UK FCA consults on rule changes for client categorisation and conflicts of interest

Under the FCA rules, a firm is required to categorise its clients.  The starting position is that a client will be categorised as a “retail client”, which gives that client the fullest protection possible under the FCA rules. 

However, provided certain criteria are met, it is possible to recategorise a client as an “elective professional client”.  This means that the client receives fewer protections (including the protections that they would have under the FCA's Consumer Duty) but can also typically avoid many of the time-consuming processes that retail clients have to go through.  In addition, being categorised as a professional client may enable the client to access more sophisticated products which cannot be marketed to retail clients. 

The criteria for a person – particularly a natural person (i.e. a human being) – to be recategorised are regarded as being very onerous.  The tests are: 

1. a “qualitative” test: the firm must assess the expertise, experience and knowledge of the client, to ensure that the client is capable of making his own investment decisions and understanding the risks involved;
2. a “quantitative” test (for MiFID business only), the firm must ensure that the client satisfies at least two of the following criteria: (i) the client has carried out similar transactions at an average frequency of at least 10 per quarter for the previous four quarters; (ii) the client's portfolio exceeds €500,000 in value; and (iii) the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged; and
3. the client has to elect to be treated in this way, must be warned of the protections that he may lose, and must agree in writing that he is aware of consequences of losing such protections.

The FCA is undertaking a wider initiative of the rules relating to consumer access to investments (see also uk-fca-discusses-possible-changes-to-its-rules-regarding-consumer-access-to-investments) and as part of that is considering whether to change the client categorisation rules.  

What changes are the FCA proposing?

In the CP, the FCA is proposing the following changes:

• Firms will be able to categorise individuals as elective professional clients where the client has investable assets of at least £10 million, subject to the client’s informed consent. No assessment of the expertise, experience and knowledge of such a client will be required.
• The current “quantitative test” will removed. (This test is seen as a major practical obstacle to recategorising individual customers, as only a very small subset will meet these criteria.)
• Firms will continue to be required to undertake a robust qualitative assessment of a client’s expertise, experience and knowledge, but the FCA proposes to identify a set of relevant factors that firms must consider in undertaking a holistic qualitative assessment of the client. The FCA’s proposed criteria are set out in the CP.
• A client will only be able to be categorised as an elective professional client if they have actively requested this and given informed consent to opt out of all retail protections. A firm may share information about opting out to help inform the client, but any attempt to incentivise, mislead or put pressure on a client to opt out will be strictly prohibited.

Notwithstanding these detailed suggestions, the FCA also encourages views on whether its objectives could be achieved through the application of the Consumer Duty rather than through any new proposed rules.

The FCA is also proposing to simplify the criteria for “per se” professional clients (that is, clients who by default are regarded as professional clients), including by allowing all types of regulated firm, and also SPVs who are controlled by authorised firms, to be categorised in this way.

Who would be affected by the proposed changes?

The impact of these proposed changes includes the following:

• The proposals should lead to a larger number of people being able to be categorised as a professional client. This would have an impact on:
  • Clients: The client would receive fewer protections under the FCA rules – and, in particular, the Consumer Duty would not apply to those customers, but would be able to access products and services that are not normally available to retail customers.
  • Wealth managers and investment firms: firms who deal with more sophisticated or wealthy customers may benefit from being able to categorise more customers in this way. This may remove some unnecessary operational burdens from the firms and also enable them to offer a more tailored solution to their clients, with a broader range of products.
  • Product providers: providers of more sophisticated or bespoke financial products may find that a larger market becomes available to them.
• All firms who currently deal with elective professional clients are likely to have to revisit their assessment processes. In particular:
  • The new emphasis on holistic processes, rather than the more “tick-box” nature of the current rules, may mean that it becomes more operationally challenging to put compliant processes in place.
  • If a firm has accepted a client ticking a box to indicate they consent to being categorised as a professional client, the FCA says in the CP that this will not demonstrate informed consent. Such firms may therefore need to re-engage with their clients again to obtain the necessary informed consent.

The FCA is proposing rationalising the conflicts of interest rules contained in its SYSC handbook.  The changes are fairly minor, and are aimed at merging very similar or duplicative provisions.  The FCA intends to maintain the current core obligations, neither increasing nor reducing the current obligations for any firm.

Among the changes are the deletion of separate provisions in SYSC 3 that apply specifically to insurers.  All firms will become subject to the same conflicts rules under SYSC 10.  Certain other provisions that currently only apply to specific types of firm will apply to all types of firm under the new proposals.