The Compliance Doctor – That UCIS Document

by | Aug 6, 2013

Share this article

Facebook Open Graph

Lee Werrell, Managing Director of CEI Compliance Ltd, Gives An In-Depth Review of June’s Policy Statement on UCIS and UCIS-like Products

As we all know, the FCA published its widely-anticipated Policy Statement PS13/3 on Unregulated Collective Investment Scheme (UCIS) in June 2013. The Policy Statement followed on from the responses to the FSA’s CP12/19 Consultation Paper, which had been published back in August 2012.

As we’re also aware, CP12/19 had set out to discuss the proposed restriction of UCIS sales to retail customers. The FSA had set the discussion in train because it had found that most of the financial promotion and sales of UCIS it had reviewed had failed to meet the regulator’s requirements – exposing ordinary investors to “significant potential for detriment”.

That’s putting it mildly. The FSA had reported that fully 64% of the firms sampled – nine out of 14 – had failed to understand or follow the existing rules restricting the promotion of UCIS in the retail market. Of the 131 UCIS transactions that it had reviewed, at least 90 transactions (76%) had been “inappropriately promoted” to retail investors.

Given that UCIS have been such hot news, it was not so very surprising that the FCA has now published its final rules on the proposals to ban the promotion of UCIS and close substitutes to ordinary UK retail investors.


Why Can These Products Be Detrimental?

UCIS, as a product, are not subject to the usual restrictions in terms of their investment areas, powers or how they are run. Even though a scheme will not be authorised or recognised by the regulator, activities in relation to UCIS – i.e. providing recommendations and advice or arranging, managing or operating a scheme – are still regulated.

Although the current rules do prohibit the promotion of UCIS to the general public (defined as “ordinary retail investors” or ORIs), the practice had been rather different. Many firms surveyed had been using exemptions to these rules to continue promoting and selling UCIS to clients for whom they were clearly not suitable.

In a bid to encompass all the right areas, and to exclude some areas that should specifically not be included, the regulator has now redefined the terminology for UCIS and close substitutes and they are now collectively referred to as Non-Mainstream Pooled Investments (NMPIs).


What Are The New Definitions?

UCIS. As we know, UCIS are Collective Investment Schemes (Collectives) which, being non-regulated, have the freedom to invest in non-traditional assets, or to concentrate on one asset (which would make them highly dependent on one stream of income). They may also be highly geared (bringing increased levels of debt).

These characteristics allow providers of the products to create complex strategies for their investment programmes. On the one hand, they may be investing into illiquid assets; on the other, they can create specific “units”, “shares”, “certificates”, “bonds” or other investment classes where it might prove difficult to obtain an independent valuation at the time of purchase – or any time in the future.

Close Substitutes. Some unregulated market makers have attempted to market their products in different ways, and using other legal structures, in their efforts to disguise their identity or their operations. In an effort to avoid such ‘regulatory arbitrage’, the regulator has identified what it is calling ‘close substitutes’ to UCIS – now collectively referred to as NMPIs.

NMPIs. These are subject to the rules laid out in this Policy Statement – but any new products that cause the FCA concern may be added to the listing through consultation. And the regulator may apply marketing restrictions to any additional products.

NMPIs currently include:

  • Units in qualified investor schemes (QIS);
  • Traded life policy investments (regardless of the legal form the product takes);
  • Units in UCIS; and
  • Securities issued by SPVs pooling investments in assets other than listed or unlisted shares or bonds


What’s Excluded From the Restrictions?

The FCA considered the responses to CP12/19 and confirmed that the following products lay outside the UCIS restrictions.

  • Securities issued by SPVs that pool investment in listed or unlisted shares or bonds;
  • Exchange traded products;
  • Overseas investment companies that would meet the criteria for investment trust status if based in the UK;
  • Real estate investment trusts; and
  • Venture capital trusts.


What about Enterprise Investment Schemes (EIS)?

Importantly, EIS funds and seed enterprise investment scheme funds that are not structured as UCIS are out of scope. Obviously, those that are structured as UCIS will be restricted in the same way as UCIS.


What Are The Risks of NMPIs?

ORIs risks are, according to the FCA, threefold:

  • The underlying assets may be speculative, illiquid and/or difficult to value accurately;
  • The investment strategies and/or terms and conditions are often highly complex; and
  • Less regulated product structures carry heightened governance risks.


The FCA acknowledges that these factors may be present in varying degrees within individual NMPIs. And it considers that it is sophisticated and high net worth investors who are best placed to be able to protect their own interests – either because they are able to personally assess and calculate complex propositions themselves, or because they can afford or have access to specialist advice.


When Do The New Rules Take Effect, And What Has Changed?

The new rules will take effect from 1 January 2014. But this is a deadline and not a starting point, so some firms may wish to comply with the rules sooner.

The main changes are that the FCA has removed three exemptions from the existing UCIS promotion rules:

  • COBS 4.12.1R Category 1 – the ability for firms to promote UCIS to people who are already participants in a UCIS or who have been in the last 30 months.
  • COBS 4.12.1R Category 2 – the ability for firms to promote UCIS to people for whom they have assessed the product to be suitable (i.e. with advice).
  • COBS 4.12.1R Category 8 – the ability for firms to promote UCIS to sophisticated highly experienced investors.

However, the FCA has also created NMPI exemptions for Existing Business, as it was considered that, with the removal of COBS 4.12.1R Category 1 (existing customers), the situation might prove restrictive to customers who have an existing product that might need to be replaced, or where benefits are offered. Accordingly, they have introduced a new exemption: Replacement products and rights issues.

To use this exemption, firms will have the ability to promote new NMPIs that are intended to replace or absorb an existing scheme, or where there is a rights issue. This is a commonsense move on the FCA’s part, because the regulator is of the opinion that, while there might be a risk that the original investment may have been mis-sold and the replacement investment may not be any more suitable than the original one, it is still preferable for a customer to hear about a planned replacement product than to have to accept encashment without any choice in the matter.

Secondly, new exemptions have also been introduced in their rules to provide greater flexibility for sophisticated and high net worth investors.

The removal of COBS 4.12.1R Categories 2 (advised sales) and 8 (sophisticated investors) have required a replacement with two new exemptions that will allow firms to promote any NMPI to retail clients who meet the necessary criteria. That is to say:

  • They are certified as sophisticated investors; or
  • They are certified high net worth individual or self-certified investors (provided that the firm considers that the NMPI is likely to be suitable for the client based on a preliminary assessment of the client’s profile and objectives)

Third party certification was an issue in the original CP12/19, and this has been covered by the rules that state that firms are now allowed to certify clients meeting the criteria set out in the high net worth or sophisticated investor exemptions, rather than requiring a third-party firm to sign the certificates.


Who Can We Still Sell UCIS To?

The following two definitions describe the categories of investors who fall outside the FCA’s ban on sales to retail investors:

  • Sophisticated investor (COBS 4.12.7) A sophisticated investor is a retail client with extensive investment experience and knowledge of complex instruments, who will be better able to understand and evaluate the risks and potential rewards of unusual, complex and/or illiquid investments such as NMPIs.
  • High net worth investor (COBS4.12.6) High net worth investors must meet the criteria of having either an annual income of more than £100,000 or having investable net assets of more than £250,000. These criteria are subject to review and may be updated in the future.


What Are The Rules On Promoting NMPIs?

NMPIs are considered to be niche risky products, and the FCA believes that they are almost certainly inappropriate for ordinary retail investors. They are more likely to be suitable for promotion to professional or institutional investors, and to those retail customers who meet the criteria to be treated as sophisticated or high net worth investors. The rules therefore restrict the promotion of NMPIs to ordinary retail investors.

To remind everyone, a financial promotion is:

an invitation or inducement to engage in investment activity that is communicated in the course of business.

Giving a disclosure document does not always amount to a promotion as it could be supplied as information, rather than a promotion, after a decision to invest is made by a manager in a discretionary management service.


An Explanatory Flow Chart

You’ll find an excellent flow chart in Annex 4 of the FCA’s Document (pages 56-58), at, of which the image below is only a small part:



What Does It All Mean In Practice?

Many retail intermediary firms would only ever have marketed these types of products to their more sophisticated clients. But, as usual, a misbehaving minority have prompted the need for more specific rules which will now need to be followed explicitly by all.

This is particularly important in the case of those products which were not previously subject to any restrictions. There might be a need to review these product sales, and to make any reviews include the changes. Remember, you have the rest of this year to ensure that everything is covered.

In practice, firms will need to ensure that their sales procedures are consistent with the new rules, which clearly and obviously place greater emphasis on suitability assessments and record keeping.

Firms should seek qualified and professional compliance advice on their existing procedures as soon as possible to ascertain what changes need to be made to ensure the necessary changes are put in place in by 1 January next year, to avoid any delay in being able to market their products; the clock is ticking.

As a final note, it is worth bearing in mind that the FCA is keen to stress that there should not be a presumption of general suitability just because a product falls outside the new NMPI definition.

It would be useful to read the document for your own satisfaction, where you will find that the FCA notes that it may use a temporary product intervention rule as part of a continuing review of market developments. As such, firms should not ignore or apply reduced diligence of the new rules completely for potentially out of scope products.


Share this article

Related articles

Trending articles