Open for responses until 3 September 2018
Part of our job as international commercial lawyers is to read, digest, and where useful, provide comment on information that is often presented in a dry and abstract way. Having read the above Consultation, we believe it is important to share some observations with you which could impact your current business practices. You may wish to consider responding to the Consultation yourself to help shape the future of Jersey’s Code of Practice for Investment Business.
The Jersey Financial Services Commission (JFSC) is proposing certain changes to align Jersey with current international trends and standards regarding:
- on-boarding investors and checking for vulnerability
- risk tolerance assessments and due diligence
- handling conflicts of interest
- best execution of trades and benchmarking
- record retention and transparency
- reporting to the JFSC
The proposals also include extending the scope of regulated investment business to:
- include within investment advice, advice on holding investments; and
- add the activity of arranging deals in investments as a class of investment business.
Finally the consultation also considers proposals to implement International Organisations of Securities Commissions (IOSCO’s) recommendations on client asset protection.
Presently there is no clear requirement to actively protect potentially vulnerable investors from fraudulent or misleading financial advice, such as the widely reported mis-selling incidents relating to Payment Protection Insurance (PPI).
The Consultation proposes including a requirement that a JFSC-regulated person has to identify and afford appropriate protection to vulnerable clients. It is not defined what ‘vulnerability’ includes or what measures should be taken to identify and protect such clients.
We believe that definitions wouldn’t necessarily be helpful and that a common sense approach is more useful given that it is already normal practice to assess a person’s legal capacity and understanding in respect to transactions such as, banking, making wills, litigating and buying real estate. When meeting a client and discussing proposed investments, professionals should (and generally do) pay attention to a client’s level of comprehension, memory, sobriety or whether a client appears to be unduly influenced by third parties instead of making considered independent decisions. When in doubt, a registered person should either refuse to provide the investment service or find a more appropriate solution tailored to the specific client.
Risk tolerance and due diligence
Currently a JFSC-registered person has to demonstrate the satisfaction of certain suitability criteria when providing advice to a client or exercising discretion on behalf of one. These include considering the facts disclosed by the client, any existing agreement and any other fact of which the registered person is or should reasonably be aware.
The JFSC’s Consultation proposal goes further and includes a more active requirement to consider the risk tolerance of the client and their ability to bear losses. This is designed to protect clients from unnecessary economic harm by potentially overextending themselves financially.
While some may argue that this goes too far and clients should be able to do as they see fit (including granting discretion to their advisors), a considered, bespoke and guided approach to the risks and losses a client can reasonably afford has been the longstanding hallmark of high quality wealth management.
Likewise, in line with the international push towards greater transparency and client protection, the new proposals also include a requirement to give clients written information about any investments covered by a compensation scheme, explain (where services are bundled) which elements of the advice are regulated and unregulated and explain the cost breakdown of the advice, financial products and service.
Finally, it is proposed that a due diligence review of the suitability criteria for products and providers is conducted annually to ensure that, where necessary, investment businesses adjust their offerings to their clients.
Conflicts of interest
Currently one common way to address conflicts of interest (if they cannot be avoided) is to manage them by disclosure but it remains open to justify tolerating certain conflicts on the basis of investment suitability.
The JFSC’s proposal states that investment suitability does not absolve from conflict management and therefore the disclosure option as a means to manage conflicts of interest will be removed from the Investment Business Code.
Instead, a registered person will be obliged to disclose conflicts to the client and it will be the direct responsibility of the board of a registered person (or suitably authorised committee) to identify and manage such conflicts.
While this may increase the compliance burden on boards, it is also likely to be welcomed by some, as it will require directors to stay closer to the coalface of their business to ensure conflicts are identified and appropriately managed.
Best execution and benchmarking
Currently the Investment Business Code requires a registered person to take reasonable care to ascertain the best available price at the time of a transaction when executing trades.
The JFSC’s view, in line with the UK’s Financial Conduct Authority, has evolved to propose that “best available price” does not equal “best possible result” for a client. Reliance purely on price can lead to poorer investment decisions and outcomes for clients.
It is proposed that the language be adjusted to require that the best possible result is obtained for the client. This is again consistent with the move to greater transparency and improvement in the quality of financial advice provided to clients worldwide. It will require investment businesses to introduce analysis of transaction costs and to measure exemption risks as well as monitoring their top trading venues and ensuring they do not discriminate unfairly between execution venues.
In addition, the JFSC identified a gap in current practices regarding performance measurement for financial advice and discretionary investment management. The current Investment Business Code does not require a registered person to identify an appropriate objective benchmark to measure their performance against, increasing the risk of inaccurate claims about performance and quality of advice or investments.
The JFSC’s proposal does not prescribe a specific benchmark and instead expects that registered persons will be able to find or develop benchmarks most appropriate for their particular industry.
Record retention and transparency
The Consultation proposal includes the introduction of a ten year retention period for any records relating to the requirements of the Investment Business Code (in addition to any retention requirements contained in Jersey’s Anti Money Laundering (AML) legislation).
This is a simplification of the current retention requirements and in line with the new Data Protection (Jersey) Law 2018.
For organisations that record telephone calls, the current exemption that no record of such recordings has to be kept will be removed and it will be necessary to prepare and retain “some” record of such recordings. We believe this requirement is vague and would benefit from further clarification.
In terms of transparency the following changes are in line with international developments, mainly under Markets in Financial Instruments Directive (MiFID II):
- JFSC-registered persons will be required to issue reports, at least quarterly, on transactions done for a client, to the client.
- Receiving commission from product providers for investment advice services provided to retail clients will not be permissible, whether the commission is by way of remuneration or not. Currently, only commission “by way of remuneration” is prohibited but the Consultation proposes deletion of this wording. This increases the scope of what counts as commission to any monetary or non-monetary benefits, such as incentives for discounts or preferred products. Further, the prohibition on receiving commission in respect of retail clients is extended to cover non-Jersey residents, unless the retail client is in a region which permits commission to be received. This will require investment businesses to record on the client file how the regulations of that region permit commission.
Reporting to the JFSC
The Consultation proposes to request registered persons to report on events and activities concerning non-regulated areas of their business and other members of their corporate group which may have adverse impacts on the registered person in Jersey. Examples might include a data breach in an overseas group member or an overseas entity receiving a public sanction from a regulator.
It is also proposed that over-the-counter derivatives trading which is not compliant with European Market Infrastructure Regulation (EMIR) (or EMIR equivalent 3rd country standards) should be reported to the JFSC on an annual basis, stating the maximum notional uncleared exposure. Currently this change would only impact JFSC-registered persons, though future changes to the Financial Services (Jersey) Law 1998 might also cover all counterparties trading in derivatives.
Expanding the scope of regulated investment business
The Consultation also proposes certain technical changes to the Financial Services (Jersey) Law 1998. The main ones are:
- The class of investment business relating to the provision of investment advice for buying and selling investments should be amended to also include advice on holding investments. This recognises that the decision to hold an investment can be as important and impactful for a client as the purchase or sale of one. The activity of “arranging deals in investments” is not currently a licensed activity under the law or the JFSC’s Codes of Practice. The JFSC considers that arranging investments carries serious risks for clients, as arrangers may facilitate business for personal gain even if unsuitable for a client. An arranger’s handling of client’s money or assets is likewise unregulated and therefore not protected against loss or misuse. An arranger’s fitness and propriety is also not subject to scrutiny. We believe that the first proposal is sensible for improving the quality of advice provided to investors.
- The second, creating a new licensed class of “Arrangers”, merits discussion. The ability to arrange deals, encourage investments and seek out beneficial opportunities is a pillar of a functioning market that thrives on entrepreneurial activity. The introduction of regulatory oversight and licensing requirements for arrangers may be unnecessary red tape, considering that: While arranging deals and investments is not a regulated activity, providing investment advice, dealing in investments, taking and handling deposits and client assets generally are. A sound protective regulatory environment is already in place to protect retail clients. If clients wish to take advice from certain arrangers and entrust them with their assets or money, knowing that these arrangers are not regulated, this is a client’s prerogative in a free market. Clients will generally know that it is safer to obtain relevant advice and services from regulated providers. Acknowledging the risk that some individuals acting as “arrangers” will be more concerned with their own self-interest than with their client’s well-being, it would still be important to obtain objective figures on how prevalent abuse of clients through such “arrangers” is before deciding to spend public funds and introduce a regulatory regime for “arranging”.
The Consultation also includes proposals to implement IOSCO’s recommendations regarding client asset protection, with the introduction of appropriate due diligence on selection of third parties and transparency in disclosure of the applicable asset protection regimes and related risks.
Details of these proposals are not included in the Consultation.
We hope this commentary is useful in gaining an overview on the new proposals for the Investment Business Code and Financial Services (Jersey) Law 1998.
You can access the consultation here: https://www.jerseyfsc.org/the-commission/general-information/consultation-papers/consultation-papers/
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.