The FCA flexes its PROD muscles and stores up future trouble for investment distributors

22 August 2019

In a supervisory notice dated 2 August 2019, the Financial Conduct Authority (FCA) imposed requirements on the terms of the Part 4A permission held by SVS Securities (SVS), an advisory stockbroking and online share dealing firm.

The requirements comprised a long list of actions to be taken within three days by SVS to preserve client money and client assets, and to prevent new business being conducted by SVS. On 5 August 2019 SVS went into administration, at which point the FCA published its supervisory notice.

The supervisory notice provides a public example of the FCA’s approach to its Product Intervention and Product Governance sourcebook (PROD), informed by work done by four separate arms of the FCA: its Supervision Department, Client Assets Resolution Department, Enforcement Division and Regulatory Decisions Committee. The PROD sourcebook came into effect as part of the main block of MiFID II reforms in January 2018. Only 20 days after PROD took effect, the FCA wrote to SVS “setting out its concerns over the lack of due diligence, high concentration and liquidity risk in relation to bonds issued by a company called Corporate Finance Bonds Limited (CFBL).”

The FCA’s supervision team interviewed the CEO of SVS and a portfolio manager and concluded they had little detailed data regarding the book of loans underlying CFBL bonds or habits of monitoring the performance of the bonds. They relied on assurances from CFBL. The supervisory notice cites PROD 3.3.1R as requiring a distributor (SVS in the FCA’s opinion being a distributor) to:

  • understand the financial instruments its distributes to clients;
  • assess the compatibility of the financial instruments with its clients’ needs;
  • take into account the manufacturer’s identified target market of end clients; and
  • distribute only when this is in the best interests of the client.

Despite SVS claiming that the bonds were strong performers, the FCA concluded that the documents it examined, following a visit to SVS, indicated otherwise: too much exposure to a set of unknown borrowers and related factors such as their creditworthiness, their potential to pay the high interest rates demanded by CFBL or to pay back the amount lent. The FCA observes that all this information is needed to assess the bonds for compliance with PROD 3.3.3R which requires an assessment that any investment product must be distributed in accordance with the needs, characteristics and objectives of its target market. The FCA did not indicate which client segment(s) it would consider to comprise the “target market”. Given the high upfront fees (in the order of 20% of the amount placed) being charged by SVS for placing clients in to CFBL bonds, it might have been helpful for the FCA to say that it could not see any properly constituted target market.

Who were SVS’s clients for these bond investments? Individual pension pots seem to be the answer. The FCA considers that about 90% of clients of SVS’s discretionary fund management business had received pension switching or pension transfer advice (but not from SVS as its Part 4A permission does not extend to pensions advice). The FCA sees the CFBL bonds as incompatible with the needs, characteristics and objectives of those clients, and that it was incumbent on SVS to have made this incompatibility determination (PROD 3.3.15R(3)). Picking up a point about distribution chains which is likely to be a big theme in future cases, the FCA notes that SVS appeared to have relied upon assessments carried out by each end client’s financial adviser (wrongly, because SVS should have done its own assessments, according to the FCA). In fact, credit is given by the FCA in its findings to an unnamed SIPP trustee who asked SVS for the information from CFBL that SVS had not previously requested.

Although the supervisory notice does not draw this point out in any form of overall reflection or analysis, the picture that is painted is one where an IFA might give a personal recommendation of an investment to a client but the distributor through whom the product may be obtained is required by PROD to undertake a second assessment and, in effect, second guess or at least question the IFA’s conclusion (and by inference the IFA’s skill sets and professionalism) in order for the distributor to demonstrate its compliance with applicable PROD rules. Any constructive collaboration in the distribution chain that may have helped oil the wheels in the past will have to be replaced by cold-headed analysis with a view to protecting one’s own interests as a regulated firm.