So What is Wrong with UCIS?

A white-paper provided by CEI Compliance Limited, in conjunction with the Compliance Doctor CEI Compliance is a specialist Compliance Consultancy that provides bespoke solutions to discerning FSA authorised firms. Tel:

0800 689 9 689

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

Now Available
as Kindle or EBook Download

Is your Compliance Department as compliant as it should be? Are your Compliance Risk Assessments accurate? Is your Annual Monitoring Plan as comprehensive as it should be? Is your risk management managed properly?

Click on the picture

Also Available
We cover 11 main areas other than competence and qualifications to help you decide your strategy and assist with your planning to get you ready for 1st January 2013. Our workbook covers; Business Vision and Mission Statement Business Plan Operational Plan Financial Crime Remuneration Investment Process Creating a Portfolio Growing Compliance (including our compliance risk assessment methodology) Governance Exit Strategy End Game Planning Click Here to get full details and your copy

NOW!

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

Disclaimer
Please be aware that this is only an interpretation of the said guidance and any responsibility must lay with you, the reader, to confirm any rules to your own satisfaction. CEI Compliance accept no liability for any action or inactions you may take due to reading this document.

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

Contents
How do we know?................................................................................................................................... 6 So what if they are not authorised, recognised or terminated? ............................................................ 7 So if they are not subject to the FSA rules, what powers does the FSA have? ...................................... 8 What do the FSA mean by promoting UCIS? .......................................................................................... 8 So how does a client invest in such a vehicle if they are not promoted?............................................... 8 The Fallacy of Assigning an Exemption ................................................................................................... 9 Article 3 MiFID exemption and the promotion and selling of UCIS ...................................................... 10 The recast Capital Adequacy Directive ................................................................................................ 11 In particular, PERG 13.5 Exemptions from MiFID Q49 and Q50........................................................ 11 I currently promote and advise on UCIS. What should I do now? ........................................................ 12 Establishing, operating and/or managing your own UCIS .................................................................... 13 Appendix ............................................................................................................................................... 15 COBS 4.12 .......................................................................................................................................... 15 PCIS ................................................................................................................................................... 15 Exemptions under PCIS: ................................................................................................................ 15 Recommending UCIS: ten top tips ................................................................................................ 16 Personal protection for Investors ................................................................................................. 17

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

So Whats Wrong with UCIS?

UCIS is an acronym for Unregulated Collective Investment Schemes and the term unregulated can lead to confusion with inexperienced investment advisers as well as clients. Many perfectly normal and commonly understood Collective Investment Schemes (CIS) are sold to investors throughout the UK. These CIS are regulated and are authorised by the Financial Services Authority (FSA) or they may also be non-UK CIS that are recognised by the FSA. The official term of recognition enables overseas CIS to be marketed to the public in the UK and the FSA will only recognise an overseas scheme if certain specified criteria are met. CIS are a type of pooled investment. This is an arrangement that enables a number of investors to 'pool' their assets and have these managed by an independent professional, such as a fund manager who will reduce risk by investing the pooled money in one or more types of asset. Most investment funds are collective investment schemes. Investments are often in gilts, bonds and quoted equities, but depending on the type of scheme can go further, such as into unquoted shares or property. Certain CISs have been regulated under the Financial Services and Markets Act 2000 (FSMA) since 1 December 2001. If you require regulatory information about a scheme from before 1 December 2001 please contact the FSAs Consumer Helpline from 8 am to 6 pm on Telephone: 0845 606 1234 Type-talk: 18001 0845 606 1234 From overseas: (+44) 20 7066 1000 (main switchboard) Or email them at consumer.queries@fsa.gov.uk Regulated schemes include authorised UK schemes like investment companies with variable capital (or open ended investment companies) and unit trusts, and recognised offshore schemes. However, not all CISs are regulated. Those which are not regulated are subject to very tight restrictions on marketing and are not usually open to investment by retail clients unless they fall into a specific criteria or under an exemption, as discussed later. Any CIS that is not authorised or recognised is basically classified as a UCIS and it may be operated, managed or administered in the UK and nothing should be read into the fact whether the UCIS is UK based or operated, managed or administered in a foreign jurisdiction.

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

How do we know?
Anyone can check whether a scheme is authorised or recognised by the FSA by using the search facility on the FSA online Register page at http://www.fsa.gov.uk/register/home.do. This register will provide you with the relevant information to find out whether a CIS is, or has been, Authorised, Recognised or Terminated by the FSA. A CIS that is not authorised by the FSA or recognised generally can not be marketed to retail investors or members of the general public. If you are a member of the public, or an investment adviser who may be considering recommending a CIS to a member of the general public, it would stand you in good stead to check the register before taking any further action regarding investment into the CIS. From the register home page, select the CIS Search Tab

Key for Fig 2 1 4: Further information for consumers hyperlinked to other pages 5: Method 1 Combination by Fund Name /Manager/ ACD 6: Method 2 by Scheme Reference Number On this page you will see a number of elements When looking at the record we have for a CIS you will see the product type. These are generally authorised investment funds (AIF), which include authorised unit trusts (AUT) and open-ended investment companies (OEIC), or unauthorised unit trusts (UUTs).
2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

The main distinction for unit trusts is whether or not they are authorised by the FSA. If an Open Ended Investment Contract (OEIC) is set up in the UK it can only as an authorised CIS. While the FSA Register can be searched using any number of criteria, you can filter the results if you know the product is authorised, recognised or terminated. Product Type could be; Feeder Fund Fund of Funds, Futures and Options Geared Futures and Options Money Market Non-UCITS Retail Not Supplied Other CIS Property Qualified Investor Securities UCITS (CIS) UCITS (COLL) Umbrella Warrant And, if you do not know the full details, you can choose; Best fit Starts with or Partial If a scheme does not appear on the FSA Register, it is likely to be a UCIS, but the consumer helpline (above) will confirm or explain further if you are not sure.

So what if they are not authorised, recognised or terminated?

The reason they are called unregulated schemes is because they are not subject to the FSA rules, so the usual restrictions and safeguards concerning schemes investment powers, how they are run, what type of assets they can invest in, or the information that must be disclosed to investors do not apply to them. To add a layer of protection to the unwary, UCIS are subject to tight restrictions on who firms may invite to invest in them. Generally speaking they are not available for investment by most retail consumers because, by their nature, they are risky products.

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

As the FSA do not regulate UCIS, in most cases you will be unable to complain about the scheme to the Financial Ombudsman Service or the Financial Services Compensation Scheme (FSCS) if things go wrong, but you may be able to complain about a regulated firm if it promoted the scheme to you or advised you to invest in it.

So if they are not subject to the FSA rules, what powers does the FSA have?
UCIS are described as unregulated because they are not subject to the same restrictions as a regulated CIS. A main feature of a regulated CIS is in terms of their investment powers and how they are run, and other areas overseen by the FSA. However, although the schemes themselves are not authorised or recognised, persons carrying on regulated activities in the UK in relation to UCIS providing personal recommendations to retail clients, arranging deals and establishing, promoting, operating and managing the schemes will be subject to FSA regulation, including Handbook requirements (e.g. the Conduct Of Business Sourcebook (COBS)).

What do the FSA mean by promoting UCIS?

As with all marketing, you have to promote a product to make people aware of it. Promoting a UCIS involves the communication, in the course of business, of an invitation or inducement to engage in investment activity in relation to UCIS.

CEI Compliance can assist you in all areas of Governance, Risk and Compliance Call 0800 689 9 689

Although a broad concept, promoting does not only mean communicating through a written financial promotion or advertisement like marketing literature. It also includes face to face discussion, phone calls, emails, advertisements, websites, presentations etc. Whenever a communication is made with a client or a potential client about investment opportunities that relate to or include a particular UCIS, this should be carefully considered whether it is promoting this investment to the client. Any firm that has a good grip on the definition of promotion, knows when it is appropriate to promote UCIS and when it is prohibited.

So how does a client invest in such a vehicle if they are not promoted?
UCIS can be promoted, but not to the general public. Section 21 of Financial Services & Markets Act 2000 (FSMA) prevents promoting UCIS by unauthorised persons, unless the financial promotion is approved by an authorised (by the FSA) person or benefits from an exemption in the Financial Promotion Order.
2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

Section 238 of FSMA then precludes promoting UCIS by authorised persons except where: there is a statutory exemption in an order made by the Treasury (see the FSMA (Promotion of Collective Investment Schemes (Exemptions) Order 2001 (SI 2001/1060) (as amended)) (in the Compliance world we refer to this order as the PCIS Order); or the financial promotion is permitted under FSA rules exempting the promotion of UCIS under certain circumstances (COBS 4.12). You will need to ensure, before you promote a UCIS, that a relevant exemption is available. For example, the exemptions permit promotions to the following (this list is not exhaustive): certified high net worth individuals (see article 21 of the PCIS Order); certified sophisticated investors (see article 23 of the PCIS Order); self-certified sophisticated investors (see article 23A of the PCIS Order); individuals that fall in one of eight categories detailed in COBS 4.12. We have reproduced COBS 4.12R in the Appendix for you but for a full list of exemptions please refer to PCIS Order and COBS 4.12R. For a comprehensive commentary on the restrictions and exemptions please refer to The Perimeter Guidance Manual (PERG), Chapter 8.20 (Additional restriction on the promotion of collective investment schemes).

All too often, as soon as somebody finds a wording within an exemption that fits their specific need, they assign the exemption and the case is closed. When relying on exemptions, you should check carefully that you comply with all the conditions of the relevant exemption. As a case in point, there are several conditions regarding the individual wording of statements concerning certified high net worth investors, certified sophisticated investors and selfcertified sophisticated investors and related warnings to investors. There may be other conditions to consider: for example, in the case of the statutory exemptions for high net worth investors and selfcertified sophisticated investors, this is restricted to promotions relating to UCIS that are limited in the types of investments they can make (broadly, UCIS that invest wholly or predominantly in shares and debentures of unlisted companies).

The FSA (soon to be FCA) are constantly conducting themed visit and ARROW assessments throughout the UK. Are you ready for a visit? How well prepared are you for an interview with the FSA? We can help just send a blank email by clicking here and we will send you a brochure straight back

The Fallacy of Assigning an Exemption

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

To demonstrate that your firm has adequate procedures in place, you will need to ensure that you document the exemption/s on which you are relying when promoting a UCIS, and the reasons why the exemption/s apply. For example, if you use exemptions in articles 2123 of the PCIS Order, you must show you have complied with the certification requirements. Alternatively, if you use exemptions under COBS 4.12R you must show you have taken reasonable steps to establish that the recipients fall within a relevant category of person. Before an investor agrees to invest in a UCIS the adviser should be clear that they are permitted to promote the scheme to the investor and explain why the scheme is suitable for their particular circumstances. If the investor is not clear whether they fall into any of the groups that can have a UCIS promoted to them they should ask the adviser which category specifically applies to them. If they have already been sold a UCIS they can still ask the firm that sold them the plan which eligible investor group they fall into. So as an adviser, you should be fully aware of the exemptions and how they are applied, in case you are asked. It is also good practice to make note of the discussion in your fact find or client file. A copy of the certification should also be placed in the file, if not already provided. The investor may also confirm with the adviser what charges there are, what the rate of return is and whether this is actual or targeted. So the bottom line is that you have to conduct your KYC exercise with extreme diligence and ascertain the investors exact position, as required by COBS 9.2, and that they are accurately identified under the exemption in COBS 4.12R and that UCIS can be promoted to them as a potential part of the portfolio.

Article 3 MiFID exemption and the promotion and selling of UCIS

Where a UCIS promotion is permitted to be made, the COBS rules apply differently in relation to the Markets in Financial Instruments Directive (MiFID) or equivalent third country business and non-MiFID business. If you consider your firm as a non-MiFID firm, you must ensure you do not fall foul of the Article 3 MiFID exempt firm requirement. For example, you will fall outside the MiFID exemption if you transmit orders directly to operators of UCIS unless they are fund managers to which MiFID applies. For more details you will need to refer to Chapter 4 of the MiFID Permissions and Notifications Guide Update 2007 and PERG 13 Guidance on the scope of the Markets in Financial Instruments Under COBS 9, Suitability (including basic advice) rules, before you recommend a UCIS, you will need to gather information about your client to establish whether the UCIS is suitable for that person. As the client is likely to be in the above 4 categories, you will already have a great deal of this information.
2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

When making a personal recommendation or providing discretionary portfolio management services on a UCIS, you must meet all suitability obligations. This includes obtaining the necessary information regarding your clients knowledge and experience in relation to UCIS, his financial situation and investment objectives, so you can make a suitable recommendation. As with most other investments, a client investing in a UCIS could lose some or all of their money. However this risk is likely to be particularly relevant to UCIS. UCIS frequently invest in assets that are not available to regulated CIS (for example, because they are riskier or less liquid), or are structured in a way that is different from regulated CIS. Unlike regulated CIS, UCIS are not subject to investment and borrowing restrictions aimed at ensuring a prudent spread of risk. As a result they are generally considered to be a high risk investment and you should always ensure that clients understand the risks before investing. Can you demonstrate that you can and have discussed with the client and that they have knowledge, understanding and experience of; Equities? (Inc Short-selling) Futures and options? Derivatives (CDS/Baskets/Exotics/IROs Monte-Carlo simulation, Asian options etc)? Leveraging (borrowing to support investment)? Arbitrage (ultra high speed transaction through to regular market inconsistencies)? Unconventional assets such as; o Long-short bond funds. o Managed futures. o Long-short funds. o Structured notes. o Non-public REITs.

This above list is not exhaustive and covers a number of generic investment categories, but UCIS are not solely restricted to these and may well invest in more obscure and illiquid investments. Just because they say their aim, or the target of the fund is to invest in x, y & z doesnt prohibit them from investing in a to v as well.

The recast Capital Adequacy Directive In particular, PERG 13.5 Exemptions from MiFID Q49 and Q50
Should you breach any of the qualifying conditions (PERG 13.5, Q51), you are required to notify the FSA of the breach (SUP 15.3.11 R Breaches of rules and other requirements in or under the Act). The FSA will then consider whether you should continue to benefit from the exemption and what, if any, supervisory or enforcement action will be taken.

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

For more details you will need to refer to Promoting unregulated CIS Communicating with clients, including financial promotions. There are other COBS provisions that apply when you provide investment services in relation to UCIS, whether these services are advisory or otherwise. In the case of MiFID, firms providing MiFID investment services other than investment advice or discretionary portfolio management in relation to UCIS, this can include appropriateness requirements (COBS 10). Warnings Disclosure: Your clients may not be covered by the Financial Ombudsman Service (FOS), should they have a complaint about the fund or the Financial Services Compensation Scheme (FSCS), should they need to seek compensation. You should make this very clear to your clients. The documents from the UCIS should help confirm whether your clients have access to FOS or FSCS.

I currently promote and advise on UCIS. What should I do now?

You need to ensure you comply with all applicable requirements concerning your promotion of UCIS and, where this is not the case, you should take appropriate action (including remedial). This is called a past business review and should form part of any organisations risk management strategy. Also, if you have been advising retail customers to invest in UCIS without explicit regard to the statutory restrictions on promoting UCIS to the general public, you should check with your professional indemnity insurer whether your cover remains valid. Another area to act on is review your systems and controls especially in relation to financial promotions (including checking whether a client can be promoted to), client risk profiling and its application, and your conflicts of interest policy. Remember that when it comes to promoting and advising on investments, you may be doing both in the course of the same communication (whether oral or written) and the effectiveness of your systems and controls will be essential in ensuring compliance with your regulatory obligations. You should seek professional advice if you are unsure about your obligations.

If you need help in how best to assess your risk, just click on this link and send a blank email to us and we will send you a guide on how to assess your compliance risks no charge!

Understanding individual UCIS and what they invest in is essential to ensuring compliance with your regulatory obligations. The regulator will expect to see that you have carried out adequate due diligence on any UCIS you recommend and that this is sufficiently documented.
2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

The FSA have been made aware through their themed visits that some firms are recommending UCIS without having any regard to the statutory restrictions on the promotion of UCIS to the general public. If you recommend UCIS to your clients and you are not aware of the restrictions on promotion, you may be acting in breach of the scheme promotion restriction and putting your clients at a significant risk of receiving unsuitable advice. If this is the case, as such, you risk not only robust and tough disciplinary action but also potentially FSMA s150 actions for damages.

Establishing, operating and/or managing your own UCIS

If you establish, operate and/or manage your own UCIS then you must have permission to do so. If this is not the case then you must stop these activities until you have permission in place. The regulator will also expect you to notify them of this breach of your regulatory obligations. Should a firm fail to obtain permission and the FSA finds out, they will consider the relevant action to be taken. More generally, you should ensure that you have permission which correspond to all your regulated activities and comply with these. This check should be done at least annually along with your Compliance Annual Monitoring Plan. You also need to be aware that the exemption from promoting UCIS to a certified sophisticated investor (article 23 PCIS Order) will not apply to a promotion by you of a scheme, which you operate, to any investor you have certified as a sophisticated investor.

If you need further information please download UCIS Good and Poor Practice July 2010. You may also benefit from reviewing the PS07/11 The Responsibilities of Providers and Distributors for the Fair Treatment of Customers

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

Now Available
as Kindle or EBook Download

Is your Compliance Department as compliant as it should be? Are your Compliance Risk Assessments accurate? Is your Annual Monitoring Plan as comprehensive as it should be?
Click on the picture

Also Available
We cover 11 main areas other than competence and qualifications to help you decide your strategy and assist with your planning to get you ready for 1st January 2013. Our workbook covers; Business Vision and Mission Statement Business Plan Operational Plan Financial Crime Remuneration Investment Process Creating a Portfolio Growing Compliance (including our compliance risk assessment methodology) Governance Exit Strategy End Game Planning

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

Appendix
COBS 4.12 Exemptions under COBS (4.12): This defines eight categories of persons to whom an authorised person may promote UCIS: Category 1 - Someone who is currently, or has been in the last 30 months, a UCIS participant. Category 2 - Someone for whom the firm has taken reasonable steps to ensure that investment in the UCIS is suitable and who is an 'established' or 'newly accepted' client of the firm. Category 3 - Someone who is eligible to participate in a scheme constituted by the Church Funds Investment Measure (1958), section 24 of the Charities Act (1993) or section 25 of the Charities Act (Northern Ireland) (1964). Category 4 - Someone who is a current or former officer or employee of the firm (or a member of their immediate family). Category 5 - Someone who is admitted to membership of the Society of Lloyd's. Category 6 - An 'exempt person'. Category 7 - Someone who qualifies as an eligible counterparty' (click HERE) or a professional client' (click HERE). Category 8 - A person to whom the firm has undertaken an adequate assessment of expertise, experience and knowledge and to whom the firm has provided certain written warnings. The full COBS exemptions rules on UCIS

PCIS
Exemptions under PCIS: UCIS may be promoted to persons defined as: Certified high net worth This person must hold a 'certificate of high net worth', which will be in writing and signed and dated within the last 12 months by both themselves and their accountant or employer. It must declare that, in the opinion of the signatory, he or she either had an annual income of not less than 100k or net assets to the value of not less than 250k during the financial year immediately preceding the date on which the certificate is signed. Certified sophisticated investor This person must hold a certificate in writing (signed and dated by an authorised person within the last three years) declaring he or she is sufficiently knowledgeable to understand the risks of investing in UCIS.

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

They must also have signed, within the last 12 months, a statement confirming they are a certified sophisticated investor. Once these requirements have been met, any communication promoting UCIS must, among other things, declare that buying units in a UCIS may expose them to a significant risk of losing all of their investment.

Recommending UCIS: ten top tips Support services provider Threesixty put together a list of tips and hints for advisers considering recommending UCIS 1. PI cover Always ensure you have relevant PI cover prior to making any recommendation. This may need to be checked on a case by case basis. 2. Read All relevant staff and management should read and be familiar with the output of the FSA review. They should receive training and their CPD should be documented in detail. 3. Process The firm must have a robust process for promoting or advising on UCIS which must be known and followed, by all relevant staff. 4. Pre-approval The process should include arrangements for pre-approval. 5. Exemptions Maintain management information showing full details of exemptions used and the results of pre-approval requests. 6. Evidence Supporting evidence for exemptions claimed should be retained. 7. Due diligence Full due diligence should be undertaken on any UCIS which the firm is considering using. 8. Promotions Consider advice on UCIS to be a promotion' and follow the financial promotion rules at all times. 9. Transparency The risks, both general and investment-specific, of a UCIS should be made clear to clients.

2012 CEI Compliance Limited. All rights reserved

So Whats Wrong with UCIS? By the Compliance Doctor

0800 689 9 689

10 MiFID If you are an Article 3 MiFID Exempt firm or an Exempt CAD firm, ensure that orders are transmitted only to entities allowed by MiFID unless the firm is prepared to opt into MiFID itself.

An Idea for submitting to clients in a suitability report or other recommendation Personal protection for Investors Where a scheme is not authorised or recognised, persons carrying on regulated activities in the UK in relation to UCIS including providing personal recommendations, arranging deals and establishing, operating and managing schemes are still subject to our regulation. Before you agree to invest in a UCIS your adviser should be clear that they are permitted to promote the scheme to you and explain why the scheme is suitable for your particular circumstances. If you are not sure whether you fall into any of the groups that can have a UCIS promoted to them you should ask your adviser which category applies to you. If you have already been sold a UCIS you can still ask the firm which eligible investor group you fall into. If you are considering investing in a UCIS be sure to read all available information, ensuring you understand and accept the risk that you may lose some or all of your investments. If your adviser is not able to clearly explain the nature of the underlying investment and risk to you then consider whether you fully understand what you are investing in. You should also confirm with your adviser what charges there are, what the rate of return is and whether this is actual or targeted. Perhaps most importantly, you should ask whether you may have access to the FOS and FSCS if things go wrong, and seek independent professional advice if you are in any doubt about the potential risk and returns involved. If you believe that a firm has promoted or sold you a UCIS that is not suitable for you, sold it to you unlawfully or that the risks were not fully explained you should make a complaint to the firm involved.

2012 CEI Compliance Limited. All rights reserved