We expect that the ESMA guidelines for the assessment of knowledge and competence will become rule requirements starting from 3 January 2018, as part of the overall MiFID II regulations.
While only 12 pages in length, the paper outlines what Paradigm considers to be a ‘step change’ in the way advisers and staff within a firm demonstrate and evidence their competence to undertake their role.
The purpose of the guidelines is to specify the criteria for the assessment of knowledge and competence required under Article 25 (10 of MiFID II) in accordance with Article 25 (9) of the same directive.
ESMA expects these guidelines to promote greater convergence in the knowledge and competence of staff providing investment advice or information about financial instruments, structured deposits, investment services or ancillary services to clients. ESMA also expects competent authorities to assess the adequacy of the compliance with such requirements.
These guidelines set important standards to assist firms in meeting their obligations to act in the best interest of their clients and to assists Competent Authorities (CAs) to adequately assess how firms meet these obligations.
Guidelines (general)
The level and intensity of knowledge and competence expected for those providing investment advice should be of a higher standard than those that only give information on investments and products.
Firms should document staff roles and responsibilities and evaluate staff performance against set criteria contained within the description of responsibilities. This could include:
- Monitoring admin staff for the accuracy of information given to clients
- Monitoring advisers for suitability report accuracy
Firms should ensure that staff know, understand and apply firm’s internal policies and procedures designed to ensure compliance with MiFID II. In order to ensure a proportionate application of knowledge and competence requirements, firms should ensure that staff have the necessary levels of knowledge and competence to fulfill their obligations, reflecting the scope and degree of the relevant services provided.
In terms of relevant services, Paradigm is taking this to mean the overall service provided to the client, including (but not exclusive to) the use of a platform and on-going investment advice services. Meaning a member of staff included within the rules would require the knowledge of how a platform would operate and be used to deliver the end service to the client. Or how the on-going advice processes operate within a firm, how this is monitored and what it delivers to the firm’s clients.
Supervisors are deemed competent to perform their roles (we believe that this will mean firms will need to establish and document set supervisory criteria).
In order to assist firms ESMA has issued two sets of guidance. The first is for staff giving information and the second, for staff giving investment advice, as shown below.
Guidelines: criteria for knowledge and competence for staff giving information about investment products, investment services or ancillary services
Firms should ensure that staff giving information about investment products, investment services or ancillary services that are available through the firm have the necessary knowledge and competence to:
- Understand the key characteristics, risk and features of those investment products available through the firm, including any general tax implications and costs to be incurred by the client in the context of transactions. Particular care should be taken when giving information with respect to products characterised by higher levels of complexity;
- Understand the total amount of costs and charges to be incurred by the client in the context of transactions in an investment product, or investment services or ancillary services;
- Understand the characteristics and scope of investment services or ancillary services;
- Understand how financial markets function and how they affect the value and pricing of investment products on which they provide information to clients;
- Understand the impact of economic figures, national/regional/global events on markets and on the value of investment products on which they provide information;
- Understand the difference between past performance and future performance scenarios as well as the limits of predictive forecasting;
- Understand issues relating to market abuse and anti-money laundering;
- Assess data relevant to the investment products on which they provide information to clients such as Key Investor Information Documents, prospectuses, financial statements, or financial data;
- Understand specific market structures for the investment products on which they provide information to clients and, where relevant, their trading venues or the existence of any secondary markets;
- Have a basic knowledge of valuation principles for the type of investment products in relation to which the information is provided.
Guidelines: criteria for knowledge and competence for staff giving investment advice
Firms should ensure that staff giving investment advice have the necessary knowledge and competence to:
- Understand the key characteristics, risk and features of the investment products being offered or recommended, including any general tax implications to be incurred by the client in the context of transactions. Particular care should be taken when providing advice with respect to products characterised by higher levels of complexity;
- Understand the total costs and charges to be incurred by the client in the context of the type of investment product being offered or recommended and the costs related to the provision of the advice and any other related services being provided;
- Fulfill the obligations required by firms in relation the suitability requirements including the obligations as set out in the Guidelines on certain aspects of the MiFID suitability requirements;
- Understand how the type of investment product provided by the firm may not be suitable for the client, having assessed the relevant information provided by the client against potential changes that may have occurred since the relevant information was gathered;
This is an issue that Paradigm has covered many times at best practice events. Particularly where a firm has a CIP in place, it is important to establish suitability and where the CIP may not be right for the client, will the adviser offer an ‘off CIP’ solution or refuse to deal with the client? Obviously regardless of whether a CIP is in place or not, where the firm does not offer the right solution for a particular client need, for example, it cannot offer advice on Long Term Care, the client may be referred elsewhere.
(Paradigm would suggest a register is kept of instances where clients are referred or no advice is offered).
- Understand how financial markets function and how they affect the value and pricing investment products offered or recommended to clients;
- Understand the impact of economic figures, national/regional/global events on markets and on the value of investment products being offered or recommended to clients;
- Understand the difference between past performance and future performance scenarios as well as the limits of predictive forecasting;
- Understand issues relating to market abuse and anti-money laundering
- Assess data relevant to the type investment products offered or recommended to clients such as Key Investor Information Documents, prospectuses, financial statements, or financial date;
- Understand specific market structures for the type investment products offered or recommended to clients and where relevant their trading venues or the existence of any secondary markets;
- Have a basic knowledge of valuation principals for the type of investment products offered or recommended to clients;
- Understand the fundamentals of managing a portfolio, including being able to understand the implications of diversification regarding individual investment alternatives.
The paper goes on to give examples of circumstances where a member of staff would not fall within the scope of the guidelines:
- Employees only pointing out where clients can find information;
- Employees distributing brochures and leaflets to clients without giving additional information with regards to its content or providing any follow up investment services to those clients;
- Employees who only hand over information such as KIID at the client’s request without giving any additional information with regards to its content or providing any follow up investment services to those clients and;
- Employees who perform back-office functions and do not have direct contact with the clients.
As seen from the list above many more staff within a firm’s practice will fall under these new rules and firms will need to start to think now about which members of staff will have to be brought under a firm’s Training and Competence (T&C) plan.
We suggest that as a starting point, firms will want to review or issue the job descriptions for every member of staff within the firm, to bench mark their day-to-day activities against the criteria above and ensure that where appropriate, the member of staff is brought into the T&C plan.
The new rules go on to outline the firm’s responsibilities under the new regulations:
- Firms should note the distinction between staff providing information and staff providing financial advice.
- Firms should adopt a code of ethics to set forth the standards of business conduct and behaviour necessary for the proper provision of relevant services and obtain written acknowledgements from staff that they have read, understood and are willing to comply with it.
- Firms should provide mandatory training to staff in the features and characteristics, including potential risks, of the products they offer. This would incorporate training about any new products offered by the firm.
- Firms should ensure staff are familiar with the situations in which conflicts of interest arise and how to apply the rules regarding the management of conflicts of interest.
- Firms should ensure staff are familiar with the situations as to when a firm may pay or receive an inducement and the relevant legal requirements regulating inducements.
We believe that having identified which members of staff are to be included in the firms’ T&C plan, these new regulations will require firms to adopt a more structured and intrusive T&C regime to include firm specific training and testing. This firm specific testing will apply to all staff caught by the T&C plan and would include assessment of the member of staff’s knowledge on:
- Investment services provided by the firm (including the price structure for initial and on-going advice and any transactional advice)
- The target audience for the firms’ CIP (if applicable) and which clients would not be suitable for the firms’ CIP (including the procedures to provide advice outside or “off” CIP and/ or the referral process, or indeed the ‘refusal to provide advice’ process)
- The firm’s internal systems and control processes (including inducement and conflict of interest policy)
- When a member of staff would be deemed competent to perform their duties and when a referral to another member of staff would be required (for example where a non-advising member of staff realises that they should stop an activity as by continuing in the activity, the client may perceive that they are receiving investment advice).
The new rules go on further to outline exactly the monitoring activity that firms will need to undertake of those staff who provide advice:
A firm must regularly monitor staff giving advice in order that they can demonstrate the adviser’s
- Ability to ask appropriate questions to the client to understand his/ her investment objectives, financial situation and knowledge and experience;
- Ability to explain the risks and rewards of a particular product or strategy to the client;
- Ability to compare selected products with regards to terms and risks, to be able to select the product best suited to the client profile
Finally, firms are required to communicate publicly, in a way that is consistent and meaningful to clients, their criteria for demonstrating how staff comply with these guidelines. A programme of Continuous Professional Development (CPD) will be required to be undertaken by staff and on-going assessment will contain updated material and will test staff on their knowledge of, for example, regulatory changes and new products and services available on the market.