European Securities Markets Authority ESMA CPD

European Securities & Markets Authority (ESMA)

CPD Learning Objectives 1. Be familiar with the Mi. FID II/ESMA legislative background insofar as it relates to the 12 Competencies for financial advisers. 2. Understand the meaning or Smith & Pinching’s interpretation of each of the 12 Competencies. 3. Solidify understanding of certain company processes, paperwork etc. 4. Understand how to apply this learning to the ESMA Competency Test and demonstrate competency for 2018 and beyond.

Legislation Summary & Objectives • 2007 – Mi. FID I became law in UK. Objectives were: 1. Competition between European trading venues. 2. Broader markets (passporting etc). 3. Investor protection standards (market integrity, conduct rules etc). • 2011 – ESMA established (an EU financial regulatory institution). • Reviewed Mi. FID I – concerns regarding 2007/8 financial crisis, market developments and lessons learned since 2007.

Legislation Summary & Objectives • 1. 2. 3. 4. • ESMA’s objectives were: Strengthen investor protection: Increase the knowledge and competence of those giving investment advice or providing information about financial instruments, investment services or ancillary services to clients on behalf of investment firms. Reduce the risks of a disorderly market. Reduce systemic risks. Increase the efficiency of financial markets and reduce unnecessary costs. 2014 – ESMA’s revisions were agreed, which led into Mi. FID II.

Determining Competence Twelve competencies for advisory staff – you must be deemed competent under all 12 in order to advise from January 2018. How do firms prove that their advisers are competent? • • There is no standardised way of proving competence. Some aspects of the 12 competencies are open to interpretation and must be tailored towards an individual firm’s investment proposition. You have to “demonstrate an understanding” of the 12 competencies. It is down to the firm to decide how this “understanding” is proven. Competence is therefore assessed via training, testing and gap fill. This is no different to how competence is assessed today.

ESMA Competency 1 Understand: • Key characteristics, risks and features of investment products offered or recommended. • General tax implications for the client. • Products with higher levels of complexity.

ESMA Competency 10 Understand: • Market structures for investment products recommended. • Trading venues. • Any secondary markets. the types offered of or

Question 1, Part 1 Describe the product in basic terms to a new, inexperienced client. Read the Addendums for “characteristics, features and tax implications”, but think about the following: 1. 2. 3. 4. 5. 6. 7. Does the investor buy units or shares? Are there any investment limitations? What tax is the fund subject to? How does the investor derive their return? What tax is the investor subject to? Can it be held in a pension, ISA or bond? Can it be held in joint/multiple names?

Question 1, Part 1 cont. Read suitability letter templates for “general risks”, but think about the following: 1. 2. 3. 4. 5. Is my capital guaranteed? What level of growth will I get/can I expect? Will my income remain steady? Why might it change? Are returns and/or risk affected by any third parties? What happens if I want to sell? Will I be penalised?

Question 1, Part 2 Market structure: How is the product made available to the investor? E. g. bought direct or through a broker; units available inside/outside a tax wrapper; existence of secondary market. Trading venue: Stock exchange (and variations thereof). Secondary market: Where investors (private and/or institutional, e. g. bank, fund) buy and sell securities that are already owned. A stock exchange can be a secondary market, but think also about trading before maturity, private equity etc. The term “primary market” is used to describe when securities are traded for the first time.

Question 1, Part 2 cont. Describe the market for the product in basic terms to a new, inexperienced client. 1. 2. 3. 4. 5. 6. Where can I buy it? E. g. stock exchange, insurer, investment house, PLC, NS&I, bank/building society. Can I buy it directly from the provider or must I go through a broker? Is it liquid? Is it designed to be held to maturity or for a given period? If I want to sell it, will the provider buy it back or must I find a buyer? How can I access the secondary market? Other examples: 1) EIS – buy from manager; no secondary; 2) VCT – buy from manager; secondary market on stock exchange; 3) share – buy direct or through broker; secondary market on stock exchange; 4) unit – buy direct from investment house or platform; highly liquid so no secondary market.

ESMA Competency 2 Understand: Total costs and charges incurred by the client as they relate to: 1. Product. 2. Advice (initial charge). 3. Service (ongoing charge).

Question 2 • We use three charge agreements at S&P: Terms of Engagement, Initial Remuneration Agreement and Review & Ongoing Remuneration Agreement. • Select service option: used if we do not apply the standard ongoing charge across all assets we manage for the client. • Suitability letter: reflects the agreed charges and services. All services and charges are described in the Client Proposition, Terms of Business, charge agreements and suitability letters.

ESMA Competency 3 Understand how to: Fulfil obligations required by the firm in relation to suitability requirements.

Question 3, Part 1 What are the FCA “Suitability Requirements”? 1. Know Your Client: • Financial situation. • Objectives. • Information relating to risk, including capacity for loss. 2. Research and due diligence: • Nature of investment. • Risks and benefits. • Provider. 3. Make recommendations: • Needs and objectives. • Personalised, suitable advice. Do not “shoehorn”. • Compare charges, features, taxation, performance.

Question 3, Part 7 Which research systems do we use? 1. What does Investment Department use to analyse fund and market data? 2. What does Group Schemes Department use to analyse defined benefit transfers? 3. Who provides reports for tax efficient products? 4. What research do you undertake on Nucleus and Amber? 5. What research do you undertake on S&P model portfolios?

Question 3, Part 8 Regulation requires you to obtain the following product-related documents from the provider and give them to the client “presale”: • Key Features Document. • Client specific illustration. • Key Investor Information Document (where available).

Question 3, Part 9 Managing client expectations post-recommendation: • • • When the suitability letter will be sent (if not already given). Underwriting procedures (if applicable). When policy documents/contract notes should be received. Cancellation rights. Review date.

ESMA Competency 4 Understand: How the type of investment product offered by the firm may not be suitable for the client.

Question 4 Consider the following: You are recommending the Smith & Pinching Centralised Investment Proposition. Is this based on a neutral assessment of their circumstances, needs and objectives, or is it because “that is the solution we offer clients”? Is this a personalised recommendation that is based on the client’s specific needs? What does it describe? Think about the FCA suitability requirements.

ESMA Competency 5 Understand: • How financial markets function. • How financial markets affect the value and pricing of investment products.

ESMA Competency 6 Understand: • The impact of economic figures on the value of investment products. • The impact of national/regional/global events on the value of investment products.

Question 5, Part 1 Explain to a new, inexperienced client, in basic terms how the London Stock Exchange works. Consider the following: 1. 2. 3. 4. Is it public or private? Is it for buying, selling or both? Are transaction costs generally considered to be high or low? How does supply and demand affect pricing?

ESMA Competency 7 Understand: • The difference between past performance and future performance. • The limits of predictive forecasting.

Question 6 What are the fundamental differences between past performance and future performance? Past performance: • Known; based on specific time periods. • Includes information that covers at least the immediately preceding five years, or the whole period that the investment has been offered, if less than five years. Future performance: • Unknown; based on standard projection rates or reasonable assumptions, supported by objective data. • Varies and can never be guaranteed.

Question 6 cont. Performance risk warning example: • Past performance is not a reliable indicator of future results. • Any forecast is not a reliable indicator of future results. • The value of investments and any growth, income or dividend can fall as well as rise.

ESMA Competency 8 Understand: • Issues relating to anti-money laundering. • Issues relating to market abuse.

Question 7 • Part 1: Covered through annual anti-money laundering training and day-to-day activities. • Part 2: Fraudsters have tried to instruct us by email to transfer/liquidate elements of clients’ portfolios. Company policy is now to telephone the client on receipt of such an email and verify it. • Part 3: “Market abuse” is concerned with high level misconduct, not personal account dealing.

ESMA Competency 9 (Understand how to) assess: • Data relevant to the types of investment products offered or recommended to clients. • Examples: KIIDs, prospectuses, statements, financial data.

Question 8, Part 1 1. Charges (product; provider; adviser; frequency). 2. Effect of charges (reduction in yield). 3. Attitude to risk (key determinant of portfolio construction or model portfolio selection). 4. Fund choice/investment strategy (how it meets ATR and ties into objectives/portfolio; performance; fact sheets).

Question 8, Part 2 EIS/SEIS due diligence areas (not exhaustive): • • Charges. Funds under management. Company selection process. Track record. Exit strategy. Anticipated returns. Allenbridge, prospectus, third party review.

ESMA Competency 11 Understand valuation principles.

Question 9 Things to think about: What would you compare the overall portfolio value to? • Last valuation; benchmarks. What factors could have an impact on the overall portfolio value? • Performance; charges; top ups; withdrawals; income; penalties. What relevance do the underlying investments have to the overall portfolio value? • Performance; volatility. What special factors might you consider for an investment trust? • Trading at discount/premium.

ESMA Competency 12 Understand: • Fundamentals of managing a portfolio. • The implications of diversification.

Question 10, Part 1 How would you explain to a new, inexperienced investor the basics of investment decision-making? Things to think about: 1. How do you build and manage a portfolio? 2. What factors affect your decisions? 3. Why is attitude to risk important? 4. What is diversification for? Does it always work? 5. What is the risk of the client wanting to concentrate capital in a stock that is performing very well?

Question 10, Part 2 1. Can you explain the fundamental difference between advisory and discretionary portfolio management? 2. Why might a client prefer one over the other? 3. Is one more efficient than the other? If so, what is the potential benefit of this?

Question 10, Parts 3 and 4 1. One of our selling points is that we do not charge extra for discretionary management of a model portfolio. 2. We reserve the right to make an additional 0. 25% charge for management of non-model portfolio assets (a bespoke portfolio).

Question 10, Part 5 How would you manage the client’s expectations regarding the discretionary management process? • Meeting takes place; adviser records agreed investment strategy in meeting note. • Post-meeting, adviser passes meeting note and other documents back to administrator; they discuss the case and any special requirements. • Administrator prepares Discretionary Management Instruction (DMI) and passes it to adviser.

Question 10, Part 5 cont. • Adviser approves DMI; administrator asks Investment Department to draw up IMA. • Investment Department draws up two IMAs and passes them to administrator and adviser for checking. • On approval, IMAs go to Smith & Pinching Directors for signature. • IMAs go to client. • Client signs both IMAs; returns one to Smith & Pinching. • Investments are established and managed in accordance with IMA.