Wma journal complete edition summer 2014 by PIMFA

Issue 2 â&#x20AC;˘ summer 2014

WMA JOURNAL Working for the Investment Community & their Clients

Top tax facts for 2014-15 tax year @WMA_UK

PERSONAL TAX

ALLOWANCE

FOR THOSE EARNING UP TO £100,000

Born before 6 April 1938 Born between 6 April 1938 and 5 April 1948 Born after 5 April 1948 AGED 77+

£10,660 £10,500 £10,000

MARRIED COUPLES ALLOWANCE £8,165

INCOME TAX RATE BANDS Basic rate: 20% Higher rate: 40% Additional rate: 45%

£0 - £31,865 £31,866 - £150,000 £150,000+

NATIONAL INSURANCE

CONTRIBUTIONS PER WEEK (Unless stated)

EMPLOYEES’ PRIMARY CLASS 1 RATE

between primary threshold and upper earnings limit:

SAVINGS Starting rate for savings income: 10% between £0 and £2,880*

ISA ALLOWANCES

(from 6 April 2014 to 1 July 2014, when ISAs are replaced with New ISAs, or NISAs)

CASH: £5,940

20%

MARRIED WOMEN’S REDUCED RATE between primary threshold and upper earnings limit: 5.85% CLASS 2 RATE: £2.75 CLASS 2 small earnings exception (per year): £5,885

PENSIONS

ANNUAL ALLOWANCE: £40,000

STOCKS & SHARES: £11,880

(you can carry forward unused allowances for the previous three tax years)

JUNIOR ISA: £3,840

LIFETIME ALLOWANCE: £1.25million

NISA ALLOWANCES (from 1 July 2014)

DEATH BENEFITS FROM PENSIONS IN DRAWDOWN: 55%

ANNUAL ALLOWANCE: £15,000 Can be held in cash or invested in stocks and shares in any combination.

JUNIOR ISA: £4,000

STAMP DUTY

CAPITAL GAINS TAX ANNUAL CGT ALLOWANCE /ANNUAL CGT EXEMPTION: £11,000 STANDARD RATE OF CGT: 18% HIGHER RATE (For higher rate income tax payers): 28% RATE FOR ENTREPRENEURS: 10%

ON SHARES TAXABLE TRANSACTIONS YOU PAY TAX OF 0.5% WHEN YOU BUY: • • • • •

existing shares in a company incorporated in the UK an option to buy shares rights arising from shares, e.g. the rights under a rights issue an interest in shares, e.g. an interest in the money from selling them shares in a foreign company that maintains a share register in the UK

NON-TAXABLE TRANSACTIONS INHERITANCE TAX

THRESHOLD

£325,000

YOU DON’T HAVE TO PAY TAX IF YOU: • • • •

are given shares for free buy a new issue of shares in a company buy units in a unit trust invest in an ‘open ended investment company’ (the trust or company pays the tax, so you don’t have to) • buy employee shareholder shares up to 50,000

*If, after deducting your Personal Allowance from your total income liable to income tax, your non-savings income is above this limit, then the 10% starting rate for savings will not apply. Non-savings income includes income from employment, profits from self-employment, pensions, income from property and taxable benefits.

Contents

Maximising tax reclaims should not be taxing How UK investors are losing 13% of their overall dividend returns as a result of not reclaiming withholding tax

Retail Distribution Review: the hidden costs Does RDR mark the end of inefficient back office processes for wealth managers and private banks?

If you’re thinking about outsourcing – do it right Advice for the increasing number of wealth management firms choosing to outsource business functions

The management of risk Clients are effectively paying for the management of an agreed level of risk but, in the context of investing, how do we define ‘risk’?

FATCA: 10 issues for WMA member firms The US tax authorities introduced the Foreign Account Tax Compliance Act to ensure US persons pay the right US tax

14 16

About the Wider Share Ownership Council WSOC is being formed as an integral part of WMA

The return of Sid and personal share ownership in the UK WMA’s new Wider Share Ownership Council initiative encourages personal share ownership and investing for all

Wealth management technology Where are we and where do we go from here? Introducing the concept of the Wealthstack

The FCA: changing governance and culture The FCA has been tackling the issue of changing governance and culture within financial institutions

The WMA Policy Statement EU 2014-2019 Outlining WMA’s position on EU retail financial services policy and legislation for the next mandate

As the digital world advances so does the risk of cyber attacks With the rise of digital wealth management, online security is vital for businesses

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WMA JOURNAL

TAX RECLAIMS

Maximising tax reclaims should not be taxing Recent research by Goal Group has shown that more than US$64bn of withholding tax is deducted globally each year and that more than US$17bn of this is not reclaimed annually by investors, for a number of reasons. Separate research by taxback.com shows that UK investors are losing around 13% of their overall dividend returns as a result of not reclaiming withholding tax.

any pension funds, pooled funds and hedge funds enjoy a legally tax exempt status and many wealthy individuals also enjoy a beneficial tax treatment through use of offshore trust funds. The complexities of the tax treatment of income on cross-border investments, despite the many double taxation agreements that the UK has established with other countries, still causes withholding tax to be paid and then reclaimed. Most pension funds, investment managers and their clients do not have a good understanding of the impact of the withholding tax that will be levied on their international equity investments and just assume that the custodian is performing this adequately as part of their overall service provision. There is a need to better educate the investors as to the potential benefits of improving the level of service that can be provided on tax reclaims. The level of local withholding tax levied on dividend income of a globally invested equity portfolio with asset allocation following the FTSE World Index can be shown to be more than 50 basis points, which is significant. This level of tax can be reduced to around 30 basis points by making the appropriate tax reclaims to the relevant tax offices. A number of significant rulings have also been made by the European Court of Justice which have the potential to reduce this tax impact by a further 7 basis points. Therefore making full use of the tax reclaims available

4 WMA JOURNAL

can provide between 20 to 30 basis points of additional income for a typical global equity portfolio, which would have a material impact on the portfolio performance. In addition, if an investor has not been actively pursuing reclaims then the statutes of limitations may allow reclaims to be made for a number of prior years, which could lead to a significant windfall amount. Many investors assume their custodian is performing tax reclamation services on their behalf. Unfortunately, this may not be the case. This places the onus on the pension fund trustees, investment manager or the portfolio manager for ensuring they recover all monies to which the investor is entitled as part of their fiduciary responsibilities in today’s regulatory environment. When an investor receives income from one country and is resident in another,they often have to pay tax in both countries under the different tax laws. The tax charged in the country where the income arises is known as withholding tax, because it’s withheld when the payment is made. To help avoid this double taxation the UK has negotiated over 100 double taxation agreements with many countries. The typical rate under most of the UK’s agreements is 15% so in theory, a UK investor should receive overseas dividend income net of 15% tax. However, countries still deduct tax at the local tax rates that apply with that country because they do not know the tax status of the beneficial owner of the investments. So for example, Switzerland deducts 35%.

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Many investors assume their custodian is performing tax reclamation services on their behalf

To demonstrate the impact of this a Swiss company’s dividends would be paid to a UK investor minus a 35% withholding tax. Under Switzerland’s double taxation treaty with the UK investors can reclaim 20% of this tax. So, on a £900 Swiss dividend local withholding tax of £315 would be deducted and only £585 paid to the investor. A total of £180 of the £315 tax paid can be recouped from the Swiss tax office by making the tax reclaim together with the appropriate paperwork. For a small number of countries it is possible for the investor to claim Relief at Source by notifying the relevant tax authority with evidence that they are domiciled in a country and meet the conditions laid down by the applicable double taxation treaty. This will ensure that dividends are taxed at source in line with the withholding tax approved in the DTT. The most important example is the US, where the default tax is 30%, but the rate for UK domiciled investors is 15%. The withholding tax on dividends will be reduced to 15% by completing a W-8BEN form, but this must be submitted to the qualified intermediary before the income is received, as it is very difficult to reclaim the excess tax afterwards in this market. The founding treaty of the European Union contains an express prohibition of national laws that restrict the free movement of capital between “Member States and Member States and third countries”. Over the past few years, this rule has been subject to numerous judgments of the European Court of Justice (ECJ), such that it now appears that the free movement of capital also applies to investors based outside the EU making portfolio investments into Europe. So far as taxation is concerned the ECJ has handed down judgments that clearly state that:

• The payment of a dividend is a movement of capital; • A withholding tax is a prohibited restriction where a resident recipient of the same dividend would not have suffered the same withholding.

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TAX RECLAIMS

Custodians are also under increasing financial pressures and need to reduce costs where possible by making themselves as efficient as possible. However, it is very difficult for a custodian to be efficient on tax reclaim processing, as each country has different processes and various items of paper documentation that are required. Keeping up to date with all the latest changes in terms of tax legislation around the world is also a real challenge and requires specialist expertise and knowledge. Most foreign dividend withholding tax reclaims need two key pieces of evidence. The first is confirmation from the tax office that the investor is entitled to the payment at the reduced treaty rate. Countries that have forms for reclaims usually also need the original forms stamped by the tax office. Those that don’t have official forms may require a letter from the tax office. Investors are often required to submit documents, such as a certificate of tax residence and a lengthy treaty claim form, which are often www.thewma.co.uk

only available in the local language. Some countries even require a form for each dividend payment. A number of specialist companies have developed tax reclaim services over recent years to provide a broader service than the custodians are able to do. However, not all these providers have a service capability to provide a really global service. The key items an investor should consider when choosing a tax reclaim provider include: • Market Coverage – do they support tax reclaims in all markets where a reclaim is possible? • Relief at Source – do they support relief at source where this is possible? • Systems – do they produce the required documentation for all markets? • Data Sources – how do they access the latest tax data to keep up to date? • Documentation – will they work under a Power of Attorney? • Time Scales – will they work to an SLA in markets where this is appropriate?

• Client Web Portal – do they have a web portal to allow clients to monitor the service being provided? In summary research shows that more than with US$17bn of withholding tax remains unclaimed each year. Investors are adopting new and emerging markets, which require knowledge of the local tax rules, impacts and reclaim processes. Maximising dividend income is an important contributor to performance and making full use of tax reclaims has the potential to provide between 20 to 30 basis points of income for a typical global equity portfolio. Choosing the right outsource provider for tax reclaims will maximise the level of reclaims that a portfolio should receive, without it being too taxing in the level of effort required by the investor. Philip Keeler of Colwin Associates in partnership with WMA associate member, Goal Group Limited – contact goalemeasales@goalgroup.com or go to www.goalgroup.com for more information WMA JOURNAL

RDR

Retail Distribution Review: the hidden costs Wealth managers and private banks have had to deal with inefficient back office processes for far too long, says Neil Wise, Vice President, Investment Fund Services at Clearstream. However, there is growing belief in the market that the Retail Distribution Review (RDR) provides a line in the sand which will force practitioners to opt for better operating and processing models.

hird-party fund processing can be a considerable drain on any company’s profitability. However, in the pre-RDR world, this was largely hidden from the wealth management community as their platform providers covered the cost of processing by taking a cut of their full trailer fee entitlement. The historical benefits of using a platform are clear: free order routing, settlement, custody and asset servicing, all of which are very appealing, along with access to a broad range of funds. Traditionally, the charging arrangements tended to be quite simple: a fund provider paid a sales commission to the platform which took a share and passed the rest back to their wealth management clients. For years, private banks and wealth managers have been broadly happy to run with this bundled fee structure, often having little idea (or interest) in how much they were actually paying for their fund processing and custody. However, when you consider that this sales commission often amounted to 0.75%, or 75 basis points, and only 50 basis points were returned to the wealth manager, you’re seeing (or not!) quite a chunk of your ‘entitlement’ leaving the chain. Twenty five basis points for custody? Not even in the 1970s were fees this high for bonds and equities. Although these platforms appear highly automated and efficient, a look below the surface reveals highly manual processing hubs. It is this lack of investment into the post-trade arena which is now coming to the fore. Is a better solution available? So why do wealth managers have to change their existing post-trade arrangements? Put simply, a much better alternative may be available that will allow them to manage risk across their fund processing activities more effectively. The standards of fund processing and custody they receive within their current service package may fall well 6 WMA JOURNAL

short of the best available in the market and, when set against this benchmark, this may offer poor value for money. By sticking with these arrangements, wealth managers need to question whether they are delivering best value to their investor customers – and truly offering the highest standards of asset protection and operational processing expected from financial regulators. For example, though fund platform providers may claim that they offer high levels of process automation, this may extend little beyond the order routing component. Downstream of the order routing, processing activities may rely on a huge manual paper flow. The post-trade component, including fund settlement and reporting, corporate action processing, the handling of tax vouchers and cash and securities reconciliation, may all be highly manual with large teams of staff in processing centres chasing fax, telephone and email communication across the investment value chain between retail investors and fund management companies. Is it appropriate in 2014 that a wealth manager should be content to receive automated handling of just 20% of the fund transaction life cycle, notably the order routing component? Order routing is a commoditised, plain-vanilla activity in the modern fund processing world and electronic order communication should be viewed as a basic requirement. But, when paying significant amounts for their fund processing (through the bundled fee retained by the fund platform), wealth managers should be pushing for high levels of automation across the fund processing cycle, including the post-trade component. Efficient alternatives are available in the market that will offer high STP rates across these processing segments. For example, Clearstream’s Vestima solution delivers full automation

across order placement, DvP settlement and asset servicing, supporting this activity from the same platform that we use to support customers’ fixed income, equities, warrants and a range of other instrument types. The benefits of this service cannot be expressed simply in terms of cost savings, important though these are. In practice, the risk management benefits may be of even greater significance. When handling large order sizes and large investment portfolios, the risks presented by a failed settlement or a misprocessed corporate action may be extremely large – resulting in late delivery of funds, sizeable claims or even a potential exclusion from the market should you face issues in the CSD. Faced with these risks, it is unthinkable that wealth managers should continue to settle for sub-optimal levels of processing efficiency from their service provider. The same applies to fund custody. Few self-respecting private banks would dream of supporting clients’ fixed income and equity portfolios without issuing a Request for Proposal (RFP) and conducting rigorous due diligence tests to select the best possible provider. And yet, some private www.thewma.co.uk

RDR

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RDR now attempts to move the UK fund market towards fee-based advice banks and wealth managers are happy to offer fund custody themselves – or to avail of fund custody from their platform provider principally because this service is bundled with their wider service package. Time for change Faced with these inefficiencies, it will come as a relief to investors that the UK fund industry is now reaching a crossroads and wealth managers and private banks have strong incentives to change how they meet their fund servicing requirements. Since its introduction on 1 January 2013, the RDR has sought to reshape the relationships between financial service providers, intermediaries and consumers in the UK market. In the past, financial advisers, even those claiming to be independent, www.thewma.co.uk

were paid largely through commissions when they sold a fund provider’s product. In theory, fee-based advice was available, but few members of the public were ready to pay for financial advice. Over time, financial regulators became increasingly uncomfortable with these arrangements, believing this created product bias (financial advisers steered sales towards fund products paying a higher level of commission) and thus poor levels of customer information. To curb this practice, the RDR now attempts to move the UK fund market towards fee-based advice and to eliminate commission-based remuneration to fund advisers. This initiative will likely bring greater transparency to the cost breakdown across the investment process. Fund platform providers will now see a sizeable chunk of revenue disappear that they previously received as a share of the trailer fee paid to the distributor. As this component disappears, platforms will come under pressure to rationalise their processing models and to operate more efficiently. Indeed, they will also have to charge for services which were previously perceived as free. In all likelihood, it will no longer be practical to maintain a sizeable processing centre with hundreds of staff performing highly manual activities. Regulatory push With the Financial Conduct Authority (FCA) monitoring fund processing and asset protection ever more closely, wealth managers are coming under greater pressure to appoint best-in-class fund processing and fund custody to support their clients’ fund assets. These firms are recognising the need to ‘futureproof’ their business. They no longer wish to be exposed to ancient operational models driven by a paper-based workflow that are a millstone to their development, exposing them to significant risk across the post-trade environment. With these dynamics, we are seeing wealth managers and private banks applying greater rigour to the selection and monitoring of their service providers. Some are now recognising the high levels of risk and inefficiency embedded in their existing providers’ custody networks and operational procedures – and they are taking steps to put better arrangements in place. At Clearstream, we recognise that the world will not change overnight. But it is important to alert the industry to the fact that a better solution is out there.

About Clearstream Clearstream is a global leader in post-trade securities services with more than GBP 10 trillion in assets under custody, of which over GBP 1.1 trillion are fund assets. Over 2,500 banks, wealth managers and financial institutions around the world use Clearstream. As a specialised fund-custodian, Clearstream delivers state-of-the-art solutions to standardise investment fund processing and to increase efficiency and safety in the investment fund sector. With more than 125,000 mutual funds and 23,000 hedge funds from 37 fund domiciles, Vestima is the world’s largest cross-border fund processing platform. Through its Vestima platform, Clearstream offers an integrated fund solution that can handle fund transactions and post-trade processing with a high level of automation. Clearstream reconciles with its fund customers on a daily basis as it feels this is crucial to eliminating risk and to ensuring that cash and securities are where Clearstream thinks they are. Fund managers and transfer agents typically hold accounts within Clearstream, so the fund settlement can be managed via an internal DVP settlement, ensuring the transfer of legal ownership and of cash happens simultaneously with cash credited to the seller’s account at 8:00 on settlement day. As an AA-rated bank with a tradition in providing fund custody and asset servicing, Clearstream offers a one-stop shop through which customers can meet all their settlement and asset servicing requirements for multiple instrument types, including fund shares and units, from a centralised platform. Clearstream continues to grow both organically and through strategic acquisitions to extend the range of assets supported by its central processing hub. This is exemplified by Clearstream’s recent agreement to acquire Citco Global Securities Services’ hedge fund custody infrastructure based in Cork, Ireland. This will reinforce its ability to service financial institutions investing in the hedge fund sector.

For more information, please contact Neil Wise, Vice President, Investment Fund Services at Clearstream on neil.wise@clearstream.com WMA JOURNAL 7

OUTSOURCING

If you’re thinking about outsourcing – do it right In a recent survey conducted by Knadel, wealth management firms were asked about their business operating models. It came as no surprise to hear that more and more of you are choosing to outsource business functions, but what was surprising was the extent of the outsourcing that is being undertaken.

he wealth management outsourcing market is still immature: while less than half of the wealth management industry outsource their back office administration, over 70% of institutional asset managers do so. However, when wealth managers do outsource, they tend to outsource more functions, and higher up the value chain – including dealing, execution and elements of client service. There’s nothing wrong in this, in fact, it can bring huge advantages: allowing a firm to focus totally on its core, valueadded activities, without having to gear up resources on administrative tasks. If all of its outsourcing is with a single provider, then the benefits to the firm of an end-to-end process can also mean lower costs and lower operational risk; as well as an opportunity to leverage front office tools already integrated to the service provider’s back office. We admit that, in practice, it’s not always as good as it sounds, but if you are thinking of outsourcing, then how do you go about turning your own business model into a shining example of how it should be done? Learn from the institutional asset management market Institutional managers have been outsourcing their investment back offices in UK since the mid-90s. This is a market that has matured, with a large number of second and third generation deals, where asset managers are transitioning between established suppliers. Wealth managers can learn much from this similar industry sector. As a result of our work across both institutional and wealth sectors, there are five key elements that Knadel see as the things to get right, and right up-front:

Partnership It isn’t just about signing a contract (see later on the regulatory factor). More importantly, it means going in with the right mindset in the first place and making sure that, culturally, the provider is a company you can work with and that their strategic direction aligns to yours. In a partnership it should be a win-win situation, so pinning your service provider to the wall on commercials and service levels will only cause pain and resentment for the future. If your chosen provider can’t manage the service levels that you want day one, consider how you can work together to continuously improve (and benefit) from them over time – tie this into the contract.

Do your homework It always surprises me how little due diligence wealth managers think they can get away with. For sure, you can make some assumptions the service provider can settle a trade, but the skill is to draw out the key differentiators (the things that matter most to you) and the things you think they might not be able to do, in an RFP. Follow this with structured workshops/site visits/ reference visits to thoroughly prove the end-to-end processes. It’s key to understand what the service provider doesn’t do, and where they do it differently to how you would like. It sometimes helps to look at the other clients that the provider is servicing in this context. If they are all advisers and you are a private client investment manager, there will be subtle differences in your requirements. Define the services you think you are engaging the provider for in the contract to a good level of detail.

Adopt not adapt The reason a provider exists, is to do what you are asking them to do, but more efficiently (and better) than you can. The best outcome for them is to have all clients using exactly the same model. While this is not always possible, as a client, you should consider that the more you can www.thewma.co.uk

OUTSOURCING

take a standardised offering, the fewer problems you will have with breaks and errors; getting enhancements to the proposition; and managing the relationship as a strategic partnership. If the supplier can’t do something you want, negotiate it as an enhancement, but as a standard offering that the supplier will leverage across other clients. That way, future upgrades are easier and the supplier benefits from a new or improved offering. It is a negotiation though, so as a client you need to be reasonable about what exactly is ‘standard market practice’. These are non-core activities or else you wouldn’t be outsourcing them. The exception to this rule is in a lift-out situation. A lift-out may mean carrying on with the same model for a time. However, you should still include a plan to standardise onto the provider’s long-term strategic platform.

Plan to exit It’s a partnership not a marriage and though ‘it’s not just for Christmas’, your agreement is unlikely to be for life. At some point you could acquire/be acquired; expand your business proposition; your provider could be giving you bad service; your

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Firms are expected to articulate, demonstrate and document robust oversight and comprehensive contingency plans contract term could be up; or worst case your supplier could fail. You need to plan for how you would exit the relationship and work out the obligations on each side regarding who pays, what needs to be done, and in what time scales for each case.

Govern and oversee The key to a happy relationship with your provider is making sure that both parties communicate well to each other. You haven’t off-loaded responsibility, so put in place a governance process, and retain sufficient skills to ensure that you are still knowledgeable about the functions you are outsourcing to oversee them. Governance should include: day-to-day oversight, monthly reviews, a clear process

for discussing change and a well-defined change management process. All the contracts we work on also include a dispute management process, for issues that cannot be managed under the normal relationship processes. It is beneficial to both parties to have a well-defined, contractual, set of Key Performance Indicators and a Service Level Agreement that dictate how both parties should work together, to what standard, and what the implications are if either party is not performing its obligations properly. Which brings us nicely to your obligations and responsibilities as far as the regulator is concerned… The regulatory factor The institutional assets managers have not yet quite got it all right. Over the past 18 months the FCA has expressed concerns regarding investment firms’ management of their key outsource service providers and the firms’ compliance with the obligations of SYSC 8 in the FCA Handbook, which covers outsourcing. The FCA’s issued a thematic review of outsourcing (TR 13/10), which essentially articulated two key concerns: WMA JOURNAL 9

OUTSOURCING

Firms need to ensure they have these ‘resilience planning’ deliverables in place to meet their obligations where they have a material outsource arrangement: 1. Know Your Outsourcer (KYO) Report

1. Ordinary Course of Business Exit Plan

2. Risk Assessment Report

2. Supplier Failure Exit Plan

3. Governance Framework Reports

3. Standardisation Strategy and Plan

4. Retained Skills Assessments Some of these already look familiar…! Most of these items should fall out of a good selection process, and these will then provide a framework for ongoing reviews.

• Inadequate contingency plans for the failure of a service provider providing critical activities; and • Effectiveness of oversight arrangements for critical activities outsourced to a service provider. To put it simply, while a firm may outsource functions to a third party, it cannot outsource the responsibility for those functions nor its obligations to the regulator and its clients. As a result of the FCA’s report, the Investment Managers Association (IMA), in mid 2013, formed the Outsource Working Group (OWG) – comprised mainly of institutional asset managers – to take the FCA’s concerns and to determine what should be deemed as best practice. The OWG published their Industry Response Principle in December 2013. The FCA was pleased with the level of industry discussion and engagement; it now wants to see the outcome flow into tangible actions and improvements. “Enough talk, time to get on with it.” What does this mean for wealth managers? To date, wealth managers could be forgiven for thinking that the focus of much of the attention from the FCA has been on the institutional asset management industry. However, the regulations equally apply to any investment firm, and wealth managers should expect more focus to be directed towards them in due course. Knadel’s view is that wealth managers are way behind their institutional counterparts in this field. The level of diligence at supplier selection; the protection and flexibility of outsourcing contracts; and the oversight models implemented, are nowhere near what constitutes best 10 WMA JOURNAL

practice in the majority of wealth businesses we have spoken to. But let’s not despair, there are specific actions you can take. We believe that there are seven key types of deliverable that fall out of the SYSC8 regulations, the FCA review and the OWG guidance. These are listed in the table above and, done properly, will meet your obligations where you have a material outsource arrangement In conclusion: Doing it right is all about starting with the contract. The contract sets out your intentions and the minimum requirements for your outsource to work well, on both sides. If you are not yet outsourced or about to change provider then you have a chance to tie-in contractually the resilience planning deliverables, above, and our five key elements for success – and we would strongly recommend you do so. Take advice for this from someone who has good credentials and has done it before if you want to apply best practice. If you have already outsourced we recommend that you start with an initial review of what you already have in each of these seven resilience planning categories against what ‘good practice’ looks like – then you can at least judge where you are. If the regulator comes calling, it’s always better to be seen to be knowledgeable about your compliance (or gaps!) and to have an action plan as proof of your intention to remediate. Finally, be prepared to accept that these things need to be negotiated with your provider, and it takes time to do them well. Gilly Green Wealth Management Practice Leader, Knadel www.thewma.co.uk

RISK

The management of risk Risk is a complex subject. It is not easy to measure. The regulators have shied away from laying down criteria on what constitutes varying levels of risk, let alone setting benchmarks by which risk can be measured. However, it is important to define what is meant by risk in the context of investing, as the client is effectively paying for the management of an agreed level of risk.

ash, for example, is not risk-free. A 5% return on a building society account with inflation at, say 2%, gives a real rate of return of 3%. However, if the rate falls to 4% the real rate of return falls by one third if inflation remains the same. Cash carries a risk. Risk is therefore the chance that expectations won’t be realised, and I use stock market returns as an example. The variability of stock market returns over past years provides a guide to how frequently expectations may not have been met. The greater the variability (deviation) of past returns the more frequent the disappointment. For example, the annual mean real return and standard deviation for equities, gilts and cash for the UK in the period 1900-1999 is shown in the chart below. This shows that historically equity returns are riskier than gilts, which are riskier than cash. But the higher the risk, the greater the potential return. If shorter periods are chosen, the result is similar – over any reasonable period of time – five to ten years is usually accepted by the financial fraternity as ‘reasonable’ – equities have given a higher rate of return than gilts or cash, but for a higher risk of prices falling in the shorter term. So an investor has to make a trade-off between risk and return. This is the reason why a total growth strategy is risky if there is an income requirement. The need for income means that if there is a short term drop

in the market the investments cannot be held for the required period to allow them to recover and therefore the risk is much higher. The risk of investing in an individual equity is magnified to the extent that many factors can affect its performance. There are spectacular instances where companies which have been regarded by investors as ‘low risk’ have failed. However, this risk can be substantially reduced by diversification. For example, a portfolio consisting of just one stock – an ice cream manufacturer – would constitute high risk, as bad weather would mean a loss. However, if the portfolio was equally invested between the ice cream manufacturer and an umbrella manufacturer, it would be of lower risk, as, whatever the weather conditions, a loss on one could be cancelled by a gain on the other. Lowering the risk in an equity portfolio is therefore achieved by diversification. Thus, although investment risk can be reduced by constructing a diversified portfolio it cannot be eliminated. A diversified equity portfolio will still be subject to movement in the economy, political factors, raw material price movements, and so on. A diversified equity portfolio is likely to exhibit the characteristics described above – higher than average returns compared with Gilts and cash over a period of time, but subject to greater volatility of return over a shorter time horizon. The longer the time period, the greater the likelihood there is of out-performance – the shorter the time period (historically up to around five years) the greater the chance of under-performance. Thus, these are the key determinants in setting an investor’s risk profile, and the risk level in a portfolio that the investor is prepared to accept is inextricably linked to the investor’s time horizon. The greater the need for the investor not to be disappointed in terms of performance in a given time-frame, the lower

Annual mean return

Equities 7.8

Standard deviation 20.1

Gilts 2.2 14.6 Cash (Source – Dimson et al 2000) www.thewma.co.uk

1.2

6.6

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Although investment risk can be reduced by constructing a diversified portfolio it cannot be eliminated the risk profile needed from the portfolio. An investor who is entirely dependent on his portfolio for producing the wherewithal to live on for the rest of his life must take a low risk approach, with a higher certainty of generating the income required at the expense of the chance of stronger capital growth. In this situation, the risk-averse investor will sacrifice future potential growth for the certainty of asset protection and predictable income. Thus, in an equity/Gilts/cash context the portfolio would be heavily weighted towards Gilts and possibly quality corporate fixed interest, with a small equity content to provide some longer term protection from inflation. An investor with the certainty of a future asset/ income stream within a reasonable timescale (as in someone able to draw on a pension fund) could afford to have a higher equity content as long as the income requirements were largely met, and that there was not an over-dependence on equity performance to make up any shortfall. The above description covers all aspects of portfolio management, but the theme is the same. The investments – whether they are in shares, structured products, insurance products, or any other form of investments – must be suited to the risk profile of the client. Diversification is essential in order to minimise risk within the portfolio. The more averse the client is to the risk of losing money, the greater the concentration there has to be in Gilts or even cash, as long as the client recognises that neither are likely to provide significant real rates of return over a long period. Mike Jones Chairman, MBA Systems WMA JOURNAL

US TAX

FATCA: 10 issues for WMA member firms The US tax authorities introduced the Foreign Account Tax Compliance Act (FATCA) to get Financial Institutions (FIs) to identify and report on US persons to help ensure they pay the right amount of US tax, particularly where these accounts are held offshore. The UK-US Inter-Governmental Agreement (IGA) helps reduce some of the cost and administrative burden as UK FIs will comply with UK law and report information to HMRC. The UK has signed similar agreements with the Crown Dependencies (Jersey, Guernsey, Isle of Man) and Gibraltar.

Will it affect my firm and our clients? Yes, particularly if you hold US investments on behalf of your clients (regardless of whether they are US resident). But even if you have no US investments, as an FI your firm will need to register with the US Internal Revenue Service (IRS) to obtain a Global Intermediary Identification Number (GIIN). There is no requirement to obtain a GIIN under the UK-Crown Dependencies (CDs)/Gibraltar IGAs.

 22 December 2014 The date by which an FI must obtain a GIIN to avoid any US withholding in 2015.

What if my firm does not register with the IRS? You will be deemed by the IRS to be a ‘non-participating’ FFI. If you have any US assets they could be subject to 30% withholding tax both on income and gross proceeds. This includes not just equities and bonds but other asset classes such as funds.

What are the key dates that firms should be aware of?  1 July 2014: The effective start date of both the UK-US and UK-CDs/Gibraltar Agreements. FIs will need a self-certification in respect of all accounts opened on or after that date (see Q6 below).

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 31 May 2015: The first reports under the UK-US IGA for calendar year 2014 are due and thereafter each year for the previous calendar year. The first reports under the UK-CD/Gibraltar Agreements for 2014 and 2015 are due a year later, by 31 May 2016. But we do not have any US-resident clients The FATCA definition of a US person goes much wider than US residency. For the purposes of FATCA, FIs must check the following for US indicia: (i) Identification of an account holder as a US resident or citizen; (ii) A US place of birth for an account holder; (iii) A US residence address or a US correspondence address (including a US P.O. Box); (iv) A US telephone number; (v) Standing instructions to transfer funds to an account maintained in the US; (vi) An ‘in care of’ address or a ‘hold mail’ www.thewma.co.uk

US TAX

paper record search for pre-existing high value accounts and for the latter there is an ongoing requirement to check with any relationship manager associated with the account. For new individual and entity accounts there is a requirement to obtain some form of self-certification which will enable the FI to determine whether the account holder is resident in the US for tax purposes or is a US citizen or is a CD/Gibraltar person. WMA has produced separate model self-certification forms for individuals, trusts, and entities.

Are there any deadlines as to when I have to check these files? Yes, for pre-existing lower value accounts the FI must complete the review by 30 June 2016. For high value accounts the FI has to complete the review by 30 June 2015. There are also requirements for pre-existing entity accounts.

8 address that is the sole address shown in the FI’s electronically searchable information for the account holder; or (vii) A power of attorney or signatory authority granted to a person with a US address. There are similar but not identical due diligence checks under the UK-CD/Gibraltar Agreements where there is no requirement to check telephone numbers and identification is based on tax residency and not citizenship. This also applies to entities such as trusts, partnerships and companies where FIs will have to check so-called ‘controlling persons’ to ascertain whether they are US Persons or CD or Gibraltar persons. Where the FI provides a discretionary managed service to a trust it will have to obtain information relating to anyone with an interest in the trust. The IGAs have deemed certain retirement accounts or products (including SIPPs) and certain tax-favoured accounts or products (including ISAs) out of scope.

What are the different type of accounts for the purposes of both the UK-US and UK-CDs/Gibraltar Agreements?

www.thewma.co.uk

FIs must distinguish their accounts as follows: • Is the account a pre-existing account (maintained by an FI as of 30 June 2014) or a new account (opened on or after 1 July 2014)? • Is the account an individual or entity account? Trusts for example fit into the definition of an entity account. • Is the account a lower value account or a high value account? For individuals a lower value account is below $1 million while a high value account is above $1 million at 30 June 2014 or at 31 December 2015 or 31 December of any subsequent year. A lower value entity account is less than $250,000 at 30 June 2014 whilst a high value entity account is more than $1 million at 31 December 2015 or 31 December of any subsequent year.

What are the due diligence requirements applying to the different accounts? For pre-existing lower value accounts FIs must undertake an electronic record search for the indicia set out in Q4 above. There may also be a requirement to undertake a

What obligations are there on firms to prove they have done the checks? The idea of a ‘responsible officer’ in the US Regulations has not been directly replicated in the UK-US Agreement but HMRC are considering the requirement for some form of nominated person to whom HMRC or the IRS could address any concerns or queries.

What must FIs do now? Start the checking process for pre-existing clients and ensure accountopening procedures can capture relevant information for new clients.

Where can I get more information? More information on the UK-US and UK-CD/Gibraltar IGAs, including relevant Guidance Notes can be found on the HMRC website www.hmrc.gov.uk/fatca. There is also information available to WMA members on the FATCA page of the website. As well as Q&A the page also includes self-certification forms and due diligence flowcharts in respect of individuals and trusts.

If you have any queries please contact Andy Thompson (andyt@thewma.co.uk) at WMA on 020 7011 9864. WMA JOURNAL

The Wider Share Ownership Council (WSOC) is being formed as an integral part of the The Wealth Management Association (WMA).

@WMA_UK

Wider Share Ownership Council

CORE PURPOSE

Provide a new focus on personal share ownership for all.

Raise the profile of widespread investment in shares

CORE PURPOSE Address issues which have the potential to help or hinder that purpose

MAIN AIMS Build a culture of savings

Wider Share Ownership Council

Increase retail participation in Initial Public Offerings (IPOs)

Champion the investment community and its customers

To become a member of WSOC contact enquiries@wsoc.info

Wider Share Ownership Council

Benefits of WSOC Membership The Wider Share Ownership Council (WSOC), an integral part of Wealth Management Association (WMA), will promote and facilitate personal share ownership. This membership allows firms to participate in the only Association which is fully representative of those firms who act for private investors, charities and trusts and represents market activities for anything non-wholesale. We will support your company by addressing the issues which have the potential to help or hinder personal share ownership, whether economic, fiscal, regulatory, market or operational in character. Attendance at two to three large forums a year at which best practice can be shared, common issues addressed and new initiatives explained. Attendance at an annual gathering of individual personal investors and affiliate members of the Wider Share Ownership Council - where companies can showcase their activities and direct contact can take place. Committal of a significant proportion of affiliate member subscriber fees to raising the profile of personal share ownership, showcasing affiliate members and improving widespread understanding of the benefits it offers: for the community, for businesses, but most of all for personal investors themselves, both by public relations and advertising. A new Wider Share Ownership Council section on the WMA website to provide easy access to useful information, links, supporting documents etcâ&#x20AC;Ś WMA educational materials â&#x20AC;&#x201C; in addition to existing documents such as the Risk Booklet and Boiler Room Information Flyer.

WSOC

The return of Sid and personal share ownership in the UK Many of us will remember the 1980s and the various privatisations that allowed ordinary retail investors to own esteemed companies such as BT, British Gas and British Airways.

ou may also remember the popular ‘Tell Sid’ advertising campaign when British Gas privatised in 1986. While these days Sid may not be as prominent as he once was, share ownership is still a central and important part of promoting a long-term savings culture, and, more widely, growth and enterprise in the UK. The Wider Share Ownership Council is a new initiative from the WMA that has been launched with the aim of encouraging personal share ownership and investing for all. Through the WSOC, we aim to raise the profile of widespread investment in shares and address issues that have the potential to help or hinder that purpose. It is important that retail investors are not drowned out by the voice of institutional investors. Retail investors should be afforded the opportunity to buy shares when any 16 WMA JOURNAL

company goes to market with an Initial Public Offering (IPO). The WSOC will also work to highlight the Alternative Investment Market (AIM) as an important market to retail investors. The most recent figures from the Office for National Statistics (ONS) show that UK individuals directly owned 10.7% of shares traded on the London Stock Exchange in addition to large amounts held for them in pension funds. The WSOC hopes to make people more aware of the opportunities in investing and encourage greater financial education across the UK by ensuring Britons learn from a young age how to look after their money from cradle to grave. Our launch event in June saw over 100 people in attendance at the East Wintergarden in Canary Wharf to hear from keynote speakers Conservative MP, John Redwood and former Director General of the CBI, Lord Digby Jones. Both made passionate cases as to why wider and deeper share ownership is not only good for the individual, but good for the economy as whole.

We must remember that individual investors are typically not speculators, but take a long-term interest in a company’s behaviour, adding an extra layer of accountability. Following the success of last year’s Royal Mail float and the recent surge in companies looking to list, today’s WSOC launch sends out a strong message to a new generation of shareholders. In the heart of the City, home to some of the most powerful institutions in the world, here is an initiative, born to empower the individual investor. The launch was a great success and our key messages were communicated to the diverse audience. The Wider Share Ownership Council was created not only to promote sensible investment in shares, but to ensure investment is not hindered by regulation, operational, fiscal or economic issues. The launch event was a fantastic start to the WSOC, but like all new initiatives, the real work begins now. Tim May Chief Executive, WMA www.thewma.co.uk

TECHNOLOGY

Wealth management technology Where are we and where do we go from here? Introducing the concept of the Wealthstack Technology is part of the job of a wealth manager, and without it we would be lost – even if it doesn’t always seem to be the case. This article will examine what we use technology for and the key issues in the market that are driving change, and suggests a way in which we can all turn technology to our advantage.

he evolution in the use of what used to be called computers – remember them? – in the wealth management industry has grown out of three basic things that we do as a business. We look after clients, we create and maintain accounts for them, and we either enact or help clients to enact transactions on those accounts. These 3 key components – clients, accounts and transactions – form the basis for a number of applications in this industry. They used all to be housed in the ‘back office’, but when the back office systems could not react quickly enough to the need for the type of calculations that portfolio managers required to monitor and rebalance accounts, there grew a need for portfolio or account management systems, which ran on personal computers able to run these calculations quickly. Finally, and in my opinion quite belatedly, we have started to look at clients and to store and analyse the data that we hold on these clients. All of this evolution has been driven by two overlapping factors up until now – the capability of the computing and the regulation that financial institutions are driven by. The WMA lives on regulation, so I will not dwell on that in this article, but focus on technology. However there are now a growing number of additional factors that are driving change. These are: • Client demands – The amount of information available to clients through the growth of the internet has meant that www.thewma.co.uk

the requirement to provide more and more relevant information to clients has grown. Clients are able to scrutinise data better, and are more demanding. There is a concept of the Millennial Generation or Generation Y, who are people who were born with the internet, and cannot imagine anything else. A survey in America found that of that generation, 97% of them own a computer, 94% own a smartphone, 76% use instant messaging and 92% multi-task whilst instant messaging. This Generation Y vision of a good working relationship with their client manager is to logon to their iPad, video conference or chat for real time advice, backed up by accurate and up-to-date information before making a decision and signing off on it and then getting back to their next meeting or their snowboarding. The need for communication is not just restricted to Generation Y, the older generation have not on the whole got their money by luck – they are intelligent and need to engage with a trusted advisor, and have more idea of what a trusted advisor is. • Wealth management is flavour of the month. In any universal bank, the last few decades have been a roller coaster. For many years the growth of the housing market meant that retail banking and lending were the star departments in the bank, and the majority of the spend on IT and resources went in that direction. Then

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Pressure to grow means that organisations are also looking for the new shiny toys and to use technology to their advantage

the trend shifted to investment or casino banking, and the shift in spend went with it. All through this period, wealth management was the poor relation, with very little being spent and there was an attitude of ‘mend and make do’. Today this is different – both retail and investment banking have hit the skids, and many banks are retrenching in these areas. This has meant that wealth has become much more prominent, and the traditional monetary returns – which looked pretty ordinary in the past – are now much more attractive. However the legacy of under-investment is apparent in the industry, and there have been many more multi-million pound transformation projects in this industry in the past 5 years than in any time since Big Bang. • There is an arms race in place as a result of wealth management being the flavour of the month, with many organisations recognising that profitability comes with size. This has led to a lot of M&A activity, and this in turn has led previously inert organisations to reviewing their technology. Pressure to grow means that organisations are also looking for the new shiny toys and to use technology to their advantage. It has also meant that there is a vast number of new entrants – both in the traditional way – a client manager leaves a big corporate with all his clients and sets up a boutique – but also the big supermarket or insurance brands wanting to get some of the action. Some of the technology barriers to entry that were around before have been broken down, and I shall explore what those are later in the article. Focusing on technology for any period of time is difficult since the pace of change is extremely rapid. What is also apparent is that the tools and the ease in which new applications can be created using these tools mean that there are many areas where buyers need to beware. WMA JOURNAL

TECHNOLOGY

The growth of the internet, the rise of apps and the advent of data mining tools mean that previously opaque systems and processes are being exposed, and in the cruel light of day are being found wanting. Clients want to get access to data because they can for every other aspect of their lives – travel, restaurants, banking and books are all industries that have been changed by the internet. You can also get access to data that has been hidden in systems by the use of data mining and discovery tools. At the same time, the amount of data generated has increased exponentially and the ability for people to make sense out of data becomes harder. Some of these new technologies have led to new entrants who have seen how they can leapfrog their competition. An example is the new online propositions such as Nutmeg which uses the internet to capture client details and sell them a discretionary product without ever meeting them. A recent PWC report indicated that the D2C market grew by 30% last year. There are a number of new technologies that will help wealth managers create new propositions or enhance existing ones. These digitally-enabled propositions include self18 WMA JOURNAL

service – i.e. getting clients to do some of the processing that you currently do such as maintaining their own records – and utilising rich media such as videos or data visualisation to drive clients towards communities. The creation and maintenance of communities is going to be key to the attractiveness of the firm to the individual. Peer-to-peer validation such as TripAdvisor is very important to the new generation of user. This used to be done face-to-face, perhaps down the golf club and now this technology is how you recreate the chumminess of a golf club online. Vanguard in the US has created a wealth management community using Facebook of over 50,000 people. However, in a regulated environment, this community building is difficult to do on

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There are a number of new technologies that will help wealth managers create new propositions

open platforms such as Twitter or Facebook. This is where come of the new breed of software such as corporate social platforms comes in. These corporate social platforms allow the wealth managers to create walled gardens where they can converse with their clients, segment those clients, or allow the same clients to self-segment. It meets the current need to check with clients on a regular basis and this client communication channel is compliant, analysable and invaluable for wealth managers. The power of the internet also means that the traditional ‘quant’ who sits in the back room surrounded by research and printouts can now be replaced by algorithms. Algorithms are programs that are looking out for conditions and monitored variables to fall within particular parameters and apply some form of action. We have always had limit orders – this is taking limit orders to the point of tracing correlation across a series of factors and placing trades accordingly. The ability for machines to show these correlations and patterns in pictures – known as data visualisation also means that these previously impermeable insights are available to all. These techniques can be used www.thewma.co.uk

TECHNOLOGY

to monitor portfolios over a wide range. Many wealth managers could supervise a large number of client enhanced portfolios through such technology only having to intervene when there are exceptions. As I described earlier, in the core of wealth management we need to focus on client, accounts and transactions and this has led to systems providers who focus primarily on each of these areas – client management is usually referred to as CRM, account management is portfolio management and transactions are usually processed by a back office system. What has also happened in the past few years is that many of the suppliers from each of these ‘heartlands’ have tried to expand into each of the other areas, with the universal result that they have create integrated yet mediocre systems in areas which are not their area of expertise. Those that have stuck to their expertise however have then had to integrate their systems – usually with antiquated inflexible systems that were not built with integration in mind. There is a time lag with all of this. The old back office legacy systems were built as specialist systems, front office systems were www.thewma.co.uk

built to compensate and were based on PC technology, and when the technology matured to allow for the internet they all tried to bolt on functionality. My suggestion is that they ‘stick to their knitting’ and integrate. This has proved a problem in the past, but now the move towards a common interfacing approach has meant that that is not the issue it used to be. This integration also needs to encompass the new trend of technology – the predilection in the manufacturers of hand held devices to create every size of machine from 3 inches wide to 15 inches wide – which in turn makes it very hard for the creators of software to get it right. There are platforms that are referred to as portals which give software providers a framework in which to publish their programs. I am seeing that in this market there is an emerging shift towards the concept of best of breed, with powerful integration between the systems using standard web services technology, and infrastructure. What does that mean for the wealth management industry? It means that as long as the companies agree on a common mechanism for exchanging data, Wealth Management companies can

benefit from the excellence that the specialist companies in each of the ‘heartlands’ bring to the party. I would characterise this as being a Wealthstack. This is in contrast to the trend of creating monolithic ‘fully integrated’ offerings in the market. In software terms, big is not better – since it creates too many interdependencies which means that there is uncertainty as to where errors are in the programs since the number of places it could be are legion. This leads to contingent testing over long periods of time. Many of the monolithic program manufacturers think little of asking their clients to spend 2-3 months testing the software in user acceptance testing every time there is an upgrade. The Wealthstack approach is that where components change, they are tested as sub-units, and as such the errors can be easily traced. The key components of the Wealthstack are the core components of CRM, Portfolio Management and Books and records or IBOR. But it should also be seen as encompassing portal technology, client communication through corporate social platforms, the use of data visualisation in the depiction of patterns in data, the ability to mine data to establish these patterns to assist with operations and fraud, the interaction with multiple channels to create a seamless customer experience, the introduction of data feeds to let clients make more informed decisions and plan their future. I anticipate this list will grow, but with the overriding view that integration and program to program communication is key. The Wealthstack allows software companies to provide strength in their specialist area – which could include CRM, portfolio management and back office as well as the more specialist areas such as tax, risk, reporting, management information and so on with the comfort of knowing that integration to each other is a given, and that the hardware and operating environment is the same. In many companies this is increasingly becoming a Microsoft stack. I will be exploring the Wealthstack in a series of seminars being held in association with the WMA. These start on the 26th June with demonstrations of the new technologies, including corporate social platforms and data visualisation. Please see the WMA Members’ Website area for more details.

Steve D’Souza Managing Director, Sales Kinetics WMA JOURNAL

Governance and culture

The FCA: changing governance and culture The financial crisis, scandals and bank failures highlighted the relationship between governance and culture. Senior management will set remuneration and incentive schemes, dictate the firm’s vision and strategy, support the control functions and punish transgressions. The tone at the top trickles down an organisation. Effective governance is likely to create a positive culture within a firm. Ineffective governance will create the opposite.

he Financial Conduct Authority (FCA) has been tackling the issue of changing governance and culture within financial institutions. It wants to hold senior management to account and ensure consumers are protected from exploitation and detriment. The FCA is creating this shift through: (i) the Senior Persons Regime; (ii) the ‘conduct risk’ agenda; and (iii) use of behavioural economics. Senior Persons Regime The most direct way the FCA is addressing governance is through changes to legislation and regulation. The Financial Services (Banking Reform) Act 2013 (‘Banking Reform Act’) will introduce a strengthened regime for regulating senior individuals within banks, replacing the current Approved Persons Regime. The new Senior Persons Regime will reverse the burden of proof whereby, provided certain conditions are met, the FCA will be able to take action against a senior person unless that person can demonstrate that he or she took all reasonable steps to mitigate the effects of a specified failing. This is a significant change and will make it easier for the FCA to take action against senior persons within banks. If the burden is upon senior persons to satisfy the FCA they took ‘reasonable steps, then decision making may be taken with an eye to future FCA action. It is likely that senior persons will expect decision making to be meticulously discussed and documented by the bank’s board, external advisors and other stakeholders to evidence a ‘reasonable’ approach. 20 WMA JOURNAL

The Banking Reform Act will also require senior persons to issue a ‘statement of responsibilities’ which will provide details of activities within the firm the senior person is responsible for. Firms will need to update the statement of responsibilities on a regular basis. Should a senior person leave the firm the FCA will require a handover certificate detailing how responsibilities will be met and if they should be made aware of any issues. This will enable the FCA to understand which senior person it needs to hold to account should a problem occur within an organisation As part of its move towards ensuring effective governance and accountability, the FCA has increased its use of attestations as a supervisory tool to hold senior persons to account. Senior persons are being asked to attest on the effectiveness of a particular control or arrangement (such as management of conflicts of interest) or attest that a particular action has been satisfactorily completed. Should a problem arise, the FCA can hold the signatory personally responsible. The impact of an attestation being provided at board level has inevitably been felt throughout the control functions. Before any senior person signs an attestation they must have confidence in their Chief Risk Officer, Chief Compliance Officer and compliance team, who must be well trained, qualified and skilled to undertake the necessary work to provide senior management with the reassurance to sign. Senior management will therefore need to understand and support the role of their control functions including providing sufficient resource and funding. This is likely to create a change in priorities for senior management as they spend increasing amounts of their time dealing with risk and compliance matters. Conduct risk The FCA’s conduct risk agenda is taking shape and is concerned with the extent to which a firm ensures its clients and market integrity is at the centre of way it conducts business. In its Business Plan and Risk Outlook, the FCA identified several conduct risk issues which will be the subject of regulatory scrutiny. It will likely conduct

thematic reviews into certain areas and use its supervisory role to create a consumer focused culture within firms. The FCA identified conflicts of interest as a source of conduct risk. Conflicts of interest can undermine market integrity and competition and cause harm to consumers. The FCA wants to ensure that firms have clear rules in place to manage conflicts, especially within the asset and wealth management sector. The FCA has specifically stated that it will assess how wealth managers and private banks control the conflicts of interest that arise when client assets are invested in in-house investments. The FCA will assess the effectiveness of controls on the identification and management of conflicts of interest, with a focus on information flows. The FCA’s scrutiny upon this sector continues following

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The FCA has increased the use of attestations as a supervisory tool its paper on dealing commissions. The FCA has also stated it will look at the agency duties of asset managers and assess whether they are acting properly and taking account of investor interests. Part of this review may look at effective management and governance and whether controls properly identify and mitigate risks. It is also likely that the FCA will want firms to demonstrate that a client’s investment strategy has been identified, is being followed and fulfilled. This will necessarily include evidencing a client’s instructions and risk appetite, as well as the nature of a firm’s relationship with third parties as it pertains to a client’s investment objectives. Pay and incentives play an important role in driving a firm’s culture. There is often a strong connection between a firm’s incentivisation arrangements and the delivery of positive www.thewma.co.uk

Governance and culture

outcomes to consumers. Mis-selling scandals, such as PPI, usually have an element of ‘sales incentivisation’, whereby there is a disproportionate weight attributed to products sold, irrespective of whether the product is beneficial to, or required by the purchaser. The FCA will consider these payment structures and look to senior management to ensure incentivisation schemes are not leading to poor customer outcomes. The incentivisation and remuneration debate applies equally to the pay of senior management. The FCA introduced Remuneration Codes in response to the financial crisis which are designed to ensure pay practices do not encourage inappropriate risk taking and are consistent with sound risk management. The Codes also import deferred bonus payments and restrictions upon guaranteed payments. Behavioural economics The FCA has stated its use of behavioural economics as a way of understanding consumer decision making and to review the way a firm designs its products, promotional material and advises consumers. Behavioural economics suggests consumers are not rational, logical market participants but subject to behavioural biases which influence preferences, beliefs and decision making. Biases can lead to misjudgement which can cause individuals to make mistakes when selecting financial products, even though they are in possession of disclosed information that should enable good, informed choices. The FCA has identified several examples of biases upon consumer purchases. An individual may seek to avoid regret by purchasing a type of insurance he does not need. A consumer may borrow excessively to purchase products without considering their ability to repay the loan. Consumers do not tend to change their existing products such as current accounts. Firms can exploit this consumer bias by charging higher fees or not improving the product, knowing they will not lose consumers or market share. Firms can take advantage by framing their promotional material to appeal to biases. Behavioural economic research has identified certain biases affecting an individual’s beliefs which impact decision making. Consumers are often overconfident in their own decision making ability which may lead to over trading by certain clients. Over confidence is likely to affect investment decisions and cause clients to take undue www.thewma.co.uk

risk or fail to properly diversify their portfolio. The research suggests that clients will recall an investment loss more than an investment gain, placing undue emphasis on the former. This may dictate their reaction to future losses, including the length of time they hold a loss making position. Firms may want to use behavioural economics as an opportunity to better understand their clients. If advisors are able to understand these biases, they may be better able to question the client, better identify his attitude to risk and reward and better understand his investment objectives. This is likely to improve the overall relationship between the client, firm and advisor. Conclusion These are just some of the methods the FCA has adopted to change culture and governance of regulated firms. To some extent, it is succeeding. It considers behavioural economics to be a ‘game changer’ 1 and this has already informed the way the FCA communicates with its regulated firms and consumers. The FCA’s ‘conduct risk’ agenda has generated much debate within regulated firms as management try to understand how it applies to their firm and customers and embed conduct risk within their organisation. The Banking Reform Act will impose additional powers upon the FCA, enabling them to better understand and monitor banks and senior persons. It is likely the scope of the new Senior Persons Regime will be extended to apply to all senior persons within FCA regulated firms. The FCA will closely monitor the impact of these changes over this year and next. It will have succeeded in its aims if it perceives a positive shift in culture and governance amongst its regulated entities. However, it is likely we will soon see robust enforcement action. There is no better way for the FCA to demonstrate its commitment to tackling poor culture and governance than to prohibit senior individuals that fail in their duties towards clients or fine firms which cause significant consumer detriment. Jagdev Kenth Director of Risk & Regulatory Strategy Financial Institutions Group Willis Limited 1 Speech by Martin Wheatley, Chief Executive, the FCA, at the Australian Securities and Investments Commission (ASIC), entitled ‘Making competition king – the rise of behavioural economics at the FCA’, dated 25 March 2014.

POLICY STATEMENT

The WMA Policy Statement EU 2014-2019 WMA’s position on EU retail financial services policy and legislation for the next legislative mandate promotes retail and wholesale differentiation, consumer protection and addressing retail consumer issues.

MA believes that EU retail financial services policy and legislation in the next legislative mandate should: 1. Differentiate clearly between retail and wholesale markets; 2. Promote high standards and principles of consumer protection across the EU; and 3. Recognise the unique role of each member state in addressing retail consumer issues. The European Commission’s Financial Services Action Plan (FSAP) of 1999 (unchanged since) set out the key objectives for the EU internal market in financial services: • To create a single EU wholesale market; • To achieve open and secure retail markets; and • To create state-of-the-art prudential rules and structures of supervision. This formalised the creation of a single market and rule book for wholesale financial services. It also recognised that retail financial services are predominantly local, confined within national boundaries, and not susceptible to such an approach. Legislation since then has not followed this dual guideline. The European Commission and Parliament have not differentiated between wholesale and retail financial markets, but legislated on the basis of a single internal market for both. www.thewma.co.uk

The WMA now calls on European institutions to: Differentiate between wholesale and retail financial markets when legislating.

1 2

Conduct a comprehensive review of retail consumer protection in EU financial services and set a framework of Common Principles or ethics based on best practice.

Complete a cumulative impact assessment of the financial legislation enacted during the 2009-2014 Parliament and ensure all Member States appropriately implement it, rather than making new proposals to cover for poor implementation.

Differentiate between wholesale and retail financial markets when legislating Retail and wholesale financial markets differ and require a different regulatory approach at EU level. Retail markets are predominantly local and vary in their structure along national boundaries. Consumers tend to purchase retail financial services from local advisers and may establish long-standing and trusted relationships with them. One result of such strong local ties is that companies find it difficult to develop large numbers of retail customers in other countries. Instead they tend to establish branches and then focus on building local markets and competing with domestic companies on a local basis. In the EU the national framing of retail financial markets means that they vary by member state in size, structure and common practices. Consumers buy financial products depending on the member state in which they are based. These will be different in kind and source from products in other member states. Wholesale markets, by contrast, are defined by their international nature. The absence of a significant cross-border element in retail financial services raises a question about whether a single EU market in such services is achievable or desirable. We strongly believe, on the basis of considerable experience, that the retail financial services sector is best handled by national regulators familiar with the domestic context. But we acknowledge that the quality of service provided to the consumer WMA JOURNAL 23

POLICY STATEMENT

can always be improved across the EU as a whole. The WMA strongly believes that EU legislation and regulation which seeks to harmonise a single market for all financial services should recognise and allow for differences between wholesale and retail financial markets, and between investment cultures in different member states.

Employ Directives not Regulations in the production of retail financial services law, thus allowing a role for national Parliaments and bringing the control of consumer protection closer to the people and markets which they serve In the UK and Ireland, firms offering retail financial services range from the wealth management arms of investment banks through to small retail brokers employing under five staff; and offering a variety of bespoke services from full discretionary management through advice to executiononly dealing. Almost all of these firms do not manufacture financial products and survey the wider market for appropriate investments. This market structure is very different from the bancassurance model prevalent in continental Europe. European authorities need to recognise these differences when proposing EU-wide legislation and not impose one-sizefits-all solutions that cannot embrace the divergence of business models across the EU. This suggests that Directives are more suited than Regulations to implementing EU retail market legislation. Their requirement for EU legislation to be brought into effect in member states by national Parliaments with local regulatory input tends to ensure that interpretations are in line with domestic market practice and consumer knowledge. The resulting rules make sense to market participants and carry local credibility. This is unlike Regulations, which may direct local supervisors in ways that conflict with, or in language that is not commensurate with, local rules. This leaves supervisors and firms uncertain about what they are supposed to comply with. 24 WMA JOURNAL

The national focus of retail markets also makes the process of implementing Regulations less meaningful. The rules giving effect to them are written for the whole EU by the relevant European Supervisory Authority (ESA), and are implemented by national supervisors under ESA oversight. National implementing rules are not written. So there is no concession to local variations of the kind described in this paper. The outcome can be a difficult mismatch between what is required on the ground and what has been brought into being higher up. This magnifies the distance of the regulatory authority from the retail markets being supervised, increases a sense of disconnection, and reduces regulatory accountability and transparency. We believe the retail system should be rebalanced towards the national level, using EU legislation only on points of principle as a framework for local legislation and regulation. Supervisors should remain close to the retail markets they supervise and should be in a position to make the rules for them and the consumers that they serve. The WMA proposes that the European Commission use Directives for retail markets legislation, rather than Regulations; define rigorous and harmonised EU-wide principles for consumer protection for these markets; and allow for differences in market form and investment culture in and between Member States.

Conduct a comprehensive review of retail consumer protection in EU financial services and set a framework of Common Principles or ethics based on best practice Retail market practices continue to differ widely throughout the EU in spite of a large and increasing volume of pan-EU legislation. This shows the strength of their inherently local and heterogeneous nature. Consumers continue to show very little appetite to purchase products or seek advice across borders, despite encouragement to the contrary. So as argued above, retail market structures and practices should be

regulated at the national level. But there are nevertheless common principles which apply everywhere to consumer protection. These should be elaborated into an EU code of practice which would provide on an EU-wide basis the ethical content so necessary to appropriate behaviour by authorised firms and individuals in the retail space. A well-drafted code of this kind could help to eliminate, throughout the EU, unethical practices such as cold calling with their attendant high risks of consumer detriment. The WMA believes that the European Commission and Parliament can add value by conducting a comprehensive study of consumer protection standards relating specifically to the sale and purchase of financial products across Europe with a view to establishing an EU-wide set of Common Principles or ethical code of best practice.

Complete a cumulative impact assessment of the financial legislation implemented during the 2009-2014 Parliament and ensure all Member States appropriately implement it, rather than making new proposals to cover for poor implementation The past five years has seen a high volume of new legislation that has fundamentally altered the retail financial services landscape. For example, EMIR has altered the OTC derivative markets and the role of clearing houses, CRD IV/CRR have upgraded and changed the prudential position of banks and investment firms and affected their remuneration policies and regulatory reporting, MiFID will affect market structures and increase consumer protection by requiring advisers to limit and disclose potential conflicts of interest, PRIIPs will improve and standardise the quality of information provided to consumers purchasing packaged retail investment products, MAD/MAR has extended and altered the anti-market abuse landscape for many member states, and other legislature such as the AIFMD and UCITS V will increase transparency and consumer protection for investors in alternative funds and UCITS. www.thewma.co.uk

POLICY STATEMENT

These are important, sizeable and overlapping reforms whose true market impact will not be known until they are fully implemented across all Member States. This will take some years, particularly since part of their overall effect will lie in the interactions between them. We will only know what this is, and where further work may be necessary to augment, revise or reduce the level and type of regulation achieved, by careful monitoring over a period of time. The WMA strongly recommends that the Commission assess the effect on the retail financial services market of the relevant legislation enacted in 2009-2014. This should cover the economic and market impact, the state of implementation in each Member State and how legislative interaction works out. The outcome should provide a basis for future policy and legislation.

Renew their commitment to the Financial Services Action Plan by launching a revised such Plan that respects different national characteristics of retail markets and promotes high standards of consumer protection in financial services across the EU Given the significant changes to EU financial services architecture, markets, practices and products across all sectors since the European Commission (EC) introduced the first Financial Services Action Plan (FSAP) in 1999, the WMA believes that the new mandate period from 2014- 2019 provides the opportunity for EU authorities, notably the EC, to revisit the FSAP and launch a renewed and revised version: FSAP II. This would symbolise the renewed commitment of the authorities to the integrity and success of the EU financial services sector with its attendant benefits of economic growth, employment, EU competitiveness in global markets, and contribution to the EU tax base. The retail financial services chapter should prioritise: • Differentiation from EU wholesale markets; • Promotion of high standards of consumer protection in EU financial services; and www.thewma.co.uk

• Respect for the different national characteristics of EU member states; It might also feature the education of EU consumers as a key long term priority, beyond the 5-year mandate just beginning, to assist them to take informed decisions on managing their general finances, savings, and investments. The WMA strongly recommends that these objectives be met through legislative and non-legislative actions by relevant EU authorities in the coming mandate period.

Summary of recommendations

• Differentiate between wholesale and retail financial markets when legislating. • Employ Directives not Regulations in the production of retail financial services law, thus allowing a role for national Parliaments and bringing the control of consumer protection closer to the people and markets which they serve. • Conduct a comprehensive review of retail consumer protection in EU financial services and set a framework of Common Principles or ethics based on best practice. • Complete a cumulative impact assessment of the financial legislation enacted during the 2009-2014 Parliament and ensure all Member States appropriately implement it, rather than making new proposals to cover for poor implementation. • Renew their commitment to the Financial Services Action Plan by launching a revised such Plan that respects different national characteristics of retail markets and promotes high standards of consumer protection in financial services across the EU.

security

As the digital world advances so does the risk of cyber attacks We are seeing more and more cyber training centres opening in the UK to help educate individuals about cyber risk, this recognise the need for all businesses including wealth and asset management companies to consider the impact of cyber attacks in their business. Who would of thought 10 years ago there would ever be a need for such training facilities in the UK?

built up company reputation and customer confidence over a long period of time, these types of leaks can damage your reputation within hours, swift action and a carefully managed PR response is needed to regain client trust.  Financial crisis – Third parties who have to compensate their own customers may claim for compensation, while business out of action profits can be lost.

What should you do? Internet threats are a challenge to wealth management businesses, it is important to start thinking about the use of digital technology within your own businesses and ensure adequate security processes are in place. As cyber threats continue to emerge, your existing security capabilities should be reviewed and upgraded or transformed to manage cyber threats. Another area to consider is reviewing your existing insurance policy, many firms will purely rely on their Professional Indemnity (PI) insurance product however, it should be warned these offer minimal protection compared to a true cyber insurance product. Many PI polices will not cover you for losses such as damages to your hardware and software or notification costs – these are costs involved for a consultant to advise whether you need to notify individuals and the costs associated with doing so. Whereas under a cyber product the exposures are broken down into two key areas 1. First party and 2. Third party (costs incurred by third parties for whom you are liable for following a cyber ‘incident’).

ith more and more customers buying or servicing their products online, many businesses are embracing digital technology to either reduce operating costs or improve customer experiences with clients. With these improved digital developments come an over expanding array of complex financial exposures for wealth managers which makes it increasingly important to take steps to mitigate these risks from your business. What are the threats? Many wealth management businesses work with highly sensitive information, most importantly client data, which is why it makes these businesses so attractive to criminal hackers. Many firms may believe they are too small to attract the notice of cyber criminals, whereas, in fact, it’s the complete opposite! The view is that hackers actually tend to target smaller firms, believing their processes and security is more relaxed. The Federation of Small Businesses revealed that 54% of UK businesses have fallen victim to online crime in the last 12 months. Threats represented by cyber include:  Data leaks – Digital data is lost or leaked from company system; it could be data loss from PC, Laptop, mobile device or tablet.  IT crisis – IT department need to deal with problems whilst maintaining businesses as usual, understanding how data was lost or taken, can they contain the leak?  Reputational crisis – News of data leaks travel fast especially with increased use of social media, many wealth managers have 26 WMA JOURNAL

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Security capabilities should be reviewed and upgraded or transformed to manage cyber threats

First party  Hardware cover Physical loss or damage to computer hardware.  Business income and extra expense In the event of a cyber incident this cover ensures the business can survive the impact of the loss of business income as a direct result of IT system failure.  Crisis management and notification costs Costs incurred in the event of the need to appoint a forensic expert to understand loss of data and impact on individuals concerned – that all comes at a cost.  Data cover Cover includes cost to reinstate data following a breach or unauthorised access. Third party  Privacy breach Liability arising from such breaches.  Virus transmission Transmission of a virus to third party which results in triggering damages to their IT systems. With the average cost of the worst security breaches for small organisations between £35,000 and £ 65,000, all companies, large or small, should start to take the threat of cyber attacks seriously. Lark Group Limited specialises in providing financial institutions insurance advice and are an affinity member of the Wealth Management Association. Contact Martin Camp, Financial Institutions Division at Lark (Group) Limited, on 020 7543 2806 or email: martin.camp@larkinsurance.co.uk for further information, or a review of your insurance policy. Alternatively, please visit www.larkinsurance.co.uk/ financial-institutions www.thewma.co.uk

The Wealth Management Association Annual Conference 2014 6th October – Mansion House This event provides an excellent opportunity to hear directly from a diverse array of thought provoking speakers. Already in place are: Lord Digby Jones, Tom Griffin, Elissa Bayer, Nicola Horlick, John Baron MP, Des Benjamin, Lara Wardle and Jo Causon

A must-attend event One of the greatest areas of opportunity for wealth firms is that of developing client relationships. With so much change having occurred post-crisis, we must ensure we take whatever steps are necessary to learn as much as possible about how people cope with change and how this has impacted their own personal development and indirectly the firms they have worked for. Observing people’s experiences therefore can assist us all in seeing change from different perspectives. Change is, of course, the essential dynamic of any positive management situation as without it there would be no need for management, in its place would come stasis and inevitable entropy. This year we are working with a specialist in the field of change from the perspective of observing how extraordinary people help organisations and individuals harness the possibilities that change brings with it. Throughout the conference day we are aiming to create a unique opportunity to immerse attendees in the heart of ‘change’ itself and from that perspective explore a selected range of issues that are a key influence on all our activities. In summary, this will help us all see that change is in fact a choice and viewed as such, myriad opportunities become available.

The Conference Agenda – why you need to be here… We know that the behaviours and actions of staff within businesses can have a long-term impact on the business and sometimes such impacts are quite damaging. We also know that the corporate risk appetite remains high in that major change aspects such as mergers and acquisitions remain in-vogue with the last two years encompassing the largest number of such consolidations that the wealth sector has seen for over 20 years. At this year’s conference, we are providing an environment where you can reflect on the approaches and behaviours of people that have come from ordinary backgrounds but have in their own lives created extraordinary outcomes, ensuring change has been managed rather than left alone to affect them. We have a diverse range of speakers across politicians, one of which is an expert on investment trusts; an industry specialist; a specialist on the discipline of customer service; a business specialist who built a very successful group via a large number of mergers and acquisitions over a period of 12 years; a specialist in the area of philanthropy and, in a world where women in business are achieving greater focus, we have a panel session of business women that will explore not only their individual experiences but also the issue of how to promote more women in business.

Who should attend? The content of this dynamic conference will appeal to a broad section of the wealth management industry – from the most senior figures in the sector through to middle managers and rising junior staff members. Whether you work for the largest multinational company or a boutique firm, you will be challenged and inspired through your attendance. What’s in it for me? • 5 hours of CPD • An opportunity to hear about developments in the wealth management sector • A chance to hear the thoughts of some high calibre, high-profile speakers • A platform for networking with senior industry professionals throughout an enjoyable and informative day Legacy In addition to WMA representing a community of shared interest, we are an aggregator and disseminator of the issues, opportunities and actions that enable the wealth management sector to dynamically prosper from the challenges of a constantly and vigorously changing environment.

Book now – places filling fast… Register online at: www.thewma.co.uk/members/events/wma-events/wma-annual-conference-2014 or email your reservation to events@thewma.co.uk

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