Davinia Collins, solicitor at Bond Dickinson, looks at the Financial Conduct Authority’s (FCA) latest consultation on how it intends to implement the Insurance Distribution Directive and its proposals regarding the application of MiFID II standards to include insurance-based investment products (IBIPs) and pensions. She considers the likely implications and what practitioners should do to prepare.
FCA opens second IDD implementation consultation
The FCA issued Insurance Distribution Directive Implementation—Consultation Paper 2 (CP17/23), setting out its proposals for the changes required to comply with the Insurance Distribution Directive 2016/97/EU (IDD). Comments are sought by 20 October 2017. The IDD replaces the Insurance Mediation Directive 2002/92/EC (IMD). It aims to enhance consumer protection when buying insurance (including general insurance, life insurance and insurance-based investment products) and to support competition between insurance distributors by creating a level playing field.
What does the FCA say in the IDD consultation (CP17/23) in relation to the application of MiFID II standards to insurance-based investment business and pensions?
The scope of financial instruments subject to the Markets in Financial Instruments Directive 2004/39/EC (MiFID) and the recast Directive 2014/65/EU (MiFID II) does not include IBIPs. Traditionally however, the UK has regulated these products in a similar manner to products such as shares, debt securities and investment funds, and most of FCA current rules on conduct of business (COB) contained in its Conduct of Business sourcebook (COBS) apply to IBIPs and pensions as these products are recognised as being in the same relevant market and substitutable for MiFID products.
MiFID II COB rules are mainly set out in chapter II of MiFID II (and embellished upon in delegated legislation made under MiFID II) and relate, among other things, to acting in the best interests of clients, suitability and appropriateness of investment products or services and acting through third parties. The FCA’s intention to apply a consistent regulatory regime for MiFID investment products and IBIPs is understandable, as it would strengthen its strategy for monitoring and supervising manufacturers and distributors of investment products and services in the UK.
The FCA believes that taking such an approach ‘helps maintain a consistent level of protection for clients and mitigates against regulatory arbitrage…’ (DP15/3: Developing the FCA’s approach to implementing MiFID II conduct of business and organisational requirements). Recital 87 of MiFID II also reiterates this approach with the acknowledgement that customers are often offered IBIPs as a potential alternative to MiFID II investments, and as such investor protection requirements under MiFID II should apply consistently also to IBIPs.
In its third MiFID II implementation consultation paper (CP) (CP16/29) published in September 2016, the FCA referred back to its proposal to apply MiFID II conduct rules to IBIPs and pensions, saying that it would revisit this issue again when consulting on implementing Directive 2016/97/EU in 2017. CP17/7 on implementing the IDD focused on the FCA’s proposals regarding:
- application of the IDD
- professional and organisational requirements
- complaints handling and out of court redress
- changes to COB rules for non-investment based contracts
- the regulatory regime for ancillary insurance intermediaries
The current CP (CP17/23) however, published in July 2017, outlines the FCA’s approach to the rules on IBIPs. It is the FCA’s intention to align IBIPs and pensions to MiFID II standards because they are substitutable for MiFID II investment products and already subject to the COBS sourcebook, even though they are not subject to MiFID and will not be within scope of MiFID II. Accordingly, this intention supports the FCA’s view that a broadly consistent regulatory regime helps to maintain an appropriate level of protection for consumers and a consistent framework for firms.
The main areas discussed in the CP which would be affected by the application of MiFID II standards are as follows.
Article 29 of the IDD contains the information requirements for IBIPs customers, who must be provided with information on all costs and related charges of the investment product. As a minimum, the IDD expects firms to provide customers with a periodic assessment of the suitability of the recommended IBIP (if advice is provided), guidance on and warning of the risks associated with IBIPs and costs relating to distribution of the products, including the cost of the advice, where relevant. All of this information must be delivered to the customer in a comprehensible form and presented in a standardised format. These requirements will be introduced into the FCA Handbook to sit alongside their MiFID II counterparts.
Article 30(1) of the IDD sets out the rules for assessing the suitability and appropriateness and reporting to customers, and like Article 25(2) of MiFID II, the insurance intermediary or the insurer will be expected to obtain information from the customer on its ability to bear losses, investment objectives and risk tolerance to ensure that the recommended IBIP(s) is suitable for the customer, taking into account the customer’s risk tolerance and ability to bear losses.
Article 29(2) of the IDD requires an insurance intermediary or insurer to ensure that any payment of fees, commission or non-monetary benefit in connection with the distribution of an IBIP product or ancillary service to or by a third party does not have a detrimental impact on the quality of the service to the customer and does not impair the insurance intermediary or insurance firm’s duty to act honestly, fairly and professionally in the best interests of its customers.
Similarly, Article 24(7)(b) of MiFID II prohibits advisers from accepting and retaining fees, commissions or any monetary or non-monetary benefits from third parties unless such benefits are ‘minor non-monetary benefits’. The FCA intends to implement Article 29(2) in COBS 2.3A and where the IDD requirements differ from those in MiFID II or the current rules, then those requirements will be copied out by the FCA and inserted into the Handbook in addition to the existing requirements.
We will have to await the FCA’s third consultation on the implementation of the IDD as to whether it intends to apply MiFID II requirements relating to sales involving more than one firm, record- keeping and ongoing assessments that inducements enhance the quality of services, although it is the FCA’s current intention to do so.
For non-advised sales, insurance intermediaries or insurance firms will be expected to consider the customer’s experience and knowledge of investments to assess whether the IBIP is appropriate for them (Article 30(2) of the IDD). Where the IBIP is not appropriate, the insurance intermediary or the insurance firm will have to warn the customer that this is the case. The same warning must be given where insufficient information of the customer’s knowledge and experience has been given.
At present, the FCA’s rules on appropriateness (COBS 10) do not apply to life policies or IBIPs and it is proposed that they will feature in a new COBS 10A chapter solely applying to IBIPs. The FCA has said that it will be reviewing the final IDD delegated acts and considering extending the guidance it developed in relation to MiFID II to include guidance on IBIPs, so that it may align the IDD requirements with its implementation of MiFID II.
Conflicts of interest
The IDD requirements for conflicts of interest are contained within Articles 27 and 28 and effectively require effective organisational and administrative arrangements to be in place to ensure that any conflict risk posed to the customer is managed.
The FCA’s existing requirements on conflicts of interests can be found in Chapter 10 of its Senior Management Arrangements, Systems and Controls (SYSC) sourcebook and are consistent with the IDD. This approach will be maintained and applied to all types of insurance, including life and general insurance, and are not limited to IBIPs.
While the FCA recognises that the IDD and MiFID II requirements for conflicts of interest are not the same and that MiFID II goes beyond the IDD level 1 requirements, it is considering amending the FCA Handbook so that guidance on this issue meets MiFID II rules instead.
What are the likely implications?
The desire to align MiFID II standards to IDD requirements may not be as strange as it may sound and will probably benefit those firms who are likely to be subject to MiFID II and the IDD. Any analogies between the two Directives should better assist firms with their implementation and, ideally, make compliance with and supervision by the FCA easier and more manageable. This does of course place additional pressure on those firms, particularly insurance intermediaries who may be aware of MiFID II but have so far disregarded its application because of the market in which they operate, and who will now have less than six months to understand MiFID II COB rules and how to become equipped to adhere to the FCA’s proposals.
What should practitioners do to prepare?
Given the impending date of implementation of both Directives (3 January and 23 February 2018, respectively) practitioners are probably aware of the FCA’s proposals for MiFID II alignment. In the event that they are not, they should identify those areas of the IDD that are expected to be affected by MiFID II COB rules and what that could mean for their clients.
While the FCA’s intentions are now clear, and firms that manufacture, distribute, arrange or advise on IBIPs should be aware of the likelihood that MiFID II-style regulation will apply, we still await both various EU delegated acts and guidance, and the FCA’s final consultation paper on IDD implementation (as well, of course, as the necessary UK implementing legislation and the ultimate FCA rules). However, as with MiFID II, enough is now clear for affected firms to complete their gap analysis and have identified areas in which they are most likely to have to change their procedures and practices.
Interviewed by Duncan Wood.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.