way. • Markets in Financial Instruments Directive (MiFID) firms are subject to additional requirements to detail the source of information and the assumptions made in the comparison. Past performance • Past performance information must not be the most prominent part of a promotion. • It must be made clear that it refers to the past, and it must contain a warning that past performance is not necessarily a reliable indicator of future results. • Past performance data must be based on at least five years (or the period since the investment commenced, if less, but must not relate to a period of less than one year). Unsolicited promotion (cold call) • Permitted only in relation to certain investments, including packaged products,such as life assurance policies and unit trusts. Not permitted in relation to higher-volatility funds (which use gearing) or life policies with links to such funds, due to the increased investment risk involved. Cold calls are not permitted in relation to mortgage contracts. • Unsolicited telephone calls or visits must only be made at‘an appropriate time of the day’. Within the industry,this is generally taken to mean between 9am and 9pm Monday to Saturday. • The caller must check that the recipient is happy to proceed with the call. • The caller must also give a contact point to any client with whom they arrange an appointment.

Answer 644

In addition to abiding by the rules laid down in industry‑specific regulations, advertisements for financial services and financial products (whether delivered via print, broadcast media, eg TV and radio, or non‑broadcast media, eg online) must meet the standards laid down by the Advertising Standards Authority (ASA). All advertisements should be: legal, ie containing nothing that breaks the law, or incites anyone to do so, and omitting nothing that the law requires; decent, ie containing nothing that is likely to cause serious or widespread offence, judged by current prevailing standards of decency; honest, ie not exploiting the credulity, lack of knowledge or inexperience of consumers; truthful, ie not misleading by inaccuracy, ambiguity, exaggeration, omission or any other means. In relation to ‘decency’, particular care should be taken with sensitive issues such as race, religion, sex or disability. The ASA can take action against individuals and organisations whose advertising contravenes its rules, from requiring an advertisement to be amended or withdrawn, to taking legal action.

Answer 645

Traditionally many investment advisers charged for their services, in full or in part, through the receipt of a commission payment from the providers of products they recommended. This led to concerns that advice could be ‘skewed’ in favour of providers or products that offered the highest commission rates. Since 1 January 2013, a firm advising on investment business must only be remunerated for its services by adviser charges; it is no longer allowed to receive commission from the product providers for the products it recommends. Furthermore, it must not accept any other commissions or benefit of any kind from any other party, even if it intends to refund the payment or pass some or all of the benefits to the client. The charging structure should be based on the service provided, rather than the product/provider recommended. Charges should be explained as part of the initial disclosures to a customer. Any continuing charges can only be made where the customer has agreed to these and where the service for which these charges are levied is actually provided. The firm can determine its charging structure for its services. This can be a standard charging structure that applies to all clients, based on an hourly rate, or can be based on a percentage of the amount being invested, but the firm must pay due regard to the client’s best interests. The charging structure must be clear, fair and not misleading and not conceal in any way the amount or purpose of any of its adviser charges from the client. For example, a firm cannot make arrangements for amounts in excess of its adviser charge to be deducted from a client’s investment, even if it is with the intention of making a cash refund of some or all of it to the client at a later date. The firm must ensure that the charging structure it discloses to its client at the outset reflects as closely as possible the total charges that are to be paid. If the firm’s charging structure is based on hourly rates, it must state whether the rates are ‘indicative’ or actual and provide an approximate indication of the number of hours that the provision of each service is likely to require. A firm cannot use an adviser charging structure that entails payments by the client over a period of time unless the service being provided is ongoing and this is disclosed to the client at the outset. The client must be provided with a right to cancel the service, without penalty and without having to give a reason. The FCA is eager to ensure that any ongoing service that is charged for is actually delivered by the adviser. The firm must provide details of its charges during the initial disclosures and, once the final charges are known, it may include the information about total adviser charges in a suitability report.

Answer 646

Before any business is discussed, the adviser must disclose to the client certain information about themselves, the services they provide and the costs of those services. The information which must be provided and confirmed in writing includes the following: Contact information – the name and address of the firm and contact details necessary to enable a client to communicate effectively with the firm. Communication – the methods of communication used between the firm and the client. Authorisation – a statement of the fact that the firm is authorised and the name of the regulator that has authorised it (the FCA if in the UK; otherwise, the name of the competent authority that has authorised the firm – ie in relation to MiFID business). Advice type – whether the advice being provided is independent or restricted, and if restricted, the nature of the restriction. If a firm offers both, it must clearly explain the different nature of the independent advice and restricted advice services. Investment management – if the firm manages investments on behalf of a client, the method and frequency of investment evaluation, details of any delegation of the discretionary management of all or part of the client’s portfolio, and the types of designated investments that may be included in the client’s portfolio. Client money or investments – if the firm holds designated investments or client money for a retail client, that that money may be held by a third party on behalf of the firm, responsibility of the firm for any acts or omissions of that third party, and the consequences of the insolvency of that third party. Charging structure/method – this may be in the form of a list of the advisory services offered with the associated indicative charges which will be used for calculating the charge for each service. Charges payable – the total adviser charge payable by a client in cash terms (or equivalent). If payments are to be made over a period of time, the firm must include the amount and frequency of each payment due, and the implications for the client if a retail investment product is cancelled before the adviser charge is paid. Details of complaints procedures, including FOS and FSCS – the firm must make available to a client who has used or intends to use their services details of their complaints procedures and explain the protections offered by the Financial Services Compensation Scheme (FSCS) and the Financial Ombudsman Service (FOS). We cover both of these in Topic 25. Clients must be notified in good time of any material change to the services the firm is providing to that client. For existing clients, the firm need not treat each of several transactions as separate, but does need to ensure that the client has received all relevant information in respect of a subsequent transaction, such as details of product charges that differ from those disclosed for a previous transaction.

Answer 647

If a firm carries out designated investment business, other than advising on packaged investment products, the firm must enter into a written basic agreement with the client, setting out the essential rights and obligations of the firm and the client. Designated investment business is dealing in investment assets directly on behalf of a client, as opposed to selling packaged investment products. It often involves making investment decisions on behalf of the client, exercising discretion as to investment choice and switching from one to another without having to gain the client’s individual agreement for every separate transaction. The types of product involved may include equities, options and futures contracts. A client agreement is not usually required for packaged investments, such as life assurance policies and personal pensions, although these may well be used as part of the whole arrangement alongside the higher‑risk instruments. In addition to providing the client with information about the firm and its services (as listed in section 20.7), the client must be given, in the form of a client agreement, the terms upon which the adviser is to operate in respect of the client’s investments. This will include investment range and limits.

Answer 648

An adviser, whether independent or restricted, will make a personal recommendation. They must not make a personal recommendation unless they are satisfied that the recommendation is suitable. This means the adviser must have fully ascertained the client’s personal and financial circumstances relevant to the services that the adviser has agreed to provide.

Answer 649

As we saw in Topic 14, the start point is to complete a confidential client information questionnaire or ‘factfind’, which will capture a range of information. That information must be retained for a specified period of time, depending on the nature of the product recommended. In practice, advisers retain information in all cases for as long as they believe they might be required to justify the advice and recommendations given. Retaining the information will help the firm to deal with complaints, provide an audit trail for advice and provide evidence of compliance with regulatory requirements. Once the factfind is completed, the adviser can formulate their recommendations. To ensure that recommendations are suitable, the adviser needs to consider a number of factors, such as ensuring that the recommendation: meets current and likely future needs; is affordable, both initially and on an ongoing basis; is consistent with the customer’s risk profile; is flexible, to take account of future changes.

Answer 650

The suitability 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 of risks that might need to be discussed include: whether or not the customer’s capital will be returned in full; the extent to which income levels from an investment may vary or the circumstances in which no income may be paid at all; the factors on which a customer’s income from a pension product will depend; any factors that might affect a customer’s ability to make a claim on a protection product; whether or not the level of life cover is sustainable for the duration of the term without an increase in premiums. The nature and extent of the discussion will depend on the client’s experience and knowledge of the type of product under consideration. In assessing the suitability of any recommendations, the adviser must be sure to first establish the client’s attitude to and ability to tolerate risk.

Answer 651

Advisers must recommend the product or service that is most suitable for the client, based on the information supplied by the client and on anything else about the client of which the adviser should reasonably be aware. The recommendation must be solely in the best interests of the client and no account should ever be taken of the remuneration that may be payable to the adviser. A suitability report explains why the particular product recommended is suitable for the client based on: their particular personal and financial circumstances; their needs and priorities as identified through the fact‑finding process; and their attitude to risk (both in general terms and in relation to the specific recommendations made). Figure 20.5 shows the products for which a suitability report is required. Note that the FCA does not require a suitability report to be provided in respect of mortgage advice, although many lenders will prepare one. The report should also identify any potential disadvantages of the transaction for the client, such as any ‘lock‑in’ period during which an investment cannot be encashed. It should be clear, concise and written in plain English, in line with the general FCA requirement for communications to be clear, fair and not misleading. Suitability requirement is required for life policys, unit trusts, OEICs, pension policies, pension transfers and opt outs, ect

Answer 652

When providing investment advice to a retail client and in the case of life policies, a firm must, before the transaction is concluded, provide the client with a suitability report. In the case of telephone selling, if, prior to the conclusion of the contract, the information is provided orally or in a durable medium other than paper, the suitability report for a life policy must be provided immediately after the conclusion of the life policy. For a personal pension or stakeholder pension, where cancellation rights apply, the report must be sent no later than the fourteenth day after the contract is concluded. In any other case, the report should be provided when or as soon as possible after the transaction is effected or executed.

Answer 653

CONTENT OF A KEY FEATURES DOCUMENT A key features document must include: a brief description of the product’s aims; a brief description of how the product works; the key terms of the contract, including any consequences of failing to maintain the commitment or investment; the material risks involved; the arrangements for handling complaints about the product; that compensation is available from the FSCS; that a right to cancel or withdraw exists (or does not exist), and if it does, its duration, the conditions for exercising it, any amount the client might have to pay, and where the notice must be sent.

Answer 654

Since 1 January 2018 a key information document (KID) must be provided if a customer is buying a packaged retail and insurance‑based investment product (PRIIP). A PRIIP is defined as an investment where the amount repayable to the retail investor is subject to risk and fluctuation as a result of exposure to reference values or the performance of assets not directly held by the client; or an insurance-based product that is exposed to market fluctuations. A PRIIPs KID is a short pre-sale disclosure document to give retail investors the necessary information to make an informed investment. It must include specific key information on an investment product in a prescribed way and in a standard format, so that retail investors can assess and compare products. The key information to be disclosed in the PRIIPs KID includes: the nature and features of the product, including whether it is possible to lose capital; the costs and risk profile of the product; relevant performance information. PRIIPs regulation aims to improve the transparency and comparability of investment products across the EU through KIDs. The purpose of the requirements is to ensure that: there is consistency between the information that different providers make available to their customers; the information provided covers certain key relevant areas; the information is presented in an easy‑to‑understand manner; it is easier for investment customers to make meaningful comparisons between providers. The KID must be no longer than three sides of A4 and the language used must be plain, concise and easy to understand. It must contain certain key information about the investment including: product name; name of the provider; main features; any possible risks; any return that could be gained by investing; costs and charges; details of the complaints procedure. Key investor information document (KIID) An investor who is subscribing to a UCITS must be provided with a key investor information document (KIID). The purpose of the KIID is to summarise the key features and risks of the UCITS to provide investors with sufficient information to make an informed investment decision. The KIID is a two‑page document that describes key fund information in concise and plain language. The KIID is split into the following five sections: objectives and investment policy; risk and reward profile; charges; past performance; practical information. The KIID contains a synthetic risk and reward indicator (SRRI) – a numerical scale from one to seven (low risk to high risk–reward potential), based on the volatility of a UCITS’s past performance. The SRRI is intended to allow investors to easily compare investment products (Matheson, 2017). KIIDs and KIDs provide important information about the fund, including its charges, risk rating and investment profile. The key difference is that PRIIPs KIDs show forward-looking performance scenarios, while UCITS KIIDs show actual historical performance data.

Answer 655

When a client buys a regulated packaged or insurance product, they have the right to change their mind and withdraw from the contract within a specified period, known as the cooling‑off period. The provider is required to send the client a statutory cancellation notice, which explains the process. The time period is usually either 14 or 30 days depending on the product type: For life and pensions policies, and contracts of insurance that are, or have elements of, a pure protection contract or payment protection, the period is 30 days. For investments or deposits and other insurances, the period is 14 days. Binding mortgage offers trigger a seven‑day reflection period. During this time the offer is binding on the lender, but the consumer can accept or reject the offer at any time. 20 The cooling‑off period runs from the date when the contract begins or from the date on which the client receives contractual terms if this is later. The client can withdraw from the contract without penalty at any time during the cooling‑off period, without any commitment or loss, by signing and returning the cancellation notice to the product provider. Generally, the client will receive a full refund of any premiums paid if they cancel the contract during this period and this must be provided within 30 days of receipt of the cancellation notice. The exception to this is if the client invests in a lump‑sum unit‑linked investment (such as a unit trust, OEIC or investment bond), the money has been invested and the value of the investment has fallen. Under these circumstances, the client is entitled to a refund of the reduced investment; no charges can be taken but an adjustment can be made to reflect the fall in value of the investment. The aim is to prevent people cancelling due to falls in the market. This risk should be explained to the client before they enter into the contract. At the time the product purchase is made, the adviser must also explain whether the client is liable to pay any outstanding adviser charges if they decide not to proceed with the product and send back the signed cancellation notice. It is important that a firm can evidence that a cancellation notice is issued to a customer since, if they fail to do so, the customer can choose to cancel at any time and will not be liable for any loss (including a fall in investment value).

Answer 656

The maintenance of clear and readily accessible records is vital at all stages of the relationship between financial services professionals, their clients and the FCA, 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. The minimum retention period varies according to the type(s) of product recommended. Records can be kept in any appropriate format, which includes computer storage, although the rules say that records stored on a 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.. In addition to the record‑keeping requirements that firms must observe to comply with COBS, there are rules relating to the prevention of money laundering and to the Data Protection Act 2018 (and UK General Data Protection Regulation). We will look at these in Topics 23 and 24 respectively.

Answer 657

The maintenance of clear and readily accessible records is vital at all stages of the relationship between financial services professionals, their clients and the FCA, 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. The minimum retention period varies according to the type(s) of product recommended. Records can be kept in any appropriate format, which includes computer storage, although the rules say that records stored on a 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.. In addition to the record‑keeping requirements that firms must observe to comply with COBS, there are rules relating to the prevention of money laundering and to the Data Protection Act 2018 (and UK General Data Protection Regulation). We will look at these in Topics 23 and 24 respectively.

Answer 658

1) The law of agency. When carrying out designated investment business, the adviser acts as the agent of the client.

Answer 659

A/ No recommendations is provided

Answer 660

3) c) A restricted adviser generally focuses on a limited selection of products or providers.

Answer 661

4) As the individuals are not existing customers, contacting them by telephone would constitute cold calling, which is not permitted in relation to mortgage contracts. Additionally, cold calls may only be made at an ‘appropriate time of day’ – evenings (to 9.00pm) and Saturdays would be permissible but not Sundays.

Answer 662

5) c) Advisers have discretion to determine their charging structures but they must pay due regard to the best interests of the client.

Answer 663

6) d) The client agreement letter.

Answer 664

7) a) Gilt‑edged securities. Key features or key information documents must only be provided in relation to packaged products, and gilt‑edged securities are a direct investment rather than a packaged product.

Answer 665

8) a) 30 days from the date when the contract begins or from the date on which the client receives contractual terms, if this is later.

Answer 666

9) c) Suitability reports are not required for mortgages, although many lenders do issue them

Answer 667

10) b) She invested a lump sum into a unit‑linked plan. The value of the investment fell between the date of her original investment and her cancelling the bond.

Answer 668

The FCA’s rules on mortgage advice are detailed in the Mortgages and Home Finance: Conduct of Business (MCOB) sourcebook. The rules cover lending, administration, advice and the arranging of loans. Banks, building societies, specialist lenders and mortgage intermediaries must be authorised to carry out these activities. In terms of training and competence requirements, every seller must hold a relevant mortgage qualification (such as CeMAP®). Mortgage advisers, arrangers and lenders fall within the remit of the Financial Ombudsman Service and the Financial Services Compensation Scheme. When the FCA’s predecessor, the FSA, began regulating mortgage advice in 2004, its rules covered loans taken out by individuals or trustees that were subject to a first charge on the borrower’s property. This included not only mortgages but also other loans where the security was a first charge on residential property. As a consequence of the way the provisions of the EU Mortgage Credit Directive were implemented in the UK, the scope of MCOB was extended in March 2016 to cover second charge loans. A regulated mortgage, subject to MCOB is defined as a contract that satisfies the following conditions: the lender provides credit to an individual or trustees (the borrower); the contract provides for the obligation of the borrower to repay to be secured on land; and at least 40 per cent of that land is used or intended to be used, as or in connection with a dwelling. As the UK left the European Union on 1 January 2021, the meaning of ‘land’ has now been modified as follows: For regulated mortgage contracts entered into before the UK left the EU, ‘land’ refers to: — land in the United Kingdom; or — if the contract was entered into on or after 21 March 2016, land in the UK or within the European Economic Area (EEA) at the time the contract was entered into. For regulated mortgage contracts entered into from 1 January 2021, ‘land’ refers to: — land in the United Kingdom only. This means that the regime covers home improvement loans, debt consolidation loans and equity release schemes such as lifetime mortgages and home reversion schemes. The Mortgage Credit Directive (MCD) introduced a new category of consumer buy to let (CBTL). Advising on, arranging, lending and administering CBTL mortgages is subject to a legal framework detailed in the MCD Order 2015, rather than the MCOB rules. The FCA is responsible for regulating, supervising and, if necessary, taking action against firms engaged in CBTL activity. Whilst the MCOB rules do not apply in full, the government has prescribed rules in respect of the sale, underwriting and administration of CBTL mortgages. The rules include requirements in respect of: pre‑contract disclosure; assessing creditworthiness; arrears management. APPLICATION OF MCOB MCOB applies to: first‑charge loans secured on residential property; second‑charge loans secured on residential property.

Answer 669

To understand what is meant by ‘consumer buy to let’, it is helpful to compare it to ‘business buy to let’, which is not regulated. Business BTL activity is carried out by professional landlords who, typically, have one or more BTL properties that they run as a business to generate profit. A consumer BTL mortgage is defined as one where the mortgage has not been entered into wholly or predominantly for the purpose of a business carried out by the borrower. The regulation of consumer BTL mortgages is aimed at providing protection for those who have taken out a BTL mortgage more as a result of circumstances than from a particular desire to operate a BTL business. Such scenarios could include a person who needs to relocate for their job but is unable to sell their property, or someone who has inherited a property that they have opted to rent out because it proves difficult to sell. In such circumstances it would be reasonable to assume that the individual would not have the same experience or expertise as a person who owns a portfolio of BTL properties; hence the additional protections provided by the conduct standards applying to CBTL mortgages. Lenders can use their own procedures to establish whether a borrower is a business and therefore not subject to the conduct standards applying to CBTL mortgages; they can also rely on the customer completing a declaration to confirm they are a business borrower. If a mortgage is taken out to support the purchase of a property that is to be let out to a close relative then, unless the mortgage meets the criteria to be classed as a business buy to let, the mortgage is regulated under the MCOB rules, rather than the CBTL regime. MCOB defines a close relative as being a spouse, civil partner, parent, brother, sister or grandparent of borrower.

Answer 670

A summary of the provisions of MCOB is provided here. MCOB 1: Application and purpose Explains the scope of the rules, ie to whom they apply and for what types of mortgage. MCOB 2: Conduct of business standards: general Includes: the use of correct terminology (‘early repayment charge’ and ‘higher lending charge’); the requirement for communications with customers to be ‘clear, fair and not misleading’; rules about the payment of fees/commission and the accessibility of records for inspection by the FCA. MCOB 2A: Mortgage Credit Directive: Includes rules on a range of matters that apply to a lender classed as a Mortgage Credit Directive mortgage lender, including: remuneration; the tying of products (making a mortgage conditional on the purchase of other products); foreign currency loans; and early repayments. MCOB 3A: Financial promotions and communications with customers Distinguishes between ‘real‑time’ promotions (by personal visit or telephone call) and ‘non‑real‑time’ (by letter, email, or adverts in newspapers and magazines, or on television, radio or the internet). Unsolicited real‑time promotions are not permitted. Non‑real‑time promotions must include the name and contact details of the firm. They must be clear, fair and not misleading. If comparisons are used, they must be with products that meet the same needs. They must state that “your home may be repossessed if you do not keep up repayments on your mortgage”. Records of non‑real‑time promotions must be retained for one year after their last use. MCOB 3B: MCD general information Specifies the requirements relating to information that must be provided to customers, for lenders who make mortgage advances regulated under the Mortgage Credit Directive. MCOB 4 and 4A: Advising and selling standards It must be clear whether advice is based on the products of the whole market, a limited number of home finance providers, or a single lender. Independent advisers are not required to be able to access all products from all providers: they can source products from a panel of lenders as long as the panel is representative of the market. Any mortgage recommended must be suitable for the customer and appropriate to their needs and circumstances; records to demonstrate this must be kept for three years. However, there is no requirement to issue a suitability report to the client. Special requirements apply if the mortgage will be used to consolidate existing debts. On first making contact with a customer, certain information must be disclosed prominently and clearly to the customer. An initial disclosure document (IDD) can be given to detail the required information, but this is not a formal requirement as long as the required information is clearly communicated. The customer must be provided with the following information: name and contact details; whose mortgages are offered; details of any limitations in service; details of any fee payable for the mortgage advice; the firm’s FCA registration details; how to complain; and details of the compensation scheme. MCOB 5 and 5A: Pre‑application disclosure Details the information that must be provided at the point at which a personal recommendation is made and before an application is submitted to the lender. This must include: the annual percentage rate of charge (APRC), which shows th the amount by which the instalment would increase for each 1 per cent rise in interest rates. The required information must be provided via a European Standardised Information Sheet (ESIS). The contents of the ESIS are set out in the rules, and variations from the prescribed format are not permitted. MCOB 6 and 6A: Disclosure at the offer stage If a mortgage offer is made, the lender must provide a detailed offer document. This is based on the information given at pre‑application stage, subject to any changes between application and offer illustration. The offer is binding on the lender but can be made conditional on the confirmation of certain details. The offer must also: state how long the offer will remain valid; point out that there will be no right of withdrawal after the mortgage has been completed; and include or be accompanied by a tariff of charges. The borrower must be granted a period of reflection of at least seven days to consider whether to accept the offer or not. MCOB 7 and 7A: Disclosure at start of contract and after sale Before the first mortgage payment is made, the lender must confirm: details of amounts, dates and methods of payment; details of any related products such as insurance; (for interest‑only mortgages) the responsibility of the borrower to ensure that a repayment vehicle is in place; and what the customer should do if they fall into arrears. Annual statements must be issued, showing: the amount owed and remaining term; what type of mortgage it is; for interest‑only mortgages, a reminder to check the performance of the repayment vehicle; interest, fees or other payments made since the last statement; any changes to the charges tariff since the last statement. If the mortgage is arranged on an interest‑only basis, then the lender must contact the borrower at least once during the term to confirm that a credible repayment vehicle remains in place interest rate with any fees added; the amount of the monthly instalment If a change is to be made to the monthly payment, the customer must be informed of the new amount, revised interest rate and date of the change. MCOB 8 and 9: Equity release – advising and selling standards, and product disclosure Details the FCA’s requirements in respect of lifetime mortgages and home reversion schemes. Special rules apply to equity release in relation to advising and selling standards, and to product disclosure. The FCA Training and Competence rules require that anyone giving advice on equity release must hold a specialist qualification in this area of business. MCOB 10: Annual percentage rate (APR) Describes how to calculate APR (see section 22.1.1). MCOB 10A: Annual percentage rate of charge Describes how to calculate APRC (see section 22.1.1). MCOB 11 and 11A: Responsible lending Lenders must put in place a written responsible lending policy, and must be able to show that they have taken into consideration a customer’s ability to pay when offering a mortgage. MCOB 12: Charges Excessive charges are not permitted. Early repayment charges must be a reasonable approximation of the costs incurred by the lender if the borrower repays the full amount early. Similarly, arrears charges must be a reasonable approximation of the cost of additional administration as the result of a borrower being in arrears. MCOB 13: Arrears and repossessions Firms must deal fairly with customers who have mortgage arrears or mortgage shortfall debt. This includes: trying to reach an agreement on how to repay the arrears, taking into account the borrower’s circumstances; liaising with third‑party sources of advice; not putting unreasonable pressure on customers in arrears; repossessing a property only when all other reasonable measures have failed; only applying arrears charges that are a reasonable reflection of the costs of the work involved in dealing with the arrears. Records must be kept of all dealings with borrowers in arrears. Customers in arrears must be given the following information within 15 working days of the lender becoming aware of arrears: the MoneyHelper information sheet ‘Problems paying your mortgage’; the missed payments and the total of arrears including any charges incurred; the outstanding debt; any further charges that may be incurred unless arrears are cleared.

Answer 671

The MCOB rules specify that one of two different levels of service can be provided: advice; execution only. There is no scope to offer an information‑only service, whereby the borrower selects their own mortgage based on information provided. The execution‑only service can only be provided in a limited range of situations defined in the MCOB rules, ie for transactions involving business borrowers, high‑net‑worth individuals and mortgage professionals. Evidence that the individual falls into one of these categories must be retained. In the case of joint applications where only one party is a mortgage professional, advice has to be given to the non‑professional. Should a customer opt for execution only, then the lender is required to make customers aware of the consequences of proceeding on an execution‑only basis. A mortgage adviser must take reasonable care to: establish (from the prospective borrower) all information that is likely to be relevant; ensure that the advice they give is suitable given the customer’s circumstances and needs. Three steps to mortgage suitability Assess whether a mortgage is, in itself, a suitable product for the client ➡️ Assess what type of mortgage is suitable, eg repayment, interest-only, interest scheme, additional features ➡️ Select best mortgage and mortgage provider to meet client’s needs and circumstances If it is established that a mortgage is suitable, then the next stage is to recommend a suitable mortgage contract. The following questions must be considered: Which mortgage type is most suitable? Repayment, interest-only or a combination of the two? Which interest rate option is most suitable? Fixed, variable, capped, etc? Over how long a term should the mortgage run? What are the costs involved? Are they affordable? There is no requirement under MCOB to issue a suitability report although many lenders will do so.

Answer 672

Mortgage lenders must verify income for every mortgage application, and verification must be provided from a source independent of the borrower. A lender must be able to demonstrate that the mortgage it is proposing is affordable, taking into account specific categories of expenditure (committed expenditure and basic essential expenditure). In assessing long‑term affordability, lenders can take into account positive expected changes, if they have evidence to support such changes. In respect of interest‑only mortgages, the lender must be satisfied that there is a clear and credible alternative source of capital repayment in place; if not, affordability must be assessed on a repayment basis. Lenders must take reasonable steps to ensure that the mortgage proposed is affordable not just at the time the application is assessed but on an ongoing basis. This is achieved by means of a stress test, which involves checking that an applicant will be able to afford the payments if interest rates should rise.

Answer 673

Firms and individuals working in the areas of general insurance, protection, critical illness, long‑term care and income protection insurance have to be authorised through the same processes of permission and approval as those that apply to the rest of the industry. Rules applicable to intermediaries who sell, administer or advise on general insurance are contained in the Insurance: Conduct of Business Sourcebook (ICOBS). The ICOBS rules are split into eight sections, which are summarised here. ICOBS 1: Application Explains that the rules cover firms that deal with retail and commercial customers for the sale of non‑investment insurance products. The activities regulated by these rules include: insurance distribution activities; effecting and carrying out contracts of insurance; managing the underwriting capacity of a Lloyds syndicate as a managing agent at Lloyds; communicating or approving a financial promotion. ICOBS 2: General matters Covers categorisation of clients: policyholders (anyone who, upon the occurrence of the contingency insured against, is entitled to make a claim); customers (anyone who makes arrangements preparatory to concluding a contract of insurance, ie a prospective policyholder). Customers are further categorised as: consumers (natural persons for purposes outside his or her profession); commercial customers (anyone who is not a consumer). ICOBS 2 also covers: communications (which must be clear, fair and not misleading); inducements (managing conflicts of interest fairly, and not soliciting or accepting inducements that would conflict with a firm’s duties to its customers); record‑keeping; and ‘exclusion of liability’ (a firm must not seek to exclude or restrict liability unless it is reasonable to do so). ICOBS 3: Distance communications Covers rules that ensure compliance with distance marketing disclosure rules, which include the following: A firm must provide a consumer with distance marketing information before the conclusion of a distance consumer contract. The identity of the firm and the purpose of the call must be made explicitly clear at the beginning of any telephone communications. Contractual obligations must be communicated to a consumer during the pre‑contractual phase, and these obligations must comply with the law presumed to apply to a distance contract. Terms and conditions must be communicated to a consumer in writing before the conclusion of a distance contract. The consumer is entitled to receive a copy of the contractual terms and conditions in hard copy on request. ICOBS 3 also covers e‑commerce activities and states that a firm must make the following information easily, directly and permanently accessible: name and address; details of the firm (including email address) that allow it to be contacted in a direct and effective manner; status disclosure statement, and confirmation that it is on the FCA Financial Services Register, including its FCA register number. Other rules include that any: prices advertised must be clear and unambiguous, and the firm must indicate whether the price includes relevant taxes; and unsolicited commercial communication sent by email must be clearly identifiable as such as soon as it is received. ICOBS 4: Information about the firm, its services and remuneration States that a firm must provide a customer with at least the following information before the conclusion of an initial contract of insurance and, if necessary, on its amendment or renewal: its identity, address and whether it is an insurance intermediary or an insurance undertaking; whether it provides a personal recommendation about the insurance products offered; the procedures for making complaints to the firm and the FOS or, if the FOS does not apply, information about the out‑of‑court complaint and redress procedures available for the settlement of disputes. An insurance intermediary must also provide the customer with the following information: the fact that it is included in the FCA Register and the means for verifying this; whether it has a direct or indirect holding representing 10 per cent or more of the voting rights or capital in a given insurance undertaking (that is not a pure reinsurer); whether a given insurance undertaking (that is not a pure reinsurer) or its parent undertaking has a direct or indirect holding representing 10 per cent or more of the voting rights or capital in the firm; and whether it is representing the customer or is acting for and on behalf of the insurer. Where an insurance intermediary proposes or advises on a contract of insurance then before the conclusion of the initial contract, the intermediary must provide information on whether the firm: gives a personal recommendation on the basis of a fair and personal analysis; or is under a contractual obligation to conduct insurance distribution exclusively with one or more insurance undertakings; or neither of the above apply. In which case it must provide its customer with the name of those insurance undertakings with which the insurance intermediary may, and does, conduct business. Where a firm has given the above information, before the conclusion of an initial contract of insurance with a consumer, a firm must also state whether it is giving: a personal recommendation, but not on the basis of a fair and personal analysis; other advice on the basis of a fair analysis of the market; other advice not on the basis of a fair analysis of the market; or just information. A firm must provide details to a customer of any remuneration, including fees, commission and economic benefits of any kind given in connection with the contract in good time before the conclusion of the initial contract of insurance, amendment or renewal. The firm must inform its customer of the amount of any fee, where payable. An insurance intermediary must, on a commercial customer’s request, promptly disclose the commission that it or any associate may receive in connection with a policy. ICOBS 5: Identifying client needs and advising States that: a firm should take reasonable steps to ensure that a customer only buys a policy from which they are eligible to claim benefits; if a firm finds that parts of the cover do not apply, they should inform the customer so that they can make an informed choice; a firm should explain the duty not to misrepresent information, what this includes, and the consequences of deliberate, reckless or careless misrepresentation; prior to the conclusion of a contract a firm must specify, on the basis of information obtained from the customer, their needs; a statement of demands and needs must be communicated in writing to the customer in a clear and accurate manner, comprehensible to the customer; the firm must take reasonable steps to ensure the suitability of its advice to any customer who is entitled to rely upon its judgement, taking account of level of cover and cost, relevant exclusions, excesses, limitations and conditions – it must inform the customer of any demands and needs not met. ICOBS 6: Product information and 6A: Product specific rules An insurer is responsible for producing, and an insurance intermediary for providing to a customer, the product information required by ICOBS 6. ICOBS 6 states that a firm must take reasonable steps to ensure a customer is given appropriate information about a policy so that they can make an informed choice about the arrangements proposed. The information given will vary according to matters such as: knowledge, experience and ability of a typical customer for the policy; policy terms, benefits, exclusions, limitations, conditions and duration; the policy’s complexity; whether the policy is purchased in connection with other products and services; distance communication information requirements; and whether the same information has been provided to the customer previously. When dealing with a consumer, a firm must provide an Insurance Product Information Document (IPID) in a durable medium. The IPID is drawn up by the manufacturer of the policy. A firm should provide evidence of cover promptly after the inception of a policy. Information disclosed ‘pre‑contract’ includes the arrangements for handling complaints and the right to cancel. Before a pure protection contract is concluded, a firm must provide the customer with information, including: the name of the insurance undertaking and its legal form; address of its head office; the definition of each benefit and option; contract term; the means of terminating the contract; means of payment and duration of premiums; tax arrangement for benefits under the policy; cancellation information; arrangements for handling complaints. 6A: Product-specific rules Applies to firms that sell guaranteed asset protection (GAP) contracts to customers in connection with the sale of a vehicle. A GAP contract is insurance covering a policyholder in the event of total loss to a vehicle, and it is the difference between: the amount claimed under the policyholder’s vehicle policy in respect of the loss; and an amount calculated in accordance with the GAP contract. ICOBS 7: Cancellation States that a consumer has the right to cancel without penalty, and without giving a reason, within: 30 days for a contract of insurance which is, or has elements of, pure protection (eg critical illness) or payment protection; 14 days for any other contract of insurance or distance contract (such as home insurance). Firms are free to offer more generous cancellation terms than this, provided they are favourable to the consumer. The right to cancel does not apply to the following: travel policies of less than one month; policies the performance of which has been fully completed; pure protection policies of six months or less, which are not distance contracts; pure protection policies effected by trustees of an occupational pension scheme, or employers (or partners) for the benefit of employees (or partners); general insurance (which is not a distance contract or payment protection contract) sold by an intermediary who is an unauthorised person; and a connected contract which is not a distance contract. On receipt of the cancellation notice, the insurance company must return all premiums paid within 30 days, and the contract is terminated. ICOBS 8: Claims handling If claims are handled by an intermediary, the insurance company must ensure that the rules are complied with, ensuring no conflict of interest. Claims must be handled promptly and fairly, and the firm must provide reasonable guidance to help the policyholder make a claim. The firm must not unreasonably reject a claim. Rejection of a claim is considered unreasonable if it is for: non‑disclosure of a material fact which the policyholder could not reasonably have expected to have disclosed; non‑negligent misrepresentation of a material fact; breach of a condition of the contract unless the circumstances of the claim are connected to the breach.

Answer 674

The Banking: Conduct of Business Sourcebook (BCOBS) applies to firms accepting deposits from UK banking customers in the UK, for example by providing savings and current accounts. BCOBS complements the Payment Services Regulations, which prescribe the way that payments are to be undertaken within the European Economic Area (EEA). The BCOBS rules are designed in such a way as not to overlap with the provisions of the Payment Services Regulations. Those areas of the Payment Services Regulations not covered by BCOBS are addressed by the Standards of Lending Practice (see section 21.7), overseen by the Lending Code Standards Board. BCOBS has eight chapters, which are summarised here. BCOBS 1: Application BCOBS applies to firms that accept deposits from banking customers, if such activities are carried on from an establishment maintained by the firm in the UK, and activities connected with accepting such deposits. BCOBS 2: Communications with banking customers and financial promotions Requires a firm to pay regard to the information needs of banking customers when communicating with, or making a financial promotion to them, and to communicate information in a way that is clear, fair and not misleading. BCOBS 2A: Restriction on marketing or providing an optional product for which a fee is payable Details the rules applying to marketing or providing an optional product (linked to a current account or savings account) for which a fee is payable. BCOBS 3: Distance communications and e‑commerce Applies to a firm that carries on any distance marketing activity from an establishment in the UK, with or for a consumer in the UK. BCOBS 4: Information to be communicated to banking customers and statements of account Details how a firm must provide or make available to banking customers appropriate information about a retail banking service and any deposit made in relation to that retail banking service. BCOBS 5: Post‑sale requirements A firm must provide a service in relation to a retail banking service that is prompt, efficient and fair to a banking customer and which has regard to any communications or financial promotion made by the firm to the banking customer from time to time. This includes dealing with customers in financial difficulty, those that wish to move bank accounts, and lost and dormant accounts. BCOBS 6: Cancellation Sets out a customer’s rights to cancel in various circumstances, and when there are no rights to cancellation. BCOBS 7: Information about current account services Requires a firm to publish information about its provision of personal current accounts and business accounts. BCOBS 8: Tools for personal current account customers Requires a firm to make available a cost calculator tool and an overdraft eligibility tool either online or via an app and to provide alerts to personal current account customers about their personal current account usage.

Answer 675

The Banking: Conduct of Business Sourcebook (BCOBS) applies to firms accepting deposits from UK banking customers in the UK, for example by providing savings and current accounts. BCOBS complements the Payment Services Regulations, which prescribe the way that payments are to be undertaken within the European Economic Area (EEA). The BCOBS rules are designed in such a way as not to overlap with the provisions of the Payment Services Regulations. Those areas of the Payment Services Regulations not covered by BCOBS are addressed by the Standards of Lending Practice (see section 21.7), overseen by the Lending Code Standards Board. BCOBS has eight chapters, which are summarised here. BCOBS 1: Application BCOBS applies to firms that accept deposits from banking customers, if such activities are carried on from an establishment maintained by the firm in the UK, and activities connected with accepting such deposits. BCOBS 2: Communications with banking customers and financial promotions Requires a firm to pay regard to the information needs of banking customers when communicating with, or making a financial promotion to them, and to communicate information in a way that is clear, fair and not misleading. BCOBS 2A: Restriction on marketing or providing an optional product for which a fee is payable Details the rules applying to marketing or providing an optional product (linked to a current account or savings account) for which a fee is payable. BCOBS 3: Distance communications and e‑commerce Applies to a firm that carries on any distance marketing activity from an establishment in the UK, with or for a consumer in the UK. BCOBS 4: Information to be communicated to banking customers and statements of account Details how a firm must provide or make available to banking customers appropriate information about a retail banking service and any deposit made in relation to that retail banking service. BCOBS 5: Post‑sale requirements A firm must provide a service in relation to a retail banking service that is prompt, efficient and fair to a banking customer and which has regard to any communications or financial promotion made by the firm to the banking customer from time to time. This includes dealing with customers in financial difficulty, those that wish to move bank accounts, and lost and dormant accounts. BCOBS 6: Cancellation Sets out a customer’s rights to cancel in various circumstances, and when there are no rights to cancellation. BCOBS 7: Information about current account services Requires a firm to publish information about its provision of personal current accounts and business accounts. BCOBS 8: Tools for personal current account customers Requires a firm to make available a cost calculator tool and an overdraft eligibility tool either online or via an app and to provide alerts to personal current account customers about their personal current account usage.

Answer 676

The Payment Services Regulations (PSRs) cover most payment services, including the provision and operation of ‘payment accounts’. Payment accounts are accounts on which payment transactions may be made and where access to funds is not restricted (a fixed‑term deposit is an example of a restricted account). The regulations extend from the information that is to be provided before a payment is made to the remedial action a firm must take if a payment goes wrong. PSRs apply to banks, building societies, e money issuers, non bank merchants, money remitters, non bank credit card issuers. The PSRs introduced a new class of regulated firms known as payment institutions (PIs). These are businesses authorised to process payments by card, credit transfer or direct debit, to issue or acquire payment instruments and to remit money. If not exempt, a PI must either be authorised or registered by the regulator. Authorised PIs are subject to prudential requirements. Conduct of business requirements apply to all payment service providers, including banks, building societies, e‑money issuers and PIs.

Answer 677

The Payment Services Regulations (PSRs) cover most payment services, including the provision and operation of ‘payment accounts’. Payment accounts are accounts on which payment transactions may be made and where access to funds is not restricted (a fixed‑term deposit is an example of a restricted account). The regulations extend from the information that is to be provided before a payment is made to the remedial action a firm must take if a payment goes wrong. PSRs apply to banks, building societies, e money issuers, non bank merchants, money remitters, non bank credit card issuers. The PSRs introduced a new class of regulated firms known as payment institutions (PIs). These are businesses authorised to process payments by card, credit transfer or direct debit, to issue or acquire payment instruments and to remit money. If not exempt, a PI must either be authorised or registered by the regulator. Authorised PIs are subject to prudential requirements. Conduct of business requirements apply to all payment service providers, including banks, building societies, e‑money issuers and PIs.

Answer 678

PSD2 came into effect on 13 January 2018 and is a significant evolution of existing regulation for the payments industry. It aims to increase competition in the payments industry, brings into scope new types of payment services, enhance customer protection and security, and extend the reach of the Directive. Even though the UK left the EU, PSD2 continues to apply to financial service providers in the UK. The key changes introduced by PSD2 can be grouped into four main themes: market efficiency and integration; consumer protection; competition and choice; and security. PSD2 increases consumers’ rights in a number of ways. For example: Payments sent or received where one of the payment service providers (PSPs) is located outside the EEA are covered, as are payments in non‑EEA currencies. The amount a payer can be obliged to pay in an unauthorised payment scenario has reduced from €150 to €50, except in cases of fraud or gross negligence by the payer. PSD2 bans surcharging for the use of payment instruments covered by the Interchange Fee Regulation and payment services covered by the SEPA Regulation. PSPs must put in place dispute resolution procedures and are required to respond to payment complaints within 15 business days of receipt. In exceptional circumstances, a holding reply can be provided, explaining the reasons for the delay, with the final response being received within 35 business days. To facilitate competition, banks must give third‑party providers access to their account in order to carry out the transactions. There are two key types of organisation involved in providing the services, often referred to collectively as third‑party providers or TPPs: An account information service provider (AISP) is defined in PSD2 Article (16) as an “online service to provide consolidated information on one or more payment accounts held by the payment service user”. Payment Initiation Service Providers (PISPs) are service providers that carry out transactions for the account holder, which could include person to person (P2P) transfers – an online technology that allows customers to transfer funds from their bank account or credit card to another person’s account via a mobile device using the internet – and general bill payments. In addition, PSD2 introduces another new definition: “account servicing payment service provider” (AS PSP) to distinguish the provider where the customer’s payment account is held. The PSD2 text makes it clear that customers have a right to use PIS and AIS where the payment account is accessible online and where they have given their explicit consent. There are further technical standards relating to strong customer authentication, and common and secure communication.

Answer 679

The Payment Systems Regulator (PSR) is a subsidiary of the Financial Conduct Authority (FCA). It oversees all domestic payment systems that are brought into the regulator’s scope by HM Treasury. The PSR has authority: over requirements regarding system rules; and to give directions to participants in designated payment systems. It has further specific powers to: require access to designated payment systems for a payment services provider; vary agreements relating to designated payment systems (including fees and charges); and require owners of payment systems to dispose of their interests in them, subject to the satisfaction of certain preconditions and subject to HM Treasury approval.

Answer 680

. Although the FCA’s CONC sourcebook applies, there is also a degree of self‑regulation by the industry in this area. The Lending Standards Board (LSB) publishes standards to which firms that are registered with the LSB must adhere. The Standards of Lending Practice for personal customers set out a number of principles, covering six main areas: financial promotions and communications; product sale; account management and servicing; money management; financial difficulty; customer vulnerability. The key requirements are shown in Figure 21.4. A separate set of Standards apply to business customers. The Standards of Lending Practice also have a section on governance and oversight, which sets out the framework that registered firms should have in place to ensure effective implementation of the standards. FIGURE 21.3 PRODUCTS COVERED BY THE STANDARDS OF LENDING PRACTICE Unsecure loans, credit card and charge cards and current account overdrafts. Registered firms must at all times comply with the Consumer Credit Act 1974, the Consumer Credit (EU Directive) Regulations 2010, the FCA’s Consumer Credit Sourcebook (CONC), the Equality Act 2010 and other relevant legislation. Compliance is monitored and enforced by the Lending Standards Board. FIGURE 21.4 KEY REQUIREMENTS OFTHE STANDARDS OF LENDING PRACTICE Financial promotions and communications Must be clear, fair and not misleading. Product sales Customers will only be provided with a product that is affordable and meets their needs. Account maintenance and servicing Customer requests will be dealt with in a timely, secure and accurate manner. Information provided will be clear and detail any action required by the customer. Money management Customers will be helped to manage their finances through proactive and reactive measures designed to identify signs of financial stress and help avoid financial difficulties. Financial difficulty Customers in financial difficulty will receive appropriate support and fair treatment. Customer vulnerability Firms are expected to provide inclusive products and services that take account of the broad range of customers and are flexible enough to meet the needs of customers who are classed as vulnerable. Firms are expected to have a formal strategy for dealing with vulnerable customers. Governance and oversight Firms are expected to put in place policies and procedures that ensure customers receive a fair outcome when taking out a consumer credit product and throughout all their dealings with the firm.

Answer 681

We looked earlier in this topic and in the previous topic at the principles and regulations governing the provision of advice on regulated products such as mortgages and insurance contracts. There are a number of other categories of advice that apply in certain limited circumstances: basic advice; generic advice; focused advice; simplified advice; robo advice. Following the Financial Advice Market Review (FAMR) in 2016, which was launched by HM Treasury and the FCA to explore ways in which the government, the industry and regulators could stimulate the development of a market delivering affordable and accessible financial advice and guidance to consumers, the FCA published guidance to help firms to provide ‘streamlined advice’. Streamlined advice is defined as “a personal recommendation which is limited to one or more of a client’s specific needs and does not involve analysis of the client’s circumstances that are not directly relevant to those needs” (FCA, 2016). The FCA has produced guidance on streamlined advice services, which it notes might include robo advice services (see section 21.8.3) or more traditional face-to-face or telephone-based models.

Answer 682

Basic advice is appropriate for clients who: have their priority needs met (ie they do not need to reduce existing debt, have adequate access to liquid cash, and have their core protection needs met); have some disposable income or capital that they wish to invest; do not want a holistic assessment of their financial situation, just advice on a specific investment need.

Answer 683

We looked at stakeholder pensions and the reasons for their introduction in Topic 10. When first introduced in 2001, stakeholder pensions were a popular option, and this encouraged the government to extend the range of savings and investments products. As with the stakeholder pension, the idea was that customers who might be deterred from making appropriate savings provision through a lack of confidence, lack of understanding or concerns about risk and cost would be attracted by a simple, low‑risk product with transparent charges. A suite of products was introduced, covering short‑ and medium‑term investment needs, along with the stakeholder pension and a Child Trust Fund. Charges were capped: the maximum permitted annual charge for the investment products is now 1.5 per cent for the first ten years of the life of a product and 1 per cent thereafter. For stakeholder pensions arranged prior to 6 April 2005, charges are capped at 1 per cent throughout. As stakeholder products were designed to be simple, the expectation was that they would be straightforward to sell and regulation could therefore be less complex. The ‘basic advice’ process was less costly for providers to deliver and it was hoped that that would encourage take‑up

Answer 684

Generic: • Advice or information that does not relate to a particular product or investment and does not meet the characteristics of regulated advice • For example,‘for most people it is sensible to have adequate financial protection in place’ Focused: • Where, at the request of the customer, advice and recommendations relate to specific needs or investments • Also referred to as limited advice Simplified • Advice that is limited, by the firm providing it, to one or more of a customer’s needs • Does not involve analysis of the customer’s circumstances that are not directly relevant to those needs • This type of advice may be provided face to face, over the phone or online

Answer 685

Robo‑advisers are a class of financial adviser that provide financial advice or portfolio management online with minimal human intervention. They provide digital financial advice based on mathematical rules or algorithms. This innovation is intended to provide a low‑cost alternative to face‑to‑face advice and go some way to address the advice gap left by the cost of the traditional advice model. The Treasury and FCA have been monitoring the development of this approach and in April 2017 published guidelines, making it clear that any funds offered to investors by robo‑advisers offering ‘streamlined advice’ are to be suitable for customers’ risk tolerance and investment objectives. The guidelines advise companies on the information they need to collect about investors, and warn on the importance of forming “clearly worded” risk questionnaires that do not assume “a high level of financial capability”. The FCA has suggested that robo‑advice companies could use consumer testing and web analytics to monitor how long customers spend on each page of their websites.

Answer 686

1) d) The mortgage arranged for Décor Plus would not be a regulated mortgage.

Answer 687

2) a) Cold calling, because it is an unsolicited real‑time promotion.

Answer 688

3) Execution‑only transactions are permitted only for business borrowers, high‑net‑worth individuals and mortgage professionals. Even if Maurice were a high‑net‑worth client, it would not be possible to carry out the transaction on an execution‑only basis because it is not possible to opt out of advice for an equity release scheme such as a lifetime mortgage.

Answer 689

4) c) This statement is untrue because it is not possible for a customer to withdraw from the contract once the mortgage is completed.

Answer 690

5) a) Repayments on a personal loan. The others are examples of basic essential expenditure.

Answer 691

6) False. ICOBS 6 requires firms to ensure customers are given appropriate information about a policy; what is appropriate may vary depending on the customer’s knowledge, experience and ability, and the complexity of the product.

Answer 692

7) Eva may cancel her policy within 30 days as it is a protection policy.

Answer 693

9) d) Basic advice may be provided for stakeholder products.

Answer 694

10) Focused advice is provided when the customer has set parameters for the areas they wish to discuss. Simplified advice is provided when the adviser sets out specific areas of a customer’s needs for which they are providing advice.

Answer 695

The Consumer Credit Act 2006 covers the regulation of certain loans to individuals, small partnerships and unincorporated bodies (but not companies) – referred to as ‘consumer credit’. The Act sets out standards by which lenders must conduct their business. It builds on the Consumer Credit Act 1974, with the objective of increasing protection and meeting the needs of the modern marketplace, while retaining many of the basic provisions of the 1974 Act. Regulatory powers for consumer credit activities and firms involved in consumer credit were transferred to the FCA in April 2014. The regulations for firms are contained in the CONC sourcebook, which incorporates and builds on the Consumer Credit Acts. CONC contains FCA rules regarding the marketing, selling, disclosure, customer information, debt handling and administration of consumer credit, together with basic principles relating to firms’ conduct and the fair treatment of customers. Regulated mortgages, including all loans secured on an individual’s main residence, are specifically exempt from the provisions of the Consumer Credit Act and are regulated under the Mortgages and Home Finance: Conduct of Business rules (MCOB).

Answer 696

The main provisions of the Consumer Credit Act 2006 and those retained from the 1974 Act are as follows: There is generally no limit to the amount of a loan covered by the Act. Loans over £25,000 to a small business for business purposes are exempt from the regulations. High‑net‑worth borrowers can opt to be exempt from the Act, but it must be at their request rather than the lender’s requirement. Borrowers protected by the Act include an ‘ordinary’ borrower or a partnership with three or fewer members. Although sole traders and unincorporated associations are covered under the Act, other businesses are outside the legislation. Complaints relating to credit arrangements regulated through the Act can be taken to the Financial Ombudsman Service (FOS). There are provisions to increase the fair treatment of borrowers. Borrowers must be given a copy of the credit agreement in writing. Borrowers are given a cooling‑off period of 14 days from the latter of the contract starting or receipt of a copy of the agreement to change their mind. If the borrower exercises this option, they must repay any money received and any interest accrued to that point. The contract for goods linked to the borrowing is not cancelled, so the borrower must find another way to pay for them. The lender must send the cooling‑off notice with a copy of the credit agreement. Certain agreements do not benefit from the right to cancel using the cooling‑off period. Examples include bank overdrafts, small loans of £50 or less (unless they are hire purchase or conditional sale agreements), small loans of £35 or less completed away from the lender’s premises and loans to pay death duties. The annual percentage rate (APR) for the loan must be calculated using a set formula, which includes all relevant costs of setting up the loan. The APR must be shown in any advertisements or agreements.

Answer 697

One of the 1974 Act’s most significant innovations was a system for comparing the price of lending. This is the 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 the APR is specified under the terms of the Consumer Credit Act 1974 and it takes account of two main factors: the interest rate – whether it is charged on a daily, monthly or annual basis; and the additional costs and fees charged when arranging the loan, such as an application fee. The result is that the APR is higher than the interest rate being charged on the loan

Answer 698

Under the provisions of the EU Mortgage Credit Directive, a new annual percentage rate of charge (APRC) was introduced from 21 March 2016. The APRC is similar to the APR and applies to first‑ and second‑charge mortgage lending. APR applies to personal loans, credit cards and hire purchase agreements.

Answer 699

The Consumer Credit Directive (CCD) was implemented by six sets of regulations (some of which have since been repealed as part of the changes in the regulation of consumer credit). The implementing regulations apply to all consumer credit agreements regulated under the Consumer Credit Acts (CCAs), other than agreements secured on land, although there are modifications for certain types of agreement. The key changes brought about by the EU Credit Directive are as follows: A representative example must be included as part of any advertisement that shows an interest rate or a figure relating to the cost of credit. This example must include a ‘representative’ APR. Creditors must assess a borrower’s creditworthiness before granting credit or significantly increasing the amount of credit. ‘Adequate explanations’ must be provided in respect of a proposed credit agreement, to enable the borrower to assess whether the agreement meets their needs. Certain information must be provided to a borrower before they enter into a credit agreement, and there are standards for the way in which that information must be provided. Pre‑contractual information must be given in good time before the borrower enters into the agreement, and the information must be clear and easily legible. The borrower has the right to withdraw from a credit agreement within a period of 14 days (the cooling-off period) from the conclusion of the agreement, or from the point the borrower receives the agreement, if this is later. The borrower must be notified, in writing, of changes to the interest rate under the agreement, before the change takes effect. The borrower is able to seek redress from the creditor in certain circumstances if they are unable to obtain satisfaction from the supplier of the goods or services. This applies in cases where the CCAs would not normally provide for such redress, and where the value of goods or services is more than £30,000 and the credit does not exceed £60,260. The borrower can terminate an open‑ended agreement at any time, subject to giving one month’s notice. The creditor must give two months’ notice of termination of credit and must give justified reasons for termination. The borrower must be informed if the debt is to be sold to a third party. Credit intermediaries must disclose the extent to which they are acting independently or work exclusively with one or more creditors. Any fee payable to the intermediary must be disclosed up front. Where an application for credit is declined based on information supplied by a credit reference agency, the creditor must notify the borrower and provide contact details of the credit reference agency.

Answer 700

The FCA has applied certain aspects of its regulatory approach to consumer credit. While the general scope of CCA provisions remains unchanged, some aspects of the FCA’s approach are more rigorous. Consumer credit firms must be authorised by the FCA. The FCA maintains a register of firms that have been granted a consumer credit licence. FCA conduct rules apply, such as the high‑level Principles for Businesses – for example, financial promotions must be clear, fair and not misleading. The FCA expects firms that offer consumer credit to demonstrate how they ensure the fair treatment of their customers. The FCA has greater supervisory powers than the OFT had. The FCA uses its senior managers and certification regime for individuals performing roles that require FCA approval or certification. The FCA also has much greater powers than the OFT had with regard to investigation, enforcement and redress. It has dedicated supervision and enforcement teams to tackle poor practice in the industry.

Answer 701

One area on which the FCA has focused is the high‑cost, short‑term lending market, such as ‘payday’ lenders. Such lenders provide loans on what is intended to be a very short‑term basis: for example to cover a shortfall in funds between one payday and the next. Prior to the FCA’s intervention, interest rates on these types of loan were very high; borrowers who were unable to repay the loan in full at the original due date and had to ‘roll over’ the loan for an extended period found themselves having to repay far more than they had originally borrowed. Following a review of this sector of the market, the FCA introduced a cap on high‑cost, short‑term credit. Interest and fees charged must not exceed 0.8 per cent per day of the amount borrowed, default fees cannot exceed £15, and borrowers must never be required to repay more than 100 per cent of the amount borrowed by way of fees and charges.

Answer 702

The FCA’s authorisation structure for consumer credit activities comprises full and limited permission tiers. Activity requiring full permission: credit broking, P2P lending, debt collecting, credit information services The limited permission tier covers ‘lower‑risk’ activities. It is aimed at businesses outside financial services that are caught by the consumer credit legislation and regulations. Firms carrying out lower‑risk activities cannot apply for full FCA authorisation and are required to supply less information to the FCA in comparison with firms that require full authorisation.

Answer 703

The FCA has not made substantial changes to the provisions of the CCAs, which continue to provide the main framework for UK consumer credit regulation. The relevant details are contained within the Consumer Credit sourcebook (CONC), which was introduced in April 2014. A summary of the provisions of CONC is provided here. CONC 1: Application and purpose and guidance on financial difficulties Explains the purpose of CONC as a specialist sourcebook for credit‑related regulated activities, and reminds firms that the Principles for Businesses apply. There is also guidance on the FCA’s indicators that a customer is in financial difficulty. CONC 2: Conduct of business standards – general In respect of their credit‑related activities, all providers are expected to treat customers fairly and not mislead them. Examples of activities that may contravene these rules are: targeting customers with offers of credit that are unsuitable for them; high‑pressure selling, aggressive or oppressive behaviour or coercion; not allowing sufficient and reasonable time to make repayments; taking steps to repossess a customer’s home other than as a last resort. CONC 3: Financial promotions and communications with customers Much of the earlier legislation relating to the provision of quotations and advertisements was repealed and included in this section of CONC. This section details what is considered to be a ‘communication’ with a customer in relation to a credit agreement, and advises that communications should be fair and not misleading. Providers must ensure they use plain and understandable language, specify who is making the offer of credit and only make credit available based upon the consumer’s financial circumstances. CONC also introduces new rules relating to risk warnings for high‑cost, short‑term credit, such as that offered by payday lenders. Any such lending must carry the message: “Warning: Late repayment can cause you serious money problems. For help, go to moneyhelper.org” (FCA, 2021). CONC 4: Pre‑contractual requirements Deals with the content of quotations for credit and the relevant ‘health warnings’ that must be included. This is particularly significant when the customer’s home is to be used as security. In such circumstances the lender must include the statement: “Your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it” (FCA, 2014). CONC 4 also details the information a lender must provide about interest rates, charges and costs should the borrower be unable to pay. CONC 5: Responsible lending Details what a provider must do before making credit available in order to ensure that the customer can afford to maintain payments in respect of their borrowing. Creditworthiness must be confirmed based on information obtained from the prospective borrower and from a credit reference agency. The rationale behind this explicit requirement is that there was concern that some lenders of short‑term funds (such as payday lenders) were not undertaking adequate checks. CONC 5A: Cost cap for high‑cost, short‑term credit Details the maximum charges that can be applied for high‑cost, short‑term credit (such as that provided by payday lenders). Broadly speaking, the payment of any charge, when combined with other charges applied under the terms of the agreement, cannot exceed an amount more than that borrowed. CONC 5B: Cost cap for high‑cost, short‑term credit This imposes a total credit cap of 100 per cent on rent-to-own agreements, meaning firms cannot charge more than the cost of the product. Firms must also benchmark their base prices (including delivery and installation) against the prices charged by three mainstream retailers on the high street. CONC 5C: Overdraft pricing This requires firms to implement and maintain overdraft charging structures that are simple, transparent and capable of easy comparison. It forbids firms from obliging a customer to pay a rate of interest for an unarranged overdraft that exceeds the rate of interest for an arranged overdraft. CONC 5D: Overdraft repeat use Firms must monitor customers’ patterns of overdraft use, identify patterns of repeat use and take appropriate steps with the aim of changing such patterns of use. CONC 6: Post‑contractual requirements Covers the checks a lender must undertake if they significantly increase the lending to a customer under a regulated agreement, eg increasing an overdraft or the credit limit on a credit card. Creditworthiness must be assessed if there is a significant increase in lending. This section also details the action a lender must take if a customer exceeds their overdraft limit, which is to contact the customer in writing without delay. CONC 7: Arrears, default and recovery (including repossessions) CONC 7 states that providers must have appropriate policies and procedures for dealing with customers whose accounts fall into arrears, and must treat such customers fairly and reasonably. This includes being aware of customers who are considered vulnerable, for example, customers with mental health difficulties. Another aspect of this regulation is that it covers debt collection and debt administration activities, and the organisations that undertake such work. This area of consumer credit was previously unregulated. CONC 8: Debt advice Debt advice can be undertaken by third‑party debt counsellors and other organisations that provide information. Failure to pay proper regard to the different debt‑solution options available to consumers, or to the differences in enforcement actions and procedures available, is likely to contravene the Principles for Businesses. Examples include recommending a debt solution that is unaffordable to the consumer, or discouraging a consumer from seeking an alternative source of debt counselling. CONC 9 used to set out requirements for credit rating agencies but has now been deleted. CONC 10: Prudential rules for debt management firms Details the rules for debt management firms (those that manage repayments to creditors on the behalf of an individual) and small, not‑for‑profit debt advice bodies to ensure that the relevant financial and management resources are in place. CONC 11: Cancellation Covers the cancellation rights of peer‑to‑peer lenders and those providers that make services available over the internet. CONC 12–15 and Appendix 1 Deal with some of the less common areas of consumer credit. Appendix 1 contains the rules relating to the total charge for credit, what it applies to and how it is calculated.

Answer 704

1) b) A further advance for house repairs of £15,000. Regulated mortgages, including further advances for any purpose, are exempt from the CCAs. Rather, these loans would be regulated under MCOB.

Answer 705

1) b) A further advance for house repairs of £15,000. Regulated mortgages, including further advances for any purpose, are exempt from the CCAs. Rather, these loans would be regulated under MCOB.

Answer 706

2) It allows consumers to compare products more accurately, as the APR includes not only the interest rate but also any fees and charges that apply to the product.

Answer 707

2) It allows consumers to compare products more accurately, as the APR includes not only the interest rate but also any fees and charges that apply to the product.

Answer 708

3) False. Partnerships with three partners or fewer and sole traders are covered by the CCAs, as well as ‘ordinary’ borrowers and unincorporated associations.

Answer 709

4) Fourteen days from the conclusion of the agreement, or from the point the consumer receives the agreement if this is later.

Answer 710

4) Fourteen days from the conclusion of the agreement, or from the point the consumer receives the agreement if this is later.

Answer 711

5) c) The lender must advise the applicant of the reason for rejecting their application and provide details of the credit reference agency used.

Answer 712

5) c) The lender must advise the applicant of the reason for rejecting their application and provide details of the credit reference agency used.

Answer 713

6) False. Full permission is required for debt counselling services that are carried out on a commercial basis.

Answer 714

7) One hundred per cent of the original amount borrowed.

Answer 715

8) A representative example that includes a representative APR.

Answer 716

9) True. These provisions are included under CONC 5: Responsible lending.

Answer 717

10) Debt collection and debt administration.

Answer 718

Money laundering involves filtering the proceeds of any kind of criminal activity (including terrorism) through a series of accounts or other financial products in order to make such funds appear legitimate or to make their origins difficult to trace. It will generally not be easy to spot someone who is trying to launder money; criminals carrying out money laundering will use sophisticated techniques. Examples of where the financial services industry has been used in an attempt to launder money include: opening an account with a small initial deposit and then adding large sums in cash; making an investment into a collective investment which is then encashed within a short period of time; arranging a mortgage or loan that is then quickly paid off using cash. A significant proportion of transactions that are identified as suspicious take place in banks and reports of suspicious transactions also come in from building societies, finance companies, credit card providers, money service businesses such as bureaux de change, accountants, tax advisers, solicitors and estate agents, among others. Financial services firms have a legal duty to take steps to mitigate the risk of money laundering; in the UK, the key legislation is the Proceeds of Crime Act 2002, the Terrorism Act 2000 and the EU’s Money Laundering Directives.

Answer 719

The National Crime Agency (NCA) works to combat serious and organised crime. Although it is a UK body, it works in partnership with law enforcement agencies internationally; the nature of serious and organised crime makes such cross‑border co‑operation essential. Its National Economic Crime Centre is responsible for tackling money laundering, fraud, bribery and corruption, and counterfeiting of currency.

Answer 720

Concealing criminal property • Criminal property is property that a person knows, or suspects, to be the proceeds of any criminal activity • It is a criminal offence to conceal, disguise, convert or transfer criminal property Arranging knows, or suspects, to be the proceeds of any criminal activity • It is a criminal offence to conceal, disguise, convert or transfer criminal property Arranging occurs when a person becomes involved in a process that they know or suspect will enable someone else to acquire,retain, use or control criminal property (where that other person also knew or suspected that the property derived from criminal activity Acquiring, using or processing It is a criminal offence for a person to acquire, use or possess any property when that person knows or suspects that the property is the proceeds of criminal activity

Answer 721

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 they have reasonable grounds for knowing or suspecting that someone is engaged in money laundering. It is also an offence to disclose to (ie tip off) a person who is suspected of money laundering that an investigation is being, or may be, carried out.

Answer 722

The Terrorism Act 2000 defines ‘terrorism’ as the use or threat of serious violence against a person or serious damage to property or electronic systems, with the purpose of influencing a government, intimidating the public or advancing a political, religious or ideological cause. The Act specifically mentions as an offence “the retention or control of terrorist property, by concealment, removal from the jurisdiction, transfer to nominees or in any other way” – in other words, money laundering. ‘Terrorist property’ is defined as: money or other property that is likely to be used for terrorism purposes; proceeds of the commission of acts of terrorism; proceeds of acts carried out for the purposes of terrorism.

Answer 723

The key EU legislation relating to money laundering is the Money Laundering Regulations, which implement the EU’s Money Laundering Directives. Directive The EU’s Third Money Laundering Directive (2005) repealed and consolidated two earlier directives. The Directive defines money laundering in some detail. It comprises “the following conduct when committed intentionally: the conversion or transfer of property, knowing that such property is derived from criminal activity or from an act of participation in such activity, for the purpose of concealing or disguising the illicit origin of the property or of assisting any person who is involved in the commission of such activity to evade the legal consequences of his action; the concealment or disguise of the true nature, source, location, disposition, movement, rights with respect to or ownership of property, knowing that such property is derived from criminal activity or from an act of participation in such activity; the acquisition, possession or use of property, knowing, at the time of receipt, that such property was derived from criminal activity or from an act of participation in such activity; participation in, association to commit, attempts to commit and aiding, abetting, facilitating and counselling the commission of any of the actions mentioned in the foregoing paragraphs”. Three more important definitions are included, in order to clarify this definition of money laundering: property is assets of every kind, tangible or intangible, movable or immovable, as well as legal documents giving title to such assets; criminal activity is a crime as specified in the Vienna Convention (the United Nations Convention Against Illicit Traffic in Narcotic Drugs) and any other criminal activity designated as such by each member state; criminal property is defined as property that consists, directly or indirectly, wholly or in part, of a benefit from criminal conduct, where the alleged offender knows or suspects that it constitutes a benefit. The Directive specifies that money laundering that takes place within the EU will be treated under EU money laundering rules, even if the activities that generated the property to be laundered took place in a non‑EU country.

Answer 724

In response to recommendations made by the Financial Action Task Force (FATF), the European Commission adopted a fourth Money Laundering Directive on 26 June 2015. The provisions of the directive were implemented in the UK in June 2017 and the Money Laundering Regulations and the Proceeds of Crime Act were updated. The aim was to strengthen the anti‑money‑laundering (AML) regime. Key elements of the Money Laundering Regulations 2017 include: a requirement to adopt a risk‑based approach to the implementation of AML measures such as customer due diligence (ie to understand the nature of the threats faced and devote most resources to the areas of greatest risk). A relevant person must produce a written AML risk report and translate its findings into written policies to be approved by the firm’s senior management; a widened definition of ‘politically exposed persons’, including those holding prominent positions in their home country. Politically exposed people are those individuals who, because of their position, are considered to be more vulnerable to corruption; the introduction of a new criminal offence. An individual found guilty of recklessly making a statement in the context of money laundering that is false or misleading may face a fine and/or a maximum two‑year jail sentence. The fourth Money Laundering Directive also: includes ‘tax crimes’ within EU legislation for the first time; strengthens co‑operation between member states; increases transparency around the beneficial ownership of legal entities – each member state must maintain a central register of the beneficial owners of legal entities (beneficial owners are those who own or control 25 per cent of a legal entity). In the UK, legislation requiring businesses to maintain a register of individuals having significant control came into effect in April 2016. This had to be strengthened as it only applied to companies, not to other legal entities such as trusts and therefore did not fully meet the requirements of the Fourth Money Laundering Directive. The Money Laundering and Transfer of Funds (Information) (Amendment) (EU Exit) Regulations 2018, published on 13 November 2018, ensures that the UK’s anti‑money‑laundering regime and counter‑terrorism financing legislation continues to work effectively even though the UK withdrew from the EU.

Answer 725

The Fifth Money Laundering Directive came into force in the UK on 10 January 2020. The scope of the new directive was broadened to include additional entities, such as virtual currency providers, art traders for transactions of €10,000 or more and estate agents acting as intermediaries for properties let at €10,000 per month. It also introduced changes regarding electronic money, including: A new maximum monthly payment transaction limit of €150 for non- reloadable payment instruments, and where the maximum amount stored electronically exceeds €150, they are now subject to customer due diligence (CDD) measures. The threshold has been reduced from €250 to €150. Remote payment transactions that exceed €50 are subjected to customer due diligence measures. The threshold has been reduced from €100 to €50. The directive also introduced changes to customer due diligence and beneficial ownership registers, such as: The identification and verification of customers must be based on documents, data or information from a reliable and independent source, which should also include electronic identification means that have been approved by national authorities. Any member of the public has the right to access beneficial ownership information held in the register for corporate and other legal entities. Access is no longer limited to persons who can demonstrate legitimate interests. Implementing requirements to harmonise the enhanced due diligence (EDD) measures for entities across member states to apply to business relationships with high risk third countries (Deloitte, 2018). The Sixth Money Laundering Directive was implemented in the EU in June 2021. Any UK regulated business in the financial sector operating in the EU must therefore comply with these new regulations.

Answer 726

The Financial Action Task Force (FATF) is an inter‑governmental organisation established in 1989 to co‑ordinate the international fight against money laundering. In 2001, the remit of the FATF was expanded to include terrorist financing. It is a policy‑making body: it does not become involved in law enforcement (that is the responsibility of local authorities in individual countries, such as the National Crime Agency in the UK). In addition to member nation states, the European Commission and the Gulf Co‑operation Council also belong to the FATF. The work of the FATF falls into three main areas: setting appropriate standards for national anti‑money‑laundering programmes, detailed in a list of 40 recommendations incorporating minimum standards for the measures that countries should have in place within their own criminal justice and regulatory systems; evaluating the extent to which individual countries have implemented these standards; identifying trends in money‑laundering methods. The FATF also maintains a list of “non‑cooperative countries and territories”, which it considers do not have adequate anti‑money‑laundering measures.

Answer 727

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, referred to as ‘customer due diligence’ or CDD. CDD is required in relation to transactions that are seen as higher risk. Figure 23.2 summarises the circumstances in which evidence of identity is required. CIRCUMSTANCES REQUIRING IDENTIFICATION PROCEDURES TO BE CARRIED OUT New business relationship:When entering into a new business relationship (particularly when opening a new account, or selling a new investment or policy). Occasional transactions exceeding 1500 When the value of an ‘occasional’ transaction exceeds €15,000, whether as a single transaction or as a series of linked transactions. Note that for a business trading in goods and services the threshold is €10,000. Life assurance policy: When the value of annual premiums exceeds €1,000, or €2,500 for single premiums. Suspicion: of money laundering Doubts: Where there are doubts about proof of identity that has previously been obtained. Change of circumstances If a client is introduced to the firm by a financial intermediary or another authorised firm, it is permissible for the firm to rely on identification carried out by the intermediary or other firm. This is important to, for instance, financial advisers and mortgage advisers. Under the terms of the Money Laundering Regulations 2017, an intermediary must provide the customer with the due diligence information it has obtained. The definition of what constitutes satisfactory evidence of identity is rather vague – evidence should be reasonably capable of establishing that the applicant is the person they claim to be, to the satisfaction of the person who obtains the evidence. Acceptable forms of identification are shown in Figure 23.3. Utility bill, passport, entry of electronic role, driving licence and national identity card.

Answer 728

Some people’s personal circumstances are such that they are unable to provide any of the documents included in Figure 23.3. For instance, a person who has never travelled abroad, does not drive a car and is not responsible for household bills may well be unable to produce a passport, driving licence or utility bill bearing their name. Nevertheless, it is important that people in these situations are not denied access to appropriate financial services. In such circumstances, the FCA 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.

Answer 729

Institutions must keep appropriate records in respect of customer due diligence for use as evidence in any investigation into money laundering. This means that: evidence of identification must be retained until at least five years after the relationship with the customer has ended; supporting evidence of transactions (in the form of originals or copies admissible in court proceedings) must be retained until at least five years after the transaction was executed. Remember also that there are record‑keeping requirements that relate to COBS (see Topic 21), and we will look in Topic 24 at the requirements in relation to GDPR.

Answer 730

Anti‑money‑laundering checks are often carried out by credit reference agencies on behalf of financial institutions. While the search leaves an anti‑money‑laundering ID footprint, this will not show up in a credit search, nor will it affect an individual’s ability to obtain credit.

Answer 731

The FCA has an operational objective to ensure the integrity of financial markets. To help achieve this, the FCA requires that all authorised firms must have systems and controls in place which mitigate the risk that the firms may be used to commit financial crime, including money laundering. The FCA details its requirements in the Senior Management Systems and Controls (SYSC) section of the Handbook and requires that all authorised firms: establish accountabilities, procedures and systems to minimise the risk of money laundering; give responsibility for anti‑money‑laundering systems and controls to a senior manager; appoint a money laundering reporting officer (MLRO) (see section 23.6.1); have a documented risk policy related to money laundering; give regular training to staff about what is expected of them under the money‑laundering rules, including the consequences for the firm and for themselves if they fail to comply; educate their staff about potential problems; take reasonable steps to ensure that procedures are up to date and reflect any findings contained in periodic reports on money‑laundering matters issued by the government, by the Financial Action Task Force (FATF) and the FCA’s own guidance on financial crime; requisition a report at least once in each calendar year from the MLRO; take appropriate action to strengthen its procedures and controls to remedy any deficiencies identified by the report. The FCA expects that firms have procedures in place to ensure that individuals working within the firm: report suspicious circumstances by completing ‘suspicious activity reports’ (SARs); refrain from alerting persons being investigated. The FCA has the power to take enforcement action against firms and to impose sanctions on them for non‑compliance with Money Laundering Regulations. When assessing a firm’s compliance with its money‑laundering requirements, the FCA will take into account the extent to which the firm has followed the: Joint Money Laundering Steering Group’s guidance notes for the financial sector – these describe the steps that firms should take to verify the identity of their customers and to confirm the source of their customers’ funds; publications of the FATF – these highlight any known developments in money laundering and any deficiencies in the money‑laundering rules of other jurisdictions; FCA’s own guidance on financial exclusion – see section 23.5.1.

Answer 732

The Joint Money Laundering Steering Group is made up of the leading UK trade associations in the financial services industry. Its aim is to promote good practice in countering money laundering and to give practical assistance in interpreting the UK money‑laundering regulations. This is primarily achieved by the publication of guidance notes.

Answer 733

Each firm must appoint a money laundering reporting officer (MLRO) with responsibility for co‑ordinating all the firm’s AML activities. The MLRO must be a person of ‘appropriate seniority’. 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 Crime Agency, using known information about the financial circumstances of the client and the nature of the business being transacted. Such reports are known as ‘suspicious activity reports’ (SARs). At least once in each calendar year senior management of the firm must requisition a report from the MLRO. This report must: assess the firm’s compliance with the Joint Money Laundering Steering Group guidance notes; indicate how Financial Action Task Force findings have been used during the year; provide information about reports of suspected money‑laundering incidents submitted by staff during the year. A firm’s senior management must consider this report and must take any action necessary to solve any problems identified.

Answer 734

Training should be given on a regular basis throughout the time that an individual handles transactions that could facilitate money laundering.

Answer 735

The FCA can discipline firms and individuals for breaches of money‑laundering rules, as described in section 23.6. 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. Anyone convicted under the Proceeds of Crime Act 2002 of concealing, arranging or acquiring (see section 23.2) 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. A partner or director who fails to comply with money laundering regulations can be fined, receive up to two years in prison (or both) or be subject to appropriate civil penalties.

Answer 736

The Bribery Act 2010, which came into effect in July 2011, created an offence of offering, promising or giving “financial or other advantage” to another where the advantage is intended to bring about improper performance by another person of a relevant function or activity, or to reward such improper performance. An offence is also deemed to have been committed if the person offering, promising or giving the advantage knows (or simply believes) that acceptance of the advantage itself constitutes improper performance. The offence applies to bribery relating to any function of a public nature, connected with a business, performed in the course of a person’s employment or performed on behalf of a company or other body. The function or activity may be carried out either in the UK or abroad, and need have no connection with the UK. The Act also makes it an offence to request, agree to receive, or accept “financial or other advantage”, where the person requesting the ‘bribe’ performs their function or activity improperly (or intends to) as a result of the ‘reward’ requested or received. The maximum penalty in the UK for an individual convicted of a bribery offence is an unlimited fine and imprisonment for up to ten years.

Answer 737

1) a) It could mean that they had knowingly become involved in the process of converting criminal property.

Answer 738

2) False. Transferring, disguising, concealing or converting criminal property is an offence, no matter what form of criminal activity the funds derive from.

Answer 739

4) d) A member of staff who has reasonable grounds for believing that a person is involved in money laundering is obliged to report the suspect transactions.

Answer 740

5) b) By alerting the customer to the fact that they were suspicious about the unusual transaction, the cashier potentially committed the offence of ‘tipping off’.

Answer 741

6) a) The threshold is €15,000, meaning that customer due diligence will be carried out in a greater number of situations.

Answer 742

7) 25 per cent.

Answer 743

8) d) Identification procedures must always be carried out for new clients, so the most likely reason why Forward Bank did not carry them out in this case is that the procedures were carried out instead by an intermediary.

Answer 744

9) The National Crime Agency.

Answer 745

10) c) The firm should review and if necessary improve the firm’s processes and training in the light of the report.

Answer 746

Interacting with a financial services institution inevitably involves the customer providing personal information; in Topic 23, for example, we looked at the process of customer due diligence, which requires the customer to prove their identity in order to complete a transaction. If such information is not handled appropriately and stored securely, then not only does the firm breach the customer’s right to privacy, it also exposes the customer to the risk of becoming a victim of crime as a result of identity theft. Until May 2018, the EU data protection legislation was the Data Protection Directive of 1995. The primary UK legislation in relation to data protection was the Data Protection Act 1998. To update the EU legislation, particularly in relation to online activity and the rise of social media, a General Data Protection Regulation came into force in May 2016 and each EU member state was required to adopt its provisions by 25 May 2018. The primary UK legislation became the Data Protection Act 2018.

Answer 747

Personal data is valuable to fraudsters. Details such as an individual’s name, address and date of birth – sometimes pieced together and supplemented from a number of sources – can be used to open bank accounts, take out credit cards, order goods, take over the victim’s original accounts or apply for key documents such as a passport or driving licence. The latter items can then be used to facilitate further criminal activity. The prevention of fraud arising from identity theft falls within the remit of the FCA, as part of its objectives to reduce financial crime and enhance consumer protection.

Answer 748

On 25 May 2018, the General Data Protection Regulation (GDPR) came into effect in the UK. It applies to ‘personal data’, which is information relating to an individual who can be identified (for example, by name, identification number, location data or online identifier). This reflects changes in technology and the way information is collected. The GDPR applies to both automated personal data and to manual records containing personal data. The provisions of the GDPR were retained in UK Law as ‘UK GDPR’ at the end of the Brexit transition period.

Answer 749

The basis of the UK GDPR is a set of six data protection principles, which all relate to the processing of personal data. The data must be: 1) Processed lawfully, fairly and in a transparent manner in relation to individuals. 2) Collected for specified, explicit and legitimate purposes and not further processed in a manner that is incompatible with those purposes; further processing for archiving purposes in the public interest, scientific or historical research purposes or statistical purposes shall not be considered to be incompatible with the initial purposes. 3) Adequate, relevant and limited to what is necessary in relation to the purposes for which they are processed. 4) Kept accurate and up to date. Every reasonable step must be taken to ensure that personal data that are inaccurate, having regard to the purposes for which they are processed, are erased or rectified without delay. 5) Kept in a form which permits identification of data subjects for no longer than is necessary for the purposes for which the personal data are processed, although archiving is allowed in certain circumstances. 6) Processed in a manner that ensures appropriate security of the personal data, including protection against unauthorised or unlawful processing and against accidental loss, destruction or damage, using appropriate technical or organisational measures.

Answer 750

Some of the relevant definitions are as follows: Data subject – an individual (a natural person) whose personal data is processed. Personal data – information that can directly or indirectly identify a natural person. This information can be in any format. Special categories of personal data – this data is more sensitive and so needs more protection. Generally (although there are exceptions) such data can only be processed if the individual has given explicit consent. Sensitive data includes information about an individual’s: — race; — religious beliefs; — political persuasion; — trade union membership; — sexual orientation; — health; — biometric data; — genetic data. Processing – this has a very broad meaning, covering all aspects of owning data, including: — obtaining the data in the first place; — recording of the data; — organisation or alteration of the data; — disclosure of the data, by whatever means; — erasure or destruction of the data. Data controller – this is the ‘legal’ person who determines the purposes for which data are processed and the way in which this is done. The data controller is normally an organisation/employer, such as a company, partnership or sole trader. They have prime responsibility for ensuring the data protection requirements are adhered to. Data processor – this is a person who processes personal data on behalf of the data controller. An organisation must have a lawful basis for processing data. At least one of the following must apply when processing personal data. 1) Consent – clear consent has been given by the individual to process their personal data for a specific purpose. 2) Contract – the processing is necessary for a contract between the organisation and the individual, or because the individual has asked for certain steps to be taken before entering into a contract. 3) Legal obligation – the processing is necessary for the organisation to comply with the law. 4) Vital interests – the processing is necessary to protect someone’s life. 5) Public task – the processing is necessary for the organisation to act in the public interest. 6) Legitimate interests – the processing is necessary for the organisation’s legitimate interests or the legitimate interests of a third party, unless there is a good reason to protect the individual’s personal data which overrides those legitimate interests. A data subject has a number of rights, including the right to: access personal data through subject access requests (under UK GDPR, no charge can generally be made for this); correct inaccurate personal data; have personal data erased, in certain cases; object; move personal data from one service provider to another. In order to demonstrate compliance with the UK GDPR, an organisation must: establish a governance structure with roles and responsibilities; keep a detailed record of all data processing operations; document data protection policies and procedures; carry out data protection impact assessments for high-risk processing operations. The UK GDPR contains rules on the transfer of personal data to receivers located outside the UK that are separate controllers or processors. These rules apply to all transfers, no matter the size of transfer or how often they are carried out. Only the controller or processor who initiates and agrees to the transfer is responsible for complying with the UK GDPR rules on restricted transfers. A restricted transfer can be made if the receiver is located in a third country or territory, is an international organisation, or is in a particular sector in a country or territory covered by UK ‘adequacy regulations’.

Answer 751

Serve information notices Requiring organisations to provide the Information Commissioner’s Office with specified information within a certain time period Serve assesment notices To conduct compulsory audits to assess whether organisations’ processing of personal data follows good practice. Issue undertakings Committing an organisation to a particular course of action in order to improve its compliance. Issue monetary policy penalty notices Notification that the organisation is to be subject to a financial penalty as a result of a serious breach of the UK GDPR Serve enforcement notices and stop now notices Requiring organisations to take (or refrain from taking) specified steps in order to ensure they comply with the law Those who commit criminal offences under the UK GDPR. Conduct Consensual assesment To check organisations are complying. Issue a ban A temporary or permanent ban on data protection can be imposed

Answer 752

The following are criminal offences. For a data controller to fail to comply with an information or enforcement notice. Failure to make a proper notification to the Information Commissioner. ‘Notification’ is the way in which a data controller effectively registers with the Information Commissioner’s Office by acknowledging that personal data are being held and by specifying the purpose(s) for which the data are being held. Processing of data without authorisation from the Commissioner. Intentionally or recklessly re-identifying individuals from data that is pseudonymised – it can no longer be attributed to a specific person without the use of additional information, which is kept separately – or anonymised – it does not relate to a natural person or has been processed so the data subject cannot be identified (ICO, no date). The maximum penalty is the higher of £17.5m or 4 per cent of an organisation’s total annual worldwide turnover in the previous financial year.

Answer 753

The regulation of work-based (ie occupational) pension schemes remains 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, financial advisers should have a good knowledge of matters relating to work-based schemes, in order, for instance, to be able to advise individuals who are members of such schemes or employers who may be considering establishing a scheme. The Pensions Regulator (TPR) is responsible for the regulation of work-based pension schemes (as well as some personal pension schemes), and it aims to: ensure employers enrol their staff onto a work-based pension scheme (known as ‘automatic enrolment’); protect the benefits of a work-based pension scheme, as well as people’s savings; protect the benefits of personal pension schemes where there is a direct pay arrangement; promote good administration of work-based schemes, as well as people’s savings; reduce the risk of situations arising that might lead to claims for compensation from the Pension Protection Fund (see section 24.3); maximise employer compliance with duties and safeguards under the Pensions Act 2008; minimise any adverse impact on the sustainable growth of an employer (TPR, 2022). The Pensions Regulator aims to identify and prevent potential problems rather than to deal with problems that have arisen, and takes a risk-based approach to its work. It assesses the risks that might prevent it from meeting its statutory and operational objectives, such as inadequate funding, inaccurate record-keeping, lack of knowledge or understanding on the part of the trustees, or even dishonesty or fraud. The regulator considers the combined effect of: 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 that represent a lower risk. To protect the security of members’ benefits, the TPR has a range of powers, and these fall broadly into the three categories shown in Figure 24.2. The Pensions Act 2004 requires the Pensions 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 TPR supervises pension schemes through engagement with trustees, managers and sponsoring employers of pension schemes. The TPR has worked with the FCA to develop a joint strategy for regulating the pensions and retirement income sector and works with other bodies including the Department for Work and Pensions, Pension Protection Fund and the Money and Pensions Service. The Act also introduced requirements for trustees to have a sufficient knowledge and understanding of pension and trust law, and of scheme funding and investment. Trustees must also be familiar with the trust deed and other important documents such as the scheme rules and the statement of investment principles. What are the powers of the pension regulator? Investigating schemes: • Identifying and investigating risks • Requiring all schemes to make regular returns to the regulator • Requiring trustees or scheme managers to give notification of any changes to important information, such as the types of benefit being provided by the scheme • Requiring that the regulator be informed quickly if the scheme discovers that it cannot meet the funding requirements,so that remedial action can be taken at an early stag Putting things right: • 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 day of the month following that in which they were deducted from the member’s salary) • Disqualifying trustees who are not considered fit and proper persons • Imposing fines or prosecuting offences in the criminal courts Acting against avoidance: • Preventing employers from deliberately avoiding their pensions obligations and so leaving the Pension Protection Fund to cover their pension liabilities • Issuing: – 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

Answer 754

The Pensions Act 2004 established the Pension Protection Fund (PPF) to protect members of private sector defined-benefit pension schemes in the event that a firm becomes insolvent with insufficient funds to maintain full benefits for all its scheme members. The PPF is also responsible for the Fraud Compensation Fund, which provides compensation to occupational pension schemes that suffer a loss as a result of dishonesty. The role of the PPF has been brought into focus as a growing number of occupational pension schemes have encountered financial problems. The PPF provides varying levels of compensation, depending on the circumstances of the member. There are only limited circumstances where the compensation paid is 100 per cent of the benefits being drawn or to which the member would have been entitled had the scheme remained solvent. The PPF funds the compensation payments it makes in several ways: It imposes a levy on defined-benefit schemes (there are exceptions for some schemes in certain circumstances). It takes on the assets of schemes that are transferred to the fund. It seeks recovery of assets from insolvent employers. It seeks to grow its funds through investment.

Answer 755

In Topic 2 we explored the role of the EU in financial services and the differences between directives and regulations. In Topic 19 we looked at the provisions of the Capital Requirements Directive and Solvency II. In this section we are going to look at some other examples of how EU legislation affects the provision of financial services and advice. 24.4.1 Electronic Money Regulations 2011 The second Electronic Money Directive (2EMD) was implemented in the UK on 30 April 2011, in the form of the Electronic Money Regulations 2011. The issuance of e-money has been regulated since 2002; the Electronic Money Regulations 2011 introduced new requirements for all electronic money issuers (EMIs), and new authorisation/registration and prudential standards for electronic money institutions. As part of Brexit, the UK government retained the Payment Services Regulations 2017 and the Electronic Money Regulations 2011 on UK statute books. This was achieved through the Electronic Money, Payment Services and Payment Systems (Amendment and Transitional Provisions) (EU Exit) Regulations 2018.

Answer 756

The Markets in Financial Instruments Directive (MiFID) applies to firms that provide services to clients in relation to tradeable financial instruments, which include shares, bonds, units in a collective investment, and derivatives. Life assurance, pensions and mortgages are outside the scope of MiFID. In the UK, MiFID became effective from November 2007. It is a key element of the EU Financial Services Action Plan and aims to harmonise the regulation of investment services across the EU. MiFID has the main objectives of increasing both competition and consumer protection by setting requirements in three main areas: conduct of business; organisation; market transparency. MiFID distinguishes between core and non-core activities: core activities are “investment services and activities” and non-core activities are “ancillary services”. Where a firm performs both core and non-core activities, MiFID applies to both aspects of its activities. A firm that only performs non-core activities is not subject to MiFID. MiFID includes the principle of an EU ‘passport’, meaning that a firm subject to MiFID has the right to operate throughout the EEA on the basis of a single authorisation in its home state. The aim of the directive is to make cross-border activity easier to conduct by imposing a single set of rules across the EEA. The FCA, as the body responsible for the securities industry in the UK, has written MiFID into its Handbook. Firms affected include securities and futures firms, banks conducting securities business, recognised investment exchanges and alternative trading systems. The types of investment activity covered by MiFID are summarised in Figure 24.3. Given that MiFID does not apply where a business only carries out ‘non-core activities’, UK firms are exempt from MiFID if they do not hold client money and do not advise on or arrange complex investments such as derivatives. However, any firm making use of the exemption in respect of ‘non-core’ activities will not be able to engage in cross-border business on the basis of home state authorisation. MiFID II The European Commission launched proposals for reform in 2010. These were intended to improve the functioning of financial markets in light of what was learned from the financial crisis, improve investor protection and tackle some of the issues that were missed in the original MiFID. MiFID II represents a comprehensive set of reforms covering eight main areas (see Figure 24.4). The legislation was published in June 2014 and has applied within EU member states since 3 January 2018. The onshore UK MiFID framework commenced at the end of the Brexit transition period on 31 December 2020.

Answer 757

Investment in Transferable Securities and the Alternative Investment Fund Managers Directive. Two EU directives regulate investment funds and their managers – the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive (2009) and the Alternative Investment Fund Managers Directive (AIFMD). The UK government retained both directives in UK law after Brexit. The UCITS Directive applies to regulated investment funds that can be sold to the general public throughout the EU. It aims to provide a common framework of investor protection and product control. The Directive lays down the principle of mutual recognition of authorisation that facilitates free circulation within the EU of the units of funds it covers. The funds must comply with various requirements, which include having an adequate spread of risk among their underlying investments and a high degree of liquidity to enable investors to redeem their units on demand. Since July 2011, management companies established in any EU state have been able to operate UCITS funds established in another state. The UCITS V Directive was implemented in the UK from March 2016 and aims to increase standards of investor protection and customer confidence. Since Brexit, UCITS authorised by the FCA are referred to as ‘UK UCITS’ but have lost their passporting right to market under a streamlined process in EU member states. UK UCITS wishing to market into the EU will be designated as Alternative Investment Funds (AIF) and therefore must comply with the marketing rules in the member state where the investor is located. Some member states do not permit the marketing of non-EU funds to retail investors. The AIFMD applies to the managers of AIFs that are typically sold to professional investors (eg hedge funds and private equity funds) and those funds that invest in assets which are ineligible for UCITS (eg real estate). The AIFMD provides a passporting framework for managing and marketing funds across the EU, enabling cross-border activities to be carried out. Some AIFs are sold to retail investors but cannot be marketed cross-border to a retail investor using the marketing passport. Instead, the local marketing rules in the member state where the investor is located apply. The AIFMD entered into force on 22 July 2011. The UK government retained the AIFMD in UK law after Brexit. As is the case with UCITS, AIF that are domiciled in the UK lost their passporting right to market under a streamlined process in EU member states

Answer 758

In 1988, the Second Non-Life Council Directive laid down rules for cross-frontier non-life insurance that 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 Council 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. That activity will be under the supervision of the competent authorities of the member state in which the insurance company’s head office is situated. Authorisation to carry out insurance business under the terms of this directive is granted for a particular class of insurance (or even, sometimes, for some of the risks relating to a particular class). General insurance risks are classified into a large number of categories or classes; companies can, of course, be authorised for more than one class. Directive on Insurance Mediation As well as ensuring that insurance companies can operate throughout the EU, the EU also wants to ensure that retail markets in insurance are accessible and secure. To this end, a Directive on Insurance Mediation (IMD) 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. A key aim of the IMD has been to regulate the sales standards of insurance brokers and 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 (a tied agent), carries out such activities, they are not included in the definition of insurance mediation. The Directive has established a system of registration for all independent insurance (and reinsurance) intermediaries. They must be registered with a competent authority in their home state: independent financial advisers based in the UK who are selling life assurance or general insurance must be registered with the FCA. Registration is subject to strict requirements regarding 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.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: convicted of a serious criminal offence relating to crimes against property or other financial crimes; declared bankrupt. The latest Directive requires that insurance intermediaries should hold professional indemnity insurance of at least a minimum threshold per case and a minimum in total per annum, or an amount equivalent to a percentage of annual income to a maximum limit – whichever is higher. 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 a percentage of premiums received per annum, subject to a minimum amount. 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: name and address; details of registration and means of verifying the registration; whether the intermediary has any holding of more than 10 per cent of the voting rights or capital of an insurance company; conversely, whether any insurance company has a holding of more than 10 per cent of the voting rights or capital of the intermediary; details of internal complaints procedures and of external arbitrators (eg ombudsman bureaux) to which the customer could complain; whether the intermediary is independent or tied to one or more insurance companies. In relation to the advice offered and products recommended: independent intermediaries must base their advice on analysis of a sufficiently large number of contracts available on the market to enable them to recommend, in accordance with professional criteria, a product that is adequate to meet the customer’s needs; the intermediary must give the customer (based on the information supplied by the customer) an assessment of their needs and a summary of the underlying reasons for the recommendation of a particular product. This requirement is satisfied in the UK by the use of a confidential client questionnaire, or factfind, to obtain the necessary information, and by the issue of a suitability letter to justify the specific recommendation. 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. Insurance Distribution Directive The existing IMD was replaced with effect from 1 October 2018 under the terms of the Insurance Distribution Directive (IDD). The aim is to address issues of inconsistency with regard to the way the IMD was adopted across member states and provide better consumer protection and greater legal clarity and certainty. IDD continues to apply in the UK.

Answer 759

In addition to the regulation of the financial services sector set out in EU Directives and carried out by bodies such as the FCA, there are also a number of other ways in which the activities of financial services institutions are kept under review. It is important to ensure that the investments of both shareholders and customers are being handled safely and honestly and that the institution is abiding by all the applicable laws and regulations, in the best interests of all its stakeholders. This oversight of an institution’s business can be carried out by different individuals and groups, such as auditors, trustees or compliance officers. 24.5.1 Auditors External auditors External auditors are concerned particularly with published financial statements and accounts. They are independent of the business whose accounts are being audited; they are normally firms of accountants, and it is their responsibility to provide reasonable assurance that published financial reports are free from material misstatement and are compiled in accordance with legislation and with appropriate accounting standards. They must conform to the professional standards of the Auditing Practices Board and the Accounting Standards Committee. External auditors may also be members of professional bodies, such as the Institute of Chartered Accountants in England and Wales (ICAEW) or the Association of Chartered Certified Accountants. Both bodies publish ethical codes that their members are expected to adhere to. Internal auditors Internal auditors may be in-house members of staff, or the process may be outsourced. Their basic task is to: review how an organisation is managing its risks; ascertain whether appropriate controls have been established; and evaluate and suggest improvements to control and governance processes. They check that operations are being conducted effectively and economically in line with the organisation’s policies, and that records and reports are accurate and reliable. It is not the responsibility of internal auditors to put controls and systems in place; that remains the responsibility of management. The role of the internal audit is to inform management decisions by identifying problems and recommending possible solutions. Internal auditors may be members of a professional body, such as the Chartered Institute of Internal Auditors.

Answer 760

A trustee is a person (or in some cases an organisation) whose responsibility is to ensure that any property held in trust is dealt with in accordance with the trust deed for the benefit of the trust’s beneficiaries. Examples of trusts can be found throughout the financial services industry. For instance, unit trusts are investment schemes set up under a trust deed and the trustees are the legal owners of the trust’s assets on behalf of the unit-holders. Similarly, most occupational pension schemes are set up under trust: this is important for the security of members’ benefits because it enables the pension assets to be kept separate from the employer’s business assets. The rights and duties of pension scheme trustees are set out in the Pensions Acts of 1995 and 2004. Trustees are subject to statutory requirements in respect of the way they carry out their duties. The key legislation is the Trustee Act 1925 and the Trustee Investment Act 2000. The former is concerned with the general duties of trustees, the latter with the way in which trustees deal with the investment of trust assets.

Answer 761

Firms that are authorised by the Financial Conduct Authority (FCA) or the Prudential Regulation Authority (PRA) are required to appoint a compliance officer to have oversight of the firm’s compliance function, in other words to ensure compliance with all relevant legislation and regulations. Firms are also required to appoint a money laundering reporting officer (MLRO). Both roles are senior management functions under the Senior Managers and Certification Regime (SM&CR). Responsibilities of a compliance officer will include: production and publication of a compliance manual; maintenance of compliance records such as complaints register and promotions records; responding to and corresponding with the FCA on compliance matters; ensuring that staff meet FCA requirements as regards recruitment, training, supervision and selling practices. Compliance officers may be members of a professional body, such as the Association of Professional Compliance Consultants.

Answer 762

Many professional bodies and trade associations have codes of conduct to which their members must adhere. For example, we saw in 18.6.4 that in order to receive a Statement of Professional Standing (SPS), an adviser must meet the professional standards of their professional body and declare that they adhere to its code of ethics. Other examples of codes of conduct include: The Advertising Standards Authority (described in 20.5); The Standards of Lending Practice (described in 21.7).

Answer 763

1) A data controller is legally accountable for the purposes for which data is processed and the way such processing is carried out. A data controller is a ‘legal person’ but not necessarily a ‘natural person’, ie it might be an organisation rather than an individual.

Answer 764

2) Sensitive data includes information about an individual’s: race; religious beliefs; political persuasion; trade union membership; sexual orientation; health; biometric data; genetic data.

Answer 765

2) Sensitive data includes information about an individual’s: race; religious beliefs; political persuasion; trade union membership; sexual orientation; health; biometric data; genetic data.

Answer 766

3) c) This statement is incorrect. The principle actually states that data must not be kept for longer than is necessary. In a financial services context, this will be determined by the record‑keeping requirements relating to specific products or to money‑laundering rules.

Answer 767

4) The maximum penalty for a criminal offence in relation to UK GDPR is the higher of £17.5m or 4 per cent of the organisation’s worldwide turnover of the previous financial year.

Answer 768

4) The maximum penalty for a criminal offence in relation to UK GDPR is the higher of £17.5m or 4 per cent of the organisation’s worldwide turnover of the previous financial year.

Answer 769

5) False. The Pensions Regulator is responsible for occupational pension schemes and for personal pension schemes where the employer has a direct pay arrangement.

Answer 770

5) False. The Pensions Regulator is responsible for occupational pension schemes and for personal pension schemes where the employer has a direct pay arrangement.

Answer 771

6) The Pension Protection Fund provides compensation payments to members of defined‑benefit pension schemes if a firm becomes insolvent with insufficient funds to maintain full benefits for scheme members.

Answer 772

7) c) Life assurance is not subject to MiFID.

Answer 773

8) Receipt and transmission of orders from investors, execution of those orders on behalf of customers, investment advice, discretionary portfolio management (on a client‑by‑client basis, in accordance with mandates given by investors), and underwriting the issue of specified financial instruments.

Answer 774

10) a) The FCA. Note that d) the IDD is the abbreviation for the Directive that governs insurance distribution, not for a regulatory body.

Answer 775

KEY CONSUMER RIGHTS Consumers have the right to buy products and services with confidence and have rights when things go wrong. In particular, they have the right to: clear and honest information before they buy; get what they pay for; be supplied with goods that are fit for purpose and services that are performed with reasonable care and skill; have any faults corrected free of charge, or get a refund/ replacement.

Answer 776

KEY CONSUMER RIGHTS Consumers have the right to buy products and services with confidence and have rights when things go wrong. In particular, they have the right to: clear and honest information before they buy; get what they pay for; be supplied with goods that are fit for purpose and services that are performed with reasonable care and skill; have any faults corrected free of charge, or get a refund/ replacement.

Answer 777

For many years consumer law in the UK was governed by the Supply of Goods and Services Act 1982 and the Unfair Terms in Consumer Contracts Regulations 1999 (UTCCRs). From 1 October 2015, the Consumer Rights Act 2015 (CRA) took effect, replacing and revoking the UTCCRs. The CRA applies to consumer contracts entered into from 1 October 2015 onwards and gives consumers enhanced and easier‑to‑understand rights that change the rules applying when things go wrong in relation to goods and services. The CRA covers: what to do when goods are faulty; what should happen when digital content is faulty (the first time that digital content has been covered in consumer rights legislation); how services should match up to what has been agreed, and what should happen when they do not; what should happen when goods and services are not provided with reasonable care and skill; unfair terms in contracts; greater flexibility for organisations such as the FCA or Trading Standards to respond to breaches of consumer law. The Consumer Rights Act 2015 is the first piece of consumer rights legislation to detail what should happen if a service is not provided in the manner agreed or with reasonable care and skill. Essentially, the business that provided the service must align it with what was agreed or, if this is not realistic, provide a refund.

Answer 778

For many years consumer law in the UK was governed by the Supply of Goods and Services Act 1982 and the Unfair Terms in Consumer Contracts Regulations 1999 (UTCCRs). From 1 October 2015, the Consumer Rights Act 2015 (CRA) took effect, replacing and revoking the UTCCRs. The CRA applies to consumer contracts entered into from 1 October 2015 onwards and gives consumers enhanced and easier‑to‑understand rights that change the rules applying when things go wrong in relation to goods and services. The CRA covers: what to do when goods are faulty; what should happen when digital content is faulty (the first time that digital content has been covered in consumer rights legislation); how services should match up to what has been agreed, and what should happen when they do not; what should happen when goods and services are not provided with reasonable care and skill; unfair terms in contracts; greater flexibility for organisations such as the FCA or Trading Standards to respond to breaches of consumer law. The Consumer Rights Act 2015 is the first piece of consumer rights legislation to detail what should happen if a service is not provided in the manner agreed or with reasonable care and skill. Essentially, the business that provided the service must align it with what was agreed or, if this is not realistic, provide a refund.

Answer 779

An aim of the Consumer Rights Act 2015 is to reduce the incidence of disagreements between businesses and consumers and to reduce the number of such disputes ending in court action. It is also hoped that the speed with which disputes are resolved will be improved and the associated costs reduced. In pursuit of these goals, the application of alternative dispute resolution (ADR) has been broadened and is now open to all business. ADR aims to help when a dispute with a consumer cannot be settled directly. The business involved in the dispute will engage the services of a certified alternative dispute resolution provider and must find out whether or not the consumer is willing to use the service.

Answer 780

The UTCCRs were revoked by the CRA, which reforms and consolidates the previous regime. The legislation in respect of unfair contract terms applies to consumer contracts between a business and a consumer, and to any notice that relates to the rights and obligations between a business and a consumer or purports to exclude or limit a business’s liability to a consumer. The main areas covered by the legislation are as follows. Fairness All terms in regulated contracts should be fair, with a contract or notice being deemed to be unfair if it causes a significant imbalance in respect of the rights and obligations of the various parties to the contract to the detriment of the consumer. All terms should adhere to the requirement of good faith. Any unfair term or notice will not be binding on the consumer unless they choose to be bound by it. Where an element of the contract is deemed to be unfair then the rest of the contract can continue to take effect, as long as this is practicable. Terms that may be deemed unfair include: — disproportionately high charges where the consumer decides not to proceed with services that have yet to be supplied; — terms allowing the business to determine the characteristics or subject matter after the consumer is bound; — terms allowing the business to determine the price after the consumer is bound. Transparency The written terms of a contract should be transparent and expressed in clear, easily understood language. If there is any doubt about the meaning of a written term, the interpretation most favourable to the consumer will be adopted. Good faith 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.

Answer 781

The FCA can challenge unfair terms in financial services consumer contracts. Specifically, it can: request that a firm amend or remove an unfair contract term from its future consumer contracts; and prevent a firm from imposing the term against existing customers by appealing to a court for an injunction. The FCA’s Unfair Contract Terms and Consumer Notices Regulatory Guide (UNFCOG), which is part of the FCA’s handbook, contains information on how the FCA exercises its powers. The FCA has also set out the following five key messages for firms to focus on: “Firms should take into account consumers’ legitimate interests in relation to contracts. Fairness is not contrary to the prudent management of the business, but part of it. Focusing on narrow technical arguments to justify a contract term that, in fact, may be unfair, risks future challenge. Schedule 2 to the CRA and the UTCCRs each contain an indicative and non-exhaustive list of types of terms that may be regarded as unfair. The fact that a term does not resemble any of the indicatively unfair terms listed in Schedule 2 may not in itself, remove the risk of unfairness. Firms need to assess whether a term is fair under the CRA/ UTCCRs as a whole and in the context of the particular product or service. Firms should take into account developments in legislation and relevant case law concerning the fairness and transparency of terms in consumer contracts.”

Answer 782

Many financial services products are, by nature, technical and not easy for the average customer to understand; there is a reliance on the provider and the adviser to give the customer full, accurate information that is easy to understand. It is easy to see that providing a customer with a financial product that does not meet their needs has considerably more serious implications than providing them with, say, an unsuitable lawnmower. These are among the reasons why the sector is so tightly regulated. One of the FCA’s operational objectives (see Topic 17) is to protect consumers of financial services and products from bad conduct. A step towards achieving this is to make it easier for customers to know how to complain when they feel that they have been badly treated by a financial institution or by an individual working in the industry. Customers who are not satisfied with a firm’s response to their complaint can refer the matter to a dedicated independent ombudsman bureau. In some circumstances, customers who have lost money can receive compensation. We look at these options in further detail here. It is important to note that consumers are expected to take some responsibility for the purchasing decisions they make – there can never be 100 per cent protection from the impact of making poor decisions. For instance, the FCA: makes it clear that it cannot protect investors from falls in stock market values (although it will attempt to educate consumers about the risks involved); and sets limits on the amounts of compensation the Financial Services Compensation Scheme can offer.

Answer 783

The activities of various government departments affect firms within the financial services industry and the process of advising clients: HM Treasury – the government’s economic and finance ministry, maintaining control over public spending, setting the direction of economic policy and working to achieve strong and sustainable economic growth. It is the department responsible for the regulation of financial services under the direct authority of the Chancellor of the Exchequer. The Chancellor is also responsible for the Budget. HM Revenue and Customs (HMRC) – the UK’s tax, payments and customs authority. It collects the money that pays for the UK’s public services and helps families and individuals with targeted financial support. The self‑employed and those who have further income tax to pay on their savings, capital gains or who have inheritance tax liabilities have direct contact with HMRC via the self‑assessment system. Pension providers also have dealings with them, as they need to reclaim tax taken at source from personal pension contributions. The Department for Work and Pensions – responsible for welfare, pensions and child maintenance policy. It administers the state pension and a range of working age, disability and ill‑health benefits. It also provides a useful website outlining the benefits payable and how they can be claimed: www. gov.uk/browse/benefits. National Crime Agency (NCA) – the role of the NCA is to protect the public by disrupting and bringing to justice those serious and organised criminals who present the highest risk to the UK. As we learned in Topic 23, it tackles money laundering, fraud, bribery and corruption, and counterfeiting of currency.

Answer 784

Earlier in this section we highlighted that consumer bodies have a role to play in consumer protection. Some of these are industry‑specific, such as the Money and Pensions Service (previously the Single Financial Guidance Body), whereas others have a broader remit such as Which? and Citizens Advice. We will consider each of these bodies in more detail, starting with the Money and Pensions Service

Answer 785

The Money and Pensions Service (MaPS), previously the Single Financial Guidance Body, brought three providers of government guidance together into one organisation: the Money Advice Service; The Pensions Advisory Service; and Pension Wise. MaPS is an arm’s-length body sponsored by the Department for Work and Pensions, with funding through levies on the financial services industry and pension schemes. Its mission is to help individuals to manage their personal finances as well as their circumstances allow. Its aim is to deliver a more streamlined service than the three previous providers by offering people easier access to the information and guidance they need to help them make effective financial decisions throughout their lives. The consumer-facing brand of MaPS is MoneyHelper. MaPS (2019) has five core functions: Pensions guidance: provision of information for the public about workplace and personal pensions. Debt advice: providing people in England with information and advice on debt. Money guidance: provision of information to enhance people’s understanding and knowledge of financial matters and day‑to‑day money management skills. Consumer protection: working with the government and the FCA to protect consumers. Strategy: working with all bodies involved in financial capability to drive significant, co-ordinated change over the longer term.

Answer 786

Which? has, for more than 60 years, championed the causes of consumers in a wide range of areas, including financial services. It campaigns to protect consumers’ rights, reviews products and services, and offers independent advice on a variety of subjects. Which? has campaigned on many occasions for fairer treatment for financial services customers, to the extent that it is now involved with the regulator in many consultations and is seen as a stakeholder on issues relating to the industry. Which?, along with other consumer bodies including Citizens Advice, are designated to make ‘super‑complaints’ related to the financial services sector directly to the FCA. In many cases, the individual consumer may not be aware of a problem because they are not able to see the ‘bigger picture’ and so are unlikely to challenge the provider. The role of Which? is to identify such issues and take action on behalf of the consumer.

Answer 787

Like Which?, Citizens Advice has ‘super‑complaint’ status. It provides free, confidential and independent advice to help people overcome their problems. It is a voice for clients and consumers on the issues that matter to them. It values diversity, champions equality and challenges discrimination for everyone. Help is available online, via telephone and face‑to‑face.

Answer 788

The FCA places a significant emphasis on the fair treatment of customers, and the rules and guidance on complaint handling aim to ensure that complainants are dealt with promptly and fairly. Firms must have appropriate and effective complaints‑handling procedures and make consumers aware of these procedures – this is normally done through the client agreement or initial disclosure document. When a complaint is received, a firm must take the steps summarised in Figure Payment services providers must give a full response to a complaint within 15 days. This can be extended to 35 days in exceptional circumstances, with a holding letter sent in the interim. Firms are also required to: report to the FCA on their complaints‑handling on a six‑monthly basis; investigate the root cause of complaints and take action to prevent the recurrence of similar issues in future. The FCA requires financial services firms to appoint an individual at the firm, or in the same group as the firm, to be responsible for oversight of the firm’s compliance with the complaints rules. The individual appointed must be carrying out a governing function. Firms are not required to notify the individual’s name to the FCA or FOS but are expected to do so promptly on request.

Answer 789

Firms are able to adopt a less formal approach to resolving a complaint where the complaint can be resolved by close of business on the third working day following receipt. This may apply to relatively minor service issues such as rudeness by a staff member or the misspelling of a name or address on a communication. More significant matters, such as an allegation of poor advice or mis‑selling, would generally take longer to investigate. Where a complaint can be resolved quickly in this way, there is no need for the firm to provide a final response letter. However, the firm must provide a summary resolution communication to the complainant. Situations might arise in which the firm believes the matter has been resolved, but the customer does not agree; the summary resolution communication will explain that, should the complainant remain dissatisfied, they can still refer the matter to the FOS. The format of the summary resolution communication is prescribed in DISP.

Answer 790

As well as dealing with individual complaints in a prompt, fair and consistent manner, firms are expected to put in place appropriate management controls and take reasonable steps to ensure that they identify and remedy any recurring or systemic problems, for example by investigating the root causes of complaints to identify any weaknesses in their procedures. In this way, they should be able to improve their service to customers.

Answer 791

Firms have to keep records of all complaints. Records have to be retained for at least three years from the date a complaint is received. Where the complaint relates to collective portfolio management services for a UCITS scheme, the minimum period for which records must be retained is five years. Where the complaint relates to MiFID business, records should generally be kept for a minimum of five years and a maximum of seven years (although there are exceptions).

Answer 792

On a six‑monthly basis, firms are required to report to the FCA the following information: total number of complaints received; total number of complaints closed: — within four weeks or less of receipt; — within more than four weeks and up to eight weeks of receipt; and — more than eight weeks after receipt; total number of complaints: — upheld in the reporting period; and — outstanding at the beginning of the reporting period; total amount of redress paid in respect of complaints during the reporting period; and the root causes of complaints and corrective action taken to prevent recurrence. There are simplified reporting requirements where a firm receives fewer than 500 complaints in a six‑month period. Publication of complaints information In the interests of transparency, firms are required to publish complaints information if they receive 500 or more complaints over a six‑month period. Both the FCA and FOS publish complaints data.

Answer 793

The Financial Services and Markets Act 2000 (FSMA) gives designated consumer bodies the right to make a ‘super‑complaint’ to the FCA where they consider that there are features of a financial services market in the UK that are or may be significantly damaging the interests of consumers. The FCA super‑complaints regime for financial services markets is distinct from the cross‑sectoral super‑complaints regime provided for in the Enterprise Act 2002. Under the Financial Services Act 2012, designated consumer bodies, regulated persons and the FOS can make a super‑complaint to the FCA. The FCA is required to respond to a super‑complaint within 90 days, setting out how it proposes to deal with the complaint and any possible actions. The FCA’s response might, for example: announce plans to consult on an issue; set out a timetable for regulatory action which would allow the FOS to consider whether or not to place a hold or stay on complaints; explain how the FCA is already taking action to address an issue; or explain why it is not taking any action. It can also carry out wider enquiries – such as internal research or public requests for information – with a view to testing the evidence. It can carry out a review of the relevant regulated firms.

Answer 794

A customer who is dissatisfied with the actions of a firm must first complain to the firm itself, as explained in section 25.3. If the customer is still not satisfied once the firm’s internal complaints processes have been completed, they can take their complaint to the Financial Ombudsman Service (FOS). Certain types of pension and aspects of pension arrangements are dealt with by the Pensions Ombudsman (see section 25.5). The FOS attempts to resolve complaints at the earliest possible stage and by whatever means appear to be most appropriate, including mediation or investigation. The process for investigation is outlined in Figure 25.4. The FOS will determine a complaint by reference to what is, in its opinion, fair and reasonable in all the circumstances of the case, taking into account: the relevant: — law and regulations; — regulators’ rules, guidance and standards; — codes of practice; and where appropriate, what they consider to have been good industry practice at the relevant time.

Answer 795

Complaints to the FOS must be made within six months of receiving a final response, 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 they had cause for complaint, whichever is the later. If a firm receives a complaint which is outside the time limits for referral to the FOS, it may reject the complaint without considering the merits. In a ‘final response’, the firm must explain to the complainant that the complaint is ‘time barred’, and indicate that the Ombudsman may waive the time limits in exceptional circumstances. In addition, the FOS will not usually consider any complaint that is the subject of a court case.

Answer 796

Limits on the maximum compensation the FOS can award for complaints about acts or omissions by firms (plus interest and the complainant’s reasonable costs) are set. Different limits apply depending on when the act or omission occurred and when a case is brought to the FOS. Awards are binding on the firm but not on the complainant, who is free to pursue the matter further in the courts if they wish. The award is not intended to punish the firm, but to restore the complainant to the financial position in which they would have been had the event complained about not taken place.

Answer 797

The Pensions Ombudsman Service (POS) deals with complaints and disputes relating to the running of personal and occupational pension schemes, and also with complaints about the Pension Protection Fund (PPF). Complaints relate to cases of maladministration, and complainants need to show that this has led to injustice (financial loss, distress, delay or inconvenience). Disputes are disagreements about facts or about law. The service does not deal with complaints about the sales and marketing of pension schemes – these are the province of the FOS (see section 25.4) – 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: members or ex‑members of schemes; spouses of members or ex‑members of schemes; widows or dependants of members who have died; solicitors or others representing the interests of such people. Complaints or disputes should first be addressed to the pension scheme’s managers or trustees. If this does not result in agreement, the next step is to contact the POS. Complaints and disputes must be communicated to the service 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 is normally excluded from this time period. A team of assessors and adjudicators review and seek to resolve cases; final, binding decisions are taken by the individual Ombudsmen, who are appointed by the Secretary of State for Work and Pensions. An Ombudsman’s decision is binding on all parties and can be enforced in the courts. See also section 24.2 on the role of The Pensions Regulator and section 24.3 on the PPF.

Answer 798

Compensation Scheme The Financial Services Compensation Scheme (FSCS) provides compensation for customers who have lost money through the insolvency of an authorised firm. The PRA and the FCA are jointly responsible for the rule‑making and oversight of the FSCS and undertake regular reviews of the compensation framework. The FSCS’s costs are made up of management expenses and compensation payments. The scheme is funded by levies on firms authorised by the FCA and the PRA. Levies are split into five broad classes corresponding to the sub‑schemes outlined below, and contributions are based on the class and specific activities each firm undertakes. To qualify for compensation, a claimant must be eligible under rules outlined in the FCA Handbook. The main points are as follows: Compensation can only be paid when an authorised firm is in default. Claims cannot be made against the FSCS for other losses, ie losses due to negligence, poor advice or a fall in stock market values. Compensation can only be paid for financial loss and there are limits to the amounts of compensation payable. The FSCS was set up mainly to assist private individuals, although smaller businesses are also covered. Larger businesses are generally excluded, although there are some exceptions for deposit and insurance claims. The FSCS does not cover firms based in the Channel Islands or the Isle of Man.

Answer 799

This sub‑scheme covers claims made against failed deposit‑taking firms, for example banks, building societies and credit unions. The FSCS is triggered when a firm authorised to accept deposits by the PRA goes out of business, eg if the firm goes into administration or liquidation, and is unable to repay its depositors. The FSCS can also be involved if the PRA considers that an authorised firm is unable, or likely to be unable, to repay its depositors. Maximum claim Generally 100 per cent of £85,000 per person per firm, although there is cover of up to £1m for temporarily high deposit balances. The £1m limit applies to balances that are held for less than six months and provides additional protection where a person’s savings are temporarily boosted by certain life events such as: sale of a house; divorce settlement; taking pension benefits; receipt of inheritance; redundancy payment; criminal injuries compensation. To claim under the higher £1m limit, a person would have to provide proof that the money was only held temporarily as a result of a relevant life event.

Answer 800

Customers with money held by debt management firms may be covered in relation to client money they held with a failed debt management firm of up to £85,000.

Answer 801

The FSCS is triggered when a firm authorised to advise on or arrange investments goes out of business, and is considered by FSCS to be unable, or likely to be unable, to pay claims made against it. This will generally be because the firm has stopped trading and has insufficient assets to meet claims, or is insolvent. Maximum claim 100 per cent of £85,000 per person per firm.

Answer 802

This sub‑scheme covers claims for compensation that arise following the failure of an authorised insurer (life and general). Maximum claim For all long‑term insurance and for certain types of general insurance, compensation is 100 per cent of the value of the policy with no upper limit. (Policies with 100 per cent protection include long‑term and general insurance that provide benefits on death/disability only.) Where a long‑term policy includes a savings as well as a protection element, the protection element has 100 per cent protection. Annuities that are being used to provide an income also receive 100 per cent protection. If the insurance is compulsory (such as employers’ liability cover or motor insurance), the figure is 100 per cent of the whole amount. For other types of insurance the compensation limit is 90 per cent of the claim with no upper limit.

Answer 803

The FSCS will safeguard policyholders if an authorised firm is unable, or likely to be unable, to pay claims against it, eg if it has been placed in provisional liquidation or administration. Maximum claim Compensation is 90 per cent with no upper limit.

Answer 804

1) c) Adjudication. Note that option d) conciliation is not one of the options available under alternative dispute resolution.

Answer 805

2) A contract or notice is deemed to be unfair if it causes a significant imbalance in the rights and obligations of the various parties to the contract to the detriment of the consumer.

Answer 806

3) d) The net asset value must be less than £5m, not £6.5m.

Answer 807

4) d) A firm must ensure the complaint is investigated by a person of sufficient competence, who, where possible, is not someone directly involved in the matter under complaint.

Answer 808

5) Eight weeks.

Answer 809

6) False. For complaints that are resolved by close of business on the third working day following receipt, the firm must provide a summary resolution communication to the complainant, advising them of their right to refer the matter to the FOS should they remain dissatisfied with the firm’s response.

Answer 810

7) c) Five years.

Answer 811

8) Complaints to the FOS must be made within six months of receiving a final response, 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 they had cause for complaint, whichever is the later.

Answer 812

9) a) The Financial Ombudsman Services. The Pensions Ombudsman Service only deals with complaints relating to the running (ie administration) of personal and occupational pension schemes. The Money and Pensions Service does not get involved in pension complaints. The Financial Services Compensation Scheme deals with compensation for customers who have lost money through the insolvency of an authorised firm.

Answer 813

9) a) The Financial Ombudsman Services. The Pensions Ombudsman Service only deals with complaints relating to the running (ie administration) of personal and occupational pension schemes. The Money and Pensions Service does not get involved in pension complaints. The Financial Services Compensation Scheme deals with compensation for customers who have lost money through the insolvency of an authorised firm.

Answer 814

10) One hundred per cent of the value of the policy with no upper limit