How not to fall foul of the regulator on UCIS

Why are IFAs becoming more interested in unregulated collective investment schemes (UCIS)?

There are two main reasons. The first is the low interest rate, low investment returns environment in which we currently find ourselves; the second is the raft of changes being introduced by the Retail Distribution Review (RDR).

At a time when investors are receiving little or no interest from banks and building societies and markets are still volatile, any investment that says it offers higher returns and is relatively low risk, with the added benefits of tax advantages, as some of the UCIS schemes do, is going to be very tempting for investors. The questions are: do they do have a place for clients in the right circumstances and, given the FSA’s concerns around promotion and sale of UCIS, how can IFAs advise on these investments and not fall foul of the regulator?

In fact, when RDR comes in on 1 January 2013, IFAs that want to retain the title independent will be required by the FSA to demonstrate knowledge of UCIS and to be prepared to advise upon the product if it is appropriate to their client. UCIS is not something IFAs are going to be able to shy away from come RDR.

The issue for IFAs however is that, having conducted an audit survey among some IFA firms, the FSA found numerous errors and omissions in the use of UCIS and so is treating UCIS as a cause for concern.

The survey

The FSA’s initial survey was of 12 firms and it found every one of them was not recommending UCIS in an appropriate manner. This resulted in 11 of the firms voluntarily varying their permissions, ie undertaking not to advise on UCIS (which could have an impact on their independent status come 2013) and for a number of them to be issued with a Section 166.

This is a process of review by a third party at the IFA firm’s expense, followed by report, appropriate redress if any and final sign off by the FSA, before the firm can resume work in that area. Given a third-party review of 20 files can cost £20,000 to £25,000, it makes sense to have the processes, procedures and management information in place now.

The FSA has since extended its survey to 66 firms, with similar negative findings, so it is very likely that any firm that has been undertaking UCIS work in the past 12 months will be contacted by the regulator at some point.

The FSA’s main concern is that people do not understand the regulatory requirements. The belief that because the products are unregulated they are not covered by the FSA is incorrect, as it is the advice that is the regulated activity, so the FSA is very much involved in the promotion and sale of these products.

The range

Due to its unregulated nature, UCIS can cover a huge range of different investment opportunities. It is essential that any IFAs advising on them understand the risks involved. Some of the forestry UCIS, for example, might rely on advantageous tax regimes in countries like South America and, while the tax regime in Guernsey or Cayman Islands where the UCIS is domiciled may be stable, it is the possibility and effect of a change of government in countries where the forests are located that need to be identified and understood as risks.

The FSA is also being more stringent around corporate governance and management information and will expect the board members to be able to demonstrate that they know the firm is selling UCIS. Also, an appropriate training and competence scheme for the IFAs advising on the products needs to be in place and individual advisers’ CPD records in respect of UCIS kept up to date. 

Understanding who the products can be promoted to is fundamental, as is tightly defining for advisers what constitutes a financial promotion to the client. The general rule is you cannot promote UCIS to anybody. Let me explain.

A financial promotion is basically any mention, either verbally or in literature, of an unregulated collective investment scheme. Simply mentioning “an interesting structured tax scheme” to a client or inadvertently leaving a UCIS brochure on the coffee table in your office, would constitute having promoted a UCIS without appropriate exemptions for clients and would put you in breach of the rules.