PIMFA Journal - Autumn 2022

JOURNAL

WHY TAX SUITABILITY SHOULDN’T BE TAXING FOR UK WEALTH MANAGERS

They say the only things certain in life are death and taxes – and the latter is top of the agenda for UK wealth managers right now.

From having to deal with the increasingly complex taxation of financial instruments, to managing the taxation of entire portfolios, tax suitability has never been more important to the investment process.

Why? Well, today, it is not just a case of how to withhold or apply tax on a specific financial product from the perspective of a UK investor. Overseas taxation is now becoming more relevant as previously unavailable financial products are now entering the UK market which has a plethora of different tax requirements. According to a report by Thomson Reuters, the UK has one of the largest network of tax treaties preventing double taxation of income or gains.

The challenge is that every wealth manager holding these non-standardised products coming over to the UK needs to source a lot of highly intricate information.

This could include having to pay some sort of indirect virtual tax (e.g. on dividend-equivalent payments under IRS Section 871m) that could negatively impact performance or working out the small price improvements that have been wiped out from overpaying tax on an instrument. In fact, when it comes to the more complex investments such as structured products, there has been – until now – no clear insight at a financial instrument level.

This presents a real predicament when investing in a particular fund that, for example, is not flagged as a reporting fund. For an instrument like a structured product, there is a need to quantify how tax efficient the instrument is before an investment decision is made and to assess whether the addition of the product negatively affects the overall tax efficiency of a portfolio.

The issue is that the vast majority of wealth managers search a tax manual in PDF for this information, making it very difficult to find the tax logic that applies to a very specific instrument. It is the equivalent of looking for a needle in a haystack.

To find the tax rate that applies in the manual you would need to know how this particular fund instrument is treated tax-wise within the asset class. As a case in point, is it a reporting fund or an accumulating fund? If they think that

a particular fund falls into a certain category, then they have to look up the text in the manual before collecting the information. The trouble is that this approach is the antithesis of what the ever more cost conscious and tech savvy investor is looking for from their wealth managers.

Investors are currently putting significant pressure on their wealth managers to offer differentiated financial products – which means there is no choice other than to look for ways to become far more efficient around taxation. Information on the tax cost impact of products is not just required pre-trade but moves into the focus of pre-investment advice.

Applicable tax rates can change rapidly and at fairly short notice depending on the budgetary needs the UK government needs to fill. Therefore, there is a pressing need to get the adjusted tax rates as quickly as possible to then be applied into the calculations. This can only really be achieved by gathering all the relevant tax information in a digital format.

Furthermore, it may well be that a wealth manager needs to disclose a specific indirect tax cost change. Even if the transaction tax rate is only around 0.3 percent, it may not seem like a large amount, but a consistent failure to disclose could lead to investors losing confidence and ultimately putting their money into other assets. Accessing this information digitally is sure to reduce the risk of this happening.

As UK wealth managers face up to pressures around needing to disclose as much information as possible about direct and indirect tax costs, digitising the tax on instrument process is the only way to be at the cutting edge of cost transparency for financial products.

Ultimately, this is what investors want to see, so the sooner the UK wealth managers adopt a more digital approach, the sooner the industry will be able to fulfil the day-to-day tax suitability demands of increasingly sophisticated investors.

JÜRG STALDER SENIOR PRODUCT MANAGER

SIX www.six-group.com

IS INVESTING IN CHINA STILL A GOOD IDEA?

Since the start of the year Chinese equities have fallen by over 20% in US Dollars terms. Other global markets have also done poorly (the S&P500 fell by 15% for example), but Chinese stocks have performed worse. This is particularly the case for those listed in Hong Kong or via US depository receipts. The Chinese market has been impacted by several simultaneous domestic and external events and it has been difficult for fund managers to outperform. This poses the question: Is investing in China still a good idea?

The arguments for and against investing in China have been made by many commentators, often swung by the most recent piece of news. Whether that be regulatory changes impacting education companies or financial problems and mortgage strikes in the property sector, the possible delisting of US ADRs of Chinese businesses, COVID lockdowns or geopolitical tensions – the news has had its share of adverse developments. Despite this, we argue in favour of a Chinese allocation. It is the world’s secondlargest economy and stock market with more than 4000 companies listed on the mainland plus another 2000 in Hong Kong. Even after applying a robust ESG screen, the universe still contains many companies including some that are global front-runners in their niche and others that are fast-growing domestic brands serving the world’s largest population.

While the rest of the world grapples with inflation and rising interest rates, China has been on a different monetary and policy path. Growth drivers across its economy are different from the rest of the world (and different from it’s own recent history). Where previously China was seen as a low-cost producer of goods for global consumers, going forward domestic consumer demand for higher quality locally made products combined with state support for the green economy create opportunities in manufacturing for skilled entrepreneurs. In addition, trade tensions have encouraged domestic companies to ‘internalise’ supply chains; that is, to seek out domestic suppliers in favour of relying on components from say the USA. The trend by Chinese consumers to buy premium local products contrasts with other emerging markets like Russia or Africa, where increased wealth often means higher demand for well-known global luxury brands. Examples of this include a premium bottle of the Chinese liquor Moutai,

which can cost as much as $25,000, and Chinese electric vehicle maker Li Auto, which outsells competitor products from VW or BMW. Despite these tailwinds, recent falls in share prices did have legitimate reasons.

China has stuck to its zero-COVID-19 policy despite the negative impact on economic activity when large cities like Shanghai or Shenzhen are locked down. Consumption is dampened, supply chains are disrupted and many businesses are affected. The justification is that China’s COVID experience is quite different from the developed world. It hasn’t had multiple infection waves; it does not yet have herd immunity and many vulnerable older citizens remain unvaccinated. The country’s leadership has decided that it is preferable to sacrifice economic growth in favour of large numbers of COVID-related deaths. Therefore, lockdowns are likely to continue and will disrupt the economy – although recent actions point to less aggressive lockdowns than in the past. While it continues, depressed equity valuations are justified, just like they were in the UK around March 2020. But looking back, that was an opportune time to invest in global equities.

Social stability and an economy growing more sustainably are both policy goals in China. Both imply a more broadly-based distribution of the gains from economic activity. Achieving this has needed a slew of regulatory action which if nothing else creates unpredictable market movements, and a difficult environment for unprepared and unskilled investors. Unlike some of the generalist global fund managers, specialist Chinese equity managers who are often based locally have thus far dodged the full effect of the regulatory onslaught. It serves as a reminder that to invest in Chinese equities specialisation and deep insight are required.

The positive news is that the regulatory wave which amplified much of the market decline may have ended. Vice Premier Liu He – President Xi’s chief economic adviser – called for transparency and order in dealings that involved big tech firms earlier this year which led to a swift rebound in the price of some technology shares (Alibaba’s price rose by 65% in the immediate aftermath).

Common Prosperity: The quest for greater economic equality is likely to generate opportunities and also more losers. Smaller companies in particular should benefit while larger ones with monopolistic behaviour are increasingly handicapped.

The green economy: China has publicly committed itself to net zero by 2060. This has created unique opportunities in the manufacture and supply chain of electric vehicles and in equipment related to renewable energy (like wind turbines and solar panels) where China has quickly become the world leader. These industries are growing at pace, with some existing almost exclusively in China. China is the biggest maker of solar panels, 6 of the top 10 wind turbine makers are Chinese and it produces 90% of the world’s lithium iron phosphate batteries.

‘Inwardisation’ of supply chains: China’s wish to develop self-sufficiency, underpinned by geopolitical and trade concerns, has hardened the policy of inward capacity replacement. Domestic premium consumption was mentioned earlier while at the strategic level industries like semi-conductors should enjoy state support for years to come.

In summary, we argue that China is investible. There are risks, but valuations are depressed, and the Chinese government is more able to provide stimulus when the world is at risk of stagflation. Meanwhile, in China high-quality businesses continue to develop at pace, with new growth drivers such as the green economy and inward-focused technology replacement.

LARS HAGENBUCH CONSULTANT RISCURA www.riscura.com

CAPITALISING ON A RISING INTEREST RATE ENVIRONMENT

Holding cash, whether in the short or the long term, will always be a necessity. The liquidity of cash allows emergency funds to be used to respond to unexpected events as well as to exploit opportunities in financial markets during economic downturns.

Future events may require us to hold cash, for example, for upcoming tax bills, care home fees or, for a business, investment or a longer working capital cycle. With the increase to the Bank of England base rate in each of the last seven consecutive MPC meetings to 2.25%, how can you take advantage of increasingly competitive interest rates? Especially when some high street banks are still offering as little as 0.10% on savings accounts.

In the current market volatility and with inflation continuing to rise, managing your cash savings may be on your ‘to-do’ list but researching and comparing different banking institutions often feels overwhelming. In addition, many of us may have concerns over unknown institutions and worry that, in the event of a collapse, they may take our savings with them.

So, how do we ensure we are maximising our savings and minimising our risk without the hassle of constantly monitoring the cash savings environment, moving funds, and opening new bank accounts?

Cash Management platforms tackle this very question by allowing you to manage your cash savings in an easy and efficient manner. Savers can open one cash management account and access more than 35 Banks and Building Societies, removing the administrative burden associated with opening, managing, and closing multiple savings accounts. This provides Clients with access to competitive savings rates and enables them to view and manage their deposits all on one cash management Platform, taking away the need to sign into multiple banking interfaces to access funds.

The large banking panel available on cash management platforms gives access to a range of high-street banks and building societies, which are well known to Clients, and to challenger banks which are usually less well-known but may offer market-leading rates. In addition, they often have access to exclusive rates that cannot be obtained directly through the bank, supporting the Client to ensure their cash works harder for them. With thousands of different savings products available on cash management platforms the service also allows Clients to manage their funds based on their liquidity requirements and aiding financial planning as funds can be spread across savings products ranging from easy access to five years. With cash management platform like Insignis Cash

Solutions the Client always maintains beneficial ownership of the funds.

All the UK-based institutions which Insignis Cash Solutions works with are authorised by the PRA and regulated by the FCA and therefore offer protection under the Financial Services Compensation Scheme (FSCS), which is a government-backed scheme providing protection for eligible deposits up to £85,000 per depositor, per institution. This enables Clients to spread their cash across various banks or building societies within the Insignis Cash Solutions service while maximising FSCS protection eligibility.

Insignis Cash Solutions offers the solution to individuals, businesses, charities, trusts, power of attorney, court of protection, pensions (both SIPP and SSAS) as well as many others. Furthermore, they offer savings rates for Pound Sterling, US Dollar, and Euro cash holdings.

A Client recently utilised the Insignis cash solution for £1,000,000 following the sale of their business. They were earning a rate of 0.10% with FSCS protection eligibility of 8.5%, as all their funds were exposed to one institution. When the couple moved their funds over to the Insignis Cash platform, they were able to view all partner banks and building societies and their associated savings rates, making it easy to compare and find the best rate. They moved funds into twelve institutions of their choosing on the platform in products ranging from Easy Access up to 1 year. The Client’s FSCS protection eligibility increased to 100% and their blended interest rate rose to over 3.7%, equating to £36,150 of net annual interest.

IMPROVING DIVERSITY AND INCLUSION IN THE FINANCIAL SERVICES SECTOR: SOCIOECONOMIC BACKGROUND DATA

Understanding and improving diversity and inclusion continues to be both a focus and a challenge for organisations across the financial services sector. Data collection remains a vital part of the process and whilst there has certainly been some progress, there is still a way to go. Our article Diversity and inclusion in the financial services sector: The “why” and “how” of collating diversity data , published last year in the PIMFA Journal, looks at the importance for financial services sector employers of collecting diversity data, how to process this data lawfully and how to increase employee engagement.

The first step to understanding and improving diversity and inclusion is to collect meaningful diversity data. This means looking at data across all areas of diversity and equality including, for example, socioeconomic background – an area highlighted by the discussion paper published by the FCA and PRA last summer [ (DP21/2: Diversity and inclusion in the financial sector - working together to drive change (fca.org.uk)) ].

The Financial Service Skills Commission (the FSSC) has now turned its attention to how organisations can better understand the socioeconomic makeup of their workforce, in its Insight Paper Collecting Socioeconomic Background Data – Best Practice for Financial Services Firms [ (220915-Collectingsocioeconomic-background-data-insight-paper-final. pdf (financialservicesskills.org) ]. This Paper highlights the importance of data collection in supporting greater representation and thereby ultimately driving sustainable growth.

FSSC acknowledges the risk that talented individuals may migrate to more inclusive sectors, worsening the skills gap across the financial services sector.

Why should organisations collect socioeconomic data?

The Paper highlights the importance of socioeconomic background data collection particularly in relation to diversity of thought, inclusivity, and the ability of an organisation to attract, retain and progress talent. By collecting socioeconomic data, organisations can identify the socioeconomic make-up of their workforce and take tangible steps, where appropriate, to ensure that employees can thrive and feel valued and supported, regardless of their socioeconomic background.

How can firms measure socioeconomic background?

What challenges are employees from a lower socioeconomic background facing and what does this mean for the financial services sector?

The Paper refers to a “progression gap” that remains prevalent in the financial services sector. Research by the Bridge Group revealed that employees from a lower socioeconomic background progress 25% slower than their peers, despite there being no difference in performance. In addition, the Social Mobility Commission found that individuals from a lower socioeconomic background are less likely to sign up for training opportunities. There also appears to be an impact on morale and wellbeing, as employees from a lower socioeconomic background reported being “exhausted” by conforming to dominant cultures. Interestingly, the Social Mobility Commission has also reported a class pay gap of £17,500 in the financial services sector, compared to just £5,000 in the technology sector. As a result, without change, the

The key is to ask the right questions of employees. The FSSC recommends using the Social Mobility Commission’s Financial and Professional Services Toolkit [ (Measurement - Social Mobility Commission (socialmobilityworks.org)) ] which provides guidance and examples of questions to ask. It identifies the key question as: “What was the occupation of your main household earner when you were about 14?”

The Paper also offers practical suggestions for successful data collection and monitoring - the key takeaways include:

Ensuring that there is support at the most senior level so that the messaging cascades down throughout the organisation.

Asking best practice questions so that the data can then be benchmarked more widely.

Considering a pilot data collection exercise across a small section of the organisation to allow for a smoother process when rolling this out to the wider workforce.

Communicating clearly with employees so they understand exactly what data is being collected and why.

The FSSC has also developed a number of resources aimed at assisting organisations with improving socioeconomic diversity and inclusion. In July 2022, the FSSC published an updated Inclusion Measurement Guide [ (FSSC-Inclusion-MeasurementGuide-updated.pdf (financialservicesskills.org)) ] which recommends focusing on three priority areas – inclusive leadership, a safe and speak up culture, and inclusive systems and processes. The Guide also offers four levels of recommendations, depending on an organisation’s existing diversity and inclusion practices.

Along with a wider cultural expectation in relation to diversity and inclusion in recent years, we have already seen a growing regulatory focus and expectation in this area. The FSSC’s recent Paper serves as yet another reminder of the importance of improving diversity and inclusion and the impact this can have on an organisation’s ability (and that of the financial services sector as a whole) to attract and retain the talent it needs.

Want to know more?

If you have any questions, or would like advice on any of the issues raised here, please contact chris.holme@clydeco.com , victoria.jervis@clydeco.com , or natasha.mills@clydeco.com

Chris has over 20 years’ experience of working with clients across the financial services sector and has also worked “in-house” as an employment lawyer at two leading North American investment banks. Victoria and Natasha work alongside Chris in the employment team at Clyde & Co and are closely involved in the team’s financial services sector focus group.

CHRIS HOLME , VICTORIA JERVIS & NATASHA MILLS , CLYDE & CO EMPLOYMENT TEAM www.clydeco.com

AN INTRODUCTORY GUIDE TO EMAIL ACCOUNT SECURITY

Your business email account is the most common entry point for criminals and is at the root of most successful cyber-attacks. It is not surprising that the most used function in a business is the one that criminals use to exploit. What is surprising, is that the security of a firm’s email system isn’t made a higher priority.

In this summary we will describe how attacks start in order to give an insight into the key things that you need to defend against. We will also describe some common consequences of an attack to help to understand why this subject deserves real attention. Finally, we give ten top tips on how to avoid becoming a victim.

TOP 4 ATTACK APPROACHES

Here are the common methods of attack against a business’ email systems.

Phishing: The criminals send blanket emails to every address they have acquired from social media, the dark web and website scraping. They pose as legitimate suppliers and trick you into giving away your email login credentials. In our simulated attacks 20% of untrained staff typically fall for this type of attack.

Malicious attachments: Emails with fake attachments will tempt you to open them with headings like “missed message”, “urgent invoice”, “bank statement” etc. They will have malicious code that will attempt to get control of your computer in some way.

Account hijack: With credentials purchased from the dark web, automatically breaking weak passwords, or tricking you with phishing attacks, the criminals get access to your account. They login as you, with full functionality including access to all your email history.

Spoofing: The criminals create their own email accounts and pretend to be you. They are not inside your account but send emails to employees to try and get access to business systems and data.

TOP 3 CONSEQUENCES

Here are the consequences if the criminals are successful in the approaches above.

Ransom: This is the most damaging consequence and can be business ending. The criminals use the access they have gained first to steal confidential and personal information, and then to encrypt your systems. They threaten to release the data if you don’t pay a ransom fee. The average business downtime is now 26 days. The average ransom payment in 2021 was £628,000.

Virus spreading spam email: The most common consequence is thousands of emails being sent from your email to every contact associated with your business. The aim of the email is to contaminate their systems with a view to stealing money from them. We probably don’t need to describe how damaging this can be for a previously trusted business.

Payment diversion: The main object here is to get money diverted to their bank accounts by tricking you or a client into sending money to the wrong payee. There is the obvious financial and reputational damage but the conversations with the ICO will not end well if a client has lost thousands of pounds because you didn’t protect their data sufficiently.

TOP TIPS TO HELP DEFEND AGAINST EMAIL ATTACKS

Here are the top 10 areas you must address to defend against the greatest cyber threat facing your business.

Appropriate business email account. Free and basic email systems are not good enough. You may need to upgrade to get the appropriate level of capability.

This guide gives you a starting point and a roadmap. Please invest some time and resources to getting this right, it will be the best money you spend this year.

DAVID FLEMING

CHIEF TECHNOLOGY OFFICER

MITIGO GROUP mitigogroup.com

TAKE A LOOK AT MITIGO’S FULL SERVICE OFFER AT WWW.PIMFA.CO.UK/FIRM/MITIGO/ FOR MORE INFORMATION CONTACT MITIGO ON 0208 191 9913 OR EMAIL MAILTO: PIMFA@MITIGOGROUP.COM

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Good employee disciplines. Email addresses should be for work purposes only and you need to make this clear to staff. The dark web is littered with business email addresses that have been used on personal accounts (e.g. Amazon, eBay etc) that have then been lost along with passwords and critical information.

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Unique, strong passwords and strong authentication. The password should not be a repeat of anything you have used elsewhere, and it is essential that authentication has another factor e.g. a code on your phone. 4

Inbound filters. Get these expertly set and don’t rely on defaults. If done well it will stop the deceptive emails ever getting into staff inboxes. 5

Staff training and simulation. Make sure your staff get annual training and run simulated attacks to make sure they know what to expect.

Domain records. The end of your email, @acme.com, is called the domain. There are important records that need to be set in the domain control panel to avoid criminals easily spoofing your address. 6

Access methods. You need to have a clear policy on how staff access emails e.g. from a laptop, mobile, through a web browser, etc. The more you reduce this, the more access points can be switched off in the security settings.

Payment methods. Make sure that there is a robust process that ensures that changes to payee details have strong challenge processes.

Antivirus & browser integration. Your web browser, email service and antivirus software need to be configured to work in unison to stop attacks. This is the most important retrospective control as it is unwise to rely on staff spotting the criminals’ tricks.

Alerts and blocks. Make sure that the alerting from security systems is properly configured and is going to your technical support and that rules are set to block, not allow.

BEWARE THE IDES OF CARF

Since 2008, we have seen the regulatory landscape evolve from a spring walk around the hillsides to an epic climb up the Rocky Mountains, but is Big Regulation really achieving its core goals and is getting bigger and harder the right answer, especially in this digital era?

Investment firms know the burden well, with the last 10 years seeing Automatic Exchange of Information (AEOI), Money Laundering Directives (MLD) and Markets in Financial Instruments Directives (MiFID) all kicking our behinds when it comes to day-to-day operations. We set up new systems and controls, policy and procedure,

then along comes a new one, or a big change, and we start all over again. It can sometimes be disheartening that there is not much visible gain from these rules, with one solitary Foreign Account Tax Compliance Act (FATCA) based prosecution since 2014.

As all tax professionals and Brian DePalma fans know, financial records are often the key to catching bigger crimes and criminals, and we have to trust that is where this unprecedented amount of reported account data is doing its work.

Looking at the evolution of the AEOI - we’re a long way away from the European Union Savings Directive days… With FATCA forging a flame filled path throughout the world, and Common Reporting Standard (CRS) hot on its heels, we’ve now got over 100 countries exchanging massive amounts of information including income, balance and valuation data from offshore financial accounts back to home states. Deterring and detecting offshore tax evasion is the primary goal of FATCA and CRS, and Financial Institutions (FIs) all over the world have bent over backwards and gone round in circles to ensure they have the systems, controls and processes in place to comply with these rules. We know that these rules are keeping the little person in line, ensuring the Joe Bloggs tax return is complete and accurate, but what about the intentional criminal?

CRS has definitely made the world a smaller place from a tax evasion perspective, with less nooks and crannies to hide in. But a quick Google search will find you a plethora of “tax planning” firms based in non-CRS or CRS-lite countries telling you exactly how to avoid being CRS reported. And they are clearly written by someone who knows the rules well.

So, regulatory response to CRS avoidance is the Mandatory Disclosure Rules. Whilst the blueprint was created by the OECD, these have been introduced across Europe with many jurisdictional differences. Therefore, FIs have more detective measures, systems and controls to put in place, the firms paying the price again for the creativeness of the criminal. The regulatory environment is expanding and it can be difficult to keep up and comply with.

The OECD proposes more updates to the CRS this year, including, amongst other changes, the hefty Crypto-Asset Reporting Framework (CARF). But is it time to look at a different approach? We’ve seen money laundering regulations make banks go hard on the “de-risking” of clients, where they have ended up just refusing to supply certain high-risk jurisdictions. This course of action penalises the average person or business in these places, potentially creating less visibility for regulators. The European Banking Authority has earlier this year commented in detail on

unwarranted de-risking and how competent authorities should take steps to address this. Is the same thing about to happen again in the Crypto world?

We have already seen 200+ crypto firms not pass authorisation from the Financial Conduct Authority to perform Crypto activity in the UK. In the EU we’ve seen multiple Crypto firms not pass authorisation in one state, then be successful in another and passport back into the original state. This industry is a lot more flexible than traditional banking when it comes to a “home state”, or main place of incorporation and business.

The proposed CARF will be picked up by the usual countries, we’ll see the EU, UK, Canada and Australia leading the way at full compliance – the USA announced their intentions to build a framework for Crypto regulation as well. Firms needing to comply, will have a lot of work to do, the transaction level reporting is particularly detailed. But will the decentralised nature of Crypto make it easier than ever to avoid the regulations?

As we’ve seen with many regulatory initiatives to tackle financial crime, international cooperation is vital for it to work. The distance between the harshest and most lenient countries when it comes to Crypto activity is an enormous gulf right now, are the hard-line countries just pushing Crypto providers into the less regulated ones?

Given the complexity of the CARF, it’s critical that firms understand their tax reporting responsibilities and implement technological solutions to collect the relevant data, right first time, without having an adverse impact on the customer journey. This will enable firms to compete effectively even the highly regulated environments and reduce the potential drive for customers to invest in less regulated countries. And most importantly, allowing the regulatory environment to keep up the good work we’ve all contributed to of making the financial crime world a much smaller place.

NATALIE DOWLING REGULATORY EXPERTISE MANAGER EFFICIENT FRONTIERS INTERNATIONAL efilimited.com

IMPLEMENTING THE FCA’S NEW CONSUMER DUTY

The FCA finally issued its much-heralded Policy Statement and Final Rules (PS22/9) together with its Finalised Non-Handbook Guidance for Firms (FG22/5) in July of this year with the intention, in the words of the FCA, of fundamentally improving how firms serve customers by setting higher and clearer standards of consumer protection across financial services. Customer needs are to be the priority for firms under the new Principle 12 which requires firms to act so as to deliver good outcomes for retail customers.

Many firms understandably took the position that until the Final Rules were issued together with the supporting guidance it would have been premature to take active steps to prepare for the new Duty. In addition, representations had been made as to the original implementation date of April 2023 and the FCA had signalled that there could be some movement as to this. The FCA has indeed extended the timetable to a degree but in respect of new and existing products and services the additional time has only been extended to end July 2023.

In its Final Guidance the FCA has given further detail as to the action it expects firms to take now to implement the new Duty. In particular, the FCA stated that it expects firms to have in place an implementation plan approved by its board (or equivalent body) by the end of October 2022 and which the board is satisfied is deliverable and robust enough to ensure the firm can meet the new standards. In addition, the FCA wants firms to have in place a Consumer Duty “Champion”, ideally an independent non-executive director (or similar), though it recognises that for smaller firms this level of formality may not be appropriate.

The FCA’s announcement that firms should have in place an implementation plan within 3 months of the Final Rules being issued was possibly influenced by feedback which suggested firms did not necessarily appreciate the impact that the new Duty would have on their existing business models, or indeed were dismissive of it.

However, despite explaining that firms can expect to be asked to provide the FCA with their implementation plans, there is regrettably little guidance from the FCA as to the precise form that a plan should take and what it should cover. Firms that are subject to the new Duty vary considerably in terms of scale and complexity but also the financial and human resource available to them.

In addition, whilst the FCA has made clear that the new Duty applies to all firms within the distribution chain, it is not clear that it appreciates the constraints on firms in drawing up implementation plans depending on where in the “chain” they sit.

For firms that are “distributors” as opposed to “manufacturers” (to use the FCA’s terminology) in many instances they will only be provided with the necessary information to enable them to finally determine the action they need to take in April 2023 (which is the date by which manufacturers

are required to make information available as to the results from their own reviews of the products or service they provide against the Four Outcomes. Some firms will be placed in the invidious position of having to make quite fundamental changes to their product and service offerings, including pricing models, in a short period of time.

In addition, there is scope for firms in the “chain” to reach quite different views as to the impact of the Duty and the interpretation of particular provisions of the new rules. Existing contractual arrangements may also be deficient in terms of allowing for changes to be implemented, especially where adjustments to pricing structures are sought to be passed down the chain. The potential for disputes appears significant. All of these present significant challenges in producing a “robust” implementation plan by the end of October 2022.

However, an imperfect or incomplete plan is better than no plan at all. The FCA will no doubt be astute to identify plans which appear to be window dressing rather than the results of substantive analysis. Where it is impracticable to complete this exercise by the end of October 2022, then the plan should map out specifically what work will be undertaken, by whom and by when. However, at an absolute minimum, firms should have in place the appropriate governance framework to demonstrate that the impact of new Duty is being properly considered with the relevant training of staff being undertaken.

There are firms who do not expect the new Duty to have a material impact on their business. However, such firms will still need to demonstrate that they have undertaken the necessary analysis and those that fail to do so plainly put themselves at risk of regulatory action.

A comprehensive and complete implementation plan by the end of October 2022 may prove to be unrealistic for many firms. However, all firms should be in a position to demonstrate - on enquiry by the FCA - that the firm understands the nature and intended effect of the new Duty and has documented the steps that are required to ensure compliance, taking into account the date by which the new rules will actually take effect, and that appropriate progress towards achieving compliance is being achieved and properly monitored.

CHARITIES AND RESPONSIBLE INVESTMENT

CHARITIES AND RESPONSIBLE INVESTMENT

Charity trustees and their investment managers should be aware of the recent High Court judgment in the case of Sarah Butler-Sloss and Ors v The Charity Commission and Attorney General.

This provides reassurance for charities wishing to adopt a responsible approach to investment and clarification for their investment managers.

It confirms that there is no absolute prohibition against a charity making investments that directly conflict with its purposes. But, where trustees reasonably believe that an investment conflicts with their charity’s purposes, they have a discretion as to whether to exclude it – and should exercise that discretion by balancing all relevant factors.

BACKGROUND

The case was brought by the trustees of two charitable trusts (the Claimants), the Ashden Trust and the Mark Leonard Trust. Both have general charitable purposes although their trustees have decided to focus primarily on environmental and associated causes.

The Claimants wished to adopt investment policies which would, as far as possible,

exclude investments that did not align with the Paris Climate Agreement 2016 (the Proposed Investment Policy).

The Proposed Investment Policy would have excluded over half of publicly-traded companies and commercially-available investment funds. Although it targeted an annual return of CPI+4% (in line with the published rates of return of other large charities), the Claimants accepted they were unable accurately to determine the extent of the financial detriment which may be suffered by the charities as a result of adopting the Proposed Investment Policy.

They therefore sought the approval of the Court.

EXISTING LAW

Prior to the judgment, the only major case in this area was Harries v Church Commissioners for England [1992] 1 WLR 1241, commonly referred to as the Bishop of Oxford case.

In the Bishop of Oxford case it was held that the starting point for charity trustees should be to seek to maximise financial return (although the judgment noted that there are exceptions to this). The greater the risk of financial detriment, the clearer trustees need to be of the advantages to the charity of a course of action.

THE RECENT JUDGMENT

As well as a declaration as to whether the adoption of the Proposed Investment Policy was a lawful exercise of their powers, the Claimants asked whether there was an absolute prohibition against making investments that directly conflict with their charities’ purposes.

The judge (Mr Justice Green) determined that the Bishop of Oxford judgment had not intended such a prohibition.

Most helpfully, Mr Justice Green summarised what he considered the law in relation to charity trustees considering non-financial aspects when exercising their powers of investment:

• Where particular investments are prohibited under a charity’s constitution, they cannot be made.

• Where there is no such prohibition, but trustees are of the reasonable view that particular investments potentially conflict with their charity’s purposes, “the trustees have a discretion as to whether to exclude [them]” and should “exercise that discretion by reasonably balancing all relevant factors”.

• In considering the financial effect of making or excluding particular investments, “the trustees can take into account the risk of losing support from donors and damage to the reputation of the charity”.

• However, trustees must be wary of “making decisions as to investments on purely moral grounds, recognising that among the charity’s supporters and beneficiaries there may be differing legitimate moral views”.

• “Essentially, trustees are required to act honestly, reasonably (with all due care and skill) and responsibly in formulating an appropriate investment policy for the charity that is in the best interests of the charity and its purposes. Where there are difficult decisions to be made involving potential conflicts or reputational damage, the trustees need to exercise good judgment by balancing all relevant factors in particular the extent of the potential conflict against the risk of financial detriment.”

• “If that balancing exercise is properly done and a reasonable and proportionate investment policy is thereby adopted, the trustees have complied with their legal duties....and cannot be criticised, even if the court or other trustees might have come to a different conclusion.”

The judge endorsed the approach of the Claimants, finding they had exercised their investment powers properly and lawfully and permitting them to adopt the Proposed Investment Policy.

WIDER IMPLICATIONS

The judgment does not represent a radical change, but it does provide helpful clarification on how charity trustees should approach non-financial factors and the process the law expects them to follow when making decisions about responsible investment.

Where it offers less clarity is on the level of diligence expected of trustees in assessing the likely financial detriment involved in a particular investment.

It remains to be seen whether the Charity Commission will tackle this in its revised guidance or whether it leaves this for trustees to work through themselves using the Commission’s guidance on decision making.

JAMES MALONEY

PARTNER

FARRER & CO LLP www.farrer.co.uk

EMMA JAMES ASSOCIATE

FARRER & CO LLP www.farrer.co.uk

CONSUMER DUTY –WHAT IS IT AND HOW WORRIED

A lot has been written on this subject recently, so in case Consumer Duty fatigue has set in, will answer my initial question upfront; it’s big, and you probably should be worried.

You may have made the mistake of waiting until after the summer break before getting your teeth in to Consumer Duty and how you’ll need to tackle it, but the October deadline for all regulated firms to have their plan to become compliant in place is fast approaching, as are the 2023 (new and existing business) and 2024 (closed products) deadlines.

Why is it ‘big’ then? Contrary to some opinions I have read and heard, Consumer Duty will be the catalyst that forces advice firms to consider the customer, through their whole journey, all parts of the value chain, from promotion all the way through to recommendation.

Firms could be forgiven for thinking it will be another ‘tick-box’ exercise given recent history, but this won’t be the case with Consumer Duty. Not only will advice firms have to consider how well they are adhering to the new regulations, they will also need to be comfortable that the firms they are recommending to the end consumer are going to be acting in-line with the regulations.

It could be said that traditionally, advice firms are only able to ensure that the consumer gets a great experience until they’re signed up with their end provider, and that any experience thereafter is the responsibility of that end provider, and not really a concern of the advice firm.

The beauty of Consumer Duty, and the ingenuity of its framework, are that (if governed properly) the Cross Cutting Rules, and Four Outcomes mean every firm in financial services has a duty to the consumer that must be acknowledged and managed, through every stage of the value chain.

For example, regarding the Cross Cutting Rules, you can’t ‘enable consumers to pursue their financial objectives’ without knowing that the provider they will end up with will help them with this in the long run. You can’t ‘avoid causing foreseeable harm’ without feeling happy with the conduct risk framework of the firms you are recommending, you can’t ‘act in good faith towards retail consumers’ without documenting your own customer journeys and understanding their likely outcomes.

The Four Outcomes effectively compel advice firms to move away from only considering the consumer experience up until the point of sale. They will need to ‘look through’, at all areas of the Products & services they recommend to ensure they will meet the needs of consumers through the entirety of their lifespan. They need to know that fair price & value will be offered at renewal, and be comfortable that consumers will be communicated to clearly so they can make informed decisions, and consumer support will allow consumers to realise the benefits of their product or service throughout the entirety of their relationship with the firm.

“NEVER SEND TO KNOW FOR WHOM THE BELL TOLLS; IT TOLLS FOR THEE.”

John Donne, 1624.

Risk of reprisal prevents me from bringing up any specific examples, but can think of scores of practices have witnessed that would be clearly at odds with the indicative Consumer Duty guidance, and each of these practices wouldn’t have been allowed to develop had Consumer Duty been an obligation at that time – there is some pain coming for such organisations, and the consumer will be much better off for it.

The key next steps for advice firms is to be focussed on quickly getting a handle on how well they are adhering to the imminent Consumer Duty guidance, by understanding how well the key business drivers of consumer duty are currently being executed, and to begin to take the remedial action where necessary.

At Investor in Customers, we have developed a Consumer Duty assessment, which can aid all FCA regulated firms in producing data which will be an integral part of the reporting required to meet the new Consumer Duty rules., while also providing targeted insight against the Cross Cutting Rules and Consumer Outcomes to drive improvements in performance

The assessment, that comes in two parts, assesses both internal preparedness for the new regime through surveying employees, and external performance, surveying consumers.

SHOULD I BE?

For the internal survey, IIC has identified the 20 most critical internal drivers of Consumer Duty performance such as strategy, back book, 3rd party suppliers etc., and aligned them to the three Cross Cutting Rules and four Consumer Outcomes. The outputs delivered show a firm’s internal performance against each key driver measured against the Cross Cutting Rules and Four outcomes. The outputs delivered show the key findings and recommendations with a dashboard to evidence performance.

For the external customer survey, IIC has aligned the survey questions to the typical value chain, and the four Consumer Outcomes, so that the effectiveness of the customer journey can be measured and understood. This covers every step from initial sale and set up all the way through to renewal and eventual exit. The same level of insight, findings and recommendations, and dashboard will be delivered as for the internal survey.

John Moret, Chairman of Investor in Customers said: “The new consumer duty rules are a significant development in the oversight of all regulated businesses. The aim of ensuring that all businesses have a culture where the customer genuinely is at the heart of the business has to be welcomed but of course the key will be the way in which the FCA enforce the new rules. In offering its new Consumer Duty reporting solution I believe IIC can help the boards and management of regulated businesses large and small ensure that they can evidence their business’s performance in meeting the new outcomes. Importantly, IIC offers an independent assessment, unlike internal surveys. IIC’s solution will also provide invaluable information to boards on where action is needed. This should, help businesses develop a culture where “ordinary acts produce extraordinary outcomes”.

JAMES EDMONDS CUSTOMER EXPERIENCE DIRECTOR

IIC www.investorincustomers.com enquiry@investorincustomers.com

CLIMATE RISKS BEYOND THE PHYSICAL

The mention of ‘Climate Risk’ inevitably turns our thoughts to dramatic weather events such as floods, storms, hurricanes as well as drought and forest fires (“Physical Climate Risk”). These often-devastating Physical Climate Risk events grab the media’s attention and are widely reported.

However, there is another kind of Climate Risk which is much less discussed and not as widely covered in the mainstream media, despite the potential for it to impact every part of daily life: Climate Transition Risk.

Climate Transition Risk has significant implications for the global economy and financial sector, affecting every asset in investment portfolios and bank loan books worldwide.

THE RECENT JUDGMENT

“Climate Transition Risk” is used to describe the disruption that is likely to be caused by a shift to a lowcarbon economy to prevent the escalation of physical climate risks. This shift to a low-carbon economy is the “Climate Transition”, and the disruption caused by the Climate Transition, including the risks inherent in overhauling business models and/or adjusting reactions to policy changes, is the likely risk during Climate Transition.

From the Paris Agreement to the COP26 Climate Summit, governments globally are setting policy and implementing regulation in a bid to guide economies towards a more environmentally sustainable future.

TARGET SETTING

One of the measures being adopted by governments globally is the introduction of targets for reducing greenhouse gases and limiting global temperature increases. Here, a common goal for companies and countries is to achieve “Net Zero” carbon emissions by the year 2050, a scientific target used to maintain alignment with the Paris Agreement, which aims to limit global warming to well below 2 °C, preferably to 1.5 °C.

While most carbon emissions reduction targets are set at country and economy wide levels, hitting these targets will require cutting emissions from high emitting industries across the world.

The energy and transport sectors for example, are often seen as the primary areas for transition and are certainly

at the forefront of policy. The transition to electric vehicles is currently one of the most visible policy initiatives globally and is gaining the most exposure.

However, the financial sector has a pivotal role to play in Climate Transition, as it can act as both a catalyst and a transmission channel for change.

FINANCE SECTOR PIVOTAL TO CLIMATE TRANSITION

Financial regulators are driving change through policy that encourages climate-related disclosures. These policies encompass asset owners, such as pension funds through to high street banks, and central banks globally that have started to introduce climate risk as a category (both physical and transition) in their stress testing frameworks.

The introduction of climate stress tests for banks suggest that financial regulators see climate risks as a potential source of financial instability. Banking stress tests are simulations to understand the robustness of individual banks and the banking system against various scenarios. The European Central Bank has been leading the way and other major G7 central banks are following.

PASSING THE TEST

The wide adoption of mandatory climate-related disclosures by the financial industry has potentially massive implications for the economy and the global population.

While the financial sector’s role as a transmission channel of monetary policy to the broader economy is well known, the growing prominence of its role as a climate policy transmission channel is less widely acknowledged.

Regulators’ strategy of requiring banks to undertake stress tests and the resulting wider financial industry’s hopes to avoid having to report environmentally unfriendly investments is creating the primary catalysts for the change in behaviour that policy makers are looking for.

However, the pressure is not only coming from regulators.

Within the finance industry, investors are also driving the Climate Transition agenda, as evident in some high-profile examples of shareholders successfully holding companies to account regarding their climate disclosure policies.

The growing trend in activist and impact investing will expose companies that are lagging when it comes to Climate Transition, which will then open these companies to further harm, including reputational risks.

CLIMATE RISK OR REVOLUTION?

The scale of change required globally for a successful Climate Transition has drawn comparisons to antecedent economic and technological revolutions, such as the industrial revolution and the introduction of the internet.

A significant difference with climate related transition changes from these previous economic and technological revolutions, which were propelled by technology and innovation, is that Climate Transition is currently driven by legislation and regulation, forcing change on businesses and the economy when the technology may not be in place to achieve those policy ambitions.

Indeed, while there are some examples of investor and consumer success in driving change, the current waves of Climate Transition legislation and regulation have technology and innovation scrambling to catch up.

While this gap between climate ambition and practical implementation exposes the economy to Climate Transition Risks, if/when technology catches up, Climate Transition Risks will quickly become climate-focused opportunities.

NOT JUST A RISK, BUT AN OPPORTUNITY

During periods of significant change there is a tendency to focus on the negatives, especially when the change is forced upon us rather than organically resulting from technological change and innovation.

But there are reasons for optimism as investment in green technology and business is growing rapidly, fuelling innovation. Regulation in the financial sector will likely drive this trend further as banks are penalised for lending to old emissions-heavy industries and rewarded for green investments.

Climate Transition evolving from a policy-driven to a technology-driven revolution could prove to be more acceptable to the population. While a technologydriven transition could reduce the risks to transition (implementation risk), it might not necessarily reduce Climate Transition Risk if that transition takes too long as an extended delay to move to a technologydriven transition could intensify some of the transition risks, especially if complacency sets in.

IAN STANNARD, SUSTAINABLE FINANCE BUSINESS DEVELOPMENT MANAGER ice.com

WOULD YOU LIKE TO CONTRIBUTE AN ARTICLE?

Alongside updates from PIMFA, the Journal includes several useful inputs from our associate member firms. These articles are an excellent opportunity to gain interesting insights into the wider industry and to learn more about PIMFA associate members. If you are an associate member who is interested in contributing to future editions of the Journal then please contact: Richard Adler, Director of Strategic Partnerships (richarda@pimfa.co.uk) or Nigel Ross-Scott, Copyright & Publications Manager (nigelrs@pimfa.co.uk)

@PIMFA_UK

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