Retail Distribution Review ‘RDR’: 2nd Discussion Document on Investment Related Matters

By Gerry Grispos, Compli-Serve SA

The Financial Sector Conduct Authority (FSCA) released its Second RDR Discussion Document on Investment Related Matters on 20 December 2019. Industry has until the end of March 2020 to comment.

In line with the overall structure of the 2018 Investments Document, this document hones in on four key focus areas:

Section 1: The general investments landscape

The FSCA fully agrees that any regulatory intervention it considers should be risk-based and proportional.  It does not agree with the position that no structural regulatory intervention at all is required.

Section 2: Defining and understanding different activities performed under a discretionary investment mandate

2.1 Defining Investment Management

Its current thinking is that the definition should cover the following:

• Obtaining a mandate from a financial customer to apply an agreed level of decision making, on behalf of the financial customer;
• after establishing and agreeing the financial customer’s investment objectives and investment risk appetite;
• identifying, selecting, acquiring or disposing of financial products, financial instruments or other assets (or identifying and selecting other investment managers to perform this activity);
• in accordance with an investment strategy and investment objectives set out in the mandate;
• in accordance with any parameters, limits, thresholds or other instructions set out in the mandate;
• handing any assets acquired over to a custodian or nominee for safekeeping.

2.2 Categorising investment management activities

This dealt mainly with identifying and defining different types of discretionary management activity, and the extent to which these should be differentiated in future licensing, fit & proper and/or other aspects of the regulatory framework.

The FSCA remains of the view that the current 'one-size-fits-all' scope of the FAIS Category II licence is too broad to adequately and proportionally deal with the range of investment management services in the market, and that a degree of sub-categorisation of these activities is needed.

The FSCA now proposes that the licensed activity of discretionary investment management be broken down into three sub-activities for licensing purposes:

• Asset management: discretionary investment management comprising asset selection (including asset class selection);
• multi-management: discretionary investment management comprising manager selection (including management style and asset class selection); and
• alternative investment management: to include hedge fund management, private equity management, and potentially other alternative investment strategies. This category would in effect be an appropriately expanded version of the current FAIS Category IIA licence category.

The proposed licensing framework would require any entity intending to perform investment management to apply for a licence for discretionary investment management and, as part of that licensing process, to apply for authorisation to perform one or more of the above-mentioned three sub-activities. The FSCA confirms that a licensed discretionary investment manager may perform any combination of the three sub-activities, subject to meeting the applicable fit and proper and other licensing requirements for that sub-activity.   

2.3 Fit and proper standards for investment management

It follows from the updated proposal that the licensing framework for investment managers should distinguish between asset management, multi-management and alternative investment management, that the fit and proper requirements will need to align to these sub-categories.

The FSCA’s current thinking is that the experience and “class of business” training requirements, in particular, will need to be tailored to the three proposed sub-activities.

2.4 Mandates of Convenience

The FSCA remains of the view that this dispensation should be subject to the following criteria as set out in the 2018 Investments Document: 

• Intermediaries holding these mandates are not regarded as exercising investment discretion but rather as holding a more limited authority to perform specified services under a written 'standing authorisation' from a customer, without having to obtain the customer’s separate written instruction on each such occasion.
• The intermediary is not regarded and may not describe itself as an investment manager (unless they also in fact hold an investment management licence).

In addition, in order to limit the scope and potential risks of this service, the dispensation will be limited to mandates granted by retail investors. Portfolio rebalancing and similar activities for non-retail customers, which are a potentially complex exercise, will therefore continue to require a full discretionary investment management licence.

Holding and acting on a 'mandate for convenience' will not require a separate licence category or authorisation by the FSCA. Any FSP licensed under the FAIS Act as a Category I FSP (for advice in relation to the applicable product categories) will be permitted to perform this activity

Section 3: Categorising investment advisers within an RDR framework

3.1 Is there a need for a 'tied' advice or product supplier agent (PSA) model in the investments sector and how would it work?

• It will be permissible for the same group of companies to operate both tied and non-tied (PSA and RFA) advice channels, provided these are operated through separate legal entities.  Group level governance controls will need to be in place to mitigate the risk of conflicts of interest arising in such business models.
• It will not be permissible for the same entity to offer tied advice for some products / solution types and non-tied advice for others; nor for different individual advisers in the same entity to provide tied advice and others to provide non-tied advice. This does not preclude an RFA firm from allowing some advisers to offer advice on a broader range of products and services than others, depending for example on their competence and experience levels or the customer groups they serve, provided that such restrictions do not limit the adviser to in-group offerings only.

3.2 Defining 'group' products and services for determining the scope of advice for a tied (PSA) investment adviser 

The FSCA believes that the regulatory framework should allow a discretionary investment manager – in any of the three sub-categories of investment management proposed in this document – to appoint 'tied' or PSA advisers if it so wishes. We agree with the view of the majority of stakeholders that the most appropriate way to provide for this will be to extend the scope of the PSA model to allow tied advisers to be appointed by either product suppliers or service providers (specifically, discretionary investment managers).

It follows that a tied or PSA adviser will therefore, in addition to being permitted to recommend financial products offered by a product supplier in its home group (such as a bank, insurer or CIS management company), also be permitted to recommend the entering into of a discretionary investment mandate with a discretionary investment manager that is also a member of that group.

3.3 Third party co-branded CIS models

The FSCA remains strongly of the view that a CIS management company that enters into third party co-branding arrangements retains full accountability for the third party’s outsourced investment management activities. In addition to the views set out in the 2018 Investments Document, the FSCA’s rationale for this approach is illustrated by and expanded on in the reasons provided in our recent administrative penalty decision against MET Collective Investments (Pty) Ltd.

Lastly, the FSCA will do further fact finding regarding the concern raised around so-called 'co-named broker funds' that are not operated through formal 3rd party co-branding arrangements, to understand the nature, prevalence and potential conduct risks posed by any such practices.

3.4 Due diligence responsibilities

Although we agree that an entity required to perform a due diligence exercise should be able to place reasonable reliance on the fact that an entity has been licensed by the FSCA, we emphasise that due diligence cannot be reduced to a mere licence check.  

Section 4: Implications for remuneration and charging structures

4.1 Cost disclosure

Based on feedback received, the FSCA will engage with ASISA and other stakeholders to understand the extent to which the EAC model could be adapted as a broader investment cost disclosure mechanism, and the associated technical challenges. We fully agree that the disclosure model needs to enable investors to understand and compare the costs associated with every entity in the value chain, what services are being provided for that cost, who the recipient of any remuneration is, and what the impact of each item of cost will be on their investment return. 

The FSCA also agrees that investment managers offering model portfolios and other non-CIS solutions should be required to provide disclosure documents similar to - and comparable with - CIS Minimum Disclosure Documents, and will consult further on how best to achieve this. 

Also note the new requirement in the amended s 3A of the FAIS General Code of Conduct requiring written customer consent to the amount, frequency, payment method and recipient of any fees (other than regulated commission and certain other regulated fees) including consent to the details of the services that are to be provided in exchange for the fees. 

4.2 Mitigating the risk of duplication of charge

Although the FSCA is in full agreement that enhanced disclosure is a significant mitigating factor in reducing the risk of inappropriate cost duplication, it cannot be relied on as the sole solution to conflicted and unjustified charging practices.  Strengthened disclosure standards therefore need to be complemented by broader interventions aimed at reducing these risks, as discussed elsewhere in our RDR proposals.

4.3 Mitigating the risk of conflicted advice in vertically integrated models

The FSCA remains of the view that branding is a useful tool to highlight intra-group relationships between advisers, investment managers and product suppliers, over and above more substantive disclosure around these relationships and the status of the advice provided. We are however open to the use of co-branding rather than a single common brand, provided the display of the respective brands is sufficiently prominent to highlight the relationships concerned. We also recognise the potential complexity of common or co-branding requirements in groups with multiple brands and are open to how best to accommodate these models without compromising customer understanding of intra-group relationships in these models.

• As advised in earlier sections, a group of companies may operate both PSA and RFA advice models, but these must be operated through separate legal entities. The same legal entity cannot act as both an RFA and a PSA.
• An investment manager may appoint a tied adviser (PSA) to provide advice on its behalf.  This would require the investment manager to be licensed for advice in addition to its investment management licence, and the PSA would then provide advice through that licence.
• However, in light of the discussion in section 3.2.2 above, note that it will be possible for a PSA appointed by another group entity (for example, a product supplier in the group) to also recommend the investment management services (i.e. the entering into of a discretionary mandate) with an investment manager in the group. In such a model, the investment manager will not itself require an advice licence, but governance arrangements must be in place in the group to ensure that the investment manager bears an appropriate level of responsibility for such recommendations.
• The FSCA also confirms that an investment manager will not be disallowed from holding an advice licence as an RFA, where it wishes to provide both advice and investment management services.  However, investment managers adopting such a model will need to take care to ensure that appropriate controls are in place to ensure that the advice so provided is objective and not biased in favour of the investment managers or its group’s own products or services (in other words to ensure that it is indeed acting as an RFA and would not be better positioned as a PSA).   

4.4 Facilitating and monitoring advice and other fees

The FSCA is still considering the divergent views expressed regarding fee facilitation and monitoring and will share our updated thinking in due course.

4.5 Remuneration for automated advice

The FSCA agrees that no separate remuneration dispensation is required for automated advice and that equivalent standards and principles should apply to all advice models.

4.6 Remuneration for non-advice distribution

The FSCA will further consider whether any explicit remuneration standards are required for non-advice distribution models, taking the above inputs into account, as part of our development of broader RDR proposals regarding these models.

4.7 Mitigating the risk of conflicted exercise of discretionary mandates

The FSCA will take the inputs regarding conflicted exercise of discretion into account as we develop more concrete regulatory frameworks for the proposals set out in Sections 2 and 3 of this document.