Policy in the making

We are building up to a crescendo, with our second policy statement to be issued at the end of June. In its present form it runs to about 130 pages. As with most of the regulator's previous policy documents on the subject, it is by and large a technical exercise in which the FCA copies out legislation into its rulebook. Although the FCA receives plenty of technical comments during its consultative exercises, most of it is not inherently exciting.

Issues on which the FCA might change its mind slightly

There were four or five issues where we got a significant amount of comments about our policy choices where we were exercising some degree of discretion and where we have been reviewing what we did to work out whether we should simply press ahead or do some things slightly differently.

The key areas that we are looking at (we have a board meeting later today that will run through the issues) are client categorisation in relation to local authorities, the scope of application of the MiFID II best execution standards we have proposed, applying them to collective portfolio managers, research and inducements (again, there is partly an issue about the application to collective portfolio managers). There are also various questions that will be raised about the practical detail of the way those provisions work in the course of next year, looking at the way in which people have implemented it.

Governance, culture, software and the presentation of information

In that respect, I think that there are four things I would emphasise. When it comes to conduct, firstly, we have emphasised the importance to us of (i) governance and (ii) culture. Governance – having the right way of running your firm so that it is clear who is accountable for what. This obviously ties in also to the implementation more broadly of the Senior Management and Certification Regime. Culture – are firms putting the customer first? Is that understood from the top to the bottom of the organisation? Are the senior management setting the right example? Are they then engaging staff so that staff more broadly understand what their expectations are?

I would also emphasise the issue of smarter communications. There are lots of areas in which MiFID II requires you to make new disclosures, whether it's costing charges, best execution or inducements.

Obviously, firms are expending a lot of effort getting the right information to make those disclosures but the right compliance is about having more than just the right information to meet the technical requirements of the legislation. It's then about how you communicate that information to clients to help them understand and to help them make choices and decisions about products and services and decisions between different sorts of firms. Please think about it in those terms!

If you've complied in terms of having the right information but, frankly, your presentation of that information doesn't help people to understand the disclosure that you are making, then as I say, that will not be a good way to comply with the legislation.

Finally, technology. We are keen to encourage the innovative use of technology, whether that is about helping you to...as part of your compliance efforts, as part of your monitoring efforts, or whether it's about the way in which you deliver your services. If there are issues that arise as a result of the use of innovative technology, where you have issues about how it actually fits in with the legislation, then obviously we're happy to have a discussion about that to try to understand it and to try to ensure that we are facilitating the use of technology.

The use of technology obviously brings risks. The two in particular that we have highlighted through a series of documents are, first, the general heading of cyber-risk, the need to have adequate security and the like, and the second is that we recognise often when you're using technology you will be outsourcing and that outsourcing has to be managed properly, both in terms of your relationship with whomever you are directly outsourcing to, but also where there is in effect a chain of outsourcers and they are using whichever company you are directly contracting with...they are using other suppliers that you have an understanding of that and how that then affects your relationship with the firm to whom you are directly outsourcing.

As I say, that review properly then they should be well placed to deal with MiFID II in terms of the basic sets of standards of best execution.

Two key issues

I think there were two key issues that we highlighted in that thematic review. The first is around the monitoring of transactions, the monitoring of the execution quality you obtain. There is going to be more information available to you as a result of MiFID II to potentially take account of but still, fundamentally, it is a question of sitting down and thinking "what is the best way I can monitor the execution quality I am achieving?" It's about asking you the selves both sets of questions in order to be able to ensure that you are complying with the rules.

The second thing, and again this ties back to what I said earlier about governance, having an appropriate governance around best execution and being clear who is responsible in the firm for your best execution arrangements and how the decision-making process works in your firm once you've done the monitoring, once you've collected the information, how do you then ensure that that is followed through on, to deliver changes in your arrangements and in your policies?

Product governance

What the product governance requirements in MiFID II do I think are twofold. One is to have a set of requirements that expand across a wider range of activities and secondly there is a greater formalisation of certain aspects of the way that the product governance process is supposed to work.

Per se, the product governance arrangements in MiFID are not there to stop people from selling products. They are there simply to require some thought about the products that are being sold and to whom those products are being sold. It's ensuring that we try to achieve good consumer outcomes, that we avoid mis-selling. Again, those are the sorts of high-level outcomes that people need to focus on when thinking about product governance.

I suspect that when we come to look at product governance...historically, our focus has been on structured products, packaged products. That will probably remain the main focus of our supervisory efforts, although MiFID II applies across a wider set of instruments. That is because that is where we think there is likely to be the most risk of harm from the way in which firms go about their business.

It's also, I think, a case of, as we have tried to emphasise by putting the proportionality provisions in the product governance rules in MiFID II up front in the product governance rules in our handbook, the rules have to apply proportionately and they will apply more heavily the more complex the product and also where the firm is undertaking something other than simply offering products on an execution-only basis.

Inducements and suitability

Again, I think what MiFID II is doing here chimes in with what we have been doing historically as a regulator. We have had concerns about receipts of inducements; obviously the Retail Distribution Review is one aspect of that. We have published the results of our review of inducements. We have finalised our guidance in FG14/1. [This was to do with the ways in which the payments that product providers (who manufacture retail investment products) make to advisory firms under service or distribution agreements can go against the FCA’s Principle 8 (on conflicts of interest) and its conduct-of-business sourcebook (COBS) inducement rules, thereby undermining the objectives of the Retail Distribution Review.] Looking at what we have said in those sorts of documents is, I think, important again for understanding how we will look at the way in which firms are implementing the requirements of MiFID II.

In terms of suitability, again our business plan emphasises the fact that we continue to have concerns in some instances about the quality of suitability assessments. We have set out in the past what we think are the sorts of failings that tend to undermine suitability assessments: inadequate references to the cost of particular products; inadequate understanding of the products which are being recommended; and also mis-profiling of the attitude to risk of clients.

Again, those are the sorts of areas I expect us to focus on. There are elements in the MiFID II rules that speak to aspects of that. As I say, it's not going to be a huge disjunction in terms of what we look at and the concerns that we have between the implementation of the...between what we have been doing recently and what happens in terms of the implementation of MiFID II.

A significant challenge

We recognise that you face a significant challenge. We are trying to help you with the implementation through communication, through various bits of work that we are doing, but if there continue to be issues that you're struggling with, please come and talk to us about them and we will try to proffer assistance.