1. Misleading Statements on the Investment Firms Websites

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1 Circular addressed to Investment Services Licence Holders in terms of Part B1 of the Investment Services Rules for Investment Services Providers [ the Rules ] Conduct Supervisory Unit Thematic Review on the documentation and the processes resorted to assess appropriateness and suitability of financial instruments provided and investment services being offered to retail clients Reference is made to the Thematic Review conducted by the Malta Financial Services Authority ( MFSA or the Authority ), through the Conduct Supervisory Unit ( CSU ) within the investment services sector. This Thematic review is based on the Rulebook applicable at the time the onsite inspections have been conducted, i.e. Part B1 of the Investment Services Rules for Investment Services Providers. During the last quarter of 2016 and the year ending 2017, CSU conducted focused onsite inspections at a number of Investment Firms (also hereinafter referred to as Firms or Licence Holders ). A broad range of Licence Holders varying in size, type and business models were selected in order to obtain a representative picture of the sector as a whole. The objective of the onsite inspections was to review the relevant documentation (including the Client Fact Find) utilised by Firms in order to assess whether the client related information being collected enables the proper assessment of the appropriateness and suitability of financial instruments and investment services being offered to retail clients. During the referred on-site inspections, the MFSA officials also obtained an insight into an array of business models and obtained a better understanding of the type of financial instruments being offered to clients. For the avoidance of doubt, the scope of the Authority s inspection was not to assess whether Licence Holders have provided financial instruments and / or investment services that were appropriate and/or suitable for the individual clients needs. The purpose of this circular is to inform the industry about the common key findings of this Thematic Review in order to encourage Licence Holders to take corrective action in order to comply with regulatory and compliance standards. Firms that were covered by the Thematic Review have received, or will be receiving, a post inspection letter detailing specific issues and findings that are relevant to such Firms for specific action or follow up at their end. In the meantime, all Firms that offer financial instruments and investment services to retail clients are encouraged to consider carefully the key findings set out below and undertake an assessment of their current position vis a vis these findings, and to ensure that any remedial action is taken in a timely manner. Page 1 of 8

2 Key Findings 1. Misleading Statements on the Investment Firms Websites It was noted that the websites of a number of Firms featured statements and disclosures which were deemed to be misleading to investors and prospective clients. By way of example, there were instances wherein Firms websites gave the impression that a broader cross section of investors were being catered for by the Firms, whereas in actual fact Firms were only targeting a more restricted niche market. Moreover some Firms were marketing a number of services which did not accurately reflect their licensable activities. Firms are encouraged to ensure that their websites portray, at all times, correct and accurate information. The Authority recommends that Firms websites are subject to the scrutiny of their Compliance Officers in order to ensure that the information presented to investors and potential investors is not misleading. 2. Training of Key Officials The Authority is concerned to note that a number of approved personnel were not adequately familiar with the Rules and guidelines (as issued by ESMA), relevant to their duties. It is of utmost importance that all approved officials are well-versed with relevant regulations and legislation, in particular with the forthcoming conduct obligations as set out in MiFID II Directive (as transposed in the Conduct of Business Rulebook) as well as the applicable ESMA guidelines. In this regard, it is expected that key personnel (including the Compliance Officers) attend training in order to familiarise themselves with the regulatory challenges presented by MiFID II and to keep up-to-date with all changes in the industry that would impact their day-to-day duties. Page 2 of 8

3 3. Issues encountered when reviewing Client Related Documentation As part of the review of the Client Fact Find and other client related documentation, the Authority noted a number of common observations as set out below. I. Integration of the Confidential Client Fact Find It has been noted that certain Licence Holders use separate Confidential Client Fact Finds when carrying out the suitability test and the appropriateness test. The Authority highly recommends that the Client Fact Find should be in the form of a single integrated document which would allow the client facing official to collect client information in accordance with the features of the financial instrument and the investment service(s) provided. Furthermore we expect Firms to retain the Client Fact Find in the form of a live document which can be adapted according to the type of asset class and investment service as provided to the client. II. Omissions of required information From our findings, it resulted that certain Confidential Client Fact Finds failed to include the extent of one s financial commitments, as per SLC 2.18 of the Rules and also failed to capture the Financial Experience and Knowledge of the potential client as required in SLCs 2.22 of the Rules; and From a desk-based review of documentation provided by Licence Holders in connection with the Thematic review, it appears that certain documentation failed to provide the necessary warnings to make it clear that potential clients will not be provided with the service where such clients did not provide the required information. III. Declarations By way of general comment, the Authority considers that it is inappropriate for clients to be required to sign declarations confirming that they have not been provided with investment advice (in cases where no such advice was requested). It is the duty of the Firm s Approved Personnel to ensure that they have not made any personal recommendations in situations where this was not required or requested by clients. Accordingly, the responsibility of such declarations should be shouldered by the Firm and not by clients. Moreover, Firms are expected to keep copies of the relative declarations in clients files and provide a copy thereof to them. Page 3 of 8

4 IV. Incorrect referencing to the Rules The Authority notes that certain client related documentation cited incorrect Rules and made reference to incorrect terminologies. By way of example, certain client documentation interchangeably used Reception and Transmission of Orders instead of Execution-only. Moreover, we observed that client document referred to the MFSA Consumer Complaints Manager, irrespective of the fact that the Office of the Arbiter for Financial Services had in the meantime been established. Firms are being requested to review their existing client documentation in order to ensure that such incorrect terminology is avoided. As a general comment, the Authority expects all Licence Holders to undertake a review of all client files and related Client fact Find documentation of all active clients, in order to ensure the accuracy of information. V. Self-assessment approach The Authority observed that in certain instances, clients were being requested to compile the client data within the Client Fact Find. This approach is not deemed acceptable as clients would be carrying out a self-assessment exercise. This kind of approach is deemed to be even more detrimental when advisory services are being provided. In this respect, Firms should not place reliance on clients self-assessment in relation to the assessment of knowledge, experience and financial situation. Thus, the Firm is expected to take reasonable steps to ensure that the information collected about clients is reliable and is properly assessed VI. Updating of client information We have also observed that a number of Firms do not have a procedure in place to remind advisors to obtain an update with regards to the clients changing circumstances (if relevant). It is advisable that Firms maintain adequate and updated client information in order to be able to perform the required suitability assessment as reflected in Guideline 6 emanating from ESMA s guidelines on certain aspects of the MiFID suitability requirements. The Authority suggests that, in such cases, a procedure is set up to enquire whether clients circumstances have changed and to ensure that the respective Client Fact Find is updated in a timely manner, rather than leaving it up to the client to communicate any major change. Firms are also required to establish appropriate procedures in order to maintain adequate and updated information about its client base. Page 4 of 8

5 VII. Execution-only business and related forms In a number of instances, Firms were compiling the full Confidential Client Fact Find in order to record execution-only transactions and at times even conducted the appropriateness test. Generally the full Confidential Client Fact Find would not feature the conditions as established in SLC 2.25 of the Rules and would contain client information which would not be required for the purpose of execution-only transactions. Furthermore the Authority is of the view that the completion of the full Confidential Client Fact Find by the retail client can be misleading to investors. Firms are therefore urged to refrain from using the full Confidential Client Fact Find for the provision of execution-only service. On the other hand, Firms are required to have in place specific documentation designed to cater for the execution-only service, in accordance with SLC 2.25 of the Rules. Furthermore, execution-only services should be provided at the client s initiative and not upon receiving a recommendation from the Firm s Approved Personnel. A service can be considered to be provided at the client s initiative if the client demands it on the basis of any communication featuring a promotion or offer of financial instruments made by any means that by its very nature is general and addressed to the public or to a larger group or category of clients or potential clients. Firms are urged to take note of this requirement. Firms should in general acquire a better understanding of non-advisory services and should therefore ensure that they fully understand the instances where the corresponding appropriateness test would need to be carried out. The Authority expects that the Firm s officials better understand which documentation would need to be completed when offering investment services to clients. The Authority reminds Licence Holders that it does not approve the Firms Confidential Client Fact Find document, the clients Terms of Business and any amendments made thereto. The onus of ensuring that such documents are in line with the relevant rules rests with the Compliance Officer and the Board of Directors of the Licence Holder. Page 5 of 8

6 4. Compliance issues MFSA Officials assessed the compliance aspect of the Firms business by conducting a review of the Procedures manual and related documentation as well as by interviewing the Compliance Officer. The main deficiencies observed were the following: I. Online systems We have noted that a number of Firms have set up an online systems /trading interfaces and all advisory and non-advisory investment services are being executed online. We came across instances where the Compliance Officers did not have access to such systems and were therefore unable to conduct all the necessary compliance related checks. In accordance with paragraph 49 of the ESMA Guidelines on certain aspects of the MiFID compliance function requirements, the Compliance Officer should have access to all relevant information, databases and relevant information systems to be in a position to better review the operations of the Company at any point in time. II. Time dedicated towards the supervision of MiFID related services In certain instances we observed that the Compliance Function was not dedicating enough time to fulfil duties related to the effective supervision of MIFID activities. The Authority is expecting Compliance Officers to dedicate sufficient time in order to be able to follow up closely the Firm s business operations from a conduct of business perspective and to be in a position to carry out all the necessary compliance related checks and raise the necessary reports. III. Compliance Monitoring Programme The Compliance Officer is expected to implement a formalised Compliance Monitoring Programme. Within this context, it is strongly recommended that the Compliance Officer considers the ESMA Guidelines on certain aspects of the MiFID compliance function requirements (hereinafter referred to as the ESMA Compliance Guidelines), within the context of monitoring work and reporting obligations of the compliance function. In accordance with paragraph 18 of the ESMA Compliance Guidelines, the Company should ensure that the compliance function establishes a monitoring programme which takes into consideration all areas of the Firm s investments services and activities. This monitoring programme should also establish priorities determined by the compliance risk assessment ensuring that compliance risk is well monitored. Page 6 of 8

7 IV. Lack of Investment Strategy Awareness We observed a lack of awareness amongst Compliance Officers of the type of financial instruments making up the Firm s White List of Investments. This may be attributed to the fact that Compliance Officers are not made aware of the outcome of decision-making meetings regarding the Investment Strategy of the Firm. In the light of this the Authority recommends that the Compliance Officer should attend meetings in which decisions are being taken in order to ensure awareness of the latest strategic and investment decisions, whilst enhancing awareness and familiarity of the financial instruments being utilised by the Licence Holder. 5. Complexity of Financial Instruments During the on-site inspections, MFSA Officials performed various walkthroughs of the investment services processes which are resorted to by Firms when compiling the white list of financial instruments. The main deficiencies noted are the following: I. Classification of financial instruments In certain instances, the financial instruments making up the White List of investments were not clearly classified as either complex or non-complex financial instruments, in accordance with: [i] the ESMA opinion on MiFID practices for firms selling complex products and [ii] the CESR Q&A on MiFID complex and non-complex financial instruments for the purposes of the Directive s appropriateness requirements. In the light of this, we expect that the Compliance Function undertakes all relevant checks and classifies financial instruments as featuring in the White List of investments as either complex or non-complex financial instruments. In the same context, the Firms White List should also identify those financial instruments which fall under the BRRD regime. II. Collection of in-depth client information Firms should consider collecting more in-depth information about the clients when advising them to purchase complex financial instruments, including bail-in financial instruments. In this respect, the ESMA statement regarding MiFID practices for firms selling financial instruments subject to BRRD resolution regime provides further details on the extent of indepth client information which needs to be collected. Licence Holders are also urged to consider the Authority s circular dated 14 th June 2016 titled Circular addressed to Investment Firms and Credit Institutions when selling bail-in securities which includes Questions and Answers covering the salient issues of Statement issued by ESMA on MiFID practices for firms selling financial instruments subject to the BRRD resolution regime. Page 7 of 8

8 Conclusion We trust that the contents of this circular will help investment firms to identify any shortcomings and to take the appropriate remedial action. We are available to assist as necessary to ensure that all investment firms adhere to the applicable requirements. Any queries are to be directed to the undersigned, Mr. Simon Bonett Ms. Sara Antonia Magri and Ms. Charlene Musu Dr. Michelle Mizzi Buontempo Director Conduct Supervisory Unit Communications Unit Malta Financial Services Authority 29 December 2017 Page 8 of 8