1 February 2014 may be a Saturday, but it is still a significant business day in the Isle of Man financial services sector. The latest round of refinements to the rules applicable to businesses licensed by the Isle of Man Financial Supervision Commission (FSC) will become effective, as the FSRB comes into operation. Here we take a look at some of the implications for different operators.
Conduct of business – financial adviser or financial therapist?
Those engaged in providing advice on investments could be forgiven for feeling as if they have been summoned to the headmaster's study. Not only do they have to make notes of all the revision they do, but they have to do even more homework and bring it all back for marking. And there's a reminder not to pick on the little kids...
The "vulnerable client" is a new character in the FSRB and requires special treatment in relation to the provision of advice. Although he/she is defined by reference to a large list of potential distinguishing features, it is clearly suggested that this is not to be regarded as exhaustive. The new requirements are not only invoked if these features are reasonably apparent; they apply even if the vulnerability is concealed.
Although Rule 6.29A is couched in terms of advice; it is not specifically excluded in the case of execution-only business. It would seem sensible for all Class 2 businesses to ensure that their client take-on processes solicit enough basic client information to allow a reasonable conclusion to be reached on the question of vulnerability. The rule stipulates that a policy must be in place. For many operators it seems almost inevitable that the only sensible policy would be that "...we do not provide financial advice to vulnerable clients; this is a specialist area that is not part of our core business...." Prudence would also suggest including a terms of business requirement for clients to notify of any circumstance occurring such that the licence holder would be required to treat the client as a vulnerable client; it may not always work but it may provide protection in some circumstances.
It seems unlikely that such exclusion from access to financial services was the intention behind these rule changes. However, given the requirement for a policy, for specific consideration of the vulnerability factor(s) for each such client, for tailored advice to reflect these factors and for records of all this to be kept, it does seem largely inevitable.
An attempt has been made to clarify the crucial provisions relating to the extent of advice – with some success. In the area between execution-only and full advice now lie two intermediate scenarios. So-called "limited advice" applies where the prospective client chooses to limit the scope of the advice; "restricted advice" applies where the licence holder only offers advice on a limited range or type of investments and – of course – this is made clear to the prospective client. The client confirmation of anything other than a full advice service must be retained on the client file. There is now a clear statement to the effect that many of these provisions do not apply to stockbrokers and discretionary portfolio managers.
There are further rule changes in the area of product suitability as well. Investment "time horizon" (as opposed simply to age) must specifically be considered. Records of all products considered, including those rejected, must be retained. The FSC has also been banging the drum about ensuring that "reasons why" letters are sent in advance of consummation of the investment and with adequate time to allow consideration; it is important to remember that these letters need to be retained on file.
Finally, one can't forget the extra prep. All financial advisers will have a minimum CPD requirement of 35 hours per year from 2014. From 1 January 2015, advice to retail clients can only be provided by someone with a current (i.e. no more than 12 months old) statement of professional standing – FSC guidance is that this will be equivalent to a UK Level 4 Qualification.
Subordinated loans – don't get tangled up with your net tangible assets
Buried in the notes to Part A of Appendix 3 to the FSRB 2014 is an innocuous looking amendment that has the appearance of being little more than a clarification, but has serious implications for some businesses if they rely on qualifying subordinated loans (QSL) to satisfy their financial resources requirements.
There is now an additional condition to be met before a QSL can be included: "...the licence holder's net tangible assets before the [QSL] is added are in excess of its minimum share capital requirement..." (our emphasis).
The starting place for determining net tangible assets (NTA) is the licence holder's capital and reserves (ie below the line on the balance sheet) less the value of any goodwill or other intangible assets (ie above the line on the balance sheet.) "Capital and reserves" includes any deficit on the profit and loss account, so a business with accumulated losses will henceforth be unable to rely on QSLs to bridge the gap.
In practice, of course, it is start-up operations that are most likely to suffer difficulties in this area. Even if you are operating to budget, if your business is in a cash burn phase that results in trading losses but does not threaten your solvency, under the amended rules, QSLs are not an option.
There are suggestions that the FSC may be sympathetic to businesses that are genuinely in this situation. So, if you may be affected, an early conversation with the FSC concerning a possible rule waiver may be prudent. Alternatively, there may be many cases in which QSLs could be restructured as equity but on commercially very similar terms, although tax implications would obviously require careful consideration; please contact us if we can help in this area.
Increased regulation – something for everyone
It is difficult to identify any licence holder that will not be affected, sooner or later, by the changes in the FSRB 2014.
Stockbrokers are now required to have an internal audit function. Anyone in the custody business is now required to undertake more frequent reconciliations. For electronic records the minimum frequency is now 25 business days. It is important to emphasise however, that this is a minimum – the over-riding requirement is for the frequency to reflect "...the licence holder's assessment of the risks to which the safe custody assets are
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.