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UCIS Don’t throw baby out with the bath water

By guest author Damian Davies – The Timebank

Better Safe than Sorry

Advisers don’t like to be linked with ‘miss selling’ scandals, and quite rightly so.

Miss selling is when an adviser incorrectly positions a product to an inappropriate investor in order to make a ‘sale’.

However, take an appropriate arrangement and correctly present it to a suitable investor and you have something very different indeed – good service.

There are many worthy products and structures which in the past have become tainted with the concept of "mis-selling” because of the fact that unscrupulous advisers have misrepresented the arrangements to inappropriate investors. As a result, many advisers stop considering these products completely in order to avoid a potential ‘miss selling’ scandal.

The problem is that by doing this there may be arrangements which may offer an ideal solution to a specific client’s need which are overlooked.

At the time of writing there are some who feel that Unregulated Collective Investment Schemes (UCIS) will also suffer this fate, and thus should be avoided.

This is unfortunate as the UCIS universe provides access to some of the most dynamic investments, which can complement and enhance a client’s portfolio by accessing assets which are diverse, not co-related to standard assets classes and can provide low volatility.

Proceed with caution

Whilst there are potential rewards, quite often providers of these arrangements will ‘over emphasis’ these opportunities so it is important that any recommendation is made only after you have clearly demonstrated two factors.

Firstly is the client suited to this type of investments and has agreed to the perceived additional risk? In simple terms the client should be seen either as a Knowledgeable Investor, a High Net Worth investor capable of accommodating any losses or have a high tolerance for risk.

Secondly, can you demonstrate due diligence has been undertaken on the product and on the provider and any counterparty risk? At the very least, the due diligence should cover the charges, liquidity, the risks and the people involved. Beyond this, care should be applied to the procedures applied to the management of the business. As a Paraplanning company, we are regularly involved with this analysis and have a rigorous process of assessment.

Most importantly, you should not rely on the product provider’s literature and research as this can be seen as bias so your research should be entirely independent. This may seem rather a lot of work but this can either be carried out by your firm or out-sourced to an appropriate party, such as a compliance support business or a firm of Paraplanners.

This will allow you to inform the client of your opinion and explain to them in more detail the risks involved, as well proving the evidence that appropriate research has been conducted to ensure the product is appropriate for the client and their needs.

If the correct approach is completed, then you can benefit from the range of investments that UCIS offer and ensure your clients are benefiting from your Independence.

Timebank House
Plough Lane

Phone: 01432 355322
Fax: 0845 2808777

IFAs - Treating Customers Fairly is a waste of time.....

By guest author Jon Pittham, director of Clientsfirst.

The statement on your website and in your brochure says:

'We're committed to treating customers fairly'.

What a shocking statement!  Put yourself in the prospect or client's shoes - they don't know what TCF is, why should they?  Yet they read on your website or brochure that you are 'committed' to treating them fairly.  Based on that, I bet they'd love to be a client of yours!

I suppose that treating customers fairly is kind of a good thing if they are about to trust you with their life savings, but hey, I think I'd expect a bit more than that.  After all, being treated fairly should come as standard, shouldn't it?

Can you imagine entering into a long term relationship with someone to whom you are probably going to pay a great deal of cash, for them to say they promise to treat you fairly.  Oh, well that's nice but no thanks.

I'd prefer to work with someone who will make a difference, treat me like I'm special and commit to delivering service and advice excellence.  A firm that's committed to delivering excellence perhaps - now that's more my language...

TCF is an FSA initiative aimed at advisers, not clients, yet it is regurgitated with the expectation that clients will understand it.  Scary eh, the FSA are now delivering your marketing (it's all part of their master plan)!  This is no different to taking Provider or Investment house commentary and technical updates and forwarding them on to clients as 'news', another no-no in my book...

Your clients want your opinion, your thoughts, to trust you and to feel like they're with the best adviser in the UK.  Make your marketing, proposition and communications suited to their world, not yours.

I think clients deserve to be treated a little better than fairly, don't you?

John Pittham


MiFID, IFA's & The Promotion of a UCIS

By guest author, Simon Webber, director of StypersonPOPE.

 "How can a non-MiFID firm of IFAs promote units in an
unregulated collective investment scheme to a UK client?"

What is the effect of MiFID on firms providing investment services related to a UCIS?

UK firms are required to follow the Europe-wide rules laid out in the Markets in Financial
Instruments Directive ("MiFID”) if they carry on an 'Investment Service' and if no exemption applies.
Investment Services include, inter alia:

  • Reception and Transmission of orders; and
  • Investment Advice.
Whilst these two activities are usually associated with the promotion of an unregulated collective
investment scheme ("UCIS”) by IFAs, the UK Treasury has opted to implement the 'Article 3
Exemption' to MiFID.

This exemption applies to firms which meet the following conditions:
     • they do not hold clients' funds or securities;
     • they do not provide any investment service other than reception and transmission of orders
        or investment advice, or both, in relation to transferable securities and units in collective
        investment undertakings; and
     • they transmit orders only to a MiFID investment firm (among other types of firm not
        relevant to this purpose).

 [Note 1] As long as the firm to which orders will be transmitted is a
MiFID investment firm, IFAs otherwise enjoying the Article 3 exemption
 will continue to be able to do so when providing investment advice
     and receiving and transmitting orders in relation to a UCIS.

What is the effect of MiFID on firms promoting a UCIS?

The promotion of a UCIS is subject to the restriction in §238 of the Financial Services & Markets Act
("FSMA”). Essentially, no firm can promote a UCIS to "the general public” but both the Treasury
(through the 'CIS Exemption Order') and the FSA (through 'COBS 4.12') are empowered to create
exemptions to this prohibition. MiFID does not affect the categories of exempt investor but it does
affect the tests applied to the marketing statements and documents ("financial promotions”) which
may be used.

For a non-MiFID firm, the promotion of a CIS will always be for non-MiFID business. However, a
MiFID firm must consider whether the promotion is for MiFID business or not.

If it is not MiFID business, and a firm uses a CIS Exemption Order exemption, the full financial
promotion rules do not apply (but the general rules relating to communications with clients still do,
including the "fair, clear and not-misleading” rule). If it is not MiFID business, and a firm uses a COBS
4.12 exemption, then the financial promotion rules in COBS 4 apply as they are relevant to that
financial promotion (some only apply to MiFID business, others only to retail clients).

For firms carrying on MiFID business, the relevant MiFID-derived rules in COBS 4 will always apply to
that firm (even if the exemption to §238 on which they are relying is one in the CIS Exemption
Order). MiFID firms should also bear in mind that they are responsible for establishing that UCIS
promotional material complies with the financial promotion rules.

[Note 2] If the financial promotion describing a UCIS is compliant with
  the financial promotion rules, any firm (whether carrying on MiFID
   business or not) will be able to use it in promoting that UCIS to an
           investor exempt from the FSMA §238 Restriction.

Exemptions to the FSMA §238 Restriction

The restriction provides that "An authorised person must not communicate an invitation or
inducement to participate in a collective investment scheme”. This does not apply to an authorised
or recognised schemes but does apply to a UCIS. There are a number of exemptions to this
restriction which fall into two parts, those created by the Treasury (the 'CIS Exemption Order') and
those created by the FSA ('COBS 4.12').

CIS Exemption Order

Under section 238 (6), the Treasury have defined a number of further categories of investor to
whom a UCIS can be promoted without breaching the restriction in FSMA. These are similar (but
not identical) to the exemptions under section 21 which apply to unauthorised persons. Like those
exemptions, the investor must qualify for inclusion in the relevant category before the promotion is
made. The categories are:

  • Existing investors in the scheme;
  • Investment Professionals, being
                     ◦ authorised persons,
                     ◦ exempt persons (not including Appointed Representatives but including some
                       professional firms)
                     ◦ investors whose 'ordinary activity' involves investing in unregulated schemes,
                     ◦ Governments, local authorities, and international organisations,
  • Certified Sophisticated Investors whose certificate is in respect of a UCIS and has been signed by an authorised person other than the scheme's operator;
  • High Net Worth Companies or Unicorporated Associations; or
  • an association made up predominantly or wholly of HNW Companies and Sophisticated Investors

For a UCIS that invests wholly or predominantly in the shares or debentures of unlisted companies,
there are further categories of investor who are exempt from the restriction. This exemption is
limited to promotions made by authorised firms. These are:

  • Certified High Net Worth Investors (who can self-certify); and
  • Self-Certified Sophisticated investors.

COBS 4.12

By these rules, the FSA have defined eight categories of investor to whom a UCIS can be promoted
without breaching the restriction in FSMA. Unlike the exemptions which are provided for under
Section 238 (6) (above), the promotion can be made, not only to investors who are known to fall into
one of the eight categories, but also when made:

"in a way that may reasonably be regarded as designed to reduce, so far as possible,
the risk of participation in the collective investment scheme by persons who are not in
that category”.

The promotion should, of course, be made only to people whom the promoter believes will meet
the criteria and the document should dissuade those who do not meet the criteria from applying.

     [Note 3] Ultimately, if COBS 4.12 is being relied upon, an authorised
  firm (eg the operator or promoter) must have processes and procedures
in place to ensure that both promotions and applications are appropriately
       filtered and that any investors who do not meet the criteria are
                    prevented from becoming participants.


The eight categories created by COBS 4.12 can be summarised as including investors who are:

   1. already participants in a scheme which is 'substantially similar' in risk profile and assets;
   2. judged as 'suitable' by an authorised person of which they are a client; *
   3. eligible to invest in a scheme under the Church Funds or Charities Act legislation;
   4. eligible employees of the firm;
   5. members of the Society of Lloyds (in respect of underwriting insurance business);
   6. exempt from the General Prohibition on carrying out regulated activities (in respect of a
       scheme which relates to the subject of their exemption), not including Appointed
   7. eligible counterparties or professional clients; ** or
   8. subjects of an 'adequate assessment' of their expertise, experience, and knowledge. ***

In the vast majority of cases, the most useful categories above will be 2, 7 or 8:

* For category 2, investors will be judged 'suitable' typically by an IFA or other authorised firm with
whom, they have a relationship and who will have to take into account their knowledge, financial
situation, and investment objectives. The scheme's operator will probably seek an undertaking from
the firm in question that such a judgement has been reached.

** For category 7, firms may use the non-MiFID client categorisation regime even if the firm will be
within the scope of MiFID when it makes the promotion.

*** For category 8, an 'adequate assessment' can be carried out by an authorised firm which will
request information from the prospective investor in order to gain:

"reasonable assurance, in light of the nature of the transactions or services envisaged,
that the person is capable of making his own investment decisions and understanding
the risks involved”.

This information will usually be gathered by way of an assessment questionnaire which, once
completed and returned, will be analysed by the assessing firm according to criteria designed to
ascertain the expertise, experience and knowledge of the prospective investor. This will result in a
positive or negative assessment and the investor's subscription application will be accepted or
rejected accordingly.

Simon Webber

Please note that this paper does not constitute legal advice and due to its limited scope and summary
form, is intended only to be an introduction to the subject matter.

Important Information COBS 9.2

By guest author The Consulting Consortium.

The FSA are ’significantly’ concerned with the level of unsuitable advice in the market and advisers’ ability to assess the risks a client is willing to take.   If you provide investment advice or discretionary management services to retail customers, or work as part of a network or platform, then you need to be aware of proposed new guidance.

A review of FSA intelligence and information gathered on firms’ risk profiling and asset allocation methodologies shows failings in how firms establish the risk a customer is willing and able to take and how they make subsequent investment selections.

This is against a backdrop of the FSA seeing an increasing trend of firms adopting risk-profiling and asset-allocation tools which are used to support, supplement or in some instances replace the more traditional ‘know your customer’ approaches.  Without adequate assessment then unsuitable products may be recommended.

Their report considers:
How firms establish and check the level of investment risk that retail customers are willing and able to take (in the wider context of the overall suitability assessment)
The potential causes of failures to provide investment selections that meet the risk a customer is willing and able to take
The role played by risk-profiling and asset-allocation tools, as well as the providers of these tools

The FSA’s guidance is expected to help firms improve the standards by which they are providing investment advice or discretionary management services to retail customers.

If you would like reassurance on your current practices or a better understanding of how this may affect you, please contact TCC on or call 020 3008 6020.


The full text of the proposed guidance can be accessed here:

The FSA has asked for responses by January 28th 2011.

Thank you and kindest regards

The Consulting Consortium

Increasing Objectivity in Hedge Fund Manager Selection

By guest author R. Nicholas Brack, CEO of Aduro Asset Group, LLC

Objectivity is at best an elusive principle.  We all see things through the filter of our own experiences and this dampens our ability to objectively assess people, situations, events and opportunities.  Through this subjective lens there is a tendency to eliminate or obfuscate facts so that our experience will align with our belief system.  This is no less true in the selection of hedge fund managers and the respective investment strategies sought to increase portfolio performance and decrease overall risk.  This article sets forth a systematic process for increasing objectivity and the mitigation of manager selection risk.

A subjective filter utilizes underlying belief systems that can often betray even common sense.  A belief that all top tier or "blue chip” hedge fund managers provide superior returns and greater mitigation of operational risk has been put to a serious test over the last two years given the collapse or dismal performance of many "top tier” hedge funds (and established financial institutions with their own internal hedge funds for that matter).  Conversely, a subjective filter that overlays the belief that emerging managers provide better returns in spite of increased operational risks, may also betray our best intentions in selecting the right investment manager. Performance and operational risk are only two components of a complex array of factors that must be analyzed in the process of selecting the right manager. 

In order to increase objectivity in the manager selection process the qualitative and quantitative factors can be blended and balanced together to provide a broader quantitative framework for the entire process.  Using a systematic scoring model that combines the qualitative and quantitative factors can bring to the forefront both seen and unseen risks that can subsequently be judged with greater objectivity.

Through a partnership with the Florida Institute of Finance, we have developed a systematic and repeatable due diligence process that can aid prospective investors in mitigating manager selection risk. This process scores prospective managers through five separate phases of the selection process.  Managers receive up to two-hundred-and-seventy points for forty-nine distinct attributes in six different categories.  The following outlines this systematic process through the five separate phases (further illustrated in Figure 1 below).

Phase one entails the identification and initial qualifications of a potential manager. Prospective managers are initially screened based on risk, historical performance, AUM and other general factors.  This initial screening aids in reducing the manager universe to a more manageable macrocosm.

Phase two engages the managers with a request for updated information through an Authorization to Release Information (ARI) and the Request for Information (RFI). The Information provided in the ARI is used to complete and send Requests for References (RFR). It is important to gain as much information in writing as this can affect the output of phase four where written correspondence is then contrasted with verbal communication and cues documented during the onsite visit. The dialogue in phase two continues until all data is compiled and the checklist is scored for its overall completeness.

Phase three focuses on information verification through two tracks: qualitative and quantitative.   Quantitative verification includes performance history and risk, audited financial statements, capacity analysis, strategy and return distribution analysis, and AUM. The objective is to validate the performance and risk as reported by the manager against the audit. Qualitative verification focuses on background, character, and administrative documents as provided in phase two. This includes phone conversations, references, and e-mail testimony of the manager’s character and background.

Both the quantitative and qualitative tracks in phase three are scored independently and then combined for an overall phase three score.   One important component of this phase is acquiring as much written documentation as possible, which is then analyzed for consistency in the verbal/face-to-face meetings of phase four.  This is a critical step for uncovering inconsistencies or unseen risks that can belie prior correspondence. 

Phase four highlights the "on-site” due diligence.  This phase evaluates and validates the operational processes and/or issues that may be considered material in terms of risk. The due diligence team administers a prepared on-site questionnaire and conducts interviews with principals, portfolio managers, C-level executives, and relevant support staff.  The goal is to not only verify and identify any significant operational issues, but also addresses any material issues that are uncovered though inconsistencies in written and verbal communication.  While this phase may be more art than science, the application of the scoring model still applies and the phase four score is combined with prior scores to aid in decreasing subjectivity.

Finally, phase five encompasses a final review of the prospective manager’s entire file and the preparation of an internal investment committee report. The final report documents all material issues throughout the due diligence process and the report is subsequently signed by two officers of the firm.  Further authentication of the report may be made by using an outside observer/advisor to also provide final signature. Third party authentication can assist in maintaining accountability throughout the selection process.

The process outlined above is not necessarily exhaustive; however it is intended to contribute to a broader dialogue of best practices.  All of us, regardless of experience and/or entrenched processes, can still have blind spots.  The systematization of due diligence and manager selection beyond a "check-the-box” methodology can help to remove these blind spots and increasing the potential for objectivity in hedge fund manager selection.  

R. Nicholas Brack, CEO of Aduro Asset Group, LLC

The case for unregulated funds

Guest author, Jonathan Gain, CEO of Stellar Asset Management, on why advisers should consider unregulated products.

Adding the prefix ‘un’ to the words ‘regulated products’ conjures up situations some advisers and their compliance staff want to avoid like the plague.

But it should not be like that. First, some background: all UK fund management firms are authorised by the FSA, which enables them to carry out regulated activities such as establishing, managing and promoting various types of funds.

Typically these funds will be either authorised collective investment funds such as investment trusts or Undertakings for Collective Investments in Transferable Securities (UCITS) or unregulated funds such as Unregulated Collective Investment Schemes (UCIS).

Authorised funds will have their scheme documentation reviewed and approved by the FSA before publication and will be required to follow specific rules on matters such as the spread of assets, dealing frequency, cash reserves and limitations on borrowings.

As we have seen in recent months, these rules do not necessarily mean that the product is any less risky, as those exposed to Keydata and Arch Cru will sadly testify.

Unregulated history

Unregulated funds were originally set up for those asset classes wherethe investment activity may preclude regular dealing or wish to have higher levels of gearing. These funds have typically been used for property transactions.

The overwhelming majority of funds, be they authorised or unregulated, will be managed or operated by an FSA-regulated company. There are, however, unfortunate exceptions, and it is possible for companies not regulated by the FSA to promote unregulated schemes. These companies can be either incorporated in jurisdictions where the regulations are less stringent, or rely on exemptions in UK legislation around introducers.

The recent report by the FSA into UCIS and their sales and promotion uncovered some issues at a small number of advisory firms, and it is the regulation around this type of product that needs to be clarified. The responses on various websites show that there is a sense of confusion. The reaction should not lead to a cessation of advice in this area as many have mooted.

Why use unregulated products or UCIS?

The FSA is not in any way stating that UCIS are fundamentally wrong structures; its regulations determine that any fund that does not meet the criteria of a collective investment scheme or CIS must therefore be a UCIS fund and therefore they impose a restriction that they cannot be promoted to the general public in the UK. However, they can be promoted to certain categories of investors who are high-net-worth, or sophisticated investors who are able to understand the risks involved.

UCIS have generally been used for less mainstream investment activities, such as property, forestry and film schemes. The rationale for this is that as the assets are more illiquid, so regular dealing virtually impossible. They are therefore normally closed-ended vehicles such as partnerships. Such funds also fall foul of the asset ­diversification rules and may acquire only one or two properties; others have higher levels of gearing, which obviously increases their risk profile.

Are the schemes suitable?

There will always be good and bad investment strategies and, as we have noted earlier, it does not really matter if you are an authorised fund or not; investors still have investment risk and some strategies will fail.

However, all advisers are well aware of the need to undertake client suitability assessments and the advice they give does not differ for either anauthorised or unregulated fund. The FSA will require evidence of ‘know your customer’ and ‘attitude to risk’ fact finds.

Compensation and complaints

The Financial Services Compensation Scheme (FSCS) is available on the default of the fund manager or operator, regardless of whether it is a UCIS or an authorised fund. The manager or operator clearly has to be a participant. The FSCS applies at the firm level, rather than at the underlying investment level. Therefore, advisers should check with the manager or the FSA whether they participate. However, investors must understand that if the fund itself fails, they will not get a return from the FSCS unless the manager or operator is at fault.

The ability to complain to the Financial Ombudsman Scheme will also apply to UCIS in the same way as it would for an authorised fund. It is important to note that if the investor has been categorised as a ­professional client, they will not be able to complain to the Financial Ombudsman Scheme. Again, any manager’s or operator’s participation in the scheme will need to be checked.

Professional indemnity (PI) policies usually provide cover in the event that a third party claims to have suffered loss as result of the policyholder’s professional negligence, omission or error.

You would expect a standard PI policy to provide cover if a firm has negligently advised its customers to invest in UCIS in contravention of the FSA’s regulatory requirements. Naturally, if there has been a deliberate breach, then the policy is unlikely to respond.

As with most things, the FSA has not made matters easy for either fund managers or advisers in terms of how the risks of both authorised and unregulated funds are indentified and managed. We will never be able mitigate investment risk either, but good fund managers with sensible strategies will never go out of fashion.

UCIS fulfil a necessary function and enable investors to obtain exposure and portfolio diversification they would not ordinarily achieve in authorised funds alone. They are not for everyone, but when structured correctly, with a regulated manager or operator, they do provide attractive opportunities in an investor’s portfolio, and some even come with attractive tax benefits.

Jonathan Gain, CEO of Stellar Asset Management

IFA’s and the promotion of, and advising on, unregulated collective investments

Unregulated collective investments cannot be marketed to the general public. This type of investment can normally only be promoted, to clients who are professional clients, eligible counterparties, investors currently participating in unregulated collective investments, or have done so in the last 30 months. In addition, if a firm has undertaken an assessment of a client’s expertise, knowledge and experience and the assessment gives adequate assurances that the client is able to make his own investment decisions and understand the risks, then such products can also be promoted to that client.

Following the introduction of MiFID in November 2007, a non-MiFID firm is only able to advise on unregulated collective investments emanating from either a regulated firm (e.g. a fund manager regulated by the FSA), or from a foreign firm approved by the FSA as having regulation nominally the same as the UK. Any firm wishing to advise on unregulated collective investments which are not provided by a regulated firm must comply with certain MiFID requirements and in order to do this the firm will need to become an exempt CAD firm. To become an exempt CAD firm you will need to apply to vary your permissions; you will also need to make changes to your systems and controls in line with the common platform requirements outlined by MiFID if you have not already done so and you may also see changes to your capital requirements depending on the PI cover that you have in place.

We would recommend that before advising on an unregulated investment, you speak to your PI insurers to ensure there are no issues with you advising in this area.
We would suggest that if you are advising on products such as this you should explain the mechanics of the investment and the relevant risks associated with the fund. You should also highlight the following points to the client to explain the additional risks associated with an investment of this nature:
  • The product is not regulated by the FSA.
  • The product is not covered by the Financial Services Compensation Scheme
  • The client will not have access to the Financial Ombudsman Service.
  • That legal action may be the only route available to him/her in the event of a dispute.
  • That they should take advice from a solicitor and/or accountant prior to entering into the investment to discuss the legal and tax aspects of the investment.
  • That the client has no cancellation rights in respect of the investment.

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