Communicating with clients, including financial promotions

The new rules are the result of our review of the financial promotions regime which took account of our move to principles-based regulation and our Better Regulation agenda. The new regime implements the Markets in Financial Instruments Directive (MiFID) which, although not the main driver of the review, was consistent with our aims. As a result we have adopted many of its provisions for non-MiFID business.

The new regime for communicating with clients gives firms the flexibility and responsibility to design systems, controls and processes that best allow them to reflect the needs of their clients, products and sales processes. COBS 4.1 sets out detailed application provisions that will help a firm establish which rules apply and in what circumstances. If a communication falls within COBS 4, the firm must establish three key things:

• What type of communication is being made – promotional or non-promotional?
  COBS 4 sets out the rules that apply to investment business communications with clients, including financial promotions. So, the application of COBS 4 is not limited to communications that are financial promotions and firms should be aware of the need to apply relevant rules to all forms of client communications. These include, for example, annual statements, responses to queries, complaints or general correspondence. As financial promotions are designed to influence or induce clients to invest, they receive a greater focus in COBS 4 than communications that are not financial promotions (non-promotional communications).
• Does the communication relate to MiFID or non-MiFID business?
  Often the same standards apply to MiFID and non-MiFID business. However, different standards apply in a limited number of cases. The exceptions, or cases in which a rule is disapplied, depend on whether the communication is MiFID business or not. In particular, the Financial Promotion Order exemptions are not available in relation to MiFID or equivalent third country business, whilst they are available for other business such as financial promotions to corporate finance contacts. The COBS 4 rules make clear which standards apply to which type of business and PERG 13 offers more guidance as to the characteristics of MiFID and non-MiFID business. Policy Statement 07/6 discusses those areas where different standards are expected. It is worth remembering that approving a financial promotion without communicating it does not relate to MiFID or equivalent third country business, nor does communicating a financial promotion to a person who is not the recipient or potential recipient of a service in the course of that business.
• What type of client is being communicated to – retail, professional or eligible counterparty?
  Most provisions apply to communications addressed to retail clients; fewer apply to those addressed to professional clients and fewer still to those addressed to eligible counterparties. More information on which rules apply to which types of client can be found below, and the usual client categorisation rules apply. As a result, firms will not need to notify recipients of financial promotions ('clients' within the meaning of COBS 3.2.1R(3)) of their client categorisation, or record their categorisation, unless the recipients are also 'clients' within the meaning of COBS 3.2.1R(1), (2) or (4). Unless the financial promotion relates to MiFID or equivalent third country business, the "non-MiFID" client categorisations are relevant.

Most of COBS does not apply to business conducted with eligible counterparties and COBS 1 Annex 1 Part 1 lists the provisions that do not apply. In COBS 4, only the provisions relating to compensation information (COBS 4.4.1R) apply.

Firms communicating to eligible counterparties should also bear in mind their obligations in PRIN, especially Principle 7 as amended by PRIN 3.4.1R, which cuts back the 'fair, clear and not misleading' standard to require that communications to eligible counterparties are 'not misleading'.

A person is only an eligible counterparty under the financial promotion rules to the extent it is a recipient or potential recipient of services in the course of eligible counterparty business.

Certain high-level rules apply when communicating to professional clients. The following table lists the COBS 4 rules that apply to non-promotional communications to professional clients.

Unless otherwise specified, all COBS 4 rules apply to communications to retail clients. Some provisions do not apply to certain communications (such as image advertising or promotions of deposits) and these are explained in each rule.

Unless otherwise specified, all COBS 4 rules apply to communications to retail clients. Some provisions do not apply to certain communications (such as image advertising or promotions of deposits) and these are explained in each rule.

Image advertising is a financial promotion that consists of only one or more of the following:

• the name of the firm;
• a logo or other image associated with the firm;
• a contact point; and
• a reference to the types of investment services provided by the firm, or to its fees or commissions.

Only the fair, clear and not misleading rule (COBS 4.2.1R) applies to image advertising.

Limited rules apply to financial promotions of deposits as follows:

Limited COBS 4 rules apply to financial promotions of pure protection contracts that are long-term care insurance contracts:

Financial promotions to clients must be clearly identifiable as such (see COBS 4.3.1R(1)). As most promotions will be readily identifiable already they will not need to include warnings like 'THIS IS A FINANCIAL PROMOTION'. However, if a promotion is designed to appear, for example, like an independently written newspaper article, an independent television programme, or an independent search engine result, then its promotional intent should be made clear.

In satisfying COBS 4.5.2R(3) we do not expect firms to perform some sort of arithmetic calculation on the needs of the median consumer. Targeting a specific group and deciding whether the promotion is likely to be understood by the average member of that group need not be a complex process. For instance, only sophisticated clients will cope with more technical language. So a product marketed to a mainstream audience must avoid the use of jargon if it is to be understood. But if a promotion is sent to a specific group of clients, it may be appropriate to address their needs more closely.

COBS 4.5.2R(3) requires that communications provide clients with 'sufficient' information. So, firms must consider the needs of the audience and the nature of the product promoted. If the product is complex or high risk then firms need to include enough information for the intended audience to understand this.

Each financial promotion needs to be compliant in its own right. In providing sufficient information, a firm cannot represent the benefits of a particular product or service without an appropriate balance of the risks. This does not mean that each financial promotion must contain all the benefits and all the risks associated with a product or service. But, in some cases, it may be appropriate to provide fuller details of benefits and risks in more detailed information which is provided later in the sales process.

If a communication mentions particular benefits or characteristics, it may not be sufficient to refer the audience to risk warnings in other documents that will be presented later (or indeed earlier) in the sales process. Firms may also wish to consider whether the proposed medium will allow them to provide sufficient information, given the needs of the audience and the nature of the product, and if not, consider using alternative means of marketing.

The rules relating to real time financial promotions, referred to as interactive dialogue financial promotions, such as telephone conversations or face-to-face meetings, are now more high level, and focus on the outcomes expected for such communications.

Cold calls are financial promotions, made, for example, in the course of a personal visit, telephone conversation or other interactive dialogue:

• that the recipient did not initiate or expressly request; or
• where a client did initiate or request, it was not made clear that they would receive communications on the kind of controlled activities or investments to which the communication relates.

So, cold calls are financial promotions over which clients have limited control.

Firms must not cold call unless they satisfy COBS 4.8.2R. This rule requires that either:

• the firm has an existing relationship with the client such that they envisage receiving cold calls; or
• the call relates to a packaged product that is not a higher volatility or geared product, or where the only investments likely to be involved are readily realisable securities (other than warrants) or generally marketable packaged products.

In making interactive dialogue promotions, the high-level rules (in COBS 4.8.3R) require firms to think of the interests of the client in deciding how to conduct the communication. For example, the communication should take place at an appropriate time of day and identify the firm and purpose of the communication at the outset.

COBS 4.6.1R to COBS 4.6.5G provides rules and guidance on the use of past performance data. The application of the rules differs depending on whether a firm is carrying out MiFID or non-MiFID business. For non-MiFID business the rules apply only to financial promotions. For MiFID business, the rules apply to all communications, including financial promotions.

Guidance (COBS 4.6.4G and COBS 4.6.5G) is provided to help firms understand the impact of these rules for packaged products and suggest how past performance data may be provided. If a firm complies with this guidance (and the promotion meets the fair, clear and not misleading rule and other high-level requirements), it will satisfy the rules relating to past performance disclosure.

Firms can provide extra data to that required, so long as they always provide the required disclosure. For example, it would be possible to include figures showing growth over five or ten years, so long as the data based on 12-month periods is also included.

Past performance obligations should be interpreted in light of their purpose and in a way that is appropriate and proportionate (COBS 4.6.3G). Where a communication is non-promotional, a firm's obligation will be less. So, for example, it may be appropriate for past performance data to form the most prominent feature of an annual statement or periodic statement provided in acordance with COBS 16.3.1R and COBS 16 Annex 2R. And, if a consumer asks over the phone how an individual share has performed in the course of the day's trading, it would not be appropriate to also disclose the share's performance over the last five years.

Case study

Information about past performance is normally based on the actual performance of a fund or funds for the entire period. Where past performance information for the actual fund does not exist, COBS 4.6.6R provides that a firm may only provide simulated past performance information if it relates to the actual past performance of one or more investments or financial indices that are the same as or underlie the investment concerned.

COBS 4.6.7R states that information that refers to future performance (projections) for financial instruments must:

• not be based on or refer to simulated past performance;
• be based on reasonable assumptions supported by objective data;
• show the effect of commissions, fees or charges; and
• contain a prominent warning that forecasts are not a reliable indicator of future performance.

COBS 4.6.9R provides that, for some packaged products, such as most pensions and life policies, more detailed rules in COBS 13 apply.

Direct offer financial promotions contain an offer or invitation to enter into an agreement and specifies a means of response. When firms issue direct offer financial promotions they are required to include specified information about the firm, its services and the investment(s) offered. Further additional information also needs to be included in the promotion, depending on whether the direct offer relates to MiFID or non-MiFID business.

Non-MiFID business: For non-MiFID business, a high-level rule (COBS 4.7.1R(1)(b)) requires firms to provide additional information that is appropriate to the investment so that the client is reasonably able to understand its nature and risks, and consequently to take investment decisions on an informed basis.

MiFID business: For MiFID business, a similar provision (in COBS 2.2.1R) requires firms to provide appropriate information to enable the client to understand the nature and risks of the investment and so take informed investment decisions.

Firms now have some flexibility about when and where the required information is disclosed (COBS 4.7.3G). For non-advised sales, firms can supply retail clients with the required product information at any point in the sales process (including within the promotion) so long as it is provided in good time before the client responds, and so long as the client must refer to it before responding. For example, a direct offer financial promotion could be an email offering a product and encouraging the client to view a website in order to apply. As long as the consumer must access the required disclosure from the website in order to respond, previous direct offer financial promotions need not include it.

Where the promotion is an unsolicited direct mailing, the information will need to be in that mailing if this is the only communication the client receives before they respond. If some of the required information is missing from the mailing, firms will need to demonstrate that clients have referred to the other documents that contain the specified required infomation before applying for the product. The client must refer to the information and it is not enough that the client has simply received it earlier or that it is available to them in a general sense. This will mean that firms need to check with clients that they have referred to other documents and, if not, firms may need to supply another copy.

The required information may be contained in a Key Features Document or Simplified Prospectus, but firms are not obliged to use these standard documents.

What other provisions may be relevant to DOFPs?

Firms should also consider whether COBS 5, regarding distance marketing, is relevant. If so, they must ensure they disclose the information required in a durable medium and in good time before the client is bound.

• Durable medium means a medium with 'enduring effect' i.e. the client has access to it in the future. One way to provide the information in a durable medium would be to provide a facility through a website that enables the client to save the information. Teletext would not count as a durable medium.
• The definition of 'in good time before the consumer is bound by a distance contract' will depend on circumstances. Firms will need to think about how to provide documentation in good time depending on the audience, product and sales method.

If the direct offer financial promotion relates to MiFID business or a derivative or warrant, the appropriateness test may be relevant (see COBS 10).

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SYSC 3 and 4 set out high-level requirements for firms to have appropriate systems and controls in place in order to ensure compliance with COBS. There is considerable flexibility for firms to consider how best to meet these requirements for their own circumstances. What is approporiate may differ by firm, product or communication. Broadly, it might help to consider the following:

• Are those who confirm compliance adequately informed and equipped to confirm compliance of high-level rules?
• Is senior management adequately involved in the process?
• What records should be retained?

Do firms need systems and controls for non-promotional communications?

Yes, firms will need adequate systems and controls to ensure that their non-promotional communications are compliant, and in particular that they are fair, clear and not misleading.

MiFID business:
A firm wishing to communicate a financial promotion in relation to MiFID business cannot rely on an earlier confirmation of compliance by a third party, even where that third party is within the same group of companies as the firm, and must, itself, ensure the promotion is compliant. This means, for example, that a MiFID-scope independent financial adviser (IFA) must establish for itself that a promotion produced by a product provider (which the IFA wants to communicate) does in fact comply with the relevant rules.

Although a firm communicating a financial promotion in relation to MiFID business always has legal responsibility to ensure that it has systems and controls in place to ensure the promotion it communicates is compliant, a firm can choose to outsource its compliance function to another firm (which may be in the same group or an external consultant). However, following an outsourcing arrangement, if the systems and controls fail and as a result the firm communicates in a way that breaches the rules, the firm – not the external consultant or company in the group – will be liable.

Non-MiFID business:
Where the financial promotion relates to non-MiFID business, a firm can rely on an earlier confirmation of compliance exercise carried out by a third party, provided it:

• has taken reasonable care to establish that the providing firm has confirmed compliance of the promotion with the rules;
• takes reasonable care to establish that it communicates only to the type of recipient for whom the promotion was intended; and
• is, or ought reasonably to be, aware that the promotion has not ceased to be fair, clear and not misleading and that the providing firm has not withdrawn the promotion.

Firms must generally keep records of any financial promotion that it communicates or approves, other than those made in the course of a personal visit, telephone conversation or other interactive dialogue. Firms should also consider maintaining a record of why they are satisfied that the financial promotion is compliant. However, it is up to firms to decide exactly what information they retain.

The Financial Promotion Order (FPO) exemptions remain available to unauthorised persons and are potentially relevant to firms communicating outside MiFID scope.

MiFID business: However, the FPO exemptions are not available in relation to MiFID business. Provisions derived from MiFID in relation to communications always apply, subject to MiFID driven exemptions, even if the promotion would otherwise fall within scope of exemptions in the FPO. So, if an FPO exemption would have applied previously, firms may need revised systems and controls to ensure their promotions are fair, clear and not misleading. The application of these systems should be proportionate to the nature of the product and the target market. For instance, the same level of attention may not be required for promotions to professional clients as to the mass market.

Other chapters of COBS may apply to financial promotions. In particular, firms should consider:

• COBS 2.2 which sets out the information that must be provided to a client to help them make investment decisions on an informed basis;
• COBS 2.3 on pre-sale inducement disclosures may be relevant to MiFID-scope DOFPs;
• COBS 3 on client categorisation as it drives the application of the rules;
• COBS 5 which contains provisions derived from the Distance Marketing Directive, relevant to direct offer financial promotions;
• The Electronic Commerce Directive rules in COBS 5.2;
• Provisions in COBS 6 and COBS 14, referred to in COBS 4.7.1R(1)(a), that set out required disclosures;
• Client agreement rules (including COBS 8.1.3R);
• COBS 10 which relates to the appropriateness test, relevant to non-advised transactions of MiFID business and all direct offer financial promotions of derivatives and warrants;
• COBS 15.2.5R on disclosure of the right to cancel; and
• PR 3.3 which may be relevant to prospectus advertisements.

When firms ensure compliance with COBS 4, they should consider SYSC 3 and 4.

The effect of the provisions relating to the promotion of UCISs is that all authorised firms can promote UCISs only if they can rely on an exemption in either the FSMA 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001² (CIS Exemption Order) or in COBS 4.12.³

However, where a promotion can be made, the COBS 4 rules apply differently in relation to MiFID or equivalent third country business and non-MiFID business. This is a result of the need to implement MiFID and is intentional.

Non-MiFID firms: If the firm uses a CIS Exemption Order exemption then, as now, the financial promotion rules do not apply (but the COBS 4 rules relating to communications with clients generally still do – including the fair, clear and not-misleading rule). If the firm uses a COBS 4.12 exemption, then the financial promotion rules in COBS 4 apply as relevant to that financial promotion.

MiFID firms: A MiFID firm can promote a UCIS if an exemption in either the CIS Exemption Order or COBS 4.12 is available. MiFID or third country firms must then ask themselves whether the promotion is for MiFID or equivalent third country business or not? For firms carrying on MiFID business or equivalent third country business, the relevant MiFID-derived rules in COBS 4 will always apply to that firm - subject to any MiFID-driven exemptions applying (even if the exemption available is one in the CIS Exemption Order). If it is not MiFID or equivalent third country business, the MiFID firm may use the CIS Exemption Order or COBS 4.12 exemptions and the financial promotion rules in COBS 4 apply as relevant to that financial promotion (as described above for non-MiFID firms doing non-MiFID business).

In the UK, the promotion of UCISs is restricted by section 238 of FSMA⁴. This provides that an authorised person may not communicate an invitation or inducement to participate in a collective investment scheme unless the scheme is an authorised unit trust scheme, a scheme constituted by an authorised open ended investment company, a recognised scheme, or otherwise falls within an exemption made under section 238 or 239 of FSMA (the CIS Exemption Order) or the UCIS exemptions rules made by the FSA (COBS 4.12). So, UCISs may not be promoted to the public by authorised firms unless they fall within one of the exemptions.

Unauthorised persons, including some regulated financial institutions abroad, are not directly subject to the section 238 FSMA restriction on the promotion of UCISs. But the financial promotion restrictions in section 21 FSMA prohibits them from communicating a financial promotion other than one which is exempt⁵ or approved by an authorised person.

Authorised persons are restricted in the approving of financial promotions for UCISs by section 240 of FSMA, which provides that a firm may not approve a financial promotion relating to a UCIS unless the firm would be able to communicate the promotion without breaching section 238(1) of FSMA.

MiFID, the marketing restriction and the retail client/professional client boundary

In implementing MiFID the FSA considered the interface between the existing provisions and the changes brought about by MiFID. The UK's restriction on promoting UCISs is not within the scope of MiFID and, as a result, exemptions permitting UCIS promotions need not follow MiFID-driven requirements. Approving a financial promotion without communicating it is not MiFID or equivalent third country business⁶ . However, MiFID or equivalent third country business does include communications that occur before an agreement to perform services in relation to MiFID or equivalent third country business⁷ . Although MiFID does not impose restrictions on the promotion of UCISs, it does require that MiFID communications with clients (including financial promotions) comply with certain requirements, which are now in COBS 4.

In summary, communicating a financial promotion is not of itself an investment service, so a firm will not be doing MiFID business or equivalent third country business when considering what UCIS promotion exemptions in the CIS Exemption Order or COBS 4.12 apply (i.e. when considering whether or not there is a marketing restriction acting as a barrier to the promotion). But, if a MiFID firm actually communicates a UCIS promotion, the firm will be doing MiFID business⁸ if it is preparatory to the provision of an investment service or activity and would be considered an integral part of that service or activity. In that case the MiFID firm will be subject to the client categorisation regime and financial promotion rules applicable to MiFID business.

COBS 4.12 details the types of scheme that may be promoted to particular categories of person. This replicates the categories listed in COB 3 Annex 5, including the Category 7 person: an eligible counterparty or a professional client⁹. In addition, COBS 4.12 includes a Category 8 person that broadly replicates the current expert intermediate client category (COB 4.1.9R). As a result, firms can promote UCISs to persons, who are not professional clients or eligible counterparties because they do not meet the quantitative requirements of the MiFID client categorisation rules, provided they otherwise fall within the Category 8 criteria.