Central Bank issues "Dear CEO" Letters to MiFID Firms on "Unregulated Activities" and "Appropriateness"
The Central Bank has set out its regulatory and compliance expectations for the provision of unregulated activities and the application of the 'appropriateness test' in recent correspondence to MiFID firms.

 

In late June 2020, the Consumer Protection Unit of Central Bank of Ireland ("CBI") issued two 'Dear CEO' letters to MiFID firms ( "Firms"), one setting out the CBI's expectations of investment firms when engaging in unregulated activities and the other setting out feedback on its thematic review of compliance with the "appropriateness" test under MiFID II. Both letters underscore the CBI's focus on investor protection, particularly for retail-type investors. The CBI will have regard to the contents of the letters in the context of any future supervisory engagement.

Dear CEO Letter on unregulated activities

The 25 June letter addresses the offering of products and services by Firms which fall outside the scope of regulation ("unregulated activities"). 

The CBI notes the significant risk to clients where Firms engage in both regulated and unregulated activities as clients may misunderstand the protections available when investing in unregulated products. The CBI reminds Firms that they must act fairly, professionally and in accordance with the best interests of their clients. 

Expectations of the CBI

The CBI states in the “Dear CEO Letter” that it expects:

  • firms to take all necessary measures to ensure clients are fully aware of the regulatory status of the product/service they are receiving;
  • when providing unregulated products or services, that the regulatory status is clearly and effectively communicated in all dealings with clients and at every stage of the sales process;
  • firms to clearly disclose to clients when regulatory protections do not apply to the product or service provided and provide information which is fair, clear and not misleading;
  • firms to include appropriate disclosures and risk warnings in a prominent position on all information provided to clients.  Information includes, but is not limited to brochures, information memoranda, webpages and other marketing materials. 

Information provided to clients should be clear about the regulatory status of the product. A Firm must not imply the product or service is regulated when this is not the case. Firms should explicitly state what investor protections are lost or are not applicable when investing in an unregulated product including compensation schemes, client assets protections and recourse to ombudsman (as applicable). 

Key Obligations concerning a Firm's regulated status

  • The Firm's regulated status must not be used as a promotional tool.
  • A Firm may only use the regulatory disclosure statement in communications with a consumer where such communications relate exclusively to a regulated activity.
  • When engaging in unregulated activities, information provided to the client or potential client, including marketing materials, should not include reference to the Firm being authorised and/or regulated by the CBI.
  • A Firm must have separate sections on any website it operates for regulated activities and other activities and these sections should be clearly distinguished. 

It should be noted that these obligations essentially mirror similar obligations imposed on other regulated financial services providers (including credit institutions and other non - MiFID financial institutions) under the Irish Consumer Protection Code.

Action to be taken 

  • The CBI expects Firms to consider these requirements and to take necessary
  • measures to ensure its processes and controls adhere to the requirements outlined.
  • Firms should, where necessary, update and amend templates, documentation and websites.
  • These obligations and expectations should be brought to the attention of the appropriate persons and discussed at the Firm's next board meeting. 

Dear CEO Letter on Thematic Inspection of Appropriateness

The "Dear CEO" letter of 29 June letter sets out the CBI's findings of a Thematic Inspection of MiFID Firms’ compliance with their legal requirements in determining whether a product is "appropriate" for their customers. The appropriateness requirements are a key protection for consumers at the point of sale when purchasing complex investment products without the benefit of financial advice.

The MiFID II appropriateness requirements are set out in Article 25(3) of MiFID II and in Articles 55 and 56 of the MiFID II Delegated Regulation. They apply to Firms when providing MiFID investment services other than "investment advice" and "portfolio management" (in those cases, the obligation is to assess "suitability"). The aim of the requirements is to increase investor protection in respect of ‘non-advised’ services. The way in which the requirements apply depends on the type of service in question, the type of investment product involved (in particular, whether the investment product is ‘complex’ or ‘non-complex’), and the type of client.  Where the appropriateness test applies, it requires a Firm to seek information from a client or potential client about his or her knowledge and experience (i.e. ability to understand the risks about a specific type of investment product or service). This is to enable the Firm to determine whether that investment product or service is appropriate for the client (unlike the requirements for "suitability", there is no specific requirement to assess the client’s financial situation or investment objectives).  If the product is not appropriate, the Firm must issue a clear warning to the consumer.

Whilst the CBI did identify some positive practices, which are identified in the Appendix to the letter, the main negative findings of the inspection are:

  • Several Firms failed to provide evidence that they are paying sufficient attention to the application of the appropriateness requirements, instead placing undue reliance upon standardised questionnaires and 'box-ticking' to demonstrate compliance. It was unclear whether firms were adequately considering the risks posed by the specific complex products they sell to retail clients on an execution-only basis.
  • In many cases, Firms’ practical application of the requirements was undermined by weak processes, systems and controls; resulting in errors and assessments proceeding with incomplete information.
  • Many Firms are relying on a blanket approach for gathering client information that fails to consider the significant differences in risk and complexity that occurs between investment products. Firms need to improve the quality of information collected and how it is used in the appropriateness assessment process.
  • In many cases, it was not clear how Firms reached the appropriateness decision. Firms must document the rationale for concluding that a product is appropriate for the client, linking the information gathered and assessed to the outcome. Documentation relating to the test should be maintained in line with the Firm's record-keeping arrangements
  • The review found evidence of inadequate and weak warnings issued where products were found to be inappropriate for clients, including the use of vague, ambiguous language.  The client should be presented with the option of exiting the process. The appropriateness warning should not be viewed by firms as a disclaimer which overrides the legal obligations of firms to act in the best interests of the consumer.

The Central Bank is currently engaging directly with those Firms where issues have arisen on foot of the thematic inspection. 

The thematic inspection was carried out as part of an ESMA (European Securities and Markets Authority) Common Supervisory Action on Appropriateness published in June 2019. This was the pilot version of a supervisory initiative designed to enhance the protection of consumers and promote consistent supervision of investment firms throughout the EU.  

A Common Supervisory Action on Suitability published in February 2020, focusing on measures designed to protect consumers availing of investment advice, is currently underway so industry can expect another thematic inspection on this subject in the near future. 

How Can William Fry Help? 

William Fry can assist firms in relation to:

  • carrying out a review of the Firm's compliance with expectations of the CBI and identifying and addressing any shortcomings in order to meet the CBI’s requirements identified in the "Dear CEO " letters;
  • reviewing the Firm’s brochures, information memoranda, webpages and other marketing and promotional materials on regulated and non-regulated activities;
  • providing training and advice with regards to compliance with regulated and non-regulated activities; appropriateness assessments and related processes, supporting documentation and record keeping; and
  • advising on regulatory enforcement action. 

Contact Our Financial Regulation Unit 

For further information, please contact any member of the William Fry Financial Regulation Unit or your usual William Fry contact.



 

Key Contacts

Patricia Taylor Partner

John Aherne Partner

Related Practice Areas