Complaints Handling

UK Financial Regulation
CeFA and CeMAP Module 1

Certificate in Regulated
Complaints Handling (CeRCH)
2013/14
These learning materials are up-to-date for examinations

from 1 October 2013.
The Institute of Financial Services may, from time-to-time, make

additional amendments to these learning materials. The latest
amendments can be located with the PDFs of this manual within
www.myifslearning.com.
It is your responsibility to ensure that you have the
up-to-date learning materials for your examination.
ISBN 978-1-84516-985-5
9 781845 169855
CeFA and CeMAP Module 1
Certificate in Regulated
Complaints Handling (CeRCH)
2013/14
David Brighouse
2013/14 update
by
Charlotte Mannouris
The Institute of Financial Services is a division of the ifs School of Finance, a registered charity incorporated by Royal Charter.
Published by the Institute of Financial Services, a division of the ifs School of Finance, a registered charity
incorporated by Royal Charter.
The Institute of Financial Services believes that the sources of information upon which the book is based
are reliable and has made every effort to ensure the complete accuracy of the text. However, neither the
Institute, the author nor any contributor can accept any legal responsibility whatsoever for consequences
that may arise from any errors or omissions or any opinion or advice given.
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ifs School of Finance 2013
ISBN 978-1-84516-985-5
Module 1 Contents
Introduction to UK Financial Regulation

learning materials
VII
Essential information
IX
Overview context and relevance to CeFA and CeMAP

Study guidance and assessment preparation
Syllabus
Unit 1
XXIII
XXXV
XLVII
Introduction to the Financial Services

Environment and Products
Section 1 The UK financial services industry
[1] 1
[1] 3
Section 2 Financial assets
[1] 67
Section 3 Financial products
[1] 99
Section 4 The financial planning and advice process
[1] 181
Section 5 The main areas of financial advice
[1] 201
Section 6 Basic legal concepts relevant to financial services [1] 221
UK financial regulation
Unit 2
UK Financial Services and Regulation
Section 1 The Financial Conduct Authority
[2] 1
[2] 3
Section 2 Money laundering
[2] 77
Section 3 Complaints and compensation
[2] 93
Section 4 Data protection
[2] 109
Section 5 Other laws and regulations relevant to

advising clients
[2] 119
Index
VI
Ind 1
Introduction to UK Financial Regulation

Units 1 and 2
Introduction to UK Financial Regulation learning

materials
UK Financial Regulation focuses on the financial services environment and the
regulation surrounding the provision of financial services.
Although the module is entitled UK Financial Regulation, in reality its scope is
much broader than that, beginning with a look at the finance industry generally
and at the range of products available, as well as the regulatory regime under
which financial institutions operate.
UK Financial Regulation forms a common initial module for two Institute of
Financial Services qualifications: the Certificate for Financial Advisers (CeFA)
and the Certificate in Mortgage Advice and Practice (CeMAP). UK Financial
Regulation is also a core module within the Institutes Customer Service
Professional (CSP) qualification and forms part of the Certificate in Regulated
Complaints Handling (CeRCH).
Because it is a common module for the CeFA and CeMAP, UK Financial
Regulation introduces a number of topics particularly in relation to products
that will be dealt with in more detail in later modules of CeFA and CeMAP
as appropriate. For this reason, we recommend that UK Financial Regulation is
studied first, regardless of whether you intend to follow CeFA or CeMAP
route to achieving your qualification.
This introduction comprises three parts as follows:
1)
Essential information: to introduce you to the rules and regulations

relating to your course of study. It provides advice on how to access the
learning support available to you as well as updates to your learning
VII
materials. This part also explains the additional learning materials available
and how they can be best used in conjunction with one another to aid
your studies.
2)
Module 1 overview context and relevance: explains the context

and relevance of the UK Financial Regulation syllabus to the CeFA and
CeMAP qualifications and, in particular, how this module will be of
benefit to you when practicing in the financial services industry.
3)
Study guidance and assessment preparation: describes how the

study manual is structured, explains how you will be assessed and
provides practical tips on how to approach your studies and examination.
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Essential information
The structure of CeFA and CeMAP

This study manual provides the subject knowledge relevant to the
examinations for module 1 of the CeFA and CeMAP qualifications. All our
study materials for CeFA and CeMAP underwent extensive revision
following the consultation and review of exams in this area carried out under
the auspices of the Financial Sector Skills Council of the Financial Services
Authority during 2003 and 2004. This manual is relevant to examinations
undertaken from 1 October 2013.
Module 1 is common to both qualifications, as well as the Institute of Financial
Services Customer Service Professional Qualification. Whether you intend to
complete CeFA or CeMAP, the study materials for subsequent modules are
specific to one qualification only. If you follow CeFA there are three further
examinations and with CeMAP a further two. You will receive study material
specific to each one upon registration.
The modules are divided into units as follows.
Module 1 (common module for CeFA and CeMAP)
Unit 1 Introduction to Financial Services Environment and Products
Unit 2 UK Financial Services and Regulation
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CeMAP Module 2 Mortgages

Unit 3 Mortgage Law, Policy, Practice and Markets
Unit 4 Mortgage Applications
Unit 5 Mortgage Payment Methods and Products
Unit 6 Mortgage Arrears and Post Completion
CeMAP Synoptic exam (case study based)
CeFA Module 2 Investment and Risks
Unit 3 Principles of Investment
Unit 4 Investment Products
CeFA Module 3 Retirement Planning and Protection
Unit 5 Protection
Unit 6 Retirement Planning
CeFA Synoptic Exam (case study based)
Certificate in Regulated Complaints Handling (CeRCH)

UK Financial Regulation is a compulsory module for the Certificate in
Regulated Complaints Handling qualification. To achieve the CeRCH
qualification, students must complete UK Financial Regulation plus the
following two modules:
t
Regulated Customer Care
Regulated Complaints Handling.
Further information can be found at http://www.ifslearning.ac.uk.
Introduction to CeFA and CeMAP Module 1
Policies and procedures

For the policies and procedures governing the conduct of the examinations
please refer to the Institute of Financial Services website:
www.ifslearning.ac.uk.
Syllabus
The syllabus for this module is printed within the study text at page XLVII. Please
ensure you familiarise yourself with it. Although the Institute has determined the
number of units and modules required to complete our qualification, the topics
and learning outcomes are the result of the consultation process embarked
upon by the FSA and the Skills Council. Therefore, while in keeping with other
awarding bodies we have had input into the review process, the Institute is not
solely responsible for determining the full range of topics that appear in the
syllabus.
Materials are designed by the Institute to support learners in their studies and,
as such, they cover the requirements set out in the syllabus for the subject you
are studying. All examination and specimen questions are based on, and
referenced to, the content of the syllabus and the learning outcomes detailed
therein. It is therefore very important that you fully familiarise yourself with
the content of the syllabus for this module/unit, both at the outset of your
preparation and as a reference point as you progress towards attempting an
examination. You can access the syllabus from a number of different sources. It
is printed in full at the front of the learning materials, or can be obtained on
request from the Institute FE Customer and Student Enquiries Team on +44(0)
1227 818609 (option 1). Please make sure you have access to a syllabus as you
begin to work towards the examination.
XI
How to use this manual

This study manual is a self-contained distance learning text. This means that it is
up to you when, where and at what pace you study in order to prepare for your
exam. The content is based exclusively around the syllabus for this Module. You
will notice that the content is clearly divided between Units 1 and 2.
Upon registering for this module you will also have been granted access to
these same materials on the Internet. By entering your login details at the
appropriate prompt within myifslearning.com you can access this manual in
.pdf format. You can read and print the files if you wish. Although you
can print out pages please note that the materials should not be
copied or transmitted onward as this constitutes a breach of
copyright.
There is no guarantee that every single topic will be covered in the questions
that arise when you take the exam. However, all the questions that will appear
in your exam are based on the content of this manual. There is nothing in the
study manual that you should consider irrelevant, however familiar you already
are with the topic. It is not intended that the study manual provides you with
verbatim answers to every question. However, it does provide subject
knowledge across the entire syllabus.
We have structured the study materials in such a way as to help you break the
topics down into a manageable size and to understand how the various
technical aspects apply in practice.
Important note
You are not expected to memorise specific case law names and dates, or
current tax or national insurance rates and allowances. A list of appropriate tax
and national insurance rates and allowances, etc, will be made available at the
examination itself.
XII
Updates
The syllabuses and study materials for CeFA and CeMAP are updated
annually, with updated materials being published in July for examinations taken
from the following September. For 2013/14 there is no standalone update for
each module to be used alongside the existing edition of the text. Instead, the
new edition indicates in the margin where a change has been made.
Amendments to the text are the result of changes to the syllabus and the
Chancellors last Budget.
Materials are designed by the Institute of Financial Services to support learners
in their studies and as such they have been prepared to cover the requirements
set out in the syllabus for the subject you are studying. The questions in
examinations are based upon the content and learning outcomes documented
in the syllabus. All questions, live and specimen, are references to the syllabus.
It is therefore very important that you fully familiarise yourself with the
content of the syllabus for this module/unit, both at the outset of your
preparation for an assessment and as a reference point as you progress
towards attempting a test. To help you in this, a syllabus has been made easy to
access from a number of different sources. It is printed in full at the front of
the learning materials on page XLVII, or obtained on request from the Institute
FE Customer and Student Enquiries Team on +44(0) 1227 818609 (option 1).
Please make sure you have access to a syllabus as you begin to work towards
the examination.
It is your responsibility to ensure that you have the up-to-date

learning materials for your examination.
XIII
The ConservativeLiberal Democrat coalition government has made
fundamental changes to the system of financial regulation in the UK. The
changes are detailed in the Financial Services Act 2012, which focuses on
changing the structure and delivery of regulation within the financial services
sector. The Financial Services Act came into effect from 1 April 2013.
The headline points are as follows.
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The tripartite system of regulation, introduced by the Labour

government in 1997, comprising the Bank of England, the Financial
Services Authority and the Treasury, is discontinued.
The FSA has been abolished.
Three new bodies have been created: the Financial Policy Committee
(FPC) within the Bank of England and the Prudential Regulation
Authority (PRA) will be a subsidiary of the Bank of England. Both have
powers relating to the regulation of financial services. A further body,
the Financial Conduct Authority, has been created.
There is an independent complaints system with a single complaints

system operating across the FCA and PRA.
The Bank of England

The Bank is responsible for protecting and enhancing financial stability. The
Chancellor of the Exchequer has limited statutory power to issue directions
to the Bank of England at times of financial stress. It is also responsible for the
oversight of payment systems, settlement systems and clearing houses.
The Financial Policy Committee (FPC)
The FPC, established at the Bank of England, has overall responsibility for
macroprudential regulation of financial services. It is charged with identifying,
monitoring and taking action to reduce and prevent systemic (large-scale)
issues that could threaten the whole of or large parts of the economy or
financial markets.
The FPC is chaired by the Governor of the Bank of England and is accountable
to Parliament.
The FPC has no direct regulatory responsibility for particular types of regulated
firm but has a number of powers to remedy threats to systemic stability.
An interim FPC was created in February 2011 in order to carry out
preparatory work for the establishment of the permanent body.
The remit of the FPC also includes the investigation of systemic risk, even if
the risk originates outside the UK.
The Prudential Regulation Authority (PRA)
The PRA is a subsidiary of the Bank of England, and it has a general objective to
promote the safety and soundness of individual firms in the financial services
sector. It is responsible for microprudential supervision of individual firms that are
systemically important; this includes banks, insurers and some investment firms.
It will aim to ensure that firms carry out their business in a way that minimises
the risk of business failure and will also aim to minimise the adverse effects of
any failure on the UK economy as a whole.
The PRA is independent from the Bank of England and FPC with regard to dayto-day regulation.
The board of the PRA has the Governor of the Bank of England as Chairman.
XV
The Financial Conduct Authority

The FCA took over most of the FSAs former roles and responsibilities,
notably the FSAs market conduct function (with the exception of
responsibility for systemically important infrastructure, which sits with the
Bank of England). The FCA is responsible for conduct of business regulation
across the financial services sector including;
t
those businesses regulated by the PRA in relation to prudential

matters;
prudential regulation of those firms not regulated by the PRA.
Key responsibilities include the protection of consumers and ensuring those

within the financial services sector comply with the relevant rules.
The FCA has a strategic objective to ensure that relevant markets function
well.
The FCA has the following operational objectives:
t
to provide appropriate protection for consumers;
to protect and enhance the integrity of the UK financial system;
to promote effective competition in the interests of consumers.
The FCA and PRA can create threshold condition codes and vary firms
permissions on their own initiative. It is intended that the threshold codes will
be stronger than the statutory guidance previously given by the FSA.
Notes for students
Please note that all Institute of Financial Services assessments in the area of
regulation are based on fact and standing legislation. Students will not,
therefore, be assessed on aspects of regulation that are not confirmed by
underpinning legislation.
The Institute will publish updates to its learning materials for key regulatory
issues and will advise students, in a reasonable timeframe, of the dates when
this content will be assessed.
XVI
Support services
In addition to the study manual you also have access to the following services.
Our website www.ifslearning.ac.uk for all general enquiries and update
information on the qualification structure.
The FE Customer and Student Enquiries team is available to assist in helping
candidates who need further information and guidance. To ensure that your
query is fully understood and dealt with appropriately, we strongly encourage
you to contact us in writing, by fax or email.
To contact FE Customer and Student Enquiries:
Tel: 01227 818609
Email: customerservices@ifslearning.ac.uk
Fax: 01227 784331
Examinations
To book examinations the hotline number is 0870 6081915.
Please note that if you are re-sitting an exam you will first need to register
your re-sit with the Institute of Financial Services: this can be done by
contacting Institute FE Customer and Student Enquiries on 01227 818609
(option 1).
Examination Results Analysis Sheet

On completion of the examination, candidates will receive their Examination
Results Analysis Sheet. This will contain their details and mark. Candidates
will also find a list of the syllabus areas they may have answered
incorrectly. References to the study manuals are not provided. The list
is designed to assist candidates to identify any gaps in their knowledge and to
steer them towards the areas to revisit before attempting the examination
again.
XVII
A sample analysis sheet is provided below.
XVIII
Additional support
The following are available at additional cost to enhance your prospects of
passing the examinations. These are NOT intended to be used as a
replacement for the study manual, but are designed to assist your
study and revision. Many financial services companies subscribe to some or
all of these products, so it is advisable for you to check with whoever handles
your companys training needs to establish whether they currently have access
to these products. Otherwise please direct your queries to our main
FE Customer and Student Services number 01227 818609 (option 1).
Specimen papers available for each unit and module in printed form.These
mirror the live exam for style, coverage of learning outcomes, etc. Each is
supplied with a full list of answers and justifications.
Revision notes summary versions of the study manuals that serve as a
quick reference to all the main topics within the syllabus.
Online Subject Expert Support an online forum to which subscribers
can post technical and study-related queries relevant to the syllabus. A subject
XIX
matter expert with experience in training students for CeFA and CeMAP
examinations will post a reply. You can also use this service to communicate
with others studying your module.
Competence Development Tool this popular eLearning tool features
complete specimen question banks for every module with feedback linking
every question to the study text. It is updated every year in line with the
syllabus. There are separate editions for CeFA and CeMAP. The CDT is
available online, providing subscribers with 12 months access to the most up
to date edition, including any update that occurs during the subscription
period. In addition, all subscribers receive the current CD Rom version.
Study Guide Sometimes, you may need more than just a simple definition,
especially when studying some of the more detailed subjects, or topics that are
completely new to you.You might, for example, be studying Financial Products
(UK Financial Regulation, Unit 1, Section 3), which describes the various types
of investments on the market, some of which share the same characteristics.
You may feel that you need an alternative way of learning their various features
to help you understand and remember the differences between them.
Or you might be reading about a more unfamiliar topic, such as Capital
Adequacy, mentioned earlier, and feel that you will benefit from an alternative
description that helps to put the subject into context and demonstrate its
relevance to you as a mortgage or financial adviser.
These are examples of when you will find the Study Guide useful as it
translates some of the trickier subjects into plain, easy-to-understand language.
The Study Guide is an online workbook that, when used in conjunction with
the manual, will break up the monotony of just reading and making notes, and
will give you a range of examples and case studies to guide you through the
syllabus.
It provides some useful tips on how to remember certain facts, and includes
some questions and exercises that will test your understanding. It will also give
you an idea of how the questions on a particular subject might present
themselves in the exam.
An exam question on taxation, for example, may require that you do a
calculation, whereas for other topics you might be asked to select a sentence
that best describes a product, or a rule, or an organisation, etc. Some questions
ask you if a statement is true or false, others ask you to select the correct
answer from a choice of options and, occasionally, you will be asked which of
the four options is untrue or incorrect.
XX
The Study Guide will help you to learn not just the facts and figures that make
up the syllabus, but their context and relevance. It will help you to prepare for
the exam as you learn so that, however the question is presented or worded,
you select the right answer with confidence.
The Study Guide will be available to students via www.myifslearning.com
from August 2011.
Training courses the Institute of Financial Services does not formally
recognise any providers of training for regulatory qualifications. However, there
are external providers of training that offer varying types of training
programmes and some employers provide their own internal training. We
suggest that when considering an external course of any type, you research the
providers website and request testimonials from previous customers.
XXI
Disclaimer
These learning materials have been designed by the
Institute of Financial Services to support students in
their studies and in particular to help them prepare for
their assessment(s). The assessments are based upon the
content and learning outcomes documented in the
award/module/unit syllabus, which is printed in full at the
front of the learning material. A copy of this syllabus can
also be obtained on request from the Institute FE Customer
and Student Services Team on +44 (0) 1227 818609
(option 1).
The learning materials have been prepared to cover the
requirements of this syllabus and a comprehensive
knowledge and understanding of the content of these
learning materials should allow students to be successful
in the assessment(s).
Because some of the topics within the syllabus are interrelated and the learning materials are written in a style
that is intended to explain concepts and engage the user
in active learning, there are occasional instances where it
is not possible to find a specific reference point to answer
each question. This is particularly true of questions
relating to case studies where the application of
knowledge is being tested.
Here, a candidates knowledge of all preceding modules is
relevant and consequently questions may relate to more
than one point in the learning materials.
XXII
Overview context and relevance to CeFA

and CeMAP
UK Financial Regulation focuses on the financial services environment and the

regulation surrounding the provision of financial services. This guide explains
the context and relevance of the Module 1 syllabus to the CeMAP and CeFA
qualifications. In particular, it addresses the relationship of Module 1 to
subsequent modules and how knowledge and understanding gained during
your studies will be of use when practising in the financial services industry.
This induction has been divided into the following six sections and includes an
explanation of the study materials available to assist you:
t
Introduction
Professional practice
What are CeMAP and CeFA?
UK Financial Regulation overview
How is UK Financial Regulation relevant to me?
Summary
Introduction
A career as a mortgage or financial adviser can be very lucrative and rewarding,
and there are plenty of opportunities for qualified individuals.The CeMAP and
CeFA qualifications are highly regarded, providing you with the knowledge
and understanding of the financial services industry that you need in order to
fulfil these roles effectively and to build yourself a reputation as a professional.
The Financial Conduct Authority (FCA) is the industry regulator whose
responsibility it is to set and maintain certain standards within the financial
XXIII
services industry. Its main objective is consumer protection to ensure that

consumers are well informed about the products they are buying, and that the
advice they are given is appropriate to their needs.
In order to achieve this objective, the FCA requires that those giving financial
advice should understand, not just the products and procedures they deal with
on a daily basis when advising their clients, but the rules and regulations within
which they work. The FCA is the backbone of the financial services industry.
The regulatory framework it has created gives credibility to the products you
sell and reliability to the advice you give.
CeMAP and CeFA will provide you with this invaluable knowledge, enabling
you to further your career as an adviser one who works within the principles
laid down by the FCA and whose clients can trust the advice they are given.
Professional practice
Twenty-five years ago, becoming a mortgage or financial adviser was easy
there were fewer companies offering financial services than there are now
and their products were less complicated. There was no requirement to pass
any exams and, being less financially aware than they are today, consumers
trusted their unqualified advisers with their hard-earned savings and entered
into long-term contracts with lenders and insurance companies on their
advice.
There was no requirement for the advisers to complete any kind of
documentation, other than the application or proposal form for the product
being sold and, with nobody looking over the advisers shoulder or questioning
the advice being given, many consumers found themselves with products they
didnt need, risky investments they thought were safe, premiums they couldnt
afford and penalty clauses that werent explained to them until it was too late.
As a result of the lack of regulation in the financial services industry, there were
a series of financial scandals in the 1980s and 1990s, not only involving bad
advice and mis-selling, but also relating to the financial soundness of the
product providers themselves. Consumers needed protection.
Regulation of the financial services industry began in earnest with the Financial
Services Act 1986 and has been reviewed and improved ever since. It is now
heavily influenced by the EU. What we have today is a financial services
environment that emphasises fairness, openness, honesty and integrity. The
XXIV
stringent regulations within which we now work ensure that product

providers are properly managed and that advisers are appropriately qualified.
Consumers are protected against fraud and mis-selling, thereby maintaining
confidence in the financial services system.
What are CeMAP and CeFA?

The Financial Services Skills Council (FSSC) is licensed by the UK government
to identify and set the standards for the industry-recognised qualifications that
must be achieved in order to become a mortgage or financial adviser. CeMAP
(Certificate in Mortgage Advice and Practice) and CeFA (Certificate for
Financial Advisers) are approved by the FSSC and are accredited by the
Qualifications and Curriculum Authority (QCA). They are incorporated into
the National Qualifications Framework at Level 3, making them equivalent to
an A level.
CeMAP is the qualification for mortgage advisers and is made up of three
modules (3 separate exams):
Module 1 UK Financial Regulation*
Module 2 Mortgages
Module 3 Assessment of Mortgage Advice Knowledge
CeFA is the qualification for financial advisers and is made up of four modules
(4 separate exams):
Module 1 UK Financial Regulation*
Module 2 Investments and Risks
Module 3 Retirement Planning and Protection
Module 4 Assessment of Investment Advice Knowledge
*Module 1 (UK Financial Regulation) is the same for both the CeMAP and
CeFA qualifications so, whether you want to become a mortgage adviser or a
financial adviser, or you havent made up your mind yet, Module 1 is the
gateway to your career in the financial services industry.
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UK Financial Regulation overview

UK Financial Regulation is the foundation module; it sets the scene and should
be the first exam that you take regardless of whether you are intending to
follow the CeMAP route or the CeFA route. This module describes the
various organisations that make up the financial services industry, and explains
what they do and where they fit into the big picture.
The UK financial services industry is a highly sophisticated engine, and some
of these organisations and bodies are fundamental to its existence; others just
oil the wheels and check that good practice and regulations are adhered to.
UK Financial Regulation will give you a comprehensive overview of how they
all work together, the checks and controls that prevent the engine from overheating, and the people and products that make the UK financial markets the
envy of the world.
UK Financial Regulation explains the role of the government and how it
influences the flow of money between individuals and organisations, why it
controls interest rates through the Bank of England, and how this impacts on
inflation. It describes the numerous investment, insurance, mortgage and
protection products that you will one day be selling, as well as how they are
taxed.
You will learn how the institutions and individuals that make up the financial
services industry are regulated and the rules that apply to them in practice
rules that ensure prudence on the part of the product providers (banks and
insurance companies) and rules that must be adhered to by the advisers
themselves to make sure that consumers are protected against the type of
financial scandal that blighted the industry two decades ago.
UK Financial Regulation will equip you with the skills you need to identify
clients financial needs those they are aware of and those they arent and
formulate solutions for them and their families. It is vital that you have studied
and passed Module 1 before you move onto the later modules because it
explains the importance of comprehensive information gathering, prioritising
of needs and assessing a persons attitude to risk, so that when you are advising
your client as to the best way forward you select the product that fits the
solution, not the other way around.
That is the difference between a good adviser and a bad one. It is what makes
you a professional; one who cares about your clients financial needs and
recognises the consequences of bad planning, or no planning at all an adviser
whose clients will return, time after time.
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More importantly, though, and one of the main reasons why Module 1 is
positioned as the foundation module, is its vital role in teaching the principles
of giving advice.
You will need to have learned these principles before you study the final
module of either the CeMAP or CeFA qualifications, both of which are
intended to assess your understanding of the entire syllabus testing your
ability to apply the knowledge you have acquired from the previous modules
to a series of case study situations.
Success in the final module rests not only on your knowledge of the facts,
figures, products and procedures, but on your ability to assess the financial
needs of individuals in a given set of circumstances. You will be expected to
make product recommendations that satisfy not only their immediate financial
requirements, but which also provide for any foreseeable changes in their
personal and financial circumstances.
Making recommendations isnt just about learning the features of all the
available products you will need to take into account possible immediate and
future tax liabilities, eligibility for allowances and benefits, as well as the
personal preferences, beliefs, plans and aspirations of the client in question. A
persons income, rate of tax, age, marital status, loans, the age of their children
and even their hobbies can influence the type of products they should or
shouldnt buy. How all of these factors can influence the recommendations that
you make, and the information you need about the taxes and benefits that
affect your client, is contained in Module 1. This is why it is so important that
you take Module 1 first.
How is UK Financial Regulation relevant to me?

Module 1 has the broadest syllabus of all the modules that make up CeMAP
and CeFA. It requires the most study time and contains material that, at first
glance, students often feel is above and beyond the scope of their future roles
as mortgage or financial advisers.
It isnt until you have passed all of the modules and become fully qualified that
you sit in front of real customers and that is when you begin to appreciate
just how useful knowledge of a wide array of topics is going to be to you.
Your clients will come from a variety of backgrounds, do a variety of jobs and
will come to you with vastly different levels of knowledge, not just of the
XXVII
products you are giving advice on, but of the industry as a whole. They read
newspapers, they talk to their friends, they browse the Internet, and their
interpretation of what they read or hear is often far removed from the actual
circumstances and intricacies.
They will have concerns, often borne out of previous experiences or those of
their parents, and they want to know that they are doing the right thing. You
are the one person to whom they are about to entrust their future financial
security, and that of their children, and that is a big responsibility. As their
adviser, you need to be able to give them answers they can trust; answers that
dont just reassure them, but that you can back up with facts.
The questions your clients will ask you will be more than just How much is that
going to cost? or What happens if interest rates go up? You are going to be
expected to know the answers to some very obscure questions, some
predictable, some not. But you can be sure that those who have worked
hardest for their money will give you the hardest time, and if you cant answer
their questions, or you provide inaccurate advice, they wont be your clients
for very long.
And that is why the UK Financial Regulation syllabus is so diverse to prepare
you for the questions you know they are going to ask, and those that you dont!
Below are a few examples of some of the more difficult topics, along with
instances of when knowledge of them will be of use to you in practice.
Example 1: Capital Adequacy and Basel II (UK Financial
Regulation, Unit 2, Section 1)
This section is primarily concerned with the Financial Services Authority and
how it regulates firms and individuals and their activities. Without a doubt you
will be able to see why it is important to learn the rules that apply to you as
an adviser (the rules that dictate how you become authorised, the rules that
tell you when you can and cannot contact a customer, the forms you must give
to them, etc), but it is less clear why you need to learn the rules that apply to
the banks and insurance companies themselves.
What is capital adequacy?
Capital adequacy is about making sure that credit institutions (banks and
building societies) maintain a minimum amount of financial capital (their own
money) to cover the risks to which they are exposed. For example, when a
XXVIII
bank or building society makes a loan to a mortgage applicant, the funds come
from its depositors (savers). The depositors place their money in an account
with the bank or building society, which then lends the money out to its
borrowers. The interest that the borrowers pay to the building society is
usually higher than the interest that it pays to its depositors and, in crude
terms, the difference is the bank or building societys profit (less expenses of
course).
If a borrower fails to pay their loan back, it is not the depositors who lose out
they save with a bank or building society because it is a safe place to put their
money. The rules on capital adequacy require these credit institutions to put
some of their own money (profit, shareholder capital, etc) to one side to cover
such losses.
What is Basel II?
The Basel Committee on Banking Supervision decides how much of their own
funds credit institutions are required to set aside to cover risks such as the
non-repayment of loans. The minimum requirements were first introduced in
1988, under an agreement called the Basel Accord, and are expressed as a
percentage of the total amount a bank has outstanding in loans currently 8%.
But there is more than one type of loan some represent a greater risk to the
lender than others. Unsecured loans represent the highest risk because if the
borrower defaults, the lender does not have the right to seize their assets in
order to recover the debt. Loans secured on property (mortgages) represent
a smaller risk because, if the borrower defaults, the lender has the right to
repossess the property and dispose of it in order to get its money back. A
banks loans are broken down into categories and the higher the risk to the
lender, the more money they have to set aside to cover the risk of default.
The Basel Accord was superseded in 2007 under a new agreement called
Basel II, which ensures that credit institutions consider and make provision
not only for the losses they might incur because of bad debt, but also for any
losses that might result from operational problems (eg computer failure, staff
fraud, or even a lightning strike). Basel II also requires that stress tests be
carried out to make sure that the credit institutions would have sufficient
capital in certain circumstances, and that such information is disclosed so that
the risks to which a bank is exposed can be assessed.
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When will you use this information?

Imagine you are sitting in front of a client who has read the following in the
newspaper that morning:
The number of people who had their homes repossessed jumped
by 20% last year to an eight-year high, latest figures have shown
Your client, who has money invested with your institution, wants reassurance
from you that this does not mean that their savings are at risk.
You can explain to your client that lending institutions are required by law to
make provision for such eventualities from their own financial reserves, and
that they are not allowed to use money deposited with them by their savers
to make up any such losses, or shortfall in their income from mortgage
interest.
Example 2: The Bank of England (UK Financial Regulation, Unit 1,
Section 1)
This part of the syllabus describes the various functions of the Bank of England
and its important role within the UK economy. Its roles include acting as
banker to the banks, adviser to the government and lender of last resort. But you
dont work for the Bank of England, your clients cant have an account with
them, and the only people likely to set foot in the Bank of England are the
Chancellor of the Exchequer, other government ministers and the senior
management of the major banks.
Anyone who pays a cheque into an account knows that it is going to take three
working days to clear, and your client wants to know why it takes so long to
get their hands on the money.
You can explain to your client that a cheque is only a promissory note just
a piece of paper telling the payers bank to give a certain amount of money to
the payees bank. At the end of each working day, all the cheques received by a
particular bank are sent to clearing centres where they are batched together
all those drawn on Barclays are put into a pile, as are those for NatWest, and
so on. The value of the cheques in each pile is totalled up to work out how
much each bank owes the other, and the net balances are then settled through
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the accounts that each bank holds with the Bank of England in its function as
banker to the banks.
So you can tell your customer that, apart from inspecting each cheque to
ensure that it has the right signature, that the words and figures match, and that
it isnt out of date or stolen, this is why it takes three days for the funds to be
cleared.
Your next customer has been watching images on the TV of investors queuing
up and down the high street to withdraw their money because their bank has
suddenly found itself in financial difficulty. Your client needs reassurance that
their savings are safe with your institution, and that the same wont happen to
them.
Although the length of the queues was fuelled largely by panic and chinese
whispers, you can explain that the Bank of England, in its capacity as lender of
last resort, stepped in and made a loan to the bank concerned, not because it
had squandered its customers savings, but because its assets could not be
liquidated at such short notice to enable it to give all of its investors their
money back.
The run on the deposits of the Northern Rock, in late 2007, was not because
the bank had become insolvent, but because a higher than usual proportion of
its lending was funded through the wholesale market, explained in the next
example
Example 3: Retail and Wholesale Funding (UK Financial
Regulation, Unit 1, Section 1)
Traditionally, lending institutions (banks and building societies) attract deposits
from people with spare cash (the savers) and then lend that money out to
those who need it to buy houses (the borrowers). This is called retail funding
they use their retail branch network to attract both types of customer.
Wholesale funding is the process of raising money, not by attracting deposits
from savers, but by borrowing large sums of money from the wholesale
market, ie borrowing from other financial institutions (banks, consortiums,
companies, etc) to lend out to mortgage borrowers. Money raised on the
wholesale market is often cheaper because the sums involved are huge and
dont just come from UK sources. Some lending institutions do not have any
branches at all; they raise all of their mortgage funds in this way, attracting
borrowers through the Internet or operating through intermediaries.
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High street banks and building societies raise their mortgage funds using a
combination of retail and wholesale funding, although building societies are
restricted as to how much they can rely on the latter. Northern Rock, the bank
referred to in the previous example, relied heavily on the wholesale market to
fund its lending activities in fact the value of its deposits is dwarfed by the
total sum it has outstanding in mortgage loans.
But because the wholesale markets are global, the availability of funds to an
institution depends on the willingness of banks across the globe to lend to
them. In the UK and the US, repossessions are at an unusually high level,
causing panic and speculation, and many wholesale sources of funding are
drying up a credit crunch.
When a bank, whose business plan is heavily weighted towards the mortgage
market, is having difficulty raising money because it has chosen to rely on
wholesale funds rather than concentrate on attracting investments, it finds
itself short of liquid cash. And when the name of their bank hits the headlines,
no matter what the reason, the first thing people do is panic and withdraw
their money hence the queues.
A bank experiencing financial difficulties is rare a more regular and pertinent
example of when knowledge of mortgage funding will be invaluable to you is
when discussing mortgage options with your client, particularly when talking
about fixed- and capped-rate products.
As a general rule, high street banks and building societies use wholesale funding
to fund their current fixed- and capped-rate mortgage deals; their variable rate
mortgages coming from retail funds.
Fixed- and capped-rate deals are for a specific term: two years, three years, five
years, etc. What this means in simple terms is that the bank borrows a large
amount of money from the wholesale market at a fixed rate, over a fixed term.
It then lends that money out to its borrowers at a slightly higher fixed rate,
over the same term, giving the bank a guaranteed profit margin.When the bank
has lent out all of the money it borrowed, that particular deal is withdrawn
from the market.
So when you have a client who wants a mortgage and they are asking why the
fixed rate deal advertised in last weeks paper is no longer available, you can
give them a more satisfactory answer than Head Office said so.
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The syllabus for Module 1 contains many more subjects, the relevance of which
will not be immediately apparent to you, but as the above examples have
hopefully demonstrated, they are all in there for a reason.
Summary
Remember that you have chosen to follow a career in financial services.
Learning about how it all works and how to become a good adviser can be an
enlightening experience.
Passing these exams is an achievement to be proud of, something that will earn
you respect and give you enormous satisfaction, not to mention the financial
rewards once you are qualified. If you take the view that it is something to get
behind you as quickly as possible, you will not enjoy your studies and you will
be less likely to remember what you have learned.
Embrace this opportunity to broaden your knowledge.Take the time to absorb
the information so that when you take your exam, you do so with confidence.
Remember that the investment you put into UK Financial Regulation will pay
dividends when you study later modules.
Good Luck with your studies!
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XXXIV
Study guidance and assessment preparation
Why study UK Financial Regulation first?

In the past, some students have chosen to leave UK Financial Regulation until
last. There are a number of reasons why you should not do this:
1.
As explained above, the UK Financial Regulation syllabus is designed to

prepare you for later modules that is why it is referred to as the
foundation module. Without the knowledge contained within UK
Financial Regulation, many of the subjects in the later modules will seem
incomplete and your understanding of them will be inadequate.
2.
Some subjects are covered in more than one module. For example:
Mortgage Interest Rate Options and Mortgage Repayment Vehicles both
appear in UK Financial Regulation and Module 2 of CeMAP. UK Financial
Regulation introduces them in simple terms, whereas Module 2 goes into
more detail, assuming that you already have a basic understanding.
3.
UK Financial Regulation contains more new subjects than the other

modules subjects that you are unlikely to have come across before. It is
better to tackle them with a clear head than to do so after struggling with
later modules that you would have found a lot easier had you taken them
in the correct sequence.
4.
Research has shown that the pass rates are higher for those who studied
the modules in the right order than for those who didnt.
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The structure of this Manual

The Manual is broken down into two Units and an appendix. Unit 1 introduces
the financial services environment and is itself split into six distinct sections,
each one dealing with different aspects of the syllabus, such as the financial
environment, products and services, and the process of giving financial advice.
Unit 2 deals with different aspects of the regulation of financial institutions and
financial products. This includes an introduction to the work of the Financial
Conduct Authority, as well as an overview of other relevant legislation relating
to, for example, data protection and money laundering.
Although the Manual does, for the most part, follow the general order of the
syllabus, there are one or two places where related items from different parts
of the syllabus have been linked together in one section.
To allow you to assess how well you have acquired and can apply what you
have studied, a number of questions have been included at the end of each
Section of the Manual (with answers supplied so that you can check how well
you did). These questions are not in the style of the questions you will meet in
the exam, although some of them are multiple choice questions. In addition to
these questions, it is recommended that you practise by answering the
Specimen Papers that are available from the Institute of Financial Services.
The content of the learning materials has been designed to cover the full range
of the syllabus for Module 1.You are also, however, encouraged to read around
the subject as much as possible to deepen your understanding and seek
alternative perspectives on current issues in financial services. A good starting
point for this is the financial pages of the more serious daily newspapers and
the personal finance supplements that many papers publish with weekend
editions.
Many websites also contain useful information about topics covered in the
Manual, from the official websites of HM Revenue & Customs, the Department
for Work and Pensions, and the Financial Services Authority, to the websites of
newspapers, accountancy firms and others. Entering one or two key words into
a good search engine should take you quickly to the most useful references.
XXXVI
The structure of the assessment

The exam is composed of 100 individual multiple choice questions; there are
no case study questions in this assessment. There are 50 questions for Unit 1
and 50 for Unit 2. Each of the questions carries one mark and you will have
two hours to complete the examination.
The pass mark is 70%. It is necessary to reach an adequate standard in both
Unit 1 and Unit 2 to obtain a pass for the exam. However, if you should pass
in one Unit but not in the other, you can re-sit just the unit in which you were
unsuccessful.
It is important to understand that the questions are designed to test the full
scope of the syllabus and therefore you will need to develop a depth of
understanding across all of areas of the syllabus.
Please note, however, that you are not expected to memorise current rates,
bands or allowances in relation to taxation or national insurance. A list of any
relevant figures will be made available at the examination centre.
Preparing for study

There is no getting away from the fact that to pass this assessment you will
have to put in some committed study time. One of the main reasons why
people fail exams is that they havent learned the material adequately; all too
often this is because they didnt plan their studies. This part of the manual is
designed to help support you with that.
Never lose sight of the fact that the CeFA and CeMAP qualifications are
professionally recognised throughout the financial services industry.
Furthermore, what you learn is valuable for your own life.
Its possible that youre taking this qualification because its part of your job.
But taking an exam simply because you have to is unlikely to be motivational.
So, think about the following questions for a couple of minutes.
t
What it will mean to you to pass this exam?
What will it be like when you get the results slip and it says Pass?
What will you do to celebrate?
What might your friends and family say?
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The answers to these questions should provide more motivation than simply
taking the exam because you have to. Passing an exam is a fantastic feeling: to
experience that feeling you will need to do some hard work to prepare yourself.
If ever you get to a point where you are struggling to understand something in
this study manual or wishing that you didnt have to take the exam at all, then go
back to the answers to those questions. Its also important to remember that
youll learn a lot that will stand you in good stead for your own life.
This section of the manual is designed to give you some guidance on how to
properly prepare yourself. Because none of this section forms part of the study
text, it may be tempting to skip it and just dive into the learning. Please dont.
There is an old saying: Failing to plan is planning to fail. Its true of many things
in life and is certainly true of preparing for exams so please read on.
To get yourself ready for the exam you will need to plan your approach, so
well consider several key aspects of planning in this section:
1.
allocating enough time;
getting your state of mind right;
how people learn;
structuring your study;
how to develop a study plan;
how to learn the content of these learning materials;
when you are studying;
other support;
on the day of the exam;
during the exam.
Allocate enough time
It is suggested that you need between 40 and 60 hours of study time before
you take your UK Financial Regulation exam, but to give yourself the best
chance of passing first time, you should probably allow more time than this.
Due to the diversity of the syllabus, UK Financial Regulation does not lend
itself to crash courses or to cramming your study into solid blocks of time.
Little and often is the best approach. Considering that the CeMAP and
XXXVIII
CeFA qualifications are regarded as the equivalent to an A level, which usually

takes two years, it is unrealistic to believe that you can read, understand and
remember the entire UK Financial Regulation syllabus in a just a few days.
2. Getting your state of mind right

Its quite possible that you have some negative feelings or baggage about sitting
this exam, for example:
t
you may have failed exams before;
you may have failed this exam before;
it may be a long time since you last sat an exam;
you dont consider yourself a bright spark;
you think that the study will be boring;
you think you will fail;
you wish that you didnt have to do the exam.
To have some or all of these thoughts and feelings is quite common, and
perhaps even to be expected; but none of them will add anything to your
chances of passing the exam.
Although your thoughts and feelings will be very real to you, you should ask
yourself whether they are making it easier or more difficult to prepare for the
exam. Almost certainly they are not helping if so, do everything you can to
get rid of them.
As already mentioned, the most common reason why people fail this exam is
that they are inadequately prepared; in short they didnt do enough study. Lets
be realistic here: this is a professionally recognised exam, so it isnt something
youre going to pass by getting the notes out the day before and doing a couple
of hours reading. You will need to plan and carry out some committed study.
The following sections will give you some ideas as to how to approach this, but
your state of mind is the key. If you approach every study session and the exam
itself with a feeling of dread, believing it to be the worst experience in your life
then thats exactly what it will be! So ... always adopt a positive approach, and
never lose sight of the good things that will happen when you pass.
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3. How people learn

There have been many studies of how people acquire, retain and apply new
information. Some of the themes that are relevant to studying for this and
similar exams are:
t
we typically only use a small fraction of the brains capacity so there is

plenty left over to learn new things;
you neednt have a track record of academic achievement, or consider

yourself to be particularly bright, to learn new things;
past performance may not be a guide to future performance, so it

neednt matter if you have failed this or other exams before;
the more you use and stimulate your brain, the easier you will find it to
take on new information.
Take a minute to reflect on the themes above and consider what they mean
for you. With regard to the third point above it may be worth remembering
that:
If you keep doing what you have always done then you will always get what
you always had.
So, if you have already sat and failed this exam, ask yourself: What can I learn
from that experience?. If you approach it this time in the same way as you
approached it last time, what do you expect to achieve that is different?
Ask yourself what positives you can take from sitting the exam before, and
what worked for you when you prepared yourself last time. Hold onto the
good things, and change anything that didnt help you.
4. Structuring your study

We have already mentioned that the main reason why people fail this exam is
that they fail to prepare themselves properly; it will therefore come as no
surprise to find that a common characteristic of those who pass is that they
are properly prepared. In this section we will consider how you can plan your
study to ensure you are properly prepared.
In many ways this is quite simple: you need to develop a robust study plan that
will enable you to commit enough time, over a period of time, for you to have
learned the material.
XL
Just reading the manual once is unlikely to be enough. You will probably need
to take notes as you work through the manual and, having gone through the
manual, you will then need time to revise the key points.
5. How to develop a study plan

Your starting point is to establish when you will be sitting the exam once this
is set as a landmark you can then work back to the present day and build up a
formal plan.
It is recommended that you spend at least 60 hours preparing for the exam,
so, once you know when you want to sit the exam you should aim to build a
plan that allows you to complete the required study before the exam date.
Points to consider in making your plan

t
Ensure that you have a clear view of any personal or business

engagements between the start of the plan and the exam; accommodate
these within your plan.
Ensure that you build in enough time to read through the whole manual,
acquire the basic knowledge and then revise. Reading through just once
is unlikely to be sufficient.
Be realistic about your plan. It is probably better to do a little study each

day over a long period, rather than try to cram all the work into the last
few days.
Decide what is your best time of day for studying; some people are
better in the mornings, others prefer to work late at night. Plan your
studies accordingly.
Look over the whole Manual and break it down into smaller chunks; use
these as milestones to mark your progress.
Aim to finish your revision two days before the examination; then, on
that last day youll have time to look through things one last time in a
more relaxed and confident frame of mind.
XLI
t
Be realistic in setting goals dont plan to do 30 pages in a session if you

know that normally you only do ten; quality is always better than
quantity when it comes to study.
Consider who else will be affected by your studies such as friends or

family; ensure that they know what youre planning, why its important
and what kind of support will help you.
Identify someone who can act as support to you as you study; for
example, there may be friends or colleagues who have passed the exam.
Their support and insight will be invaluable. If possible, arrange for
someone you know who has passed the exam to act as your mentor as
you study.
Build your plan so that you can continue doing your favourite things
while you work towards the exam. Study is not a punishment, and a
properly constructed plan should allow you do all the fun things you
would normally do, while working towards the exam.
6. How to learn the content of this Manual

It is generally acknowledged that we are more likely to remember something
that we write as opposed to something that we just read. Re-writing the whole
text, however, is not a recommended approach it would take far too long
and, more significantly, merely copying the text wont promote understanding
of it.Therefore its advisable to use a system for summarising the text. Selecting
and highlighting key points is an important step in developing good
comprehension and memory of the information.
Common ways to highlight the main ideas include:
t
make a separate set of study notes;
make a set of key cards of themes and main topics you can easily study
these on a train or at a bus stop;
prepare self-assessment questions on cards questions on one side,

answers on the reverse;
add your own marginal notes to the text;
underline or highlight the text itself, particularly for key points.
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Bite-sized chunks
When you look at the syllabus and the course manual for UK Financial
Regulation, it may well appear daunting at first glance. If you separate it into its
individual sections, some of which are only 10 to 15 pages long, you break it
down into a series of more manageable sections. Tackle each section one at a
time you might want to take the section you are studying out of the manual
and put it in a ring binder so that when you are making your own notes, you
can keep all of the relevant papers together.
When you sit down for a study session, maybe for one or two hours at a time,
having just one section in front of you instead of the whole manual gives you
a sense of accomplishment. It helps you to focus on one topic at a time,
without dwelling on those before and after it.
Read the section, and then read it again. Make notes in your own words that
help you to remember.When you are confident that you have learned all of the
information in that particular section, it is a good idea to make a list of all the
sub-headings for that section from the manual, close the book and write down
everything you can remember for each of those sub-headings.
For example: UK Financial Regulation, Unit 2, Section 5 contains a sub-heading
describing CAT Standards as they apply to mortgages. It explains what CAT
stands for and lists the restrictions that apply to the charges on CAT Standard
Mortgages, making them attractive to borrowers. Your notes may look
something like this:
CAT Standards Charges, Access, Terms
Variable rate max 2% above BofE base rate
Interest calculated on daily basis
No arrangement fees or early redemption charges for
variable rate
Max 150 arrangement fee and limit to early
redemption charges for fixed/capped rate
No Mortgage Indemnity Fees
Disclosure of other fees before signing
When you have completed the first three sections in this way, use your next
study session to review everything you have learned so far, and do the same
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when you have completed a couple more. When you have completed all of the
sections in UK Financial Regulation, you will have your own set of revision
notes that you can revise from when you are preparing for your exam.
7. When you are studying

Approaching your study in the right way can ensure that you make best use of
the time. Some ideas that have been tried and tested are included below.
t
Pick a time and place where you will not be disturbed as you study; there
is nothing more frustrating that having an interruption just as you are
about to grasp a complex point. Interruptions will happen, of course; its
not the end of the world when they do. Be flexible in your approach, and
re-plan when it does happen.
Make sure the environment is right; if its too hot you will feel drowsy,
too cold and it will be difficult to concentrate.
There is no hard and fast rule on listening to music while you study.
Some people find that their favourite music helps them to anchor what
they are learning, whilst for others its just distracting. Find out what
works for you.
At the start of each session of study, clarify in your mind what it is you
are studying today, how long you have allocated, and what you hope to
learn.
At the end of each session, take a few minutes to reflect on what you
have learned and note down the key points.
Have frequent breaks when you are working: studies suggest that
optimum concentration may only be achieved for 20 to 30 minutes, so
it is advisable to break your study up with a 10 or 15 minute break
between each session.
Having made a study plan, ensure that you review it frequently to ensure
that you are staying on target. If you fall behind the plan, being aware of
this at an early stage can allow you to take corrective action before it is
too late.
Reward yourself for making progress studying is never easy and there
are always more enjoyable things to do instead, so reward yourself along
the way if you have a good days study or reach a target.
XLIV

t
Dont be disheartened if you have a difficult day or dont get as far as

you had hoped: some topics are more difficult than others. If this
happens, consider moving onto the next section of your plan and then
coming back to the difficult bit another day.
Stick to your plan: if you can make the study habitual it then becomes
less of a chore. Furthermore, working regularly is much more effective
than cramming just before the exam.
The more times you go over something the better your memory of the
information is likely to be, so dont expect to read something and learn
it all in one go.
Monitor your comprehension: you can only remember and fully use ideas
that you understand. Always check the logic behind ideas you are less
likely to remember something that doesnt seem logical or that you
dont agree with.
Manage your energy and workload. Make sure that you get enough sleep,
eat well and get plenty of exercise you will perform better in your
revision and in the examination if youre relaxed and have a clear mind.
8. On the day of the exam

Ideally youll have followed your study plan through, and youll be feeling ready
and prepared for the exam. Dont worry if youre feeling nervous; this is very
common, and only to be expected. There are a few things to consider as final
preparations:
t
ensure you have a good breakfast to ensure that your body is well
fuelled;
make sure you know where the examination centre is, where you can
park and how long it will take you to get there; you might want to
consider doing a dummy run of the journey in order to be certain of
timings;
try to arrive at least 15 minutes before the exam starts so that any
formalities can be taken care of without having to rush;
wear light, comfortable clothing so that you wont get too hot;
relax if youve done the work the rest should be straightforward.
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9. During the examination

Listed below is some guidance to help you to approach the actual exam in the
right way.
t
Remember that the examination tests the whole syllabus and each
question is a vital mark towards passing.
Carefully read and understand each question before looking at the

answers. If you can deduce the correct answer without looking at the
options you wont be distracted by the wrong answers.
Read each alternative carefully for understanding not just for

recognition. Pay careful attention to key words in the text. Read
particularly carefully if the question or any of the answers contain
negative words such as not.
If you dont know the answer, narrow your choices by eliminating any of
the alternatives which you know are incorrect. If two options still look
plausible, compare each to the stem, making sure that the one you
eventually choose answers what is asked.
If you are unable to make a choice and need to spend more time on a
question, flag that question and move on to the next.
Avoid getting bogged down on one question part way through the exam.
It is much better to move on and finish all those questions that you can
answer and then come back later to the problematic questions.
Remember any questions you miss because you ran out of time will
be wasted opportunities to score more marks.
If you really are stuck on a question at the end of the examination, make
an educated guess at the answer the exam is not negatively marked so
you wont lose marks if you are wrong; its always better to give an
answer (even if its a guess) than not to answer at all.
Dont select an alternative just because you remember learning the

information; something may well be a true statement in its own right, but
you have to be sure it is the correct answer to that particular question.
Dont necessarily pick an answer just because it seems to make sense.

You should be answering from your knowledge of the course content
not just from your general knowledge and logic. However, if you need to
make a guess, it may be sensible to try applying common sense and logic
rather than to make a random guess.
Good luck in your studies!

XLVI
Module 1 Syllabus
Learning Outcomes
Unit 1 Introduction to Financial Services
On completion of this part of the module, candidates will be expected to:
Demonstrate an understanding of:
1
the purpose and structure of the UK financial services industry
the main financial asset classes and their characteristics, covering past
performance, risk and return
the main financial services product types and their functions
the main financial advice areas
the process of giving financial advice, including the importance of regular

reviews of the consumers circumstances
the basic legal concepts relevant to financial advice
the UK taxation and social security systems and how they affect personal
financial circumstances
the impact of inflation, interest rate volatility and other relevant socioeconomic factors on personal financial plans.
XLVII

On completion of this part of the module, candidates will be expected to:
Demonstrate a knowledge of:
1
the main aims and activities of the Financial Conduct Authority (FCA),
and its approach to ethical conduct by firms and individuals
how other non-tax laws and regulations impact upon firms and the
process of advising clients.
Demonstrate an understanding of:

1
the regulator's approach to regulating firms and individuals
how the regulator's rules affect the control structures of firms and their
relationship with the FSA
how the regulator's Conduct of Business rules apply to the process of

advising clients/customers
how the Anti-Money Laundering regulations apply to dealings with clients/

customers
the main features of the rules for dealing with complaints and
compensation
how the Data Protection Act 1998 affects the provision of financial advice
and the conduct of firms generally.
XLVIII
Detailed Syllabus
Key: K = Knowledge. U = Understanding. An = Analyse. As = Assess. A = Apply.
Unit 1 Introduction to Financial Services

Attainment
Level
Demonstrate
an understanding of:
Outcome
Indicative Content
U1.1 The function of the financial services

industry in the economy transferring
funds between individuals, businesses
and government risk management
The purpose and structure of

the UK financial services
industry
U1.2 The main institutions/organisations

markets, retail institutions, wholesale
institutions, credit unions
U1.3 The role of the EU and of the UK
government regulation, taxation,
economic and monetary policy,
provision of welfare and benefits
U1.4 The purpose and position of clearing
and settlement organisations
2
The main financial asset classes

and their characteristics,
covering past performance,
risk and return
U2.1 Cash deposits and money market

instruments
U2.2 Government securities and
corporate bonds fixed
interest and index linked
U2.3 Equities
U2.4 Real estate residential and commercial
U2.5 Commodities
U2.6 Foreign exchange
XLIX
3
The main financial services

product types and their functions
U3.1 Direct investment cash, government

securities and corporate bonds, equities
and property, commercial money market
instruments
U3.2 Collective investments structure, tax
and charges OEICs/unit trusts,
investment trusts, life assurance
contracts, offshore funds
U3.3 Derivatives their structure and purpose
U3.4 Mortgages and other loans personal
and commercial
U3.5 Pensions
U3.6 Structured products
U3.7 Protection products life and general
The main financial advice areas
U4.1 Budgeting
U4.2 Protection
U4.3 Borrowing and debt
U4.4 Investment and saving
U4.5 Retirement planning
U4.6 Estate planning
U4.7 Tax planning
The process of giving financial

advice, including the importance
of regular reviews of the
consumers circumstances
U5.1 The nature of the client relationship,

confidentiality, trust and consumer
protection
U5.2 The information required from
consumers and methods of obtaining it
U5.3 Factors determining how to match
solutions with consumer needs and
demands
U5.4 How to assess affordability and suitability
U5.5 The importance of communication skills
in giving advice and how to adapt advice
to customers with different capacities
and needs
U5.6 The importance of monitoring and
review of consumers circumstances
U5.7 Information for consumers and when
it should be provided (outline only)

6
The basic legal concepts relevant

in financial advice
U6.1 Legal persons individuals, wills,

intestacy, personal representatives (and
administration of estates), trustees,
companies, limited liabilities, partnerships
U6.2 Contract, capacity to contract
U6.3 Agency
U6.4 Real estate, personal property and
joint ownership
U6.5 Powers of attorney, enduring power of
attorney and lasting power of attorney
U6.6 Insolvency and bankruptcy, Individual
Voluntary Arrangements (IVAs), CVAs
The UK taxation and social

security systems and how they
affect personal financial
circumstances
U7.1 Concept of residency/domicile

U7.2 UK Income tax system liability to
income tax, allowances, reliefs, rates,
grossing up interest and dividends,
employed and self-employed income,
self-assessment deadlines, priorities
for taxing different classes of income,
gift aid, Give As You Earn
U7.3 Capital gains tax liability to CGT,
disposals, death, deductions, losses,
main reliefs and exemptions,
calculation of chargeable gains
U7.4 Inheritance tax liability to IHT,
main exemptions, calculation of
IHT liabilities
U7.5 Corporation tax
U7.6 Stamp duty, land tax and stamp duty
reserve tax on securities
U7.7 VAT and Insurance Premium Tax
U7.8 Withholding tax
U7.9 National insurance
U7.10 Social security benefits
The impact of inflation, interest

rate volatility and other relevant
socio-economic factors on
personal financial plans
U8.1 Definition of inflation, deflation,

disinflation
U8.2 The difference between fixed and
variable interest rates and their impact
U8.3 The impact of socio-economic factors
and how they affect the affordability,
suitability and performance of financial
products in both the long and short term
LI
Attainment
Level
Demonstrate
a knowledge
of:
Outcome
Indicative Content
K1.1
The FCAs statutory objectives, roles

activities and powers
K1.2
The FCAs principles for businesses

and approved persons how they
reflect the need for ethical
behaviour by firms and approved
persons, FCA guidance
K1.3
The approach to, and requirements

for, treating customers fairly
K1.4
Arrangements, systems and controls

for senior managers
K1.5
The fit and proper test for approved

persons
K1.6
The prevention of financial crime
K2.1
The Office of Fair Trading and the

Consumer Credit legislation
K2.2
The Competition Commission
K2.3
The Pensions Regulator
K2.4
Unfair Contract Terms; Advertising

Standards Authority; Banking Code
K2.5
EU directives
K3.1
The role of internal and external

auditors, trustees and compliance
function
LII
The main aims and activities of

the Financial Conduct Authority
(FCA) and its approach to ethical
conduct by firms and individuals
How other non-tax laws and

regulations are relevant to
firms and to the process of
advising clients
The role of oversight groups

Demonstrate
The regulators approach to

regulating firms and individuals
How the regulators rules affect

the control structures of firms
and their relationship with the
regulator
How the regulators Conduct

of Business Rules apply to the
process of advising clients/
customers
U1.1
Authorisation of firms,
regulated activities &
regulated investments, firms status
U1.2
Capital adequacy and liquidity
U1.3
Supervision and the risk based

approach
U1.4
Discipline and enforcement

including notification requirements
U1.5
Regulatory developments eg Retail

Distribution review (RDR)
U2.1
Approved persons and controlled

functions
U2.2
Reporting and record keeping
U2.3
Training and competence rules
U3.1
Advertising and financial promotion

rules
U3.2
Types of client
U3.3
Information about the firms services,

including client agreements
U3.4
Status of advisers and status

disclosure to customers, specific
rules for independent financial
advisers and whole of market advisers
U3.5
Identifying client circumstances

and needs
U3.6
Suitability of advice
U3.7
Execution only, non-advised sales,

and statements of demands and
needs
U3.8
Charges and commissions
U3.9
Cooling off and cancellation
U3.10 Product disclosure and risk

disclosure statements
U3.11 Simplified advice on the stakeholder
suite of products
U3.12 Regulatory rules for mortgage
advice (MCOB) status disclosure,
initial disclosure document, charges,
suitability, product disclosure,
cancellation
U3.13 Regulatory rules for general insurance
advice (ICOB) status disclosure,
initial disclosure document, charges,
suitability, product disclosure, cancellation
LIII
Demonstrate
LIV
How the Anti-Money Laundering

regulations apply to dealings with
clients/customers
The main features of the rules

for dealing with complaints and
compensation
How the Data Protection Act

1998 affects the provision of
financial advice and the conduct
of firms generally
U4.1
Definition of financial crime and

proceeds of crime
U4.2
Money laundering regulations

and offences, the Terrorism Act 2000,
Proceeds of Crime Act 2002
U4.3
Client identification procedures
U4.4
Record keeping requirements
U4.5
Reporting procedures
U4.6
Training requirements
U4.7
Enforcement
U4.8
The role of the Financial Action

Task Force and the Serious Organised
Crime Agency (SOCA)
U5.1
Consumer rights and remedies,

including awareness of their
limitations
U5.2
Firms internal complaints

procedures
U5.3
The Financial Ombudsman

Service (FOS)
U5.4
The Financial Services

Compensation Scheme (FSCS)
U5.5
The Pension Ombudsman
U6.1
Definitions in the Data

Protection Act
U6.2
The data protection principles
U6.3
Enforcement of the Data

Protection Act
Unit 1
Introduction to the Financial Services
Unit 1
Introduction to the financial services and
products
All references are to pages prefixed [1]
Section 1
The UK financial services industry
Introduction
1.1
The functions of the financial services industry
1.1.1 Intermediation
1.1.2 Risk management
1.1.3 Product sales intermediaries
5
6
6
1.2
Financial institutions
1.2.1 The Bank of England

1.2.2 Proprietary and mutual organisations
1.2.2.1 Credit unions
1.2.3 Retail and wholesale
1.2.4 Money transmission and the clearing process
1.2.4.1 Current accounts
1.2.4.2 Clearing
7
10
11
13
16
16
17
1.3
18
The role of government
1.3.1 The influence of the European Union

1.3.1.1 European Supervisory Authorities
1.3.2 Regulation in the UK
1.3.3 Taxation
1.3.3.1 Residence and domicile
1.3.3.2 Income tax
18
19
20
21
22
22
[1] iii
Unit 1
1.3.3.2.1 Allowances and tax rates

1.3.3.2.2 Employees
1.3.3.2.3 Self-employed persons
1.3.3.2.4 Classification of types of income
1.3.3.2.5 Income taxed at source
1.3.3.2.6 Tax-paid investment income
1.3.3.2.7 Taxation of proceeds from a life assurance policy
1.3.3.2.8 Taxation of proceeds from a unit trust
1.3.3.2.9 Calculation of income tax liability
1.3.3.3 National Insurance
1.3.3.4 Capital gains tax
1.3.3.4.1 Calculation of CGT
1.3.3.4.2 Roll-over relief
1.3.3.4.3 Hold-over relief
1.3.3.4.4 Payment of CGT
1.3.3.5 Inheritance tax
1.3.3.6 Value added tax
1.3.3.7 Stamp duty
1.3.3.7.1 Stamp Duty Land Tax relief for zero-carbon homes
1.3.3.7.2 Stamp Duty Land Tax relief for multiple purchases
1.3.3.8 Corporation tax
1.3.3.9 Withholding tax
1.3.4 Economic and monetary policy
1.3.4.1 Monetary policy
1.3.4.1.1 The impact of interest rate changes
1.3.4.2 Fiscal policy
1.3.5 Welfare and benefits
1.3.5.1 Support for people on low incomes
1.3.5.1.1 Working Tax Credit
1.3.5.1.2 Income Support
1.3.5.1.2.1 Income Support payments
1.3.5.1.3 Jobseekers Allowance
1.3.5.2 Support for bringing up children
[1] iv
25
27
27
28
28
29
29
30
30
32
33
34
36
36
37
37
38
39
40
41
41
42
43
45
46
47
48
49
49
50
51
51
52
Introduction to the financial services environment and products
1.3.5.2.1 Statutory Maternity Pay

1.3.5.2.2 Maternity Allowance
1.3.5.2.3 Child Benefit
1.3.5.2.4 Child Tax Credit
1.3.5.3 Support for people who are ill or disabled
1.3.5.3.1 Statutory Sick Pay
1.3.5.3.2 Incapacity Benefit
1.3.5.3.3 Employment and Support Allowance
1.3.5.3.4 Attendance Allowance
1.3.5.3.5 Disability Living Allowance
1.3.5.3.6 Carers Allowance
1.3.5.4 Support for people in hospital or receiving
residential/nursing care
1.3.5.5 Support for people in retirement
1.3.5.5.1 Basic state pension
1.3.5.5.2 Additional state pension
1.3.5.5.3 Pension Credit
1.3.5.6 Universal Credit
Section 2
52
52
53
53
54
54
54
55
56
56
57
58
59
59
60
60
61
Financial assets
Introduction
67
2.1
68
Deposits
2.1.1 Bank accounts

2.1.1.1 Deposit accounts
2.1.1.2 Money-market deposit accounts
2.1.1.3 Interest-bearing current accounts
2.1.1.4 Taxation
2.1.2 Building society accounts
2.1.2.1 Taxation
2.1.3 Offshore deposits
2.1.4 Cash ISAs
2.1.5 National Savings and Investments
68
69
69
70
70
70
71
71
72
72
[1] v
Unit 1
2.1.5.1
2.1.5.2
2.1.5.3
2.1.5.4
2.1.5.5
2.1.5.6
2.1.5.7
2.1.5.8
2.1.5.9
2.1.5.10
2.2
2.2.1
2.2.2
2.2.3
2.2.4
2.2.5
2.3
Direct Saver
Investment account
Income bonds
Guaranteed income bonds
Guaranteed growth bonds
Guaranteed equity bonds
Savings certificates
Premium bonds
Childrens bonds
Direct ISA
Fixed-interest securities
Government stocks
Local authority stocks
Permanent interest-bearing shares
Corporate bonds
Eurobonds
73
73
73
73
73
74
74
74
75
75
75
75
77
77
78
78
Equities and other company finance
78
2.3.1 Ordinary shares

2.3.1.1 Buying and selling shares
2.3.1.1.1 The main market
2.3.1.1.2 Alternative Investment Market
2.3.1.1.3 Participants in the markets
2.3.1.1.4 Off-market trading
2.3.1.2 Returns from shares
2.3.1.2.1 Risk and reward
2.3.1.2.2 Assessment of financial returns
2.3.1.3 Taxation of shares
2.3.1.4 Ex-dividend
2.3.1.5 Share indices
2.3.1.6 Rights issues and scrip issues
2.3.1.7 Preference shares and other shares
2.3.2 Loan stock
78
79
80
80
81
81
81
81
81
82
83
83
84
84
85
[1] vi
2.4
Property
86
2.4.1 Taxation
2.4.2 Buy-to-let
2.4.2.1 Buy-to-let regulation
2.4.3 Commercial property
87
87
88
89
2.5
Commodities
90
2.6
Foreign exchange
91
2.7
Money-market instruments
92
2.7.1 Treasury bills

2.7.2 Certificates of deposit
2.7.3 Commercial paper
93
93
94
Section 3 Financial products

Introduction
99
3.1
Investments
99
3.2
Regulated collective investments
99
3.2.1 Unit trusts

3.2.1.1 The role of the unit trust manager
3.2.1.2 The trustees
3.2.1.3 Authorisation of unit trusts
3.2.1.4 Pricing of units
3.2.1.4.1 Historic and forward pricing
3.2.1.4.2 Buying and selling units
3.2.1.5 Charges
3.2.1.6 Types of unit
3.2.1.7 Taxation of unit trusts
3.2.1.7.1 Income tax
3.2.1.7.2 Capital gains tax
3.2.1.8 Risks of unit trusts
101
101
102
102
102
103
104
104
105
105
105
106
106
[1] vii
Unit 1
3.2.2 Investment trusts

3.2.2.1 Taxation of investment trusts
3.2.2.2 Split-capital investment trusts
3.2.2.3 Real estate investment trusts
3.2.3 Open-ended investment companies
3.2.3.1 Legal constitution of an OEIC
3.2.3.2 Investing in an OEIC
3.2.3.3 Pricing of OEIC shares
3.2.3.4 Charges
3.2.3.5 Taxation of OEICs
3.2.3.6 Risks
3.2.4 Unregulated collective investments
3.2.5 Platforms, wraps and fund supermarkets
3.2.6 Individual savings accounts
3.2.6.1 Tax reliefs
3.2.6.2 Subscription limits
3.2.6.3 Withdrawals and transfers
3.2.7 Life assurance-based investment products
3.2.7.1 Endowments
3.2.7.1.1 Non-profit endowment
3.2.7.1.2 With-profit endowment
3.2.7.1.2.1 Principles and Practices of Financial Management
3.2.7.1.3 Unit-linked endowment
3.2.7.1.4 Unitised with-profit endowments
3.2.7.2 Investment bonds
3.2.7.2.1 Taxation
3.2.8 Child Trust Fund
3.2.8.1 Junior ISAs
3.2.9 Structured products
107
107
108
108
109
109
110
110
111
111
111
112
112
113
114
114
114
115
115
115
115
116
117
117
118
119
120
122
122
3.3
124
Insurance
3.3.1 Life assurance protection

3.3.1.1 Whole-of-life assurance
3.3.1.1.1 Low-cost whole-of-life
[1] viii
125
125
126
3.3.1.1.2 Flexible whole-of-life

3.3.1.1.3 Universal whole-of-life assurance
3.3.1.1.4 Uses and benefits
3.3.1.1.5 Joint-life second-death policies
3.3.1.2 Term assurance
3.3.1.2.1 Level term assurance
3.3.1.2.2 Decreasing term assurance
3.3.1.2.3 Increasing term assurance
3.3.1.2.4 Convertible term assurance
3.3.1.2.5 Renewable term assurance
3.3.1.3 Family income benefits
3.3.1.4 Pension term assurance
3.3.2 Ill-health insurance
3.3.2.1 Critical illness cover
3.3.2.2 Income protection insurance
3.3.2.2.1 Premium rates
3.3.2.2.2 Payment of benefits
3.3.2.2.3 Taxation of IPI benefits
3.3.2.3 Accident, sickness and unemployment insurance
3.3.2.3.1 Taxation of ASU policies
3.3.2.4 Private medical insurance
3.3.2.4.1 Underwriting
3.3.2.4.2 Taxation
3.3.2.5 Long-term care insurance
3.3.2.5.1 Benefits
3.3.2.5.2 Taxation of benefits
3.3.3 General insurance
3.3.3.1 Indemnity
3.3.3.2 Average
3.3.3.3 Excess
3.3.3.4 Buildings insurance
3.3.3.5 Contents insurance
3.3.3.6 All-risks insurance
126
128
128
129
129
130
130
132
132
133
133
134
134
134
135
136
137
138
139
140
140
141
142
142
142
143
144
144
145
145
146
146
147
[1] ix
Unit 1
3.3.3.7 Private motor insurance

3.3.3.7.1 Third party
3.3.3.7.2 Third party, fire and theft
3.3.3.7.3 Comprehensive
3.3.3.8 Travel insurance
3.3.3.9 Payment protection insurance (PPI)
3.3.3.10 Insurance premium tax
147
147
148
148
148
149
149
3.4
Derivatives
150
3.5
Lending products
151
3.5.1 Mortgages
3.5.1.1 Definitions
3.5.1.2 Repayment mortgages
3.5.1.3 Interest-only mortgages
3.5.1.3.1 Endowment assurances
3.5.1.3.1.1 Low-cost endowment
3.5.1.3.1.2 Unit-linked endowment
3.5.1.3.1.3 Performance review
3.5.1.3.2 Pension mortgages
3.5.1.3.3 Individual Savings Accounts Mortgages
3.5.1.4 Mortgage interest options and other schemes
3.5.1.4.1 Variable rate
3.5.1.4.2 Discounted mortgage
3.5.1.4.3 Fixed rate
3.5.1.4.4 Capped rate
3.5.1.4.5 Base rate tracker mortgages
3.5.1.4.6 Flexible mortgages
3.5.1.4.6.1 Current account mortgage
3.5.1.4.6.2 Offset mortgage
3.5.1.4.7 Cashbacks
3.5.1.4.8 Low-start mortgage
3.5.1.4.9 Deferred interest
3.5.1.4.10 CAT-standard mortgages
[1] x
151
151
152
152
153
153
154
155
155
156
157
158
158
158
158
158
159
160
160
160
161
161
161
3.5.1.5 Methods of releasing equity

3.5.1.5.1 Lifetime mortgages
3.5.1.5.2 Home Income Plans
3.5.1.5.3 Home reversion schemes
3.5.1.6 Shared ownership
3.5.1.7 Related property insurance
3.5.2 Other secured private lending
3.5.2.1 Second mortgages
3.5.3 Unsecured loans
3.5.3.1 Personal loans
3.5.3.2 Overdrafts
3.5.3.3 Revolving credit
3.5.3.3.1 Credit cards
3.5.3.3.2 Charge cards
3.5.3.3.3 Debit cards
3.5.4 Commercial loans
162
163
163
165
165
166
166
167
167
167
168
168
169
170
170
170
3.6
171
Pension products
3.6.1
Additional Voluntary Contributions/Free Standing

Additional Voluntary Contributions
3.6.2 Personal pensions
3.6.3 Stakeholder pensions
3.6.4 NEST Pension Schemes
173
174
174
175
Section 4 The financial planning and advice process

Introduction
181
4.1
The saving pattern
182
4.2
The financial lifecycle
183
4.2.1 School-age young people

4.2.2 Teenagers and students
4.2.3 Post-education young people
4.2.4 Young families
183
183
183
184
[1] xi
Unit 1
4.2.5 Established families

4.2.6 Mature households
4.2.7 Retirement
184
184
184
4.3
185
Gathering information
4.3.1 Clients circumstances

4.3.1.1 Personal and family details
4.3.1.2 Financial situation
4.3.1.2.1 Employment details
4.3.1.2.2 Income and expenditure
4.3.1.2.3 Assets
4.3.1.2.4 Liabilities
4.3.1.3 Plans and objectives
4.3.2 Attitude to risk
4.3.3 Client preferences
186
186
187
187
187
188
188
189
190
190
4.4
190
Identifying and agreeing needs and objectives
4.4.1
Agreeing order of priority
192
4.5
Recommending solutions
192
4.6
Implementing solutions
193
4.6.1 Presenting recommendations

4.6.2 Handling objections
4.6.3 Obtaining commitment to buy
4.6.4 Documentation
4.6.5 After-sales care
4.6.5.1 Proactive servicing
4.6.5.2 Reactive servicing
[1] xii
193
194
194
195
195
196
196
Section 5 The main areas of financial advice

Introduction
201
5.1
Budgeting
201
5.2
Protection
202
5.2.1 Family protection

5.2.1.1 Losses due to death
5.2.1.2 Losses due to sickness
5.2.1.3 Losses due to unemployment
5.2.2 Business protection
5.2.2.1 Death of a key employee
5.2.2.2 Death of a business partner
5.2.2.2.1 The automatic accrual method
5.2.2.2.2 The buy and sell method
5.2.2.2.3 The cross-option method
5.2.2.3 Death of a small business shareholder
5.2.2.4 Sickness of an employee
5.2.2.5 Sickness of a business partner
5.2.2.6 Sickness of a self-employed sole trader
202
202
203
204
204
204
206
206
206
207
207
207
207
208
5.3
Borrowing and debt
208
5.4
Investment and saving
209
5.4.1
5.4.2
5.4.3
5.4.4
5.4.5
Regular savings or lump sum

Level of risk
Accessibility
Taxation
The effect of inflation
210
210
210
211
211
5.5
Retirement planning
212
5.6
Estate planning
214
5.7
Tax planning
215
5.8
Regular reviews
216
[1] xiii
Unit 1
Section 6 Basic legal concepts relevant to financial

services
Introduction
221
6.1
Legal persons
221
6.2
Personal representatives and wills
222
6.2.1
Intestacy
223
6.3
Trusts and trustees
224
6.4
Companies
225
6.5
Partnerships
226
6.5.1
Limited liability partnerships
226
6.6
Law of contract
227
6.7
Law of agency
230
6.8
Ownership of property
231
6.8.1
6.9
6.10
Joint ownership
Power of attorney
Insolvency and bankruptcy
6.10.1 Individual voluntary arrangements

6.10.2 Company voluntary arrangements
[1] xiv
231
232
233
234
234
Unit 1
Introduction to the financial services
environment and products
After studying this unit, you will be able to demonstrate an
understanding of:
t
the purpose and structure of the UK financial services industry;
the main financial asset classes and their characteristics, covering

past performance, risk and return;
the main financial services product types and their functions;
the main financial advice areas;
the process of giving financial advice, including the importance of

regular reviews of the consumers circumstances;
the basic legal concepts relevant to financial advice;
the UK taxation and social security systems and how they affect
personal financial circumstances;
the impact of inflation, interest rate volatility and other relevant

socio-economic factors on personal financial plans.
[1] 1
[1] 2
Section 1
The UK financial services industry
Introduction
Section 1 begins by providing a broad introduction to the functions of the
financial services industry and to the institutions that make up the industry.
The impact of the government on the development of financial services is now
greater than it has ever been: some aspects of the involvement of government
are considered in this section (ie taxation and social security). Regulation of the
industry is considered in Unit 2.
Section 1 covers parts 1 and 7 of the syllabus for Unit 1, ie the purpose and
structure of the industry and the taxation and social security systems.
1.1 The functions of the financial services industry

The existence of money is taken for granted in all advanced societies today
so much so that most people are unaware of the enormous contribution that
the concept of money, and the industry that has developed to manage it, have
made to the development of our present way of life.
In earlier civilisations, the process of bartering was adequate for exchanging
goods and services: a poultry farmer could exchange eggs or chickens for
carrots and cabbages grown by a gardener. In modern society, people still
produce goods or provide services that they could, in theory, trade with others
for the things they need. The complexity of life, however, and the sheer size of
[1] 3
Unit 1
some transactions make it virtually impossible for people today to match what
they have to offer against what others can supply to them.
What is needed is a separate commodity that people will accept in exchange
for any product, which forms a common denominator against which the value
of all products can be measured. These two important functions (defined
technically as being a medium of exchange and a unit of account
respectively) are carried out by the commodity we call money. In order to be
acceptable as a medium of exchange, money must have certain properties. In
particular it must be:
t
sufficient in quantity;
generally acceptable to all parties in all transactions;
divisible into small units, so that transactions of all sizes can be precisely
carried out;
portable.
Money also acts as a store of value. In other words, it can be saved because
it can be used to separate transactions in time: money received today as
payment for work done or for goods sold can be stored in the knowledge that
it can be exchanged for goods or services later when required. To fulfil this
function, money must retain its exchange value or purchasing power and the
effect of inflation can, of course, adversely affect this function.
Notes and coins are legal tender, ie they have the backing of the government
and the central bank, but money comprises much more than cash. It includes
amounts held in current accounts and deposit accounts, and other forms of
investments.
The financial services industry exists largely to facilitate the use of money to
carry out these main functions. It oils the wheels of commerce and
government by channelling money from those who have a surplus, and wish to
lend it for a profit, to those who wish to borrow it, and are willing to pay for
the privilege (this is described in more detail in Section 1.1.1). Of course, the
financial organisations want to make a profit from providing this service and, in
the process of doing so, they provide the public with products and services
that offer, among other things, convenience (eg current accounts), means of
achieving otherwise difficult objectives (eg mortgages) and protection from
risk (eg insurance).
[1] 4
1.1.1 Intermediation
In any economy there are surplus and deficit sectors. The surplus sector
comprises those individuals and firms that are cash-rich, ie they own more
liquid funds than they currently wish to spend. These want to lend out their
surplus funds to earn money. The deficit sector comprises those who own
fewer liquid funds than they wish to spend. These are prepared to pay money
to anyone who will lend to them.
In this context, a financial intermediary is an institution that borrows
money from the surplus sector of the economy and lends it to the deficit
sector, paying a lower rate of interest to the person with the surplus and
charging a higher rate of interest to the person with the deficit. Banks and
building societies are the best-known examples. An intermediarys profit
margin is the difference between the two interest rates.
But why do the surplus and deficit sectors need the services of a financial
intermediary? Why can they not just find each other and cut out the
middlemans profit? Actually, there are some cases where this does happen and
this is known as disintermediation. Disintermediation is the process by
which lenders and borrowers interact directly rather than through an
intermediary. An example of disintermediation is when companies issue shares
to raise funds from the public.
There are, however, several reasons why both individuals and companies need
the services of the intermediaries. The four main reasons relate to the
following factors.
t
Geographic location: firstly, there is the physical problem that

individual lenders and borrowers would have to locate each other and
would probably be restricted to their own area or circle of contacts. An
individual potential borrower in Surrey is unlikely to be aware of a
person in Edinburgh with money to lend, but each may have easy access
to a branch of a high-street bank.
Aggregation: even if a potential borrower could locate a potential

lender, the latter might not have enough money available to satisfy the
borrowers requirements. The majority of retail deposits are relatively
small, averaging under 1,000, while loans are typically larger, with many
mortgages being for 50,000 and above. Intermediaries can overcome
this size difference by aggregating small deposits.
[1] 5
Unit 1
t
Maturity transformation: even supposing that a borrower could find

a lender who had the amount they wanted, there is a further problem.
The borrower may need the funds for a longer period of time than the
lender is prepared to part with them. The majority of deposits are very
short term (eg instant-access accounts), whereas most loans are
required for longer periods (personal loans are often for two or three
years, while companies often borrow for five or more years and typical
mortgages are for 20 or 25 years). Intermediaries are able to overcome
this maturity mismatch by offering a wide range of deposit accounts to
a wide range of depositors, thus helping to ensure that not all of the
depositors funds are withdrawn at the same time.
Risk transformation: individual depositors are generally reluctant to

lend all their savings to another individual or company, mainly because of
the risk of default or fraud. However, intermediaries enable lenders to
spread this risk over a wide variety of borrowers so that, if a few fail to
repay, the intermediary can absorb the loss.
1.1.2 Risk management

Another way of mitigating risk is offered by insurance, which has been defined
as a means of shifting the burden of risk by pooling to minimise financial loss.
Individuals effectively get together to contribute to a fund from which the
losses of the few who suffer in certain specified circumstances are covered.
Without the services of a central organisation the insurance company
individuals would struggle to find a convenient way of sharing their risks in this
manner. The companies therefore provide another form of intermediation.
1.1.3 Product sales intermediaries

There is a further type of intermediation, slightly different in nature from those
defined above. This is the intermediation that oils the wheels of the financial
services industry itself by bringing together the product providers (such as
banks and insurance companies) and the potential customers who wish to
purchase the providers products and services. These product sales
intermediaries include financial advisers, insurance brokers and mortgage
advisers.
[1] 6
1.2 Financial institutions

This section will briefly describe some of the types of financial institutions that
make up the financial services industry in the UK. Regulatory organisations are
not included here because they are described in more detail in Unit 2.
Prior to the 1980s, there were more clearly defined boundaries between
different kinds of financial organisations: some were retail banks, some
wholesale banks; others were life assurance companies or general insurance
companies, although a few offered both types of insurance and were known as
composite insurers; yet others were investment companies. Today, many of the
distinctions have become blurred, if they have not disappeared altogether.
Increasing numbers of mergers and takeovers have taken place across the
boundaries and now even the term bancassurance, which was coined to
describe banks that owned insurance companies (or vice versa), is inadequate
to describe the complex nature of modern financial management groups. For
example, one major UK bank offers the following range of services:
t
retail banking services;
mortgage services through a subsidiary that is a former building society;
credit card services, split into: UK customers; international customers;

corporate chargecards; and merchant services;
wealth management services, for high-net-worth individuals;
financial asset management (fund management) for institutional

customers;
investment banking, including financing, risk management and corporate

finance advice;
insurance services, by acting as an independent intermediary in relation

to general insurance and as an appointed representative in relation to
life assurance, pensions and income protection.
1.2.1 The Bank of England

The Bank of England (often referred to simply as the Bank) was founded by a
group of wealthy London merchants in 1964 and later granted a Royal Charter
by William III. It developed a unique relationship with the Crown and
Parliament, which was formalised in 1946 when it was nationalised and became
the UKs central bank. A central bank is an organisation that acts as a banker
[1] 7
Unit 1
to the government, supervises the economy and regulates the supply of money.
In the United States, for example, these tasks are the responsibility of the US
central bank, which is known as the Federal Reserve. Within the Eurozone of
the European Union, the European Central Bank (ECB) acts as central bank for
those states that have accepted monetary union.
The Bank of England has a number of important roles within the UK economy.
Its main functions are as follows.
t
Issuer of banknotes: the Bank of England is the central note-issuing

authority and is charged with the duty of ensuring that an adequate
supply of notes is in circulation.
Banker to the government: the governments own account is held at the

Bank of England. The Bank provides finance to cover any deficit by
making an automatic loan to the government. If there is a surplus, the
Bank may lend it out as part of its general debt management policy.
Banker to the banks: all the major banks have accounts with the Bank of
England for depositing or obtaining cash, settling clearing, and other
transactions. In this capacity, the Bank can wield considerable influence
over the rates of interest in various money markets, by changing the rate
of interest it charges to banks that borrow or the rate it gives to banks
that deposit.
Adviser to the government: the Bank of England, having built up a

specialised knowledge of the UK economy over many years, is able to
advise the government and help it formulate its monetary policy. The
Banks role in this regard has been significantly enhanced since May 1997,
with full responsibility for setting interest rates in the UK having been
given to the Banks Monetary Policy Committee (MPC). This committee
meets once a month and its mandate in setting the base rate is to ensure
that the governments inflation target is met.
Foreign exchange market: the Bank of England manages the UKs official
reserves of gold and foreign currencies on behalf of the Treasury.
Lender of last resort: the Bank of England traditionally makes funds

available when the banking system is short of liquidity, in order to
maintain confidence in the system. This function became very important
in 2007/2008 following a run on Northern Rock and subsequent
liquidity problems for a number of banks.
[1] 8
The Bank of England was also formerly responsible for managing new issues of
gilt-edged securities. This function has now been transferred to the Debt
Management Office within the Treasury, in order to avoid conflicts of interest
that might arise from the Banks responsibility for setting interest rates. Gilt
edged securities, also known as gilts, are loans to the government. There are a
wide variety of loans on different terms and for varying periods, including some
with no fixed redemption date. These securities are called gilt-edged because
the government guarantees their income and redemption amounts.
In addition to the functions described above, the Bank of England was
previously charged with responsibility for the supervision and regulation of
those institutions that make up the banking sector in the UK. This
responsibility was transferred to the Financial Services Authority (FSA) in
1998, but the Chancellor of the Exchequer announced in June 2010 that the
FSA was to be discontinued.
The commencement of the Financial Services Act 2012 on 1 April 2013
implemented the Governments commitment to strengthen the financial
regulatory structure in the UK. The legislation delivered significant reform of
the current regulatory system, dividing responsibility for financial stability
between the Treasury, the Bank of England and the new conduct of business
regulator, the Financial Conduct Authority (FCA).
The new system gave the Bank of England macro-prudential responsibility for
oversight of the financial system and, through a new, operationally independent
subsidiary, for day-to-day prudential supervision of financial services firms
managing significant balance-sheet risk. The FSA was replaced by the FCA,
created to protect consumers, promote competition and ensure integrity in
markets.
The legislation implemented these reforms by:
t
establishing a macro-prudential authority, the Financial Policy

Committee (FPC) within the Bank of England, to monitor and respond
to systemic risks;
clarifying responsibilities between the Treasury and the Bank of England

in the event of a financial crisis by giving the Chancellor of the
Exchequer powers to direct the Bank of England where public funds are
at risk and there is a serious threat to financial stability;
transferring responsibility for significant prudential regulation to a

focused new regulator, the Prudential Regulation Authority (PRA),
established as a subsidiary of the Bank of England; and
[1] 9
Unit 1
t
creating a focused new conduct of business regulator the Financial

Conduct Authority (FCA) which supervises all firms to ensure that
business across financial services and markets is conducted in a way that
advances the interests of all users and participants.
1.2.2 Proprietary and mutual organisations

We have already mentioned that the boundaries between different types of
financial organisation have become blurred. One distinction that still exists,
albeit to a reduced extent, is the split between proprietary and mutual
organisations.
Proprietary organisations, which account for the great majority of the
large financial institutions, are those that are limited companies. They are
owned by their shareholders, who have the right to share in the distribution
of the companys profits in the form of dividends and can contribute to
decisions about how the company is run by voting at shareholders meetings.
By contrast, a mutual organisation is one that is not constituted as a
company and does not, therefore, have shareholders. The most common types
of mutual organisation are building societies and friendly societies, each of
which is mutual by definition, and life assurance companies, of which only a
small proportion are mutual.
A mutual organisation is, in effect, owned by its members, who can determine
how the organisation is managed through general meetings similar to those
attended by shareholders of a company. In the case of a building society, the
members comprise its depositors and borrowers; for a life company, they are
the with-profit policyholders.
Since the Building Societies Act 1986, a building society has been able to
demutualise in other words, to convert to a bank (with its status changed
to that of a public limited company). Such a change requires the approval of its
members, but this approval has in practice generally been readily given, not
least because of the windfall of free shares to which the members have been
entitled following conversion to a company.
The possibility of a windfall on conversion led to a spate of carpetbagging. This
refers to the practice of opening an account at a building society that it is
believed will soon convert, purely to obtain the subsequent allocation of
shares. Societies considering conversion have, in response, sought to protect
[1] 10
the interests of their long-term members by placing restrictions on the

opening of new accounts.
In the past, some mutual life assurance companies, including Norwich
Union(now Aviva) and Standard Life, have also elected to demutualise.
1.2.2.1 Credit unions
Another example of a mutual organisation is the credit union. Credit unions
are financial co-operatives run for the benefit of their members who are linked
in particular ways, for instance by living in the same area or belonging to the
same club, church or other association. (A co-operative is an autonomous
group of people who have come together to meet common economic, cultural
and social needs by forming a jointly owned, democratic organisation.)
In order to join a credit union, the member must meet the membership
requirements, pay any required entrance fee and buy at least one 1 share in
the union. All members are equal, regardless of the size of their shareholding.
Due to the changes to the Credit Union Act 1979, which came into force on
8 January 2012, and which are detailed in the Legislative Reform (Industrial &
Provident and Credit Union) Order 2011, credit unions can now allow
membership on the basis of several different criteria, known as the field of
membership test. This will enable credit unions to offer services to new
groups such as housing associations, community groups and social enterprises.
Traditionally, credit unions operated in the poorer sections of the community,
providing savings and reasonably priced short- and medium-term loans to their
members as an alternative to loan sharks. In more recent years it has been
recognised that credit unions have a strong role to play in combating financial
exclusion and delivering a range of financial services and financial education to
those outside the mainstream. It has also been recognised that the image of
credit unions needs to be improved in order to encourage participation from
a wider range of consumers. As a result, the government has funded a number
of initiatives to widen the scope of the movement.
Credit unions are owned by the members and controlled through a voluntary
board of directors, all of whom are members of the union.The board members
are elected by the members at the annual general meeting (AGM). Although
the directors control the organisation, the day-to-day management is usually
carried out by employed staff. Credit unions are authorised and regulated by
[1] 11
Unit 1
the Financial Conduct Authority (FCA), and savers are protected through the
Financial Services Compensation Scheme.
Credit unions offer simple savings and loan facilities to members. Savers invest
cash in units of 1, with each unit buying a share in the credit union. Each share
pays an annual dividend, typically 23 per cent.The maximum rate of 8 per cent
for dividends was removed by the recent amendments to the Credit Union
Act, which also allows credit unions to accept deposits on which they pay
interest. These savings create a pool of money that can be lent to other
members; the loans typically have an interest rate of around 1 per cent of the
reducing balance each month (with a legal maximum of 2 per cent of the
reducing capital).
A unique feature of credit unions is that members savings and loan balances
are covered by life assurance. This means that any loan balance will be paid off
on death, and a lump sum equal to the savings held will also be paid, subject to
overall limits.
In order to compete in todays financial services marketplace, many credit
unions offer additional services, often in conjunction with partners, including
basic bank accounts, insurance services and mortgages.
Main changes brought about by the recent amendments to the Credit Union
Act include the following.
t
Credit unions no longer have to prove that all members have something
in common with each other, which means that they can provide services
to different groups of people, such as housing associations and
employees of a national company, even if some of the tenants/employees
live outside the geographical area that the credit union serves.
Credit unions can choose whether to offer ordinary shares (which are
paid up and bring all the benefits of credit union membership), or
deferred shares, which are only payable in special circumstances.
Credit unions can now choose to pay interest on savings instead of

dividends (although those that choose to pay interest must show that
they have the necessary systems and controls in place and have at least
500,000 or (5 per cent of total assets, whichever is greater) in reserve.
[1] 12
1.2.3 Retail and wholesale

The concepts of retail and wholesale are most obvious in the world of banking.
The main distinction between retail and wholesale transactions is one of size,
wholesale transactions being generally much larger than retail ones. Because of
this, the end-users of retail services are normally individuals and small
businesses, whereas wholesale services are provided to large companies, the
government and other financial institutions.
Retail banking is primarily concerned with the more common services
provided to personal and corporate customers, such as deposits, loans and
payment systems. It is largely the province of high-street banks and building
societies that deliver their products through traditional branch networks, call
centres, or the internet.
These institutions are, as described in Section 1.1.1, acting as intermediaries
between people who wish to borrow money and people who have money that
they are prepared to deposit. The price of borrowing and the reward for
investing is, of course, interest.
With the widespread replacement of cheques by credit and debit cards, the
traditional suppliers of retail banking are experiencing increasing competition
from major stores, such as Tesco and Sainsburys, which are offering their own
banking facilities, credit cards and other financial services.
Wholesale banking refers to the process of raising money through the
wholesale money markets in which financial institutions and other large
companies buy and sell financial assets.
This is the method normally used by finance houses, but the main retail banks
are also heavily involved in wholesale banking in order to top up deposits from
their branch networks as necessary. For example, if a bank has the opportunity
to make a substantial profitable loan but does not have adequate deposits, it
can raise the money very quickly on the interbank market. This is a very
large market encompassing over 400 banking institutions, which serves to
recycle surplus cash held by banks, either directly between banks or more
usually through the services of specialist money brokers. However, as a result
of the credit crisis of the late 2000s, banks have become increasingly reluctant
to lend to one another.
The rate of interest charged in the interbank market is the London
interbank offered rate (Libor). It acts as a reference rate for the majority
of corporate lending, for which the rate is quoted as Libor plus a specified
[1] 13
Unit 1
margin. Libor rates are fixed daily and vary in maturity from overnight through
to one year.
LIBOR is an average interest calculated through submissions of interest rates
by major banks in London. Banks submit the actual interest rates they are
paying, or would expect to pay, for borrowing from other banks. LIBOR is
supposed to be the total assessment of the health of the financial system, and
the confidence felt by the banks as to the state of affairs at any one time is
reflected in the rates they submit but they must be true. In the summer of
2012, a series of fraudulent actions connected to LIBOR were uncovered
known as the LIBOR Scandal. The scandal arose when it was discovered that
banks were falsely inflating or deflating their rates so as to profit from trades,
or to give the impression that they were more creditworthy than they were.
In September 2012, the British Bankers Association said that it would transfer
oversight of LIBOR to the UK regulators, and this is in the pipeline. In the
meantime, a review of LIBOR was carried out by Martin Wheatley, the
Managing Director of the then regulator, the Financial Services Authority.
The review recommended that banks submitting rates to LIBOR must base
them on actual inter-bank deposit transactions, and not on expectations of
what rates should or are expected to be. It was also recommended that
banks keep records of the transactions the rates relate to and that their
LIBOR submissions be published. Criminal sanctions are recommended for any
form of rate manipulation (the full report can be viewed at
http://hm-treasury/wheatley_review.htm).
Building societies are also permitted to raise funds on the wholesale markets,
up to 50 per cent of their liabilities.
The distinction between retail and wholesale in financial services is much less
obvious than it used to be, with many institutions operating in both areas. The
terms are not part of the day-to-day terminology in other financial areas such
as life assurance, pensions and unit trusts, but the concepts are present in the
background.
Some organisations are clearly based at the wholesale end of the market,
notably product providers such as life assurance companies and unit trust
managers. Other organisations and individuals, such as insurance brokers and
financial advisers, are purely retailers of the products and services offered by
the providers. Product providers that sell direct to the public or through their
own dedicated sales forces are, in effect, operating in both a wholesale and
retail capacity.
[1] 14
Independent Commission on banking

The Independent Commission on Banking was established in June 2010 to
consider structural and related non-structural reforms to the UK banking
sector to promote financial stability and competition. It was established in the
wake of the 2007 global financial crisis. The ICBs final report (known as the
Vickers report after the chairman Sir John Vickers) was published 12
September 2011. Its key recommendations were as follows.
t
UK retail ring-fencing: the ICB concluded that the best way to

prevent another financial crisis was to separate retail banking operations
from investment/wholesale banking functions, effectively creating a ringfence around personal and SME deposits and overdrafts. The aim is to
provide continuity of service to those more vulnerable customers, while
allowing the banking groups activities outside the ring-fence to fail in an
orderly fashion.
Capital: under the recommendations, the largest ring-fenced UK retail

banks will be required to hold equity capital equivalent to 10 per cent
of their risk-weighted assets (RWAs). They will also have to hold capital
equivalent to an additional 710 per cent of RWAs in the form of
primary loss-absorbing capital.
Bail-in and depositor preference: the report recommends that the

UK resolution authority should have a statutory power of bail-in (to
recapitalise banks in resolution) and that insured deposits should have
preferred creditor status.
Competition: the ICB called for improved processes for customers to

switch accounts and greater transparency so that customers can
compare prices. The proposals may also create opportunities for nonUK banks to compete in the British retail banking market and could
inhibit UK investment banking operations in competing globally.
Structural reform: under ring-fencing, banks will be required to create

separate standalone subsidiaries with their own governance
arrangements. There will be limits on their financial and operational links
with investment or wholesale banking entities in the wider group. The
ICB has allowed flexibility over the positioning of other activities such as
the corporate loan book.
The government has committed to completing the necessary primary and

secondary legislation to give effect to the ring-fence by May 2015, ie the end
of this Parliament, and full compliance by banks is expected by 2019.
[1] 15
Unit 1
1.2.4 Money transmission and the clearing process

Money transmission is a term that covers a range of services, including the
provision of cash, cheque clearing, direct debits and standing orders, credit and
electronic transfers, and credit card services. The original source of these
services for most customers was through a branch network, with customers
visiting their banks to make their transactions and possibly to see their
personal or business manager. Although branch networks still exist, many of
them are reduced in extent, and numerous other methods of delivery are now
also provided, include automatic teller machines (ATMs) in remote locations
such as supermarkets, as well as telephone banking and internet banking for
account management and payment of bills.
1.2.4.1 Current accounts
The basis of money transmissions for most people is the current account,
which enables money to be paid in or taken out as cash, by cheque or
electronically. In the UK, current accounts also generally offer an overdraft
facility. Originally, current accounts were no-frills accounts on which
customers paid monthly or quarterly fees for the service provided by the bank.
Fierce competition for customers led most banks to dispense with the fees and
sometimes to pay interest on current account balances. More recently some
banks have offered current accounts with additional benefits packages including
travel insurance or car breakdown cover, usually for the payment of a fee.
These accounts are known as packaged accounts.
Traditionally, current accounts were held mainly by middle- and higher-income
groups in the UK, but were much less common among lower-income groups.
To some extent this distinction has been removed by the insistence of many
employers on paying wages direct to a bank or building society, but there still
remain a significant number of people estimated at around 1.5m households
in the UK who do not have a bank account.
This led to the introduction of a new form of current account, the basic bank
account, largely as a result of pressure from the government.This is a simplified
current account designed to encourage people who have not previously had
an account to open one and also to be used by people (typically on low income
or state benefits) who might not otherwise be able to open a current account.
Basic bank accounts are particularly appropriate for people receiving state
benefits or pensions who have been accustomed to receiving their payments
in cash. The accounts are able to receive money by a wide variety of methods
[1] 16
but the methods of withdrawing money are limited. Cash can be obtained with
a card from ATMs and from post offices. Payments can be made by direct debit
but no chequebooks are issued on these accounts and there is no overdraft
facility.
1.2.4.2 Clearing
At the very heart of money transmission services is the clearing process.
Clearing in the banking context refers to the process of settling between banks
the transfers of money outstanding as a result of customers use of cheques,
direct debits, debit cards and other means of money transfer. This happens at
the end of each business day. For instance, NatWest will need to pay to
Barclays a total sum in relation to cheques written by its customers and
banked by Barclays customers and of course exactly the same will be true
in reverse. As a result, a net figure will be due from one of the banks to the
other, and this is settled through accounts that the banks hold at the Bank of
England.
As a result of the development of more automated methods of fund transfer,
such as direct debits and debit cards, cheque volumes are falling and are
expected to continue to fall. Around five million cheques a day are issued in the
UK, less than half the amount 15 years ago. More than four times as many card
transactions as cheques are used daily, and it is estimated that by 2015 less than
3 per cent of all non-cash transactions will be by cheque. This trend has been
accelerated by the decision of many retailers, such as supermarkets and petrol
stations, to cease accepting payment by cheque. It has been suggested that
cheques as a form of money transfer may be withdrawn, possibly as soon as
2018.
Not all retail banks are clearing banks. Clearing banks are those that have
established their own clearing systems in conjunction with other clearing
banks. Those banks, and some building societies, that require payment systems
to be set up but do not have their own clearing service have to establish an
agency arrangement with one of the clearing banks.
Clearing services in the UK are co-ordinated by the UK Payments
Administration Ltd (formerly APACS), an association of major banks and
building societies that acts as the umbrella organisation for the UK payments
industry. It manages the major UK payment clearing systems through three
operational clearing companies:
[1] 17
Unit 1
t
the Cheque and Credit Clearing Company, which oversees the

clearing of cheques and paper credits on a three-day processing cycle;
the Bankers Automated Clearing Services Ltd (BACS), which is

responsible for the bulk electronic clearing (eg direct debits) operated
on their behalf by VocaLink Ltd; and
the Clearing House Automated Payment System (CHAPS), an

electronic same-day interbank transfer system for high-value wholesale
payments.
In November 2007, the 2-4-6 clearing system was introduced. Funds from
deposited cheques start earning interest after two days, are available to
withdraw after four days, and cannot be reclaimed due to insufficient funds in
the drawers account after six days.
1.3 The role of government

1.3.1 The influence of the European Union
The UK has been a member of the European Union (as it is now known) since
1973. However, it remains outside the eurozone, having chosen not to adopt
the euro when the single currency was introduced in 1999.
In spite of the UK retaining, at least for the time being, its own currency and
control over its own monetary policy, the financial services industry is hugely
influenced by the European Unions policies and laws. Few people realise that
large portions of the UKs financial regulatory regime for individuals and for
companies are closely determined by European laws. This includes regulation
relating to banking, investment, life assurance, general insurance, operating as a
financial adviser, compensation for losses, money laundering, data protection
and many other areas.
The European Parliament and the Council of Ministers share the power to
adopt European laws, often acting on suggestions from the European
Commission. These laws can take a number of forms, of which the two most
common are regulations and Directives:
t
regulations have general application, are binding in their entirety and

directly applicable in all member states (unless particular states have
specific dispensation);
[1] 18

t
Directives are binding as to the result to be achieved upon each

member state to which they are addressed. In other words, the
objectives of the Directive must be achieved within a specified timescale
(typically two years) but exactly how they are achieved is left to national
authorities in each state.
Many of the regulatory requirements that affect UK financial services

organisations can be seen to mirror closely the details found in related
European Directives, and the former regulator, the FSA, estimated that in 2011
around 70 per cent of its policy making effort was driven by European
initiatives.
The financial crisis highlighted some weaknesses in Europes financial
regulatory systems and emphasised the need for reform of virtually every area
of EU wide financial services. The EU set up the new European System of
Financial Supervision (ESFS), recognising that improved regulatory cooperation was needed in Europe to ensure that regulators are properly
informed about relevant risks, that there is a consistent approach to common
community requirements, and that oversight of internationally active firms is
improved.
The EU has sought to achieve this through a network of national regulators
and now through the European Supervisory Authorities (ESAs). Also, the G20
agreed that the primary cause of the financial crisis was failure to identify
international systemic risk, so the EU set up the European Systemic Risk
Board.
The European Systemic Risk Board (ESRB) was established on the 1 January
2011 and has responsibility for the macro-prudential oversight of the financial
system within the EU; it plays a key part in the new European System of
Financial Supervision.
1.3.1.1 European Supervisory Authorities
In 2011, the EU set up three European Supervisory Authorities that have
significant powers to propose new rules and make decisions that are binding
upon national supervisors, such as the FCA, and firms directly. The ESAs are:
t
The European Securities and Markets Agency (ESMA);
The European Banking Agency (EBA);
The European Insurance and Occupational Pensions Authority (EIOPA).
[1] 19
Unit 1
The aims of the ESAs are to:

t
create a single EU rule book by developing draft technical standards,

which will then be adopted by the European Commission as law. The
ESA will also issue guidance and recommendations with which national
supervisors and firms must comply;
investigate national supervisory authorities who are failing to apply, or

who are in breach of, EU law;
in a crisis, provide EU-wide coordination and, if an emergency is

declared, make decisions that are binding upon national supervisors and
firms;
mediate in certain situations where national supervisory authorities

disagree and, if necessary, make decisions that are binding on both
parties to ensure compliance with EU law;
conduct reviews of national supervisory authorities to improve

consistency of supervision across the EU;
consider consumer protection issues.
ESMA has direct supervisory responsibility for credit reference agencies.
1.3.2 Regulation in the UK

Regulation of the financial services industry in the UK is, broadly speaking, a
five-tier process.
t
First level: European legislation that impacts on the UK financial

industry. The two main types of European legislation are regulations and
Directives (see Section 1.3.1).
Second level: the Acts of Parliament that set out what can and cannot
be done. Whenever reference is made to Acts of Parliament, it should be
borne in mind that the effects of the laws are often achieved through
subsidiary legislation known as statutory instruments which are
made pursuant to the Act. Examples of legislation that directly affect the
industry are the Financial Services and Markets Act 2000, the Banking
Act 1987 and the Building Societies Act 1997.
Third level: the regulatory bodies that monitor the regulations and
issue rules about how the requirements of the legislation are to be met
in practice. The main regulatory bodies are the Prudential Regulation
Authority (PRA) and the Financial Conduct Authority (FCA).
[1] 20

t
Fourth level: the policies and practices of the financial institutions

themselves and the internal departments that ensure they operate
legally and competently, eg the compliance department of a life
assurance company.
Fifth level: the arbitration schemes to which consumers complaints

can be referred. For most cases, this will now be the Financial
Ombudsman Service, which has taken over the responsibilities of a
number of earlier ombudsman bureaux and arbitration schemes.
The current regulatory regime is described in more detail in Unit 2.
1.3.3 Taxation
Governments use taxation not only for the basic process of raising revenue but
also as a means of controlling the money supply. Here we will consider briefly
how the manipulation of the taxation regime can have an impact on the
financial services marketplace, before we review the main UK taxes. This
section will give an overview of the main UK taxes, together with some detail,
but it is not intended to equip its readers to give professional taxation advice.
Changes in taxation affect the market for financial services and products in two
main ways:
t
increased general taxation reduces the amount of money available for

investment or to fund loan repayments;
tightening of the taxation regime for particular products makes them

less attractive to investors. An example of this is the governments
decision, in 1998, to remove the right of pension fund managers to
reclaim tax deducted from dividends received. The effect of this step is
that pension funds are now taxed on a proportion of their income,
whereas previously they were effectively tax-free. Although this move
was clearly made in order to bring in more tax revenue, it seems to be
in conflict with the governments acknowledged need to persuade
individuals to contribute more towards their own pension provision.
It is worth mentioning that, with many of the more popular investment

schemes, such as unit trusts and investment trusts, there are two possible
levels at which taxation can occur: the fund managers can be taxed and the
investor can be taxed. It is essential to view both aspects when assessing the
tax position of an investment.
[1] 21
Unit 1
1.3.3.1 Residence and domicile

Whether or not a person is liable to pay income tax, capital gains tax and
inheritance tax will depend on the taxpayers residence or domicile according
to UK law.
Residence mainly affects income tax and capital gains tax. Any person who is
present in the UK for at least 183 days in a given tax year is regarded as a UK
resident for tax purposes.
A person who is resident in the UK should be subject to UK income tax on
their worldwide earned and unearned income, whether or not such income is
brought into the UK. Similarly, capital gains tax is charged on the realisation of
gains anywhere in the world. The UK, however, has double taxation agreements
with many other countries, the purpose of which is to ensure that individuals
are not taxed twice on the same income or gains.
Domicile is best described as the country that an individual treats as their
home, even if they were to live for a time in another country. Everyone
acquires a domicile of origin at birth. This is the domicile of their father on
the date of their birth (or the domicile of the mother if the parents are not
married).
A person can change to a different domicile (known as domicile of choice)
by going to live in a different country, intending to stay there permanently and
showing that intent by generally putting down roots in the new country and
severing connections with the former country. There is no specific process for
this.
Domicile mainly affects liability to inheritance tax. If a person is domiciled in
the UK, inheritance tax is chargeable on assets anywhere in the world, whereas
for persons not domiciled in the UK, tax is due only on assets in the UK.
Persons who are not UK-domiciled but have lived in the UK for at least 17 of
the previous 20 years are, however, deemed to be UK-domiciled for
inheritance tax purposes.
1.3.3.2 Income tax
Income tax is one of the main sources of government revenue. Liability for
income tax is based on income received in a tax year or fiscal year that, in the
UK, runs from 6 April in one calendar year to 5 April in the next.
[1] 22
Each year, following delivery of the Budget, a Finance Bill is published containing
the taxation proposals made in the Budget. When the Bill is approved by
Parliament and later becomes law, the new tax measures take effect at dates
provided in the legislation.
The new Act (a Bill that has gone through Parliament and has received Royal
Assent) becomes a part of the substantial body of legislation that forms the
basis of the rules relating to income tax and other taxes.
The main statute is the Income and Corporation Taxes Act 1988 but there are
other sources of tax law, both by way of statute and case law.
Tax is due from individuals on their income from employment (including
benefits in kind, such as company cars) and also on interest, dividends and
other income they receive from investment. All UK residents, including
children, may be subject to income tax, depending on the type and amount of
income they receive.
All residents, both children and adults, who are not income taxpayers, are
entitled to make a declaration (on form R85) that they do not pay tax. They
are then able to receive interest from certain deposits gross, without
deduction of tax at source.
The income of a child that arises from a settlement or arrangement made by
the parents, will normally be treated as the parents income for tax purposes.
If treated as the parents income, a childs unused allowances cannot be set
against this income.
Not all of the income that an individual receives is taxable. Examples of types
of income that are taxable and of those that are not are given below.
Income assessable to tax includes:
t
salary/wages from employment, including bonuses and commissions, and

taxable benefits in kind;
pensions and retirement annuities, including state pension benefits;
profits from a trade or profession;
inventors income from a copyright or patent;
tips;
interest on bank and building society deposits;
dividends from companies;
[1] 23
Unit 1
t
income from government stocks and local authority stocks;
income from trusts;
rents and other income from land and property;
the value of benefits in kind, such as company cars or medical insurance

(if total income, including the value of benefits in kind, exceeds 8,500).
Income not assessable to tax includes:

t
redundancy payments and other compensation for loss of office (if total
receipts exceed 30,000, then the excess over 30,000 is assessable);
the first 2000 of shares given to an employee in their employers

company (workers participating in this employee shareholder scheme
must agree to waive certain employee rights in exchange for the shares);
interest on NS&I Savings Certificates;
income from ISAs;
certain covenanted or Gift Aid payments;
proceeds of a qualifying life assurance policy (in most circumstances);
casual gambling profits (eg football pools, etc);
lottery prizes;
wedding presents and certain other presents from an employer that are
not given in return for ones services as an employee;
certain retirement gratuities and redundancy monies paid by an

employer (within limits);
any scholarship or other educational grant that is received if one is a fulltime student at school, college, etc;
certain grants received from an employer solely because an individual

has passed an examination or obtained a degree or diploma (certain
criteria need to be satisfied in order for such grants not to be taxable);
war widows pensions;
certain social security benefits;
housing grants paid by local authorities;
the capital part of a purchased life annuity (but not the interest portion);
interest on a tax rebate.
[1] 24
1.3.3.2.1 Allowances and tax rates

In addition, all UK residents, including children from the day of their birth, have
a personal allowance, ie an amount of income that can be received each year
before income tax begins to be charged. In the 2013/14 tax year, this allowance
is 9440 rising to 10,500 for people aged 65 and over, and to 10,660 at age
75. Personal allowances cannot be transferred to a spouse or any other
person, even where an individual has insufficient income to use the full
allowance.
For persons over the age of 65 whose annual income exceeds a certain figure
(26,100 in 2013/14), the increased personal allowance is reduced, on a scale
of 1 reduction for every 2 of income above the threshold. It cannot be
reduced below the level of the basic under-65 allowance except that, for
persons with income over 100,000, the personal allowance is reduced,
without limit, by 1 for every 2 of income over 100,000. (The age-related
allowance for the over 65s is abolished for new claimants after April 2013, and
will be frozen at current levels for those born before 6 April 1948.)
The Blind Persons Allowance (2,160 in 2013/14) is available to those
registered with a local authority as blind. If the allowance cannot be used by
the blind person, it can be transferred to the spouse, even if the spouse is not
blind.
Prior to April 2000, married couples were entitled to receive an additional
allowance, but this has now been withdrawn, except that it continues to be
available to couples where at least one spouse was born before 6 April 1935.
In addition to these allowances, taxpayers are permitted to make certain
deductions from their gross income before their tax liability is calculated.These
include:
t
pensions contributions (within specified limits) either to a scheme

set up by an employer or to a personal pension or stakeholder pension;
allowable expenses, such as costs incurred in carrying out ones

employment. For self-employed persons, these must be incurred wholly
and exclusively for the purpose of trade, while for employed persons
they must be incurred wholly, exclusively and necessarily while doing
the job.
When all the relevant deductions have been made from a persons gross
income, what remains is their taxable income. This is the amount to which the
appropriate tax rate(s) is applied in order to calculate the tax due.
[1] 25
Unit 1
Income tax rates and the bands of income to which they apply are reviewed
by the government each year. Any changes are announced in the Budget and
included in the subsequent Finance Act.
In the 2013/14 tax year, the tax rate on earned income is 20 per cent (basic
rate) on the first 32,010 of taxable income, 40 per cent (higher rate) on
taxable income between 32,011 and 150,000, and 45 per cent (additional
rate) on income above 150,000. For investment income (eg deposit account
interest), there will continue to be an initial lower rate band of 10 per cent up
to 2,790, with the basic rate (20 per cent) applying above 2,790 and up to
32,010 the higher rate (40 per cent) between 32,011 and 150,000 and the
additional rate above 150,000. However, if an individuals non-savings taxable
income is above 2,790, then the 10 per cent savings rate does not apply.
For most forms of investment income, tax is normally deducted at source. This
applies, for example, to interest on bank and building society deposit accounts
and to ordinary shares. In the case of deposit accounts, non-taxpayers can
choose to receive their interest without deduction of tax by signing an
appropriate declaration. Since many depositors pay basic rate income tax,
interest rates are often quoted net, ie after deduction of 20 per cent tax. The
true gross rate can be calculated by dividing the net rate by 0.8, so, for
example, a net rate of 3 per cent is equivalent to a gross rate of 3.75 per cent.
Higher-rate taxpayers will have to pay a further 20 per cent of the grossed-up
interest through their tax returns or tax coding (and additional-rate taxpayers
a further 25 per cent).
A different system applies to share dividends, which are received net of a
nominal 10 per cent tax. This is deemed to satisfy the income tax payable by
lower-rate taxpayers and also basic-rate taxpayers, who have no more to pay.
In this case, the gross dividend can be calculated by dividing the net dividend
by 0.9, so that if a shareholder receives a net dividend of 100, say, the
equivalent gross dividend is 111.11. In this case, a higher-rate taxpayer has to
pay a further 22.5 per cent of the grossed-up dividend, making an unusual total
higher rate of 32.5 per cent on share dividends. The additional rate (above
150,000) is 37.5 per cent. In the case of share dividends, non-taxpayers are
not able to reclaim the 10 per cent tax deducted at source.
The method of collection of income tax from employment depends on the
nature of a persons work.
[1] 26
1.3.3.2.2 Employees
Employees pay income tax under the pay-as-you-earn (PAYE) system, under
which the amount of tax due is calculated by their employers using tables
supplied by HM Revenue & Customs (HMRC), deducted from their wages or
salary and passed on by their employers to HMRC. In order to deduct the right
amount of tax, the employer is supplied with a tax code number for each
employee: the tax code is related to the amount of free pay for the employee,
including allowances, exemptions and adjustments for fringe benefits and for
amounts overpaid or underpaid from previous years.
A P60 is issued to each employee by the employer in April each year. This
shows, for the previous tax year, total tax deducted, National Insurance
Contributions and the final tax code.
On leaving an employer, an employee should be provided with a form P45
showing:
t
name;
district reference;
code number;
week or month of last entries on the employees deductions working

sheet;
total gross pay to date;
total tax due to date.
A copy is sent to HMRC. The P45 provides the new employer with all the
information they require to complete a new tax deductions working sheet for
the employee.
1.3.3.2.3 Self-employed persons
Self-employed persons (including partners in a business partnership) pay
income tax directly to HM Revenue & Customs (HMRC) on the basis of a
declaration of net profits calculated from their accounts. Net profits for a selfemployed person are broadly the equivalent of the gross income of an
employee, ie they are the amount on which income tax is based. They are
calculated by taking the total turnover of the business and deducting allowable
business expenses and capital allowances.
[1] 27
Unit 1
Under the current self-assessment rules, taxpayers are expected to calculate

their own liability and submit their figures to the tax authorities for approval
(although taxpayers who submit their returns promptly can ask HMRC to do
the calculation for them). Many self-employed persons engage an accountant to
prepare their accounts for them and to deal with HMRC on their behalf.
Self-employed persons pay their income tax (plus Class 4 National Insurance
Contributions) in two equal parts. The first payment is due on 31 January of
the tax year in which their business year ends; the second is due on 31 July, six
months later.
1.3.3.2.4 Classification of types of income
Different types of income used to be classified under Schedules A, D, E and F.
These schedules have now been abolished for income tax purposes and
replaced by a new regime established under two pieces of legislation:
t
Income Tax (Earnings and Pensions) Act 2003. This covers income
that previously fell under Schedule E income from employment,
pensions and taxable social security benefits.
Income Tax (Trading and Other Income) Act 2005. This covers
income that previously fell under the other schedules, in particular:
Part 2: Trading income, ie income from self-employment that
previously fell under Schedule D Cases I and II;
Part 3: Income from property (previously Schedule A);
Part 4: Income from savings and investment, including interest,
previously under Schedule D Case III, and dividends, previously under
Schedule F.
Although the legislative source of the rules has changed, the way in which tax
is calculated is unchanged.
1.3.3.2.5 Income taxed at source
Whenever possible, HM Revenue & Customs collects income tax at source, ie
from the person who makes the payment, not the recipient. Tax is usually
deducted at the basic rate and any further liability at the higher rate will be
collected by direct assessment on the taxpayer.
[1] 28
An example of where tax is deducted at source is PAYE (see Section 1.3.3.2.2).

Employers deduct tax weekly or monthly (as appropriate) from wages and
salaries, which are then paid to the employee net of tax. (This does not take
account of other deductions that are also made, eg National Insurance
Contributions.)
1.3.3.2.6 Tax-paid investment income
Where investment income has been taxed at source, the recipient normally
has no further tax to pay, unless as a higher-rate taxpayer. Higher-rate taxpayers
are liable for the difference between the higher rate and the rate of tax
deducted at source.
Examples of investments that have income tax deducted at source include:
t
interest on fixed-interest loans to companies (eg loan stocks and

debentures);
distributions from unit trusts;
dividends from UK companies (dividends are not subject to deduction

of income tax and are dealt with by the use of tax credits, but the result
to the taxpayer is the same);
the interest from building society and bank deposits;
the interest element of certain life annuities;
interest from certain finance company deposits;
income from trusts and settlements.
In most cases, non-taxpayers can reclaim the tax deducted at source by

completing a tax return.
1.3.3.2.7 Taxation of proceeds from a life assurance policy
An investors premiums paid into a companys life fund are invested in different
assets such as property, gilts, shares, etc. It is necessary to be aware of how the
taxation of the life fund itself impacts on the investor.
In effect, the fund pays sufficient tax to satisfy the basic rate tax liability on
income such as dividends, gilt interest or rental income. When the fund sells
any of its assets at a profit, it incurs 20 per cent tax on the capital gain.
[1] 29
Unit 1
The net result for the investor is that all benefits coming out of a life fund are
deemed to have already borne tax at 20 per cent and for the basic-rate
taxpayer there is no further liability. There may, however, be a tax liability for a
higher-rate taxpayer, amounting to 20 per cent of the gain (ie higher-rate tax
of 40 per cent less the 20 per cent already paid), or 25 per cent of the gain (ie
additional-rate tax of 45 per cent less the 20 per cent already paid).
This additional tax liability can only arise if the policy is non-qualifying. Qualifying
policies do not suffer any additional tax. Broadly speaking, in order to be a
qualifying policy, a policy must meet the following rules.
t
Premiums must be payable annually, half-yearly, quarterly or monthly for

at least ten years.
If premiums cease within ten years, or three-quarters of the original
term if less, the policy becomes non-qualifying.
Premiums in any one year must not exceed twice the premiums in any
other year or one-eighth of the total premiums payable.
The sum payable on death must be at least equal to 75 per cent of the
total premiums payable.
1.3.3.2.8 Taxation of proceeds from a unit trust

The investments within a unit trust will generate income in the form of
dividends on shares and gilt interest. Dividends from UK shares are received
net of tax; when passed on to unit-holders, there is no liability to basic-rate tax.
There may, however, be a liability for higher-rate tax.
Gilt interest and dividends on foreign shares, however, will not have paid UK
tax. The unit trust in this instance will pay corporation tax on foreign dividends
and basic-rate tax on gilt interest. Unit trusts are exempt from capital gains tax
(CGT) but unit-holders may have a liability if they sell units at a profit.
1.3.3.2.9 Calculation of income tax liability
The calculation of personal liability to income tax is broadly speaking a fourstage process as follows.
1.
Ascertain the total income.
2.
Make appropriate deductions. For self-employed people, the expenses of

running their business are allowable deductions. Employees may also be
[1] 30
able to deduct certain expenses if they can show they were incurred
wholly, exclusively and necessarily while doing their job. Contributions to
a pension scheme can be set against tax and, in the case of occupational
schemes, this is done by deducting contributions from gross salary. The
tax relief for other pension arrangements such as stakeholder pensions
and free-standing AVCs is, however, obtained by deduction from the
contributions before they are paid, so these are not deducted from
income.
3.
Deduct personal allowance and other reliefs (eg blind persons

allowance).
4.
The resultant figure is known as the taxable income and the current tax
rates are applied to the appropriate bands of income, as described earlier.
Example 1
A married man aged 30 receives 20,000 (gross) building
society interest, and no other income, in the 2013/14 tax year.
He has a personal allowance of 9,440.
Gross income
20,000
Personal allowance
9,440
Taxable income
10,560
Income tax due

2,790 at 10%
279
7,770 @ 20%
1,554
Total tax due
1,833
[1] 31
Unit 1
Example 2
A single woman aged 40 earns 50,000 (gross) pa in the
2013/14 tax year. She has no other income. She is employed
and has a personal allowance of 9,440.
Gross income
50,000
Personal allowance
9,440
Taxable income
40,560
Income tax due

32,010 at 20% =
6,402
8,550 at 40% =
3,420
Total tax due
9,822
If a persons income comes from several different sources, there is an order of

priority in which different forms of income are taxed: earned income is taxed
first, then interest, and, finally, dividends.This may make a difference because the
tax calculation for dividends, for instance, is different from that for interest.
1.3.3.3 National Insurance
National Insurance Contributions are a form of taxation in everything but
name. They are in effect a tax on earned income and are payable in different
ways according to whether the earner is employed or self-employed.
They are classified as follows.
t
[1] 32
Class 1: these are paid by employees at 12 per cent on earnings

between certain levels known as the primary threshold (149 per week
in 2013/14) and the upper earnings limit (797 per week in 2013/14),
with a reduced level of 2 per cent payable on earnings above the upper
limit. They are also paid by employers at 13.8 per cent on employees
earnings above a lower limit called the secondary threshold (148 per
week in 2013/14) but with no upper limit. Reduced contributions apply
if employees are contracted out of the state second pension (S2P).

t
Class 2: these are flat-rate contributions paid by the self-employed if

their annual profits exceed a specified lower threshold (5,725 pa for
2013/14). They are quoted as a weekly amount (2.70 per week in
2013/14) but are normally paid monthly by direct debit. Many selfemployed people also pay Class 4 contributions.
Class 3: these are voluntary contributions that can be paid by people

who would not otherwise be entitled to the full basic pension or
sickness benefits. This can occur because a person has, for instance,
taken a career break or spent some time working overseas. They are
flat-rate contributions (13.55 per week in 2013/14).
Class 4: these are additional contributions payable by self-employed

persons on their annual profits between specified minimum and
maximum levels, with a reduced rate payable above the upper limit, as
for Class 1. They are paid to HMRC in half-yearly instalments along with
income tax.The rate for 2013/14 is 9 per cent of profits between 7,755
and 41,450, plus 2 per cent of profits above 41,450.
1.3.3.4 Capital gains tax

Capital gains tax (CGT) is payable on the net gain made on the disposal of
certain physical assets and the realisation of many financial assets, including
shares and unit trusts. Most disposals relate to the sale of an asset but the full
definition of a disposal also includes transferring or giving an asset, or receiving
compensation for its loss or destruction.
There are some circumstances under which CGT is not due in particular, it
is not payable when property changes hands as the result of a death (although
there may be inheritance tax see Section 1.3.3.5). There is a deemed disposal
of assets on death, when the assets are deemed to be acquired by the personal
representatives at their market value at the time of death. This is to establish
the cost of acquisition, should it be necessary at some time in the future to
calculate capital gains.
Similarly, there are certain assets that are exempt from CGT, including:
t
main private residence;
ordinary private motor vehicles;
personal belongings, antiques, jewellery and other tangible movable

objects (referred to as chattels), provided each object is valued at
6,000 or less;
[1] 33
Unit 1
t
gifts of items of national, historic or scientific interest to the nation;
foreign currency for personal expenditure;
British government stocks (gilts);
NS&I Savings Certificates and Save As You Earn schemes;
Premium Bonds winnings and lottery winnings;
gains on qualifying life assurance policies disposed of by the original

owners;
individual savings accounts (ISAs).
If an individual makes a loss on disposal of an asset, this can be offset against

gains made elsewhere. It must be offset first against gains in the year the loss
occurred. Residual losses may then be carried forward to future years. A capital
loss cannot, however, be carried back to a previous year.
Tax is payable on net gains made in the tax year, after deducting any allowable
capital losses that were made in the same year or carried forward from
previous years. Each individual also has an annual CGT allowance (10,900 in
2013/14) rather like the personal income tax allowances, this is the level of
gains that can be made in the tax year before CGT starts to be payable. This
figure also applies to trustees of a mentally disabled person and to personal
representatives; half the amount (5,450 in 2013/14) applies to most other
trustees. The annual allowance cannot be carried forward to subsequent years
if it is unused in the year to which it applies.
Given that capital losses can be carried forward but the annual exemption
cannot, capital losses brought forward are used only to the extent necessary
to reduce gains to the level of the annual exemption. Residual losses are then
carried forward.
1.3.3.4.1 Calculation of CGT
The calculation of the amount of a taxable gain is governed by a number of
rules that make it more complex than merely a simple subtraction of purchase
price from sale price. However, the process has been simplified since 6 April
2008 by the removal of indexation and taper relief. The rules include:
t
costs of purchase can be added to the purchase price and selling costs
can be deducted from the sale price;
[1] 34

t
the cost of improvements to an asset can be treated as part of its

purchase price (but costs of maintenance and repair cannot);
capital gains made prior to 31 March 1982 are not taxed so, for an asset
acquired before that date, its value on that date must be substituted for
the actual purchase price.
When the amount of the gain has been calculated, deduct the annual CGT
allowance (if this has not been used against other gains in the same tax year).
Then deduct any losses that can be offset against the gain. What remains is the
taxable gain.
For basic-rate taxpayers, the taxable gain is subject to 18 per cent tax; for
higher rate and additional rate taxpayers the rate is 28 per cent.
A lower rate of 10 per cent is applied to the first 10m of cumulative gains
arising from the disposal of trading businesses and from certain disposals of
shares in trading companies. This is commonly known as entrepreneurs
relief. In order to claim this relief, the individual must own at least 5 per cent
of the ordinary share capital of the business, which enables them to exercise
at least 5 per cent of the voting rights in that company. Most property letting
businesses do not qualify for this relief.
Example
Vanessa, a basic-rate taxpayer, bought units in a unit trust for
50,000 in May 2007 and sold them for 80,000 in June 2012. At
the same time she sold some shares for 10,000 that she had
bought for 12,000.
What capital gains tax will she pay?
Gain on unit trust
30,000
Deduct annual allowance
10,900
Deduct loss on shares
2,000
Taxable gain
17,100
Tax @ 18%
3,078
[1] 35
Unit 1
One constant source of complaint about the capital gains tax regime is that
CGT is due on the whole gain in the year in which the gain is realised, even
where that gain has actually been made over a longer period. This means that
only one annual exemption can be set against what may be many years worth
of gain. In the past, some holders of shares and unit trusts sought to minimise
the effect of this by selling their holding each year and repurchasing it the
following day, thus realising a smaller gain that could be covered by that years
exemption. This was known as bed and breakfasting, but the government
effectively outlawed the process in the 1998 Budget. Since then, any shares and
unit trusts that are sold and repurchased within a 30-day period are treated,
for CGT purposes, as if those two related transactions had not taken place.
1.3.3.4.2 Roll-over relief
Business assets are chargeable to CGT. If the assets disposed of are replaced
by other business assets, however, roll-over relief may be claimed. This means
that, instead of CGT falling due on the original disposal, it is deferred until a
final disposal is made.
The replacement asset must be bought within a period of one year before and
three years after the sale of the original asset.
Relief can be claimed up to the lower of either the gain or the amount
reinvested.
1.3.3.4.3 Hold-over relief
Similarly, CGT on any gain arising on the gift of certain assets can normally be
deferred until the recipient disposes of it.
Gains may be wholly or partly passed on to the recipient in the case of gifts
(or sale at under value) of the following broad categories of assets:
t
assets used by the donor in their trade or the trade of their family
company or group;
shares in the transferors personal company or in an unlisted trading

company;
agricultural property that would attract relief from inheritance tax;
assets on which there is an immediate charge to inheritance tax.
[1] 36
1.3.3.4.4 Payment of CGT

CGT is charged on gains arising from disposals in the period 6 April to 5 April
in the following year.
CGT is normally payable on 31 January following the end of the tax year in
which the gain is realised. For example, CGT for 2012/13 will normally be
payable on 31 January 2014.
Details of chargeable assets disposed of during the tax year must be included
in an individuals tax return.
1.3.3.5 Inheritance tax
Inheritance tax (IHT), as its name suggests, is levied mainly on the estates of
deceased persons. The tax is charged at 40 per cent of the amount by which
the value of the estate exceeds the nil-rate band, which is up to 325,000 in
2013/14. Surviving spouses and civil partners can increase their own nil-rate
band by the proportion of unused nil-rate band from the earlier death of their
spouse/partner (whether the first death occurred before or after 9 October
2007). So, for example, if on the first death an estate of 200,000 was left
entirely to the deceaseds son when the nil-rate band was 300,000, the
unused proportion is 33.33 per cent. If the wife then died when the nil-rate
band was 325,000, this could be increased by 33.33 per cent to 433,333. If,
on the first death, the estate of 200,000 was left entirely to the deceaseds
wife (with or without a will), the unused proportion of the husbands nil-rate
band is 100 per cent, since transfers between spouses and civil partners on
death are exempt from inheritance tax. If the wife then died when the nil-rate
band was 325,000, this would have increased by 100 per cent to 650,000.
In order to prevent avoidance of tax by death-bed gifts or transfers, the figure
on which tax is based includes not only the amount of the estate on death but
also the value of any money or assets that have been given away in the seven
years prior to death.
IHT is also payable in certain circumstances when assets are transferred from
a persons estate during their lifetime (usually in the form of gifts). Most gifts
made during a persons lifetime are potentially exempt transfers (PETs)
and are not subject to tax at the time of the transfer. If the donor survives for
seven years after making the gift, these transactions become fully exempt and
no tax is payable. If the donor dies within seven years of making the gift, and
the value of the estate (including the value of any gifts made in the preceding
[1] 37
Unit 1
seven years) exceeds the nil-rate band, inheritance tax becomes due. The gifts
are offset against the nil-rate band first and, if there is any nil-rate band left, this
is offset against the remainder of the estate, the balance being subject to tax
at 40 per cent. If the value of the gifts alone exceeds the nil-rate band, the
portion of the gifts that exceeds the threshold is taxed at 40 per cent along
with the remainder of the estate (although the amount of tax on the gifts is
scaled down by tapering relief over the final four years of the seven to 80
per cent, 60 per cent, 40 per cent and 20 per cent of the maximum tax in the
fourth, fifth, sixth and seventh years respectively.
Some lifetime gifts notably those to companies, other organisations and
certain trusts are not PETs but chargeable lifetime transfers, on which
tax at a reduced rate of 20 per cent is immediately due. This lifetime tax is
only payable if the value of the chargeable lifetime transfer, when added to the
cumulative total of chargeable lifetime transfers over the previous seven years,
exceeds the nil-rate band at the time the transfer is made. As with PETs, the
full tax is due if the donor dies within seven years (subject to the same tapering
relief) and any excess over the 20 per cent already paid then becomes payable.
There are a number of important exemptions from inheritance tax:
t
transfers between spouses and between civil partners both during their
lifetime and on death;
small gifts of up to 250 (cash or value) per recipient in each tax year;
donations to charity, to political parties and to the nation;
wedding gifts of up to 1,000 (increased to 5,000 for gifts from parents

or 2,500 from grandparents);
gifts that are made on a regular basis out of income and which do not
affect the donors standard of living;
up to 3,000 per tax year for gifts not covered by other exemptions. Any
part of this 3,000 that is not used in a given tax year can be carried
forward for one year, but no further.
1.3.3.6 Value added tax

Value added tax (VAT) is an indirect tax levied on the sale of most goods and
the supply of most services in the UK. The VAT rate in the UK is currently 20
per cent (from 4 January 2011). Anti-forestalling legislation was passed to
[1] 38
prevent avoidance of the additional VAT on large invoices (over 100,000)

issued before 4 January 2011 for services carried out after that date.
Some goods and services are exempt from VAT, including certain financial
transactions such as loans and insurance. The supply of financial advice is not
exempt and advisers who charge a fee for their service are subject to VAT in
the same way as solicitors or accountants.
The supply of health and education services is exempt and a number of related
goods and services are currently zero-rated. This is not technically the same
as being exempt: zero-rated goods and services are theoretically subject to
VAT but the rate of tax applied is currently 0 per cent (although this could
change). Zero-rated items include food, books, childrens clothes, domestic
water supply and medicines. Domestic heating is charged at a reduced rate
(currently 5 per cent).
Businesses, including the self-employed, are required to register for VAT if their
annual turnover (not profit) is above a certain figure (79,000 in 2013/14).
Firms with turnover below this figure can choose to register for VAT if they
wish, but are not obliged to. An advantage of registering is that VAT paid out
on business expenses can be reclaimed; two disadvantages are:
t
the fact that the firms goods or services are more expensive to
customers (by the amount of the VAT that the firm must charge);
the additional administration involved in collecting, accounting for and

paying VAT.
The de-registration threshold is 77,000 (2013/14), ie if turnover falls below

this figure, businesses may de-register for VAT.
1.3.3.7 Stamp duty
Stamp duty is a form of tax, payable by the purchaser in respect of certain
transactions, notably purchases of securities and of land. It is a tax imposed on
the documents that give effect to the transaction (eg conveyances of property
or stock transfer forms) and is calculated as a percentage of the purchase
price.
It is important to ensure that the documents are stamped within the permitted
time period. Failure to do so means, for instance, that the conveyance of the
land cannot be registered or that share transfers will not be accepted for
registration. The rates of stamp duty are shown below.
[1] 39
Unit 1
t
Stamp duty reserve tax: the rate of stamp duty on securities is 1.5
per cent of the market value for bearer instruments and 0.5 per cent of
market value for shares. From 13 March 2008, transactions that result in
a stamp duty (certificated shares) reserve tax charge of 5 or less are
exempt. Bearer instruments are financial instruments, such as bonds, on
which the name of the owner is not recorded. Possession of the
certificate is the only proof of ownership, and title passes by physical
delivery to a new owner.
Stamp duty land tax (SDLT): the rate of stamp duty on property
depends on the purchase price:
there is no stamp duty on purchases of up to 125,000 (or 150,000
in certain designated disadvantaged areas).
between 125,001 and 250,000, stamp duty is 1 per cent of the
whole purchase price;
between 250,001 and 500,000, it is 3 per cent of the whole
purchase price;
between 500,001 and 1m it is 4 per cent of the whole purchase
price;
between 1,000,001 and 2m it is 5 per cent of the whole purchase
price (residential only);
above 2m it is 7 per cent of the whole purchase price (residential
only);
above 2m it is 15 per cent of the whole purchase price for certain
types of purchasers, including corporate bodies.
(Until 24 March 2012, first-time buyers benefited from 0 per cent stamp duty
up to 250,000.)
1.3.3.7.1 Stamp Duty Land Tax relief for zero-carbon homes
Until 30 September 2012, there was a relief from Stamp Duty Land Tax (SDLT)
when a zero-carbon home was bought for the first time. Zero-carbon homes
had to meet certain requirements for generating the energy needed for things
like heating and cooking.
In order to qualify for relief, a zero-carbon home certificate for the home had
to be issued by an accredited assessor.
[1] 40
If the property met the conditions and cost 500,000 or less then, then there
was no SDLT to pay. Properties costing more than 500,000 benefitted from a
maximum reduction of 15,000 in the amount of SDLT payable.
Relief for zero-carbon homes ended on 30 September 2012.
1.3.3.7.2 Stamp Duty Land Tax relief for multiple purchases
From July 2011, relief is available where a transaction or a number of linked
transactions includes freehold or leasehold interests in more than one
property.
In this case, SDLT is charged on the average value of the properties being
purchased.
For example, if five houses are purchased for a total cost of 1m, the average
price per property is 200,000. SDLT on a purchase price of 200,000 is
charged at one per cent. The amount of SDLT due in this case would be one
per cent of 1m, which is 10,000.
However, the minimum rate of tax under this relief is one per cent, even if the
average value of multiple properties purchased in one transaction is less than
125,000.
1.3.3.8 Corporation tax
Corporation tax is paid by limited companies on their profits. It is also payable
by clubs, societies and associations, by trade associations and housing
associations, and by co-operatives. It is not, however, paid by either
conventional business partnerships or limited liability partnerships, or by selfemployed individuals: these are all subject to income tax.
Companies are taxed on all their profits arising in a given accounting period,
which is normally their financial year. The definition of profits includes:
t
trading profits (less allowable expenses such as labour and raw

materials);
capital gains;
income from letting;
interest on deposits.
[1] 41
Unit 1
Companies resident in the UK pay corporation tax on their worldwide profits,

whereas companies resident elsewhere pay only on their profits from their
UK-based business.
Corporation tax rates for the tax year 1 April 2013 to 31 March 2014 are
outlined in the table below.
Profits
Rate
Small profits rate
0 to 300,000
20%
Marginal rate
300,001 to 1.5m
A marginal rate to ease the

transition between the small
companies rate and the main
rate
Main rate
Over 1.5m
23%
For companies with profits up to 1.5m, corporation tax is normally due nine
months after the end of the relevant accounting period. For those with profits
over 1.5m, corporation tax is due in quarterly instalments beginning
approximately halfway through the accounting period.
1.3.3.9 Withholding tax
The phrase withholding tax refers to any tax on income that is levied at
source before that income is received. So, technically, income tax paid by UK
employees is a withholding tax.
However, the phrase is normally understood to apply to tax that is levied, in a
particular country, on income received in that country by non-residents of that
country; this could be earned income or investment income. The aim is to
ensure that the income does not leave the country without being taxed. In the
UK, for example, withholding tax of 20 per cent is levied on the earnings of
non-resident entertainers and professional sportspeople. The UK has double
taxation agreements with over 100 other countries to prevent the same
income from being taxed twice.
[1] 42
1.3.4 Economic and monetary policy

At this point, it is useful to consider briefly the long-term objectives that the
economic policies of most governments try to achieve. These are known as
macroeconomic objectives because they concern economic aggregates, ie
totals that give us a picture of the economy as a whole, as opposed to
microeconomic objectives that concern individual firms or consumers.
t
Price stability, ie a low and controlled rate of inflation. This inflation is

popularly defined as a rise in the level of prices. In more formal
economic terminology, it can be defined as a situation where the rate of
growth of the money supply is greater than the rate of growth of real
goods and services; in more common terms, too much money chasing
too few goods, which, of course, results in prices rising. Price stability
does not mean, however, that zero inflation is desirable and there is a
body of economic opinion that believes that moderate inflation can
stimulate investment, which is good for the economy.
In times of recession, economies may experience deflation, which is a
general fall in the price of goods and services. This should not be
confused with disinflation, which is a fall in the rate of inflation (ie
prices still rising, but less quickly than before).
Low unemployment, ie to expand the economy so that there is more

demand for labour, land and capital.
Balance of payments equilibrium, ie a situation where expenditure

and receipts of foreign currencies are equal. The aim should be to
achieve a balance (ie neither a deficit nor a surplus) over the medium
term. The UK has, for some years, experienced a deficit on its balance of
payments current account with a deficit on manufacturing and on money
transfers partly compensated for by a surplus on services and on income
from investments. The exchange rate of the countrys currency is linked
to the balance of payments and most governments aim to keep the price
of currency stable at a level that is not so high that exports will be
discouraged but not so low as to increase inflation.
Satisfactory economic growth, meaning that the output of the

economy is growing in real terms over time and that standards of living
are getting higher. The UK economy, like that of other industrialised
countries, grew quite fast in the years up to 2000 but this has fallen off
with the onset of recession, which has affected the US and European
economies. The annual growth of GDP (gross domestic product) in the
UK was around 3 per cent at the end of 2005, but had fallen to
[1] 43
Unit 1
almost 6 per cent by the beginning of 2009 before starting to recover.

At the beginning of 2011, the GDP growth rate was approximately 1.4
per cent. GDP is a measure of the value of the goods and services
produced within the country over a specified period of time.
In practice, it has proven impossible to achieve all of these objectives
simultaneously, as the history of the British economy shows. If a government
tries to reduce the rate of unemployment by means of expansionary measures
such as lower interest rates and lower taxation, demand is boosted and
inflation begins to rise. At the same time, people buy more imports and the
balance of payments suffers, although the economy will probably grow.
The four objectives given above tend to fall into two pairs: policies to reduce
unemployment will also boost growth; measures to reduce inflation will also
help to improve the balance of payments. Governments generally have to trade
off objectives against each other, ie they want price stability but know that the
price of getting rid of inflation altogether would be very high unemployment,
so they accept a low inflation rate to avoid pushing the economy into
recession.
Economic policy in the UK, from the beginning of the 1960s until fairly recently,
was of the stop-go variety, within which governments accelerate and
decelerate the economy in turn. This leads to a situation where periods of fast
growth, high employment and high inflation are followed by a slowing-down
into high unemployment and lower inflation. The current approach in both the
UK and Europe aims at growth via price stability.
The current overall long-term objective aimed at by the UK government is to
keep inflation steady at a low rate in the hope that price stability will lead to a
long period of sustained economic growth. It aims to keep aggregate demand
in line with the productive capacity of the economy.
In order to achieve this objective, the government has set an official direct
target, which is to keep inflation, as measured by the Consumer Prices Index
(CPI), at an average annual rate of 2 per cent, with a maximum divergence
either side of 1 per cent. This measure is derived in the same way as the
Harmonised Index of Consumer Prices (HICP) used within the eurozone and
has replaced the Retail Price Index (RPI) that was previously used in the UK
for this purpose (although the RPI is still used for some other purposes).
To achieve their objectives, the monetary authorities have a range of
instruments at their disposal. The main instrument of monetary policy used to
keep inflation in check in the UK is the rate of interest, which is manipulated
[1] 44
by the Bank of England Monetary Policy Committee (MPC) according to

economic circumstances.
There are two major types of policy used by modern governments in their
attempts to achieve long-term economic objectives:
t
monetary policy, which acts on the money supply and on interest

rates;
fiscal policy, which acts on public sector spending, revenue and

borrowing or saving.
Both types of policy try to influence the level of aggregate demand in the
economy and therefore the level of output, unemployment and prices.
1.3.4.1 Monetary policy
Several decades ago, monetary policy generally took second place to fiscal
policy because governments believed that fiscal policy was the best way of
making large adjustments to demand. Monetary policy was felt to be suitable
only for fine-tuning. Since 1979, however, monetary policy has become the
most important means of controlling the economy.
Monetary policy is based on the ideas of the monetarist school and particularly
on those of the American economist Milton Friedman (19122006). Monetary
economists believe that inflation is caused by an increase in the money supply.
Broadly speaking, they conclude that, since most of the growth in the money
supply is caused by an increase in credit creation by banks, a government that
wants to control the growth of the money supply must control the amount of
credit creation carried out by banks. A common way to do this is by
manipulating interest rates, which in turn influences the demand for credit by
customers.
Other methods can be used and have been used in the past. For example,
banks can be restricted on the amount they can lend, or borrowers can be
required to provide a minimum cash deposit when borrowing to make a
purchase. None of these is currently in use in the UK, where the favoured
method is the manipulation of interest rates. The Monetary Policy Committee
(MPC) of the Bank of England decides on the rate of interest at which the Bank
of England will lend to banks and other financial institutions (the repo rate,
commonly known as the base rate), and it is this official rate that determines
all the other interest rates charged to borrowers and paid to lenders.
[1] 45
Unit 1
The MPC meets every month to decide whether or not to change interest
rates and, if so, in what direction and by how much. It announces its decision
immediately after the meeting and publishes the minutes of the meeting two
weeks later. The Treasury retains the right to give instructions to the Bank of
England regarding its monetary policy in extreme economic circumstances;
otherwise the Bank acts independently of the government.
1.3.4.1.1 The impact of interest rate changes
When the Monetary Policy Committee (MPC) decides to change its interest
rate, the effect is that all banks and similar deposit-takers have to follow suit
and alter the interest rates at which they lend and borrow by something close
to the same amount.
This means that banks base rates are inevitably variable because they follow
the rate of the Bank of England, which is adjusted as necessary to implement
the monetary policy used to control the UKs economy. However, in the
difficult financial conditions since 2007, bank interest rates (particularly rates
charged to borrowers) have not followed the Bank of England base rates as
closely as they did in more stable times.
Until fairly recently, most loan interest rates, including mortgage rates, were
variable rates. A major disadvantage of variable rates, particularly in relation to
a large transaction such as a mortgage, is that it is difficult for the borrower,
whose income does not vary in the same way, to budget for likely future
expenses. Sudden large rate increases can lead to borrowers being unable to
make their mortgage repayments and, in the worst cases, some borrowers may
even lose their homes if the lender has to take possession.
With the development of a large and active wholesale money market, it is now
possible for lenders to obtain large amounts of money at fixed rates, which
they can in turn lend out to their mortgage borrowers and others. Fixed-rate
mortgages in the UK still tend to be fixed only for a short initial period, with
the rate reverting to the variable rate for the remainder of the term. Longerterm fixed rates are available in many other European countries and it has been
suggested that a greater use of long-term fixed rates in the UK would assist in
stabilising the sometimes very volatile British housing market. Fixed-rate
mortgages do have their own disadvantages, however, not least of which is the
danger that a borrower will lose out if the variable rate falls and they are
locked into a higher fixed rate. There is normally a penalty for paying off the
mortgage within the fixed-rate period, in order to protect the lender. There
[1] 46
may also be an arrangement fee, charged by the lender for reserving sufficient
funds at the fixed rate.
1.3.4.2 Fiscal policy
Fiscal policy (which is sometimes called budgetary policy) involves influencing
the money supply and the overall level of economic activity, including
consumption and investment, by manipulating the finances of the public sector
(which comprises the central government, local authorities and public
corporations).
The public sector has a responsibility to provide certain services that are of
national or regional importance, such as education, healthcare and transport.
To pay for these services, the government must raise funds from the private
sector, ie from individuals and firms, in the form of direct and indirect taxes.
Because the public sector is responsible for taking a large amount of money
from the private sector and for making large amounts of expenditure on its
behalf, any changes in either side of the account and thus in the balance have a
significant effect on the economy as a whole. There are three general
outcomes:
t
a balanced budget, where the effect on the economy is neutral

because the amount taken away in taxation is put back into public
spending;
a budget surplus, where the amount of money taken away is more

than that put back the effect is contractionary in terms of
employment and deflationary in terms of the money supply; or
a budget deficit, where the amount of money put back is more than
that taken out (the difference being the amount borrowed) the overall
effect is expansionary in terms of employment and also inflationary in
terms of the money supply.
A government that has a deficit must borrow to finance it. The Public Sector
Net Cash Requirement (PSNCR) is a cash measure of the public sectors
short-term net financing requirement.
The central economic goal of the UK government is to achieve high and
sustainable levels of growth and employment. Fiscal policy is directed towards
maintaining sound public finances over the medium term, based on strict rules,
[1] 47
Unit 1
and towards supporting monetary policy where possible over the economic
cycle. The government has specified two key fiscal rules:
t
the so-called golden rule: over the economic cycle, the government
will borrow only to invest and not to fund current spending this rule
has proved impossible to maintain in the financial turmoil since 2007;
the sustainable investment rule: public-sector net debt as a

proportion of gross domestic product will be held over the economic
cycle at a stable and prudent level.
The government outlines its fiscal policy in the annual Budget statement made
by the Chancellor of the Exchequer, normally in March. The statement includes
revenue plans (including taxation of individuals and companies) and the
governments planned expenditure. At least three months prior to the Budget,
the government publishes a Pre-Budget Report that allows it to consult the
public on specific policy initiatives.
Monetary policy acts on the economy as a whole, currently through changes
in the general level of interest rates. Although fiscal policy can have an overall
macroeconomic effect on the level of activity in the economy, it also has
microeconomic effects and can be targeted to particular areas of the economy.
For example, tax incentives can be given to manufacturing industries to boost
employment in what is a declining sector or government grants can be given
to firms that move to relatively underdeveloped geographical areas.
In practice, however, fiscal policy and monetary policy are not applied in
isolation but are closely linked, and governments generally use a combination
of the two.
1.3.5 Welfare and benefits

In the UK, the government plays a vital role in providing assistance to people
in need. Although the welfare state has had its critics in recent years largely
because it is increasingly expensive to run it still remains the envy of many
other nations.
State benefits can affect financial planning in two main ways.
1.
Social Security benefits can affect the need for protection. The amount of
additional cover needed by a client can be quantified as the difference
between the level of income or capital required and the level of cover
already existing. Existing provision includes not only any private
[1] 48
insurances that the client already has, but also any state benefits to which
they or their dependants would be entitled.
2.
Financial circumstances can affect entitlement to benefits. Certain benefits

are means-tested in other words, the amount of benefit is reduced if the
individuals (or sometimes the familys) income or savings exceed specified
levels. This might mean, for example, that a financial plan that increased a
persons income might be less attractive than it seemed at first sight, if it
also had the effect of reducing entitlement to, for instance, Income
Support.
There is a wide range of Social Security benefits covering many different

circumstances. Many of them, however, are small in amount and can do little
more than prevent people from suffering extreme poverty. The Social Security
benefit structure is very complex and it is not possible to cover every detail
here.The main benefits are described in the remainder of this section, together
with some information about them that is relevant to the work of financial
advisers.
The Department for Work and Pensions (DWP) publishes a wide range of
booklets that provide detailed descriptions of the various benefits. These are
available from DWP offices, most post offices or by visiting its website at
www.dwp.gov.uk.
A number of changes are being brought in to the benefits system during 2013
and 2014, the details and timing of which are covered at the end of this section.
1.3.5.1 Support for people on low incomes
The two main benefits for those on low income, or no income at all, are
Working Tax Credit and Income Support.
1.3.5.1.1 Working Tax Credit
Working Tax Credit is designed to top up the earnings of employed or selfemployed people who are on low incomes; this includes those who do not
have children. There are extra amounts for:
t
working households in which someone has a disability; and
the costs of qualifying childcare.
[1] 49
Unit 1
People with children can claim Working Tax Credit if they are aged 16 or over
and work at least 16 hours a week.
Those without children can claim Working Tax Credit if:
t
they are aged 25 or over and work at least 30 hours a week; or
they are aged 16 or over and work at least 16 hours a week and have a
disability which puts them at a disadvantage in getting a job; or
they are aged 60 or over, and work 16 hours a week or more.
1.3.5.1.2 Income Support

Income Support is a tax-free benefit designed to help people aged 16 or over
whose income is below a certain level and who are working less than 16 hours
per week (or where the partner works for less than 24 hours on average per
week). It can be claimed by people with no income at all or can be used to top
up other benefits or part-time earnings.
Eligibility for Income Support is not dependent on the claimant having paid
National Insurance contributions (NICs). It is, however, means-tested on both
income and savings.
Income support can be claimed by people who:
t
have income less than an amount specified by the government;
have capital and savings of less than 16,000. All savings below 6,000 are
ignored; if they have savings of between 6,000 and 16,000 then they
are assumed to have 1 per week of income for every 250 above
6,000, and this is deducted from their income support payments;
are working 16 hours a week or less (but people with a disability who
work more than 16 hours a week may still be able to get Income
Support);
are not a full-time student;
are aged 16 or over.
The rules relating to Income Support are complex, and only a brief outline of
them can be given here. The range of people who can claim Income Support
includes those who are: aged 60 or over; single parents; sick or disabled;
looking after a disabled or elderly person; unemployed; only able to work parttime.
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1.3.5.1.2.1
Income Support payments
The exact amount of Income Support payments depends on a number of

factors, including: claimants age; income and savings levels; and whether the
claimant has a partner and/or children (and their ages).
Payments are made up of three main parts:
t
personal allowances (not to be confused with the tax allowances of

the same name), which are meant to cover the day-to-day living
expenses of the claimant, partner and dependent children;
premiums (nothing to do with life policies), which are additional

payments given to people who have extra needs, such as one-parent
families or people with disabilities;
other additions, which may include payments for mortgage interest

and certain other housing costs.
1.3.5.1.3 Jobseekers Allowance

Jobseekers Allowance (JSA) is a benefit for people who are unemployed and
are actively seeking work.
There are two forms of JSA: contribution-based and income-based.
Contribution-based JSA depends on having paid sufficient Class 1 National
Insurance contributions and is payable for a maximum of six months. It is paid
at a fixed rate irrespective of savings or partners earnings, but no additional
benefits are paid for dependants. Contribution-based JSA is paid gross but is
taxable.
People who do not qualify for contributions-based JSA may be able to get
income-based JSA, which is, to all intents and purposes, Income Support under
another name.
Claimants for JSA must satisfy a number of strict requirements, including the
following.
t
They must be capable of actively seeking and available for work, normally
for at least 40 hours per week.
They must be out of work or working less than 16 hours per week.
They must normally be 18 or over but below pensionable age.
[1] 51
Unit 1
t
They must not be in full-time education.
They must have signed a Jobseekers Agreement, which sets out the
steps they must take to look for work.
Claimants are usually credited with National Insurance contributions (NICs)

for every week when they receive JSA.
1.3.5.2 Support for bringing up children
Benefits related to bringing up children fall into two categories: benefits payable
during pregnancy and benefits payable as the children are growing up.
1.3.5.2.1 Statutory Maternity Pay
Women who become pregnant while they are in employment may be able to
get Statutory Maternity Pay (SMP) from their employer.The requirements
that a woman must meet in order to receive SMP are as follows.
t
She must have worked for the same employer, without a break, for at
least 26 weeks including (and ending with) the 15th week before the
baby is due known as the qualifying week.
Her average weekly earnings in the eight weeks up to the qualifying

week must not be less than the lower earnings limit.
SMP is payable for a maximum of 39 weeks. The earliest it can begin is 11

weeks before the baby is due and the latest is when the baby is born.
There are two rates of SMP: for the first six weeks, the amount paid is equal
to 90 per cent of the employees average weekly earnings; after that, the
remaining payments are at a flat rate of 136.78 (from 6 April 2013) or 90 per
cent of the employees average weekly earnings, whichever is the lower.
SMP is taxable and NICs are due on the amount paid.
1.3.5.2.2 Maternity Allowance
Some working mothers who become pregnant are not able to claim SMP.These
will include those who are self-employed or who have recently changed jobs.
They may be able to claim an alternative benefit called Maternity Allowance.
This is paid by the Department of Work and Pensions (DWP) and not by
employers.
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Maternity Allowance is paid at a lower rate than SMP but, unlike SMP, it is not
subject to tax or NICs on the amount paid.
A standard rate of Maternity Allowance is payable to those whose earnings
exceed the lower earnings limit. For those who earn less than the limit but
above the minimum threshold for a claim to be made, an amount equal to 90
per cent of average earnings will be paid.
Contrary to popular belief, Maternity Allowance is not a benefit available to all
women who become pregnant, whether or not they have been working. There
are restrictions on who can claim.
Like SMP, Maternity Allowance is payable for a maximum of 39 weeks. The
earliest it can begin is 11 weeks before the baby is due and the latest is when
the baby is born.
1.3.5.2.3 Child Benefit
Child Benefit is a tax-free benefit available to parents and others who are
responsible for bringing up a child. It does not depend on having paid NICs. It
is not affected by receipt of any other benefits.
From 7 January 2013, Child Benefit is means-tested in the form of an income
tax charge. The charge applies at a rate of 1 per cent of the full Child Benefit
award for each 100 of net income of the highest households earning above
50,000 and up to 60,000. The charge on taxpayers with net income above
60,000 is equal to the amount of Child Benefit paid, ie the charge cancels out
the benefit.
Child Benefit is available for each child under age 16. It can continue up to and
including age 19 if the child is in full-time education or on an approved training
programme. A higher rate is paid in respect of the eldest child and a lower rate
in respect of every other child.
1.3.5.2.4 Child Tax Credit
Child Tax Credit is designed mainly to help parents on low incomes but people
earning as much as 40,000 per year can be eligible. It brings together the child
elements of Income Support, Jobseekers Allowance and the Disabled Persons
Tax Credit and is payable in addition to the entitlement to Child Benefit. The
parent does not have to be working to claim Child Tax Credit.
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Unit 1
Child Tax Credit is paid directly to the person who is mainly responsible for
caring for the child. Payment is made in respect of each child until 1 September
following their 16th birthday or up to their 20th birthday if the child is:
t
in full-time education or on an approved training programme;
not claiming Income Support or any tax credit;
not serving a custodial sentence of four months or more.
1.3.5.3 Support for people who are ill or disabled

There is a wide range of benefits for people who are sick, injured or disabled,
or who need constant care.
1.3.5.3.1 Statutory Sick Pay
Statutory Sick Pay (SSP) is paid by employers to employees who are off work
due to sickness or disability for four days or longer.
To qualify, claimants must earn more than the lower earnings limit (LEL).
SSP is paid for a maximum of 28 weeks in any spell of sickness. Spells of
sickness with less than eight weeks between them count as one spell. It is
payable to employed people whose average weekly earnings are above the level
at which NICs are payable.
Amounts paid as SSP are subject to tax and to NI deductions, just as normal
earnings would be.
People who are still sick after 28 weeks may be able to claim short-term
Incapacity Benefit.
1.3.5.3.2 Incapacity Benefit
Incapacity Benefit is a benefit for people who are unable to work due to illness
or disability. Before October 2008 it could be claimed by those who could not
get SSP because they were self-employed or because the SSP payment period
had expired, but this has now been replaced for new claimants by Employment
and Support Allowance (see Section 1.3.5.3.3).
[1] 54
The right to receive Incapacity Benefit depends on having paid sufficient Class
1 or Class 2 NICs. Those who have not paid sufficient NICs may be able to get
Income Support.
Incapacity Benefit has three different levels of benefit, which apply in different
circumstances.The lowest rate is not subject to income tax, but the two higher
rates are taxable. The rates are:
t
short-term lower rate, which is payable for up to 28 weeks to people

who cannot get SSP;
short-term higher rate, which is payable from 29 weeks to 52 weeks;
long-term rate, which is the highest rate of Incapacity Benefit and is

payable to people who are still sick after a year. People who are
terminally ill can get Incapacity Benefit at the highest rate from 28 weeks
onwards.
Those receiving Incapacity Benefit will be sent a questionnaire between now

and 2014 and if the response demonstrates that they are unable to work they
will be transferred onto Employment and Support Allowance.
1.3.5.3.3 Employment and Support Allowance
As a result of the Welfare Reform Act 2007, the new Employment and Support
Allowance replaced Incapacity Benefit from October 2008, for new claimants.
The new system considers what an individual is capable of, and what help and
support they need to manage their condition and return to work. The
governments aim is to move all existing Incapacity Benefit claimants to
Employment and Support Allowance by 2013.
A new test, the work capability assessment, was introduced in October
2008 for Employment and Support Allowance claims and is applied to all
claimants. It changes the emphasis by assessing what people can do, rather than
what they cant do. The assessment looks at peoples physical and mental
abilities, taking account of learning disabilities and similar conditions. Following
the assessment, most people will be given support and employment advice to
enable them, if possible, to return to work. From 2010, this assessment was
extended to existing Incapacity Benefits customers.
[1] 55
Unit 1
During this 13-week assessment period a lower benefit rate is payable. After
this period, those who can carry out a work-related activity will receive an
increase. People whose condition causes very severe limitation of their ability,
and who are not able to engage in any work-related activity, will get a higher
rate of benefit.
1.3.5.3.4 Attendance Allowance
Attendance Allowance is a benefit for people aged 65 or above needing help
with personal care as a result of sickness or disability.This benefit is not meanstested and it does not depend on having paid NICs.
There are two levels of benefit: a lower rate for people who need help with
personal care by day or by night and a higher rate for those who need help
both by day and by night.
1.3.5.3.5 Disability Living Allowance
Disability Living Allowance (DLA) is a tax-free benefit for people who need
help with personal care and/or need help getting around. It can only be
received by people whose disability claim began before age 65 but, once
granted, it can continue beyond age 65.
To be eligible for DLA, a person must have needed help for a qualifying period
of three months and must be expected to need help for a further six months.
The qualifying period is waived for people who are not expected to live for six
months.
There are two components to DLA and claimants may receive either or both:
t
care component: this component is for people who need help in

carrying out daily tasks such as washing, dressing, using the toilet or
cooking a meal;
mobility component: this component applies if a person has difficulty

in walking or cannot walk at all.
From 8 April 2013, Disability Living Allowance is starting to be replaced by a

new benefit called Personal Independence Payment (PIP) for claimants of
working age.
To receive PIP, the claimant must be between 16 and 64, satisfy the daily
living/mobility test for 3 months prior to claiming, and be likely to continue to
[1] 56
satisfy this test for a period of at least 9 months after claiming. The claimant
doesnt have to wait 3 months from the date of their claim before receiving PIP
as the qualifying period starts from when their eligibility needs arise, not from
the date the claim is made, Claimants will not be able to claim PIP once they
reach 65, but will be able to stay on PIP if they claimed or received it prior to
reaching 65.
Like DLA, PIP consists of two components:
t
Daily living component at the standard rate (53.00 April 2013) if the
claimant has limited ability to carry out daily living activities, and at the
enhanced rate (79.15 April 2013) if the claimant has a severely limited
ability to carry out daily living activities.
Mobility component at the standard rate (21.00 April 2013) if the

claimant has limited mobility, and at the enhanced rate (55.25 April
2013) if the claimant has severely limited mobility.
If the claimant has a terminal illness (death is expected within 6 months), they
will automatically receive the enhanced rates.
The change is being introduced on a phased basis starting with new claims for
PIP in Merseyside, north-west England, Cumbria, Cheshire and parts of northeast England. From June 2013, the government expects to take new claims for
PIP in all parts of the country.
For existing DLA claimants, PIP is being introduced in stages over a number of
years. From October 2013 individuals will be invited to claim PIP if they:
t
report a change in their care or mobility needs;
reach the end of an existing award of DLA and havent already received
a DLA renewal letter; or
are approaching the age of 16, unless they are terminally ill.
From October 2015, all individuals receiving DLA will be invited to claim PIP.
The contact process is expected to be completed by late 2017.
1.3.5.3.6 Carers Allowance
The government recognises that support is also needed for carers, ie people
who give up a large part of their time and possibly their jobs in order to
look after someone who is seriously ill or severely disabled. Carers
Allowance (CA) is a benefit for people who are caring for a severely disabled
person; they do not have to be a relative of the patient in order to qualify.
[1] 57
Unit 1
The right to receive CA does not depend on having paid NICs. The benefit is
a flat rate, with possible additions for a partner or children. It is taxable and
must be declared on tax returns.
The following criteria must be met.
t
The carer must:

be aged between 16 and 65;
spend at least 35 hours per week as a carer;
be earning no more than a certain amount each week;
not be in full-time education (defined as 21 hours or more a week of
supervised study).
The person being cared for must:

be receiving Disability Living Allowance or Attendance Allowance or
Constant Attendance Allowance (Personal Independence Payment
will also qualify);
not be in hospital or in residential care.
1.3.5.4 Support for people in hospital or receiving

residential/nursing care
When people are in hospital, some of the needs normally met by benefits or
pensions are instead met by the National Health Service. In the past, therefore,
some benefits were reduced or suspended while a claimant was in hospital. In
the 2005 budget, however, it was announced that these reductions will no
longer be made.
For those in a residential care or nursing home provided by a local council,
who cannot afford the minimum charges, Income Support may be available. For
those in residential or nursing care in a private establishment, Income Support
may be available provided that savings do not exceed 16,000. Income Support
amounts are worked out by adding together the fees for the home and any
meals that have to be paid for separately, subject to a maximum benefit amount
depending on the type of care received.
[1] 58
1.3.5.5 Support for people in retirement

The government first introduced pension provision in 1908 but state pensions
first appeared in something like their current form after the Second World War
when the National Insurance Act 1946 provided for pensions to be payable to
employed people on retirement at age 65 (men) or 60 (women). By 2018, state
retirement age will have been equalised at 65 for both men and women. The
government also plans to increase the state retirement age for men and
women to 66 by 2020, to 67 by 2028 and to 68 by 2046.
This flat-rate pension, now known as the basic state pension, was not
related to an employees earnings. It was later extended to include selfemployed people and others who have made sufficient National Insurance
contributions which at present means that they have contributed for at least
30 years. Benefits are scaled down for lower contribution rates.
The National Insurance Act 1959 first introduced a second tier of state
pensions, in which benefits were earnings-related. This was known as the
graduated pension scheme and operated from 1961 until it was replaced by the
state earnings-related pension scheme (SERPS), which came into
operation in 1978. SERPS was itself replaced in 2002 by the State Second
Pension (S2P).
1.3.5.5.1 Basic state pension
The basic state pension always was and still is today designed to provide
little more than a subsistence-level standard of living. The amount paid to a
single pensioner is approximately 25 per cent of the national average earnings
level. In 2013/14, the single persons basic state pension is 110.15 per week
and the married couples rate is 176.15 per week.
The pension is administered on a pay-as-you-go basis, with current National
Insurance contributions from the working population being immediately paid
out as current pensions to those entitled to receive them. It is readily apparent
that, with the number of pensioners increasing and the numbers in
employment decreasing, there is little scope for increasing state pensions by
anything more than the rate of inflation.The Government proposed to increase
the basic state pension in line with the average earnings index rather than a
cost of living index, but said that this would not be implemented until 2012. In
its autumn statement 2011, the coalition government confirmed its
commitment to triple lock the indexation of the basic state pension. This
means that the basic state pension will rise each year by the higher of earnings,
prices or 2.5 per cent.
[1] 59
Unit 1
1.3.5.5.2 Additional state pension

The objective of the state earnings-related pension scheme (SERPS)
was originally to boost pension provision from 25 per cent of national average
earnings (ie the basic pension) to a level around 50 per cent. Like the basic
pension, it is funded on a pay-as-you-go basis, a system that is coming under
increasing cost pressures. This has resulted in a scaling-down of prospective
benefits, which are determined by a complex formula, and it is likely that there
will be further reductions in the future.
SERPS was replaced by the State Second Pension (S2P) in 2002. Although
initially offered on an earnings-related basis, it will change to a full flat-rate basis
at a later date (as yet unspecified, but likely to be around 2030). New
contributions are to S2P but previously purchased SERPS benefits are retained.
Unlike the basic pension, S2P is available only to employed persons who are
paying Class 1 National Insurance contributions. Self-employed people cannot
currently be members of S2P. Employed people are in fact obliged to be in S2P
unless they contract out or are contracted out by their employer on the basis
of membership of the employers pension scheme. Until April 2012, contracting
out was permitted only if the employer, or the individual, provides acceptable
alternative pension provision. After April 2012, however, contracting out on a
defined contribution basis ended. This meant that any individuals who are
contracted out of S2P through a personal pension, stakeholder pension, or
money-purchase (defined contribution) occupational pension scheme were
automatically brought back into the State Second Pension (S2P). They began to
build up additional state pension from this time. Individuals who are contracted
out through a final salary (defined benefit) pension continue to do so, paying
lower National Insurance Contributions and, when they retire, their second
pension will come from their employers scheme, not from the State Second
Pension (S2P).
1.3.5.5.3 Pension Credit
Pension Credit is a benefit designed to ensure that all people of retirement
age have a total income of a specified minimum amount. In 2013/14, Pension
Credit guarantees a minimum income of 145.40 per week to a single person
and 222.05 to a couple. Like the state pensions, this amount is expected to
increase each year to take account of inflation.
[1] 60
1.3.5.6 Universal Credit

The Welfare Reform Act 2012 introduces a new state benefit called Universal
Credit, which is a means-tested credit for people of working age. The upper
age limit is at which people qualify for Pension credit.
Universal Credit is not specifically an in-work or out of work benefit; it is one
benefit for people whatever their employment status. This makes it easy for
people to ease into and out of work as they will not need to keep transferring
from one type of benefit to another as their circumstances change.
The structure is intended to be much simpler than that of the current system,
where separate benefits (which often overlap) are administered by different
agencies, different premiums and different methods of means-testing.
Between 2013 and 2017, Universal Credit is to replace the following benefits:
t
Income support
Income-based Jobseekers Allowance
Income-related Employment and Support Allowance
Working Tax Credit and Child Tax Credit
Housing benefit
The timetable for the transition to Universal Credit is as follows:

t
April 2013 the benefit is launched in a small area of the UK to test

capability and iron out teething problems;
October 2013 to April 2014 new claimants for the benefits that
Universal Credit replaces will be awarded Universal Credit instead, and
existing claimants will move onto Universal Credit when a significant
change in circumstances is reported (changes such as starting a new job,
having a baby, etc.). This is called natural migration;
April 2014 to the end of 2015 those existing claimants who will benefit
most from the switch, and who have not already switched to Universal
Credit through natural migration, will be moved to the new benefit in a
process known as managed migration. New claims and natural
migration will continue;
End of 2015 to October 2017 the remaining estimated 3 million

households still claiming the old benefits will be transferred onto
Universal Credit under a managed migration as the old benefits system
winds down. Again, new claims and natural migration will continue.
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Unit 1
The benefits that will remain outside of Universal Credit are:

t
Carers Allowance
Contribution-based Jobseekers Allowance and Contribution-based

Employment and Support Allowance
Disability Living Allowance (although this is replaced by the Personal

Independence Payment (PIP) for claimants of working age from April
2013)
Child Benefit
Statutory Sick Pay
Statutory Maternity Pay
Maternity Allowance
Attendance Allowance (as this is for claimants over 65 anyway)
The amount of Universal Credit awarded to claimants depends on their

income and personal and financial circumstances. There is a basic allowance
with different rates for single claimants and couples (and a lower rate for
younger people), and additional amounts available for those with a disability,
caring responsibilities, housing costs, and children and/or childcare costs.
There is an earnings disregard, which is based on the claimants needs. For
example, a couple with children have a higher earnings disregard than a couple
without children. As earnings increase, entitlement to Universal Credit is
reduced (by 65 pence for every 1 earned), and there is a maximum cap on
the total amount of State benefits that a household can receive (based on the
average earnings of a working family), and this maximum includes any Child
Benefit that they receive.
In the 2013 Budget, it was announced that childcare support is to be provided
for Universal Credit claimants. Given in the form of tax relief, it covers the
equivalent of 85% of childcare costs.
Universal Credit will be introduced in Scotland and Wales from October 2013,
and in Northern Ireland from April 2014.
[1] 62
Test your knowledge and understanding

with these questions
Take a break before using these questions to assess your learning
across Section 1. Review the text if necessary.
Answers can be found at the end of this unit.
1.
What are the four main elements of financial intermediation, as practised

by banks and building societies?
2.
How does a mutual organisation differ from a proprietary organisation?
3.
Who issues UK banknotes?

(a) The Bank of England.
(b) The Treasury.
(c) The Royal Mint.
4.
What is the effect of European Union directives on UK law?
5.
Karen was born in the United States while her mother, Laura (born and
bred in England), was working there on a two-year assignment. Her father
was American but he and Laura never married, and she returned to
England with Karen. What is Karens domicile?
6.
Which of the following is not subject to income tax?

(a) Income from a trust.
(b) A waiters tips.
(c) Educational scholarships.
7.
What classes of National Insurance contributions are paid by selfemployed persons?
[1] 63
Unit 1
8.
What rate of inheritance tax is payable immediately on chargeable

lifetime transfers?
9.
How much Stamp Duty Land Tax is payable by a woman who sells her
house for 395,000?
10. It is possible to influence a nations level of economic activity by

manipulating the amount of tax revenue and the amount of spending by
the government, local authorities and public bodies. What is the name for
this kind of economic policy?
11. What is the maximum term for which Maternity Allowance can be paid?
12. What is the minimum period per week that must be spent as a carer
before Carers Allowance can be claimed?
(a) 25 hours.
(b) 30 hours.
(c) 35 hours.
[1] 64
Answers
1.
Geographic location; aggregation; maturity transformation; risk

transformation.
2.
Mutual organisations have no shareholders but are owned by their

members.
3.
(a) The Bank of England.
4.
The objectives of the directive must be implemented in each state,

including the UK, within a specified timescale, typically two years. The
choice of exactly how they are implemented is left to national authorities
in each state.
5.
Her domicile of origin is the domicile of her mother at the date of her
birth (not the domicile of the father, since they were not married). This is
probably UK domicile, although we dont know for certain without
knowing more about Lauras parents.
6.
(c) Educational scholarships.
7.
Subject to specified minimum profits levels, Class 2 and Class 4.
8.
20 per cent.
9.
None. Stamp Duty Land Tax (like all forms of stamp duty) is paid by the
purchaser.
10. Fiscal policy.

11. 39 weeks.
12. (c) 35 hours.
[1] 65
Unit 1
[1] 66
Section 2
Financial assets
Introduction
Few people today hold their financial wealth in cash. While we still sometimes
read of people with large quantities of notes and coins stored in their homes,
this is increasingly rare. At the very least they generally keep their money
mainly in bank and building society accounts. Many people have wealth stored
in the form of property, such as houses or works of art.
When people have more money than they need to spend immediately, they
tend to invest it with a view to making a profit, thus becoming part of the chain
of intermediation described in Section 1.1.1.
Section 2 looks at a range of what might be described as direct investments
distinct from indirect investments in financial assets (eg collective investments
such as unit trusts), which are covered in Section 3.
Section 2 covers part 2 of the syllabus for Unit 1. The assets covered in Section 2
are deposit-type investments, fixed-interest securities such as gilts and corporate
bonds, shares (and other forms of corporate financing) and property. We describe
the nature of each type of asset, with its features and benefits, its advantages and
drawbacks, and how it is affected by taxation of income and capital gains.
[1] 67
Unit 1
2.1 Deposits
Deposit-based investments are those in which the capital element is fixed
but the income from the investment may vary.
Investors place money in deposit-based savings accounts for a number of
reasons. Some consider their capital to be secure. In one respect this is true,
ie the amount of capital invested remains intact, but inflation reduces the value
of capital and, in times of high inflation, the value of their deposits can quickly
be eroded in real terms.
There is also the risk of loss of capital if the institution becomes insolvent. This
is rare with banks and building societies, but is not unknown. In the event of
insolvency, investors may be able to reclaim some of their funds through the
Financial Services Compensation Scheme.
The convenience of the ready accessibility of banks and building societies is a
strong reason for investors to deposit money with them; it is believed that, to
some extent, inertia inhibits an investors search for a more rewarding home
for their deposits.
If the reason for saving or investing money is for a short-term purpose (eg next
years holiday or a new car) then few would argue that a deposit-based savings
account is a sensible place in which to invest the money. It is prudent to have
a part of an investment portfolio that is easily accessible in, for example, a nonotice deposit account; this is often referred to as money put by for a rainy
day. Institutional investors maintain a part of each of their funds in readily
accessible form.
2.1.1 Bank accounts

In general, banks offer three types of interest-bearing account:
t
deposit accounts;
money-market deposit accounts;
interest-bearing current accounts.
[1] 68
2.1.1.1 Deposit accounts

Deposit accounts are among the most straightforward types of account that
banks offer. Depositors,whether individuals or corporate bodies, can invest
from as little as 1 (no maximum) and receive a return on their investment in
the form of interest.
Interest is normally variable and is usually linked to the banks base lending
rate. It is calculated daily and added to the account on a periodic basis (ie
quarterly, half-yearly or yearly).
Some deposit accounts offer higher interest rates provided that a certain
minimum investment is made. Deposits can be subject to notice of withdrawal,
with the typical notice period being seven days. Often the requirement for
notice will be waived subject to a penalty, which is normally equal to the
amount of interest that could be earned over the notice period.
Deposit accounts may be considered as an investment of funds kept for an
emergency or otherwise in case of need. Over the longer term, however, they
have proved to be unattractive when compared with asset-backed investments.
2.1.1.2 Money-market deposit accounts
Money-market deposit accounts usually attract a higher rate of interest than
ordinary deposit accounts. The rate of interest reflects current money-market
interest rates and may vary according to the amount invested. There are two
basic types of money-market account: fixed accounts and notice accounts.
t
Fixed accounts are term deposit accounts, where a sum of money is

invested for a fixed period during which time it cannot normally be
withdrawn. This period can vary from overnight to five years. The rate of
interest is normally fixed for the whole period.
Notice accounts have no fixed term but, as the name implies, there is
a requirement on the investor to give an agreed period of notice of
withdrawal. Similarly, the bank must normally give the investor the same
period of notice of a change in interest rate. A typical period of notice
could be anything from seven days to six months, although 12-month
notice periods are available.
Money-market deposit accounts may be suitable for individuals with very large
amounts of cash to place on short-term deposit until they commit the cash to
other purposes.
See also Section 2.7 (money-market instruments).
[1] 69
Unit 1
2.1.1.3 Interest-bearing current accounts

Interest-bearing current accounts provide investors with immediate access to
their funds without loss of interest. These accounts provide a range of services
such as a cheque book and guarantee card, cashpoint facilities and overdrafts.
Interest-bearing current accounts for the mass market are a relatively recent
phenomenon and have developed as a result of increased competition between
the banks and building societies. Interest rates on current accounts are
generally very low although higher rates may be available on accounts
processed through telephone call centres or the internet.
Many banks have, for several years, offered high-interest cheque accounts. As
the name implies, higher rates of interest are available with these accounts that,
as a consequence, have higher minimum levels of investment, typically from
1,000 to 10,000. These accounts are normally free of charges subject to the
minimum balance being maintained. Some accounts, however, allow only a
limited number of cheques to be drawn in a given period without charge.
2.1.1.4 Taxation
Interest paid on bank deposit accounts has tax deducted at a rate of 20 per
cent. If the gross interest rate is, for example 4 per cent, the actual net rate
received is 3.2 per cent. Starting-rate and basic-rate taxpayers have no further
liability. Higher-rate taxpayers will be liable for an additional 20 per cent (or an
additional 25 per cent if income exceeds 150,000).
Interest can be paid gross if the depositor declares that he is a non-taxpayer
by completing form R85. Alternatively, non-taxpayers can reclaim any tax
deducted and 10 per cent taxpayers can reclaim the additional 10 per cent.
2.1.2 Building society accounts

Building society accounts have long been the home for investors surplus funds.
They have offered competitive rates of interest in various types of account
such as ordinary share accounts, high-interest-bearing accounts and term
accounts. The main difference between a bank and a building society is in their
legal structure. Building societies are mutual organisations and are owned by
their members (investors with share accounts and borrowers), whereas banks
are limited companies owned by their shareholders. Building societies offer:
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t
ordinary share accounts offer instant access without penalty but pay
a lower interest rate than notice accounts;
notice accounts offer access to money within 7, 30, 60 or 90 days.

Societies may allow immediate access to these accounts but will usually
charge a penalty equal to the interest earned over the notice period.
Tiered interest rates are often available on building society accounts.

Basically, the larger the investment, the higher the rate paid, but should the
investment level fall into a lower tier, the interest rate will be reduced.
In addition, building societies may offer monthly income facilities on some of
their accounts. For this facility, it is a usual requirement to have a higher
minimum level of investment.
Building societies, along with banks, provide the appropriate investment for
those investors who have short-term investment needs but also require
immediate access to their funds.
2.1.2.1 Taxation
Currently, all building society deposit accounts subject to tax are taxed the
same way as bank deposit accounts (see Section 2.1.1.4).
2.1.3 Offshore deposits

The term offshore is usually applied to any investment medium, whether bank
or building society account or other form of investment, which is based
outside the UK in a country that offers a more advantageous taxation of
investments. Such countries (sometimes referred to as tax havens), include the
Channel Islands, Luxembourg and the Cayman Islands.
Offshore investment can potentially expose the investor to greater risk than a
similar onshore investment. Firstly, the account may not be denominated in
sterling and will therefore be at risk of adverse currency movements if the
investment is to be converted back to sterling at some point. Secondly, not all
offshore accounts are protected by investor protection schemes. Investors
should check what protection is available through local regulatory regimes.
Offshore investments may be useful to an investor who needs money to be
available outside the UK, eg someone who owns a property abroad or who
plans to move abroad in the future.
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The interest on an offshore deposit will be paid gross. A UK resident must

declare the income to HM Revenue and Customs. Overseas interest is taxable
in the hands of UK residents (unless they are not domiciled in the UK). They
may, however, be able to obtain relief from some or all of this tax under a
double taxation agreement if the interest has been taxed overseas.
There are specific rules governing whether or not an individual is resident or
non-resident as far as their liability to UK taxation is concerned (see Section
1.3.3.1). Care should be taken to determine an investors residential status.
2.1.4 Cash ISAs

Individual savings accounts (ISAs) are a form of tax-efficient personal savings
scheme. ISAs can take a number of forms, which are described in Section 3.2.4.
One form of ISA is the cash ISA: it is basically a means of obtaining tax-free
interest on a bank or building society deposit account, subject to certain limits
and regulations. National Savings and Investments (NS&I) also offers a cash ISA.
The maximum annual investment in a cash ISA is 5,760 per tax year in
2013/14.
2.1.5 National Savings and Investments

National Savings and Investments (NS&I) offers a range of saving and
investment products on behalf of the government. The risk associated with the
products is very low because all products guarantee the return of any capital
invested.
There are NS&I products to suit most types of investor, with different terms,
interest rates and taxation. Full details of the range of deposit-based savings
and investments offered can be obtained from the Post Office or by visiting the
National Savings and Investments website at www.nsandi.co.uk.
A brief summary of the main products is included below.
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2.1.5.1 Direct Saver

Managed online or by phone, this account offers variable interest rates, instant
access, and a minimum investment of 1 up to 2m maximum. It is available to
anyone aged 16 or over.
2.1.5.2 Investment account
An investment account may be opened by anyone over the age of 16 and, for
those under this age, a parent, grandparent or legal guardian may open the
account.
The account pays a variable rate of interest. Investments minimum 20,
investment maximum 1m.The interest is paid gross but is liable to income tax.
This account is postal only.
2.1.5.3 Income bonds
Income bonds offer regular monthly income. The income bond has no term
and capital can be withdrawn at any time. Interest is paid up to, but not
including, the day it is withdrawn.
The interest rates are variable. Investment minimum 500, investment maximum
1m. Interest is paid gross but is liable to income tax and must be declared.
2.1.5.4 Guaranteed income bonds
A guaranteed income bond is a lump-sum investment for a fixed term of one,
three or five years, paying a fixed rate of interest depending upon the term
chosen. Interest is paid monthly, net of basic-rate income tax. Existing investors
will be written to up to 30 days before expiry of term with options. These are
not currently available (April 2013), but were previously available to anyone
over the age of 16.
2.1.5.5 Guaranteed growth bonds
A guaranteed growth bond is a lump sum investment for a fixed term of one,
three or five years. Interest is calculated yearly but added to the investment at
the end of the term. Interest is paid net of basic rate income tax. Existing
investors will be written to up to 30 days before expiry with options. These
are not currently available (February 2013), but were previously available to
anyone over the age of 16.
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2.1.5.6 Guaranteed equity bonds

A guaranteed equity bond is a lump-sum, fixed-term investment with growth
potential linked to the FTSE 100 index, while guaranteeing the security of the
original capital invested. Income is paid gross, but is liable to income tax and
must be declared. Each issue of guaranteed equity bonds is only available for a
limited period. Once opened, funds cannot be accessed until bond matures.
These are not currently available (April 2013), but were previously available to
anyone over the age of 18.
2.1.5.7 Savings certificates
There are two main types of savings certificate: fixed-interest and index-linked.
The fixed-interest certificates pay a fixed rate of interest throughout the
chosen term of two years or five years. The index-linked certificates (currently
available in three-year and five-year terms) differ in that their value increases
with inflation as well as offering interest. Existing investors will be written to
up to 30 days before expiry of term with options.
Interest is paid gross and carries no liability to personal income or capital gains
tax. Certificates are therefore particularly attractive to higher-rate taxpayers.
For example, if the rate of interest is 2.25 per cent, this is equivalent to a gross
rate of 2.88 per cent to a basic-rate taxpayer and 3.75 per cent to a higherrate taxpayer.
These certificates are not currently available (April 2013), but were previously
available for investments of between 100 and 15,000.
2.1.5.8 Premium bonds
Premium bonds provide investors with a regular draw for tax-free prizes, while
they retain the right to cash in the bond. Available to those aged 16 and over.
For those under 16, parents, grandparents and great grandparents can invest
on their behalf.
The minimum purchase is 100 and the maximum is 30,000 per person.
Prizes are drawn each month and can be worth up to 1 million. Winnings
from premium bonds are tax-free.
The bonds can be encashed at any time, subject to eight working days notice.
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2.1.5.9 Childrens bonds

The childrens bond is a lump sum investment intended to be retained for at
least five years. Available to parents, grandparents, great grandparents and
guardians for those under 16. Minimum investment 25, maximum investment
3,000 per issue. The bond should be encashed no later than the childs 21st
birthday because no interest is payable after that age.
The interest rate is fixed for the first five years and a bonus is added on the
fifth anniversary. A final bonus is added on the 5th anniversary following the
childs 16th birthday.
2.1.5.10
Direct ISA
A Direct ISA is available to anyone who is UK resident and aged 16 or over.

Interest is variable and the minimum opening balance is 1. As with all cash
ISAs, the investment limit for 2013/14 is 5,760.
2.2 Fixed-interest securities

2.2.1 Government stocks
Gilt-edged securities (commonly known as gilts) are British government
securities and represent borrowing by the government. Gilts are safe
investments because the government will not default on interest or capital
repayments.
A gilt is categorised primarily according to the length of time left to run until
its redemption. The redemption date is the date on which the government
must buy back the gilt at its original issue value or par value, normally quoted
as a nominal 100. Each gilt pays interest on the par value at a fixed interest
rate known as the coupon.
Most gilts have a specific redemption date; some have two dates between
which there will be redemption on a date selected by the government, at its
discretion.
The categories are as follows:
t
short-dated gilts: also known as shorts, these are gilts with less than
five years to run before redemption;
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t
medium-dated gilts: also known as mediums, these are gilts with

between 5 and 15 years to run before redemption;
long-dated gilts: also known as longs, these are gilts with over 15 years
to run before redemption;
undated gilts: gilts with no redemption date at all are redeemable at

any time subject to the governments discretion. The government is,
however, under no obligation ever to redeem them.
The above definitions come from the financial press. The UK Debt
Management Office, which issues gilts, defines short and medium gilts as
follows:
t
short-dated gilts: 07 years;
medium-dated gilts: 715 years.
Index-linked gilts are gilts where the interest payments and the capital value
move in line with inflation. The redemption value and the interest paid are
therefore index-linked. For the investor this means that the purchasing power
of their capital and interest received will remain constant, unlike all other fixedinterest stock where inflation erodes the purchasing power of fixed-interest
payments.
A gilt-edged stock with a coupon of 5 per cent and a redemption date in 2021
might be designated as Treasury 5% 2021.
Interest on gilts is normally paid half-yearly, so the holder of 10,000 nominal
of Treasury 5% 2021 would receive 250 in interest every six months. The
interest is paid gross, but is subject to income tax at the investors highest rate.
Gilts cannot be redeemed by investors prior to the redemption date but can
be sold to other investors. The price at which they are sold depends on a
number of factors: the level of market rates of interest; nearness to the
redemption date; supply and demand.
Gilt prices are quoted either cum dividend or ex dividend. If a stock is bought
cum dividend, the buyer acquires the stock itself and the entitlement to the
next interest payment. If, however, the stock is bought ex dividend, then while
the buyer acquires the stock itself, the forthcoming interest payment will be
payable to the previous owner of the stock (ie the seller).
Any capital gains made on the sale of gilts are entirely free of capital gains tax
(CGT).
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Example
A higher-rate taxpayer buys 100,000 par value of Treasury 5%
2019 at a price of 80.0, ie he pays 80,000 for the stock.
He receives annual interest of 5,000 (actually 2,500 per half
year), which represents a yield of 6.25% on his investment of
80,000.
The interest is paid gross but he must pay tax of 40% on it,
leaving him with net annual interest of 3,000.
Later he sells the stock for 90,000. There is no capital gains tax
to pay on his gain of 10,000.
2.2.2 Local authority stocks

Like the government, local authorities can borrow money by issuing stocks or
bonds, which are fixed-term, fixed-interest securities.They are secured on local
authority assets and offer a guaranteed rate of interest, paid half-yearly. The
interest is paid net of the basic rate of income tax (20 per cent). Higher-rate
taxpayers are liable for a further 20 per cent tax, and additional-rate taxpayers
are liable for a further 25 per cent tax. Non-taxpayers can reclaim any tax paid.
The bonds are not negotiable and have a fixed return at maturity.
Return of capital on maturity is guaranteed but these are not quite as secure
as gilts since there is no government guarantee.
2.2.3 Permanent interest-bearing shares

Permanent interest-bearing shares (PIBS) are issued by building societies to
raise capital. They pay a fixed rate of interest on a half-yearly basis. Interest is
paid gross, although it is taxable as savings income according to the investors
tax status.
Investors should also note that PIBS rank below ordinary accounts in priority
of payment, should a society become insolvent.
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2.2.4 Corporate bonds

Corporate bonds are similar in nature to gilt-edged stocks, but they represent
loans to commercial organisations rather than to the government. They
normally have a fixed redemption date, a specified redemption value and a fixed
interest rate, and like gilts they can be bought and sold at prices that reflect
market rates of interest. They are considered higher risk than gilts because
they do not have government backing, and they therefore tend to offer higher
yields.
2.2.5 Eurobonds
A Eurobond is a bond issued or traded in a country using a currency other
than the one in which the bond is denominated. This means that the bond uses
a currency, but operates outside the jurisdiction of the central bank that issues
that currency. Eurobonds are issued by multinational organisations and
governments. For example, a UK company may issue a Eurobond in Germany,
denominating it in US dollars. It is important to note that the term has nothing
to do with the euro currency, and the prefix euro is used more generally to
refer to deposits outside the jurisdiction of the domestic central bank.
2.3 Equities and other company finance

When companies need to raise money in order to commence or to expand
their business, there are various ways in which this can be done. Section 2.2.4
above introduced corporate bonds, which is one way of borrowing money for
a fixed period at a fixed rate of interest. Other types of loan, either secured or
unsecured, can also be used and the most common way for companies to be
funded is through the issue of shares. These methods of company financing are
described in the following sections.
2.3.1 Ordinary shares

Ordinary shares, also known as equities, are the most important type of
security that UK companies issue. They can be, and are, bought by private
investors, but most transactions in equities are made by institutions and by life
and pension funds.
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Holders of ordinary shares (shareholders) are in effect the owners of the

company. The two main rights that they have are:
t
to receive a share of the distributed profits of the company in the form

of dividends;
to participate in decisions about how the company is run, by voting at

shareholders meetings.
The rights attaching to shares of the same class can sometimes differ from
company to company, even though the shares normally have the same major
characteristics. It is therefore prudent for investors to find out precisely what
rights attach to a particular share. These rights are given in the companys
Articles of Association, which is a public document and can be examined at the
registered office of the company or at Companies House.
Direct investment in shares is considered to be high risk because the failure of
the company can result in the loss of all the capital invested. This risk can be
mitigated by investing across a range of shares and the products available to
facilitate this (such as unit trusts and investment trusts) are described in
Section 3.2.
The prices at which shares are traded depend on a range of factors, including:
t
the profitability of the individual company;
the strength of the market sector in which it operates;
the strength of the UK and worldwide economies;
supply and demand for shares and other investments.
In the short term, share prices can fluctuate both up and down sometimes
quite spectacularly but in the long term, investment in equities and equitylinked markets has outpaced inflation and has provided higher growth than
deposit-type investments.
2.3.1.1 Buying and selling shares
The Stock Exchange has been Londons market for stocks and shares for
hundreds of years. Government stock, share capital and loan capital, overseas
shares and options are all traded on this market.
There are two markets for shares: the main market (for which full listing is
required) and the Alternative Investment Market.
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2.3.1.1.1 The main market

The main market allows companies to be quoted on the Exchange if they
conform to the stringent requirements of the Listing Rules laid down by the
FCA, acting in its capacity as the UK Listing Authority (UKLA).
For a full listing (ie a listing of the main market), a considerable amount of
financial and other information is required to be disclosed accurately. In
addition:
t
the applicant company must have been trading for at least three years;
at least 25 per cent of its issued share capital must be in the hands of
the public.
The London Stock Exchange, like most stock markets, is both a primary and
secondary market. The primary market is where companies and financial
organisations can raise finance by selling securities to investors.They will either
be coming to the market for the first time, through the process of going public
or flotation or issuing more shares to the market. The main advantages of
listing include greater ease with which shares can be bought or sold, and the
greater ease with which companies can raise additional funds. The secondary
market which is much bigger in terms of the number of securities traded
each day is where investors buy and sell existing securities.
2.3.1.1.2 Alternative Investment Market
The Alternative Investment Market (AIM), which started in 1995, is an
additional, separate market on the London Stock Exchange. It is mainly
intended for new, small companies with the potential for growth.
Its purpose is to enable suitable companies to raise capital by issuing shares
and it allows those shares to be traded. In addition to the benefit of access to
public finance, companies will enjoy a wider public audience and enhance their
profiles by joining the AIM.
Rules for joining the AIM are fewer and less rigorous than those for joining the
official list (the main market) and were designed with smaller companies in
mind.
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2.3.1.1.3 Participants in the markets

Those that trade in financial markets include:
t
governments, public institutions and corporations who raise money on

the markets and whose securities are traded;
investment banks and other large organisations that facilitate the issue
of new securities;
banks and other traders that issue, buy or sell shares or derivatives;
investors who wish to invest their money this includes individuals and
financial institutions, such as life insurance companies and pension funds.
2.3.1.1.4 Off-market trading

This is sometimes called over-the-counter (OTC) trading. It is not very
common between individual private investors, but becoming more prolific
between institutions who trade large blocks of securities with little publicity
about the price paid or the company(ies) whose shares are being traded. This
form of trading is sometimes called dark pools.
2.3.1.2 Returns from shares
2.3.1.2.1 Risk and reward
Shareholders in a limited liability company do not have a liability for the debts
of the company. The company has a separate legal identity and is liable for its
own debts. Shareholders do, however, run the risk that the value of their
investment in the company could go down or even, in the event of a liquidation,
be lost altogether. In line with the broad rules of risk and return, therefore, it
might be expected that the potential for high returns would also be a feature
of the share market. It is certainly true that, on average and over the longer
term, equity markets have far outpaced the returns available on secure depositbased investments.
2.3.1.2.2 Assessment of financial returns
The financial returns that shareholders hope to receive from their shares are
of two forms: the growth in the share price (capital growth) and the dividends
they receive as their share of the companys distributable profits (income).
There are a number of measures that can be used to assess the success of
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investment in a companys shares and to predict future performance. Some of

these measures are as follows.
t
Earnings per share: this is equal to the companys net profit divided
by the number of shares, but it is not normally the amount of dividend
to which a shareholder is entitled on each of their shares.This is because
a company may choose not to distribute all of its profits: some profits
may be retained in the business to finance expansion, for instance. This
in turn leads to the concept of dividend cover.
Dividend cover: this factor indicates how much of a companys profits

are paid out as dividends in a particular distribution. If, for example, 50
per cent of the profits are paid in dividends, the dividend is said to be
covered twice. Cover of 2.0 or more is generally considered to be
acceptable by investors, whereas a figure below 1.0 indicates that a
company is paying part of its dividend out of retained surpluses from
previous years.
Price/earnings ratio (P/E ratio): as its name suggests, the P/E ratio is
calculated as the share price divided by the earnings per share. It is
generally considered to be a useful guide to a shares growth prospects:
a ratio of 20 or more, for example, indicates that a share is doing well
and can be expected to increase in value in the future. Such a share is
likely, as a result, to be relatively more expensive than others within the
same market sector. A low ratio less than about 4 indicates that the
market feels that the share has poor prospects of growth.
2.3.1.3 Taxation of shares

Dividends are received by shareholders net of 10 per cent, with a tax credit
equal to the amount deducted. Non-taxpayers cannot reclaim this deduction;
lower-rate and basic-rate taxpayers have no further liability, but higher-rate
taxpayers have to pay sufficient tax to bring their tax paid up to the higher rate
applicable to dividends (32.5 per cent of the grossed-up dividend). For
additional-rate taxpayers with income over 150,000 the rate is 37.5 per cent.
This extraordinary system was introduced to smooth out the effect of the
abolition of advance corporation tax (ACT) from 6 April 1999.
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Example
t
An investor who is a higher-rate taxpayer receives a net

dividend of 900 from shares in a UK company.
The grossed-up dividend is 1000.
She must pay a further 22.5% of the gross dividend, ie a

further 225.
Gains realised on the sale of shares are subject to capital gains tax (CGT),
although investors may be able to offset the gain against their annual CGT
exemption allowance.
2.3.1.4 Ex-dividend
Dividends are usually paid half-yearly. Because of the administration involved in
ensuring that all shareholders receive their dividends on time, the payment
process has to begin some weeks before the dividend dates. A snapshot of the
list of shareholders is made at that point, and anyone who purchases shares
between then and the dividend date will not receive the next dividend (which
will be paid to the previous owner of the shares). During that period, the shares
are said to be ex-dividend (or xd). The share price would normally be expected
to fall by approximately the dividend amount on the day it becomes xd.
2.3.1.5 Share indices
The Stock Exchange Daily Official List gives the closing prices of all listed
securities on the previous day. The Financial Times and other newspapers
produce daily lists of the share prices of most companies, making it easy to
check up-to-date share prices.
It is possible to measure the overall performance of shares by using one or
more of the various indices that are produced. These include
t
Financial Times 30 Share Index (FT 30): this is an index of 30 major

industrial companies shares, which represent around one-quarter of the
market value of UK equities;
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t
FTSE 100 Index (commonly known as the Footsie): this is an index of

the top 100 companies in capitalisation terms. Each company is weighted
according to its market value;
FTSE All-Share Index: this is an index of around 900 shares, split into
sectors. It measures price movements and shows a variety of yields and
ratios as well as a total return on the shares.
2.3.1.6 Rights issues and scrip issues

Stock Exchange rules require that, when an existing company that already has
shareholders wishes to raise further capital by issuing more shares, those
shares must first be offered to the existing shareholders. This is done by means
of a rights issue offering, for example, one new share per three shares already
held, generally at a discount to the price at which the new shares are expected
to commence trading. Shareholders who do not wish to take up this right can
sell the right to someone else, in which case the sale proceeds from selling the
rights compensate for any fall in value of their existing shares (due to the
dilution of their holding as a proportion of the total shareholding).
Scrip issue, also known as a bonus issue or a capitalisation issue, is an issue of
additional shares, free of charge, to existing shareholders. No additional capital
is raised by this action it is achieved by transferring reserves into the
companys share account. The effect is to increase the number of shares and to
reduce the share price proportionately.
2.3.1.7 Preference shares and other shares
As with ordinary shares, holders of preference shares are entitled to
dividends payable from the companys profits. Preference dividends are
generally at a fixed rate; in the payment hierarchy, they rank after loan interest
but ahead of ordinary share dividends. Many preference shares are
cumulative preference shares, which means that if dividends are not paid,
entitlement to dividends is accumulated until such a time as they can be paid.
Preference shares do not normally carry voting rights but, in some cases,
holders may acquire voting rights if their dividends have been delayed.
In the event of winding up a company, preference shares rank behind loans but
ahead of ordinary shareholders claims.
Convertibles are securities, issued by companies to raise capital, which carry
the right to be converted at some later date to ordinary shares of the issuing
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company. Traditionally they were issued in a form that effectively made them a
loan (with a lower rate of interest than conventional debt because of the right
to convert to equity) but, in recent years, they have been increasingly issued as
convertible preference shares.
2.3.2 Loan stock

As well as issuing shares, companies can seek loans for use in their business.
They can borrow from banks or other lenders. They can also issue what are
known as loan stocks and debentures. These types of borrowing are usually
over the longer term, which helps the company to make long-term business
plans. Loan stocks and debentures are issued on specified terms, including the
rate of interest payable by the issuing company (and when that interest is
payable) and the redemption date. They are usually issued at a fixed rate of
interest.
Loan stocks and debentures are essentially the same, that is, borrowings by the
company on certain terms, but, as is the case with shares, it is important to
ascertain the precise rights and obligations of a particular borrowing. Broadly
speaking, loans that are secured in some way perhaps on the companys
property are normally referred to as debentures, while those that are not
are simply called loan stocks.
Some loan stocks are issued that give the holder the right to convert the loan
into ordinary shares of the issuing company.There is no obligation to do so and
if the option is not exercised the loan continues unchanged.
Interest rather than dividends is payable on both types of debt and normally
should be payable whether or not sufficient profit has been made by the
company. The holders of these types of debt are creditors of the issuing
company and so, in a winding-up, take priority over the shareholders. On the
other hand, the loan stock and debenture holders do not have the right to vote
at company meetings.
The interest on stock is paid net of 20 per cent tax. Basic-rate and lower-rate
taxpayers have no further liability; higher-rate taxpayers are liable for a further
20 per cent and additional-rate taxpayers a further 25 per cent; and nontaxpayers can reclaim.
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The risk inherent in these types of debt is related to the viability of the issuing
company, its prospects and strength. Loan stocks have a greater level of risk
than debentures because they do not have the backing of security.
2.4 Property
In broad terms, investment in real estate falls into three categories:
t
residential property;
agricultural property;
commercial and industrial property.
The vast majority of investors will only ever be involved in residential property.
For most people this does not extend beyond the purchase of their own
home, although an increasing number of people are buying residential
properties specifically as an investment. The significant fall in property values in
2008 and the continuing uncertainty in the market have been a timely reminder
that property can prove to be a risky investment in the short term.
Property investment has a number of benefits and advantages, including the
following.
t
Property is a very acceptable form of security for borrowing purposes.
The UK property market is highly developed and operates efficiently and

professionally.
rents (and therefore capital values) tend to move with money values and
consequently provide a good hedge against inflation.
professional property management services are readily available.
On the other hand, there are a number of pitfalls and disadvantages of which
inexperienced investors in particular should be made aware, including the
following.
t
There is the risk of being unable to find suitable tenants or that tenants
will prove to be unsuitable.
Location is of paramount importance and a badly-sited development

may prove a problem.
The property market is affected by overall economic conditions in

times of recession, lettings may be difficult and property prices may fall.
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t
Property is less readily marketable than most other forms of investment.
Investment costs tend to be high and can include management fees, legal
charges and stamp duty.
As with direct investment in shares, direct investment in property can be a

risky business for the small investor, although the advent of buy-to-let
mortgages (see Section 2.4.2) has made it easier. For smaller amounts of capital
and for those who wish to spread the risk, there are property bonds where
the underlying fund is invested in a range of properties and shares in property
companies. Another alternative is real estate investment trusts (see Section
3.2.2.3).
2.4.1 Taxation
Income from property, after deduction of allowable expenses, is subject to
income tax. It is treated as earned income for tax purposes. On the disposal
of investment property, any gain will be liable to capital gains tax (CGT); but
any capital expenditure on enhancement of the propertys value can be offset
against taxable gains.
2.4.2 Buy-to-let
Despite some dramatic falls from time to time, the overall trend in UK house
prices over the last 30 years has been strongly upwards. The early 2000s saw
dramatic rises in the price of property in the UK. One unfortunate
consequence of this is that young people and other first-time buyers now find
it difficult to afford to purchase a property, especially in the south-east of
England, which has seen significant increases. In times of economic downturn,
this effect is worsened by an uncertain job market that makes it difficult for
people to commit to large mortgages.
The situation can be eased if there is a reasonable supply of good quality
properties to rent but traditionally the UK has had a shortage of private rental
property particularly compared to most other European countries, for
instance. There are a number of reasons for this, including the following.
t
Historically, lenders viewed loans to buy property-to-let as being

commercial rather than residential loans even if the property was to
be let for residential purposes. This meant higher rates of interest than
for standard mortgage loans on owner-occupied property.
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t
Rental income was traditionally excluded from a borrowers income

when assessing their ability to make the mortgage repayments.
Buy-to-let is an initiative designed to stimulate growth in the private sector

of the rental market. The aim is to encourage private investors to borrow at
competitive interest rates with a view to investing in rental property that
should give them a reasonable expectation of sustained income and capital
growth. Lenders involved in this scheme will now take potential rental income
into account and will charge interest rates broadly in line with those for
owner-occupation mortgages.
The scheme is the result of a joint initiative by the Association of Residential
Letting Agents (ARLA) and mortgage lenders. Alliance and Leicester, Halifax
and NatWest were instrumental in the early stages, although many more banks
and building societies now offer buy-to-let mortgages.
This change in policy results from the knowledge that a buy-to-let scheme will
be professionally managed. For many schemes, it is a requirement that an agent
who is a member of ARLA should be involved in:
t
selecting suitable properties;
selecting suitable tenants;
arranging appropriate tenancy agreements (normally assured shorthold

tenancies);
managing the properties.
Gross rents for buy-to-let properties are typically 125150 per cent of the
monthly mortgage payments. There are of course other costs, such as agents
commission/fees, insurance and maintenance costs.
Rental income is subject to income tax but the cost of insurance, agents fees,
maintenance etc can be offset as a deduction against tax. The initial cost of
furniture, fixtures and fittings cannot be deducted, but a wear-and-tear
allowance of 10 per cent per year may be allowed.
2.4.2.1 Buy-to-let regulation
Buy-to-let mortgages are treated as commercial loans and not regulated by the
FCA. In December 2009, the Treasury published Mortgage regulation: a
consultation, which proposed that buy-to-let mortgages should be regulated by
the FSA. On 26 March 2010 the Treasury published Mortgage regulation:
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summary of responses announcing that it would reconsider changes to the

form of regulation proposed to protect consumers in the buy-to-let sector.
The paper said The Government will examine how to ensure the impact of
regulation on the buy-to-let market is proportionate, particularly for individual
professional landlords. It will also consider how best to protect consumers
from the range of possible causes of detriment that may result from buy-to-let
including, if appropriate, the consequences of poor investment decisions as well
as unaffordable borrowing.
Subsequently, the coalition government has indicated that if industry did more
to provide information for landlords it may not feel the need to introduce
regulation of buy-to-let mortgages.
In the EU a directive on credit agreements relating to residential property
(CARRP) is being discussed, which seeks to harmonise mortgage regulation
across member states. The EU plans would mean that buy-to-let agreements
would be subject to earnings rather than rental income and would therefore
be regulated by the FCA, and give borrowers access to the Financial
Ombudsman.
The UK has been seeking an exemption for buy-to-let from the outset based
on the argument that buy-to-let is a commercial activity and therefore not
entitled to the protections offered under this consumer directive. At time of
writing (April 2013), this is still being negotiated.
2.4.3 Commercial property

Investment in commercial property covers almost anything that is not defined
as wholly residential. This includes:
t
individual retail shops;
shopping arcades and shopping centres;
offices;
industrial units, ie factories, workshops and storage units;
hotels and leisure resorts;
mixed-use property shops/offices, perhaps including a residential

element.
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Commercial property tends to provide reasonably high rental income together

with, in general, steady growth in capital value. The main advantages are:
t
regular rent reviews, with typically no more than five years between
each;
longer leases than for residential property;
more stable and longer-term tenants;
typically lower initial refurbishment costs.
Drawbacks may include the following:

t
the higher average value means that spreading the risk is more difficult;
commercial property does not generally show the spectacular growth in

value that can sometimes be achieved in residential property;
if the investment is to be funded by borrowing, interest rates may be

higher than for residential loans.
Lenders often carry out detailed investigations before lending for the purchase
of commercial property, checking on:
t
the quality of the land and property;
the reputation of builders, architects and other professionals involved;
the suitability of likely tenants.
2.5 Commodities
Commodities have been traded for thousands of years, particularly metals
(such as silver and gold) and foodstuffs (including wheat and other grain crops).
In modern times the concept of a commodity has been broadened
considerably and now includes, for instance, electricity, timber and even future
royalties on music and other artistic work.
For the modern investor, commodities offer a number of opportunities, both
directly and indirectly. Investment in precious metals, particularly gold, is
available even to small investors through the sale, by various governments, of
gold coins such as South African krugerrands.
A lot of trade in commodities is carried out through the medium of forward
contracts, ie binding agreements made under which one party must sell and the
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other party must buy a specified amount of a commodity at a specified price

on a particular date in the future. Other, more sophisticated, commodity
derivatives have also been developed, primarily to enable farmers and other
producers to hedge their risks (for instance the risk of a crop failure). The
majority of trading in the commodity derivatives markets is now done by
people who have no need of the commodity itself: they make a profit by
speculating on the price movements of the commodities through the purchase
and sale of derivatives.
2.6 Foreign exchange

Most countries have their own individual currency, eg the UK uses sterling (),
the EU states within the eurozone use the euro (b) and the USA uses the US
dollar ($). Individuals and companies within each country (or group of
countries, in the case of the euro) use the domestic currency within that
countrys boundaries. When transactions take place between individuals and
companies from different currency areas, purchasers and investors need to
obtain the appropriate foreign currency. For instance, if a UK company buys
components from a French supplier, the UK company wants to pay in sterling
but the French supplier wants to receive payment in euros. So the UK
purchaser needs to exchange sterling for euros and this is done on the
foreign exchange market.
The foreign exchange market is an international market where currencies are
exchanged. The main participants in the market are banks, central banks and
other financial institutions, which need to transfer one currency into another
either on their own account or on behalf of their customers.The market is not
situated in one place but is the result of all buying and selling transactions
originating from bank dealing-rooms all over the world. Technology has made
it possible for the market to take place on a 24-hour basis. Millions of individual
transactions are thus taking place every hour and the changing price of one
currency in terms of another reflects all the amounts demanded and supplied.
The two main reasons why individuals or companies need to exchange
currency are international trade and investment. As regards trade, there is a
huge international trade in both goods and services.
t
Goods trade: companies in different countries purchase raw materials,

components and finished goods from each other. For example, the UK
imports cars from Japan and Germany and exports Scotch whisky all
over the world.
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t
Services trade: companies buy financial services from banks and

insurance companies in other countries and deliver their goods overseas
using foreign-owned transport; individuals go to other countries for the
purposes of tourism or education.
The amount of money being transferred for investment purposes is even

greater than that being transferred for trading purposes. International
investment can be split into short-term and long-term.
Where a company has a temporary surplus, it needs to invest it, if only for a
short period, in order to earn a return. This is where short-term
international investment comes in and it will invest money in a country
that currently has the highest interest rates.
A long-term international investment is where individuals and companies
buy shares and make longer-term loans to borrowers in other countries. A
company may wish to invest in overseas expansion by opening a branch in
another country.
Currency speculators trade in the currency markets on their own account.
They aim to make profits by anticipating changes in exchange rates and
buying/selling at the appropriate time. A speculator might spend 1m on buying
US dollars at an exchange rate of 55p and then exchange the resulting
$1,818,182 back into sterling when the rate changed to 57p, making a profit of
36,364.
2.7 Money-market instruments

Money-market instruments is a generic term used to describe a number of
forms of short-term debt. Interest is not normally paid during the term of the
transaction, the rate of interest being determined by the difference between
the amount invested/borrowed and the amount repaid.
In order to illustrate the nature of these instruments, we will describe three of
them: Treasury bills, certificates of deposit, and commercial paper.
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2.7.1 Treasury bills

Treasury bills are short-term redeemable securities issued by the Debt
Management Office (DMO) of the Treasury. Like gilt-edged stocks (gilts see
Section 2.2.1), they are fund-raising instruments used by the UK government,
but they differ from gilts in a number of ways. Two major differences are:
t
Treasury bills are short-term, normally being issued for a period of 91

days, whereas gilts can be long-term or even undated;
Treasury bills are zero-coupon securities, ie they do not pay interest.

Instead, they are issued at a discount to their face value or par value (the
amount that will be repaid on their redemption date).
As with gilts, Treasury bills are considered to be very low-risk securities, the
risk of default by the borrower (the UK government) being so low as to be
effectively zero.
Because they are such short-term securities, changes in market rates of
interest have little impact on the day-to-day prices of Treasury bills unless the
changes are significantly large.
Throughout their term, Treasury bills can be bought and sold, and there is a
strong secondary market, provided mainly by banking organisations as there is
no centralised marketplace. The price tends to rise steadily from the issue
price to the redemption value over the 91-day period, but prices can also be
affected by significant interest rate changes, or by supply and demand.
Treasury bills are purchased in large amounts, and they are not, therefore,
generally of interest to small private investors. They are held in the main by
large organisations (particularly financial institutions) seeking secure shortterm investment for cash that is temporarily surplus to requirements.
2.7.2 Certificates of deposit

Certificates of deposits (CDs) are a method of facilitating short-term larger
scale lending typically for periods of three months or six months, and for
amounts of 50,000 or more. Depositors who require a longer term can often
obtain CDs that can be rolled over for a further three or six months on
specified terms.
They are issued by banks and building societies, and are in effect a receipt to
confirm that a deposit has been made with the institution for a specified period
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at a fixed rate of interest. The interest is paid with the return of the capital at
the end of the term.
Certificates of deposit are bearer securities, which means that repayment on
the specified terms will be made to the bearer of the certificate on the
maturity date. So, if the depositor needs money before the end of the term,
the certificate can be sold to a third party.
Banks may also hold CDs issued by other banks, and they can issue and hold
CDs to balance their liquidity positions. For example, a bank would issue CDs
maturing at a time of expected liquidity surplus, and hold CDs maturing at a
time of expected deficit.
2.7.3 Commercial paper

Businesses need to borrow for a variety of purposes. When they need funds
for investment in their longer-term business plans, they may issue corporate
bonds (see Section 2.2.4).
When they wish to borrow for working capital purposes, however, they can
issue commercial paper, which is an unsecured promissory note (ie a
promise to repay the funds that have been received in exchange for the paper).
The transactions are for very large amounts, with most purchasers being
institutions such as pension funds and insurance companies. Commercial paper
can be placed directly with the investors, or through intermediaries.
The commercial paper market offers cheaper borrowing opportunities for
companies that have good credit ratings, but even companies with lower credit
ratings can issue commercial paper if it is backed by a letter of credit from
a bank that guarantees (for a fee) to make repayment if the issuer defaults.
Most commercial paper is issued for periods of between five and 45 days, with
an average of around 30 to 35 days. Firms that need to retain funds for longer
than this regularly roll over their commercial paper the advantages of this are
(i) flexibility and (ii) the fact that the rate of interest is not fixed for a long
period.
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1.
To what extent can deposit accounts be said to be secure?
2.
What rate of tax, if any, is normally deducted at source from building

society accounts?
(a) None.
(b) 10%.
(c) 20%.
3.
Give two reasons why offshore investments may be more risky than
similar onshore products.
4.
What is the minimum age at which a person can take out a National
Savings and Investments Direct Saver?
(a) 11.
(b) 16.
(c) 18.
5.
What is the difference between the taxation of interest on government

stocks and of that on local authority stocks?
6.
The price/earnings (P/E) ratio of a share indicates the relationship

between the shares current price and the most recently declared
dividend. True or false?
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Unit 1
7.
How can a company raise additional finance for expansion without

borrowing?
8.
What is the normal distinction between debentures and other loan

stocks?
9.
What change of attitude by lenders led to the establishment of the buyto-let market?
10. What type of tenancy agreement would normally be used for a buy-to-let
property?
[1] 96
Answers
1.
Apart from the small chance of a bank or building society failing, the
capital is secure, but the real value of the capital will be eroded by
inflation. The amount of interest could fall on variable interest accounts.
2.
(c) 20%.
3.
If not denominated in sterling, the value of capital and income will be

subject to currency fluctuations. The local regulatory regime may not be
as strong as that of the FCA in the UK.
4.
(b)16.
5.
Interest on government stocks is normally paid gross (but it is taxable),

whereas that on local authority stocks is paid net of 20% tax.
6.
False. It relates the share price to the earnings (net profits) per share.
Profits are not necessarily all distributed as dividends.
7.
By a rights issue of new shares to existing shareholders.
8.
Debentures are normally secured on company assets.
9.
Lenders began to treat buy-to-let business as residential rather than

commercial, applying different underwriting principles and lower interest
rates.
10. Assured shorthold tenancy.
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Section 3
Financial products
Introduction
This section contains a review of the main products designed to help
customers to solve their financial problems and to meet their financial needs
and objectives.
Here we concentrate on packaged products supplied by product providers
such as banks, insurance companies and investment managers. The products
considered include collective investments, derivatives, life assurance, general
insurance, mortgages and other loans, and pension policies.
Section 3 covers the topics listed in part 3 of the syllabus for Unit 1, ie the
main financial services product types and their functions.
3.1 Investments
The main forms of direct investment, ie cash, current and deposit accounts,
fixed interest stocks, shares and property, are described in Section 2.
3.2 Regulated collective investments

Collective or pooled investments are arrangements whereby individual small
investors can contribute, by means of lump sums or regular savings, to a large
investment fund. Pooled investments offer a number of advantages to individual
investors, including the following.
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t
The services of a skilled investment manager are obtained at a cost that

is shared among the investors. Individual investors do not need to
research particular companies nor do they need to understand and
deal with occurrences such as rights issues.
Investment risk can be reduced because the investment manager

spreads the fund by investing in a large number of different companies
so that if one company fails, the whole investment is not compromised.
Such a spread could not normally be achieved with small investment
amounts.
Fund managers handling investments of millions of pounds can negotiate

reduced dealing costs for their investors.
There is a wide choice of investment funds, catering for all investment

strategies, preferences and risk profiles.
Investment funds can be categorised in a number of ways, for example by:

t
location, eg UK, Europe, America, Far East;
industry, eg technology, energy;
type of investment, eg shares, gilts, fixed interest, property;
other forms of specialisation, eg recovery stocks, ethical investments.
Many funds are based on more than one categorisation, eg a UK equity fund.
Most companies also offer one or more managed funds. This is an
unfortunate choice of name, since it seems to imply that other funds are not
managed. Nevertheless, the name has become accepted as applying to the type
of fund where its managers sometimes invest appropriate proportions in a
range of the companys other funds to meet the managed funds objectives.
Most managed funds are middle-of-the-road in terms of risk profile, and are
often chosen by people seeking steady market-related growth in situations
where risk of loss needs to be kept to a minimum, such as pension provision
or mortgage repayment.
A further categorisation is possible: into funds that aim to produce a high level
of income (perhaps with modest capital growth); those that aim for capital
growth at the expense of income; and those that seek a balance between
growth and income.
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The main forms of collective investment are:

t
unit trusts;
investment trusts;
investment bonds; and
open-ended investment companies (OEICs).
Although they may appear broadly similar to the unsophisticated investor, they
are in fact very different, both in the way they operate and in the taxation
treatment of both the fund managers and the investors.
3.2.1 Unit trusts

A unit trust is a pooled investment created under trust deed. An investor may
contribute to a unit trust by way of a lump sum or regular contributions, or a
combination of both. Unit trusts have been particularly successful in attracting
investment from individuals in the UK, with total funds under management of
the order of 550bn.
The unit trust is divided into units, with each unit representing a fraction of the
trusts total assets. A unit trust is open-ended in the sense that a manager can,
in response to demand, create more units.
The trust deed places obligations on both the manager and the trustee.
3.2.1.1 The role of the unit trust manager
The manager is responsible for:
t
managing the trust fund;
valuing the assets of the fund;
fixing the price of units;
offering units for sale;
buying back units from unit-holders.
The manager is obliged, under the terms of the trust deed, to buy back units
from investors who wish to sell them, and will generate profit from charging
management fees and dealing in the units.
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Unit 1
3.2.1.2 The trustees

The trustees have an overall responsibility to ensure investor protection. To
enable this to happen they carry out a number of duties:
t
set out the trusts investment directives;
hold and control the trusts assets;
ensure that adequate investor protection procedures are in place;
approve proposed advertisements and marketing material;
collect and distribute income from the trusts assets;
issue unit certificates to investors;
supervise the maintenance of the register of unit-holders.
The trustees have a policing role to ensure that the manager complies with the
terms of the trust deed. The role of trustee is often carried out by an
institution such as a clearing bank or life company.
3.2.1.3 Authorisation of unit trusts
Unit trusts are primarily regulated in the UK under the terms of the Financial
Services and Markets Act 2000, and have to be authorised by the Financial
Conduct Authority (FCA).
3.2.1.4 Pricing of units
To price the fund, the manager will calculate the total value of trust assets,
allowing for an appropriate level of costs, and then divide this by the number
of units that have been issued. The prices at which units are bought and sold
are calculated by the managers on a daily basis using a method specified in the
trust deed. The unit prices are directly related to the value of the underlying
securities that make up the fund.
There are three important prices in relation to unit trust transactions:
t
the offer price is the price at which investors buy units from the
managers;
the bid price is the price at which the managers will buy back units
from investors who wish to cash in all, or part, of their unit-holding;
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t
the cancellation price is the minimum permitted bid price, taking into
account the full costs of buying and selling. At times when there are both
buyers and sellers of units, the bid price is generally above this minimum
level, since costs are reduced because underlying assets do not need to
be traded.
Many unit trusts still use bid and offer prices, with the difference between them
(known as the bid offer spread) being of the order of 5 per cent or 6 per
cent. Some unit-trust managers, however, are moving to a single-price system
because they believe that this is better understood by investors. In this case,
they may impose an exit charge if units are sold within, say, three or five years
of purchase.
3.2.1.4.1 Historic and forward pricing
A significant change in the pricing of units took place in 1988. Prior to that
time, clients bought or sold at prices determined before the start of the dealing
period typically the previous days valuation. (If a funds daily valuation takes
place, for example, at noon, the dealing period is from midday on one day to
midday on the following working day.) This system, known as historic pricing,
is now considered unacceptable because prices clearly do not reflect what is
happening in the market: an investor might telephone for a price and complete
a purchase, just before the newly calculated daily price is published, knowing
that the market has risen in the meantime.
Concern about historic pricing led to the introduction of the system known as
forward pricing, which is now standard practice for unitised funds. Under
forward pricing, clients buy or sell in a given dealing period at the prices that
will be determined at the end of the dealing period. The prices published in the
financial press are therefore only a guide to investors, who do not know the
actual price at which their deal will be made.
Fund managers are still permitted to use historic pricing if they wish, subject
to the proviso that they must switch to forward pricing if an underlying market
in which the trust is invested has moved by more than 2 per cent in either
direction since the last valuation.
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Unit 1
3.2.1.4.2 Buying and selling units

Unit-trust managers are obliged to buy back units when investors wish to sell
them. There is consequently no need for a secondary market in units and they
are not traded on the Stock Exchange. This adds to the appeal of unit trusts to
the ordinary investor, for whom the buying and selling of units is a relatively
simple process.
Units can be bought direct from the managers or through intermediaries. They
can be purchased in writing or by telephone: all calls to the managers dealing
desks are recorded as confirmation that a contract has been established.
Purchasers receive two important documents from the managers:
t
the contract note: this specifies the fund, the number of units, the unit
price and the amount paid. It is important because it gives the purchase
price, which will be needed for capital gains tax (CGT) purposes when
the units are sold;
the unit certificate: this specifies the fund and the number of units
held, and is the proof of ownership of the units.
In order to sell some or all of the units, the unit-holder signs the form of
renunciation on the reverse of the unit certificate and returns it to the
managers. If only part of the holding is to be sold, a new certificate for the
remaining units is issued.
3.2.1.5 Charges
There are two types of charges applied to unit trusts:
t
the initial charge will cover the costs of purchasing fund assets.The initial
charge is typically covered by the bid-offer spread;
the annual management charge, which, as its name suggests, is the

fee paid for the use of the professional investment manager. The charge
varies but is typically between 0.5 per cent and 2 per cent of fund value.
Although an annual fee, it is commonly deducted on a monthly or daily
basis.
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3.2.1.6 Types of unit

Unit trusts may offer the following units.
t
Accumulation units automatically reinvest any income generated by

the underlying assets. This would suit someone looking for capital
growth.
Distribution or income units split off any income received and

distribute it to unit-holders. The units may also increase in value in line
with the value of the underlying assets.
3.2.1.7 Taxation of unit trusts

3.2.1.7.1 Income tax
Authorised unit trusts, other than fixed interest trusts, are treated as
companies for tax purposes and, as such, are subject to corporation tax on
income (though not on growth within the fund).
Dividend income received by the trust will already have borne tax at 10 per
cent; the unit trust has no further liability on such income. Please note the
following.
t
When the income is paid out to unit-holders, it is treated as having

borne tax at 10 per cent.
A non-taxpayer is not able to reclaim the 10 per cent tax already

deducted.
Starting rate and basic rate taxpayers need take no further action
because the 10 per cent tax already deducted is deemed to satisfy their
tax liability on the income.
Higher-rate taxpayers have a further liability of 22.5 per cent of the

gross income distribution, ie on the income paid plus the 10 per cent tax
deducted at source. Thus the total liability for a higher-rate taxpayer is
32.5 per cent, increasing to 37.5 per cent for income over 150,000.
So, a distribution of 18 net received by a unit-holder is equivalent to gross

income of 20. If the unit-holder is a higher-rate taxpayer, a further 4.50 tax
will be payable through self-assessment. An additional rate taxpayer would pay
7.50 tax.
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Unit 1
Income from overseas securities, cash and fixed-interest securities is subject to

corporation tax at a rate of 20 per cent. This will mean that when this income
is paid out:
t
non-taxpayers can reclaim the tax that has been deducted;
starting-rate taxpayers can reclaim half the tax deducted (ie they are
only liable to tax at 10 per cent and therefore can reclaim 10 per cent);
basic-rate taxpayers have no additional liability;
higher-rate taxpayers must pay a further 20 per cent of the gross income
and additional-rate taxpayers would pay a further 25 per cent on top of
the basic liability.
So, in this case, a distribution of 40 net received by a unit-holder is equivalent

to gross income of 50. If the unit-holder is a higher-rate taxpayer, a further
10 tax will be payable through self-assessment. A non-taxpayer can reclaim
the 10 deducted.
3.2.1.7.2 Capital gains tax
No capital gains tax is levied within the unit trust, but the investor may be liable
to capital gains tax on any gain made when units are encashed. The annual
exemption allowance can be used to reduce any liability to capital gains tax.
3.2.1.8 Risks of unit trusts
The legal constitution of a unit trust helps to mitigate risk of fraud because the
trustees have a responsibility to ensure there is proper management.
Given the nature of a unit trust as a pooled investment, the risk will be lower
than that of an individual investing directly into equities on their own behalf.
Unit-trust funds will typically invest in a spread of between 30 and 150 different
shares.
The actual risk will depend on the type of unit trust selected. The wide range
of choice means that there are unit trusts to match most investors risk
profiles. A cash fund will carry similar risks to a deposit account, specialist funds
such as emerging markets are high risk by their very nature and overseas funds
carry the added risk of currency fluctuations.
Unit trusts provide no guarantee that the initial capital investment will be
returned in full or that a particular level of income will be paid.
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3.2.2 Investment trusts

Investment trusts are collective investments but, unlike unit trusts, they are not
unitised funds. Furthermore despite their name they are not even trusts.
They are in fact public limited companies whose business is investing (in most
cases) in the stocks and shares of other companies. Investing in an investment
trust is achieved by purchasing shares of the investment trust company on the
Stock Exchange; similarly, in order to cash in the investment, it is necessary to
sell these shares to another investor. As with all companies, the number of
shares available remains constant, so an investment trust is said to be closedended (in contrast to the open-ended nature of unit trusts).
The share price of an investment trust obviously depends to some extent on
the value of the underlying investments, but not so directly as in the case of a
unit trust.The price can depend on a number of other factors that affect supply
and demand. In many cases, the share price of an investment trust is less than
the net asset value (NAV) per share; the NAV per share is the total value
of the investment fund divided by the number of shares issued. This situation
referred to as being at a discount means that an investor should achieve
greater income and growth levels than would be obtained by investing directly
in the same underlying shares.
One advantage of being constituted as a company is that an investment trust
can benefit from gearing: this means that, like all companies, it can borrow
money in order to take advantage of business opportunities (in their case,
investment opportunities).This avenue is not open to unit trusts, which are not
permitted to borrow. Gearing enables investment trusts to enhance the
growth potential of a rising market, but investors should be aware that it can
equally accentuate losses in a falling market.This factor led to some high-profile
difficulties for certain investment trusts in the volatile stock market of the early
2000s.
3.2.2.1 Taxation of investment trusts
The taxation situation is broadly the same as that described for unit trusts. At
least 85 per cent of the income received by investment-trust-fund managers
must be distributed as dividends to shareholders, who receive them net of 10
per cent, with a tax credit. As with all share dividends, lower-rate and basic-rate
taxpayers have no further liability, but higher-rate taxpayers pay the balance of
the special rate of 32.5 per cent of the grossed-up dividend, increasing to 37.5
per cent for income over 150,000.
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Unit 1
Fund managers are exempt from tax on capital gains, but investors are subject
to capital gains tax on the sale of their investment trust shares.
3.2.2.2 Split-capital investment trusts
Sometimes known as split-level trusts or simply as splits, split-capital
investment trusts are fixed-term investment trusts offering two or more
different types of share.The most common forms of share offered by split-level
investment trusts are:
t
income shares, which receive the whole of the income generated by

the portfolio but no capital growth;
capital shares, which receive no income but which when the trust is
wound up at the end of the fixed term share all the capital growth
remaining after fixed capital requirements have been met.
Recent innovations have seen the introduction of intermediate types of shares,

offering different balances of capital and income.
3.2.2.3 Real estate investment trusts
Real estate investment trusts (REITs) are tax-efficient property investment
vehicles that allow private investors to invest in property while avoiding many
of the disadvantages of direct property investment (see Section 2.4).
REITs (pronounced reets to avoid confusion with rights) became available in
the UK from January 2007. Similar schemes operate in a number of other
countries, particularly the USA and Australia.
A summary of the main UK features of REITs is as follows.
t
They will pay no corporation tax on income or growth provided they

meet the requirements listed below.
At least 75 per cent of their gross income must be derived from

property rent. The remainder can come from development or other
services.
At least 90 per cent of their profits must be distributed to their

shareholders. At present these dividends must be in cash, but the
government intends to introduce an amendment to allow UK REITs to
issue optional stock dividends as an alternative to cash.
[1] 108

t
No individual shareholder can hold more than 10 per cent of the shares.
Single-property REITs are only be allowed in special cases such as, for
example, a shopping centre with a large number of tenants.
They can be held in ISAs, child trust funds and self-invested personal
pensions.
Property companies converting into REITs are subject to a one-off charge of

2 per cent of the value of their assets.
3.2.3 Open-ended investment companies

Open-ended investment companies (OEICs) have been popular in mainland
Europe for many years and have been available in the UK since 1997. They
share a number of characteristics with unit trusts and investment trusts. The
similarity with unit trusts is not surprising, as there is a high degree of
commonality between the Financial Conduct Authoritys two sets of
regulations on OEICs and unit trusts.
OEICs are a pooled investment offered by a company that buys and sells the
shares of other companies and deals in other investments. The OEIC will issue
shares, typically participating redeemable preference shares, that can be bought
and sold by investors.
Although operating as a company, an OEIC cannot borrow money to finance
its activities other than for short-term purposes, unlike an investment trust.
3.2.3.1 Legal constitution of an OEIC
An OEIC is established under company law, not under trust. OEICs must be
authorised by the FCA.
The role of overseeing the operation of the company and of ensuring that it
complies with the requirements for investor protection is carried out by a
depositary, who will be authorised by the Financial Services Authority. The
role of the depositary is much the same as the trustee of a unit trust.
[1] 109
Unit 1
An authorised corporate director, whose role is much the same as the

manager of a unit trust, manages the OEIC. The role of the corporate director
is to:
t
manage the investments;
buy and sell OEIC shares as required by investors;
ensure that the share price reflects the underlying net asset value of the
OEICs investments.
The range of OEICs is similar to that of unit trusts. OEICs are available that
offer: income; capital growth; fixed interest; access to overseas markets; access
to specialist markets (eg commodities, technology or healthcare); index
tracking.
3.2.3.2 Investing in an OEIC
As with unit trusts and investment trusts, investments can be made either by
lump sum, regular contribution or a combination of both.
Investors buy shares in the OEIC. The number of shares that are available is
unlimited so the OEIC is, as the name would suggest, open-ended like a unit
trust, rather than closed-ended like an investment trust.The value of the shares
vary according to the market value of the companys underlying investments.
An OEIC may be structured as an umbrella company that is made up of
several sub-funds. Different types of share can be made available within each
sub-fund.
3.2.3.3 Pricing of OEIC shares
The basic procedure for establishing the share price is the same as that for
determining the unit price in a unit trust: the total value of OEIC assets is
established and then divided by the number of shares currently in issue.
There are, however, some differences in pricing when OEICs are compared to
unit trusts. OEIC shares have only one price, not a separate bid and offer price
as for units in a unit trust.
[1] 110
3.2.3.4 Charges
As already mentioned, OEIC shares are single-priced so there is no bid offer
spread. An OEIC will levy an initial charge, however, normally in the region
of 3 per cent to 6 per cent of the value of the individuals investment.
Annual management charges based on the value of the fund are also
deducted, normally from the income that the OEIC generates. The range of
annual management charges is typically between 0.5 per cent for indexed funds
and 2 per cent for more actively managed funds.
Other administration costs may also be deducted from the income that is
generated.
3.2.3.5 Taxation of OEICs
The tax treatment of OEICs is exactly the same as that for unit trusts and
investment trusts.
Any dividend distribution will be paid net of tax at 10 per cent and:
t
a non-taxpayer cannot reclaim the tax;
lower-rate and basic-rate taxpayers have no further tax liability;
higher-rate taxpayers must pay a further 22.5 per cent of the gross
dividend (27.5 per cent over 150,000).
The fund managers are not subject to tax on capital gains, although a liability
to CGT may arise for the investor when the OEIC is encashed. The amount of
any CGT liability can be mitigated by use of the annual exemption.
3.2.3.6 Risks
The risks associated with investing in an OEIC are similar to those of investing
in a unit trust. As a pooled investment employing the services of professional
investment managers, the degree of risk is lower than direct equity investment.
Risk is also mitigated by the spread that can be achieved for a relatively small
investment. There is, however, no guarantee of the maintenance of the original
capital invested or the level of income that will be generated.
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Unit 1
3.2.4 Unregulated collective investments

Conventional collective investment schemes are those that the FCA authorises,
or which are authorised elsewhere in the world and recognised by the FCA and
permitted to operate in the UK. In order to become authorised, these schemes
must have certain characteristics, which include that the scheme assets are
managed on behalf of all investors by the operator of the scheme (in other
words, the investor must not have control over the management of the scheme
assets), and that both income and profits must be pooled.
Regulated collective investment schemes must adhere to the investment and
promotional parameters laid out in the regulators Handbook, and there are
also certain regulatory restrictions that apply to them, such as investment and
borrowing limits. By adhering to these rules, they are permitted to be sold to
the general public in the UK.
Schemes that fall outside this definition are, unregulated. Unregulated
collective investment schemes (UCIS) have the freedom to invest in nontraditional scheme assets, such as wine, classic cars, crops and life assurance
policies but, because of the increased risk associated with such diverse and
unusual assets and the fact that recourse by the investor to the Financial
Ombudsman Scheme (FOS) and the Financial Services Compensation Scheme
(FSCS) may be limited if the provider is based abroad they are only
considered suitable for a very small group of high net worth individuals.
It should be noted that, although UCIS are unregulated as products, the
provision of advice is classed as a financial promotion and such activity is
regulated. In 2010, the former regulator (FSA) carried out a review of the use
of UCIS and found that only one in four sold was suitable for the customer. In
2011, the FSA highlighted such products as an emerging risk and are proposing
to limit the type of customer to whom a firm may promote UCIS. They also
proposed to introduce a new rule ensuring that each sale of a UCIS product
is signed off by the firms compliance function.
3.2.5 Platforms, wraps and fund supermarkets

Wrap accounts are a long-established feature in the US and Australia, and were
introduced into the UK in the early 2000s. The basic premise of a wrap account
is that one provider sets up an Internet-based platform to hold all of the investors
investments within one framework, enabling the investor to see all relevant
information in one place. The wrap account allows the investor to analyse and
quantify the holdings according to value, tax treatment and product type.
[1] 112
Wraps are generally offered by independent financial advisers, with charges

being levied by them in addition to any individual fund management charges
that may already have been applied to the investments being held in the
framework. Most wraps are able to hold any class of asset or fund on behalf of
the investor.
A fund supermarket is designed to provide access to a wide range of funds,
such as OEICS, unit trusts and ISAs, but not investment trusts. The investor has
a general investment account, which is exposed to the UK tax regime (apart
from any ISAs that are included, as they are tax-free). The investors pay the
annual management charges for each of the funds they invest in, but the fund
supermarket receives a rebate of some of these charges from the managers of
the individual funds included this is how it makes its money.
Both wraps and fund supermarkets are often referred to as platforms, but
they are different. A wrap offers all the same investments as a fund
supermarket, plus a whole range of other investments, such as investment
trusts, offshore investments and direct equities (shares).
3.2.6 Individual savings accounts

In 1997, the government decided that the existing tax-free savings schemes
were not sufficiently accessible to a large proportion of the population. It was
estimated that 50 per cent of the population of the UK had less than 200 in
savings, with about 25 per cent having no savings at all. The government
subsequently introduced, from 6 April 1999, the individual savings account
(ISA). Its stated objectives are to develop the savings habit and to ensure that
tax relief on savings is fairly distributed.
There are now two possible components of new investments into ISAs:
t
stocks and shares (or equity) ISAs: this component can include:
shares and corporate bonds issued by companies listed on stock
exchanges anywhere in the world;
gilt-edged securities and similar stocks issued by governments of
countries in the EEA;
UK-authorised unit trusts that invest in shares and securities;
UK open-ended investment companies (OEICs);
UK investment trusts;
[1] 113
Unit 1
t
cash ISAs, including:

bank and building society deposit accounts;
certain taxable National Savings and Investments (NS&I) accounts
excluding the investment account. NS&I also offers a deposit
account-type ISA.
An earlier third type of component life assurance is no longer available for

new investments, but can be incorporated in the stocks and shares component.
The minimum age for investing in an equity ISA is 18 years, but a cash ISA can
be opened by anybody aged 16 or over. An ISA investor must be both resident
and ordinarily resident in the UK for tax purposes, and an ISA can only be held
in a single name, ie joint accounts are not permitted, although husbands and
wives can have one each.
3.2.6.1 Tax reliefs
Investors are exempt from income and capital gains tax on their ISA
investments. Prior to 5 April 2004, fund managers of equity ISAs could reclaim
the 10 per cent deduction from UK share dividends but this benefit has now
been withdrawn. Fund managers are exempt from tax on other income and
gains received for the benefit of ISA investors.
3.2.6.2 Subscription limits
The overall annual subscription limit for ISAs in 2013/14 is 11,520, of which
up to 5,760 can be in cash. The remainder of the 11,580 can be placed in a
stocks and shares ISA with the same provider or a different provider. Each
individual can therefore have up to two separate ISAs in a tax year.
From 6 April 2011 the ISA limits increase each year in line with the Retail
Prices Index (RPI), rounded to the nearest multiple of 120. If the RPI falls the
ISA limits will remain unchanged.
3.2.6.3 Withdrawals and transfers
Many ISAs allow no-notice withdrawals to be made, although there are now
some fixed-rate cash ISAs available that do not permit withdrawals during the
fixed-rate period. It is not possible to replenish withdrawals made during a
particular tax year. For example, if an investor aged 40 paid in 5,760 to open
[1] 114
a cash ISA on 20 November 2013 and then withdrew 2,000 on 25 March

2014, they could not add any further money to the account during the 2013/14
tax year because they would have already invested the maximum allowance of
5,760 during that tax year.
It is permissible to transfer funds from a cash ISA to a stocks and shares ISA
without contravening the ISA limits (but not vice versa).
ISAs can still be transferred between providers on a like-for-like basis.
3.2.7 Life assurance-based investment products

3.2.7.1 Endowments
The most common form of savings contract offered by life assurance
companies is endowment assurance, which is, broadly speaking, a policy on
which the sum assured is paid out at the end of a specified term or on the
earlier death of the life assured (although some policies are open-ended and
allow policyholders to choose when to receive the proceeds of their
investment). The clients investment is made in the form of regular premiums
to the life assurance company throughout the term of the policy. There are a
number of variations, the most common of which are as follows.
3.2.7.1.1 Non-profit endowment
A non-profit endowment has a fixed sum assured, which is payable on
maturity (ie at the end of the policy term) or on earlier death. Because the
return is fixed and guaranteed, the investor is shielded from losses due to
adverse stock market movements; on the other hand, they are equally unable
to share in any profits the company might make over and above those allowed
for in calculating the premium rate (hence the name, non-profit). For that
reason, non-profit policies are rarely used today.
3.2.7.1.2 With-profit endowment
Like its non-profit equivalent, a with-profit endowment has a fixed basic sum
assured and a fixed regular premium. The premium, however, is greater than
that for a non-profit policy of the same sum assured, and the additional
[1] 115
Unit 1
premium (sometimes called a bonus loading) entitles the policyholder to share

in the profits of the life assurance company.
The company distributes its profits among policyholders by annually declaring
bonuses that become part of the policy benefits and are payable at the same
time and in the same circumstances as the sum assured. There are two types
of bonus.
t
Reversionary bonuses: these are normally declared each year and,

once they have been allocated to a policy they cannot be removed by
the company, provided that the policy is held until the end of the term
or earlier death. Some companies declare a simple bonus, where each
annual bonus is calculated as a percentage of the sum assured; others
declare a compound bonus, with the new bonus being based on the total
of the sum assured and previously declared bonuses. Most companies
set their reversionary bonuses at a level that they hope to be able to
maintain for some time, in order to smooth out the short-term
variations of the stock markets, but with the level of interest rates and
other investment yields falling in recent years, bonus rates in general
have also been falling. In spite of this, with-profit policies have produced
much better returns in the long run than non-profit policies.
Terminal bonuses: these are bonuses that may be added to a withprofit policy when a death or maturity claim becomes payable. Unlike
reversionary bonuses, a terminal bonus does not become part of the
policy benefits until the moment of a death or maturity claim, thus
allowing the company to change the terminal bonus rate or even
remove the terminal bonus altogether. Terminal bonuses are intended to
reflect the level of investment gains that the company has made over the
term of the policy, so the rate of bonus often varies according to the
length of time that the policy has been in force. In the current climate of
reduced stock market values, many companies have reduced the level of
their terminal bonuses.
A variation of the with-profit endowment, known as a low-cost endowment, is

sometimes used for mortgage repayment purposes (see Section 3.5.1.3.1.1).
3.2.7.1.2.1
Principles and Practices of Financial Management
The FCA requires life companies that carry on with-profits business to publish
a document (called the Principles and Practices of Financial Management
PPFM) that sets out how a firm manages its with-profits business. Each year the
[1] 116
insurance company has to certify to the FCA that their with-profits funds have
been managed in accordance with the PPFM. With-profits companies must also
produce a customer-friendly version of the PPFM (CFPPFM) explaining the
main PPFM document in clear and non-technical language.
3.2.7.1.3 Unit-linked endowment
The first unit-linked endowments were issued in the late 1950s and
represented a revolutionary change in the way in which policies were designed.
The development reflected the desire of many policyholders to link investment
returns more directly to the stock market, or even to specific sectors of the
market.
Unit-linked endowments work on the basis that, when a premium is paid, the
amount of the premium less any deductions for expenses is applied to the
purchase of units in a chosen fund. A pool of units gradually builds up and, at
the maturity date, the policyholder receives an amount equal to the total value
of all units then allocated to the policy. Most unit-linked endowments also
provide a fixed benefit on death before the end of the term. The cost of
providing this life cover is taken from the policy each month by cashing in
sufficient units from the pool of units.
Over the longer term, the most successful unit-linked endowments have
shown better returns than with-profit endowments. Unlike with-profit
endowments, however, unit-linked policies do not provide any guaranteed
minimum return at maturity; they are, therefore, a good illustration of the
maxim that greater potential return generally goes hand-in-hand with the
acceptance of greater risk.
3.2.7.1.4 Unitised with-profit endowments
Unitised with-profit endowments have been available since the late 1980s,
when they were introduced in an attempt to combine the security of the withprofit policy with the greater potential for reward offered by the unit-linked
approach. As with unit-linking, premiums are used to purchase units in a fund
and the benefits paid out on a claim depend on the number of units allocated
and the then-current price of units.
The difference from a standard unit-linked policy lies in the fact that unit prices
increase by the addition of bonuses which, like the reversionary bonuses on a
with-profit policy, cannot be taken away once they have been added.This means
[1] 117
Unit 1
that unit prices cannot fall and the value of the policy, if it is held until death or
maturity, is guaranteed. If the policy is surrendered (ie cashed in before its
maturity date), however, a deduction is made from the value of the units. This
deduction, the size of which depends on market conditions at the time of the
surrender, is known as a market value adjustment (MVA).
3.2.7.2 Investment bonds
Investment bonds are collective investment vehicles based on unitised funds.
Because of the unitised structure of their funds, they may appear similar to unit
trusts, but they are actually very different.
Investment bonds are available from life assurance companies and are set up as
single-premium unit-linked whole-of-life assurance policies. Investing in a bond
is achieved by paying the single (lump sum) premium to the life company. The
investor then receives a policy document that shows that the premium has
purchased (at the offer price) a certain number of units in a chosen fund and
that those units have been allocated to the policy. In order to cash in the
investment, the policyholder accepts the surrender value of the policy, which
is equal to the value of all the units allocated, based on the bid price on the day
when it is surrendered.
Investors are attracted by the relative ease of investment and surrender, by the
simplicity of the documentation and also by the ease of switching from one
fund to another: companies generally permit switches between their own
funds without charging the difference between bid and offer prices.
The range of available funds is similar to those offered by unit trusts and
investment trusts. In addition, some companies offer with-profits investment
bonds, in which premiums are invested in a unitised with-profits fund (see
Section 3.2.7.1.4). If a with-profits bond is cashed in within a specified period
after commencement (typically five years), the amount received is likely to be
less than the value of the units.
In the event of the death of the life assured, the policy ceases and a slightly
enhanced value (often 101 per cent of the bid value on the date of death) is
paid out.
[1] 118
3.2.7.2.1 Taxation
The funds in which the premiums are invested are internal life company funds
and their tax treatment is different from that of unit trusts. In particular, they
attract tax at 20 per cent on capital gains (whereas unit trust funds are
exempt) and this tax is not recoverable by investors even if they themselves
have a personal exemption from capital gains tax. The taxation system for
policy proceeds in the hands of the policyholder is complex but, broadly
speaking, because gains have been taxed at 20 per cent within the fund, tax on
the gain is payable only by higher rate taxpayers, and then only at 20 per cent
the excess of the higher rate over the 20 per cent already deemed to have
been paid within the fund. This is because investment bonds are non-qualifying
policies (see Section 1.3.3.2.7).
Unlike investment trusts and unit trusts, investment bonds do not normally
provide income in the form of dividends or distributions, but it is possible to
derive a form of income from them by making small regular withdrawals of
capital (by cashing in some of the units allocated to the policy.). These
withdrawals are tax-free to basic rate taxpayers, and even higher rate taxpayers
can withdraw up to 5 per cent of the original investment each year without
incurring an immediate tax liability. This 5 per cent allowance can, if not used,
be carried forward and accumulated up to an amount of 100 per cent of the
original investment.
Unlike investment trusts and unit trusts, investment bonds do not normally
provide income in the form of dividends or distributions, but it is possible to
derive a form of income from them by making regular withdrawals of up to 5
per cent of the original investment each year (by cashing in some of the units
allocated to the policy) without incurring an immediate tax liability. This 5 per
cent allowance can, if not used, be carried forward and accumulated up to an
amount of 100 per cent of the original investment.
These withdrawals are tax-deferred and on maturity, death or encashment of
the bond, a tax liability may arise and this is determined by top slicing. Top
slicing is a term that refers to the way of determining what tax is due for UK
residents by calculating the average return over the term of the bond so that
the whole gain is not taken into consideration in one year.
If the planholder is a higher rate or additional rate taxpayer in the tax year a
plan is surrendered, the gain (ie the surrender value + withdrawals, less original
purchase money) will be subject to tax.
[1] 119
Unit 1
1.
The gain on the policy (surrender value + withdrawals less original

investment) is calculated.
2.
This gain is divided by the number of complete years the investment has
been in force.
3.
This gives what is termed the average gain.
4.
The average gain is added to the planholders taxable income in the year
of surrender
5.
There is a tax liability if the combined taxable income and average gain
(after Personal Allowance) takes the planholder from a 20 per cent
taxpayer into the 40 per cent rate. In this instance 20 per cent tax would
be payable on the income in excess of the higher rate tax band.
If the taxable income plus average gain straddles the additional rate tax
band then 20 per cent tax will be payable on the income that falls within
the 40 per cent band and a further 25 per cent on the income in excess
of the additional rate band.
6.
The proportion of any gain above the preceding tax band is the
investment bonds taxable slice referred to as the Top Slice.
7.
The top slice is multiplied by the complete years the investment has been
in force to give the taxable gain.
3.2.8 Child Trust Fund

The Child Trust Fund (CTF), a tax-free savings account for children, was
introduced in 2002 as an attempt by the government to encourage savings on
behalf of children. It was withdrawn in the emergency Budget of June 2010, but
existing CTFs will be able to continue unchanged, except that no further
government contributions will be made.
A summary of the main characteristics of the Child Trust Fund is as follows.
t
[1] 120
Each individual CTF began with an initial payment of 250 (or

sometimes more, see below) provided by the government in the form of
a voucher, sent automatically to the Child Benefit claimant, who is
usually, but not always, one of the parents. Only children living in the UK
were eligible. This payment was reduced to 50 for children born on or
after 1 August 2010, and withdrawn altogether on 1 January 2011.

t
If the childs family is eligible for the full Child Tax Credit (see Section
1.3.5.2.4), the initial payment was increased to 500. This was reduced
to 100 from 1 August 2010 and withdrawn on 1 January 2011.
The parent or carer then used the voucher to open a CTF account with
a CTF provider. The voucher can be used only to open a CTF. The
account remains in force until the childs 18th birthday, at which point
the child has access to the money in the account and can use it for any
purpose they wish.There is no access to this money (or any added later)
before the childs 18th birthday.
The parent remains responsible for the CTF until the child is 16, after
which the child can manage their own account.
There is a wide range of CTF providers, including banks, building

societies, friendly societies and other financial institutions.
There are three broad types of CTF:

1. deposit-type savings accounts;
2. accounts that invest directly or indirectly in shares;
3. stakeholder CTF accounts.
Stakeholder CTF accounts invest in a range of company shares, subject

to certain government rules designed to reduce the risk. From the
childs 13th birthday, the money will gradually be moved to lower risk
assets to protect it from stock market losses as the childs 18th birthday
approaches.
The maximum annual charge permitted on a stakeholder CTF is 1.5 per

cent. There is no limit on charges on other types of CTF.
Parents had 12 months in which to choose the type of account and the
provider. If the voucher had not been used by the parents to open an
account within 12 months of issue, a stakeholder account was
automatically opened by HM Revenue & Customs on behalf of the child.
Parents (and other family, or even friends) can make additional

investments into a CTF.The maximum additional investment in each CTF
is 3,720 (2013/14) per year (ie the year between the childs birthdays).
Neither the parent nor the child will be subject to tax on income or
capital gains from the CTF. There is, however, no tax relief on any
amounts invested into the CTF.
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Unit 1
3.2.8.1 Junior ISAs

t Junior ISAs (JISAs) became available in November 2011 for all children
who do not have a Child Trust Fund (CTF).
t
They are tax efficient in the same way as adult ISAs.
A Junior ISA must be taken out by the childs parent (or other adult with
legal responsibility for the child), but anyone can contribute to it. Unlike
the CTF, there will be no contributions from the government.
JISAs allow investment in stocks and shares, cash or both, with an overall
limit of 3,720 a year (2013/14). There is no individual limit for each
component, and the eligible investments are the same as a standard ISA.
The annual investment limit is index-linked from April 2013.
The funds are locked in until the childs eighteenth birthday and cannot
be accessed by the child or parents. When the child reaches 18, the
Junior ISA will automatically change to an adult ISA and the child can
access the funds.
3.2.9 Structured products

The defining characteristic of structured products is that they offer an element
of protection of the capital invested (up to 100 per cent in some cases) while
also enabling participation in underlying assets that may be higher-performing
but are also higher-risk (such as ordinary shares).They appeal to investors who
are cautious about direct exposure to the possible downside of stock markets
but would like to share in the growth possibilities.
The FCA classifies structured products as either deposits or investments in its
handbook as follows:
Structured deposit a deposit paid on terms under which any interest or
premium will be paid, or is at risk, according to a formula which involves the
performance of:
(a) an index (or combination of indices) (other than money market indices);
(b) a stock (or combination of stocks); or
(c) a commodity (or combination of commodities).
[1] 122
Structured capital-at-risk product (SCARPs) are defined as a product,

other than a derivative, which provides an agreed level of income or growth
over a specified investment period and displays the following characteristics:
(a) the customer is exposed to a range of outcomes in respect of the return
of initial capital invested;
(b) the return of initial capital invested at the end of the investment period is
linked by a pre-set formula to the performance of an index, a combination
of indices, a basket of selected stocks (typically from an index or indices),
or other factor or combination of factors; and
(c) if the performance in (b) is within specified limits, repayment of initial
capital invested occurs but if not, the customer could lose some or all of
the initial capital invested.
A non-SCARP structured investment product is one that promises to
provide a minimum return of 100 per cent of the initial capital invested so long
as the issuer(s) of the financial instrument(s) underlying the product remain(s)
solvent. This repayment of initial capital is not affected by the market risk
factors in (b) above.
Structured products, which offer exposure to stock market growth along with
capital protection from a counterparty bank, have come under the spotlight in
recent years as many investors failed to understand the risks involved. The
former regulator, the FSA, highlighted structured products as one of its main
areas of concern in the Retail Conduct Risk Outlook 2012. It noted that, in the
current environment of low interest rates and poor returns on investments,
consumers are increasingly attracted to products that claim to offer a degree
of security plus returns that outperform cash. However, the FSA warned that,
in many cases, the benefits and risks of structured products are opaque, with
the potential for mis-selling or mis-buying high.
Consumers sold structured products take on a number of risks, including
counterparty risk, market risk and inflation risk. These products have varying
features, such as different payoff profiles and reference indices, which can be
difficult for some retail consumers to understand. In the past, the mis-selling
and non-compliant marketing of structured investment products has caused
significant consumer detriment, examples being so-called precipice bonds and
more recently the Lehmans-backed products. This has led us to have
continuing concerns regarding structured investment products. More recently,
we have been concerned that a lack of robustness in firms product
development and marketing processes can increase the risk of poorly designed
[1] 123
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products and lead to mis-selling, or mis-buying by consumers (Source

RCRO2012 www.fsa.gov.uk).
FSA published the results of its thematic review of the development and
governance of structured products in provider firms in March 2012. The
former regulator found that the products themselves have tended to become
more complex and exotic, in terms of design and features. FSA also identified
a number of weaknesses in product design and governance at a number of
firms. One of the key weaknesses was a lack of early consideration of
consumer needs (e.g. little in the way of identifying the appropriate target
market), which FSA and its successor, the FCA, consider fundamental. In its final
guidance, the FSA set out a number of requirements of providers, including the
monitoring of structured products through their life cycle, and the adoption of
a robust product approval process for new offerings.
Compensation schemes one of the FCA requirements is that where
structured products are covered by the FSCS (or another EU guarantee
scheme), firms should include a statement which sets out clearly the level of
cover afforded and where additional information about the cover can be
obtained. This is particularly important in the case of structured investment
products, which are only likely to be eligible for cover in a limited range of
circumstances.
3.3 Insurance
Very few aspects of life are entirely free from some element of risk and most
people have some form of insurance to protect them against the financial
effects of adversity. In some cases, it is compulsory for instance, third party
liability for drivers of motor vehicles on public roads. In many other cases it is
wise to insure against the loss of (or damage to) items that are too valuable to
replace out of normal income, such as a house and its contents. Similarly, most
families need protection against unforeseen events that would deprive them of
their sources of income, such as the untimely death or serious illness of a main
breadwinner.
The examples mentioned above illustrate the two main types of insurance
available: general insurance and life assurance.
At the start of 2011, the European Court of Justice ruled that insurers could
no longer consider gender when calculating insurance premiums rates and any
benefits. This became known as the EU gender directive. The Belgian consumer
[1] 124
group Test-Achats had argued that the exemption for insurers to be able to use
gender-based pricing contradicted the wider European principle of gender
equality.
Insurers had to have implemented changes to their pricing model to take this
into account by 21 December 2012. The changes will only impact new
insurances policies and renewals.
3.3.1 Life assurance protection

3.3.1.1 Whole-of-life assurance
Whole-of-life assurance is, as the name implies, designed to cover the life
assured for the whole of that lifetime. It will pay out the amount of the life
cover in the event of the death of the life assured, whenever that death occurs,
provided that the policy remains in force.
Premiums may be:
t
payable throughout life (ie for the full term of the policy, whatever that
turns out to be); or
limited to a fixed term (eg 20 years) or to a specified age (such as 60 or

65).
If limited premiums are chosen, the minimum term is normally ten years.
Because whole-of-life assurance (unlike term assurance) will definitely pay out
sooner or later, life companies build up a reserve to enable them to pay out
when the life assured dies.This enables companies to offer surrender values on
whole-of-life policies that are cancelled by the client before death has
occurred. These surrender values are, however, generally small in relation to
the sum assured. In fact, in the early years of a policy, the surrender value will
be less than the premiums paid. This emphasises the fact that whole-of-life
policies are protection policies and not investment plans.
Whole-of-life policies can be taken out on a number of different bases:
t
non-profit;
with-profit;
unit-linked;
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Unit 1
t
unitised with-profit;
low-cost;
flexible;
universal.
The principles of non-profit, with-profit, unit-linked and unitised with-profit are

described in Section 3.2.5.1. The others are described below.
3.3.1.1.1 Low-cost whole-of-life
A low-cost or minimum-cost whole-of-life policy has a sum assured that is
payable on death whenever it occurs. It is however, made up of two elements:
a whole-of-life with-profits and a decreasing term assurance.
The basic whole-of-life with-profits sum assured is lower than overall level of
cover required, with bonuses being added as the policy continues. A guaranteed
death benefit is offered and, while the whole-of-life with-profits sum assured
increases with the addition of bonuses, the shortfall is made up by a decreasing
term assurance. Once the basic sum assured plus bonuses increases beyond
the guaranteed death benefit, the decreasing term assurance element ceases.
This policy is suitable for anyone seeking maximum life cover on a permanent
basis at minimum cost.
3.3.1.1.2 Flexible whole-of-life
When whole-of-life policies are issued on the unit-linked basis, they are
generally referred to as flexible whole-of-life.
The flexibility to which the name refers lies in the fact that these policies can
offer a variable mix between their life cover and investment content. The key
to this flexibility is the method of paying for the life cover by cashing in units
at the bid price:
t
the policyholder pays premiums of an amount that they wish to pay or

feel that they can afford to pay;
the premiums are used to buy units in the chosen fund or funds, and
these units are allocated to the policy;
the policyholder selects the level of benefits that they wish to have:
[1] 126
if a high level of life cover is required, a larger number of units will be

cashed each month, and a correspondingly lower number will remain
attaching to the policy.This means that the investment element of the
policy (which depends on the number of units) is also lower;
conversely, a low level of life cover means fewer units cancelled and
hence a higher level of investment.
The flexibility of the system, under which benefits are paid for by cashing units,
means that other options are often available. These include an option to take
income, indexation of benefits (for automatic adjustment of death benefits) and
the ability to add another life assured.
Although it can have a high level of investment, a flexible whole-of-life
assurance should never be thought of primarily as a savings vehicle, but rather
as a protection plan that could be adapted to investment if circumstances
changed.
Most companies offer three main levels of cover on their flexible whole-of-life
policies (although it is usually possible to choose other levels in between):
t
maximum cover: this is normally set at such a level that cover can be
maintained for ten years but, after that point, all the units will have been
used up and increased premiums will be needed if the cover is to
continue;
minimum cover: a minimum level of life cover is maintained probably

the minimum required for the policy to remain qualifying and the
number of units attaching to the policy builds up to a substantial
investment element;
balanced cover: this is the level of cover, for a given premium, which
the company expects to be able to maintain throughout the life assureds
lifetime.
To calculate the various levels of cover, the company makes an assumption

about the future growth rate of unit prices.
In all cases, the initial life cover is guaranteed for a certain period, often ten
years. Beyond that point, the company reserves the right to increase the
premiums or to reduce the cover to take account of increases in costs or to
allow for the fact that unit prices have not grown as quickly as had been
assumed. The death benefit is then guaranteed until the next review.
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Unit 1
Further reviews are usually undertaken at five-yearly intervals, or even annually

with older lives assured, and adjustments may again be made.The need for such
reviews is the price that clients have to pay for the flexibility of the system. In
fact, the reviews are beneficial to the client because they reveal possible
shortfalls at any early stage, when they can be rectified before the cost
becomes prohibitive.
3.3.1.1.3 Universal whole-of-life assurance
The flexibility of unit-linked whole-of-life assurance is sometimes extended
further by adding a range of other benefits and options to the policy. When
that is done, the policy is usually referred to as universal whole-of-life
assurance. Benefits and options that may be added include:
t
permanent health insurance;
critical illness cover;
accidental death benefit;
total and permanent disability cover;
hospital benefits or other medical cover;
guaranteed insurability (to increase cover);
indexation of benefits;
flexibility of premium levels;
waiver of premium during periods of inability to pay due to, for instance,
disability or unemployment.
Most of the additional benefits will be at extra cost, the additional cost being
met by cashing more units.
3.3.1.1.4 Uses and benefits
Whole-of-life policies are appropriate to those circumstances where the need
is for a sum of money to be paid on the death of an individual, whenever that
death may occur. Like all protection policies, therefore, their overall benefit is
that they provide peace of mind. They can be used in personal and business
situations, and for certain taxation purposes.
[1] 128
The uses of whole-of-life policies include the following:

t
to protect dependants against loss of financial support in the event of

the death of a breadwinner;
to provide a tax-free legacy;
to cover expenses on death;
to provide funds for the payment of inheritance tax.
3.3.1.1.5 Joint-life second-death policies

When a whole-of-life policy is used to provide the funds likely to be needed
to pay inheritance tax (IHT), it is normal to use a whole-of-life policy that will
pay out on the death of the survivor of the husband or the wife (known as a
joint-life second-death policy or a last survivor policy).
The reason for this is that, in most families, the estate of the first spouse to die
passes to the surviving spouse (free of IHT), and the IHT becomes due only
when the surviving spouse dies and the estate passes to the family or to
others.
It is usual to put these policies into trust to ensure that the proceeds of the
policy are used to meet the IHT liability and do not pass into the value of the
estate.
3.3.1.2 Term assurance
There is a wide variety of term assurances available, but they all share one
common characteristic: that the sum assured is payable only if the death of the
life assured occurs within a specified period of time (the term).
Term assurance is the most basic form of life assurance pure protection for
a limited period with no element of investment. For this reason, it is also the
cheapest.
Term assurance can be used for personal and family protection and also for a
wide range of business situations. Business use includes the provision of key
person insurance, to protect against the loss of profits resulting from the death
of an important employee, and partnership insurance schemes, to enable
surviving partners to buy out the share of a partner who has died.
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Unit 1
Other characteristics shared by term assurances are as follows.

t
The term can be anything from a few months to, say, 40 years or more
(for terms that end after age 65, it may be better to take out a wholeof-life policy instead).
If the life assured survives the term, the cover ceases and there is no
return of premiums.
There is no cash value or surrender value at any time.
If premiums are not paid within a certain period after the due date
(normally 30 days), cover ceases and the policy lapses with no value.
Most companies will allow reinstatement within 12 months provided all
outstanding premiums are paid and evidence of continued good health
is provided.
Premiums are normally paid monthly or annually, although single

premiums (one payment to cover the whole term) are also allowed.
Premiums are normally level (the same amount each month or year),
even if the sum assured varies from year to year.
There are a number of basic types of term assurance and a number of options
that can be included. These are described below.
3.3.1.2.1 Level term assurance
With level term assurance, the sum assured remains constant throughout the
term. Premiums are normally paid monthly or annually throughout the term,
although single premiums can be paid.
Level term assurance is often used when a fixed amount would be needed on
death to repay a constant fixed-term debt such as a bank loan.
It can also be used to provide family cover, for instance, until the children leave
home. If it is used for that purpose, the policyholder should bear in mind that
the amount of cover in real terms would be eroded by the effect of inflation.
3.3.1.2.2 Decreasing term assurance
With decreasing term assurance the sum assured reduces to nothing over the
term of the policy. Premiums may be payable throughout the term, or may be
limited to a shorter period such as two-thirds of the term. This policy could
be used to cover the outstanding capital on a decreasing debt.
[1] 130
Two particular kinds of decreasing term assurance are mortgage protection

assurance and gift inter vivos cover. These are described below.
The most common use of decreasing term assurance is to cover the amount
outstanding on a repayment mortgage. It is usually known as a mortgage
protection policy. Be careful not to confuse this with short-term sickness
and redundancy cover for mortgage repayments, which is sometimes also
referred to as mortgage protection insurance.
The sum assured on mortgage protection assurance is calculated in such a way
that it is always equal to the amount outstanding on a repayment mortgage of
the same term, based on a specified rate of interest. The sum assured (like the
mortgage) decreases more slowly at the start of the term than towards the
end.
Decreasing term assurances can also be arranged to cover special
requirements, such as gifts inter vivos, which are gifts made during a persons
lifetime, as opposed to on death. Under inheritance tax rules, no tax is
immediately due when such a gift is made from one person to another, but may
become due if the donor dies within seven years of making the gift. For
inheritance tax purposes, the estate on death includes the value of any gifts
that were made in the preceding seven years. If the estate, including the gifts,
exceeds the inheritance tax threshold, it is the gifts that are offset against the
nil-rate band first. If there is any nil-rate band left, this is then offset against the
remainder of the estate. If the value of the gifts alone exceeds the nil-rate band,
the portion of the gifts that exceeds the threshold is taxed along with the
remainder of the estate, although the tax on the gifts is scaled down if they are
made more than three years prior to the date of death (tapering relief).
So, if a person makes a gift during their lifetime that, either on its own or when
added to gifts made in the previous seven years, exceeds the current nil-rate
band, provision needs to be made for the tax that may become due in the event
of the donor not surviving the whole seven years. Gift inter vivos cover is
a term assurance policy designed to provide an amount sufficient to pay the
inheritance tax due should the donor die within seven years of making the gift.
To achieve this, the sum assured under the policy is set at the start of the
policy as the amount of tax that is due. It remains level for three years and then
reduces in year four to 80 per cent of the tax due, 60 per cent in year five, 40
per cent in year six and 20 per cent in year seven, after which time the cover
ceases as the gift will be exempt. Additional cover should also be arranged to
protect the remainder of the estate.
[1] 131
Unit 1
3.3.1.2.3 Increasing term assurance

Some companies offer increasing term assurance where the sum assured
increases each year by a fixed amount or a percentage of the original sum
assured.
This type of policy can be used where temporary cover of a fixed amount is
required but where the cover needs to increase to take some account of the
effects of inflation on purchasing power.
3.3.1.2.4 Convertible term assurance
Convertible term assurance is a term assurance that includes an option to
convert the policy into a whole-of-life or endowment assurance without
further evidence of health (or indeed any additional underwriting). This
guaranteed insurability means that no medical or other evidence is required
and the conversion is carried out at normal premium rates whatever the state
of health of the life assured.
The cost of this option is an addition of, typically, around 10 per cent of the
premium.
The option is normally included only on level-term assurance policies but
there is no technical reason why it should not be included on decreasing term
assurances and others.
Certain rules and restrictions apply to the conversion option.
t
The conversion is normally carried out by the cancellation of the term

assurance and the issue of a new whole-of-life or endowment policy. A
new endowment can extend beyond the end of the original convertible
term policy.
The option can only be exercised while the convertible term assurance
is in force.
The sum assured on the new policy cannot exceed the sum assured of
the original convertible term assurance: if a higher level of cover is
required after conversion, the additional sum assured will be subject to
normal underwriting.
The premium for the new policy is the current standard premium for
the new term and for the life assureds age at the conversion date.
[1] 132
3.3.1.2.5 Renewable term assurance

Renewable term assurance includes an option, which can be exercised at
the end of the term, to renew the policy for the same sum assured without the
need for further medical evidence.
The new term is the same as the previous term and the new policy itself
includes a further renewal option, except that there is a maximum age, usually
around 65, after which the option is no longer available.
The premium for the new policy is based on the life assureds age at the date
when the renewal option is exercised.
Renewable and increasable term assurance is similar to the renewable
policy, with the added option on renewal to increase the sum assured by a
specified amount often either 50 per cent or 100 per cent of the previous
sum assured, again without evidence of health.
Some companies offer renewable, increasable and convertible term assurances,
combining all three of the options described above.
3.3.1.3 Family income benefits
The aim of family protection is often to replace income lost on the death of
the breadwinner. A family income benefits (FIB) policy is designed to meet
this need by providing income rather than a lump sum.
The policy pays out a tax-free regular income (monthly or quarterly) from the
date of death of the life assured until the end of the chosen term.
Since the cover reduces as time passes, this policy can be described as a form
of decreasing term assurance.
As an alternative to regular income payments, beneficiaries may choose to
receive a lump sum payment that will be calculated as a discounted value of the
outstanding instalments.
Policies can be arranged with escalating instalments, to combat the effects of
inflation. Since these provide higher levels of cover than ordinary FIBs, the
premiums are also higher.
[1] 133
Unit 1
3.3.1.4 Pension term assurance

Prior to A-Day (6 April 2006) it had been possible for people with personal
pension plans and stakeholder pension plans to take out (within specified
limits) term assurance policies for which they could obtain tax relief on the
premiums at their highest rate. The new pension regime introduced by A-Day
appeared to open the availability of such policies to virtually everyone,
whatever their pension arrangements.
The result was that virtually all term assurances could then be issued as
pension term assurance and could obtain tax relief. The government
considered this to undermine the principles of their new pension regime, and
in the Pre-Budget Report of December 2006 announced that it would act
quickly to prevent standalone term assurances from being eligible for pensions
tax relief.
In all cases where an application applying for life insurance cover was fully
completed on or before 6 December 2006, submitted to the insurance
company and receipt recorded by that insurance company by midnight on 13
December 2006, the existing tax relief regime still applies, provided that the
sum assured issued is no greater than that applied for on or before 6 December
2006.
Since that date, no new pension term assurances have been issued.
For further details of pension products, see Section 3.6.
3.3.2 Ill-health insurance

3.3.2.1 Critical illness cover
Critical illness cover (CIC) will provide a tax-free lump sum payment on
diagnosis of one of a range of specified illnesses. The illness need not be
terminal and one significant purpose of critical illness cover is to provide a
lump sum to meet the additional costs that someone may face if they are
diagnosed with a serious illness.
The range of illnesses and conditions covered varies from one insurer to
another but would typically include the following:
t
most forms of cancer;
heart attack;
[1] 134

t
stroke;
coronary artery disease requiring surgery;
major organ transplant;
multiple sclerosis;
kidney failure.
Other conditions that are sometimes covered are:

t
paralysis;
blindness;
loss of limb(s).
Many policies also make provision for payment of the sum assured in the event
of total and permanent disability. Again, the definition of total and permanent
disability varies between companies. Some take it as being a total and
permanent disability that prevents the policyholder from doing any job to
which they are suited by virtue of status, education or experience. Other
companies employ a tighter definition that requires that the disability prevents
the person from doing any job at all.
Typical uses of critical illness cover are:
t
provision of long-term care, either in hospital or in the home;
alterations to living accommodation;
purchase of specialised medical equipment, eg a kidney dialysis machine;
mortgage repayment;
improving the quality of life of a terminally ill person.
3.3.2.2 Income protection insurance

Income protection insurance (IPI) pays an income when accident/illness
prevents someone from earning a living by carrying out their normal
occupation. It is designed to protect people who are working and who would
lose part or all of their income if they were unable to work due to illness or
accident. For that reason, IPI is often referred to as simply income protection.
Many companies also offer IPI to housewives/homemakers. This is because,
although they may not actually earn an income, there is usually a clear need to
[1] 135
Unit 1
provide income in the event of their illness. The income could then be used to
pay for housekeeping or childminding fees if the homemaker is unable to
perform these duties due to illness or accident.
3.3.2.2.1 Premium rates
A major factor in determining the premium to be charged is the occupation of
the life insured. A typical classification of occupations by an IPI provider might
be:
t
Class 1: the lowest risk covering those in clerical, professional or

administrative roles, eg accountants and civil servants;
Class 2: occupations carrying a low risk of an accident, eg hairdressers

and pharmacists;
Class 3: occupations carrying a moderate risk of accident or health

problems, eg farmers and electricians;
Class 4: occupations with the highest risk of a claim there will be a

substantial risk of health problems or the risk of accident arising from
the occupation, eg coal miners and industrial chemists.
Certain occupations will be excluded from IPI cover on the basis that they
represent too great a risk.
The occupation class that a person is deemed to fall within will determine the
level of premium (Class 1 occupations get the cheapest rates) and may also
influence the terms on which cover is offered.
Other factors that will influence the premium rate are:
t
the age of the life insured;
the amount of benefit;
current state of health;
past medical history;
the length of the deferred period (see below).
[1] 136
Types of income protection premiums

There are three types of income protection premiums available reviewable,
renewable and guaranteed.
t
Reviewable premiums: a reviewable premium means that premiums

may start off relatively low, but will be reviewed in the future and may
go up every few years or so. In some cases, the premium may be
reviewable every year, or every five years, to take into account changing
circumstances.
Renewable premiums: renewable premiums are similar to reviewable

premiums, but every time the policy comes up for renewal, the premium
is reviewed and the amount paid to the insurer may change.
Guaranteed premiums: the nature of guaranteed premiums means

that these tend to be more expensive than the other two options, but
the premiums are guaranteed for the life of the policy, which may be as
long as 25 years.
A waiver of premium option may also be provided whereby premiums for the
IPI policy are not required while benefits are being paid from the policy, but the
policy cover continues as normal.
3.3.2.2.2 Payment of benefits
The payment of benefits commences after a deferred period. This is the amount
of time that elapses between the onset of the illness/injury and the point at
which benefits payments commence. Typical deferred periods are 4, 13, 26, 52
and 104 weeks. The minimum four-week deferred period is to prevent multiple
claims for minor ailments such as colds.
A self-employed person, who typically would suffer a loss of income after a
very short period of illness, should opt for a short deferred period. Conversely,
an employed person may wish to opt for a long deferred period if they have
sickness benefits paid by their employer. If this is the case, the deferred period
should be set to match the date at which the employers sick pay ceases. The
longer the deferred period chosen, the cheaper the premium will be.
Benefit levels are set so that the claimant is unable to receive a higher income
when not working than they could from working. The maximum benefit payable
from an IPI policy varies between providers. It is normally in the range of 50 per
cent to 75 per cent of pre-disability earnings. If the provider allows a benefit
[1] 137
Unit 1
level towards the top end of this range they are more likely to make a deduction
to allow for any state benefits to which the claimant may be entitled. These
limits apply to total benefits from all IPI contracts held by the individual.
Benefits are paid pro-rata if illness means that a person can work but only parttime.
Cover is permanent in the sense that the insurer cannot cancel the cover
simply because the policyholder makes numerous claims. The policy could be
cancelled, however, if the customer fails to keep up their premium payments or
takes up a hazardous job or pastime.
Some policies will allow benefits to be indexed either before or during a claim.
The rate of increase may be at a fixed rate, perhaps 3 per cent to 7 per cent,
or based on a published measure of inflation.
Benefits are normally paid until death, return to work or retirement, whichever
event occurs first.
IPI is available as a standalone policy, either as a pure protection plan or on a
unit-linked basis. Additionally, IPI can be available as an option on a universal
whole-of-life plan.
3.3.2.2.3 Taxation of IPI benefits
Where income protection insurance (IPI) is taken out on an individual basis the
benefits are tax-free.
IPI can be arranged by an employer on a group basis and in this case the
income will be taxable as earned income. The employer pays the premium,
which is a tax-deductible business expense; the premium paid by the employer
is not taxable as a benefit in kind on the employee/scheme member, ie no tax
or national insurance is payable by the member on the premium paid, provided
that the employer has discretion as to whether to pay the proceeds to the
employee. In practice, the employer has such discretion and then pays the
proceeds on to the member concerned. The scheme member pays income tax
and national insurance on the proceeds.
[1] 138
3.3.2.3 Accident, sickness and unemployment insurance

Accident, sickness and unemployment insurance (ASU) plans are a type of
general insurance that may be considered as an alternative to income
protection insurance (IPI).
ASU insurance is typically used to cover mortgage repayments in the event
that illness, accident or loss of employment prevents the policyholder from
earning a living. A level of income equal to monthly mortgage repayments is
paid for limited period, usually a maximum of two years.
Additional cover can sometimes be included to cover other essential
outgoings.
As with IPI, there will be a deferred period, normally one month, which must
elapse before benefit payments can commence. Lump sums may be paid on
certain events (death, disablement, and loss of a limb).
In contrast to IPI, these plans should be viewed as short term to protect
mortgage payments rather than as providing total protection of earned
income.
It would be more accurate to describe these policies as accident, sickness and
redundancy insurance, as they do not offer protection from unemployment
when the insured is sacked, or resigns voluntarily. The policy will often include
the following restrictions.
t
The proposer must have been actively and continuously employed for a
specified minimum period prior to affecting the plan.
Any redundancy that the proposer had reason to believe was pending
when they took out the policy will be excluded.
No benefit will be payable if redundancy occurs within a specified period

of the cover starting.
A person may have to have been employed for a minimum period either
before they can take out this type of plan or before the unemployment
element of the plan becomes valid.
ASU policies are annually renewable at the discretion of the insurer.This means
that the insurer could increase premiums in light of poor claims experience or
may even withdraw the cover offered. This is a major difference from IPI.
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Unit 1
3.3.2.3.1 Taxation of ASU policies

All benefits are tax-free but there is no tax relief on contributions to an ASU
plan, regardless of whether it is arranged on a group or personal basis.
If the scheme is set up on a group basis, any employer contribution will be
allowed as an expense against corporation tax. Any employer contribution will
be classed as a benefit in kind for employees earning in excess of 8,500 pa
(including the value of the benefit).
3.3.2.4 Private medical insurance
Private medical insurance (PMI) is a pure protection plan designed to provide
cover for the cost of private medical treatment, thus eliminating the need to
be totally dependent on the NHS.
Plans can be arranged on an individual basis or as part of a group scheme
established by an employer. Employer-sponsored schemes currently account
for the vast majority of PMI provision in the UK.
In a non-emergency situation, PMI can offer the following benefits:
t
avoidance of NHS waiting lists;
choice of hospital where the treatment will take place;
choice of timing of the treatment (to fit in with work demands, for
example);
high-quality accommodation;
choice of medical consultant.
The range of cover normally provided includes reimbursement of:

t
in-patient charges including nursing fees, accommodation, operating

fees, drugs, and the cost of a private ambulance;
surgical and medical fees including surgeons fees, anaesthetists fees,

pathology, and radiology;
out-patient charges including consultations, pathology, radiology, and

home nursing fees.
Some policies offer additional benefits such as the payment of a daily rate if
treatment is delivered within an NHS hospital and involves an overnight stay.
[1] 140
The way in which benefits are paid varies between providers. Some will offer a
full refund of charges with payment direct to the healthcare provider. Other
plans impose an upper limit on the amount that can be reclaimed in any one year.
Premium rates depend on a number of factors, including:
t
location this is mainly because the cost of medical care varies

throughout the country (costs are particularly expensive in London);
type of hospital to which the individual is allowed access under the

terms of the plan again, treatment in the postgraduate teaching hospitals
in London is more expensive and will be reflected in higher premiums;
standard of accommodation available to the patient under the

terms of the plan.
A major factor will be the type of scheme that is taken out. For example, many
providers offer a budget scheme, which may limit the patients choice of hospital
or require treatment on the NHS if the waiting list does not exceed a maximum
period, eg six weeks. Any limit on the range of cover provided will reduce the
premium payable. The limit may take the form of a financial limit on the amount
of benefit that is provided or limits on the range of treatment covered.
One other significant factor is the age of the person applying for cover. The
morbidity risk increases with age and consequently so does the probability of
a claim being made under the terms of the plan.
3.3.2.4.1 Underwriting
Certain events will be excluded from cover under the scheme. Cover will not
be provided for any pre-existing medical conditions, and other general
exclusions are the costs of:
t
routine optical care (such as provision of spectacles or lenses);
routine dental treatment;
routine maternity care;
chiropody;
the treatment of ailments that are self-inflicted, for example, the

consequences of drug abuse and alcohol;
cosmetic surgery;
alternative medicine.
[1] 141
Unit 1
3.3.2.4.2 Taxation
Premiums are subject to insurance premium tax but the benefits are paid out
tax-free.
Employers who contribute to PMI on behalf of their employees are able to
claim the cost as an allowable deduction against corporation tax.
Contributions paid by an employer are regarded as a benefit in kind as far as
the employee is concerned and may be taxable if the employees total income,
including the value of all benefits in kind, exceeds 8,500 per annum.
3.3.2.5 Long-term care insurance
The purpose of long-term care insurance (LTC) is to provide the funds to
meet the costs of care that arise at a point in later life, when a person is no
longer able to perform competently some of the basic activities involved in
looking after themselves each day and consequently requires assistance.
The need for this cover has increased because families are more spread out
than in earlier generations and less able to take care of elderly relatives. The
problem has also been increased by the fact that life expectancy has increased
and peoples expectations for their quality of life in their later years are higher
than ever. There has been increasing concern over the standard of care that
state support and the NHS can realistically be relied upon to provide.
3.3.2.5.1 Benefits
The amount of benefit paid from a LTC plan will depend on the degree of care
required by the insured. This will be established by ascertaining the persons
ability to carry out a number of activities of daily living (ADLs).
Typical ADLs would be:
t
washing;
dressing;
feeding;
using the toilet;
moving from room to room;
preparing food.
[1] 142
Each LTC insurer will have its own definitions of what constitutes an inability
to carry out an ADL. Many follow the definitions laid down by the Association
of British Insurers.
The greater the number of ADLs that cannot be performed without assistance,
the greater the amount of care required and, therefore, the higher the level of
benefit that will be paid. It is normal for insurers to require that the person
must be incapable of performing at least two or three of the ADLs before a
claim can be accepted. A person need not be confined to a nursing home to
receive LTC benefits: for example, a person may be unable to dress themself in
the morning and prepare and eat food without assistance. Therefore, the range
of support they would need may be limited to a person coming in at certain
points during the day to help with those specific activities.
3.3.2.5.2 Taxation of benefits
If an annuity is purchased for immediate long-term care needs, it must be an
immediate needs annuity in order for the benefits to be tax free. An immediate
needs annuity is one where the benefits are payable directly to the care
provider for the care of the person protected under the policy. Furthermore,
the annuity must have qualified as an immediate needs annuity when it was taken
out. In other words, the benefits from an ordinary purchased life annuity cannot
be paid as tax free just because they are being used to fund long-term care.
If an annuity does not qualify as an immediate needs annuity, ie its benefits can
be paid to the policyholder, only the interest element is taxable (20 per cent
tax will be deducted at source, higher-rate taxpayers having a further liability
of 20 per cent).
Where an immediate needs annuity is established on a life of another basis, the
benefits can still be paid tax free, provided that they are paid direct to the care
provider and are used solely for the care of the person protected under the policy.
If any part of the annuity benefits are paid to anyone other than the care provider,
or for any purpose other than for the care of the person protected under the
policy (including payments that may be due on the death of the protected person),
that portion of the benefits is taxable, but only the interest element.
Benefits are also tax free if the long-term care policy is pre-funded, ie where
there is no annuity but, instead, premiums are paid to an insurance company
(out of tax-paid income) to insure against a possible future event. For prefunded long-term care policies, it doesnt matter whether the benefits are paid
direct to the care provider or to the protected person.
[1] 143
Unit 1
3.3.3 General insurance

General insurance includes all types of cover that are not defined as life
assurance. The types of losses that are covered by general insurance can be
categorised in five broad bands. The first two relate to both personal and
commercial situations:
t
property loss: this is the best-known category, covering loss, theft or

damage to static and moveable assets from diamond rings to houses
to supertankers;
liability loss: resulting from a legal liability to third parties, eg personal

injury or damage to property.
The remaining three are restricted to commercial situations. They are:

t
personnel loss (due to injury, sickness or death of employees);
pecuniary loss (as a result of defaulting creditors);
interruption loss (when a business is unable to operate due to one of

the other losses occurring, eg because its premises have suffered fire
damage).
Some policies may combine protection against two or more types of risk.
Comprehensive motor policies, for example, cover damage to the
policyholders property and to third parties property.
Before looking at some of the common types of general insurance, it is
appropriate to mention some important principles and practices that apply to
general insurance: these are indemnity, average and excess.
3.3.3.1 Indemnity
Unlike life assurance policies, general insurance policies are contracts of
indemnity. The principle of indemnity is that in the event of a claim, insured
persons should be restored to the same financial position after a loss that they
were in immediately before the loss occurred. In particular, this means that an
insured person should not be able to benefit from the event that caused the
loss.
Life and personal accident policies, on the other hand, are not contracts of
indemnity. They are benefit policies since it is much more difficult to measure
accurately in financial terms the impact of a loss of life or of a serious injury.
[1] 144
The choice of the method by which indemnity is achieved in a particular case is

normally at the discretion of the insurance company.There are four main methods:
t
cash (normally a cheque);
repair (used very commonly with motor insurance);
replacement sometimes, the purchasing power of the insurer can

reduce costs;
reinstatement, for instance, where the insurance company may

arrange for a damaged building to be restored to its former condition.
3.3.3.2 Average
It is not uncommon for policyholders to underinsure: in other words, to insure
for a smaller amount than is actually required to replace or repair the lost or
damaged property. This may be because they are unaware of the appropriate
figure or because inflation has increased the amount required, or it may be
deliberate in order to keep the premium down.
In the event of a complete loss, ie where a whole house is destroyed by fire,
the amount paid out would be limited to the sum insured, even if the actual
cost were considerably more.
Many losses are only partial, however, and in these circumstances it would be
unfair if a policyholder who had paid less premium than was really appropriate
should be indemnified in full, even where the actual claim amount is less than
the overall sum insured. In such cases, the principle of average is applied, which
means that the claim is scaled down in the same proportion that the premium
actually paid bears to the premium that should have been paid for the full
appropriate sum insured.
So, for example, a policyholder who insured contents for 10,000, when their
true insurance value was 15,000, would find that if they claimed 300 for a
damaged carpet, the insurer would pay only 200.
3.3.3.3 Excess
Many general insurance policies are subject to an excess: in other words, a
deduction is made from any claim payment. Many motor policies have an
excess of, say, 100 on the accident damage part of the cover. This avoids the
high administrative costs of dealing with a lot of small claims. An excess can be
either compulsory or voluntary in order to obtain a reduction in premium.
[1] 145
Unit 1
3.3.3.4 Buildings insurance

Buildings are defined as anything on the premises that would normally be left
behind if the property were sold. This generally includes sheds, swimming
pools, walls, fitted furniture and all fittings and decorations.
Cover is normally provided against:
t
fire and lightning strikes;
explosions, subsidence and earthquakes;
storms and floods;
damage by vehicles and aircraft, and even by animals;
damage by falling trees/branches or television aerials.
Policies normally also cover the costs of alternative accommodation during

repairs.
Some types of cover are subject to the property not being left unoccupied for
more than a specified period, typically 30 days. These include cover against
damage caused by:
t
riot, civil commotion and vandalism;
theft or attempted theft;
burst water pipes or oil leakages.
Most policies also cover property owners liability.

3.3.3.5 Contents insurance
Cover is provided for contents, which can be defined as anything you would
normally take with you if the property were sold.
Cover would typically be provided against the same events and circumstances
as described above for buildings insurance, with a few additions, including:
t
accidental damage to goods while being removed by professional

removers;
extended contents cover for specified personal property outside the

home;
damage to freezer contents due to electricity failure.
[1] 146
3.3.3.6 All-risks insurance

The aim of an all-risks policy (sometimes known as extended contents cover)
is to indemnify the policyholder for loss, damage or theft of items that are
regularly taken out of the home. Cover is normally split into two categories:
t
unspecified items: these need not be specifically named but each item
must have a value below a specified amount;
specified items: these items are above the single-item value limit and
are individually listed.
Both of the above categories require the policyholder to take reasonable care
of the property.
3.3.3.7 Private motor insurance
There are three main types of motor insurance cover: third party only; third
party, fire and theft; and comprehensive. There are variations in the exact
nature of cover offered by different companies in each category particularly
on comprehensive policies but a summary of what might typically be offered
is shown below.
3.3.3.7.1 Third party
The Road Traffic Act 1988 makes it unlawful to use a motor vehicle on a public
road unless there is in force a policy of insurance in respect of third party risks.
Third-party-only policies typically provide cover for:
t
death or bodily injury to third parties, including passengers in the car

hospital charges and emergency medical treatment charges are also
covered;
damage to property;
legal costs incurred in the defence of a claim.
Death, injury and damage cover is extended to include occasions when the
policyholder is using another vehicle, and also to other drivers using the
policyholders car with permission.
Motor insurance differs from other personal insurances in that a policy of
motor insurance is of no effect unless a certificate of insurance is given to the
policyholder. The certificate is what provides evidence of the existence of the
contract of insurance and, as third party motor insurance is compulsory, this is
very important.
[1] 147
Unit 1
3.3.3.7.2 Third party, fire and theft

In addition to third party cover, a third party, fire and theft policy provides
cover against:
t
fire, lightning or explosion damage to the vehicle;
theft of the vehicle, including damage caused during theft or attempted

theft.
3.3.3.7.3 Comprehensive
In addition to the third party, fire and theft cover, a typical comprehensive
policy would include some or all of the following:
t
accidental damage to the vehicle on an all-risks basis;
loss or damage to personal items in the vehicle;
personal accident benefits;
windscreen damage.
The private motor insurance market is large and extremely competitive, and
many other extensions to the cover are offered in order to attract business.
These may include: roadside breakdown assistance; legal protection services;
provision of a courtesy vehicle while repairs are carried out; out-of-pocket
expenses resulting from an accident.
3.3.3.8 Travel insurance
Travel insurance is available for individual journeys (typically from five days to
one month) or on an annual basis. A typical policy might include cover against
the following:
t
cancellation due to illness or injury of the policyholder or a close

relative;
missed flights due to transport failure;
delayed departures;
medical expenses;
personal accident;
loss of personal possessions or of a passport;
personal liability;
legal expenses.
[1] 148
Because of the increased risk of injury, cover for winter sports holidays is
usually more expensive.
3.3.3.9 Payment protection insurance (PPI)
Payment protection insurance can cover monthly loan repayments if the
policyholders salary reduces due to accident, sickness or unemployment. The
policy will pay out only for a fixed period of time, usually 12 months.
This insurance is linked to the repayments of a specific lending product and
may be offered at the same time as the loan itself.
PPI can be extremely useful, although many PPI policies have been mis-sold
alongside loans, credit cards and mortgages over the years to people who
didnt need it, were ineligible to claim its benefits for one reason or another,
or who didnt even realise it had been included as part of their loan
repayments. Some lenders developed sales scripts for their customer services
advisers to follow that included a statement that the loan was protected
without mentioning the fact that this protection was in the form of an
insurance policy a policy that the customer should have been given the
opportunity to opt out of taking.
Several companies have been fined for mis-selling this product, and many
customers are being encouraged (mainly through TV advertising campaigns) to
make a claim against their lender if they feel they were wrongly sold this
product. For those whose claims are successful, they are not only given back
the insurance premiums they have paid, they are also able to claim the interest
that this money would have earned had it been in a savings account.
3.3.3.10
Insurance premium tax
Some insurance premiums payable in the UK are subject to insurance premium

tax (IPT). The rate is 6 per cent of the premium on most general insurance,
one exception being travel insurance, on which it is 20 per cent. There is no
premium tax at present on long term insurance such as life assurance and
permanent health insurance.
IPT is paid by the policyholder as part of the premium; it is collected by the
insurer and passed on to the tax authorities.
[1] 149
Unit 1
3.4 Derivatives
A derivative is a financial product that is indirectly based on, or derived from,
another financial product. It is usually related to a commitment to buy or sell
that other product at a fixed price on a future date or between two dates. The
key factor is that, because they convey rights (such as the right to buy at a price
different from the current market price), derivatives themselves have a value
and, in most cases, can themselves be traded.The most common products dealt
with in this way are ordinary shares, commodities, interest rates and exchange
rates. The main forms of derivatives are described below.
t
Options are the best-known form of derivative. An option is the right

(but not the obligation) to buy or sell a specific amount of an asset
which might, for instance, be a certain number of ordinary shares at a
specified price (the exercise price) within a specified period. An option to
buy is known as a call option, whereas the equivalent right to sell is
referred to as a put option. The buyer of an option contract pays a
purchase price, or option premium, to the seller (who is also known as
the writer) of the contract.
Futures are similar to options, except that with futures there is an

obligation to buy or sell at the specified price on a specified date. Futures
are available in a range of financial products as well as commodities (eg
coffee) and currencies, for which they can be used as a hedge against
movements in exchange rates. Some such deals are contracts directly
between two parties and are not traded, in which case they are known
simply as forward contracts.
Warrants are similar to call options, except that they are generally
issued by companies and give the holder the right to purchase that
companys ordinary shares.This allows the company to raise new capital.
Derivatives provide sophisticated investors and institutions with the

opportunity to gamble on the stock market or other investments without
risking all their capital. Although they can be used to reduce risk, they can also
be used to speculate, in which case they present a significant risk to the
invested capital. However, like all high-risk investments, the potential rewards
are large.
[1] 150
3.5 Lending products

Most large purchases such as houses, cars and holidays, are now made with the
aid of borrowed money, and the success of most western economies is based
on credit. Financial institutions have not been slow to develop products to
satisfy the wide-ranging needs of borrowers.
3.5.1 Mortgages
Since a mortgage loan is such a large and long-term transaction the
consequences of making a mistake can be very serious. It is therefore
particularly important for an adviser to choose wisely and to suit the products
chosen to the clients needs.
t
Choosing the wrong lender or the wrong interest scheme can lead to
the client paying more than is necessary for the loan.
Choosing the wrong investment product can lead at worst to the

mortgage not being repaid in full at the end of the term. At best, it will
mean that the client misses out on possible surplus funds.
Failing to protect the outstanding capital or the repayments against

sickness, death or redundancy, can leave a clients family destitute or lead
to them having to leave their home.
3.5.1.1 Definitions
A house purchase loan is usually known as a mortgage loan (or simply a
mortgage) because the borrower mortgages the property, in other words
creates a legal charge over the title deeds to the lender as security for the loan.
The parties involved in a mortgage are as follows:
t
the mortgagor: the individual borrower who transfers their property

to the lender for the duration of the loan;
the mortgagee: the lender (bank, building society or other institution)

who has an interest in the property for the duration of the loan.
[1] 151
Unit 1
3.5.1.2 Repayment mortgages

With a repayment mortgage (sometimes also known as a capital-and-interest
mortgage), the borrower makes monthly repayments to the lender and each
monthly amount consists partly of interest and partly of capital repayment: the
higher the interest rate (for any given mortgage amount and term), the higher
the monthly repayment.
The repayment is calculated in such a way that, provided interest rates do not
change, it will remain the same throughout the term of the mortgage. If interest
rates do go up or down, the repayment is increased or decreased, or
alternatively the mortgage term can be extended or shortened.
Because the repayment remains unchanged (ignoring fluctuations in the
interest rate), the relative proportions of capital and interest vary throughout
the term: for example, at the beginning, when very little capital is repaid, the
repayment is mainly interest; then, as more capital is repaid, the interest
proportion of the repayment grows less and less.
The result is that the amount of capital outstanding decreases by smaller
amounts each month at the start compared with towards the end of the term.
Two important factors that should be noted are the following.
t
The mortgage will be repaid at the end of the term, provided that
changes in interest rate have been allowed for and that all repayments
have been made when due.
If the borrower, or the breadwinner in the borrowers family, dies before

the end of the mortgage term, the repayments will have to be continued
or the outstanding loan repaid. Separate life assurance is required to
cover this eventuality.
3.5.1.3 Interest-only mortgages

In the case of an interest-only mortgage, the monthly payments made to the
lender are solely to pay interest on the loan. No capital repayments are made
to the lender during the term of the loan and the capital amount outstanding
therefore does not reduce at all but, for this reason, payments are lower than
a repayment mortgage.
The borrower still has the responsibility of repaying the amount borrowed at
the end of the term, and this is normally achieved through the borrower
making regular payments to an appropriate savings scheme, although the loan
[1] 152
might be repaid out of other resources, eg from the proceeds of a legacy. The
main schemes used for this purpose are: endowment assurances of various
kinds; individual savings accounts (ISAs); and personal pension or stakeholder
pension plans.
Borrowers should be made aware of the risks involved in taking out an
interest-only mortgage, in particular that repayment of the mortgage is
dependent on the performance of an investment plan achieving a predetermined rate of return. If this is not achieved, then the borrower will be left
with a shortfall: the value of the policy or plan will be lower than that of the
total debt.
Under FSAs Mortgage Market Review (the proposed changes stemming from
which were published by the former regulator in October 2012), mortgage
lenders will be responsible for obtaining evidence that the prospective
borrower has a credible way of repaying the mortgage. Furthermore, they must
then contact the borrower at least once during the term of the mortgage to
establish whether the repayment strategy remains in place and still has the
potential to repay the capital.
3.5.1.3.1 Endowment assurances
Both with-profit and unit-linked endowments can be used for mortgage
purposes. In each case, special adaptations have been developed to take
account of the particular needs of mortgage repayment.
One feature of life policies is that they can be legally assigned to a third party,
who effectively becomes the owner of the policy and is entitled to receive the
benefits in the event of a claim. Some lenders require the endowment to be
assigned to them as part of the mortgage deal; others may simply require that
the policy document be passed into their possession, without a formal
assignment.
3.5.1.3.1.1
Low-cost endowment
Borrowers prefer to use with-profit policies rather than non-profit because of

the potentially better returns. The problem is, however, that the premiums are
higher an important consideration for most borrowers, who are seeking to
minimise their mortgage costs.
The low-cost endowment provides a suitable compromise by basing
premiums on a sum assured that is lower than the mortgage loan amount but
[1] 153
Unit 1
which, including the bonuses that are expected to be declared over the policy
term, should become sufficient to repay the loan. Since bonuses are not
guaranteed, the basic sum assured is calculated using a conservative estimate
of future bonus rates often around 75 per cent of the companys current
reversionary bonus rate. Terminal bonuses are not taken into account.
If the borrower were to die before the bonuses had reached the required level,
the amount paid out would be insufficient to repay the loan. To cover this
shortfall, a decreasing term assurance is added to the policy, the additional
benefit being calculated as just sufficient to make up the difference between the
mortgage amount and the current level of sum assured plus reversionary
bonuses. Some companies add a level term assurance, or even a level
convertible term assurance, in place of the decreasing term assurance.
If the total of sum assured plus bonuses does not reach the amount of the loan
at the end of the term, it is, of course, the borrowers responsibility to fund the
difference. Life companies help their policyholders to avoid this by including
regular progress reviews of mortgage-related endowments, to check whether
the policy is on target to reach the required amount by the end of the term.
If the policy does not seem to be on target, the company may either
recommend an increase in premium, possibly without further medical evidence
being required, or suggest other ways of addressing the problem.
On the other hand, if the total benefit at maturity, including bonuses, proves
greater than the amount required to repay the loan, the surplus will provide a
tax-free windfall for the borrower.
3.5.1.3.1.2
Unit-linked endowment
When used for mortgage purposes, the premium required to fund a unit-linked
endowment is calculated as the amount that will provide sufficient to repay the
loan at the end of the term if unit prices increase at a specified conservative
rate of growth. Policyholders can choose which fund or funds to use for their
investment, but it is usually recommended that premiums be invested in a
managed fund: it would certainly not be wise to use a very speculative fund for
mortgage repayment purposes.
The growth rate is not guaranteed, and it is the borrowers responsibility to
ensure that the policy will provide sufficient funds to repay the loan. Regular
reviews, by the life company, of the policys progress enable the borrower to
increase the premiums (or make other provisions) if the policy is not on target.
Most companies also provide the facility to switch to a cash fund, or similar, in
[1] 154
order to protect the policy value from sudden market falls towards the end of
the term.
One advantage of the unit-linked policy as a repayment vehicle is that, in a
strongly rising market, the value of the policy may reach the required amount
before the end of the term. In that event, the policy can be surrendered and
the loan repaid early thus saving on future interest, and freeing the repayment
amounts for the client to use for other purposes.
3.5.1.3.1.3
Performance review
The actual performance of endowment plans during the 1990s led to a major
review of this area of financial advice and, during 1999, the regulatory
authorities instructed providers of endowment plans to review the actual
performance of these products. This was for three main reasons:
t
poor performance of endowment plans during the 1990s;
concern over the standard of advice provided by financial advisers in

making sure customers understood the risks involved with investmentbacked schemes;
concern that holders of endowment mortgages would be faced with a

large shortfall on the maturity proceeds, leaving them unable to repay
their mortgage debt.
3.5.1.3.2 Pension mortgages

One of the benefits of a personal pension plan or stakeholder pension is that
up to 25 per cent of the accumulated fund can be taken as a tax-free cash sum
when the pension payments commence. This fact means that these plans have
the potential to be used as mortgage repayment vehicles, with the loan being
repaid out of the cash lump sum.
The plans have other financial benefits.
t
Pension contributions qualify for tax relief at a persons highest rate of

tax. The practical effect of this for a higher rate taxpayer, for instance, is
that each 100 of contribution costs them only 60. This tax relief is
restricted to annual contributions of 50,000, or an amount equal to the
persons earned income if this is less than 50,000. (There is no tax relief
on endowment policy premiums.)
[1] 155
Unit 1
t
The fund in which the contributions are invested is not subject to tax
on capital gains, meaning that it should grow faster than an equivalent
endowment policy fund, which is taxed on both income and capital gains.
On the other hand, there are a number of factors a borrower might feel are
possible drawbacks to the use of a pension plan for mortgage repayment
purposes.
t
There is a minimum age at which the lump sum can be taken: in most
cases this is 55, which means, in effect, that the term of the mortgage
must run until at least age 55 and the mortgage cannot be paid off
earlier, even if the fund has grown to a sufficient value. (This minimum
age increased to 55 from 50 with effect from 6 April 2010).
Because only 25 per cent of the fund can be taken in cash, a fund of four
times the loan value must be built up, which means that contributions
must be four times what is actually required to repay the loan. The
remaining 75 per cent is not wasted, of course, because it will provide a
retirement pension nevertheless, it may mean that total contributions
are more than the borrower can afford or more than are permitted by
the regulations.
A personal pension or stakeholder pension, unlike an endowment

assurance, does not automatically carry with it any life assurance, so a
separate policy will be required to cover the repayment of the loan in
the event of premature death. As of 6 December 2006, it was no longer
possible to obtain pension term assurance for this purpose (see further,
Section 3.3.1.4).
There is a further characteristic of the use of a pension plan that might be

considered a disadvantage by the lender: as with all pension contracts, personal
pensions and stakeholder pensions cannot be assigned to a third party as
security for a loan or for any other purpose. The lender cannot, therefore, take
possession of the plan or become entitled to receive benefits directly from it.
This fact has not, in practice, prevented the majority of lenders from moving
into the pension mortgages market.
3.5.1.3.3 Individual Savings Accounts Mortgages
Individual Savings Accounts (ISAs) are recognised as an attractive means of
repaying an interest-only mortgage. All managers allow investments to be made
on a regular monthly basis, provided, of course, that the overall annual limits
are not exceeded.
[1] 156
The ISA managers calculate the amount of regular investment that would be
required to produce the necessary lump sum at the end of the mortgage term,
based on an assumed growth rate and on specified levels of costs and charges.
The main benefits of using an ISA as a repayment vehicle are:
t
the funds grow free of tax on capital gains, thus reducing the cost of
repaying the mortgage;
if the funds rate of growth exceeds that assumed in the initial

calculations, the mortgage can be repaid early.
One drawback to the use of ISAs is that they may not be available in the longer
term. Since mortgages are generally long-term contracts, this might lead to
many borrowers having to change their repayment vehicle mid-stream. In
November 2006, however, the government stated that ISAs will continue to be
available indefinitely.
Other drawbacks associated with the use of ISAs (and other similar investment
schemes) are the following.
t
If growth rates do not match the initial assumptions, the final lump sum
will fall short of the mortgage amount unless additional investments
have been made.
In the event of premature death, the value of the ISA investment is

unlikely to be sufficient to repay the loan. Additional life assurance cover
is required to meet this eventuality.
The limits on annual contributions can make it difficult to pay back a loan
quickly. This is less of an issue for couples, as they are each allowed to invest
their individual maximum but it is not normally possible for these funds to be
held together in order to accumulate at a faster rate.
3.5.1.4 Mortgage interest options and other schemes
Regardless of whether a customer chooses a capital-and-interest repayment
mortgage or an interest-only mortgage with some kind of a repayment vehicle,
there are often a number of different types of mortgage product available. The
main variations are described below but remember that these are not
necessarily specific products in themselves; they are characteristics of
products. Some of these characteristics can be combined within a single
product, eg a fixed-rate mortgage with a cashback.
[1] 157
Unit 1
Remember also that how interest is charged will vary from one lender to
another: some charge interest on an annual basis; some on a monthly basis; and
some on a daily basis.
3.5.1.4.1 Variable rate
A variable rate is the basic method of charging interest, with monthly payments
going up or down without limit as interest rates change. One disadvantage is
that borrowers cannot easily predict the level of future payments, which can
cause budgeting problems.
3.5.1.4.2 Discounted mortgage
A discounted mortgage takes the form of a genuine discount off the normal
variable rate (eg 2 per cent off for three years). It is not a deferment of capital
or interest payments. There is usually a restriction on how soon the mortgage
can be repaid, or a penalty for repaying within a certain period.
3.5.1.4.3 Fixed rate
With a fixed-rate mortgage, the borrower is able to lock in to a fixed interest
payment for a specified period, usually between one and five years. At the end
of the period, the rate reverts to the lenders prevailing variable rate. This
scheme is popular with first-time buyers and others who want to be able to
budget precisely. There is often a substantial arrangement fee, however, and
there may be restrictions or penalties on changing to another lender.
3.5.1.4.4 Capped rate
An interest rate might have an upper fixed limit, known as the cap. The lenders
normal variable rate will apply to this type of mortgage, but it will be subject
to the capped rate. Should the variable rate exceed the cap, the borrower
will still pay not more than the capped rate. If there is also a fixed lower limit,
it is known as a cap and collar mortgage.
3.5.1.4.5 Base rate tracker mortgages
As the name suggests, base rate tracker mortgages are linked to the base rate
set by the Bank of England.The base rate is reviewed once a month and reflects
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the cost of borrowing money from the Bank of England. Base rate tracker
mortgages give the borrower the certainty that their payments will rise and fall
in line with base rate changes. It should be noted that most lenders offering
this type of mortgage do charge a premium above the base rate. A typical
example would be a borrower being charged interest at 0.95 per cent above
the base rate.
3.5.1.4.6 Flexible mortgages
The flexible mortgage gives the borrower some scope to alter their monthly
payments to suit their ability to pay, as well as the opportunity to pay off the
loan more quickly. Although there is no precise definition of a flexible
mortgage, it is generally considered that such a product should offer the
following basic features:
t
interest calculated on a daily basis;
the facility to make overpayments at any time without incurring an early

repayment charge;
the facility to underpay, but only within certain parameters set out by
the lender when the mortgage was arranged;
the facility to take a payment holiday, again within certain parameters laid
down at the outset.
The combination of a daily interest calculation and occasional, or regular,

overpayments will result in considerably less interest being paid overall and the
mortgage term being reduced.
The ability to reduce monthly payments, or suspend them entirely, for a limited
period will benefit the borrower who is experiencing temporary financial
difficulties. Such a situation can be further relieved by the borrower being able
to borrow back previous overpayments.
Most flexible mortgages allow the borrower to draw down further funds as
and when required, although the lender will have set a limit on total borrowing
at the outset. Some lenders provide borrowers with a chequebook to enable
additional funds to be drawn. Flexible mortgages involve a much easier
administrative process than is usual when dealing with further advances. The
wording of the mortgage deed generally used for flexible mortgages is such
that all additional funds withdrawn, within the limit on total borrowing, will
automatically take priority over any other subsequent charges registered
against the property.
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3.5.1.4.6.1
Current account mortgage
An increasingly popular version of the flexible mortgage is the current account

mortgage. This enables the borrower to carry out all of their personal financial
transactions within the single account. The account is able to receive salary
credits and pay standing orders and direct debits in exactly the same way as a
conventional current bank account. The borrower will be provided with a
cheque book and a debit/credit guarantee card.
The combination of salary credits and the calculation of interest on a daily
basis considerably reduces the amount of interest payable and consequently
also the mortgage term.
3.5.1.4.6.2
Offset mortgage
A more recent development is the offset mortgage.This requires the borrower

to have savings or other accounts with the lender and enables the interest
payable on such accounts to be offset against the mortgage interest charged.
For example, if a borrower has an offset interest-only mortgage for 80,000
and 25,000 in a savings account with the lender, they can opt to waive
payment of interest on their savings, enabling interest to be charged on a net
loan of 55,000.This calculation is repeated on a daily basis.
Even more complex offset mortgages are becoming available that enable the
borrower to offset interest payable on various savings accounts against interest
charged on their mortgage and on any other secured or unsecured loans held
with the lender.
Many lenders now offer flexible mortgages with a fixed, discounted or capped
rate for an initial period. Early repayment charges do not normally apply to
these products but an arrangement fee may be payable and, in some cases, it
may be a condition of the loan that a particular insurance product is purchased
from the lender.
3.5.1.4.7 Cashbacks
Cashback is a relatively common incentive offered by many lenders. A lump
sum is paid to the borrower immediately after completion of their mortgage,
either as a fixed amount or as a percentage of the advance. Generally, lower
loan-to-value ratios will result in higher cashbacks. For example, the cashback
may be 3 per cent of the advance for a loan-to-value ratio of up to 80 per cent,
and 2 per cent for a higher loan-to-value ratio.
[1] 160
It is usually a condition of the mortgage that some or all of the cashback must
be repaid if the loan is redeemed within a specified period.
Discounted rates and cashbacks are sometimes used by lenders either to tempt
borrowers away from competitors or as a loyalty bonus to persuade them to
stay. Payment of legal fees is another offer that is commonly made to encourage
switching of the loan between lenders while incurring minimum costs.
3.5.1.4.8 Low-start mortgage
The low-start mortgage is a repayment mortgage designed to assist borrowers
who want to keep down costs in the early years.The low initial repayments are
achieved by deferring the capital instalments for the first few years. Borrowers
need to be aware that payments will increase at the end of the initial period
and that no capital will have been repaid.
3.5.1.4.9 Deferred interest
In the early years of a deferred interest mortgage, some of the interest is not
paid but is added to the outstanding capital. This is a useful method for those
who expect an increasing income, and who wish to maximise the loan while
minimising the costs in the early years.
This type of mortgage is not suitable for people who borrow a high proportion
of the property price especially at a time when prices may be falling
because there is an increased danger of negative equity.
3.5.1.4.10
CAT-standard mortgages
The government has introduced specified CAT (charges, access and terms)
standards that can be applied to mortgage products, although lenders do not
have to offer CAT-standard mortgages, and there is no guarantee by either the
government or the lender that a CAT-standard mortgage will be the most
suitable product for a particular borrower.
CAT-standard mortgages are likely to appeal to borrowers who wish to have
clearly stated limits on charges. Examples of the limits set on charges and other
costs are the following.
t
The variable interest rate must be no more than 2 per cent above Bank
of England base rate and must be adjusted within one calendar month
when the base rate is reduced.
Interest must be calculated on a daily basis.
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t
No arrangement fees can be charged on variable-rate loans and no more

than 150 can be charged for fixed-rate or capped-rate loans.
Maximum early redemption charges apply to fixed-rate and capped-rate

loans.
No separate charge can be made for mortgage indemnity guarantees.
All other fees must be disclosed in cash terms before the customer
makes any commitment.
Other rules relating to access and terms include the following.

t
Normal lending criteria must apply.
The customer can choose on which day of the month to pay.
All advertising and paperwork must be clear and straightforward.
Purchase of related products cannot be made a condition of the offer.
3.5.1.5 Methods of releasing equity

Equity in a mortgage context is the excess of the market value of a property
over the outstanding amount of any loan or loans secured against it. There are
a number of ways to release the equity in a property. Releasing equity means
using the excess value to obtain capital or income this can then be used for
another purpose.
Equity release plans are designed to enable elderly homeowners who do not
have a mortgage on their property to release some of the equity in order to
provide capital or supplement their retirement income. Most of the schemes
are available only to property owners over the age of 60, and many have a
minimum age of 70. Some of these schemes involve mortgages known as
lifetime mortgages.
Although they are aimed at those who do not have a mortgage, a homeowner
with a small mortgage would also be able to enter such a scheme; the existing
mortgage would have to be paid off as part of the arrangement.
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3.5.1.5.1 Lifetime mortgages

The majority of lifetime mortgages are on a fixed-rate basis and taking into
account the unknown term of the loan. The capital released in this way can be
used to provide an annuity, or invested in an income-producing vehicle, or as
capital to meet the borrowers needs.
The lender will restrict the lending, usually from around 25 per cent to 55 per
cent of the property value, depending on the borrowers age. Although interest
is charged at the lenders lifetime mortgage rate, no regular payments of capital
or interest are made.
The interest charged but not paid is added to the loan (rolled up). At current
interest rates this means that a typical loan will double around every 10 11
years. When the borrower dies, moves or sells the property, the property is
sold and the original mortgage plus rolled-up interest is repaid to the lender;
the borrower, or their estate, receives the balance of the sale proceeds. If the
property is owned jointly, the mortgage would continue until the second death
or vacation of the property.
Most lenders provide a no-negative-equity promise, which means that the
borrower cannot owe more than the value of the property when the loan is
due to be repaid.
A lifetime mortgage can be arranged on a drawdown basis. The lender agrees
a maximum lending limit and the borrower can borrow an initial minimum loan
and subsequently draw down lump sums as they wish, subject to a minimum
withdrawal, typically 2,000 to 5,000. Interest is charged on the amount
outstanding, but is rolled up rather than paid each month. The benefit of this
type of loan over a standard lifetime mortgage is that interest only accrues on
the amount actually borrowed, so the borrower has a degree of control and
the debt will not increase as rapidly. It will allow the borrower to provide an
annual income while maintaining control over the speed at which the debt
builds up.
3.5.1.5.2 Home Income Plans
Home income plans (HIPs) are not common today. They were launched in the
1980s when annuity rates were much higher than today and mortgage interest
relief was available. The arrangement involved the following:
t
The minimum age was at least 70.
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Unit 1
t
The homeowner took out a mortgage, with the interest rate fixed for
life.
The provider allowed the borrower to take some cash, typically 10 per
cent of the money released, and bought a lifetime annuity for the
borrower with the balance.
The annuity income was used to pay the monthly interest charge with
the balance paid as income to the borrower.
Annuity rates were much higher in the early 1990s than now, which
meant that the borrower had a significant additional income from the
arrangement, even after interest was paid.
Unfortunately, as annuity rates fell, HIPs were viable only for the very elderly,
and even then the benefits were unlikely to be particularly attractive; few, if any,
plans are sold today. The major benefit of the HIP arrangement was the ability
to provide an increased income without rolling up interest and reducing the
equity further.
The Equity Release Council came into being on 28 May 2012, as a relaunch of
the SHIP organisation. While SHIP membership was limited to product
providers, the Equity Release Council will broaden its membership to include
advisers, lawyers, surveyors and other interested parties involved in equity
release. The Equity Release Council has adopted the SHIP Statement of
Principles and Code of Conduct. The Code of Conduct provides the following
main safeguards.
t
The planholder(s) will be entitled to remain in their home for the rest
of their life in the case of joint borrowers this applies to each of them.
The applicant must be given the right to seek independent legal advice
to ensure that they fully understand the risks involved and the fact that
any children and other beneficiaries will receive a reduced inheritance.
The solicitor will be required to sign a certificate confirming that the

implications have been explained to the applicant and that they
understand the risks and benefits.
Providers must give customers fair, simple and complete presentations

of their plans.This means that the benefits and limitations of the product
together with any obligations on the part of the customer are clearly set
out in their literature.
[1] 164

t
The provider will give a no-negative-equity guarantee. This means that

the amount that has to be repaid will not be more than the price that is
obtained when the property is sold.
The plan must be portable without financial penalty the borrower

must be allowed to transfer the loan to another property, although part
of it may have to be repaid if the value of the new property is insufficient
to cover it.
Since 2004, protection for customers taking out home income plans has been
provided through the regulation of such plans by the FSA, and now the FCA.
3.5.1.5.3 Home reversion schemes
Home reversion schemes are an alternative to home income plans and involve
the homeowner selling all or part of their property to the company in return
for an income for life. The customer(s) retains the right to live in the house
until their death(s), after which the company sells the property and retains all
the proceeds.
At first, it was believed that home reversion schemes would not be regulated
because they do not involve a mortgage but, as of 6 April 2007, these
schemes are now regulated.
3.5.1.6 Shared ownership
Shared-ownership mortgages combine owner-occupation with rental. They
enable the borrower to buy a stake in the property and rent the remainder.
For example, the borrower can purchase a 25 per cent stake in the property,
funded by a mortgage, with the option of buying subsequent 25 per cent shares
in the future. As the borrower increases their share in the property, the
mortgage element increases and the rented element reduces. This process of
increasing ones share in the property is sometimes called staircasing.
This type of scheme (usually arranged by housing associations) enables those
on relatively low incomes to become owner-occupiers, even though they
cannot afford a conventional mortgage.
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3.5.1.7 Related property insurance

A lenders security depends on the property being maintained in an acceptable
condition. For that reason, borrowers have to covenant (ie promise under the
terms of the mortgage deed) to maintain the property in good condition.
They also have to covenant to insure the property adequately. A lender is
permitted by law to:
t
insist that a property subject to a mortgage is continuously insured by

means of a policy that is acceptable to the lender;
have its interest as mortgagee noted on the policy;
secure a right over the proceeds of any claim and to insist that the
proceeds be applied to remedy the subject of the claim or to reduce the
mortgage debt.
3.5.2 Other secured private lending

With all secured loans, the borrower offers something of value as security for
the loan so that, in the event of default, the lender can take and sell that asset
(ie realise the security) and be repaid out of the proceeds.
The major form of secured personal lending is, of course, the mortgage loan
for house purchase, the security being a first charge on the borrowers private
residence.
When property values increase significantly, as they have over the last ten
years, it is common for people to borrow against the increased equity in their
property (ie the excess of the property value over the amount owing on the
mortgage loan). They then use the loan to fund purchases that are not related
to the house purchase but which improve their lifestyle in other ways.
This may be done by way of a further loan from their existing mortgage lender,
a second mortgage from a different lender or by remortgaging for a larger
amount.
Most secured lending, therefore, is secured on bricks and mortar, even where
its purpose is not directly or even indirectly related to house purchase or
improvement.
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3.5.2.1 Second mortgages

A second mortgage is one that is created when the borrower offers the
property for a second time as security while the first lender still has a
mortgage secured on the property. The new lender takes a second charge on
the property; the original lender retains the deeds and its charge takes
precedence over subsequent charges. This means that, in the event of a sale
due to default, the original lenders claim will first be met in full (if possible)
and, if sufficient surplus then remains, the second mortgagees charge will be
met.
Lenders will, of course, only offer a second mortgage if there is sufficient equity
in the property and, since second mortgages represent a higher risk to lenders,
they are likely to be offered at higher rates of interest than first mortgages.
3.5.3 Unsecured loans

In contrast to secured loans, an unsecured loan relies on the personal promise,
or covenant, of the borrower to repay. Unsecured loans are, therefore, generally
higher risk than secured lending, with the consequence that they are subject
to higher rates of interest and are normally available only for much shorter
terms. For example, while a mortgage secured on a property will be available
for 25 years or even longer, a personal loan is rarely offered over much more
than six or seven years.
Unsecured loans have long been available from banks and finance houses, but
it was not until the passing of the Building Societies Act 1986 that building
societies were able to move into this area of business. While societies must
ensure that 75 per cent of their lending is in the form of mortgages on
residential property, there is no restriction on the remaining 25 per cent that
need not be secured on property.
Unsecured personal lending takes a number of forms, the most common of
which are described below.
3.5.3.1 Personal loans
Personal loans are offered by banks, building societies and by some finance
houses. They are normally for a term of one to five years, and the interest rate
is generally fixed at the outset and remains unchanged throughout the term.
Many of the larger lenders operate a centralised assessment of loan
[1] 167
Unit 1
applications through telephone call centres, using a form of credit scoring to

assess the suitability of the borrower.
The loan can be used for any purpose by the customer: typically it might be
used to purchase a car, fund a holiday, or consolidate an existing higher-cost
borrowing such as a credit card balance.
The purpose of the loan determines whether it is regulated under the terms
of the Consumer Credit Act 2006. Most loans are regulated by the Act unless
they are for house purchase or home improvement.The 2006 Act removed the
previous 25,000 limit, with effect from April 2008.
The FCA are expected to take responsibility for the regulation of consumer
credit (from the Office of Fair Trading) in 2014.
3.5.3.2 Overdrafts
An overdraft is a current account facility, offered by all retail banks and some
building societies, which enables the customer to continue to use the account
in the normal way even though its funds have been exhausted. The bank sets a
limit to the amount by which the account can be overdrawn. An overdraft is a
convenient form of short-term temporary borrowing, with interest calculated
on a daily basis, and its purpose is to assist the customer over a period in which
expenditure exceeds income for instance, to pay for a holiday or to fund the
purchase of Christmas gifts.
Because it is essentially a short-term facility, the agreement is usually for a fixed
period, after which it must be renegotiated or the funds repaid. Overdrafts that
have been agreed in advance with the institution are normally an inexpensive
form of borrowing, although there may be an arrangement fee. Unauthorised
overdrafts, on the other hand, attract a much higher rate of interest.
3.5.3.3 Revolving credit
Revolving credit refers to arrangements where the customer can continue to
borrow further amounts while still repaying existing debt. There is usually a
maximum limit on the amount that can be outstanding, and also a minimum
amount to be repaid on a regular basis.
The most common way of providing revolving credit is through credit cards,
although some institutions do provide revolving personal loans that allow the
borrower to draw down funds as the original debt is repaid.
[1] 168
It is hard to believe that plastic cards, now an integral part of most peoples
financial affairs, have only been around for the last 40 years. Their development
and their impact have gone hand-in-hand with the rapid advance of the
electronic processing technologies on which their systems now largely depend.
Many cards can now hold a wealth of information about cardholders and their
accounts, and can therefore interact directly with retailers and banks
electronic equipment: these cards are often referred to as smart cards.
3.5.3.3.1 Credit cards
Credit cards enable customers to shop without cash or cheques in any
establishment that is a member of the credit card companys scheme.
Originally all credit card transactions were dealt with manually at the point of
sale, but most retailers now have terminals linked directly to the credit card
companies computers, enabling online credit limit checking and authorisation
of transactions.
As well as providing cash-free purchasing convenience, credit cards are a
source of revolving credit. The customer has a credit limit and can use the card
for purchases or other transactions up to that amount, provided that at least
a specified minimum amount (usually 3 per cent of the outstanding balance) is
repaid each month. The customer receives a monthly statement, detailing
recent transactions and showing the outstanding balance. If the balance is
repaid in full within a certain period (usually 25 days or so), no interest is
charged; if a smaller amount is paid, the remainder is carried forward and
interest is charged at the companys current rate.
Credit cards are an expensive way to borrow, with rates of interest
considerably higher than most other lending products. There is also normally a
charge if the card is used to obtain cash either over the counter or from an
ATM, or if the card is used overseas.
Credit card companies charge a fee to the retailers for their service. This is
deducted as a percentage (typically around 3 per cent) of the value of
transactions when the credit card company makes settlement to the retailer.
There are, however, a number of advantages to retailers, in addition to the fact
that more customers may be attracted if payment by credit card is available.
For instance, payment is guaranteed if the card has been accepted in
accordance with the credit card companys rules. Furthermore, the retailer can
reduce their own bank charges because the credit card vouchers paid into a
bank account are treated as cash.
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Unit 1
Two other types of card are mentioned below for completeness, although they
do not offer credit facilities (except in a very limited sense, in the case of
charge cards).
3.5.3.3.2 Charge cards
Although used by the customer in the same way as a credit card to make
purchases, the outstanding balance on a charge card must be paid in full each
month. The best-known examples are American Express and Diners Club.
3.5.3.3.3 Debit cards
Introduced in the late 1980s, debit cards enable cardholders to make payment
for goods by presenting the card and entering a PIN, in just the same way as
with credit cards or charge cards. In the case of debit cards, however, the effect
of the transaction is that funds equal to the amount spent are transferred
electronically from the cardholders current account to the account of the
retailer. This is known as EFTPOS (electronic fund transfer at point of
sale) and the system effectively replaces the use of cheques, leading in the
longer term to reduced handling costs.
Debit cards can also be used to withdraw cash from ATMs. They previously
acted as cheque guarantee cards, but this facility ended on 30 June 2011.
3.5.4 Commercial loans

There is an extensive market for what might be called commercial lending, ie
loans to businesses of all sizes from sole traders and partnerships to family
companies to multinational traders. Loans may be required to start up or
expand businesses, to purchase shops, factories or hotels, or to refurbish
premises.
All the high-street retail banks have departments operating in this field and
there is also a wide range of companies specialising in commercial lending.
The lending is normally secured on the companys property or other assets,
with the interest rate set at a specified margin above base rate. The exact
interest rate will depend on the risk that the lender believes is involved in
lending to the particular company; this will be assessed by looking at the
[1] 170
companys past performance where applicable, business plans, projected profits

and management quality, as well as the business sector in which it will operate.
Investment in commercial property is also described in Section 2.4.3.
3.6 Pension products

As we have seen in Section 1.3.5.5, individuals who have made sufficient
National Insurance contributions will be entitled to a basic state pension and,
in certain circumstances, additional state pension/pension credit. However,
these are set at a fairly low level and most people would prefer a higher level
of income in retirement than the state provides.
Employees may also be members of an occupational scheme although not
all employers offer occupational pensions. Occupational schemes fall into two
types:
t
final salary (defined benefit) the employee will receive a pension

that is calculated as a percentage of final salary (the salary on or near
retirement). The longer the employee has been a member of the
scheme, the higher the percentage;
money purchase (defined contribution) an agreed contribution

is invested for each member. On retirement, the accumulated fund is
used to purchase benefits. The level of benefits is not guaranteed by the
employer.
As people are now living longer in retirement, employers are finding final salary
schemes more expensive. As a result, many are being forced to reduce their
commitment and to transfer the responsibility to individuals. Many individuals
may therefore wish to supplement retirement income by contributing to
private arrangements.
The following are tax-efficient pension arrangements:
t
additional voluntary contributions (AVCs);
free-standing additional voluntary contributions (FSAVCs);
personal/stakeholder pension plans (PPP/SHPs).
AVCs and FSAVCs are available to employees who are members of

occupational schemes. Personal/stakeholder pensions are generally available to
anyone under the age of 75.
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Some AVCs are final salary arrangements although most are money purchase.
All FSAVCS, PPP/SHPs are money purchase schemes.
The funds do not pay capital gains tax, pay no income tax on savings income
and no higher-rate income tax on dividend income. They are, however, unable
to reclaim the 10 per cent tax credit on UK dividends.
Any individual, who is a UK resident and under the age of 75, can receive
income tax relief at their highest marginal rate on annual contributions to
occupational and private pension schemes up to a maximum of the higher of:
100% UK earnings
or
3,600.
(Before the new regulations came into effect on A-Day, different schemes had
different maximum contribution limits).
However, there is an annual allowance limit (50,000 in 2013/14). This is
reducing to 40,000 in April 2014. If the combined total of employer and
employee contributions in a year exceeds this figure, tax will be charged on the
excess. The individual can however, carry forward any unused annual allowance
from the previous three tax years to the current tax year. The unused
allowance is added to this years annual allowance and only if pension
contributions exceed this amount is the annual allowance charge payable.
Benefits can (normally) be taken from the schemes from age 55 onwards. This
minimum pension age increased from 50 on 6 April 2010. 25 per cent of the
fund can be taken as tax-free cash and the remainder must be used to provide
a taxable income.
There is also a lifetime allowance (1.5m 2013/14). If the individuals total
benefits on retirement exceed this limit, there is a lifetime allowance tax charge.
The lifetime allowance will be reduced to 1.25m in April 2014, but the
government will offer an individual protection regime and a fixed protection
regime for individuals with pension rights above 1.25m when the new lifetime
allowance is introduced.
The income may be taken by purchasing an annuity with the remaining fund. It
is not essential to buy the annuity from the company that supplied the pension
plan. An individual can shop around to see if higher annuity rates are available
from other providers. This facility is known as an open-market option.
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As an alternative to purchasing an annuity, an individual can make regular

withdrawals of capital from the fund (within certain limits) this is referred to
as drawdown or pension fund withdrawal.
Before 6 April 2006, it was compulsory to purchase an annuity by the age of
75. Although it is now possible to continue drawdown beyond age 75, taxation
and other restrictions can make it unattractive. Since 6 April 2011, it has been
possible under new flexible drawdown rules to take unlimited amounts out
of your pension pot provided that you have a guaranteed lifetime income of at
least 20,000pa.
3.6.1 Additional Voluntary Contributions/Free

Standing Additional Voluntary Contributions
Additional Voluntary Contributions (AVCs) are additional contributions
to an occupational scheme. Sometimes, this will purchase additional years
service in a final salary scheme. However, most AVCs operate as money
purchase arrangements and the employee will only have a limited choice of
funds.
The employer will usually cover some or all of the costs.
Contributions to AVCs are deducted from gross salary and the employee
therefore receives full tax relief at the same time.
Alternatively, an individual may contribute to a Free Standing Additional
Voluntary Contributions (FSAVCs) money purchase fund provided by a
separate pension provider. FSAVCs are available from a range of financial
institutions, including insurance companies, banks and building societies.
A FSAVC may be attractive to an employee who wishes to keep financial
arrangements independent from the employer. FSAVCs offer a wider range of
investment funds than AVCs. However, they tend to be more expensive as the
employer is not bearing the costs.
Contributions to FSAVCs are made from taxed income. Tax relief of 20 per
cent is given at the time. Higher-rate taxpayers will need to claim additional
relief separately.
Note: since April 2006, all employees have been able to contribute to
personal/stakeholder pensions. FSAVCs, which are generally more expensive,
are expected to become obsolete.
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3.6.2 Personal pensions

Personal pensions (PPPs) are individual money purchase arrangements
provided by financial services companies such as life assurance companies,
banks and building societies.
Before 6 April 2006, employees who were members of an occupational scheme
could only contribute to a PPP/SHP (from the same earnings) if their earnings
were no more than 30,000pa.The maximum contribution for such employees
was 3,600pa.
However, all employees can now contribute to PPP/SHPs, up to the maximum
of the higher of 100 per cent of UK earnings or 3,600 (see Section 3.6),
subject to an overall limit of 50,000pa.
Contributions receive 20 per cent tax relief at source, even for non-taxpayers.
A higher-rate taxpayer will need to claim additional relief separately through
self-assessment.
3.6.3 Stakeholder pensions

Stakeholder pensions (SHPs) became available from 6 April 2001. The
governments aim in introducing it was to take some of the pressure off the
state provision of pensions by encouraging more individuals to contribute to
their own pension arrangement. They felt that this could be achieved by
organising a scheme that is simple and has lower costs.
Although stakeholder pensions are available to most people, they were
intended to be particularly attractive to people at lower earnings levels, who
traditionally do not have pension provision and who rely on the state pension.
Early indications suggest that this move to include the lower paid has largely
failed, with the majority of stakeholder pensions being purchased by people
who are financially more sophisticated and who would have been making
pension provision anyway.
One common misconception is that stakeholder pensions are state pensions.
They are in fact private pensions, although there are certain circumstances in
which the government makes it compulsory for stakeholder pension facilities
to be provided by employers. Where an employer has five or more employees,
but does not provide an occupational pension scheme, the employer must
make a stakeholder scheme available to all employees who meet certain
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criteria. The employees are not obliged to join, but the employer must provide
a payroll deduction scheme for those who do join and pass on the employees
contributions to the scheme. The employers themselves are not obliged to
contribute to the scheme.
As mentioned earlier, stakeholder pensions are a form of personal pension and,
as such, subject to the same rules. In order to encourage those on lower
incomes or with limited understanding of pensions, certain standards were
introduced for stakeholder pensions. The key standards are:
t
charges cannot exceed 1.5 per cent of the fund value per annum for the
first ten years of the term and cannot exceed 1 per cent after that time;
entry and exit charges are not permitted;
the minimum contribution required cannot be more than 20.
One effect of the restriction on charges is that the low limit precludes the
payment of commission to independent financial advisers and this may result
in people finding it difficult to obtain advice on stakeholder pensions. To
overcome this problem, the government has prepared a set of decision-making
flowcharts, known as decision trees, which people can use to determine
whether stakeholder pensions are appropriate to their own circumstances.
3.6.4 NEST Pension Schemes

Currently, not all employers offer a pension scheme for their workforce, and
not all employees who have access to a work pension scheme bother to join
it. In 2009, only 50% of UK employees were members of their employers
pension scheme.
From October 2012, employers must offer a qualifying pension scheme to their
employees and all workers who earn above a certain amount per year
(currently 9,440) are automatically enrolled into a pension scheme. The
employee can choose to opt out, but only after they have automatically been
made a member. Many existing workplace pensions already qualify as a suitable
pension scheme for this purpose; those employers who dont currently have a
scheme already set up can set one up from scratch, or they can enrol their
employees into the National Employment Savings Trust (known as NEST),
although contributions to NEST are restricted to 4,000 per year.
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Unit 1
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1.
What are the main advantages to an investor of collective investments?
2.
Who owns and controls a unit trust funds assets?

(a) The depositary.
(b) The fund manager.
(c) The trustees.
3.
How would you define forward pricing?
4.
How does gearing benefit investment trusts?
5.
Michael, aged 35, invests 5,760 in a cash ISA in July 2013 and then
withdraws 1,000 in September 2013. How much can he invest in the
same cash ISA in December 2013?
(a) Nothing.
(b) 1,000.
(c) 4,760.
6.
In what circumstances might a terminal bonus be added to a with-profits

endowment policy?
7.
What rate of tax would be payable on the proceeds of a non-qualifying

policy?
8.
How much can parents invest in a Child Trust Fund?
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Unit 1
9.
In what circumstances might a gift inter vivos term assurance be used?
10. How does the deferred period on an IPI policy affect the premium?
11. Which of the following would NOT normally be excluded from a private
medical insurance claim?
(a) Dental treatment.
(b) Chiropody.
(c) Outpatient consultation.
12. What is the definition of indemnity?
13. Which of the following would not normally be covered against damage
under a buildings insurance policy?
(a) Garden shed.
(b) Fitted wardrobe.
(c) Dining room table.
14. What is a mortgagee?
15. Whose responsibility is it to ensure that an interest-only mortgage is
repaid at the end of the term?
16. A self-employed plumber aged 30 takes out a pension mortgage. What is
the minimum term for which the mortgage could run?
17. What is a cap and collar mortgage?
18. Why do mortgage lenders insist that properties on which they lend
should be continuously insured?
19. What is the most common form of revolving credit?
20. What is the maximum permissible contribution to a stakeholder pension
in 2013/14?
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Answers
1.
The services of a skilled investment manager; reduction of investment risk

by spreading the fund; reduced dealing costs; wide choice of investment
funds.
2.
(c) The trustees.
3.
Under forward pricing, clients buy or sell units in a given dealing period
at the prices that will be determined at the end of the dealing period.
4.
A companys gearing relates to the amount of borrowing it has taken on.

Investment trusts, being companies, are able to borrow in order to take
advantage of investment opportunities (whereas unit trusts and OEICs
cannot borrow).
5.
(a) Nothing.
6.
On maturity or on earlier death of the life assured. Terminal bonuses are

not usually added to surrender values.
7.
Higher-rate taxpayers would pay 20 per cent on the gain (policy proceeds
less premiums paid). For others there would be no tax due.
8.
Up to 3,720 per year. This remains true for CTFs already in force before
they were withdrawn.
9.
To cover the possible inheritance tax on a gift if the donor dies within
seven years.
10. The deferred period is the length of time before benefits commence. The
longer the deferred period, the lower the premium.
11. (c) Outpatient consultation.
12. In the event of a claim after loss, insured persons should be restored to
the same financial position that they were in immediately before the loss
occurred.
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Unit 1
13. (c) Dining room table.

14. A lender (bank, building society or other institution) who has an interest
in the property for the duration of the loan.
15. The borrower.
16. 25 years because the minimum age at which they could take the cash
lump sum on their pension plan is 55 (from 2010 onwards).
17. A mortgage where the interest rate cannot rise above a specified
maximum rate or drop below a specified minimum rate.
18. Because if the property is damaged, the value of the lenders security is
reduced.
19. Credit cards.
20. The greater of 3,600 gross or 100 per cent of UK earnings, with an
overall limit of 50,000.
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Section 4
The financial planning and advice process
Introduction
The relationship between the adviser and the client is formally defined by a
number of legal elements, such as the law of agency and data protection
legislation, which are described in Section 6 and in Section 4 of Unit 2
respectively.
It is also essential that the client should understand the terms on which any
business will be transacted, and advisers are required to have a written
agreement with the client, setting out the terms of business, the exact nature
of which is described in Unit 2.
It is, however, vital that the relationship should also be one of mutual trust. This
will be much more easily achieved if the adviser can show an understanding not
only of the products that they sell, but of human nature and of the situations
in which people find themselves and both the perceived and real needs that
they consequently have.
Part of this relationship of trust will be the confidentiality with which the
adviser treats the customers personal and financial information. Some
confidentiality requirements are specified by legislation for example the Data
Protection Act 1998 but an adviser should make it clear that all of the
customers information will be kept confidential at all times unless there is a
legal requirement for it to be revealed.
An adviser must also be aware of all of the major consumer protection
legislation that regulates the relationship with the client, much of which is
described in Section 6 of this unit and in Unit 2.
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Unit 1
In this section, we will consider how advisers obtain the information they need
from their clients, how they assess and structure that information to
determine the most suitable products and services to recommend, and how
they communicate effectively with their clients at all stages of the relationship.
Section 4 covers the topics in part 5 of the Unit 1 syllabus, ie the process of
giving financial advice.
4.1 The saving pattern

There is a well-established pattern to the way in which most savers and
investors build up and hold their assets. It begins with savers attitudes to the
need for liquidity and safety and then, as incomes and savings grow, moves
gradually away from liquidity and towards an acceptance of greater risk.
The first stage in the saving pattern is cash; after that, a current account with a
guarantee card is virtually as good as cash. People do not generally hold any
other form of asset until their cash requirements are met. The next stage is
secure, short-term investment such as instant access (or short-notice) bank
and building society deposits.
With a sufficient balance in short-term savings, investors look next at products
with less flexibility but a greater return, such as fixed-term bonds.
Further down the line, individuals may be attracted to products that offer
greater long-term potential but at the risk of short-term loss. Shares and other
equity-linked investments, such as unit trusts, are good examples. In times of
stock market volatility, however, these investments may prove considerably less
popular.
Similar patterns can be recognised in relation to other types of financial
products, though perhaps to a less pronounced extent: for example, the first
type of bank account that most people open is a personal current account,
often out of necessity to enable receipt of their wages or salary. It is only later,
as their financial situation improves, that they begin to use a wider range of
accounts and other banking products. Similarly with insurance products where
the first experience is often of compulsory cover, particularly for motor
insurance, and of holiday insurance.
In terms of borrowing, many people commence with short-term unsecured
borrowing, by way of credit cards or personal loans, to pay for holidays or a
car.
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4.2 The financial lifecycle

In all of these examples, the pattern is determined to a greater or lesser extent
by the market segment, or segments, into which the individuals fall. These can
be categorised in a number of different ways: it is well established that the
financial needs of individuals and families change as people pass through the
different stages of life. While accepting that everyone is different, there are
some broad statements that can be made about a typical financial lifecycle as
follows.
4.2.1 School-age young people

The very young may be attracted by small lump-sum or regular savings
schemes; it is typical for accounts to be opened for young people by
grandparents or other relatives, at birth or later as birthday gifts. National
Savings and Investments products (including Premium Bonds) and building
societies are popular homes for such savings. Stakeholder pensions can be
opened on behalf of children, from birth onwards.
4.2.2 Teenagers and students

Few teenagers and students have any surplus income, although some who have
started to work full-time or during holidays may be able to accumulate savings.
Some may borrow to purchase a car or to fund a holiday. Many students now
have to borrow to finance their college or university studies, mainly through
special schemes established for that purpose.
4.2.3 Post-education young people

The ability to save increases for those young people in employment with the
possibility of higher incomes as their careers progress. If they establish a home
of their own (often initially by renting), their savings may be modest at first.
Some may decide to save towards a deposit for a first home purchase. Shortterm accessible saving schemes are their most likely choice. Many telephonebased and internet-based financial services are aimed at this market.
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Unit 1
4.2.4 Young families

Although statistics indicate that fewer young people today get married, many
still form relationships and raise families. This often leads to increased
borrowing, particularly for a mortgage. At the same time, income may be
reduced if one partner gives up work to look after children or, alternatively,
outgoings may increase if a childminder is employed. Similar factors affect the
growing number of one-parent families. Whatever the situation, there is often
little scope for savings at this stage. Protection of the earners income against
illness or death becomes very important. Young people should also begin to
think about pension provision, although in practice very few do.
4.2.5 Established families

As families settle into an established lifestyle, they tend to become better off
financially. There may be a return to a two-income situation. People often
trade-up to a larger house, increasing their borrowing accordingly.
Creditworthiness may improve, enabling greater borrowing for cars and
household goods. This is also the beginning of the time when wealth may be
increased by the receipt of inheritances from the estates of parents or other
relatives.
4.2.6 Mature households

Maturity is generally the period of highest earning potential and outgoings may
also decrease as children leave home and mortgages may be paid off. At this
stage, pension provision becomes a priority for many people as they begin to
realise that they may not have as high an income in retirement as they had
hoped.
4.2.7 Retirement
Prior to retirement, most peoples financial planning is centred on converting
income into lump sums (or lump sums into bigger lump sums). At retirement,
when income from employment ceases, the focus changes: the requirement is
now to produce income from capital. Other factors also become more
relevant: the need to prepare for possible inheritance tax liabilities should be
[1] 184
considered. Similarly the cost of health care, and the possibly of long-term care
in old age, may become an issue.
Age or time of life is not, of course, by any means the only way in which market
segments can be defined, but it has been analysed in detail to give an illustration
of the concept. Other breakdowns are possible, for instance, by the level of
annual income or by an individuals attitude to investment risk. Both of these
characteristics can contribute to determining the appropriate financial product
for a particular investor or borrower.
4.3 Gathering information

Regulations that were first introduced by the Financial Services Act 1986, and
which now continue to operate under the Financial Services and Markets Act
2000, oblige advisers to ensure that any advice offered is suitable for the client,
based on the clients circumstances, experience, needs and objectives. Advisers
must be able to identify the clients needs, which are the starting point for the
sales process.
Most, if not all, advisers will complete a comprehensive computer or paperbased factfind to obtain their clients details. An advisers responsibility during
the factfind is to define the clients needs and objectives quickly and accurately.
To gather appropriate information it is necessary to ask questions in respect
of the clients:
t
financial situation;
existing and future needs;
ability to provide for them;
attitude towards providing for them;
objectives;
knowledge and experience of investment (where relevant to the service

the adviser will provide). This will support an assessment of the clients
ability to understand and accept investment risks.
This means, in practice, that any factfind should look at both the clients
circumstances and preferences.
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Unit 1
4.3.1 Clients circumstances

These relate to three main areas: personal details; financial details; objectives.
4.3.1.1 Personal and family details
Current personal and family situation information includes the details of all of
the people who may need to be included in the planning exercise, together
with any constraints that may apply. The following basic information will be
needed.
t
Name and address: full name of the client, along with their contact
address and telephone number.
Date and place of birth: dates of birth for all those included in the
factfind. The clients place of birth may be important for underwriting or
taxation reasons, but any hint of racial discrimination must be avoided.
Marital status: the use of the word marital in this context now carries
a wider meaning than in earlier generations, and may include single,
married, civil partners, cohabiting, divorced, widowed, etc. It is usually
preferable to have both partners of a relationship involved in the
financial planning process, since the decisions made will often affect both
partners. Some clients, however, prefer to keep their financial affairs
separate.
Family details: the clients family details are important for a number of
reasons:
there may be family members who are, or who will be, financially
dependent on the client;
the client may become the beneficiary of gifts or trusts;
the client may wish to become a donor, now or in the future;
from a marketing viewpoint, there may be an opportunity for
referrals to family members.
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The most important group of family members is usually the children. In

order to give appropriate advice about protection against death and
disability, as well as about savings for school or university fees for
example, it is necessary to know how old the children are. This may
include children from previous relationships.
4.3.1.2 Financial situation

The information required will include the following.
4.3.1.2.1 Employment details
Is the client employed, self-employed, unemployed or retired? If the client is a
director or a partner, it may be necessary to delve deeper and establish basic
information about their business arrangements.
It also helps to know whether they are part-time or full-time, temporary or
permanent, as well as gaining details of the clients profession or trade.
Details of the clients income and benefits package (or net profit, if selfemployed) will need to be established. It is often useful to ascertain an exact
breakdown of income by its component parts, eg basic, commission, bonus and
overtime, together with the average level of overall earnings. Similarly, an
adviser must establish the exact nature of benefits provided, eg private medical
insurance, company cars, pension and/or death-in-service details, subsidised
loans etc.
Additional information that may be required will include details of previous
employment (especially if the client has preserved pension entitlement), details
of share-option schemes or profit-related pay schemes, or even details of
additional employment. It may be helpful to obtain copies of payslips, P60s, tax
returns and notices of tax coding.
4.3.1.2.2 Income and expenditure
By analysing a clients income and expenditure, it is possible to identify more
easily the implications of, say, premature death on the family income and
spending patterns. It is also possible to identify any surplus income that could
be used to fund the purchase of any additional products recommended.
To calculate a households income is usually relatively straightforward. An
analysis of clients expenditure can be more difficult: certain items are easily
determined, ie those paid by standing order such as rent and some household
bills. Other items will cause a degree of difficulty or even embarrassment
when trying to pin down how much is spent on, for example, food and drink,
holidays or motoring.
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Unit 1
4.3.1.2.3 Assets
For each of the clients assets, from their home (if they own it) to all their
various bank accounts, some or all of the following details, as appropriate,
should be obtained:
t
ownership, ie single ownership or jointly owned;
purpose of the investment;
type of investment, eg property, deposit in a bank account, pension

policy or fund;
size of original investment and date;
current value and/or projected future value;
rate of return (if any);
type of return, eg capital growth or income, and whether that return is

fixed, guaranteed or variable;
tax status of the investment or other asset;
options available and/or penalties;
sum assured and/or lives assured and maturity dates;
name of the institution providing the asset.
4.3.1.2.4 Liabilities
The relevant information with regard to certain borrowing liabilities includes
the following:
t
lender;
amount of loan;
balance outstanding;
original term and term remaining;
type of loan, eg secured, unsecured (and if secured, on what);
amount of monthly or other periodic payment;
rate of interest;
repayment method;
protection of capital or payments.
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Clients are often unaware of the details of any arrangements that they have. It
is an advisers responsibility to try to obtain this information and clients should
be asked, wherever possible, to bring all relevant details with them.
4.3.1.3 Plans and objectives
This part of the factfind is substantially different from the other two parts: the
personal and family details and the financial situation are concerned with the
gathering of hard facts, ie about tangible items and people.The clients plans and
objectives tend to be more intangible in nature: here the aim is to find out
why?, how? or do you feel that?, in other words, to discover the clients
feelings about what they have, what they want and where they want to go from
a financial point of view. These are known as soft facts.
Advisers need to know the following:
t
how the clients feel about their current arrangements or lack of them
in each area;
their objectives within each area, now and in the future;
why they have certain arrangements, or goals or views;
their willingness to take action in each area;
the likelihood of change in their situation.
Having knowledge of their feelings about their situation and their existing
arrangements will help build on understanding of clients in a number of ways:
t
discovering the reasons behind the clients existing arrangements may in

turn indicate the clients level of understanding of their finances;
determining the level of the clients interest in their situation, will

indicate their level of motivation towards improving their situation and
the likelihood of their taking action;
ascertaining the clients views on a number of possible alternative

solutions will help in constructing acceptable recommendations.
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Unit 1
4.3.2 Attitude to risk

As well as the soft facts, additional information is needed to ascertain correctly
the clients attitude to risk, or risk profile. It is essential to take full account
of this attitude when giving recommendations to a client and attitude to risk
will differ from client to client.
The client must understand what the risk is this may mean providing
explanations to distinguish between the degrees of risk. There is, for example,
risk to the capital that is invested: the value of an investment may fall as well
as rise and the amount of income or capital growth may not be guaranteed.
The clients attitude towards this must be explored. Historically, many so-called
low-risk investments, such as bank or building society accounts, have provided
a safe haven and a relatively stable level of income, although inflation will cause
the value of the investment to fall.
Another important factor that advisers should consider is a customers
Capacity for loss. The FCA describes this as the customers ability to absorb
falls in the value of their investment. If any loss of capital would have a
materially detrimental effect on their standard of living, this should be taken
into account in assessing the risk that they are able to take.
4.3.3 Client preferences

It is important to take note of a clients stated preferences, but advisers should
also be aware of their own duty of care: this means recognising that, whilst
clients may have a clear view on what they want to do, their appreciation of
what they ought to do can be less than clear. This means that advisers may have
an educational role in helping clients to explore their own financial
circumstances and to make the right choices.
4.4 Identifying and agreeing needs and objectives

We can categorise an individuals financial needs and objectives into the
following five areas:
t
protecting dependants from the financial effects of either a loss of income

or a need to meet extra outgoings in the event of premature death;
protecting self and dependants from the financial effects of losing the
ability to earn income in the long term;
[1] 190

t
providing an income in retirement, sufficient to maintain a reasonable

standard of living;
wanting to increase and/or to protect the value of money saved or

invested; wanting to increase income from existing savings or
investments; wanting to build up some savings in the first place;
saving tax.
In seeking to assess any of these areas, an adviser should look for examples of
typical things that clients either do wrong or fail to do at all.This might include:
t
a young family, with little or no savings, relying solely on mortgage

protection cover as their only form of life assurance. It would repay the
mortgage but is not designed to meet the ongoing costs of running the
house and bringing up the family;
a low level of life assurance premiums being paid, suggesting that cover
might need to be increased for the required protection to be adequate;
unnecessarily large amounts being held on deposit in banks and building

society accounts over the long term and so not gaining access to better
returns available elsewhere;
substantial taxable investment income being received by an individual

who pays higher-rate income tax;
a non-taxpayer holding investments where tax on interest received

cannot be reclaimed;
too many small holdings of shares over a wide range of companies

causing administration and monitoring difficulties;
a married couple owning most of their assets in an individuals sole name

and paying more tax as a result;
no pension contributions being paid, or very small pension contributions

as a percentage of total earnings, which will mean being dependent upon
state benefits unless action is taken;
people aged over 65 who have their age-related tax allowances reduced
because of their income;
people who have not made a valid will, whose assets on death may,
therefore, not be distributed as desired.
The advisers role is to define the clients needs and objectives accurately, to
enable the client to see the key issues facing them and to recommend and
discuss a priority order for action.
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Unit 1
4.4.1 Agreeing order of priority

Failing to establish a priority order with the client can result in a client ignoring
an advisers recommendations.The clients priorities may well differ from those
that the adviser feels appropriate, and so the process is one of discussion and
agreement rather than straightforward selection by any single person. In the
end, however, deciding a plan of action and agreeing its priority order remains
the clients decision, assisted by the advisers recommendations.
4.5 Recommending solutions

Once an adviser has gathered all of the necessary information about the
clients circumstances and preferences, has a clear appreciation of their ability
to pay, and has obtained agreement on priorities, then the process of matching
solutions to requirements can begin. The advisers aim should be to help the
client to:
t
put the right amount of money...
in the right form...
in the right hands...
at the right time.
In practice, these four aims mean that advisers will look in detail at a number
of specific areas. These will include:
t
state benefits: the nature and level of state benefits to which a client
may be entitled;
existing arrangements: there is no point in recommending products

that satisfy needs already met by the clients existing arrangements or by
state provision;
affordability: any recommendations made must not, in terms of total

cost, jeopardise the clients current and likely future financial situation;
taxation: one purpose of the recommendations may be to mitigate tax

but it is also important to ensure that any course of action
recommended does not unnecessarily add to or create a tax burden;
risk: there must be a close correlation between the risk inherent in the
product recommended and the clients risk profile and capacity for loss;
[1] 192

t
timescale: the product recommended should meet the clients needs

within a defined timescale;
flexibility: recommendations should display the flexibility to deal with

possible changes in the clients circumstances.
4.6 Implementing solutions

4.6.1 Presenting recommendations
When a solution is recommended to a client, it is vital that the client
understands exactly what it will do. The client needs to know why the
particular recommendation is being made.
The first rule of presentation is to keep it simple: avoid using jargon and stick
to the particular features that are relevant to the needs of the client, provided
that a fair and accurate explanation is given.
For each type of product recommended, it is a good idea to have a planned
way of presenting it. This ensures that the adviser covers all of the relevant
details, some of which may be mandatory under the Financial Services and
Markets Act 2000. It also helps the adviser to avoid irrelevant details that are
of no interest to the client.
The best way to proceed is to go step by step through each product, at the
clients pace. As each feature and its benefits are covered, the adviser should
check that the client understands the benefits, perhaps by asking a few simple
questions.
There are a number of steps that should always be included when presenting
recommendations:
t
the purpose of the product and the clients needs that the product will
address;
the benefits that the client will enjoy;
the risks and limitations inherent in the product;
any options that exist within the product that may be appropriate to the
client;
a summary of reasons why the product is being recommended.
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Unit 1
For each product, part of the presentation should involve a features and benefits
analysis. This means going through the product and identifying each of its
features, and then putting into simple terms what specific benefits these
features provide to the client.
4.6.2 Handling objections

The first point in handling an objection is to qualify it. This means finding out
whether it is a real or a false objection and how important it is. This can be
done by trying to understand the objection as specifically as possible, ie by
clarifying exactly what the client means by what they are saying. A good way of
doing this is by paraphrasing what the client has said: So what youre saying
is...?
Once the nature of the objection and its importance are clear, then an attempt
can be made to solve the problem. If the problem lies in the clients
understanding or interpretation of what they have heard, then it should be
straightforward to solve. If the problem lies in something specific and the client
is not willing to move, then the obstacle should be put into perspective and
other compensating factors stressed.
The handling of objections or queries is another step in helping the client to
buy something for which they have seen a clear need and of which they can
now see the full benefit.
4.6.3 Obtaining commitment to buy

Obtaining a commitment from the client in the form of a completed
application form will depend on how effectively all of the earlier stages of the
sales process have been carried out. Attempting to close a sale too early is
clearly not sensible, and deciding when to close a sale is determined by two
factors: the reaction of the client and their understanding of the proposal.
Closing the sale simply involves asking the client if they are happy to set the
wheels in motion and complete the application. Sometimes the client may
expect the adviser to complete the form on their behalf. It is permissible to do
this but only with the clients permission to do so. If the adviser does complete
the proposal form, the client must read it through thoroughly, checking what
has been written before signing it.
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In particular, the client must be made aware of the consequences of nondisclosure. If the contract is later made void because of something that the
client failed to disclose on the application form, then the client may not have
been protected and also incurred a loss of premiums.
4.6.4 Documentation
Advisers also have a duty to explain the ancillary factors to clients such as the
cancellation notice. This notice explains the clients right to withdraw from
any arrangements within a defined period. Similarly, a key features
document together with a client-specific illustration must be given to the
client before the sale is closed. These documents provide the client with all the
information they need in order to make a decision. The client should also be
provided with a product brochure explaining product details and features in
full.
The business card that the client will have been given during the meeting gives
the client a clear route back to the adviser should there be any queries later
on.
Detailed records of the transaction must be kept securely stored but
accessible. For life policies and pension contracts, the retention period is five
years but details of pension transfers, opt-outs and free-standing AVCs must be
kept indefinitely. For other contracts (eg collective investment schemes) the
retention period is three years. Note, however, that where MiFID business is
involved, a uniform retention period of five years applies.
4.6.5 After-sales care

Providing a professional service means more than selling a product to meet
needs: it means ensuring that proper after-sales care is given and that reviews
are carried out.
This will include ensuring that, where the acceptance procedure involves any
delay, the client is kept fully informed. It will also mean dealing with other
related matters such as direct debits, policy delivery, cancellation notices,
standard reviews and any requests to alter the plan.
After these general areas, client servicing falls into two categories: proactive
and reactive servicing.
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4.6.5.1 Proactive servicing

Proactive servicing involves instigating action by contacting the client to discuss
further needs. This might be on a matter previously agreed, such as the next
salary review, a job change, or even the taking up of recommendations of which
the client was unable to take advantage originally.
Even where there is no known future event or requirement, it is a good idea
to agree a time to review the clients position. At a review, an adviser can find
out if there have been any changes to the clients circumstances and can update
the appropriate records. By doing this, an adviser is in a strong position to
identify opportunities to recommend new products appropriate to the clients
needs, or to recommend changes to existing products.
4.6.5.2 Reactive servicing
Reactive servicing happens as the result of a request from the client, eg a
request to discuss the recommendation after comments made in the media or
by competitors.The clients circumstances might change unexpectedly, resulting
in a request for advice.
The request may not be received directly from the client: it might be
notification of non-payment of premiums or a request by the next of kin to
sort out a death claim. In order to be fully prepared for all eventualities, clear
and concise records must be maintained.
The keeping of all appropriate records will not only comply with the
requirements of the Financial Services and Markets Act 2000, but can also lead
to more business.
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1.
What is likely to be the main financial priority of a couple with a young

family?
2.
What is the main objective of completing a factfind?
3.
List the employment details of a client that an adviser would normally

need to ascertain.
4.
What details should an adviser request in relation to loans?
5.
What risks might apply to investment in a bank or building society deposit

account?
6.
List the factors that an adviser might take into account when deciding on
an appropriate solution/product for a client.
7.
The first stage in handling an objection should be to:

(a) Qualify it.
(b) Agree with it.
(c) Quantify it.
8.
What is proactive servicing?
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Unit 1
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Answers to questions
1.
Family protection, particularly the protection of income and assets against

the effects of the death or illness of a breadwinner.
2.
To define accurately the clients needs.
3.
Whether the client is: employed, unemployed, self-employed, retired; parttime/full-time, permanent/temporary.
The details of their employer; nature of work; income (basic, overtime,
bonuses, commission); benefits; pension scheme.
4.
Lender, purpose of loan, balance outstanding, remaining term,

secured/unsecured, interest rate, repayment method, repayment amounts.
5.
Risk of loss due to collapse of bank/building society (small risk, some

compensation available). Risk that interest rate falls below that expected.
Risk of fall in capital value due to inflation.
6.
State provision; clients existing arrangements; clients and products tax

position; clients risk profile; timescale of needs; flexibility required.
7.
(a) Qualify it.
8.
Instigating action by contacting the client to discuss their continuing

needs.
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Unit 1
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Section 5
The main areas of financial advice
Introduction
Clients often have a range of financial needs, even when they approach an
adviser with one particular need in mind. In order to give the most appropriate
advice, advisers must be aware of the nature of all of the needs that clients may
have and must be able to recognise those needs even where clients
themselves are not aware of them. Some needs may be immediate, such as
family protection, while others, particularly retirement needs, will seem a long
way off.
This section looks at the different areas in which financial advice may be
required.These are listed in Part 4 of the Unit 1 syllabus, and include budgeting,
protection, borrowing, investment, retirement planning, estate planning and tax
planning.
5.1 Budgeting
The need to budget underpins all other forms of financial planning. At its
simplest, it reflects the need to have sufficient funds to purchase the necessities
of daily living. It also encompasses the need to determine how much can be
spent on other items: on capital purchases; on leisure pursuits and holidays; on
provision for a secure retirement.
Many savings products can be used to budget for future capital and income
needs, but advisers must be careful not to put pressure on the clients current
and future income when selling products paid for out of that income. An
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Unit 1
increase in mortgage interest rates, for example, could push a familys

expenditure beyond its means.
It might be argued that the need to balance the budget on a weekly/monthly
basis is not as great as it once was, as a result of the easy availability of credit,
but all borrowing must be repaid at some point, and advisers should exercise
caution when considering clients likely future income and expenditure levels.
5.2 Protection
Life can be a risky business and it is not possible to avoid all the dangers and
difficulties that it can bring. It is, on the other hand, possible to take sensible
precautions against the impact of the risks that affect people, their lives, their
health, their possessions, their finances, their businesses, and their inheritances.
Many people, however, make little or no provision for minimising the financial
consequences of death or serious illness. This may be because they are not
aware of the size of the risk or because they believe that they cannot afford to
provide the cover, not realising how cheap it can be, especially if taken out
when young.
The probability of dying before age 65 is about one in five for males in the UK.
In a typical year, according to government statistics, about 150,000 males aged
between 20 and 65 will die in the UK, while about four times that number
(600,000) will be off work for more than six months due to ill health. In the
same period, about 200,000 people in the UK are diagnosed as suffering from
cancer and about 100,000 will suffer a stroke.
Many people take an it wont happen to me attitude but, the simple fact is, it
might!
5.2.1 Family protection

5.2.1.1 Losses due to death
For most families, it is income rather than savings that enables them to enjoy
their standard of living. Loss of that income on the death of the breadwinner
usually causes a reduction in a familys quality of life.
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State benefits may be available but they generally do little more than sustain a
very basic lifestyle, and increasing pressure on funding means that they are
more likely to reduce than increase in real terms in the future. The surviving
spouse/partner may, therefore, have to become the earner, leaving a problem
of who will look after the children (or alternatively, the problem of funding the
cost of childcare).
Another consequence of the death of the main earner is that dependants may
not be able to make loan repayments, particularly mortgage repayments. If the
loan cannot be serviced, the property may have to be sold and the family
rehoused in less suitable circumstances. This problem can be addressed either
by making provision for a monthly income equal to the loan repayments, to be
payable for the remainder of the loan term, or by providing for a lump sum to
pay off the outstanding loan capital.
It is equally important for the life of a dependent spouse or homemaker to be
insured, even though they are not the familys earner. In the event of their
death, the normal earner may have to give up work in order to look after the
children, or may have to pay the cost of full-time childcare.
5.2.1.2 Losses due to sickness
Many of the arguments for protection against the adverse financial
consequences of death apply equally to the need for protection against the
impact of long-term illness. In fact, the arguments for protection against
financial loss through sickness may be even stronger than those for protection
against that from death, not just because the likelihood of suffering a long-term
illness is greater than that of premature death, but also because the financial
impact on a family of long-term sickness can be even more severe than that
resulting from a death.
Protection against the impact of sickness may fall into a number of categories:
t
an income to replace lost income (for instance when the main earner
suffers a long-term illness);
an income to pay for someone to carry out the tasks normally

undertaken by a person who is ill;
an income to pay for continuing medical attention or nursing care during

an illness or after an accident;
a lump sum to pay for private medical treatment;
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Unit 1
t
a lump sum to pay for changes to lifestyle or environment, such as

alterations to a house or a move to a more convenient house.
As in the case of protection against death, there may be a requirement to

cover not just a main breadwinner, but also a dependent spouse.
A number of factors contribute to the amount and type of cover required,
including the following:
t
the ability of the insured person to adapt to other types of work;
the extent to which an employer might continue to pay salary during an

illness;
the number and ages of children and other dependants;
the availability of help from family and friends;
the nature and amounts of state benefits available.
5.2.1.3 Losses due to unemployment

The problems resulting from unemployment/redundancy are, in many ways,
similar to those caused by illness, but it is much more difficult for insurers to
predict statistically the likelihood of loss of employment than it is to predict
loss of health or loss of life. Unemployment cover is, consequently, much more
difficult to obtain as a stand-alone insurance and, when it is available (normally
only in conjunction with sickness cover and often only in relation to covering
mortgage repayments), it is usually subject to a number of restrictions (see also
Section 3.3.2.3).
5.2.2 Business protection

There are a number of business situations in which the loss of a colleague can
have severe implications for the financial health of an organisation. Life or
sickness insurance can be used to mitigate the financial loss that may result.
One or two of the more common circumstances are described below.
5.2.2.1 Death of a key employee
The death of an important employee, particularly in a small company, can have
a devastating effect on a companys profits. Key personnel, though more often
found among the management of companies, can actually be found at all levels
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of a company. People with different roles may, for very different reasons, be key
personnel on whom the companys profits depend:
t
a managing director with a strong or charismatic personality;
a research scientist with specialised knowledge;
a skilled engineer with detailed understanding of the companys

machinery;
a salesperson with a wide range of personal contacts.
Determining the level of cover that is required can be difficult. A simple

method is to use a multiple of the key persons salary, say five or ten times.
Another method is to relate the cover to an estimate of the key persons
contribution to the companys profits. This contribution can be calculated by
multiplying the amount of current annual profit by the ratio of the key persons
salary to the companys overall wage bill. This estimate of the key persons
contribution is then multiplied by the length of time that the company would
take to recover from the loss, often assumed to be five years.
Example
Using this method, calculate the level of cover for Goran, who
is the production director of a firm whose last published gross
profits were 4 million. Goran is paid 50,000 pa; the firms total
wage bill is 2 million.
The sum assured for a policy on Gorans life could be
calculated as:
50,000
x 4,000,000 x 5 = 500,000
2,000,000
The company would then take out a term assurance on the life of the
employee, for the period during which the employee is expected to be a key
person. This may be until retirement, or until the end of a contract or a
particular project. If a term assurance of five years or less is chosen, the
premiums are likely to be allowed as a business expense, which the firm can
set against corporation tax. In the event of a claim, however, the policy
proceeds will then be taxed as a business receipt and subject to corporation
tax.
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Unit 1
5.2.2.2 Death of a business partner

A partnership is defined in the Partnership Act 1890 as the relationship that
exists between persons carrying on a business in common with a view to
profit. Groups of professionals such as solicitors and accountants normally
work together as partners.
On the death of one of the partners, the beneficiaries of that partner (often
their spouse and/or family) may wish to withdraw their share of the
partnerships value. This can cause problems for the remaining partners
because it might mean that they will have to sell partnership assets to pay the
deceased partners family. Since much of the value may be in the form of
goodwill, it may not be possible to realise it except by selling the whole
business. Goodwill is that intangible and yet real portion of the value of a
business that relates to the firms good name or reputation. In such
circumstances, the need for partnerships to insure against the death of each
partner in order to buy out their share is clear.
There are three main types of scheme used for this purpose.
5.2.2.2.1 The automatic accrual method
Within the automatic accrual method, all partners enter into an agreement
under which, on the death of a partner, his or her share is divided among the
remaining partners in agreed proportions. The deceased partners family is
compensated by the proceeds of a life policy written in trust for their benefit.
5.2.2.2.2 The buy and sell method
Under the buy-and-sell method, all partners enter into an agreement under
which, on the death of a partner, the deceaseds legal representatives are
obliged to sell the partners share to the other partners, who are obliged to
buy it. To enable them to do so, each partner takes out a life policy on their
own life in trust for the other partners. One problem is that the person who
inherits the share is deemed to receive cash rather than business assets, so no
business relief from inheritance tax is available.
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5.2.2.2.3 The cross-option method

The cross-option method is basically the same as the buy-and-sell method,
except that the agreement specifies that the deceased partners estate has the
option to sell their business share to the remaining partners, who have the
option of buying it. They always do but, because there is no legal obligation to
do so, those who inherit are deemed to receive business assets and relief from
inheritance tax may be available.
5.2.2.3 Death of a small business shareholder
Small businesses are often run as private limited companies with a small
number of shareholders, who are often family members or close relatives or
friends. In the same way that partners may wish to buy out the share of a
deceased partner, surviving shareholders in a small business will probably want
to buy the shares of a deceased shareholder to prevent the shares from going
out of the close circle of existing shareholders. The same types of schemes as
described on Section 5.2.2.2 can be used for shareholder protection.
5.2.2.4 Sickness of an employee
If sickness prevents a key employee from working, the effect on profits can be
just as serious as in the case of that employees death. The company may need
funds with which to pay the salary of a replacement who can supply the skills
and attributes lost through sickness.
5.2.2.5 Sickness of a business partner
If a partner falls ill, they may be able to continue to draw income from the
partnership for some time, even if not contributing their skills to the
partnerships earning capacity. There will be a need to provide a replacement
income to avoid the partner becoming a drain on the partnerships resources.
In the event of the partner being unable to return to work, the remaining
partners may even wish to buy the sick partners share of the business. Clearly
there is a possible need for income protection and/or for critical illness cover
in addition to life assurance.
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Unit 1
5.2.2.6 Sickness of a self-employed sole trader

Although sole traders may employ others to work for them, they often do
much of the key work themselves, including accounting and decision-making. If
a sole trader ceases working, their income is likely to stop very quickly. Worse
still, their customers may be lost to competitors, causing the business to
collapse. The pressure and anxiety resulting from such a situation is likely to
hinder recovery from the very illness by which it was caused.
5.3 Borrowing and debt

House purchase is, for the majority of people, the largest financial transaction
of their lives and, since most people are not able to fund the price of a house
out of their own capital, a loan from a bank, building society or other source
is normally required.
Since a mortgage loan is such a large and long-term transaction, the
consequences of making a mistake can be very serious. It is therefore
particularly important for an adviser to choose wisely and to suit the products
chosen to the clients needs. Choosing the wrong lender or the wrong interest
scheme, for example, could lead to the client paying more than is necessary for
the loan. For people who may wish to make their interest payments early, a
daily interest scheme could help them to save money; a flexible mortgage might
give yet more freedom, allowing overpayments, underpayments and even
payment holidays. Lower interest rates can often be obtained by remortgaging.
Choosing the wrong investment product can lead, at worst, to the mortgage
not being repaid in full at the end of the term. At best, it might mean that the
client misses out on possible surplus funds. Recent industry experience of
borrowers who were originally ill-advised to choose endowment assurances,
without being warned about the possible disadvantages, has confirmed the
importance of good advice in this area. The exact nature of what constitutes
good advice in a particular case will depend on a variety of factors, including
the term for which a loan is required and the tax situation of the borrower.
Failing to protect the outstanding capital or the repayments against sickness,
death or redundancy, can leave a clients family destitute or lead to them having
to leave their home. Many clients are unaware of the magnitude of the risk or
of the ease with which it can normally be mitigated.
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A low level of interest rates coupled with strong house price inflation has led
to a large increase in individual and family indebtedness in the UK, with many
people increasing the proportion of their net income that they spend on
mortgage and other loan repayments. Any increase in interest rates or
reduction in income can leave people unable to service the high levels of debt
that they have taken on.
A number of products and services are available to assist people who can no
longer afford their loan repayments. A common system is the consolidation
loan: this usually takes the form of a remortgage for an increased amount, the
new loan incorporating the existing mortgage plus the individuals unsecured
loans such as personal loans and credit card balances. The advantage of this is
that the overall monthly repayments are reduced, because the unsecured loans
are now subject to a lower rate of interest and a longer repayment term.There
is also, however, a serious downside to the arrangement, which is that the
formerly unsecured loans are now secured against the property, adding to the
borrowers problems if the borrower defaults on the repayments of the
consolidated loan.
For borrowers who can see no prospect of being able to pay off their debts,
there is the possibility of using an individual voluntary arrangement
(IVA) under which the lender may be prepared to write off part of the debt
in exchange for a realistic rescheduling of repayments. IVAs are described in
Section 6.10.1.
5.4 Investment and saving

Broadly speaking, there are two reasons why people invest: to provide income
(either now or in the future) or to provide a capital sum. The particular
purposes for which they may need income or capital include:
t
short-term emergencies (rainy-day funds);
specific purchases;
education fees;
gifts to children;
buying a business;
loan repayment;
retirement.
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Unit 1
Saving and investment needs change over the course of a lifetime, as explained
at the beginning of Section 4. The financial services industry provides a very
extensive range of savings and investment products to meet the needs of a
wide spectrum of customers. The products can be categorised in a number of
different ways. Some of those categories are mentioned here, together with a
few illustrative examples.
5.4.1 Regular savings or lump sum

Most people build up their savings by small regular amounts from their
disposable income. They may use regular savings schemes such as deposit
accounts or unit trusts, or pay regular premiums to endowment policies, or
they may make contributions to pension plans.
The need to invest a lump sum may arise from the receipt of a legacy or other
windfall, or it may reflect the desire to move money from one form of
investment to another.
5.4.2 Level of risk

The level of risk ranges from products where there is virtually no risk to the
capital, such as bank deposit accounts, to those where the customer accepts
the risk of loss of some or all of the capital in order to speculate for higher
returns. Most stock market-related investments fall into the latter category to
some degree. The relationship between risk and reward is very important. As
a general rule, products that carry a greater risk also have a greater potential
for higher returns.
5.4.3 Accessibility
Many deposit accounts offer instant access or require only short notice of
withdrawal. At the other end of the scale, some investments are not directly
accessible until a fixed maturity date: most gilt-edged securities fall into this
category, although they can be sold prior to their redemption date (but
without any guarantee of the price that may be obtained). Shares and some giltedged stocks (and other investments) are irredeemable, ie they have no
maturity or redemption date. Here again, investors requiring access to their
money must sell the securities to an investor who wishes to buy.
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5.4.4 Taxation
The main UK taxes affecting investors are income tax and capital gains tax.
With many investments, tax is payable by investors both on the income
received and on any capital gain made on eventual sale. Shares and unit trusts
fall into this category. Some investments, eg gilt-edged securities, are taxed on
income but are exempt from capital gains tax.
It is important to consider the tax regime of the product in conjunction with
the tax position of the investor: for instance, an investor who does not pay
income tax will not benefit from taking out a cash ISA.
5.4.5 The effect of inflation

One of the factors that is least understood by clients is the impact of inflation
on investment returns. As long as there is inflation, the purchasing power of a
given amount of money will fall. For example, the purchasing power of 1,000
after ten years of 3 per cent inflation will have fallen to under 750. Before an
investment can grow in real terms it must first increase in line with inflation:
the aim of any investment should be to provide a real return. Over the long
term, equity-linked investments have proven most likely to offer growth rates
over and above the rate of inflation.
Inflation in the UK is currently running at a relatively low rate and this is
expected to continue for the foreseeable future. It is important that advisers
educate customers about the impact of low inflation on potential returns from
investments. The significant measure for an investment is the real rate of
return, which reflects the true purchasing power of invested funds. The real
rate of return can be estimated by subtracting the rate of inflation from the
interest/growth rate obtained on the investment: an investment paying 4 per
cent interest at a time when inflation is 3 per cent is providing a real rate of
return of only about 1 per cent. If the rate of interest is less than the rate of
inflation, the real rate of return will be negative and the purchasing power of
the invested funds will fall in real terms.
Low inflation and low interest rates tend to go together, and one effect of this
is that people tend to suffer from the so-called money illusion, ie they tend to
think of interest rates in their nominal sense and not to adjust their thinking
to allow for inflation. Both savers and borrowers can be affected.
t
Savers feel that the low interest rates currently being paid on savings
are a poor return for their money. They may, therefore, react to lower
[1] 211
Unit 1
inflation by putting their money into riskier assets in order to seek

higher returns demand for high-yield bonds has certainly increased in
recent years. But if a high number of people on average incomes lose
their money because of opting for riskier investments, they may not be
able to afford to retire and social problems will result.
t
Borrowers (particularly those repaying mortgage loans) feel that they

are gaining from the lower monthly repayments that have resulted from
interest rate falls. This may persuade them to take out a larger mortgage
since they feel they can more easily afford the monthly repayments. This
is a misconception as, although less cash flows out in interest payments
at the start of the mortgage term, a higher proportion of cash flow will
be necessary to repay the capital. Again, problems may be stored up for
the future as people take on debt they cannot afford, especially if interest
rates rise again. In the meantime, an increased demand for houses can
push up house prices and threaten price stability.
5.5 Retirement planning

One of the great difficulties faced by UK governments in recent years has been
to convince the population, brought up for the most part in the era of the
welfare state, that changes in its demographic structure and social environment
make it increasingly difficult for the state to provide the social security benefits
and particularly pensions that will be needed to maintain peoples lifestyles
but which will represent a realistic and acceptable cost to the taxpayer.
The basic state pension set at about one quarter of the national average
earnings level is clearly inadequate for anything more than subsistence living,
yet many people are continuing to reach retirement age with little or no
pension provision to look forward to apart from the basic state pension. This
is particularly although by no means exclusively true of people at the lower
end of the earnings scale. They are often financially unsophisticated and
unaware of products such as stakeholder pensions that could have been used
to boost their pension. Even when aware, these people may have more pressing
demands on their income; and if they do know of the products, they may have
been put off by talk of high charges or of product mis-selling.
It is not unrealistic to refer to the situation as a crisis. The extent of the
problem is illustrated by the fact that recent estimates of the total shortfall in
pension provision popularly known as the savings gap have varied between
27 billion and 33 billion. Statistics show that 90 per cent of people now live
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to the age at which they receive their state pension, compared with 66 per
cent of people only 50 years ago and those who do collect their pension
receive it on average for eight years longer than did pensioners in the early
1950s.
The problem has been accentuated by the accelerating trend in occupational
pensions away from final salary schemes (also known as defined benefit
schemes) and towards money purchase (or defined contribution) schemes.
Successive governments have been increasingly aware of the potential problem,
and have introduced certain measures to attempt to counteract it (such as
stakeholder pensions), but these initiatives have not, on the whole, been a great
success. Stakeholder pensions were supposedly targeted at people in the
income range 9,000 to 20,000 believed to include the greatest proportion
of people who are failing to make adequate provision for their retirement. The
product was designed with a number of features intended to attract the savings
of this particular group, including low charges and low minimum contributions.
Despite this, initial evidence suggests that there has been very little take-up of
stakeholder pensions among this main target group, with most of the sales
being to people who would have been making pension provision anyway
through other schemes and have chosen stakeholder pensions because of the
lower costs. Some people feel that one of the reasons for the low demand for
these pensions is that the maximum charge providers can incorporate is 1.5
per cent of the fund. It remains a fact, however, that individuals will increasingly
have to take responsibility for their own retirement provision, and they will
need advice to help them through this complex area of financial services.
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Unit 1
5.6 Estate planning

The nature of inheritance tax (IHT) is described in Section 1.3.3.5. It is, broadly
speaking, a tax that is levied at 40 per cent on the estates of deceased persons.
However, there is a nil-rate band (set at 325,000 in 2013/14) that effectively
exempts any estates (or portions of larger estates) that fall under that threshold.
There are basically two approaches that people can take to minimise the
impact of IHT: one is to try to avoid having to pay it and the other is to make
provision for paying it when it is due.
To avoid paying IHT, it is necessary to reduce the value of the estate to below
the nil-rate threshold. This can be done by making use of the various
exemptions described in Section 1.3.3.5 to make tax-free, or potentially
exempt, gifts during ones lifetime. Another method is to place assets in trust,
since trust property no longer forms part of the settlors estate.
The largest component of most peoples wealth is the property in which they
live. It is not possible to avoid IHT by giving the property away while continuing
to live in it, as this would be caught by HM Revenue & Customs gift with
reservation rule, which specifies that if the donor retains any benefit from a
gifted asset, the asset is treated for IHT purposes as remaining in the donors
estate. In the past, many people avoided this restriction by the device of placing
their property (known technically as a pre-owned asset) in a trust. The tax
authorities have for some time been seeking a way of closing this loophole and
this was finally achieved by means of Schedule 15 of the Finance Act 2004,
which introduced new rules for the taxation of pre-owned assets. The rules
came into force from 6 April 2005 but are partly retrospective, in that people
will be liable to an income tax charge each year on the benefit of occupying or
using any asset previously owned but disposed of after 17 March 1986. The tax
charge will be based on a realistic annual rental for the property they occupy.
If the deemed rental amount is less than 5,000, no tax charge is levied. Some
people may decide that cancelling their schemes (with the loss of the benefits
and some, or all, of the set-up costs) is better than paying the future tax bills.
Married couples and civil partners are now able to use the whole of both their
nil-rate bands to pass property tax-free to their relatives or others. The
percentage of nil-rate band unused on the first death can be carried forward
and used to increase the nil-rate band on second death.
If avoiding the tax is not a realistic option, a life assurance policy for the
anticipated amount of the IHT should be taken out. Whole-of-life assurance is
appropriate and, in the case of a married couple, the policy should normally be
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payable on the second death (since no tax will be due if the estate of the first
to die is left to the surviving spouse). To avoid the policy proceeds becoming
part of the deceaseds estate and therefore themselves subject to IHT the
policy should be written in trust for the benefit of the beneficiaries of the will.
Finally, it should be mentioned that a vital element of estate planning is for
the client(s) to have an appropriate (and valid) will. Financial advisers should
not generally become involved in writing a will, but should strongly advise that
the client consult a legal adviser to ensure that a will is in place. If necessary,
the financial adviser can provide a document explaining any financial objectives
that the will should help to achieve.
5.7 Tax planning

The recommendation of a financial product should always take account of the
products impact on the clients tax situation, but not in isolation: it should be
considered in context, in conjunction with other features of the product. For
instance, contributions to a pension arrangement are often the most taxefficient way for an individual to invest, but this should never be the main
reason for recommending a pension product.
Just as it is wise to leave the writing of wills to solicitors, financial advisers
should normally avoid becoming involved in complex tax-planning schemes,
which should be left to taxation experts. On the other hand, it is important to
be able to choose appropriate products that can complement and improve a
clients current tax situation:
t
clients should normally consider the use of ISAs and friendly society
policies to maximise the advantage of tax-free income or growth;
clients who expect to exceed their annual capital-gains tax allowance

might consider investments that are CGT-free, such as gilt-edged stocks.
Advisers should be aware of circumstances where tax that has been paid (in
effect on behalf of the investor) cannot be reclaimed even though the investor
is not a taxpayer. An example of this would be an endowment policy or a life
office investment bond, where gains made within the life companys funds are
taxed at 20 per cent: this deduction cannot be reclaimed by a policyholder who
does not pay capital gains tax. By contrast, unit trust managers are not taxed
on gains within their funds; holders of units are liable for CGT if they sell their
units at a profit but they may be able to avoid this by use of their annual CGT
exemption.
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5.8 Regular reviews

At any given time, one or more of the advice areas described above might be
the most significant for a particular client. Circumstances can, however, change
very quickly and the financial needs of a client and their family may change
dramatically. Births, marriages (and divorces), deaths, moving home, changing
jobs, losing a job and many other events can change peoples attitudes and
desires, as well as their assets and liabilities. Advisers should take account of
this by allowing (as far as possible) flexibility in the products recommended and
also by making plans to review the clients situation at regular intervals. This
topic is also covered in Section 4.6.5.
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1.
Why should the life of a dependent spouse be covered with life

assurance?
2.
What main factors affect the calculation of the level of sickness cover
needed by a family man with children?
3.
What is the purpose of key person insurance?
4.
How does the cross-option method differ from the buy-and-sell method
of partnership protection?
5.
What is the most common reason for remortgaging?
6.
What is the relationship between risk and reward?
7.
If the rate of inflation is 2.5 per cent, what yield must an investor obtain
on their deposit account in order to achieve a real return of 3 per cent?
(a) 0.5%.
(b) 2.5%.
(c) 5.5%.
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1.
Although a dependent spouse is not in paid employment, their death can

lead to severe problems in a family with young children. Either the
working widow(er) must give up work to look after the children or funds
must be found to pay for childcare.
2.
The extent of any sickness benefit from an employer; the nature and
amount of available state benefits; the number and ages of the children;
and the availability of any family help with domestic tasks.
3.
To mitigate the loss of a companys profits caused by the death or longterm illness of an important member of staff.
4.
Because it comprises an option to purchase the deceased partners share

rather than a binding contract, the deceaseds family or heirs are deemed
to receive business assets rather than cash, so business relief from
inheritance tax can be claimed.
5.
To get a loan with a lower rate of interest.
6.
As a broad rule, investments that carry a greater degree of risk offer the
prospect (but not the guarantee) of a greater reward in the form of
interest income or capital growth.
7.
(c) 5.5%.
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Section 6
Basic legal concepts relevant to financial
services
Introduction
Section 6 covers part 6 of the Unit 1 syllabus, ie some of the more general legal
concepts and legislation to the provision of financial services such as wills,
trusts, contracts, agency agreements, powers of attorney and bankruptcy.
The legislation that is related specifically to the regulation of financial services
is covered in more depth in Unit 2.
6.1
Legal persons
Legal persons in the context of financial services refers to those who have a
separate legal existence and can, therefore, enter into contracts or be sued in
a court of law. It is important to remember that this includes individuals in a
personal/private capacity and those individuals acting in a formal capacity such
as executors, as well as groups of individuals such as trustees. It also includes
organisations such as limited companies.
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6.2 Personal representatives and wills

The people who carry out the procedures necessary to distribute the estate
of someone who has died are known as the deceased persons personal
representatives.
The exact procedure to be carried out in order to distribute a deceased
persons estate depends on whether or not there is a valid will. The following
comments apply to the law of England and Wales (Scottish law differs both in
the procedures involved and in the terminology used).
If there is a valid will, the executor(s) apply for a grant of probate. The
executors are appointed (ie named in the will) by the testator (the person
making the will) to ensure that the actions specified in the will are carried out.
The grant of probate gives the executors legal authority to carry out the
testators instructions, as set out in the will. An executor can also be a
beneficiary of the will. The duties of an executor can be time-consuming and
onerous and it is not uncommon for executors to appoint a solicitor to carry
out all or part of their duties.
If there is no will (or the will is invalid), a grant of letters of administration
is issued to an appropriate person, who is known as the administrator. This
will often be the surviving spouse or another close relative.The administrators
responsibility is to deal with the estate as prescribed by the rules of
intestacy (see Section 6.2.1).
A will is a written declaration of an individuals wishes regarding what they
want to happen after they have died. Although primarily concerned with how
the person wishes to dispose of their assets, a will can also deal with other
matters, such as giving instructions about burial.
The terms of a will only take effect on the death of the testator, the person
who made the will. Before then, the testator can revoke (cancel) or modify the
will at any time. Modifications are recorded in a document known as a codicil.
To make a valid will, two formalities must be followed:
t
the will must be in writing;
the will must be properly executed.
The minimum age for making a valid will under English law is 18.
The will should be a clear and unambiguous statement of the deceaseds wishes
in respect of their estate, and must be signed by the testator in the presence
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of two witnesses, who must not be beneficiaries under the will (or the spouses
of beneficiaries).
In the event of marriage or remarriage or entering into a civil partnership, a
will is automatically revoked, unless specifically written in contemplation of the
change of status.
In the UK, approximately seven out of ten people die intestate, meaning that
they die without leaving a valid will. Writing a will is the first step in gaining
control over an estate and is, therefore, a vital part of financial planning.
The cost of writing a will is quite reasonable and should not be viewed as a
barrier to making a will. A financial advisers role should not involve the writing
of a will but it is important that clients understand the benefits of a valid will
and the risks of not having one. If the client has no will, the financial adviser
should recommend that they seek professional advice from a solicitor.
In certain circumstances it may be advantageous, following the death of the
testator, for the beneficiaries under a will to vary the way the estate has been
allocated. This can be achieved by executing a deed of variation. All those
who would be affected by the provisions of the will must be over 18 years of
age and be in agreement on the terms of such a variation. A deed of variation
is often executed for tax purposes: a change in beneficiaries or in the relative
shares received that could reduce the inheritance tax liability, for example. In
order to be effective for tax purposes, the deed of variation must be executed
within two years of the death and HM Revenue & Customs (HMRC) must be
informed within six months of its execution.The variation must not be entered
into for any consideration of money or moneys worth.
6.2.1 Intestacy
A person who has died without having made a valid will is said to have died
intestate. This includes the situation where the deceased has left a will but
where the will turns out to be invalid.
If a will makes valid provision for the distribution of some of the assets of the
estate, but not of others, this is referred to as partial intestacy.
The distribution of the estate of a person who has died intestate is determined
by a complex set of rules known as the rules of intestacy.They are very specific
and there is no flexibility or discretion for their variation by the person dealing
with the estate. The destination of property under the intestacy rules depends
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on the size of the estate and the deceaseds family circumstances. In many cases
especially if the estate is a large one the distribution of the assets may not
be as the deceased would have wished. In particular, it is not necessarily true
as many people believe that a surviving spouse or civil partner will receive
the whole estate.
The main rules are as follows. Please note that for the purpose of these rules,
the word spouse includes civil partner.
t
If the deceased leaves a spouse but no children: the spouse gets

all of the deceaseds personal chattels plus the first 450,000 plus half
the remainder; the balance goes to the deceaseds parents or, if they are
dead, to the deceaseds brothers and sisters.
If there is both spouse and children: the spouse gets the first
250,000; half of the balance goes to the children; the other half of the
balance goes into a trust from which the spouse receives income for life,
and the capital goes to the children when the spouse dies.
If there are children but no spouse: the estate is shared equally

among the children.
If there is neither spouse nor children: the estate goes to the

deceaseds parents or (if they are dead) to the deceaseds brothers and
sisters.
This is just a summary of the main rules and that ultimately, if no blood relative
can be found, the estate will pass to the Crown.
6.3 Trusts and trustees

A trust (also known as a settlement) is a method by which the owner of an
asset (the settlor) can distribute or use that asset for the benefit of another
person or persons (the beneficiaries) without allowing them to exert control
over the asset while it remains in trust. Depending on the nature of the trust,
the beneficiaries may eventually become the absolute owners of the asset.
The settlor is the person who creates the trust and who originally owned the
assets placed in the trust (the trust property). Once it is placed in trust, the
asset is no longer owned by the settlor (unless the settlor is also a trustee
see below).
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The beneficiaries are the people or organisations that will benefit from the
trust property. They may be named specifically or referred to as a group, eg all
my children.
The trustees are the people, appointed by the settlor, who will take legal
ownership of the trust property and will administer the property under the
terms of the trust deed. The trustees, who can include the settlor, are named
in the trust deed. Trustees must be aged 18 or over and of sound mind. If a
trustee dies, the remaining trustees, or their personal representatives, can
appoint a new trustee.
Trustees must:
t
act in accordance with the terms of the trust deed. If the trust deed
gives them discretion to exercise their powers (eg discretion over which
beneficiaries shall receive the trust benefits), the agreement of all of the
trustees is required before a course of action can be taken;
act in the best interests of the beneficiaries, balancing fairly the rights of
different beneficiaries if these should conflict. For example, some trusts
provide income to certain beneficiaries and, later, distribution of capital
to other beneficiaries; the chosen investment must preserve a fair
balance between income levels and capital guarantee/capital growth.
Under the Trustee Act 2000, trustees who exercise investment powers are
required to:
t
be aware of the need for suitability and diversification of assets;
obtain and consider proper advice when making or reviewing

investments;
keep investments under review.
6.4 Companies
Companies are legal entities, quite separate from their shareholders (see
Section 2.3) or their individual employees. Shareholders of a limited liability
company cannot be held personally responsible for the debts of the company,
the limit of their liability being the amount that they have invested in company
shares. This is the most they could lose if the company were to become
insolvent with large debts.
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The nature of the company, and the rules about what it can and cannot do, are
set out in its memorandum and articles of association. In relation to a
companys ability to borrow money, for example, the memorandum normally
includes the power to borrow, but may place limits or restrictions on that
power in terms of amounts or purpose. This will be significant if the company
wishes to take out a mortgage or other form of loan.
The actions of the company are, of course, carried out by people and, when
making a contract with a company or lending money to a company, it is
essential to check that the persons committing the company to a particular
course of action are authorised and empowered to do so.
6.5 Partnerships
A partnership is an arrangement between people who are carrying on a
business together for profit. Unlike a company, a partnership is not a separate
legal entity and the partners jointly own both the assets and the liabilities of
the partnership (see notes on limited liability partnerships in Section 6.5.1).
Partnerships should have a written agreement that sets out in detail the
relationship between the partners, including proportions in which they share
the partnerships profits and what will happen when a partner leaves, retires or
dies (see also Section 5.2.2.2).
6.5.1 Limited liability partnerships

Since 2001, it has been possible to run a business as a limited liability
partnership (LLP). This means that partners have a limited personal liability if
the business should collapse: their liability is limited to the amount that they
have invested in the partnership, together with any personal guarantees they
have given, eg to a bank that has made a loan to the business.
As with companies, LLPs have to be registered with Companies House; they
are clearly more like companies than are standard partnerships but the
taxation of LLPs is not the corporation tax regime that applies to companies.
LLPs are taxed in the same way as other partnerships: each partner is taxed on
a self-employed basis, with their individual share of the profits being treated as
their own personal income and subject to income tax.
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6.6 Law of contract

Most business agreements, particularly in the world of financial services, are
established as legally binding contracts. Some are made orally, some in writing
and some by deed. Not all contracts can be made orally but all contracts
generally are subject to certain basic requirements for them to be binding.
The basic requirements for contracts to be binding on the parties involved are:
t
offer and acceptance: there must be an offer made by one party (the
offeror) and there must be an unqualified acceptance by the other. This
acceptance must be communicated to the other party. In practice there
may be a number of counter-offers before agreement is reached;
consideration: the subject of the contract (often a promise to do

something or supply something) must be matched by a consideration
(which is frequently, but not necessarily, the payment of money). This is
given by one of the parties (the promisee) to the person making the
promise, that is, the other party to the contract (the promisor). A
promise to pay is valid consideration;
capacity to contract: each of the parties to the contract must have

the legal capacity, or power, to enter into the contract. Certain parties
have only limited powers to enter into a contract, for example, minors
and those of unsound mind. For financial institutions such as insurance
companies, capacity to contract depends on being authorised by the
FCA;
the terms of the contract must be certain, complete and free from
doubt;
there must be an intention to create a legal relationship, as distinct

from a merely informal arrangement;
legality of object: contracts cannot be made for illegal or immoral

purposes;
the contract must not have been entered into as a result of

misrepresentation, or under duress or undue influence.
Some contracts have to be recorded in a specific legal form: all agreements for
the sale of land must be made in writing and conveyances of land (the actual
transfer of ownership) must be performed by deed.
Generally, there is no duty of disclosure between parties to a contract; most
contracts are based on the principle of caveat emptor (let the buyer beware).
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However, there are exceptions. For example, insurance contracts have been
based traditionally on the principle of utmost good faith (uberrima fides),
whereby all material facts must be disclosed by both parties. For an insurance
policy, this means that the person applying for the policy must supply all the
facts that a prudent underwriter would need to decide the terms on which the
policy could be issued. Non-disclosure by the customer makes the contract
voidable at the option of the insurance company. In recent years there have
many cases of insurance companies declining seemingly valid claims because
the policyholder failed to disclose information about previous illnesses or
medical consultations, even though the fact would have had no bearing on the
reason for the claim, and the majority of application forms relied on the
applicant to determine, remember and list all such relevant information.
Many of these cases related to critical illness policies, where applicants failed
to disclose a condition for which they had previously visited a doctor. In many
cases the doctor had confirmed that there was not a problem, or had
diagnosed a minor problem that was successfully treated. On later suffering
from a specified critical illness, the policyholders claim was declined due to the
non-disclosure at the application stage. For example, cancer claims have been
rejected because the policyholder failed to declare a doctors consultation
about a skin rash some time before the application was made, which the
doctor diagnosed as a minor irritation and nothing to worry about. In many
cases the Financial Ombudsman found the insurance companys rejection
unreasonable and found in favour of the policyholder. One of the major factors
in many cases was the reliance on the applicant to determine what was
relevant to disclose. Typical questions on the application form would be along
the lines of: Have you ever visited a doctor or suffered from a medical
condition requiring treatment? This required the applicant to remember all
such occasions and decide which, if any, to include. In some cases the insurer
rejected claims on the basis that the policyholder failed to disclose information
that they should have realised was relevant and important, even though no
direct question asked for the information. In recent years the problem has
been exacerbated by many insurers practice of reducing the level of preapplication underwriting and effectively asking medical underwriting questions
when a claim is made, at which point problems may arise.
The situation caused much concern to the regulator and legislators and led to
the Consumer Insurance (Disclosure and Representations) Act 2012, which
came into force on 6 April 2013. In simple terms the Act more clearly defines
the responsibilities of insurance customers, and abolishes the duty of
consumers to volunteer material facts when applying for insurance, instead
requiring them to take reasonable care to answer the insurers questions fully
[1] 228
and accurately. If they do volunteer information, they must take reasonable

care to ensure that the information is not misleading. For example, section 2(2)
of the Act states that it is the duty of the consumer to take reasonable care
not to make a misrepresentation to the insurer. The representations will be
based on responses to specific insurer questions, because there is no duty on
the consumer to volunteer information that is not asked for. Section 2.3 states
that a failure by the consumer to comply with the insurers request to confirm
or amend particulars previously given is capable of being a misrepresentation.
The Act defines, as far as possible, the meaning of reasonable in this context,
which depends on a number of factors including, how clear, and how specific,
the insurers questions were. In the case of misrepresentation, the Act also
indicates what actions the insurer may take:
t
If the consumer has taken reasonable care, and the misrepresentation

was honest and reasonable, the insurer has no right to refuse a later
claim.
In the case of misrepresentation due to carelessness, detailed rules will

allow the insurer to apply a compensatory remedy to the claim, based
on what the insurer would have done had the applicant answered all
questions completely and accurately. In other words whether the
insurer would have refused cover completely (which means the claim
would be rejected), excluded certain illnesses (which means claims for
such an exclusion would not be met), or offered a reduced benefit or an
increased premium. If the claim is rejected then the insurer must refund
the premiums paid.
If careless misrepresentation is identified in situations other than a claim,

the insurer and the policyholder have the right to terminate the
contract with reasonable notice. However, the insurer cannot cancel a
life insurance policy in this situation.
In the case of deliberate or reckless misrepresentation, the insurer may

reject the claim completely as if the contract never existed and is not
required to refund premiums paid unless there is a good reason to do so.
Breach of contract occurs when a party fails to perform their side of the
contract and does not have a legal excuse for doing so; several court remedies
are available in these circumstances. The main remedies are to seek damages,
an order for specific performance or an injunction. Of these, by far the most
frequently sought is damages, whereby the injured party seeks to obtain
financial compensation for their loss. The intention is to put them in the
position they would have been in had the contract not been breached by the
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other party, insofar as it is possible to do so with money. In certain

circumstances, an order for specific performance can be obtained to
compel the other party to complete the contract. Alternatively, an injunction
can be sought this is a court order preventing someone from doing
something.
6.7 Law of agency

An agent is a person who acts on behalf of another, who is called the principal.
The agent can conclude contracts on behalf of the principal. In law, the acts of
the agent are treated as being those of the principal.
In any kind of agentprincipal relationship, it is important to ascertain how
much power and authority has been vested in the agent, just as it is important
that the agent is fully aware of what they can and cannot do. Some agents are
given very wide authority while some are severely restricted in what they can
do.
An agent should only act within the authority given to them by their principal.
This should be strictly observed, because, if an agent exceeds their power, it
could result in their principal being liable on the contract. This happens when,
although the agent acts outside of their actual authority, they act within what
is known as their apparent authority. Apparent authority is where
something either done or said by the principal leads to the impression that
they have authorised the agents actions.
Another result is that the agent may be made liable. This is protective of the
third party who, if they are unable to rely on the agents claim to have authority,
must be able to hold the agent personally responsible. It would otherwise be
unfair to the third party, who would have entered in good faith into the
contract only to find themselves without recourse to either the principal (if
there is no apparent authority) or to the agent.
If the agent does exceed their authority, the principal can, if they choose, agree
after the event to what the agent has done. This is called ratification.
This very brief introduction to agency cannot cover all the detail of agency law
but it will serve to illustrate how important it is for advisers to know,
understand and act within the extent of their authority.
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6.8 Ownership of property

The law of England and Wales defines two distinct types of property; in this
context, the word property is used to refer to all types of assets, rather than its
more narrow reference to land and buildings. The two types are:
t
realty: property is deemed to be real if a court will restore it to a

dispossessed owner and not merely provide compensation for loss. Real
property tends to be distinguished by being immovable, eg land and what
is attached to it, also known as real estate;
personalty: all other property is called personalty.
6.8.1 Joint ownership

There are two types of joint ownership, both of which are described in terms
of tenancy (but the meaning of tenancy here does not relate to the letting of
property). These phrases refer to the joint ownership of any form of asset (or
liability):
t
joint tenants: the whole property is deemed to be owned by each of the

owners, so that if one owner dies, the property automatically transfers
into the ownership of the other. The transfer on death to the surviving
owner is automatic and cannot be overridden by any provision in the
deceased persons will;
tenants in common: each owner has an identifiable share of the

property; if one owner dies, their share of the property passes to
whoever is entitled to inherit it under the terms of the will or under the
rules of intestacy.
The concept of joint tenants or tenants in common can apply equally to debts,
such as mortgages. In the former case, all borrowers are equally liable for the
whole debt, while in the latter each is responsible for a portion of the debt.
Banks, building societies and other commercial lenders always insist that joint
mortgages are written on a joint tenancy basis.
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6.9 Power of attorney

An attorney is a person who is given the legal responsibility to act on behalf
of another person. This may be necessary in the cases, for example, of an
elderly person who is incapable of managing their own finances or of someone
living abroad. The person who makes a power of attorney is called the donor
and the person who acts for them is called the donee or simply the attorney.
A person who does not have the legal capacity to enter into a contract (eg a
minor or a mentally incapacitated person) cannot appoint someone else as
their attorney. In fact, an ordinary power of attorney would automatically cease
if a person were to become mentally incapacitated. The Enduring Powers of
Attorney Act 1985 created a new type of power, called an enduring power
of attorney, which does continue if the donor becomes mentally
incapacitated. Enduring powers of attorney have to be registered with the
Public Guardianship Office if the attorney believes that the donor is becoming
mentally incapacitated. Once the enduring power has been registered, the
attorney can continue to act despite the donors mental capacity. An enduring
power of attorney can be revoked only with the consent of the Court of
Protection.
From October 2007, when the Mental Capacity Act 2005 came into force,
enduring powers of attorney have been replaced by lasting powers of
attorney (LPAs) under which attorneys are able to make decisions not only
about financial matters, but also about personal and health matters (an
enduring power of attorney can only deal with property and finances). An LPA
is established while a person still has a mental capacity, but only comes into
force either when they they have become incapacitated, or provided they have
agreed and it has been registered. Following the implementing of the Mental
Capacity Act, the Public Guardianship Office has been renamed as the Office
of the Public Guardian. Existing enduring powers of attorney can remain in
force, but all new arrangements must be lasting powers of attorney.
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6.10
Insolvency and bankruptcy
Insolvency arises when:

t
a persons liabilities exceed their assets; or
a person cannot meet their financial obligations within a reasonable time

of their falling due.
Bankruptcy takes the position a stage further and arises when a persons state
of being insolvent is formalised under the terms of a county court order. A
person can petition to have themselves declared bankrupt or a creditor may
petition to have someone else declared bankrupt. The bankruptcy level, ie the
amount of money owed for which a person can be made bankrupt, is only 750.
The primary UK legislation on insolvency is the Insolvency Act 1986, but this
has been subject to amendments over the years. In 2000, an EU Regulation on
Insolvency Proceedings was adopted and it came into force in 2002. As a
regulation rather than a directive (see Section 1.3.1) it had direct effect in the
UK. To clarify the position in the UK, a number of statutory instruments were
issued including, for example, the Insolvency (Amendment) Rules 2002.
In 2011, there were around 16,886 company liquidations in England and Wales,
of which around 11,883 were voluntary liquidations. In the same year there
were around 119,850 individual insolvencies, of which around 59,000 resulted
in bankruptcies and the remainder were dealt with through individual
voluntary arrangements (see Section 6.10.1).
As a result of the Enterprise Act 2002, which came fully into force in April
2004, most bankruptcy orders now remain in force for 12 months, during
which time the person is said to be an undischarged bankrupt. During this
time, a bankrupt persons possessions are, in effect, surrendered to an Official
Receiver, who can dispose of them and use the cash to pay off the creditors.
The only exceptions are clothing and household items, and work-related items.
Although bankruptcy cancels most kinds of debt and allows people to make a
fresh financial start, it comes at a price: it normally makes it more difficult to
obtain credit in the future and it can affect employment prospects.
One practical effect of bankruptcy is that a person will be unable to borrow,
other than nominal amounts, during the period that the order is in force. Even
after the end of the period, the person must, by law, disclose the existence of
a previous bankruptcy when applying for a mortgage. This may mean that it will
be more difficult for them to obtain a loan or that they may be charged a
higher rate of interest to cover the greater perceived risk.
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6.10.1
Individual voluntary arrangements
An individual voluntary arrangement (IVA) is an alternative to bankruptcy,

under which the debtor arranges with the creditors to reschedule the
repayment of the debts over a specified period. An IVA can be set up only if
creditors who represent at least 75 per cent of the debt agree to the
arrangement. The scheme must be supervised by an insolvency practitioner.
In recent years, a large market has arisen for firms that assist individuals with
significant personal debts to enter into IVAs. In most cases they are able to
arrange for interest to be frozen, for a reduction in the amount of the debt,
and for legal protection from creditors if the terms of the IVA are met. The
firms are generally able to persuade the bank or other lender to write off part
of the debt in exchange for reasonable guarantee of receiving repayment of the
remainder. In many cases this is better for the bank than simply writing off the
debt or selling it to a debt recovery firm.
An individual with an IVA will find it difficult to obtain credit while the IVA is
in place, and credit-worthiness is likely to be impaired even after the end of the
arrangement.
6.10.2
Company voluntary arrangements
The company equivalent of an IVA is the company voluntary arrangement

(CVA). A CVA is a legal procedure under the terms of the Insolvency Act 1986,
where a company that is in temporary financial difficulties (but which its
directors believe to have a viable long-term future) can make a binding
agreement with its creditors including the tax authorities about how its
debt and liabilities will be dealt with.
In this way, the directors retain control of the company and it can continue to
trade. A CVA can be proposed by the directors of the company, or by a
liquidator if one has been appointed, but not by the creditors. However, many
creditors may feel that it will be to their advantage for the company not to go
into administration. As with IVAs, creditors representing 75 per cent of the
companys debt must agree to the CVA being set up.
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1.
In what sense could a company be described as a legal person?
2.
Harry has died without leaving a will. His estate will be distributed by:
(a) An administrator.
(b) A solicitor.
(c) A probate officer.
3.
Which of the following statements about a will is correct?

(a) An executor cannot be a beneficiary.
(b) A beneficiary cannot be a witness.
(c) A witness cannot be an executor.
4.
Marian was married but had no children although her parents were still
alive. She died without leaving a will. If her estate was 600,000, how much
will her husband inherit?
5.
What is consideration in relation to a contract?
6.
Can a contract be made verbally?
7.
In agency law, what is ratification?
8.
Why do mortgage lenders insist that joint mortgages are always on a joint
tenancy basis?
9.
Whose consent is required before an enduring power of attorney can be

revoked?
(a) The donee.
[1] 235
Unit 1
(b) The donor.

(c) The Court of Protection.
10. What is the normal period for which a bankruptcy order remains in
force?
[1] 236
Answers
1.
A company is a legal person in that it has a separate legal existence and

can, for instance, enter into contracts. The contract is not with the
directors but with the company.
2.
(a) An administrator.
3.
(b) A beneficiary cannot be a witness.
4.
525,000 (ie 450,000 plus half the balance).
5.
It is the payment (or a promise to pay) for the goods or services that are
the basis of the contract.
6.
Yes, many can, eg contracts for the purchase/sale of unit trusts can be
made by telephone, with a recording of the conversation providing proof.
Contracts for the sale of land, however, must be in writing.
7.
The process by which the principal formally agrees to stand by a contract

made by their agent, even though the agent has exceeded the authority
granted by the principal.
8.
If one borrower should default on the contract, the lender will wish to be
able to obtain full repayment from the remaining borrower.
9.
(c) The Court of Protection.
10. 12 months.
[1] 237
Unit 1
[1] 238
Unit 2
UK Financial Services
and Regulation
Unit 2
UK financial services and regulation
All references are to pages prefixed [2]
Section 1 The Financial Conduct Authority

Introduction
1.1
1.1.1
1.2
The Financial Services and Markets Act 2000

Regulatory reform The Financial Services Act 2012
The FCAs objectives, role and activities
1.2.1 Status of provisions in the FCA Handbook

1.2.2 High-level standards
1.2.3 Prudential standards
1.2.4 Business standards
1.2.5 Regulatory processes
1.2.6 Redress/specialist sourcebooks
1.2.7 Principles for firms and approved persons
1.2.8 Treating Customers Fairly
1.2.9 Arrangements, systems and controls for senior managers
1.2.9.1 A clear chain of responsibility
1.2.9.2 Systems and controls
1.2.9.3 Whistle-blowing
1.2.9.4 The role of oversight groups
1.2.9.4.1 Auditors
1.2.9.4.2 Trustees
1.2.9.4.3 Compliance officers
1.2.10 The fit and proper test for approved persons
1.2.11 The prevention of financial crime
1.2.12 The Financial Stability and Market Confidence sourcebook
7
8
9
9
10
10
10
11
11
12
15
15
15
16
16
16
17
17
18
18
19
[2] iii
Unit 2
1.3
The FCAs approach to regulating firms and individuals
19
1.3.1 Regulated activities

1.3.2 Regulated investments
19
20
1.4
21
Capital adequacy and liquidity
1.4.1 Capital adequacy regulations for deposit-takers

1.4.2 Capital adequacy for investment business
1.4.3 Solvency margins for life assurance companies
1.4.4 Liquidity 25
1.4.5 Developments in the regulation of capital and liquidity
1.4.5.1 Basel III
1.4.5.2 How Basel III will be implemented CRD IV
1.4.6 Solvency II
26
27
27
28
29
1.5
31
The FCAs approach to regulation
21
23
24
1.5.1 Prudential supervision

1.5.2 Dual regulation
33
33
1.6
34
1.6.1
1.7
Discipline and enforcement

Enforcement powers
35
FCA Conduct of Business sourcebook
36
1.7.1 Approved persons and controlled functions

1.7.1.1 FCA controlled functions for FCA-authorised firms
1.7.1.1.1 FCA Governing functions*
1.7.1.1.2 FCA Required functions*
1.7.1.1.3 System and controls function*
1.7.1.1.4 Significant management function*
1.7.1.1.5 Customer functions
1.7.1.2 PRA controlled functions for dual-regulated firms
1.7.1.2.1 Governing functions
1.7.1.2.2 Required functions
1.7.1.2.3 System and controls function
1.7.2 Advertising and financial promotion rules
[2] iv
36
36
36
37
37
37
37
38
38
38
38
39
1.7.2.1 Comparisons
1.7.2.2 Past performance
1.7.2.3 Unsolicited promotions
1.7.3 Record keeping
1.7.4 Training and competence
1.7.4.1 Training
1.7.4.1.1 Assessing competence
1.7.4.1.2 Appropriate examinations
1.7.4.1.3 Time limits
1.7.4.1.4 Maintaining competence
1.7.4.1.5 Record-keeping
1.7.4.1.6 Wholesale business
1.7.5 Specific rules for financial advisers
1.7.5.1 Types of client
1.7.5.2 Types of adviser
1.7.5.2.1 Independent advice
1.7.5.2.1.1 Panels
1.7.5.2.1.2 Specialists
1.7.5.2.2 Restricted advice
1.7.5.3 Adviser charges
1.7.5.3.1 Ongoing adviser charges
1.7.5.4 Information about the firm, its services and its charges
1.7.5.5 Client agreement designated investment business
1.7.5.6 Suitability requirements
1.7.5.6.1 Suitability reports
1.7.5.7 Product disclosure
1.7.5.8 Execution only
1.7.5.9 Cooling off and cancellation
1.7.6 Stakeholder-type products
1.7.7 Basic advice
1.7.8 Regulation of mortgage advice
1.7.8.1 Mortgage Market Review
1.7.9 Regulation of general insurance
40
40
40
41
41
42
42
42
43
43
43
44
44
44
45
46
47
47
48
48
49
49
50
51
52
53
54
54
55
57
58
62
65
[2] v
Unit 2
1.7.9.1 ICOBS 1 The scope of the rules

1.7.9.2 ICOBS 2 General rules
1.7.9.3 ICOBS 3 Distance Communications
1.7.9.4 ICOBS 4 Information about the firm, its services
and remuneration
1.7.9.5 ICOBS 5 Identifying client needs and advising
1.7.9.6 ICOBS 6 Product information
1.7.9.7 ICOBS 7 Cancellation
1.7.9.8 ICOBS 8 Claims handling
Section 2
66
66
66
67
68
69
70
70
Money laundering
Introduction
77
2.1
78
2.1.1
Proceeds of Crime Act 2002

Terrorism Act 2000
78
2.2
Definitions
78
2.3
Money laundering offences
80
2.3.1 The Financial Action Task Force

2.3.2 Serious Organised Crime Agency
2.3.3 Failure to disclose
2.3.4 Tipping off
82
82
83
83
2.4
83
2.4.1
Client identification
Financial exclusion
84
2.5
Record-keeping requirements
84
2.6
Reporting procedures
85
2.7
Training requirements
85
2.8
Enforcement
86
2.9
The Bribery Act 2010
86
[2] vi
Section 3
Complaints and compensation
Introduction
93
3.1
94
Firms complaints procedures
3.1.1 Eligibility
3.1.2 Complaints resolved by next business day
3.1.2.1 Non-reportable complaints
3.1.3 Complaint requirements
3.1.4 Complaint procedures
3.1.4.1 Root cause analysis
3.1.4.2 Record keeping
3.1.4.3 Reporting
3.1.4.4 Publication of complaints information
3.1.4.5 Super Complaints
94
94
95
95
95
96
97
97
97
98
3.2
98
The Financial Ombudsman Service
3.2.1 Ombudsman Process

3.2.1.1 Compensation limits
3.2.1.2 Time limits
99
100
100
3.3
100
The Financial Services Compensation Scheme
3.3.1 Customer Eligibility

3.3.2 FSCS sub-schemes
3.3.2.1 Deposits
3.3.2.2 Investments
3.3.2.3 Home Finance
3.3.2.4 Insurance Business
3.3.2.5 Insurance Mediation
3.3.3 Funding
100
101
101
101
102
102
102
102
3.4
103
The Pensions Ombudsman
[2] vii
Unit 2
Section 4
Data protection
Introduction
109
4.1
109
The Data Protection Act 1998
4.1.1 Definitions
4.1.2 Data protection principles
4.1.3 Enforcement
4.1.4 EU Data Protection Directive
Section 5
110
111
112
113
Other laws and regulations relevant to

advising clients
Introduction
119
5.1
119
Consumer Credit legislation
5.1.1 Consumer Credit Act 1974

5.1.3 Other consumer credit regulations
5.1.4 The EC Consumer Credit Directive
119
121
122
123
5.2
125
Unfair contract terms
5.2.1 Supply of Goods and Services Act 1982

5.2.2 The Unfair Terms in Consumer Contracts Regulations 1999
5.2.2.1 Fairness
5.2.2.2 Plain language
5.2.2.3 Good faith
125
125
126
127
127
5.3
128
Rules regarding occupational pension schemes
5.3.1 Pensions Act 2004

5.3.1.1 Pensions Regulator
5.3.1.2 Pension Protection Fund
5.3.2 The Pensions Act 2011
[2] viii
128
128
130
131
5.4
EU directives
132
5.4.1 Banking
5.4.2 Investment
5.4.2.1 Markets in Financial Instruments Directive
5.4.2.1.1 MiFID II
5.4.2.2 Undertakings for Collective Investment in
Transferable Securities
5.4.3 Insurance
5.4.3.1 Life assurance
5.4.3.2 General insurance
5.4.3.3 Insurance intermediaries
133
133
134
135
136
136
136
139
139
5.5
CAT standards
143
5.6
Advertising standards
144
5.7
Banking Regulation
146
5.7.1 The Lending Code

5.7.2 Banking Conduct of Business rules
5.7.3 Payment Services Regulations
5.7.3.1 Electronic Money Regulations 2011
146
149
150
151
5.8
Competition Commission
152
5.9
The Enterprise and Regulatory Reform Bill
153
5.9.1 Competition and Markets Authority

154
5.9.2 Competition objective of the Financial Conduct Authority (FCA) 154
[2] ix
Unit 2
[2] x
Unit 2
After studying this unit, you will be able to demonstrate knowledge of:
t
the main aims and activities of the Financial Conduct Authority

(FCA), and its approach to ethical conduct by firms and individuals;
how other non-tax laws and regulations impact upon firms and the
process of advising clients.
You should also be able to demonstrate an understanding of:

t
the FCAs and the PRAs approach to regulating firms and

individuals;
how the FCAs rules affect the control structures of firms and
their relationship with the FCA;
how the FCAs Conduct of Business rules apply to the process of

advising customers/clients;
how the Anti-Money Laundering rules apply to dealings with

private and intermediate customers;
the main features of the rules for dealing with complaints and
compensation;
how the Data Protection Act 1998 affects the provision of financial
advice and the conduct of firms generally.
[2] 1
[2] 2
Section 1
The Financial Conduct Authority
Introduction
Section 1 covers parts K1, U1, U2 and U3 of the syllabus, including the aims
and activities of the Financial Conduct Authority (FCA); its approach to ethical
conduct and to the regulation of firms and individuals; how its rules affect the
control structures of firms; and how its Conduct of Business rules apply to the
process of advising customers.
In the latter part of the 20th century, there was a strong assertion in Western
societies of the rights of the consumer. Many people believe that, as
commercial organisations have grown through mergers and acquisitions, they
have become more remote from their customers and more concerned with
their own financial results than with customer satisfaction. This is reflected in
the emergence of both government-sponsored organisations, such as the
Office of Fair Trading and the Competition Commission, and openly
consumerist bodies such as Which?
Although some people believe that this trend to consumerism has gone too
far notably in the USA there is a general acceptance that protection for the
consumer is both necessary and appropriate.
One of the primary objectives pursued by most modern governments is an
economic and legal environment in which a balance is established between the
need for businesses to make a profit and the rights of customers to receive a
fair deal. This has led to the regulation, to some degree, of most industries in
the UK but, at the same time, the government recognises the right of
companies to make a profit. Indeed, it recognises that it is essential that
[2] 3
Unit 2
companies be permitted to make a reasonable profit; it would otherwise be

impossible to attract the investment that sustains the industries on which the
UK economy depends.
These twin objectives of a free market for business enterprise and the
protection of the consumer are among the principles on which the European
Union is based. It is not surprising to discover that these objectives have been
promoted largely through European legislation most of which impacts, either
directly or indirectly, on the UK.The force of European law can be seen in most
recent major developments in the regulation of UK financial institutions.
Perhaps because it deals with money a vital common denominator both in
the lives of individuals and in the national economy the financial services
industry has become one of the most regulated business sectors of all.
Following the governments establishment in 1998 of the Financial Services
Authority (FSA) as the single regulator of the financial services industry and
the passing of the Financial Services and Markets Act 2000, there is no sign of
a slowing down in the trend to greater supervision of the industry. The FSA
was abolished on 1 April 2013 and the Financial Conduct Authority (FCA) has
now assumed responsibility for the regulation of the industry. The FCA works
alongside another new regulator, the Prudential Regulation Authority (PRA),
which ensures the financial soundness of individual firms within the financial
services sector. Details of the nature and scope of the FCA as the regulator of
the UK financial services industry are covered later in this section.
Although governments try to foresee problems and to introduce legislation as
a means of prevention rather than cure, it remains true that most regulatory
legislation in the past has been reactive rather than proactive, ie it has been
passed in response to problems, rather than designed to foresee and prevent
them. Legislation has often resulted from:
t
particular scandals or crises: most recently, for example, the events

surrounding the collapse of Barings Bank in the 1990s and the credit
crisis of the late 2000s. These have shown up the need for prudential
control and for protection against mismanagement and fraud;
an increase in consumers financial awareness and a demand

for a more customer-focused business approach: demands for a
one-stop shop approach to financial services sales was instrumental in
the deregulation of banks and building societies over the past 25 years
or so;
[2] 4

t
the need to respond to changes in lifestyle: more relaxed attitudes

to marriage and divorce in recent years have led to a strengthening of
the rights of divorcees to share in former spouses pension benefits; the
introduction of civil partnerships for same-sex couples has extended the
scope of some tax benefits and other financial and social benefits;
developments in business methods: technological advance, in

particular, has fuelled many changes in the last years of the 20th century
and the early part of the 21st; this is particularly true for banks and
building societies, whose customers now carry out many of their
transactions electronically;
innovation in product design: rapid expansion has been seen in the

ranges of certain products, particularly in mortgage business. This has
made it more important than ever that a consumer should be provided
with sufficient clear information about the features and benefits of the
products they are buying;
the increase in the number and complexity of financial

products: this has made it necessary to provide customers with more
information and advice.
Government policy on the regulation of the financial services industry in the

UK has, since the late 1970s, displayed what appears to be something of a
paradox. There have been specific moves in what seem to be two opposite
directions: in some areas, deregulation has been a key development; at the
same time, many aspects of the industry have become more closely regulated.
The aims of developments in all areas have been to benefit the consumer
through greater choice, better service and stronger protection.
Deregulation was experienced mainly in the worlds of banking and building
societies. Traditionally, banks had not been active in the mortgage market
because government credit controls had severely restricted their lending
activities, while building societies operating under legislation that dated, in
some cases, from as far back as the nineteenth century were restricted to
lending on mortgages and to offering simple personal savings products.
However, the world had moved on: the increase in home ownership was
creating a huge demand for mortgages and customers were demanding a much
wider range of products and services from their chosen financial providers.
The deregulation introduced in the 1980s was designed to remove these
barriers, enabling institutions to broaden their services and to move into new
markets. The relevant changes were introduced largely through the Building
[2] 5
Unit 2
Societies Act 1986 and the Banking Act 1987. Increased competition was
beneficial for customers who, in addition to having a much wider choice of
both products and providers, saw a reduction in the cost of many products.
The increased size and complexity of the financial marketplace, however,
quickly revealed the inadequate protection afforded to customers by existing
legislation. Many existing laws, such as the Prevention of Fraud (Investments)
Act 1958, were quite inadequate to deal with what was now a much more
sophisticated and competitive industry.
1.1 The Financial Services and Markets Act 2000

One consequence of the changes described in the Introduction was, in the
1980s and 1990s, a number of new pieces of regulatory legislation, including
the Financial Services Act 1986, which included an element of self-regulation.
By the mid-1990s it was becoming clear that the self-regulatory aspects of the
system had not been wholly successful and that the overall structure of
regulation was too fragmented for the increasingly integrated world of financial
services. For example, many large banking groups now providing a wide range
of financial products and services were regulated by the Bank of England and
also by several other organisations relating to fund management, investments
and marketing. This sometimes led to confusion over where regulatory
responsibility lay. The collapse of Barings Bank in 1992 highlighted many of
these anomalies, with both the Bank of England and the body then regulating
stock market organisations (the Securities and Futures Authority) being
criticised.
The first major step in the development of a new regulatory regime came in
June 1998, when responsibility for the regulation of the UK banking sector was
transferred from the Bank of England to a new single regulator, the Financial
Services Authority (FSA). The next stage was achieved in December 2001,
when the FSA assumed regulatory responsibility for almost all of the financial
services industry. A wide-ranging new Act, the Financial Services and Markets
Act 2000, gave effect to the new regulatory regime.
This Act provided the legislative framework through which the FSA was able
to regulate the professional and business behaviour of all parts of the industry,
from the largest institutions (including around 800 insurance companies and
600 banks) to individual employees and sole traders. The Act covers a wide
range of matters, including solvency, capital adequacy, sales and marketing
[2] 6
practices, prevention of crime, competence of managers and sales staff,

complaints and compensation.
Two sectors of the industry that did not come under the wing of the FSA in
2001, however, were mortgages and general insurance. Regulation of mortgage
sales continued on a voluntary basis, overseen by the Mortgage Code
Compliance Board (MCCB), until their regulation under the FSA in October
2004. Similarly, general insurance continued to be the responsibility of the
General Insurance Standards Council (GISC), until its regulation under the FSA
in January 2005.
1.1.1 Regulatory reform The Financial Services

Act 2012
The Chancellor of the Exchequer announced in June 2010 that the FSA would
cease to exist in its current form, with much of its responsibility being handed
back to the Bank of England. A new body, the Prudential Regulation
Authority (PRA), operating as a subsidiary of the Bank of England, now has
sole responsibility for the day-to-day prudential supervision of banks and other
financial institutions. In addition, the new Financial Policy Committee
(FPC) looks at the economy in more broad terms to identify and address
risks that may threaten the stability of the economy.
These two bodies have not taken over the consumer protection aspects of
the FSAs current role. These have been transferred to another new body, the
Financial Conduct Authority (FCA), which has responsibility for the
conduct of all retail and wholesale financial firms.
These changes were brought about by the Financial Services Act 2012, which
received Royal Assent in December 2012. The Financial Services Act 2012 had
the effect of modifying FSMA 2000 to enable the new regulatory structure
under existing legislation.
[2] 7
Unit 2
1.2 The FCAs objectives, role and activities

The role of the FCA and PRA is to oversee the regulation of the financial
services industry in the UK. It involves the publication of a large handbook
setting out principles, rules and guidance for compliance, split into two, the
FCA Handbook and the PRA Handbook. In this text, we look at the provisions
of the FCA Handbook as it is the FCA that regulates the day to day activities
of firms and advisers.
The FCA is a quasi-government department with statutory powers, given to it
under the Banking Act 1987, the Financial Services and Markets Act 2000, and
the Act that actually created the FCA, the Financial Services Act 2012.
The FCAs key aim is to ensure financial markets work well so consumers get
a fair deal. To do this, the FCA follows three statutory objectives:
t
protect consumers;
enhance the integrity of the UK financial system;
help maintain competitive markets and promote effective competition in

the interests of consumers.
The FCA has product intervention powers, which means that it is able to act
quickly to ban or impose restrictions on financial products if it thinks that they
are not in the best interests of consumers due to complexity or suitability. It
also has the power of disclosure to publish details of warning notices issued in
relation to disciplinary action and to take formal action against misleading
financial promotions and publicise the fact that it has done so.
The PRA and the FCA jointly take over the FSAs former responsibilities in
relation to the Financial Services Compensation Scheme (FSCS), and the FCA
takes over the FSAs former responsibilities in respect of the Financial
Ombudsman Service (FOS) and the Money Advice Service.
[2] 8
1.2.1 Status of provisions in the FCA Handbook

The Handbook consists mainly of rules and guidance, and it is important to
understand the difference between them.
t
Most of the rules in the Handbook create binding obligations on

authorised firms. If a firm contravenes a rule, it may be subject to
enforcement action and, in certain circumstances, to an action for
damages.
The purpose of guidance is to explain the rules and to indicate ways

of complying with them. The guidance is not binding, however, and a firm
cannot be subject to disciplinary action simply because it has ignored the
guidance.
It would be impossible to explore every area in this text that is covered by the
FCA Handbook. It will, however, cover the areas of greatest interest to financial
advisers and mortgage advisers in sufficient detail to enable them to carry out
their activities in an efficient, safe and well-regulated manner.
1.2.2 High-level standards

The High-level standards section of the FCAs Handbook covers:
t
the threshold conditions;
the Statements of Principle and Code of Practice for approved persons;
the fit and proper test for approved persons;
the Principles for Businesses;
senior management arrangements, systems, and controls;
financial stability and market confidence sourcebook;
general provisions;
fees manual;
training and competence.
[2] 9
Unit 2
1.2.3 Prudential standards

Prudential standards are covered in:
t
the Prudential sourcebooks: these are concerned with the financial

soundness of solely FCA-regulated firms (such as valuation of a firms
assets and liabilities, its reserves, and financial reporting). The PRA
established and monitors prudential requirements for dual-regulated
firms see 1.5.1 and 1.5.2
1.2.4 Business standards

Business standards are described in:
t
The Conduct of Business sourcebooks: comprising The Conduct of

Business sourcebook (COBS), the Banking: Conduct of Business
Sourcebook (BCOBS), the Insurance: Conduct of Business Sourcebook
(ICOBs), and the Mortgages and Home Finance: Conduct of Business
Sourcebook (MCOB). These address the standards applied to the
marketing and sale of financial services products.
The Market Conduct sourcebook: this concerns investment markets

and is therefore primarily of interest to investment firms. It covers such
issues as insider dealing.
The Client Assets sourcebook: contains the requirements relating to

holding client assets and client money.
1.2.5 Regulatory processes

This section of the Handbook covers regulatory processes, including rules and
guidance for firms wishing to seek authorisation. It also includes the
Supervision manual, which sets out the way that the FCA will regulate and
monitor the compliance of authorised firms.
[2] 10
1.2.6 Redress/specialist sourcebooks

The two remaining sections of the Handbook cover:
t
redress (including investor complaints and compensation); and
specialist sourcebooks (including arrangements for credit unions,

professional firms such as solicitors and accountants, and the
supervision of Lloyds of London).
1.2.7 Principles for firms and approved persons

The FCAs regulatory regime is based on a set of 11 Principles for Business,
from which all of the more precise rules and regulations follow. They apply to
the behaviour of firms and of the individuals who carry out the firms activities
and refer to:
t
the integrity with which a firm must conduct its business;
the skill, care and diligence with which a firm must conduct its
business;
management and control: a firm must take reasonable care to

organise and control its affairs responsibly and effectively, with adequate
risk management systems;
financial prudence: a firm must maintain adequate financial resources;
the proper standards of market conduct that a firm must observe;
customers interests: a firm must pay due regard to the interests of

its customers, and treat them fairly;
communications with clients: a firm must pay due regard to the

information needs of its clients and communicate information to them
in a way that is clear, fair and not misleading;
the way in which a firm must manage conflicts of interest fairly, both
between itself and its customers and between one customer and
another;
the customer relationship of trust: a firm must take reasonable care

to ensure the suitability of its advice and discretionary decisions for any
customer who is entitled to rely on its judgement;
the adequate protection that a firm must arrange for clients assets
when it is responsible for them;
[2] 11
Unit 2
t
the relations with regulators of a firm, which must deal with its
regulators in an open and co-operative way, and must disclose anything
which the FCA or PRA would reasonably expect it to notice.
There are seven further statements of principle for members of staff who are
approved persons and are carrying out controlled functions (see Section
1.7.1 for a definition of approved persons and controlled functions). These
statements of principle specifically stress that approved persons must, while
carrying out controlled functions:
t
act with integrity;
act with due skill, care and diligence;
observe proper standards of market conduct;
deal with the FCA and PRA and with other regulators in an open and
co-operative way.
As you can see, the first four statements of principle are taken directly from
the Principles for Business (see section 1.2.7).
In addition to these, there are three principles that apply to persons who are
in positions of significant influence in a firm (ie those who carry out senior or
supervisory functions). Such persons must:
t
take reasonable steps to ensure that the business of the firm is

organised so that it can be controlled effectively;
exercise due skill, care and diligence in managing the business of the firm;
take reasonable steps to ensure that the business of the firm complies
with the relevant requirements and standards of the regulatory system.
1.2.8 Treating Customers Fairly

In order to ensure that these principles are translated into a practical, properly
controlled regulatory regime, the FCA has established a very large body of
rules, many of which are found in the sourcebooks listed in Section 1.2.2. A
selection of the important rules affecting financial advisers and mortgage
advisers is also included.
The establishment of rules and regulations can, however, carry with it one very
serious drawback, which is that people and organisations make it their aim to
comply with the letter of the law rather than to operate according to its spirit.
[2] 12
There is also the danger that it is sometimes possible for firms to hide behind
the rules, using loopholes or technicalities to their own advantage.
The former regulator, the FSA, was aware of this potential drawback to their
complex system of rules and has introduced an initiative known as Treating
Customers Fairly (TCF). The aim of the scheme, which is being taken very
seriously by the new regulator, the FCA, is to develop a more ethical frame of
mind within the industry, leading to more ethical behaviour at every stage of
firms and individuals relationships with their customers, who in turn should
become more capable and confident regarding financial products. This is an
important part of the move to a principles-based form of regulation.
What exactly is meant by Treating Customers Fairly? Clearly, it depends on the
definition of fair, but the regulator has declined to supply a definition, claiming
that fairness is a concept that is flexible and dynamic and that it can vary with
particular circumstances. Instead, firms will have to decide for themselves
exactly what TCF means within their own context. What is clear is that the
FCA intends that TCF will apply at every stage throughout the life cycle of
financial products, beginning with product design. All the stages that follow
including sales and marketing, advice and selling, and administration must also
be carried out with TCF in mind, and this carries through into all post-sales
activities such as claims handling and, where necessary, dealing with complaints.
Firms and employees must embed the principle of Treating Customers Fairly
into the firms culture and day-to-day operations.
Despite failing to specify what fairness entails, the FCA has given some
guidance on the types of behaviour it would wish to see and has suggested a
number of areas that a firm should consider. These include:
t
considering specific target markets when developing products;
ensuring that communications are clear and do not mislead;
honouring promises and commitments that it has made;
identifying and eradicating root causes of complaints.
Responsibility for the introduction of TCF lies with a firms senior

management, which is required to ensure that TCF is built consistently into the
operating model and culture of all aspects of the business.
One of the key issues that the FSA intended to address when it launched the
initiative was the extent to which customers are helped to understand the
financial products they are buying. Firms are expected to be clear about the
services they offer and about the true cost to the customer. It is vitally
[2] 13
Unit 2
important for instance, that information is provided to customers in a way that

is clear, fair and not misleading. Firms should always consider the ways in which
the customer will assess their product against others in the market, and ensure
that a fair comparison can be made.This means not only that product literature
should be clear and appropriate to the expected financial sophistication of the
customer, but also that the advice given should be of a sufficiently high quality
to reduce the risk of mis-selling.
In summary, the Treating Customers Fairly initiative is designed to deliver six
improved outcomes for retail financial consumers, which are described as
follows:
t
consumers will be confident that the firms they are dealing with are
committed to fair treatment of customers;
products are designed to meet the needs of properly identified

customer groups;
consumers are provided with clear information at all stages, before,

during and after a sale;
any advice given is suitable for the customer, taking account of their
circumstances;
products perform as customers have been led to expect, and associated

services are of an acceptable standard;
there are no unreasonable barriers to switching product or provider,

making a claim, or complaining.
Since 2009, firms have had to demonstrate to the regulator that they are
consistently treating their customers fairly. This can be done by means of a
review and report showing how they are delivering the six consumer
outcomes described above.
[2] 14
1.2.9 Arrangements, systems and controls for senior

managers
Senior managers must take responsibility for a firms compliance with FCA
regulations and produce relevant management information (MI). This is to
demonstrate that their advisers give quality advice and treat customers fairly,
and there are three particular ways in which they are required to achieve this.
They must ensure:
t
The firm embodies a compliance culture with senior managers using MI

to drive forward the firms fair treatment of customers and the quality
of their advice process.
All staff have clearly defined responsibilities and are monitored

appropriately.
Monitoring and compliance procedures are regularly reviewed and

updated.
The exact nature of the systems and controls used by a firm is left to its
discretion but it must be able to demonstrate that these systems and controls
are appropriate.
1.2.9.1 A clear chain of responsibility
Senior managers will be held personally responsible for the firms activities but
in many large firms it is not realistic for them to do everything themselves.They
must, therefore, identify specific individuals within the firm to take
responsibility for specific areas of activity. These individuals must be made
aware of their areas of responsibility and records must be kept showing a clear
chain of responsibility.
A firm must implement systems and controls that are appropriate to its
business. These systems and controls must be clearly documented and
regularly reviewed. They will relate to a wide range of the firms activities,
including:
t
chains of responsibility, delegation and reporting;
compliance;
assessment and reporting of risk (see also Section 1.5);
[2] 15
Unit 2
t
reporting of other management information;
competence and honesty of staff, particularly those who fill approved

person roles, with senior management applying the competent
employee rule, ie employees must have the necessary skills to carry out
the job for which they are employed;
a strategy for controlling business risks and for recovering from serious
problems such as fire or computer failure;
adequate and readily accessible records (with backup) of systems and

controls must be securely kept;
an audit of the systems and controls must be made independently of the

persons who normally operate them.
1.2.9.3 Whistle-blowing
Firms should have whistle-blowing procedures in place to enable employees to
report serious inappropriate circumstances or behaviour within the firm,
which they believe are not being addressed. Workers who wish to report their
knowledge or suspicions regarding, for example, a failure by the firm to comply
with legislation, have a right to protection under the Public Interest Disclosure
Act 1998. The firms procedures should assist staff and not hinder them in the
whistle-blowing process.
1.2.9.4 The role of oversight groups
It is appropriate that all aspects of the activities of financial services institutions
should be kept under review to ensure that the investments of both
shareholders and customers are being handled safely and honestly and that the
institution is abiding by all the relevant laws and regulations that apply to it, in
the best interests of all its stakeholders. This oversight of an institutions
business can take a number of different forms, of which three are described
briefly here for illustration purposes.
1.2.9.4.1 Auditors
External auditors are concerned particularly with published financial
statements and accounts. They are independent of the institution whose
accounts are being audited; they are normally firms of accountants, and it is
their responsibility to provide reasonable assurance that published financial
reports are free from material mis-statement and are compiled in accordance
with legislation and with appropriate accounting standards. They must conform
[2] 16
to the professional standards of the Auditing Practices Board and the

Accounting Standards Committee.
Internal auditors may be in-house members of staff, or the process may be
out-sourced. Their basic task is to review how an organisation is managing its
risks, to ascertain whether appropriate controls have been established, and to
evaluate and suggest improvements to control and governance processes. They
check that operations are being conducted effectively and economically in line
with the organisations policies, and that records and reports are accurate and
reliable. It is not the responsibility of internal auditors to put controls and
systems in place; that remains the responsibility of management.The role of the
internal audit is to inform management decisions by identifying problems and
recommending possible solutions.
1.2.9.4.2 Trustees
A trustee is a person (or in some cases an organisation) whose responsibility
is to ensure that any property held in trust is dealt with in accordance with the
trust deed for the benefit of the trusts beneficiaries. Examples of trusts can be
found throughout the financial services industry. For instance, unit trusts are
investment schemes set up under a trust deed and the trustees are the legal
owners of the trusts assets on behalf of the unit-holders. Similarly, most
occupational pension schemes are set up under trust: this is important for the
security of members benefits because it enables the pension assets to be kept
separate from the employers business assets. The rights and duties of pension
scheme trustees are set out in the Pensions Acts of 1995 and 2004.
1.2.9.4.3 Compliance officers
Firms that are authorised by the Financial Conduct Authority (FCA) should
appoint a compliance officer to have oversight of the firms compliance
function, in other words to ensure compliance with all relevant legislation and
regulations. Responsibilities of a compliance officer will include:
t
production and publication of a compliance manual;
maintenance of compliance records such as complaints register and

promotions records;
responding to and corresponding with the FCA on compliance matters;
ensuring that staff meet FCA requirements as regards recruitment,

training, supervision and selling practices.
[2] 17
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1.2.10 The fit and proper test for approved persons

The FSA established a set of criteria for determining whether an individual is
a fit and proper person to be approved to undertake a controlled function.
These have been adopted by the FCA, although it is possible they may be
subject to modification in the future. This refers to the need for individuals to
be authorised under the terms of the Financial Services and Markets Act 2000
(FSMA) before they can undertake certain specified jobs or activities within
the financial services industry. This is described in more detail in Section 1.7.1.
The criteria relate to a persons:
t
honesty, integrity and reputation, which can be judged from a

number of factors, including:
criminal record;
disciplinary proceedings;
known contravention of FCA (or other) regulations or involvement
with companies that have contravened regulations;
complaints received, particularly about regulated activities;
insolvency, or management of companies that have become insolvent;
dismissal from a position of trust or disqualification as a director;
competence or capability, in terms of meeting the FCAs training and

competence requirements (see Section 1.7.4);
financial soundness, based on:

current financial position;
previous bankruptcy or an adverse credit rating.
1.2.11
The prevention of financial crime
The FCA is committed to reducing financial crime of all kinds, in particular:

t
market abuse which is separated (under EU definitions) into two

aspects:
insider dealing, where a person who has information not available to
other investors (eg a director with knowledge of a takeover bid)
makes use of that information for personal gain;
[2] 18
market manipulation, where a person knowingly gives out false or

misleading information (for instance about a companys financial
circumstances) in order to influence the price of a share for personal
gain;
t
money laundering, which is dealt with in Section 2.
1.2.12
The Financial Stability and Market

Confidence sourcebook
The Financial Stability and Market Confidence sourcebook (FINMAR) contains

provisions relating to financial stability, market confidence and short selling, and
was introduced in August 2010. The first part covers the FCAs and the PRAs
powers for gathering financial stability information, requiring an individual or
firm to provide information or documentation on request. The second part
sets out rules and guidance in relation to short selling, and the final part deals
with assessing conditions imposed by the Banking Act 2009 in respect of failing
or potentially failing banks.
1.3 The FCAs approach to regulating firms and

individuals
Any financial services organisation carrying on business in the UK must be
authorised by the FCA if it carries out regulated activities in relation to
regulated investments. Regulated activities and regulated investments are
defined in Sections 1.3.1 and 1.3.2. Similarly, individuals who carry out certain
specified controlled functions also have to be authorised, as described in
Section 1.7.1.
1.3.1 Regulated activities

The activities for which firms must be authorised were first listed in the
Financial Services and Markets Act 2000 (Regulated Activities) Order 2001,
often referred to simply as the Regulated Activities Order (RAO). These
activities include:
t
accepting deposits;
effecting and carrying out insurance contracts (including funeral plans);
[2] 19
Unit 2
t
dealing in and arranging deals in investments;
managing investments;
establishing and operating collective investment schemes;
establishing stakeholder pension schemes;
advising on investments;
mortgage lending and administration;
advising on and arranging mortgages;
advising on and arranging general insurance.
Permission is given in the form of a list of regulated activities that the firm is
allowed to carry out; it also shows the regulated investments with which the
firm is allowed to deal. The relevant section of the Financial Services and
Markets Act (FSMA) 2000 under which permission is granted is Part IV as a
result, this form of permission is often referred to as Part IV permission.
1.3.2 Regulated investments

The Regulated Activities Order 2001 (see Section 1.3.1) also defines regulated
investments. They include:
t
deposits;
electronic money (e-money);
insurance contracts, including funeral plans;
shares, company loan stocks and debentures, and warrants;
gilt-edged stocks and local authority stocks;
units in collective investment schemes;
rights under stakeholder pension schemes;
options and futures;
mortgage contracts.
The FCA defines two key categories of regulated investments: securities (such
as shares, debentures and gilts) and contractually based investments (including
life policies, personal pensions, options and futures).
[2] 20
1.4 Capital adequacy and liquidity

A vital element of the work of any industry regulator is to ensure that the
firms operating in the industry are prudently managed. The aim is to protect
the firms themselves, their customers and the economy, by establishing rules
and principles that should ensure the continuation of a safe and efficient
market, able to withstand any foreseeable problems.
One of the key areas of prudential control for financial institutions relates to
their capital adequacy. There are different rules for deposit-takers (eg banks
and building societies), for investment firms and for life assurance companies.
1.4.1 Capital adequacy regulations for deposit-takers

Regulations about capital adequacy broadly state that institutions must have
sufficient capital to make it very unlikely that deposits will be placed at risk.The
meaning of capital in this context is perhaps best illustrated by the fact that
it is also sometimes referred to as own funds, ie the banks own capital base,
obtained from shareholders and related sources, as distinct from funds
deposited by customers.
Although a banks lending is generally financed by deposits, any losses made (for
instance if a loan is written off because repayment cannot be obtained) should
be borne by shareholders rather than by depositors. Minimum requirements
for capital adequacy are set to protect a banks depositors so that they do not
lose money, whereas shareholders are expected to take risks.
The Basel Committee on Banking Supervision, a multinational body acting
under the auspices of the Bank for International Settlements, first established
an international framework for deposit-takers (ie principally banks) in 1988.
This agreement, which among other things set out minimum capital
requirements for banks, was commonly referred to as the Basel Accord. This
has now been superseded by a new expanded Accord, commonly known as
Basel II (see below), which became fully operational in 2007.
These minimum capital requirements are specified in terms of a banks
solvency ratio, which means that the capital required is denominated as a
proportion of the banks assets (ie mainly its loans), with appropriate
allowances made for the perceived risk level of different assets.
The solvency ratio is defined as own funds of the institution as a percentage of
the risk-adjusted value of its assets. This reflects the very reasonable principle
[2] 21
Unit 2
that any losses made on traditional banking business such as debts written
off when borrowers default should be carried by the institutions
shareholders and not by the investors whose deposits provide the funds that
the institution lends out. Current regulations require credit institutions to keep
a solvency ratio of at least 8 per cent. This means that their own funds must
amount to at least 8 per cent of their risk-weighted assets. In practice,
institutions normally keep more than the required 8 per cent.
Own funds means the banks paid-up share capital, plus any retained profits.
The risk weighting of assets is a process that is largely self-explanatory. Since
the solvency ratio is designed, broadly speaking, to calculate how much an
institution must hold to cover the risk of loss on its lending (its credit risk),
each asset is categorised according to risk. The percentage contribution of the
less risky assets to the risk-weighted total is less than that of the more risky
assets, as in the following table of examples.
Figure 1: Example percentage contributions to a banks riskweighted lending total
0%
Cash in hand and equivalent items.
20%
Loans to the European Investment Bank and to multilateral

development banks. Also loans to governments (such as gilt-edged
stocks in the UK) and local authorities.
50%
Loans fully secured by mortgages on residential property.
100%
Unsecured loans.
Under Basel II, the minimum capital requirements for credit risk remain
broadly as described above, although there is more flexibility to reflect the
business of individual institutions.
Capital requirements for operational risk are included for the first time in
Basel II. Operational risk is the risk of loss from failed or inadequate internal
processes, people and systems, or external events: this might include computer
failure, a serious earthquake or staff fraud. The basic approach to calculating
the capital required is to multiply the institutions gross annual income
(averaged over the past three years) by 0.15. Insurance held against the events
happening cannot be offset against this. For large organisations with different
business lines, a more sophisticated system (called the standardised
approach) can be applied, using different multiplying factors for each line.
[2] 22
In addition to the traditional capital requirements approaches, Basel II

introduced a more robust system of supervision.This includes the requirement
for banks to carry out stress tests to ascertain the extent to which they
would have sufficient capital if certain unexpected adverse economic
conditions prevailed. These supervisory processes are backed by a set of
disclosure requirements to ensure that banks publish sufficient information to
enable market participants to assess a banks risk profile and the extent of its
capitalisation.
1.4.2 Capital adequacy for investment business

In the early 1990s it was recognised that investment firms that are not credit
institutions should have the same freedom to provide services across the
frontiers of the EU as is available to banks and other credit institutions. In
order to achieve fair competition on investments, the Investment Services
Directive (ISD) came into effect in 1996 and has now been superseded and
updated by the Markets in Financial Instruments Directive (MiFID).
In conjunction with the ISD, a second directive commonly known as the
Capital Adequacy Directive (CAD) was issued, setting out the
requirements for capital adequacy of investment firms. The CAD established
minimum capital requirements to cover market risks arising from debt, equity
and related derivatives in the trading books of those credit institutions and
investment companies that were subject to the provisions of the ISD. A new
directive, the Capital Requirements Directive (CRD) was issued in
conjunction with MiFID.
The CRD sets minimum capital requirements for investment firms. The actual
level of capital required depends on the category of the firm, as follows.
t
Own account dealers, who deal as principal on their own account, are
required to hold capital of the equivalent of b730,000.
Matched principal brokers, who deal as principals only to fulfil

customers orders, are subject to a smaller figure b125,000.
Broker/managers are firms that deal in investments as agents, or act

as investment managers on behalf of customers. Their capital
requirement is b125,000, but this is reduced to b50,000 if they do not
hold client money or assets.
[2] 23
Unit 2
t
Advisers/arrangers, ie those who give investment advice or arrange

investment deals, are also subject to capital requirement of b125,000,
with a reduction to b50,000 if they do not hold client money or assets.
1.4.3 Solvency margins for life assurance companies

Determining whether a life assurance company is solvent is a more complex
process than determining solvency for most other companies more complex
even than for other financial services companies such as credit institutions.This
is because the liabilities of a life assurance company relate to payments that the
company may or may not have to make at unknown dates in the future, eg as
a result of a death claim on a life assurance policy. Determination of the
current value of these future liabilities, based on estimates of future mortality
rates and future interest rates, is the province of actuaries. Although the
valuation liabilities known in the Life Directive issued by the EU in 2002 as
mathematical provisions must continue to be assessed according to the
professional judgement of the actuarial profession, the directive sets out
principles designed to harmonise the sometimes very technical methods and
calculations used.
The directive requires that a life assurance company must maintain an
adequate solvency margin at all times in respect of its entire business. The
solvency margin is the excess of the companys assets over its mathematical
provisions (the discounted current value of its liabilities).
An adequate solvency margin means a margin that is at least equal to that
prescribed by the directive. The regulations are complex and the detail is
beyond the scope of this text, but the basic rule is that, for policies that carry
an investment risk (such as endowment assurances), the required minimum
solvency margin is 4 per cent of the mathematical provisions in other words,
the value of a life companys assets must be at least 104 per cent of the value
of its liabilities. For policies with no investment risks (such as term assurance),
the percentages are less. This reflects the fact that actuaries can be more
confident about future mortality rates than about future yields on investments.
The competent authorities in individual EU states (eg the FCA and PRA in the
UK) can, in extreme circumstances, relax the rules on a temporary basis if they
feel it is appropriate to do so. In early 2003, in the wake of a deep and
continuing fall in the value of stock market securities, the former regulator, the
FSA, indicated that it would not take action against life assurance companies
that had become, or were in danger of becoming, technically insolvent under
[2] 24
the 4 per cent rule, provided that they could show that they were taking steps
to rectify the situation. This would normally mean taking action to reduce their
prospective liabilities, for instance by reducing the levels of annual bonuses and
terminal bonuses on with-profits policies.
The directive also sets out the components of a companys solvency margin,
including:
t
paid-up share capital;
statutory and free reserves;
profit brought forward after dividends have been paid;
cumulative preference-share capital and subordinated loan capital, but at

only up to 50 per cent of the solvency margin.
1.4.4 Liquidity
Liquidity can be defined as the ease and speed with which an asset can be
converted into cash and thus into real goods and services without
significant loss of capital value. It must not be confused with insolvency, or with
capital adequacy, which are different issues.
The question of liquidity has been at the heart of the credit crunch and the
general economic difficulties affecting many countries in the latter part of the
2000s.The UKs central bank, the Bank of England, has had to operate in its role
as lender of last resort to rescue banks whose liquidity was inadequate.
In relation to banks, the definition of liquidity is a measure of a banks ability to
acquire funds immediately at a reasonable price in order to meet demands for
cash outflows. The regulators define liquidity risk as the risk that a firm,
though solvent, does not have sufficient financial resources available to enable
it to meet its obligations as they fall due.
The situation of Northern Rock in 2007 illustrates the problems that can arise.
t
The bank had a business plan that involved borrowing money short term
on the money markets on a regular basis to fund a proportion of its
(much longer-term) mortgage lending. The success of the plan depended
on the continuing availability of short-term interbank lending, and when
this dried up, the banks liquidity quickly disappeared.
[2] 25
Unit 2
t
At that point, a different aspect of liquidity risk appeared, when a large

number of depositors chose to withdraw their savings (a so-called run
on the bank). Banks do not, of course, retain all the funds deposited with
them in a readily accessible form most of their deposits are lent to
customers who wish to borrow. Only a small proportion is kept in cash
or assets convertible into cash. If a run on the bank occurs, their liquidity
can be quickly used up.
In assessing liquidity risks that they may face, banks need to consider the timing
of both their assets and their liabilities, and endeavour to match them as far
as possible.
t
Asset liquidity: a firms assets can provide liquidity in three main ways:
by being sold for cash, by reaching their maturity date, and by providing
security for borrowing. Asset concentrations, where a large number
of receipts from assets are likely to occur around the same time, should
be avoided.
Liability liquidity: similarly banks try to avoid liability

concentrations, where a single factor or a single decision could result
in a sudden significant claim. A wide spread of maturity dates is one
obvious way to achieve this.
Basel III is introducing a new Liquidity Requirement (LCR) for banks (see
below)
The regulator establishes liquidity risk standards, with the primary objectives
of promoting consumer protection and market confidence.These are, however,
couched in broad terms, as the regulator recognises that the appropriate types
of system and control may vary between companies. The requirements are
documented in SYSC11, part of the PRA Handbook regulations relating to
Senior Management Arrangements, Systems and Controls.
t
Banks and other deposit takers are required to have adequate risk
management systems in place to identify, measure, monitor and control
liquidity risk on an ongoing and forward-looking basis.
They are required to carry out stress testing, in other words to use
computer-based simulations to examine how their liquidity would be
affected by both firm-specific and market-wide crisis scenarios.
t
[2] 26
They must document their policy for managing liquidity.

1.4.5 Developments in the regulation of capital and

liquidity
1.4.5.1 Basel III
As the 2007-2012 global financial crisis unfolded, the international community
moved to protect the global financial system through preventing the failure of
systemically important financial institutions (SIFIs), or, if one does fail, limiting
the adverse effects of its failure.
The Basel Committee on Banking Supervision introduced new regulations
(known as Basel III) that also specifically target SIFIs. Basel III is a
comprehensive set of reform measures, developed by the Basel Committee on
Banking Supervision, to strengthen the regulation, supervision and risk
management of the banking sector. The proposals consist of five general
improvements:
1.
An improvement of the quality, consistency and transparency of the

capital base.
2.
A strengthening of risk coverage in the capital base by raising the capital

requirement, mainly for counterparty risk, which arises from derivatives
trading and repo transactions.
3.
The introduction of a leverage ratio as a supplement to Basel IIs RWA

measure; the purpose is to reduce banks gearing.
4.
An increase in the capital buffer during periods of economic growth; the

purpose is to make credit institutions more resilient during periods of
economic contraction.
5.
The introduction of global minimum liquidity standards for credit

institutions.
These measures aim to:

t
improve the banking sectors ability to absorb shocks arising from

financial and economic stress, whatever the source;
improve risk management and governance;
strengthen banks transparency and disclosures.
[2] 27
Unit 2
The reforms target:

t
bank-level, or microprudential, regulation, which will help raise the

resilience of individual banking institutions to periods of stress;
macroprudential, system wide risks that can build up across the banking
sector as well as the procyclical amplification of these risks over time.
These two approaches to supervision are complementary as greater resilience

at the individual bank level reduces the risk of system-wide shocks. The
package includes a new key capital ratio of 4.5 per cent (more than double the
previous 2 per cent), and a new buffer of a further 2.5 per cent. Banks whose
capital falls below the buffer will face restrictions on paying dividends and
discretionary bonuses.
1.4.5.2 How Basel III will be implemented CRD IV
The Basel Committees standards have no legitimacy in individual nations, so they
must be implemented in national law. In the EU, Basel III will be incorporated in
a major revision of the Capital Requirements Directive (CRD IV).
Objectives for CRD IV:
t
Enhancing the quality of capital:

increasing the quality and quantity of bank capital;
emphasis on core tier one;
allowing deductions directly from core tier one; and
simplifying capital structure (lesser tiers and removing gearing).
Strengthening capital requirements for counterparty credit risk resulting

in higher Pillar I requirements.
Introducing a leverage ratio as a backstop to risk-based capital.
Introducing new capital buffers: capital conservation and countercyclical.
Implementing liquidity regime: Net Stable Funding Ratio and Liquidity

Coverage Ratio.
Introduction of harmonised capital ratios reporting (Common

Reporting or COREP).
Better disclosure (reconciliation of the balance sheet to regulatory

disclosure).
[2] 28
The CRD IV reforms were expected to come into force on 1 January 2013 but
implementation has been delayed as EU governments and lawmakers could not
agree on how the international rules should apply. However, in April 2013, the
European Parliament formally adopted the CRD IV legislative package. There
are two proposals in the EU package: the Capital Requirements Regulation
(CRR), and the Capital Requirements Directive (CRD). The CRR contains the
Pillar 1 and Pillar 3 requirements and the CRD contains the requirements for
Pillar 2, supervisory review and the buffers framework. The CRR will be
directly applicable and therefore will not be transposed via the PRA
Handbook; the CRD will still need to be transposed via a mixture of Treasury
regulations and PRA Handbook.
Single Rule Book the CRD IV package will be a key instrument through which
the Commission intends to introduce substantive parts of the new European
supervisory architecture, including the development of the Single Rule Book
for financial services, which the UK signed up to at the June 2009 European
Council. The objective driving the development of the Single Rule Book is to
replace separately implemented rules within Member States, with a
harmonised approach to implementation across the EU.
Timescales the CRD remains subject to a detailed review of legal drafting and
translation into other official EU languages, and formal adoption by ministers.
If translation can be completed in time for the legislation to be published
before 1 July 2013, implementation of CRD IV will be from 1 January 2014. If
it is published from 1 July 2013, implementation will be from 1 July 2014. On
the basis of the indicated desire of the EU institutions, the PRA is currently
planning on the basis of implementation from 1 January 2014. The capital
requirements will be phased in gradually over several years.
1.4.6 Solvency II
Solvency II is a fundamental review of the capital adequacy regime for the
European insurance industry. It aims to establish a revised set of EU-wide
capital requirements and risk management standards with the aim of increasing
protection for policyholders. The strengthened regime should reduce the
possibility of consumer loss or market disruption in insurance.
Solvency II will be adopted by all 27 European Union (EU) Member States plus
three of the European Economic Area (EEA) countries. As a consistent
European standard, Solvency II should protect policyholders interests more
effectively by making firm failure less likely, and by reducing the probability of
[2] 29
Unit 2
consumer loss or market disruption. It should make it easier for firms to do

business across the EU, as the current patchwork of varying local standards,
established to supplement Solvency I, will be replaced by more consistent
requirements.
Solvency I was a minimum harmonisation directive introduced in the early
1970s. It allowed for differences to emerge in the way that insurance regulation
was applied across Europe, leading to different regimes. It was primarily
focused on the capital adequacy of insurers and did not include requirements
for risk management and governance of firms.
Solvency II aims to achieve consistency across Europe and includes the
following key ideas:
t
market consistent balance sheets;
risk-based capital;
own risk and solvency assessment (ORSA);
senior management accountability;
supervisory assessment.
The new regime will apply to all insurance firms with gross premium income
exceeding b5m or gross technical provisions in excess of b25m. Some
insurance firms will be out of scope depending on the amount of premiums
they write, the value of technical provision, or the type of business written.
The Solvency II Directive will go live for supervisors and the European
Insurance and Occupational Pensions Authority (EIOPA) on 30 June 2013. The
Solvency II requirements will replace the Solvency I requirements on 1 January
2014. It is clear, however, that this Solvency II timetable is not feasible. EU
Member States cannot implement the Solvency II framework by the set dates,
for the simple reason that it is not finalised. Many people expect
implementation to be put back to January 2016.
[2] 30
1.5 The FCAs approach to regulation

When it took over as the single industry regulator in 1998, the Financial
Services Authority (FSA) made it clear that its approach was going to be
radically different from that of earlier regulators. In particular, it stated it would:
t
employ a risk-based approach;
aim to act in a proactive rather than a reactive way.
It recognised that regulation has to be built on realistic aims and has stated that
it would not aim to prevent all failure. The FSA stressed not only the
responsibilities of firms own management in this regard, but also the need for
consumers to take some responsibility for their own decisions. This appeared
to be a tacit admission that there is a danger in the 21st century of
consumerism going too far and eventually acting to the detriment both of
providers and of consumers themselves.
The FSA claimed that its new approach would integrate and simplify the
different approaches employed by its predecessors.
The FSAs successor, the FCA, has confirmed that it will supervise using a riskbased and proportionate approach, recognising diversity among firms and
markets. They have stated that they will act more quickly and decisively and be
more pre-emptive in identifying and addressing problems before they cause
harm. This approach means that they will focus their attention on the bigger
issues, either in individual firms or within and across sectors, and have a more
open, engaged and challenging approach with firms at the senior management
and board level than the FSA did.
The new approach will be underpinned by judgement-based supervision. This
means that they will make supervisory judgements about a firms business
model and forward-looking strategy, and will intervene if they see unacceptable
risks to the fair treatment of customers. Essentially, they will be looking for
firms to base their business model, their culture, and how they run the
business, on a foundation of fair treatment of customers as set out in the
Treating Customers Fairly (TCF) initiative.
The starting point in describing how they will supervise a firm is to say which
one of their four conduct supervision categories a firm falls into: C1, C2, C3
or C4.
At the time of writing (April 2013), the list of firms in each category is still to
be finalised, but essentially the categories are as follows:
[2] 31
Unit 2
C1: banking and insurance groups with a very large number of retail customers
and investment banks with very large assets and trading operations;
C2: firms across all sectors with a substantial number of retail customers and
large wholesale firms;
C3: firms across all sectors with retail customers and a significant wholesale
presence;
C4: smaller firms, including almost all intermediaries.
Firms are categorised according to their potential impact on the FCAs
objectives. The category they place a firm in determines the style of
supervision they carry out.
Their categorisation they will use a combination of current impact measures,
retail customer numbers and some measures of market impact.C1 and C2
firms will be classed as fixed portfolio, which means they will have a
nominated supervisor. The vast majority of firms will be C3 and C4 firms and
classed as flexible portfolio, which means they will be supervised by a team of
sector specialists and not have a nominated supervisor similar to the way the
FSA previously supervised smaller firms.
Overall, the new categorisation means they will have supervisors allocated to
firms with the greatest potential to cause risks to consumers or market
integrity.
The FCAs supervision model is based on 3 pillars:
1.
Firm Systematic Framework (FSF) preventative work through

structured assessment of firms in respect of conduct, asking whether the
interests of customers and market integrity are at the heart of how the
firm is run;
2.
Event-driven work dealing faster and more decisively with problems

that have happened or are emerging, and making sure customers receive
redress. Having fewer firms with a dedicated supervisor means that they
can devote greater resources to firms where there is a heightened risk to
consumers;
3.
Issues and products fast, intensive campaigns on sectors of the market

or products that are putting or are at risk of putting consumers at risk.
[2] 32
1.5.1 Prudential supervision

Although the PRA has prudential responsibility for all deposit-takers, insurers
and significant investment firms, the FCA has prudential responsibility for all
other sectors across the financial services industry.
The FCAs general approach to prudential supervision is based on managing
failure when it happens rather than focusing valuable resources on reducing its
probability. This is because isolated failure of FCA-only regulated firms would
not generally present a risk to the integrity of the whole financial system.There
are exceptions, and where failure of a particular firm is likely to have a wider
impact, the FCA will focus on reducing the impact on customers and the
integrity of the financial system.
1.5.2 Dual regulation

Some firms are dual-regulated; that is regulated and supervised by both the
PRA (for prudential issues such as capital adequacy and liquidity), and the FCA
(for conduct). A Memorandum of Understanding between the PRA and FCA
(only in draft form at the time of writing April 2013) sets out two key
principles for cooperation between the two regulators, which are that:
t
Each regulators supervisory judgments will be based on all relevant

information; and
Supervisory activity will not usually be conducted jointly
The FCA is to work closely with the PRA to exchange information that is
relevant to their own individual objectives, but will act separately when
engaging with firms.
One example where the cooperation between the FCA and the PRA is
particularly important is in the supervision of insurers with with-profits
business because the returns from such investments are not well-defined and
impact on, or depend on, prudential as well as performance criteria. As part of
its continuous assessment of an insurers financial soundness, the PRA will
ensure that any discretionary benefit allocations (such as discretionary
bonuses) are compatible with its continued safety and soundness.The FCA will
monitor whether the proposed allocations are consistent with the insurers
previous communications to policyholders, that conduct in communicating and
administering such payments are in line with their conduct rules, and that the
insurers overriding obligation to TCF is maintained.
[2] 33
Unit 2
1.6 Discipline and enforcement

The FCA will take action, including enforcement action, when it considers that
particular aspects of a firms business model or culture (such as products,
training, recruitment procedures or remuneration policies) are likely to harm
consumers. They intend to place greater emphasis on securing redress for
consumers who have suffered harm.
The former regulator, the FSA, had already begun to take faster action in cases
of suspicious market activity as a result of close cooperation with Enforcement
and Market Monitoring teams. The FCA will continue to work in this way, and
one of its primary objectives in this area is to make sure that its Enforcement
team carries out its investigations based on the latest market intelligence.
The circumstances that may lead to an investigation cover a wide range of
situations including, for example, suspicion of an authorised person is:
t
contravening regulations;
providing false information;
falsifying documents;
acting outside the scope of their Part IV permission;
participating in money laundering;
allowing persons who are not approved to carry out controlled

functions;
falsely claiming to be authorised;
undertaking insider dealing or market manipulation.
The person who is appointed to carry out the investigation on the FCAs
behalf has the power to:
t
demand that the person being investigated or anyone connected with

them:
answer questions,
provide information;
demand that any person (whether or not they are being investigated or
are connected with the person under investigation) provide documents.
In the case of a specific investigation, any person can also be required to
answer questions or provide information.
[2] 34
1.6.1 Enforcement powers

If the FCA is satisfied that it has discovered a contravention of its rules, it has
a number of steps that it can take, depending on its view of the nature and/or
the severity of the contravention. Some of these are described below.
t
Variation of a firms permissions: this may involve removal of one of

the firms permitted regulated activities or a narrowing of the
description of a particular activity.
Withdrawal of approval: the FCA might withdraw or suspend a

persons approval to carry out some or all of the controlled functions
that they currently carry out.
Injunction: if a person has contravened a regulation, the FCA can apply

for an injunction to prevent that person from benefiting from the action,
for instance by selling assets that they have misappropriated.
Restitution: similarly, if a person has benefited from a contravention of

a regulation, the FCA can ask the court for an order requiring that
person to forfeit to the FCA any profit made from the activity.
Redress: if it can be shown that losses have been made by identifiable

customers as a result of the contravention of a rule, the FCA may be
able to obtain a court order requiring such losses to be made good.
There may be other more appropriate ways for that customer to pursue
such claims, however, for instance through the Financial Ombudsman
Service or the Financial Services Compensation Scheme (see Section 3).
Disciplinary action: if an approved person or an authorised firm is

judged to be guilty of misconduct, the FCA has a range of options
regarding the sanctions it might apply. These are:
to issue a warning notice;
to publish a statement of misconduct;
to impose a financial penalty.
The FCA has a new power, which is to announce that it has begun
disciplinary action against a firm, although they will have to consult the
recipient of the warning notice before publishing.
Before taking action against a dual-regulated firm, the FCA will consult with the
PRA. If the decision is relevant to both regulators, they will decide whether it
is best to pursue a joint investigation, or for one of them to act alone, keeping
the other informed of developments and findings.
[2] 35
Unit 2
1.7 FCA Conduct of Business sourcebook

The Conduct of Business sourcebook is part of the FCA Handbook. It draws
on the principles established in the Principles for Business (and elsewhere) and
sets out, in more detail, the rules by which approved persons must operate
when carrying out their controlled functions.
1.7.1 Approved persons and controlled functions

A controlled function is a function relating to the carrying on of an activity by
a firm which is specified by either the FCA (in the table of FCA controlled
functions) or the PRA (in the table of PRA controlled functions). Any person
working in an authorised firm who carries out a controlled function must be
an approved person, i.e. must be approved by either the FCA or the PRA,
depending on the role and whether the firm is Dual Regulated or Solo
Regulated.
1.7.1.1 FCA controlled functions for FCA-authorised firms
For firms that are Solo-Regulated (i.e. authorised and regulated by the FCA
only), these are the FCA controlled functions:
1.7.1.1.1 FCA Governing functions*
Governing functions relate to those of the people who run the business, even
those who do not necessarily do so on a day-to-day basis such as nonexecutive directors and sleeping partners including the:
t
CF1 Director function;
CF2 Non-executive director function;
CF3 Chief executive function;
CF4 Partner function;
CF5 Directors of an unincorporated association;
CF6 Small friendly society function.
[2] 36
1.7.1.1.2 FCA Required functions*

t CF8 Apportionment and oversight function
t
CF10 Compliance oversight function
CF10A CASS operational oversight function
CF11 Money laundering reporting function
CF40 Benchmark submission function (Libor function)
CF50 Benchmark administration function (Libor function)
1.7.1.1.3 System and controls function*

t CF28 System and controls function
1.7.1.1.4 Significant management function*
t CF29 Significant management function
* All of these roles are classified by the FCA as Significant Influence Functions.
The significant influence controlled functions regime was created by the FSMA
2000 to capture those individuals who exercise a significant influence on the
firms affairs.To ensure firms are effectively governed and able to deal with their
customers fairly, only individuals with the appropriate skills, capabilities and
behaviours should be appointed to these positions.
1.7.1.1.5 Customer functions
The customer functions cover client-facing roles such as those of:
t
an investment adviser;
a corporate finance adviser;
a pension transfer (and opt-out) specialist;
an adviser on syndicate participation at Lloyds;
dealing as principal or as agent and arranging deals in investments;
investment management;
Bidding in emissions auctions (acting as the bidders representative).
[2] 37
Unit 2
1.7.1.2 PRA controlled functions for dual-regulated firms

For firms that are dual regulated (i.e. authorised by the PRA and regulated by
the FCA and the PRA), The PRA approves individuals to the following
controlled functions:
1.7.1.2.1 Governing functions
Governing functions relate to those of the people who run the business, even
those who do not necessarily do so on a day-to-day basis such as nonexecutive directors and sleeping partners including the:
t
CF1 Director function;
CF2 Non-executive director function;
CF3 Chief executive function;
CF4 Partner function ;
CF5 Director of a unincorporated association;
CF6 Director of a small friendly society.
1.7.1.2.2 Required functions

The PRA required functions are as follows
t
CF12 Actuarial function (including the duties of the appointed actuary):

one or more directors or senior managers responsible for performing
actuarial duties in respect of long-term insurance and with-profits
business
CF12A With-profits actuary function
CF12B Lloyds Actuary function
1.7.1.2.3 System and controls function

t CF28 System and controls function (relates to finance, risk assessment
and internal audit)
The PRA and the FCA have taken steps to minimise the need for an individual
to apply to both the PRA and the FCA because they will be carrying out a
combination of PRA and FCA controlled Functions.
[2] 38
Where an individual is applying to perform certain PRA governing functions

(CF1, CF3, CF4, CF5, CF6 or CF28) and they also intend to carry out the FCAs
CF8 function, they will be required to apply to the PRA only. There will be no
need for a separate application to the FCA. Instead, the PRA approval will
effectively cover the FCAs CF8 function as well. However, the person will be
required to notify the FCA when they begin or cease to perform a role which
would have required approval for CF8 were it not for the arrangement
described above.
On approval, the individuals PRA governing function will include the FCA role;
only the PRA designated Controlled Function will be shown on the Register.
1.7.2 Advertising and financial promotion rules

A financial promotion is defined as an invitation or inducement to engage in
investment activity. This includes:
t
advertisements in all forms of media;
telephone calls;
marketing during personal visits to clients;
presentations to groups.
Financial promotions can be communicated only if they have been prepared,

or approved, by an authorised person.
There is a distinction between:
t
real-time financial promotions (non-written financial promotions),

such as personal visits and telephone conversations; and
non-real-time financial promotions (written financial

promotions), such as newspaper advertisements and those on internet
sites.
The overall principle is that financial promotions to retail clients and

professional clients (see Section 1.7.5.1.1) must be fair, clear and not
misleading. In the case of retail clients, this means specifically that information
supplied must:
t
be accurate, including the requirement not to emphasise potential

benefits without giving a fair and prominent indication of the risks;
[2] 39
Unit 2
t
be understandable by an average member of the group it is aimed at;
not disguise or obscure important terms or warnings;
direct offer advertisements must contain the name of the conduct

regulator, the Financial Conduct Authority (FCA).
1.7.2.1 Comparisons
Comparisons with other products must be meaningful, and presented in a fair
and balanced way. Markets in Financial Instruments Directive (MiFID) firms are
subject to additional requirements to detail the source of information and the
assumptions made in the comparison.
1.7.2.2 Past performance
Past performance information must not be the most prominent part of a
promotion. It must be made clear that it refers to the past, and it must contain
a warning that past performance is not necessarily a reliable indicator of future
results. Past performance data must be based on at least five years (or the
period since the investment commenced, if less, but not less than one year).
1.7.2.3 Unsolicited promotions
There are particular rules about unsolicited non-written promotions (cold
calls), as follows.
t
They are permitted only in relation to certain investments, including

packaged products, such as life assurance policies and unit trusts. They
are not permitted in relation to higher volatility funds (which use
gearing) or life policies with links to such funds, due to the increased
investment risk involved. Cold calls are not permitted in relation to
mortgage contracts.
Unsolicited telephone calls or visits must only be made at an

appropriate time of the day. Within the industry, this is generally taken
to mean between 9.00am and 9.00pm Monday to Saturday. Outside of
these times is regarded as unsocial hours.
The caller must check that the recipient is happy to proceed with the call.
The caller must also give a contact point to any client with whom they
arrange an appointment.
[2] 40
1.7.3 Record keeping

The maintenance of clear and readily accessible records is vital at all stages of
the relationship between financial services professionals, their clients and the
FCA, from details of advertisements to information collected in factfinds, to
the reasons for advice given and beyond. Record-keeping requirements for the
different stages can be found at appropriate points within the Conduct of
Business sourcebook, with details of what must be kept and the minimum period
for which it must be retained.
There are many business reasons for maintaining good records. From a
regulatory point of view, the most important reason is to be able to
demonstrate compliance with the regulations. Records can be kept in any
appropriate format, which includes computer storage, although the rules say
that records stored on computer must be capable of being reproduced on
paper in English.
Firms are expected to take reasonable steps to protect their records from
destruction, unauthorised access and alteration.
1.7.4 Training and competence

The FCAs philosophy of regulation is proactive rather than reactive and there
is little doubt that one of the major steps towards the achievement of this
objective lies in achieving high levels of knowledge and ability among financial
services staff. This is reflected in the importance that the FCA places on
training and competence.
The FCA has published a Training and Competence sourcebook that requires
firms to make certain commitments regarding the competence of all persons
who are employed in controlled functions (see Section 1.7.1). It is particularly
prescriptive in relation to three types of employees, for whom it sets out
detailed training and competence rules:
t
financial advisers and those who deal in, or manage, investments;
supervisors of those advisers, dealers or fund managers;
supervisors who oversee certain back-office administrative functions,

particularly within a product provider (eg supervisors of the
underwriting or claims functions in a life assurance company).
[2] 41
Unit 2
Following rule changes at the start of 2011, the Training and Competence
sourcebook was moved into the High Level Standards part of the Handbook
to reflect its increased importance.
These training and competence rules cover the following areas.
1.7.4.1 Training
Firms must, at appropriate intervals, determine each employees training needs
and must organise training that is both appropriate and timely. The success of
the training in achieving its objectives must be evaluated.
1.7.4.1.1 Assessing competence
Employees must not be allowed to engage in carrying out any of the activities
covered by these rules until the employer is satisfied that the employee has:
t
achieved an adequate level of knowledge and skill to operate when

supervised; and
passed the relevant regulatory module of an appropriate examination.
Individuals must work under close supervision until they have been assessed
as competent. Individuals must not be assessed as competent until they have:
t
passed all modules of an appropriate examination; and
demonstrated a consistent ability to act competently under minimum

supervision.
Supervisors should have coaching and assessment skills as well as technical

knowledge.
1.7.4.1.2 Appropriate examinations
Approved persons who carry out certain controlled functions are required to
achieve a pass in an appropriate examination as demonstration of their
competence. Lists of appropriate examinations for different functions are held
by the FCA. The FCA sets the standards for appropriate examinations:
awarding bodies submit proposals for particular examinations; when these are
accredited, they are added to the lists.
[2] 42
The ifs School of Finances Diploma for Financial Advisers (DipFA) and the
Certificate in Mortgage Advice and Practice (CeMAP) are examples of
appropriate examinations for financial advisers and for mortgage advisers,
respectively.
1.7.4.1.3 Time limits
If an employee carries on a regulated activity, the employer must ensure that
that employee attains an appropriate qualification within 30 months of starting
to carry on that activity.
1.7.4.1.4 Maintaining competence
As well as ensuring that employees become competent, firms must have
definite arrangements in place for ensuring that they maintain that
competence. A review must take place on a regular and frequent basis to assess
the employees competence and take appropriate action to ensure that they
remain competent for their role, taking account of such matters as:
t
Technical knowledge and its application
Skills and expertise
Changes in the market and to products, legislation and regulation
A retail investment adviser who has been assessed as competent must

complete a minimum of 35 hours of appropriate continuing professional
development (CPD) in each 12 months period. 21 hours of that CPD must be
structured CPD. Examples of structured CPD include attending courses,
seminars, lectures, conferences, workshops or e-learning activities which entail
a contribution of 30 minutes or more. Unstructured CPD includes conducting
research as part of the advisers role, reading industry or other relevant
material and participating in coaching or mentoring sessions.
1.7.4.1.5 Record-keeping
Firms must maintain records showing how and when employees competence
has been and is being assessed. All records relating to the training and
competence of individual employees must be retained for at least three years
after they leave the firm. For pensions transfer specialists, records must be kept
indefinitely.
[2] 43
Unit 2
Typical records might include some, or all, of the following:

t
details of prior competence;
initial assessments;
training courses, etc, attended;
assessment by written examination or by observation;
success in appropriate examinations;
summary of meetings/discussions with supervisor.
1.7.4.1.6 Wholesale business

The T&C rules do not apply to firms transacting wholesale business with nonretail clients.
1.7.5 Specific rules for financial advisers

This section deals with a number of aspects of the relationship between a
financial adviser and their clients.
1.7.5.1 Types of client
There are three defined categories of client, which can be broadly described as
follows.
t
Eligible counterparty: this category provides the lowest level of

investor protection. It includes large financial institutions such as banks,
insurance companies, investment firms, collective investment funds, and
governments, where the counterparty requires a limited service, such as
straightforward execution of transactions.
Professional client: this category includes all the bodies that would
otherwise be eligible counterparties, except for the fact that they
require a higher level of service than would apply to eligible
counterparty business, eg they require advice, in addition to execution
of transactions. This category also includes other types of large clients,
particularly other institutional investors whose main activity is to invest
in financial instruments. When dealing with professional clients, advisers
can assume an adequate level of experience and knowledge and an
ability to accept financial risks.
[2] 44

t
Retail client: this category provides the highest level of investor

protection and comprises customers who do not fall into either of the
previous two categories especially, customers who might be described
as the person in the street and who cannot be expected to have
anything more than a simple general understanding of financial services.
It is expected that most customers will fall into this category.
1.7.5.2 Types of adviser

Prior to 1 January 2013, advisers fell into one of three categories:
t
Whole-of-market advisers, who could offer any generally available

product in the market (although, in practice, because of the huge size of
the marketplace, whole-of-market advisers were allowed to select from
a smaller panel of product providers);
Advisers who offered products from a limited range of specified

providers. This system was commonly known as multi-tie and allowed
advisers to use, for instance, one provider for protection policies,
another for pensions and another for mortgages;
Advisers who were tied to only one provider, or a linked group of

providers, known as a marketing group.
Following a comprehensive review of the market, known as the Retail

Distribution Review (RDR), carried out by the former regulator, the FSA,
advisers now fall into one of two new categories.
From 1 January 2013, the two types of adviser are:
t
Independent advisers advisers or firms of advisers who can provide

recommendations that are unrestricted and unbiased.
Restricted advisers any firm or adviser that does not meet the
requirements to be independent will, by default, be providing advice that
is restricted. This is designed to reflect the idea of genuinely
independent advice being free from any restrictions that could impact
on the ability to recommend whatever is best for the customer. The
restrictions may be in respect of product providers or products.
[2] 45
Unit 2
1.7.5.2.1 Independent advice

The FCA Handbook Glossary sets out a new definition for independent
advice: Independent advice is: A personal recommendation to a retail client in
relation to a retail investment product where the personal recommendation
provided meets the requirements of the rule on independent advice.
The rule on independent advice is that To be able to provide independent
advice, firms would need to make recommendations based on a
comprehensive and fair analysis of the relevant market, and to provide
unbiased, unrestricted advice.
t
A personal recommendation is advice on investments or on a home

finance transaction, and is presented as suitable for the person for whom
it is made, based on the consideration of the circumstances of that person.
A retail client is a client that is not a professional client or an eligible

counterparty.
The term retail investment product includes not just packaged products,
but also structured investment products, investments trusts, unregulated
collective investments schemes and all other investments that offer
exposure to underlying assets but in a packaged form which modifies that
exposure when compared with a direct holding of that financial asset.
Comprehensive means that while advisers are not expected to be

expert in every investment product, they should be aware of every type
of retail investment product that is plausible for each client.
It is the firm who actually provides the advice to the client which could be
independent or restricted, or both, and a key question to ask when
determining status is whether a firm cannot or will not ever recommend a
product type or a product provider, even if that product or that product
provider would be suitable for a client. However, the nature of the advice is
also assessed at personal recommendation level.
The independent regime has been widened to include advising on exchange
traded funds, structured products, at-risk products and unregulated collective
investment schemes, etc., thus extending the product range that independent
advisers are required to consider beyond that of the current packaged
product regime. What has also changed is that any firm advising retail clients
on any of these products will be drawn into the regulatory regime of the
financial adviser and, as such, be subject to the requirements for independence
and adviser charging (see Section 1.7.5.3). This is of particular importance to
the stockbroking and wealth management community.
[2] 46
For example, a firm that only advises on direct shareholdings currently falls
outside the new regime. However, should it wish to include investment trusts
in its client recommendations, it must take account of all of the implications of
the Retail Distribution Review, including deciding whether to offer
independent or restricted advice, because these products fall within the
definition of retail investment product.
1.7.5.2.1.1
Panels
The new rules do not prohibit, or even restrict, the use of panels or best advice
lists by firms wishing to hold themselves out as independent, but any panel or
best advice list should be reviewed regularly and updated as necessary. A firm
would need to ensure that any panel is sufficiently broad in its composition to
enable the firm to make personal recommendations based on a comprehensive
and fair analysis of the relevant market. The use of a panel must not materially
disadvantage any client.
The firm must recognise that there may be clients for whom the panel doesnt
work. It should therefore be possible for advice off-panel to be available
where a different product or product provider would provide a more suitable
outcome for that client.
1.7.5.2.1.2
Specialists
The rules relating to independent advice are at the firm and personal
recommendation level. Every adviser working in a firm describing its advice as
independent needs to ensure that each personal recommendation meets the
definition of independence. This does not, however, prohibit firms having
advisers specialising in certain areas. The key point to note is that specialists
claiming to offer independent advice must meet the independence rule in
every personal recommendation they provide. If any specialists within a firm
do not meet this requirement, the firm should not hold itself out as
independent.
For example, a firm providing independent advice has three advisers, each with
their own specialist area. The IHT specialist has a client for whom a personal
pension might be appropriate. He consults the pension expert to seek his
advice and guidance. The personal recommendation provided to the client by
the IHT expert would meet the independence rule, provided that the
recommendations of the pension expert would also meet the independence
[2] 47
Unit 2
rule, i.e. it is unbiased, unrestricted and based on a comprehensive and fair

analysis of the market.
1.7.5.2.2 Restricted advice
Restricted advice is either:
t
A personal recommendation to a retail client in relation to a retail

investment product which is not independent advice; or
Basic advice, providing advice on stakeholder products using a process

that involves putting pre-scripted questions to a retail client (See Section
1.7.7).
1.7.5.3 Adviser charges

From 1 January 2013, a firm advising on investment business must only be
remunerated for their services by adviser charges; they are no longer allowed
to receive commission from the product providers for the products they
recommend. Furthermore, they must not accept any other commissions or
benefit of any kind from any other party, even if it intends to refund the
payment or pass some or all of the benefits to the client.
They may, however, accept commission for recommendations made before 31
December 2012, which includes renewal commissions for product sold in the
past. If the adviser makes any recommendations after 1 January 2013 that affect
products sold before 31 December 2012, such as a recommendation to pay an
additional lump sum into an investment purchased prior to 31 December
2012, the adviser can continue to receive any trail commission that is due on
the original investment, but advice leading to the top-up must be paid for via
adviser charging.
The firm must determine and use an appropriate charging structure for
calculating its adviser charge for each retail client. This can be a standard
charging structure that applies to all clients, based on an hourly rate, or based
on a percentage of the amount being invested, but the firm must pay due
regard to the clients best interests. The charging structure must be clear, fair
and not misleading and not conceal in any way the amount or purpose of any
of its adviser charges from client. Examples of this may include making
arrangement for amounts in excess of its adviser charge to be deducted from
the clients investment, even if it is with the intention of making a cash refund
of some or all of it to the client at a later date.
[2] 48
The firm must ensure that the charging structure it discloses to its client at the
outset reflects as closely as possible the total charges that are to be paid. If the
firms charging structure is based on hourly rates, it must state whether the
rates are indicative or actual and provide an approximate indication of the
number of hours that the provision of each service is likely to require.
The firm may include the information about total adviser charges in a suitability
report.
1.7.5.3.1 Ongoing adviser charges
A firm cannot use an adviser charging structure that entails payments by the
client over a period of time unless the service being provided is ongoing and
this has been disclosed to the client at the outset. The client must be provided
with a right to cancel the service, without penalty and without having to give
a reason.
1.7.5.4 Information about the firm, its services and its charges
Before any business is discussed, the adviser must disclose to the client certain
information about themselves and the services they provide, including the
costs of those services. The information which must be provided includes:
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The name and address of the firm and contact details necessary to
enable a client to communicate effectively with the firm;
The methods of communication used between the firm and the client;
A statement of the fact that the firm is authorised and the name of the
regulator that has authorised it (FCA if in the UK, or the name of the
competent authority that has authorised the firm if the it is not based in
the UK i.e. MiFID business);
Whether the advice being provided is independent or restricted, and if

restricted, the nature of the restriction. If a firm offers both, it must
clearly explain the different nature of the independent advice and
restricted advice services;
If the firm manages investments on behalf of a client, the method and

frequency of investment evaluation, details of any delegation of the
discretionary management of all or part of the clients portfolio, and the
types of designated investments that may be included in the clients
portfolio;
[2] 49
Unit 2
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If the firm holds designated investments or client money for a retail

client, that that money may be held by a third party on behalf of the firm,
responsibility of the firm for any acts or omissions of that third party,
and the consequences of the insolvency of that third party;
Its charging structure/method, which may be in the form of a list of the

advisory services it offers with the associated indicative charges which
will be used for calculating the charge for each service;
The total adviser charge payable to it by a client in cash terms (or

equivalent). If payments are to be made over a period of time, the firm
must include the amount and frequency of each payment due, and the
implications for the client if a retail investment product is cancelled
before the adviser charge is paid;
The firm must make available to a client who has used or intends to use
their services details of the Financial Services Compensation Scheme
(FSCS) and the Financial Ombudsman Service.
To provide a format for supplying the required information, the former

regulator, the FSA, introduced a document, known as the services and costs
disclosure document (SCDD). This document, and the combined initial
disclosure document (CIDD), which is used if the adviser is advising on more
than one product, may still be used. However, firms are not obliged to use the
SCDD; they can if they wish develop their own disclosure material provided
that it satisfies the FCAs disclosure requirements.
Clients must be notified in good time of any material change to the services
the firm is providing to that client. For existing clients, the firm need not treat
each of several transactions as separate, but does need to ensure that the
client has received all relevant information to a subsequent transaction where
such as product charges that differ from those disclosed for a previous
transaction.
1.7.5.5 Client agreement designated investment business
If a firm carries on designated investment business, other than advising on
packaged investment products, the firm must enter into a written basic
agreement with the client setting out the essential rights and obligations of the
firm and the client.
Designated investment business is dealing in investment assets directly on
behalf of a client, as opposed to selling packaged investment products, and
[2] 50
often involves making investment decisions on behalf of the client, exercising

discretion as to investment choice and switching from one to another without
having to gain the clients individual agreement for every separate transaction.
The type of products involved may include equities, options and futures
contracts. A client agreement is not usually required for packaged investments,
such as life assurance policies, personal pensions, although these may well be
utilised as part of the whole arrangement alongside the higher risk
instruments. In addition to providing the client with information about the firm
and its services (as listed above), the client must be given, in the form of a client
agreement, the terms upon which the adviser is to operate in respect of the
clients investments. This will include investment range and limits.
1.7.5.6 Suitability requirements
An adviser must not give advice to a client unless they have fully ascertained
the clients personal and financial circumstances relevant to the services that
the adviser has agreed to provide.
This process is carried out by the completion of a confidential client
information questionnaire, commonly known as a factfind. There is no
prescribed format for this document. The information gathered normally
includes the following details about the client, spouse or partner, children and
other dependants:
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personal information, ie name, address, date of birth, marital or

relationship status, state of health;
employment details, ie occupation, employer details, income and

benefits, pension arrangements;
assets, ie property, personal belongings, savings and investments, policies;
liabilities, ie mortgage, other loans, credit cards;
expenditure, ie household expenses, loan repayments, regular savings,

holidays, luxuries;
attitudes and objectives, including attitude to investment risk and

capacity for loss;
knowledge and experience of investment relevant to the required

product or service.
[2] 51
Unit 2
The suitability rules specifically require advisers to take all reasonable steps to
ensure that the client understands the nature of any risks implicit in the
product proposed. Examples are whether or not the customers capital will be
returned in full or whether or not the level of life cover is sustainable for the
duration of the term without an increase in premiums. The extent of these
requirements will depend on the clients experience and knowledge of the type
of product under consideration.
Advisers must also determine the customers risk profile: in other words, how
much risk, if any, is the customer willing to take with their capital?
The information obtained through the factfind must be retained for a specified
period of time, depending on the nature of the product recommended. These
periods are:
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indefinitely for pension transfers/opt-outs and free-standing additional

voluntary contributions (AVCs);
five years for life policies, pension contracts and MiFID business;
three years for all other products.
In practice, advisers will wish to retain the information in all cases for as long
as they believe they may be required to justify the advice and
recommendations given.
1.7.5.6.1 Suitability reports
Advisers must recommend the product or service that is most suitable for the
client, based on the information supplied by the client and on anything else
about the client of which the adviser should reasonably be aware. The
recommendation must be solely in the best interests of the client and no
account should ever be taken of the remuneration that may be payable to the
adviser.
A suitability report explains why the particular product recommended is
suitable for the client based on their particular personal and financial
circumstances, their needs and priorities as identified through the fact-finding
process and their attitude to risk (both in general terms and in relation to the
specific recommendations made). The report should also identify any potential
disadvantages of the transaction for the client, such as any lock-in period. It
should be clear and concise and written in plain English.
[2] 52
Suitability reports are required for:

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life policies;
pension policies;
unit trusts and OEICs, investment trusts (where acquired through an

investment trust savings scheme);
pension transfers and opt-outs.
They are not required for mortgage advice.

For most investment products, a suitability report should be provided as soon
as possible after the transaction has been effected, and no later than the date
when the cancellation notice is issued to the client (see Section 1.7.5.9).
For a life policy the report must be sent before the contract is concluded
unless the necessary information is provided orally or immediate cover is
necessary. For a pension plan, where a cooling off notice is required, the report
must be sent no later than the fourteenth day after the contract is concluded.
For investment business the report must be issued or as soon as possible after
the transaction is effected or executed.
1.7.5.7 Product disclosure
Advisers who advise on or sell packaged products (eg life policies, pension
policies, unit trusts and investment trust saving schemes) must provide clients
with written details of the key features of a product before the sale is
concluded. Although it is the advisers responsibility to provide the documents,
the product providers usually prepare the papers. It is a requirement that key
features documents should be of the same quality as the materials used for
marketing purposes.
The rules on what must be included are very detailed, but, as a broad guide, a
key features document must provide enough information about the nature and
complexity of the product, how it works, any limitations or minimum standards
that must apply, and the material benefits and risks of buying or investing for
the client to make an informed decision about whether to proceed. It must
explain:
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The arrangements for handling complaints about the product
That compensation is available from the Financial Services

Compensation Scheme (FSCS)
[2] 53
Unit 2
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That a right to cancel or withdraw exists, or does not exist, and if it

does, its duration, the conditions for exercising it, any amount the client
may have to pay, and where the notice must be sent
A brief description of the products aims
What the client is investing in and any consequences of failing to

maintain the commitment or investment
The material risks involved
1.7.5.8 Execution only

Some transactions with customers may be carried out on an execution-only
basis, which means that, rather than wanting an adviser to make specific
recommendations, the customer instructs the adviser to effect a specific
transaction on their behalf, detailing in full the nature of the product required.
For an execution-only transaction, the advisers duty of care to fully explain the
nature of the transaction and risks involved does not apply. The customer is
acting entirely on their own responsibility.
Advisers who deal with this type of client should obtain the clients signature
confirming that the transaction is execution-only. Similarly, where a nonexecution-only client wishes to effect a transaction that contravenes any advice
given, the adviser should require the client to sign to that effect.
It is expected that only a very small proportion of any advisers cases would be
on an execution-only basis.
1.7.5.9 Cooling off and cancellation
When a client buys a regulated packaged or insurance product, they have the
right to change their mind and withdraw from the contract within a specified
period. The provider is required to send a statutory cancellation notice, known
as the cooling-notice, which explains the process.
The time period are either 14 or 30 days depending upon the product type:
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For life and pensions policies and contracts of insurance which are, or
have elements of, a pure protection contract or payment protection, the
period is 30 days;
For investments or deposits and other insurances, the period is 14 days.
[2] 54
The notice must be sent by post direct from the product provider to the client
and the notice runs from the date when the contract begins or from the date
on which the client receives contractual terms if this is later.
The client can withdraw from the contract without penalty at any time during
the cooling off period without any commitment or loss, by signing and
returning the cancellation notice to the product provider.
Generally, the client will receive a full refund of any premiums paid if they
cancel the contract during this period. The exception to his is where the client
invests in a lump sum unit-linked investment (such as a unit trust, OEIC or
investment bond) where money has been invested and the value of the
investment has fallen. Under these circumstances, the client is entitled to a
refund of the reduced investment; no charges can be taken but an adjustment
can be made to reflect the fall in value of the investment. This is to prevent
people cancelling due to falls in the market. This risk should be explained to
the client before the contract is entered into.
At the time the product purchase is made, the adviser must also explain
whether the client is liable to pay any outstanding adviser charges if they
decide not to proceed with the product and send back the signed cancellation
notice.
1.7.6 Stakeholder-type products

In 2001, the government asked Ron Sandler to:
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identify the competitive forces driving the retail financial services

industry; and
suggest policy responses to ensure that customers are well served.
The Sandler report suggested that there were three main reasons why the
industry seemed to be failing to serve large portions of the population who
have urgent and genuine financial needs. The government is particularly
concerned about the so-called savings gap, ie the failure of many people to
provide adequate funds for their retirement. The report cited:
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the complexity and opacity of many financial services products, alleging

that people do not understand how the products work, what the
inherent costs are and what the risks are;
[2] 55
Unit 2
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the failure of the industry to attract and engage with the majority of
lower- and middle-income consumers;
the inability of consumers to drive the market.
Sandler suggested the development of a suite of simple, low-cost, riskcontrolled products that would appeal to a target audience comprising the less
financially sophisticated. The phrase stakeholder was coined to describe such
products indeed it had already been introduced with the concept of
stakeholder pensions (see Section 3.6.3 of Unit 1) although they are still
commonly referred to, for obvious reasons, as Sandler products.
It was felt that a simpler sales regime would require less complex regulation,
thereby reducing costs. In addition to this, more direct cost-reducing measures
were suggested, including a cap on charges. After considerable heated debate
about the appropriate level for charges, the maximum permitted annual charge
for the investment products was set at 1.5 per cent for the first ten years of
the life of a product and 1 per cent thereafter. For stakeholder pensions
arranged prior to 6 April 2005, charges are capped at 1 per cent throughout.
The suite of stakeholder products initially included five types of product:
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a cash deposit product, similar to a cash ISA.The interest rate will

be within 1 per cent of the Bank of England base rate, and the minimum
deposit is not more than 10;
a medium-term investment product, related to collective

investment schemes such as unit trusts and OEICs;
a smoothed investment fund (a with-profits-type fund);
the stakeholder pension;
the Child Trust Fund. No new CTFs have been available since the end
of 2010, but existing CTFs will continue in force.
A firm is permitted to maintain more than one range of stakeholder products.

A range of stakeholder products may include more than one deposit-based
stakeholder product (such as cash ISA), and may include the stakeholder
products of more than one stakeholder product provider, but it must not
include any more than one collective investment scheme stakeholder product
or linked-life stakeholder product, one or stakeholder Child Trust Fund, and
one stakeholder pension scheme.
[2] 56
Many of the conduct of business rules do not apply to recommendations for

stakeholder products; this is called giving basic advice and there are special
rules that apply.
1.7.7 Basic advice

Basic advice is a limited form of advice that is focused on one or more specific
client needs, and does not involve an analysis of the clients circumstances that
are not directly relevant to those needs. Basic advice is likely to be appropriate
for clients who:
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have their priority needs met (i.e. they do not need to reduce existing
debt, have adequate access to liquid cash, and have their core protection
needs met);
have some disposable income or capital that they wish to invest;
do not want a holistic assessment of their financial situation, just advice

on a specific investment need.
When a firm first has contact with a client with a view to giving basic advice
on a stakeholder product, the client must be provided with a basic advice initial
disclosure document, or a services and costs disclosure document that
contains information about the basic advice service.
When giving basic advice, it must do so using a single range of stakeholder
products, and a sales process that includes putting pre-scripted questions to
the client. They must not describe a product that it outside the firms range,
recommend a particular fund, or recommend the level of contributions
required to be made to achieve a specific income in retirement.
A stakeholder product can only be recommended if:
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reasonable steps have been taken to assess the clients answers to the
scripted questions and any other facts disclosed by the client during the
basic sales process;
there are reasonable grounds for believing that the stakeholder product
is suitable for the client; and
the client understands the basis upon which the advice has been
provided.
[2] 57
Unit 2
The client must be provided with enough information about the nature of the
stakeholder product, including its aims, commitment and risks, to make an
informed decision about the recommendation being made to them. The client
must be provided with a copy of the completed questions and answers as soon
as possible after concluding the sale.
A record must be kept of the fact that the firm has chosen to give basic advice
to a particular client, including the range of stakeholder products used. This
record must be retained for 5 years.
A firm providing basic advice may use the same stationery as it does for other
business purposes, provided that it does not mislead the client into believing
that the firm is acting or advising independently.
Basic advice may be provided wholly through an automated system, but it is
recognised that the basic advice process may necessitate the involvement of a
facilitator to provide ad hoc help and to support the consumer.There are two
ways this can be achieved:
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there is a competent adviser (qualified to level 4) to answer questions

as the client goes through the process and to discuss the merits of the
personal recommendation; and
there is a competent adviser (qualified to level 4) to hand to answer

questions of a factual nature and to help clients through the process, but
who does not influence the advice or discuss the merits of the personal
recommendation with the client (ie does not give regulated advice).
1.7.8 Regulation of mortgage advice

The FSA took over the regulation of mortgage advice and sales with effect
from 31 October 2004. They are now regulated by the FCA.
The FCAs rules relate to loans taken out by individuals or trustees, which are
subject to a first charge on the borrowers property. This includes not only
mortgages but also other loans where the security is a first charge on
residential property.
Second mortgages and other second-charge loans are not covered. The
property must be in the UK and it must be residential to the extent that the
borrower or their immediate family must occupy at least 40 per cent of the
property. This means that the new regime will cover home improvement loans,
[2] 58
debt consolidation loans and equity release schemes such as home income
plans, but that buy-to-let mortgages will not normally be covered.
The rules cover lending, administration, advice and the arranging of loans.
Banks, building societies, specialist lenders and mortgage intermediaries will
need authorisation.
The sales process must distinguish between cases where advice is given and
those where only information is given and a series of pre-determined
questions is used as a filter through which a client can narrow down the
selection of mortgages. In the latter case, sales staff must ensure they do not
stray into the area of giving advice.
Where advice is given, it must be based not only on a consideration of which
mortgage best suits the clients needs, but also on the affordability of the
scheme for that client. This might include, for instance, recognising the impact
of any possible increase in interest rates on a variable rate mortgage.
Determination of the suitability of a mortgage involves three stages:
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assessing whether a mortgage is, in itself, a suitable product for the

client;
assessing what type of mortgage is suitable (eg repayment/interest only,

interest scheme, additional features;
selecting the best mortgage and mortgage provider to meet the clients
needs and circumstances.
Mortgage advisers, arrangers and lenders now come under the scope of the
Financial Ombudsman Service and the Financial Services Compensation
Scheme.
Mortgage advisers are outside the scope of MiFID, and the Mortgage Conduct
of Business Rules continue unchanged.
The structure of the MCOB rulebook is as follows.
MCOB 1: Application and purpose. This explains the scope of the rules, ie
whom they apply to and what types of mortgages.
MCOB 2: Conduct of business standards: general. This includes: the use of
correct terminology (early repayment charge and higher lending charge); the
requirement for communications with customers to be clear, fair and not
misleading; rules about the payment of fees/commission; and the accessibility
of records for inspection by the FCA.
[2] 59
Unit 2
MCOB 3: Financial promotions. This distinguishes between real time

promotions (by personal visit or telephone call) and non-real time (by letter,
e-mail, or advert in newspapers, magazines, or on television radio or the
internet). Unsolicited real-time promotions are not permitted.
Non-real-time promotions must include the name and contact details of the
firm. They must be clear, fair and not misleading, and if comparisons are used
they must be with products that meet the same needs. They must state that
your home may be repossessed if you do not keep up repayments on your
mortgage. Records of non-real-time promotions must be retained for one
year after their last use.
MCOB 4: Advising and selling standards. It must be clear whether advice is
based on the products of the whole market, a limited number of home finance
providers, or a single lender. Independent advisers must be wholly or
predominantly whole of market. Any mortgage recommended must be suitable
for the customer and appropriate to their needs and circumstances; records
to demonstrate this must be kept for three years. However there is no
requirement to issue a suitability report to the client. Special requirements
apply if the mortgage will be used to consolidate existing debts.
On first making contact with a customer, an initial disclosure document (IDD)
must be given, showing (in addition to name and contact details) the following
information: whose mortgages are offered; details of any fee payable for the
advice; the firms FCA registration details; how to complain and details of the
compensation scheme.
MCOB 5: Pre-application disclosure. This gives details of the illustration that
must be provided at the point at which a personal recommendation is made
and before an application is submitted to the lender.This must include the APR,
the amount of the monthly instalment and the amount by which the instalment
would increase for each 1 per cent rise in interest rates.
The contents of an illustration are set out in the rules, and variations from the
prescribed format are not permitted.
MCOB 6: Disclosure at the offer stage. If a mortgage offer is made, the lender
must provide a detailed offer document. This is based on the information given
in the mortgage illustration. The offer document must also: state how long the
offer will remain valid; point out that there will be no right of withdrawal after
the mortgage has been completed; include or be accompanied by a tariff of
charges.
[2] 60
MCOB 7: Disclosure at start of contract and after sale: After the first mortgage
payment is made, the lender must confirm: details of amounts, dates and methods
of payment; details of any related products such as insurance; the responsibility
of the borrower to ensure that (for interest-only mortgages) a repayment
vehicle is in place; what the customer should do if they fall into arrears.
Annual statements must be issued, showing: the amount owed and remaining
term; what type of mortgage it is, and for interest only a reminder to check the
performance of the repayment vehicle; interest, fees or other payments made
since the last statement; any changes to the charges tariff since the last statement.
If a change is to be made to the monthly payment, the customer must be
informed of the new amount, revised interest rate and date of the change.
MCOB 8 and 9: Equity release. Special rules apply to equity release in relation
to advising and selling standards , and to product disclosure.
MCOB 10: Annual percentage rate. This describes how to calculate APR.
MCOB 11: Responsible lending. Lenders must put in place a written responsible
lending policy, and must be able to show that they have taken into
consideration a customers ability to pay when offering a mortgage.
MCOB 12: Charges. Excessive charges are not permitted. Early repayment
charges must be a reasonable approximation to the costs incurred by the
lender if borrower repays the full amount early. Similarly, arrears charges must
be a reasonable approximation to the cost of additional administration as the
result of a borrower being in arrears.
MCOB 13: Arrears and repossessions. Firms must deal fairly with customers
who have mortgage arrears or mortgage shortfall debts; this includes: trying to
reach an agreement on how to repay the arrears, taking into account the
borrowers circumstances; liaising with third party sources of advice; not
putting unreasonable pressure on customers in arrears; repossessing a
property only when all other reasonable measures have failed. Records must
be kept of all dealings with borrowers in arrears.
Customers in arrears must be given the following information within 15
working days of becoming aware of arrears: the Money Advice Service
information sheet Problems paying your mortgage on what do when in
arrears; the missed payments and the total of arrears including any charges
incurred; the outstanding debt; any further charges that may be incurred unless
arrears are cleared.
[2] 61
Unit 2
1.7.8.1 Mortgage Market Review

The purpose of the Mortgage Market Review (MMR) was primarily to restore
confidence in the financial markets following the financial crisis and, in line with
its statutory objective, to increase consumer protection in the mortgage arena.
It has been recognised that developments in the housing and mortgage
markets over the last two decades contributed significantly to the most
serious financial crisis since the 1930s, and that there is a need to examine the
mortgage market from both the lenders and borrowers perspectives.
Since the beginning of the credit crunch, many have been of the opinion that
the global financial downturn that followed it was a predictable, direct and
unavoidable consequence of the credit-fuelled housing and general spending
boom that preceded it, and that some of the key contributing factors were:
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the increased availability of mortgages to credit-impaired individuals

sub-prime lending;
low interest rates over a prolonged period of time;
the availability of higher loan-to-value advances which encouraged

excessive borrowing and reduced the robustness of the lenders
security;
the increased demand for housing due to demographics, and the

increasing number of two-property households and amateur landlords;
house prices rising to unprecedented (and unsustainable) levels, against

which further borrower was permitted;
securitisation of debt, enabling lenders to bundle their assets into

complex financial investments, the underlying risk of which became
increasingly difficult to quantify and assess.
In December 2011, the FSA published a Consultation Paper, entitled CP11/31

Mortgage Market Review: Proposed package of reforms, inviting comments
and feedback from interested parties on their proposed reforms. In October
2012, Policy Statement PS12/16 Mortgage Market Review Feedback and Final
Rules was published. Below is a summary of the reforms and new rules, which
will be introduced into the FCA Handbook on 26 April 2014:
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Income will have to be verified for every mortgage application, bringing

an end (as anticipated) to both self-certification and fast-track mortgage
products.
[2] 62

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A lender will have to demonstrate that the mortgage is affordable,

introducing specific categories of expenditure (committed expenditure
and basic essential expenditure) that must be considered.
Lenders will have to carry out a stress test to check that mortgage
applicants will be able to afford the payment should interest rates rise.
Lenders will be allowed to form their own internal view of future
interest rate rises, provided they can justify the basis used to form this
view by reference to some independent forecast of market
expectations. Furthermore, firms will not be expected to make their
interest rate assumptions public. The purpose of the stress test is to
encourage lenders to take reasonable steps to factor expected changes
in interest rates into their affordability assessments.
It will be compulsory for Right-to-Buy customers to receive advice as it

is believed that RTB customers have, in the past, been more at risk of
taking on unaffordable housing and additional consumer protection is
required for this category of borrower. Advice in this context, however,
does not extend to the decision as to whether or not they should
exercise the right to buy at all this is outside the remit of mortgage
advice.
Income multiples firms will be allowed to continue to use income

multiples to express a maximum amount that it is prepared to advance
under a regulated mortgage contract, and income multiples may be used
as part of the assessment of affordability, but not in isolation. A lender
must be able to demonstrate that the loan is affordable, taking full
account of the customers income AND expenditure and the impact of
future likely interest rate changes.
It will be permitted to take known positive expected changes to income

into account when assessing long term affordability, provided the lender
has some evidence of this, such as a contract confirming that the
applicant is to receive a promotion and salary increase. In respect of
income in retirement, lenders will be expected to take a common sense
view, with state pension age used as a default if the actual retirement age
is not known.
Firms will be required to have a responsible lending policy, approved by

their governing body (e.g. board of directors or recognised professional
body in the case of sole traders), which sets out their approach to the
affordability assessment, interest rate stress test and interest-only
mortgages, and compliance with which must be reviewed annually.
[2] 63
Unit 2
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Affordability will be assessed on a capital and interest basis unless there

is a clear and believable alternative source of capital repayment. Lenders
will not be able to accept speculative repayment strategies such as
reliance of increased property prices or expected inheritances, but
regular deposits into a savings or investment product, or periodic
repayment of capital from sources of income , such as bonuses, may be
acceptable, depending on the circumstances. Lender should be able to
assess as far as is possible that the repayment strategy as the
potential to repay the capital.
Lenders will be required to carry out a review at least once during the
term of an interest-only mortgage to check that the customers
repayment strategy is still in place and still has the potential to repay the
capital borrowed.
All sales that involve spoken or other interactive dialogue with the
consumer will be advised.
The exception to this will be in the case of business borrowers, high net
worth individuals and mortgage professionals, who will be permitted to
proceed with application on an execution-only basis. Evidence will need
to be retained that the individual falls into one of these categories, and
that they dont fall under the vulnerable customer definition, in which
case they will not be able to opt out of the advice process. In the case
of joint applications where only one party is a mortgage professional,
advice will have to be given to the non-professional.
Customers will be permitted to opt-out of receiving advice by making

online and postal applications. These customers will be able to purchase
on an execution-only basis, although facilities such as online chat
functions, where the applicant interacts with an adviser; will be classed
as advised (as mentioned previously, vulnerable customers such as RTB,
Sale and Rent Back and equity release applicants will not be able to opt
out of the advice process).
Lenders will be expected to make customers aware of the

consequences of proceeding on an execution-only basis.
new definition credit-impaired customer is to be introduced, this being

a customer who, has overdue payments equivalent to three months
payment on a mortgage or other loan in the last two years, or has been
the subject of an IVA, a bankruptcy order, or a county court judgment
(CCJ) more than 500 in the last 3 years. This definition is being created
in the context of debt consolidation mortgages, applicants for which
[2] 64
(along with other vulnerable borrowers, such as those applying for

equity-release , Sale and Rent Back or Right-to-Buy mortgages) will not
be permitted to circumvent the advice process and apply for their loans
through a non-interactive process.
t
It will no longer be necessary to issue an Initial Disclosure Document

(IDD) it will be made optional, although it is believed that most
advisers will continue to make some form of written service disclosure
to their customers. There will, however, be a requirement for firms to
give key messages about the firms product range and remuneration
policy clearly and prominently.
There will be restrictions on costs charged to borrowers in arrears in

that they are clearly and directly attributable to the additional
administration incurred by a firm when dealing with a borrower in
arrears.
Lenders will be limited to collecting two direct debits a month from a

borrower in arrears, and there will be a limit on the number of missed
payment fees that can be charged.
1.7.9 Regulation of general insurance

With effect from January 2005, the FSA assumed responsibility for regulating
activities relating to general insurance and other protection products. This
move was prompted in part by the need to implement the terms of the EU
Directive on Insurance Mediation, which was designed to open and standardise
the market for insurance intermediaries across the European Union. The
current FCA regulatory regime does, however, apply to product providers
(insurance companies) as well as intermediaries.
Firms and individuals working in the areas of general insurance, protection,
critical illness, long-term care and permanent health insurance have to be
authorised through the same processes of permission and approval as apply to
the rest of the industry.
Rules applicable to intermediaries who sell, administer or advise on general
insurance are contained in a new FCA rulebook known as the Insurance
Conduct of Business (ICOB) sourcebook. The ICOB rules are split into a
number of sections, the contents of which are summarised below.
The ICOBS rulebook is made up of eight chapters.
[2] 65
Unit 2
1.7.9.1 ICOBS 1 The scope of the rules

ICOBS 1 explains that the rules cover firms who deal with retail commercial
customers for the sale of non-investment insurance products. The activities
regulated by these rules include:
t
insurance mediation;
effecting and carrying out contracts of insurance;
managing the underwriting capacity of a Lloyds syndicate as a managing

agent;
communicating or approving a financial promotion.
1.7.9.2 ICOBS 2 General rules

ICOBS 2 covers categorisation of clients, as follows:
t
policyholders (anyone who, upon the occurrence of the contingency

insured against, is entitled to make a claim);
customers (anyone who makes arrangements preparatory to concluding

a contract of insurance). Customers are further categorised as:
consumers (natural persons for purposes outside his or her profession);

commercial customers (anyone who is not a consumer).
Also covers: communications (which must be clear, fair and not misleading);
inducements (managing conflicts of interests fairly, and not soliciting or
accepting inducements that would conflict with a firms duties to its
customers); record keeping; and exclusion of liability (a firm must not seek to
exclude or restrict liability unless it is reasonable to do so).
1.7.9.3 ICOBS 3 Distance Communications
ICOBS 3 covers rules that ensure compliance with the EU Distance Marketing
Directive, which include the following.
t
A firm must provide a consumer with distance marketing information

before the conclusion of a distance consumer contract.
The identity of the firm and the purpose of the call must be made
explicitly clear at the beginning of any telephone communications.
[2] 66

t
Contractual obligations must be communicated to a consumer during

the pre-contractual phase, and these obligations must comply with the
law presumed to apply to a distance contract.
Terms and conditions must be communicated to a consumer in writing

before the conclusion of a distance contract.
The consumer is entitled to receive a copy of the contractual terms and

conditions in hard copy on request.
ICOBS 3 also covers e-commerce activities and states that a firm must make
the following information easily, directly and permanently accessible.
t
Name.
Address.
Details of the firm (including email address) which allow it to be

contacted in a direct and effective manner.
A status disclosure statement, and confirmation that it is on the FCA

Register, including its FCA register number.
Other rules include: that any prices advertised must be clear and unambiguous,
and the firm must indicate whether the price includes relevant taxes; and that
any unsolicited commercial communication sent by email must be clearly
identifiable as such as soon as it is received by the recipient.
1.7.9.4 ICOBS 4 Information about the firm, its services and
remuneration
ICOBS 4 states that a firm must provide a consumer with at least the following
information.
t
Name and address.
The fact that it is on the FCA Register.
Whether it has a direct or indirect holding representing more than 10

per cent of the voting rights or capital in an insurance undertaking (ie
that it is not a pure reinsurer).
Whether a pure reinsurer has more than a 10 per cent holding in the
firm.
The procedures for making complaints to the firm and the Financial
Ombudsman Service.
[2] 67
Unit 2
Prior to the conclusion of a contract, a firm must tell the consumer whether:
t
it gives advice after a fair analysis of the market; or
it is under a contractual obligation to conduct insurance mediation

business exclusively with one or more insurance undertakings; or
neither of above apply.
A firm must provide details to a customer of any fees, other than premiums,
that are payable for insurance mediation activity before the fee is incurred. If
an exact fee cannot be given, it must disclose the basis for its calculation.
An insurance intermediary must, on a commercial customers request,
promptly disclose the commission that it or any associate may receive in
connection with a policy.
A firm must use an initial disclosure document (IDD) or combined initial
disclosure document (CIDD) to disclose status, scope of service and fees.
1.7.9.5 ICOBS 5 Identifying client needs and advising
ICOBS 5 states that:
t
a firm should take reasonable steps to ensure that a customer only buys
a policy for which he or she is eligible to claim benefits;
if a firm finds that parts of the cover do not apply, they should inform
the customer so that they can make an informed choice;
a firm should explain the duty to disclose all material facts, what this
includes, and the consequences of non-disclosure;
prior to the conclusion of a contract a firm must specify, on the basis of

information provided by the customer, their needs and the reasons for
the advice being given on that policy;
a statement of demands and needs must be communicated in writing to

the customer in a clear and accurate matter;
the firm must take reasonable steps to ensure the suitability of its advice
to any customer who is entitled to rely upon its judgment, taking
account of costs, exclusions, excesses, limitations and other conditions.
[2] 68
1.7.9.6 ICOBS 6 Product information

ICOBS 6 states that a firm must take reasonable steps to ensure a customer
is given appropriate information about a policy so that he or she can make an
informed choice about the arrangements proposed.
The information given will vary according to matters such as:
t
knowledge, experience and ability of the customer;
policy terms, benefits, exclusions and limitations;
the policys complexity;
whether the policy is purchased in connection with other products and

services;
whether the same information has been provided to the customer

previously.
A firm should provide evidence of cover promptly after the inception of a

policy.
If the product is purchased in connection with any other product or service,
the firm must confirm the price of the policy separately from any other, and
whether it is compulsory.
It is the intermediarys responsibility to provide this information, but insurance
companies must provide the intermediary with adequate information to be
able do this. If there is no intermediary, the insurance company must provide
the information
Information disclosed pre-contract includes the arrangements for handling
complaints and the right to cancel.
Before a pure protection contract is concluded, a firm must provide the
customer with:
t
the name of the insurance undertaking and its legal form;
address of their head office;
the definition of each benefit and option;
contract term;
the means of terminating the contract;
means of payment and duration of premiums;
[2] 69
Unit 2
t
tax arrangement for benefits under the policy;
cancellation information;
arrangements for handling complaints.
1.7.9.7 ICOBS 7 Cancellation

ICOBS 7 states that a consumer has the right to cancel without penalty, and
without giving a reason, within:
t
30 days for contracts of insurance which is, or has elements of, pure
protection (eg critical illness) or payment protection;
14 days for any other contract of insurance or distance contract.
Firms are free to offer more generous cancellation terms than this, provided
that they are favourable to the consumer.
The right to cancel does not apply to the following:
t
travel policies of less than one month;
policies, the performance of which has been fully completed;
pure protection policies of six months or less, which are not distance
contracts;
pure protection policies effected by trustees of an occupational pension

scheme, or employers (or partners) for the benefit of employees (or
partners);
general insurance (which is not a distance contract or payment

protection contract) sold by an intermediary who is an unauthorised
person.
On receipt of the cancellation notice the insurance company must return all
premiums paid within 30 days, and the contract is terminated.
1.7.9.8 ICOBS 8 Claims handling
ICOBS 8 covers claims handling. If claims are handled by an intermediary, the
insurance company must ensure that the rules are complied with, ensuring no
conflict of interest. Claims must be handled promptly and fairly, and the firm
must provide reasonable guidance to help the policyholder make a claim. The
firm must not unreasonably reject a claim.
[2] 70
Rejection of a claim is considered unreasonable if it is:

t
for non-disclosure of a material fact which the policyholder could not

reasonably have expected to have disclosed;
for non-negligent misrepresentation of a material fact.
Breach of a condition of the contract unless the circumstances of the claim are
connected to the breach.
[2] 71
Unit 2
[2] 72

1.
Name the three operational objectives of the FCA.
2.
What is the difference between rules and guidance in the FCA

Handbook?
3.
How, according to the Principles for Business, must authorised firms

behave in their dealings with the regulators?
4.
What, according to the FCA, must be embedded into the culture and dayto-day operations of authorised firms?
5.
Whose rights are protected by the Public Interest Disclosure Act 1998?
(a) Borrowers who fall into arrears.
(b) Whistle-blowing employees.
(c) Bank/building society deposit account holders.
6.
What are the two forms of market abuse defined by the EU?
7.
Which of the following is NOT a regulated investment under the

Financial Services and Markets Act 2000?
(a) Works of art.

(b) Funeral plans.
(c) Insurance policies.
8.
What is Basel II?
[2] 73
Unit 2
9.
The risk of losses from failed or inadequate internal processes, people

and systems, or from external events. What is this a description of?
10. What European legislation determines the capital adequacy requirements

of investment businesses?
11. In relation to the FCAs enforcement powers, explain the difference
between restitution and redress.
12. The role of financial adviser is a controlled function. Which category of
controlled function is it?
(a) Required function.
(b) Management function.
(c) Customer function.
13. During what hours can an unsolicited sales call be made by a financial
adviser?
14. What is an eligible counterparty?
15. An adviser has just sold a personal pension plan to a client. What is the
minimum period for which the factfind and related information must be
retained?
16. If the current Bank of England base rate is 4.5 per cent, what is the
minimum rate of interest that can be offered on a stakeholder cash
deposit scheme?
(a) 1.5 per cent.
(b) 2.5 per cent.
(c) 3.5 per cent.
[2] 74
1.
Protect consumers; enhance the integrity of the UK financial system; help

maintain competitive markets and promote effective competition in the
interests of consumers.
2.
Rules create binding obligations on authorised firms. Guidance provides

assistance in understanding how to abide by the rules.
3.
In an open and co-operative way, disclosing anything that the FCA or PRA
might reasonably expect to be told.
4.
The principle of Treating Customers Fairly (TCF).
5.
(b)Whistle-blowing employees.
6.
Insider dealing, where a person who has information not available to

other investors makes use of that information for personal gain; and
market manipulation, where a person knowingly gives out false or
misleading information in order to influence the price of a share for
personal gain.
7.
(a) Works of art.
8.
An international standard for the capital adequacy requirements of

financial institutions.
9.
Operational risk.
10. The Capital Requirements Directive (CRD).

11. Restitution refers to the FCAs power, with a court order, to require a
person or firm to forfeit any profit made from contravening an FCA rule.
Redress refers to the situation where identifiable customers have made a
loss as a result of contravention of a rule and the FCA, again with a court
order, can require the loss to be made good.
12. (c) Customer function.
[2] 75
Unit 2
13. At an appropriate time (taken to be between 9am to 9pm Monday to

Saturday)to an existing client.
14. An eligible counterparty is someone who is in the business, ie someone
who transacts the same kind of business for their own customers as they
are proposing to transact for themselves.
15. Five years.
16. (c) 3.5 per cent.
[2] 76
Section 2
Money laundering
Introduction
There is no formal definition of financial crime. It includes many kinds of
financial fraud, criminal market conduct such as insider trading, the funding of
terrorism, and money laundering.
The prevention of the use of financial systems for money laundering purposes
has, for many years, been a key objective of most national, European and
international communities. In 1989, the Financial Action Task Force on Money
Laundering (FATF) was created as an international body dedicated to the fight
against criminal money. The FATF has over 30 members including the European
Commission and many of the EU member states.
One indication of the scale of the problem is that, in the 12 months from
October 2011 to September 2012, the Serious Organised Crime Agency (see
Section 2.3.2) received 277,000 suspicious activity reports (SARs).
Because money laundering is such a high profile issue, it forms a separate part
of the Unit 2 syllabus, and will be dealt with in some detail in this Section, which
will cover the Proceeds of Crime Act 2002 and the money laundering offences;
client identification, record keeping and reporting; training requirements; and
enforcement.
[2] 77
Unit 2
2.1 Proceeds of Crime Act 2002

The UKs laws and regulations about money laundering were developed in a
number of Acts and Amendments over a period of more than 15 years before
they were consolidated in the Proceeds of Crime Act 2002. The 2002 Act
no longer separates the proceeds of drug-related crimes from others, and
deals with the laundering of the proceeds of all forms of crime. In particular,
the 2002 Act extends the obligation to report suspicions about the laundering
of proceeds of all forms of crime, where previously it had been restricted to
those about the proceeds of drug or terrorism offences.
2.1.1 Terrorism Act 2000

The Terrorism Act 2000 defines terrorism as the use of (or threat of) serious
violence against a person or serious damage to property or electronic
systems, with the purpose of influencing a government, intimidating the public
or advancing a political, religious or ideological cause.
The Act specifically mentions as an offence the retention or control of
terrorist property, by concealment, removal from the jurisdiction, transfer to
nominees or on any other way in other words, money laundering. Terrorist
property is defined as:
t
money or other property that is likely to be used for terrorism purposes;
proceeds of the commission of acts of terrorism;
proceeds of acts carried out for the purposes of terrorism.
2.2
Definitions
Money laundering can be defined as the process of filtering the proceeds of

criminal activity through a series of accounts or other financial products in
order to give it apparent legitimacy or to make its origins difficult to trace.
The EUs Third Money Laundering Directive (2005) repealed and
consolidated two earlier directives. The directive defines money laundering in
some detail. It is said to comprise the following conduct when committed
intentionally:
t
the conversion or transfer of property, knowing that such property is

derived from criminal activity or from an act of participation in such
[2] 78
activity, for the purpose of concealing or disguising the illicit origin of the
property or of assisting any person who is involved in the commission
of such activity to evade the legal consequences of his action;
t
the concealment or disguise of the true nature, source, location,

disposition, movement, rights with respect to or ownership of property,
knowing that such property is derived from criminal activity or from an
act of participation in such activity;
the acquisition, possession or use of property, knowing, at the time of

receipt, that such property was derived from criminal activity or from an
act of participation in such activity;
participation in, association to commit, attempts to commit and aiding,

abetting, facilitating and counselling the commission of any of the actions
mentioned in the foregoing paragraphs.
Two more important definitions were included, in order to clarify this

definition of money laundering:
t
property: this means assets of every kind, tangible or intangible,

movable or immovable, as well as legal documents giving title to such
assets;
criminal activity: this means a crime as specified in the Vienna

Convention (the United Nations Convention Against Illicit Traffic in
Narcotic Drugs) and any other criminal activity designated as such by
each member state;
Criminal property is defined as property that consists, directly or indirectly,

wholly or in part, a benefit from criminal conduct, where the alleged offender
knows or suspects that it constitutes a benefit.
The Directive specifies that money laundering that takes place within the EU
will still be treated under EU money laundering rules even when the activities
that generated the property to be laundered took place in a non-EU country.
Following the implementation of the Third EU Money Laundering Directive
(2005), the former regulator, the FSA, decided to change the way in which it
regulated authorised firms with regard to Money Laundering. The Money
Laundering Sourcebook, which was contained within the Business Standards
part of the FSA Handbook, was very prescriptive in its requirements, with little
consideration given to the specific nature of a firms business or type of
customer. It was felt that this was in direct contradiction with the FSAs
principles of good regulation, ie that its resources should be allocated in the
[2] 79
Unit 2
most efficient and economic way. It was also felt that many of the FSAs
requirements within the Money Laundering Sourcebook were merely a
duplication of the legislative requirements contained within the Proceeds of
Crime Act (2002) and the Terrorism Act (2000). As a consequence, the Money
Laundering Sourcebook was deleted on 31 August 2006 and firms are now
given the flexibility to structure their controls and procedures to reflect the
specific risks they face, drawing guidance from the Joint Money Laundering
Steering Groups revised guidance notes, which were given Treasury approval
on 15 December 2007.
2.3 Money laundering offences

Under the Proceeds of Crime Act 2002 there are three principal money
laundering offences:
t
concealing criminal property: criminal property is property that a

person knows, or suspects, to be the proceeds of any criminal activity. It
is a criminal offence to conceal, disguise, convert or transfer criminal
property clearly money laundering is included in those definitions;
arranging: this happens when a person becomes involved in a process

that they know or suspect will enable someone else to acquire, retain,
use or control criminal property (where that other person also knew or
suspected that the property derived from criminal activity);
acquiring, using or possessing: it is a criminal offence for a person to

acquire, use or possess any property when that person knows or
suspects that the property is the proceeds of criminal activity.
These definitions lead to a number of practical procedures designed to ensure

that persons working in the financial services industry do not become involved
in money laundering. The rules require that all authorised firms must:
t
establish accountabilities and procedures to prevent money laundering;
educate their staff about potential problems;
obtain satisfactory evidence of identity for individual transactions (or a

series of linked transactions) over b15,000 the sterling equivalent is
set each year and is around 10,000 (special limits apply for life
assurance policies see Section 2.4);
report suspicious circumstances;
refrain from alerting persons being investigated;
[2] 80

t
appoint a Money Laundering Reporting Officer. This post is a controlled

function (see Section 1.7.1), and must be filled by a person of
appropriate seniority;
give regular training to staff about what is expected of them under the
money laundering rules, including the consequences for the firm and for
themselves if they fail to comply;
take reasonable steps to ensure that procedures are up to date and

reflect any findings contained in periodic reports on money laundering
matters issued by the government or by the Financial Action Task Force;
requisition a report at least once in each calendar year from the Money
Laundering Reporting Officer. This report must assess the firms
compliance with the Joint Money Laundering Steering Group, indicate
how Financial Action Task Force findings have been used during the year
and provide information about reports of suspected money laundering
incidents submitted by staff during the year;
take appropriate action to strengthen its procedures and controls to

remedy any deficiencies identified by the report.
Contravention of any of the money laundering rules is a criminal offence.

When assessing a firms compliance with its money laundering requirements,
the FCA will take into account the extent to which the firm has followed:
t
the Joint Money Laundering Steering Groups guidance notes

for the financial sector. These describe the steps that firms should take
to verify the identity of their customers and to confirm the source of
their customers funds. The Joint Money Laundering Steering Group is
made up of the leading UK trade associations in the financial services
Industry. Its aim is to promote good practice in countering money
laundering and to give practical assistance in interpreting the UK money
laundering regulations. This is primarily achieved by the publication of
guidance notes;
the publications of the Financial Action Task Force, which

highlight any known developments in money laundering and any
deficiencies in the money laundering rules of other jurisdictions;
the FCAs own guidance on financial exclusion (see Section 2.4.1).
Two areas of particular concern to financial advisers are failure to disclose and
tipping off.
[2] 81
Unit 2
2.3.1 The Financial Action Task Force

The Financial Action Task Force (FATF) was established in 1989 to coordinate
the international fight against money laundering, and its main office is in Paris.
It currently has 36 members: these are countries and international bodies,
including the European Commission (and many EU member states), the United
States, and other countries in North and South America, Eastern Europe and
the Far East. Similar bodies around the world also operate as Associate
members of the FATF or have observer status with the FATF.
The FATF also maintains a list of non-cooperative countries and territories,
which it considers do not have adequate anti-money laundering measures.
The work of the FATF falls into three main areas:
t
setting appropriate standards for national anti-money laundering

programmes: these are set out in a list of 40 Recommendations
incorporating minimum standards for the measures that countries
should have in place within their own criminal justice and regulatory
systems;
evaluating the extent to which individual countries have implemented

these standards;
identifying trends in money laundering methods.
The FATF describes itself as an inter-governmental policy-making body, and

points out that it does not itself become involved in law enforcement. That is
the responsibility of local authorities in individual countries, such as the Serious
Organised Crime Agency (SOCA) in the UK.
2.3.2 Serious Organised Crime Agency

Serious Organised Crime Agency (SOCA) is a public body sponsored by but
operationally independent of the Home Office. It is an intelligence-led agency
with law enforcement powers and a responsibility to reduce the impact of
serious organised crime on people and communities; this includes
responsibility for pursuing and recovering the proceeds of crime. Three of its
major priorities relate to drug trafficking, immigration crime and money
laundering.
[2] 82
2.3.3 Failure to disclose

All suspicions of money laundering must be reported to the authorities. The
Proceeds of Crime Act 2002 introduced the requirement for a person to
disclose information about money laundering if they have reasonable grounds
for knowing or suspecting that someone is engaged in money laundering. The
FCA will determine this on the basis of whether a reasonable professional
should have known so the importance of appropriate training of staff is
obvious.
2.3.4 Tipping off

It is also an offence to disclose to or tip off a person who is suspected of
money laundering that an investigation is being, or may be, carried out.
2.4 Client identification

One of the most important elements in the financial service industrys action
against money laundering is the process of confirming the identity of
customers.
Evidence of identification is required in the following cases:
t
when entering into a new business relationship (particularly when

opening a new account, investment or policy);
in the case of new customers (and any existing customers whose

identity has not been verified previously), when the value of a
transaction exceeds b15,000, whether as a single transaction or as a
series of linked transactions. For life assurance policies the limits are
b1,000 for annual premiums and b2,500 for single premiums.
Evidence of identification must be obtained in every case where there is

suspicion of money laundering. If there is suspicion that the applicant may not
be acting on their own behalf, reasonable measures must be taken to identify
the person on whose behalf the applicant is acting.
If a client is introduced to the firm by a financial intermediary or other
authorised firm, it is permissible to accept the written assurance of the
intermediary that they have obtained sufficient evidence of identity. This is
clearly important to, for instance, financial advisers and mortgage advisers.
[2] 83
Unit 2
Many will use a standard format for giving the required confirmation, such as
that developed by the Association of Independent Financial Advisers.
The definition of what constitutes satisfactory evidence of identity is rather
vague it requires that it should be reasonably capable of establishing that the
applicant is the person that they claim to be, to the satisfaction of the person
who obtains the evidence. Acceptable forms of identification include:
t
current passport;
national identity card with photograph;
driving licence with photograph;
entry on electoral roll;
recent utility bill or council tax bill.
2.4.1 Financial exclusion

The regulator offers guidance on financial exclusion. This guidance helps firms
to ensure that, where people cannot reasonably be expected to produce
detailed evidence of identity, they are not denied access to appropriate financial
services. Guidance cites the example of a person who does not have a
passport or driving licence, and whose name does not appear on utility bills. In
such circumstances, the FCA considers that a firm may accept, as evidence of
the customers identification, a letter or statement from a person in a position
of responsibility (such as a solicitor, doctor or minister of religion) who knows
the client.
2.5 Record-keeping requirements

Institutions must keep appropriate records for use as evidence in any
investigation into money laundering. This means that:
t
evidence of identification must be retained until at least five years after

the relationship with the customer has ended;
supporting evidence of transactions (in the form of originals or copies

admissible in court proceedings) must be retained until at least five years
after the transaction was executed.
[2] 84
2.6 Reporting procedures

Each firm must appoint a Money Laundering Reporting Officer (MLRO),
a person of appropriate seniority who will co-ordinate all the firms antimoney laundering activities.
All members of staff must make a report to the MLRO if they know or suspect
that a client is engaged in money laundering. The MLRO will then determine
whether to report this to the Serious Organised Crime Agency (SOCA),
using known information about the financial circumstances of the client and
the nature of the business being transacted.
At least once in each calendar year senior management of the firm must
requisition a report from the Money Laundering Reporting Officer. This report
must:
t
assess the firms compliance with the Join Money Laundering Steering
Group guidance notes (revised guidance, December 2007);
indicate how Financial Action Task Force (FATF) findings have been used
during the year;
provide information about reports of suspected money laundering

incidents submitted by staff during the year.
A firms senior management must consider this report and must take any
action necessary to solve any problems identified.
2.7 Training requirements

Firms are required to:
t
take appropriate measures to make employees aware of money

laundering procedures and legislation;
provide training in the recognition and handling of money laundering

transactions.
In particular, staff should be made aware of the following aspects:

t
the law relating to money laundering;
the firms procedures and staff individual responsibilities;
[2] 85
Unit 2
t
the identity of the firms Money Laundering Reporting Officer and what
their responsibilities are;
how any breach of money laundering rules can impact on the firm and
on themselves, ie the consequences of committing what may be a
criminal act.
Training should be given on a regular basis throughout the time that the
individual handles transactions that could lead to money laundering.
2.8 Enforcement
The FCA can discipline firms and individuals for breaches of money laundering
rules, as described in Section 1.6. It also has the power to prosecute anyone
who breaks the Money Laundering Regulations 2003 established under UK law
to give effect to the EU money laundering directives.
The penalties are severe. Anyone convicted of concealing, arranging or
acquiring (see Section 2.3) could be sentenced to up to 14 years imprisonment
or an unlimited fine, or both. The offence of failing to disclose or of tipping off
carries a prison sentence of up to five years or an unlimited fine, or both.
2.9 The Bribery Act 2010

The Bribery Act 2010, which came into effect in April 2011, creates an offence
of offering, promising or giving financial or other advantage to another where
the advantage is intended to bring about improper performance by another
person of a relevant function or activity, or to reward such improper
performance.
An offence is also deemed to have been committed if the person offering,
promising or giving the advantage knows (or simply believes) that acceptance
of the advantage itself constitutes improper performance.
Improper performance means performance which amounts to a breach of an
expectation that a person will act in good faith, impartially or in accordance
with a position of trust. The test used is what a reasonable person in the UK
would expect of a person performing the relevant function or activity.
[2] 86
The offence applies to bribery relating to any function of a public nature,

connected with a business, performed in the course of a persons employment
or performed on behalf of a company or other body.
The function or activity may be carried out either in the UK or abroad, and
need have no connection with the UK.
The Act also makes it an offence to request, agree to receive, or accept
financial or other advantage, where the person requesting the bribe
performs his function or activity improperly (or intends to) as a result of the
reward requested or received.
The maximum penalty in the UK that can be imposed on an individual
convicted of a bribery offence is an unlimited fine and a term of imprisonment
of up to ten years.
[2] 87
Unit 2
[2] 88

1.
Transferring criminally obtained money through different accounts is not

the only action treated as money laundering. What other activities are
also defined as money laundering?
2.
What is the name of the international body that co-ordinates the fight
against money laundering?
3.
What is the transaction level above which firms must obtain evidence of
identity of the client?
4.
How often must a Money Laundering Reporting Officer provide a report

to their firms senior management?
5.
What is tipping off?
6.
How long must evidence of identification be retained for anti-money

laundering purposes?
7.
If a Money Laundering Reporting Officer suspects a case of attempted

money laundering, to whom must this be reported?
8.
Which types of financial services employees must be given training about

money laundering?
[2] 89
Unit 2
[2] 90
1.
Concealing the true nature or source of property that you know to result
from criminal activity; acquiring or using property that you know to result
from criminal activity; aiding or abetting any other type of money
laundering activity.
2.
The Financial Action Task Force (FATF).
3.
b15,000.
4.
At least once every calendar year.
5.
Disclosing to a person who is suspected of money laundering that they

are under investigation.
6.
Five years after the relationship with the client has ended.
7.
The Serious Organised Crime Agency (SOCA).
8.
Anyone who handles transactions that could involve money laundering.
[2] 91
Unit 2
[2] 92
Section 3
Complaints and compensation
Introduction
Consumers in the UK today are better protected than they have ever been.
Legislation, ombudsman bureaux and other arbitration schemes, voluntary
codes of practice, compensation schemes, consumerist bodies such as Which?:
these are all examples of ways in which rights of the consumer are upheld
against fraud, malpractice and the pressure of modern marketing. It must
always be borne in mind, however, that consumers cannot be protected 100
per cent, and they should take some responsibility for the purchasing decisions
that they make. Examples of this from the financial services industry are: the
fact that the FCA specifically says that it cannot protect investors from falls in
stock market values (although it will attempt to educate consumers about the
risks involved) and the fact that the Financial Services Compensation Scheme
(FSCS) sets limits on the amounts of compensation it can offer.
One of the FCAs operational objectives (see Section 1.2) is to protect
consumers of financial services and products. One step towards the
achievement of this is to make it easier for customers to know how to
complain when they feel that they have been badly treated by a financial
institution or by an individual working in the industry. Customers who are not
satisfied with a firms response to their complaint can refer the matter to a
dedicated independent ombudsman bureau. In some circumstances, customers
who have lost money can receive compensation.
Section 3 deals with the practical aspects of these consumer rights, as specified
in part U5 of the syllabus, with particular reference to complaints procedures,
arbitration schemes (ombudsmen) and compensation arrangements.
[2] 93
Unit 2
3.1 Firms complaints procedures

The FCA defines a complaint as any oral or written expression of
dissatisfaction, whether justified or not, from or on behalf of an eligible
complainant about the firms provision of, or failure to provide, a financial
service and involves an allegation that the complainant has suffered, or may
suffer:
t
financial loss; and/or
material distress; and/or
material inconvenience.
3.1.1 Eligibility
The FCA defines an eligible complainant as:
t
a private individual;
a business with a turnover or annual balance sheet that does not exceed
b2 million when the complaint is made;
a charity with an annual income of less than 1m when the complaint is

made; or
a trustee of a trust that has a net asset value of less than 1m when the
complaint is made.
3.1.2 Complaints resolved by next business day

Complaints resolved by close of business on the business day following receipt
of the complaint are subject to different rules. Sometimes known as one and
done complaints, they are normally straightforward issues such as servicing
matters that can be resolved quite simply. In these cases, a complaint is
resolved where the complainant has indicated acceptance of a response from
the respondent, with neither the response nor acceptance having to be in
writing. In these cases, the rules relating to recording, time limits, reporting, and
data publication do not apply.
[2] 94
3.1.2.1 Non-reportable complaints

Non-reportable complaints are any other complaints that do not meet the
FCA definition and are, for the most part, subject to the same rules as
reportable complaints the only differences are that they are not subject to
the usual deadlines and they do not have to be reported to the FCA.
3.1.3 Complaint requirements

The key requirements for firms complaints procedures are that firms must:
t
have appropriate and effective complaint-handling procedures;
make consumers aware of these procedures this is normally done

through the client agreement or initial disclosure document (see Section
1.7.5.1.2);
aim to resolve complaints promptly, within eight weeks;
notify complainants of their right to approach the Financial Ombudsman

Service (see Section 3.2) if they are not satisfied;
report to the FCA on their complaint handling, on a regular six-monthly

basis.
3.1.4 Complaint Procedures

Complaints may be received orally (in person or by telephone) or in writing.
In either case, the complaint should be acknowledged promptly and in writing.
Once a complaint has been received FCA rules require that the firm:
t
investigates the complaint competently, diligently and impartially,

obtaining additional information as necessary;
assess fairly, consistently and promptly:

a) the subject matter of the complaint;
b) whether the complaint should be upheld;
c) what remedial action or redress (or both) may be appropriate;
d) if appropriate, whether it has reasonable grounds to be satisfied that
another respondent may be solely or jointly responsible for the
matter alleged in the complaint.
[2] 95
Unit 2
All complaints must be investigated by a person of sufficient competence who,

wherever possible, was not directly involved in the matter under complaint.
The overall aim should be to ensure that any specific problem identified by the
complainant is remedied.
The firms response to the complainant is in the form of a final response letter,
which must adequately address the subject matter of the complaint. It must
also inform the complainant that if they are not satisfied, they can refer their
complaint to the Financial Ombudsman Service within six months of the date
of the letter.
The firm should keep the complainant informed of the progress of the
complaint. If, after eight weeks, a final response still cannot be given, the client
must be told that they can refer the matter to the Financial Ombudsman
Service if they are dissatisfied about the delay.
3.1.4.1 Root cause analysis
As well as dealing with individual complaints in a prompt fair and consistent
manner, firms are expected to put in place appropriate management controls
and take reasonable steps to ensure that in handling complaints it identifies and
remedies any recurring or systemic problems, for example, by investigating the
root causes of complaints to identify any systemic concerns in their
procedures. In this way they should be able to improve their service to
customers (see section 1.2.8 on Treating Customers Fairly).
In addition to this, the FCA has introduced a rule requirement for firms to
investigate root cause considering whether such root causes may also affect
other processes or products, including those not directly complained of; and
correcting, such root causes where reasonable to do so.
Recognising the importance of effective complaints handling, FCA requires
financial services firms to appoint an individual at the firm, or in the same group
as the firm, to have responsibility for oversight of the firms compliance with
the complaints rules.The individual appointed must be carrying out a governing
function. Firms are not required to notify the name of the individual to the
FCA or the Financial Ombudsman Service but would be expected to do so
promptly on request.
[2] 96
3.1.4.2 Record keeping

Records of reportable complaints have to be retained for at least three years
from the date a complaint is received.
Where the complaint relates to MiFID business or collective portfolio
management services for a UCITS scheme or an EEA UCITS scheme the
minimum period is five years
3.1.4.3 Reporting
On a six monthly basis, firms are required to report to the FCA the following
information:
(1) total number of complaints received;
(2) total number of complaints closed:
(a) within four weeks or less of receipt;
(b) more than four weeks and up to eight weeks of receipt; and
(c) more than eight weeks after receipt;
(3) total number of complaints:
(a) upheld in the reporting period; and
(b) outstanding at the beginning of the reporting period; and
(4) total amount of redress paid in respect of complaints during the
reporting period.
3.1.4.4 Publication of complaints information
In the interests of transparency, firms are required to publish complaints
information if they receive more than 500 or more complaints over a sixmonth period.
Both the FCA and FOS publish complaints data.
[2] 97
Unit 2
3.1.4.5 Super Complaints

The Financial Services and Markets Act 2000 gives designated consumer bodies
the right to make a super-complaint to the FCA where they consider that
there are features of a financial services market in the UK that are or which
may be significantly damaging the interests of consumers. The FCA supercomplaints regime for financial services markets is distinct from the crosssectoral super-complaints regime provided for in the Enterprise Act 2002.
Through the Financial Services Act, designated consumer bodies, regulated
persons and the Financial Ombudsman Service (FOS) will be able to make a
super-complaint to the FCA.
The FCA is required to respond to a super-complaint or reference within 90
days setting out how it proposes to deal with the complaint and any possible
actions. The FCAs response might, for example:
t
announce plans to consult on an issue;
set out a timetable for regulatory action which would allow the Financial
Ombudsman Service (FOS) to consider whether or not to place a hold
or stay on complaints;
explain how the FCA is already taking action to address an issue; or
explain why it is not taking any action.
It can also carry out wider enquires with a view to testing the evidence like
internal research, public requests of information and carry out a review of the
relevant regulated firms.
3.2
The Financial Ombudsman Service
The Financial Services and Markets Act 2000 (FSMA) provides for a mechanism
under which certain disputes may be resolved quickly and with the minimum
of formality by an independent person.
The FOS took over from the existing financial services ombudsman schemes
in December 2001, with the aim of being a single organisation with a consistent
set of rules that would deal with complaints and disputes arising from almost
any aspect of financial services (although certain types of pension and aspects
of pension arrangements are dealt with by the Pension Ombudsman).
[2] 98
The FOS does not make the rules under which firms are authorised, nor can
it give advice about financial matters or debt problems. The FOS is able to deal
with complaints brought by eligible complainants (see section 3.1).
It is funded by organisations that are members of the FOS and membership is
compulsory for all organisations authorised under the FSMA 2000. Members
of the FOS pay a general levy plus case fees of 550 for the fourth and
subsequent cases per year.From April 2012 an additional case fee of 350 was
introduced for the twenty-sixth and subsequent PPI mis-selling case per year.
3.2.1 Ombudsman Process

Complainants must first complain to the firm itself; the FOS will become
involved only when a firms internal complaints procedures have been
exhausted without the customer obtaining satisfaction.
The Ombudsman will attempt to resolve complaints at the earliest possible
stage and by whatever means appear to him to be most appropriate, including
mediation or investigation.
If the Ombudsman decides that an investigation is necessary, he will then:
(1) ensure both parties have been given an opportunity of making
representations;
(2) send both parties a provisional assessment, setting out his reasons and a
time limit within which either party must respond; and
(3) if either party indicates disagreement with the provisional assessment
within that time limit, proceed to determination.
The Ombudsman will determine a complaint by reference to what is, in his
opinion, fair and reasonable in all the circumstances of the case taking into
account:
t
the relevant:
(a) law and regulations;
(b) regulators rules, guidance and standards;
(c) codes of practice; and
where appropriate, what he considers to have been good industry

practice at the relevant time.
[2] 99
Unit 2
3.2.1.1 Compensation limits

From 1 January 2012, the maximum the FOS can award is up to 150,000
(prior to this 100,000), plus interest and the complainants reasonable costs.
Awards are binding on the firm but not on the complainant, who is free to
pursue the matter further in the courts if they wish. The award is not intended
to punish the firm, but to put the complainant back into the same financial
position in which they would have been had the event complained about not
taken place.
3.2.1.2 Time limits
Complaints to the FOS must be made within six years of the event that gives
rise to the complaint, or within three years of the time when the complainant
should have become aware that they had cause for complaint, whichever is the
later. If a firm receives a complaint which is outside the time limits for referral
to the Financial Ombudsman Service, it may reject the complaint without
considering the merits (known as time barred), but must explain this to the
complainant in a final response and indicate that the Ombudsman may waive
the time limits in exceptional circumstances.
In addition, the FOS will not usually consider any complaint that is the subject
of a court case.
3.3 The Financial Services Compensation Scheme

Compensation arrangements for customers who have lost money through the
insolvency of an authorised firm have been co-ordinated under a single scheme
with effect from December 2001. From 1 April 2013, both the PRA and the
FCA are jointly responsible for the rule-making and oversight of the FSCS.
3.3.1 Customer Eligibility

To qualify for compensation a claimant must be eligible under rules outlined in
the FCA Handbook. The main points are:
t
[2] 100
Compensation can only be paid when an authorised firm is in default.

Claims cannot be made against the Financial Services Compensation
Scheme for other losses, i.e. losses due to negligence, poor advice or
simply due to a fall in stock market values.

t
Compensation can only be paid for financial loss and there are limits to
the amounts of compensation payable.
The FSCS was set up mainly to assist private individuals, although smaller
businesses are also covered.
Larger businesses are generally excluded, although there are some

exceptions to this for deposit and insurance claims.
The FSCS does not cover firms based in the Channel Islands or the Isle
of Man.
3.3.2 FSCS sub-schemes

The FSCS is made up of five sub-schemes relating to different default
situations:
3.3.2.1 Deposits
This Sub-scheme covers claims made against failed deposit-taking firms, for
example banks, building societies and credit unions. FSCS is triggered when a
firm authorised to accept deposits by the Prudential Regulation Authority
(PRA) goes out of business, for example if the firm goes into administration or
liquidation, and is unable to repay its depositors. FSCS can also be involved if
the PRA considers that an authorised firm is unable, or likely to be unable, to
repay its depositors.
Maximum claim 100% of 85,000 per person per firm (for claims against firms
declared in default from 31 December 2010).
3.3.2.2 Investments
FSCS is triggered when a firm authorised to advise on or arrange investments
goes out of business, and is considered by FSCS to be unable, or likely to be
unable, to pay claims made against it. This will generally be because the firm has
stopped trading and has insufficient assets to meet claims, or is insolvent.
declared in default from 1 January 2010).
[2] 101
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3.3.2.3 Home Finance

Customers of authorised mortgage firms are protected by FSCS for business
conducted on or after 31 October 2004. FSCS can provide protection if a
mortgage firm is unable, or likely to be unable, to pay claims against it. FSCS is
triggered when a firm authorised to advise on or arrange mortgages by the
Financial Conduct Authority (FCA), goes out of business, for example if the
firm goes into administration or liquidation.
declared in default from 1 January 2010).
3.3.2.4 Insurance Business
This Sub-scheme covers claims for compensation that arise following the
failure of an authorised insurer (life and general).
Compensation is 90 per cent with no upper limit. If the insurance is
compulsory (such as employers liability cover or some types of motor
insurance), the figure is 100 per cent of the whole amount;
3.3.2.5 Insurance Mediation
From 14 January 2005 the protection of the FSCS was extended to include
customers of general insurance intermediaries. FSCS will safeguard
policyholders if an authorised firm is unable, or likely to be unable, to pay
claims against it, for example if it has been placed in provisional liquidation or
administration.
Compensation is 90 per cent with no upper limit. If the insurance is
compulsory (such as employers liability cover or some types of motor
insurance), the figure is 100 per cent of the whole amount.
3.3.3 Funding
The FSCS is funded by levies on firms authorised by the FCA and the PRA. The
FSCSs costs are made up of management expenses and compensation
payments. The FSCS levy is split into the five broad classes. With the exception
of the deposits class, each broad class is divided into two sub-classes based on
provider/intermediation activities. Each sub-class is made up of firms which are
providers or intermediaries and engage in similar styles of business with similar
types of customer. The sub-classes are based on the activities a firm undertakes
[2] 102
(and are aligned to their FCA and PRA permissions). A firm could be allocated
to one or more sub-classes according to the activities that it undertakes.
Each firms contribution is calculated on the tariff base applicable to the
relevant sub-class. Each firm contributes proportionally. A threshold for each
sub-class is set by the FCA by reference to what a particular sub-class or class
(taken as a whole) can be expected to afford in a year. The threshold sets the
maximum that the FSCS can levy for compensation in any one year. The model
operates on the basis that a sub-class will meet the compensation claims from
defaults in that sub-class up to the threshold. Once a sub-class reaches its
annual threshold, the other sub-class in that broad class will be required to
contribute to any further compensation costs up the threshold for the class as
a whole. A layer of cross-subsidy is then available from a general retail pool,
through which firms in the other broad classes support any other broad class
which has reached its overall threshold, up to the overall limit of 4.03bn.
3.4 The Pensions Ombudsman

The Pensions Ombudsman was created by the Social Security Act 1990 to deal
with complaints relating to occupational pension schemes and certain aspects
of personal pension schemes. The Secretary of State for Work and Pensions
appoints the Ombudsman.
The Pensions Ombudsman can decide about complaints and disputes relating
to the running of pension schemes. The Ombudsman does not deal with
complaints about the sales and marketing of pension schemes these are the
province of the Financial Ombudsman Service (see Section 3.2) or with
complaints about state pensions.
Complaints are related to cases of maladministration, and it must be shown
that this has led to injustice (financial loss, distress, delay or inconvenience).
Disputes are disagreements about facts or about law.
Complaints and disputes can be made by a wide range of people: individuals,
managers, trustees or employers. They are commonly made by:
t
members or ex-members of schemes;
spouses of members or ex-members of schemes;
widows or dependants of members who have died;
solicitors or others representing the interests of such people.
[2] 103
Unit 2
Complaints or disputes should first be addressed to the pension schemes

managers or trustees. If this does not result in agreement, the next point of
reference should be to the Office of The Pensions Advisory Service (TPAS),
who try to resolve the dispute through conciliation and mediation. TPAS
decisions are not legally binding and cases that cannot be agreed are normally
then referred to the Pensions Ombudsman.
Complaints and disputes must be communicated to the Ombudsman in writing
within three years of the event being complained about. Any time spent trying
to resolve the matter using the schemes internal complaints procedures, or
through TPAS, is normally excluded from this time period.
The Ombudsmans decision is binding on all parties and can be enforced in the
courts.
Under the governments reorganisation of quangos in 2010 it was decided that
the Pensions Ombudsman would be merged with the Pension Protection Fund
Ombudsman to form a single tribunal. This merger has now taken place
although the two names of the organisations remain.
[2] 104

1.
The FCA expects firms to aim to resolve complaints within:

(a) Six weeks.
(b) Eight weeks.
(c) Twelve weeks.
2.
A customer has received a final response letter in which the firm he has
complained to declines to uphold his complaint. What is the time limit for
the customer to refer the matter to the Financial Ombudsman Service?
3.
A customer has lost 35,000 as a result of the insolvency of an

investment firm. How much compensation can she receive from the
Financial Services Compensation Scheme?
4.
If an investor loses her 100,000 deposit when a building society

collapses, how much compensation will she receive from the Financial
Services Compensation Scheme?
5.
What types of complaints can be dealt with by the Pensions Ombudsman?
[2] 105
Unit 2
[2] 106
Answers
1.
(b)Eight weeks.
2.
Six months.
3.
35,000
4.
85,000
5.
Complaints about maladministration of pension schemes. The Pensions

Ombudsman can also deal with disputes about facts or the interpretation
of the law.
[2] 107
Unit 2
[2] 108
Section 4
Data protection
Introduction
This section covers part U6 of the syllabus for Unit 2, incorporating details of
how the Data Protection Act 1998 affects the provision of financial advice and
the general conduct of financial firms.
4.1 The Data Protection Act 1998

The Data Protection Act 1998 replaced an earlier Act (the Data Protection Act
1984) when it became necessary for UK law in this area to comply with an EU
data protection directive issued in 1995. The 1998 Act is much wider in its
scope than the earlier Act: in particular, it extends the regulations to cover not
only computerised data (as in the 1984 Act) but also any structured set of
personal data. It can therefore include data held in manual filing systems.
The purpose of the legislation is, broadly speaking, to give private individuals
control over the use of personal data about themselves held by commercial
(and other) organisations. It does so by establishing a series of data protection
principles, together with enforcement processes.
[2] 109
Unit 2
4.1.1 Definitions
The Data Protection Act 1998 uses a number of words and phrases that have
precise meanings within its terms. These include:
t
data subject: an individual whose personal data (see below) is processed;
personal data: the Act relates only to personal data, which is defined
as information relating to a living individual who can be identified from
that information or from a combination of that information and other
information in the possession of the data controller (see below);
sensitive personal data: this data can only be processed if the

individual has given explicit consent (in other words, it is not sufficient
to claim that the individual has never specifically withheld their consent).
Sensitive data includes information about an individuals:
racial origin;
religious beliefs;
political persuasion;
physical health;
mental health;
criminal (but not civil) proceedings;
processing: this has a very broad meaning, covering all aspects of

owning data including:
obtaining the data in the first place;
recording of the data;
organisation or alteration of the data;
disclosure of the data by whatever means;
erasure or destruction of the data;
data controller: this is the legal person who determines the purposes
for which data is processed and the way in which this is done. It is
normally an organisation/employer, such as a company, partnership or
sole trader.The data controller has prime responsibility for ensuring that
the requirements of the Act are carried out;
data processor: this is a person who processes personal data on behalf

of the data controller.
[2] 110
4.1.2 Data protection principles

The basis of the Data Protection Act is a set of eight data protection
principles. These are described below; they all relate to the processing of
personal data (as defined in Section 4.1.1).
1.
Data must be processed fairly and lawfully. This includes the specific
requirement for the data controller to tell the individual what information
will be processed and why, and whether it will be disclosed to anyone
else. Data must not be processed unless the data subject has given their
consent or the processing is necessary for one of the following reasons:
to perform the data controllers contact with the data subject or to

protect the interests of the data subject;
to fulfil a legal obligation or to carry out a public function;
to pursue the legitimate interests of the data controller unless this

could prejudice the interests of the data subject.
2.
Data must be obtained only for a specified lawful purpose or purposes

and must not be processed in any way that is not compatible with the
purpose(s) this includes the use of the data by any person to whom it
is later disclosed.
3.
Data must be adequate (but not excessive) and relevant to the purpose
for which it is processed. This should be borne in mind by advisers when
determining how much information it is appropriate to collect and retain
in a factfind document.
4.
Data must be kept accurate and up to date.
5.
Data must not be kept for longer than is necessary. This will be dictated
to some extent by FCA rules on how long information must be kept for
(see Section 1.7.5.3).
6.
Data must be processed in accordance with the rights of data subjects.

These include:
the right to receive (on payment of a fee of 10) a copy of the

information being held (the information must be provided within 40
days of a written request);
the right to have the information corrected if it can be shown to be

incorrect.
[2] 111
Unit 2
7.
Data controllers must take appropriate technical and organisational

measures to keep data secure from accidental or deliberate misuse,
damage or destruction. This includes taking reasonable steps to ensure
the reliability of any employees of the data controller who have access to
the data.
8.
Data must not be transferred to a country outside the European

Economic Area unless that countrys data protection regime ensures an
adequate level of protection for the rights and freedoms of data subjects.
Broadly speaking that means that it should be comparable to that within
the EEA.
4.1.3 Enforcement
The Information Commissioner oversees the application of the Data
Protection Act. The Commissioners responsibilities are:
t
to educate organisations about their responsibilities under the Act, and

individuals about their rights;
to take action where necessary to enforce the provisions of the Act.
The Commissioner can take several courses of action if the Commissioner

believes that there has been an infringement of the terms of the Act:
t
serve information notices requiring organisations to provide the

Information Commissioners Office with specified information within a
certain time period;
issue undertakings committing an organisation to a particular course

of action in order to improve its compliance;
serve enforcement notices and stop now orders where there has
been a breach, requiring organisations to take (or refrain from taking)
specified steps in order to ensure they comply with the law;
conduct consensual assessments (audits) to check organisations are

complying;
serve assessment notices to conduct compulsory audits to assess

whether organisations processing of personal data follows good practice
(data protection only);
[2] 112

t
issue monetary penalty notices, requiring organisations to pay up to

500,000 for serious breaches of the Data Protection Act occurring on
or after 6 April 2010 or serious breaches of the Privacy and Electronic
Communications Regulations;
prosecute those who commit criminal offences under the Act; and
report to Parliament on data protection issues of concern.
The enforcement powers of the Information Commissioner include the power

to prosecute a data controller who fails to comply with an information notice
or enforcement notice. This is a criminal offence and there are two further
criminal offences under the Act.
t
It is an offence to fail to make a proper notification to the Information

Commissioner. Notification is the way in which a data controller
effectively registers with the Office of the Information Commissioner, by
acknowledging that personal data is being held and by specifying the
purpose(s) for which the data is being held.
It is also an offence to process data without authorisation from the

Commissioner.
The maximum penalty for these offences is 5,000, unless the case goes to the
Crown Court, in which case there is no limit on the possible fine.
4.1.4 EU Data Protection Directive

On the 25 of January 2012 the European Commission published a proposal for
a new data protection Regulation to replace the existing EU Data Protection
Directive. The proposal sets out a general data protection framework aimed at
unifying the current differing data protection rules in the EU.
Processing of personal data by businesses established in more than one EU
country will be monitored by one single data processing authority (DPA) the
lead authority. The lead authority will be the DPA of the country where the
business has its main offices, i.e. where it carries out its central administration
or where the majority of management decisions take place. The long-term
effect of the new Regulation, should it be adopted, is that current local data
protection provisions mainly exemptions that have been introduced by EU
countries for national reasons would disappear.
[2] 113
Unit 2
The new rules will also apply to non-EU based businesses who offer their
goods and services to EU customers based in the EU. For example, a US
company with a subsidiary in the EU will have to comply with the EU data
protection law as well as local US laws.
A breach of the new rules could result in a fine of up to b1 million or 2% of
the organisations global annual turnover. Currently, the maximum fine in the
UK for breach of data protection law is 500,000.
Under the proposed new laws, serious breaches will have to be notified to
both the DPA and the data subject within 24-hours, opening up a new market
for cyber risk insurance.
An independent data protection officer will have to be appointed by public
authorities and businesses with more than 250 employees.
Data subjects will have to give explicit consent for their data to be used, and
they will have the right to be forgotten, i.e. the right to have all personal data
that businesses hold on them deleted (this includes photos and any links to or
copies of personal data that can be found on the internet, for example on
social network sites).
The draft legislation is expected to come into force around 2015.
[2] 114

1.
What is the correct term for an individual whose personal information is

held and used by a commercial organisation?
2.
What are the main categories of sensitive data under the Data
Protection Act 1998?
3.
What is the difference between a data controller and a data processor?
4.
What is the time limit for the supply of a copy of information held,
following a written request by a data subject?
(a) 14 days.
(b) 30 days.
(c) 40 days.
5.
Which body enforces the terms of the Data Protection Act 1998?
6.
What is the purpose of an information notice, issued in relation to the

Data Protection Act 1998?
7.
What is the correct term for the process by which a data controller
registers the fact that personal information is being held and processed?
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Answers
1.
Data subject.
2.
Racial origin; religious beliefs; political persuasion; physical and mental

health; criminal proceedings.
3.
A data controller is the person or organisation that determines why and

how data will be processed. The data processor is the person who
processes the data on behalf of the data controller.
4.
(c) 40 days.
5.
The Office of the Information Commissioner.
6.
It is issued to indicate that a data controller has failed to comply with

some aspect of the law and requires the data controller to specify what
steps will be taken to ensure compliance.
7.
Notification.
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Section 5
Other laws and regulations relevant to
advising clients
Introduction
In addition to the legislation already described, the interests of financial
services customers are safeguarded by aspects of a range of other laws and
regulations. Some of these relate closely to financial services, while others are
aimed more broadly at the rights of consumers in general.
Section 5 covers part K2 of the Syllabus for Unit 2, showing how a range of
non-tax laws and regulatory schemes affect different aspects of financial
services including consumer credit, pensions and advertising.
5.1 Consumer Credit legislation

The regulation of consumer credit in the UK (with the exception of most
mortgage lenders) is the result of the Consumer Credit Acts of 1974 and 2006.
The 1974 Act established the basic principles of consumer credit regulation,
many of which are still in force today.The 2006 Act consolidated, expanded and
brought up to date the earlier Act.

The purpose of the Consumer Credit Act 1974 was to regulate, supervise and
control certain types of lending to individuals, and to provide borrowers with
protection from unscrupulous lenders. The provisions of the Act, and those of
the 2006 Act, are regulated by the Office of Fair Trading, not the FCA.
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There are many types of lender in the market for financial services, ranging
from large multinational banks to individual moneylenders. The Act sets out
standards by which all lenders must conduct their business. It includes a
number of safeguards under which potential borrowers must be made aware
of the nature and conditions of a loan, and of their rights and their obligations.
The Act affects most aspects of a banks lending activities, including personal
loans and revolving credit such as credit cards. Not all loans are covered by the
Act. Loans for the purchase of a private dwelling are exempt and further loans
for the improvement or repair of a private dwelling are also exempt, provided
that they are from the same lender as the original mortgage loan. Loans raised
on the security of a dwelling but used for other purposes are not exempt,
unless on a first charge basis.
Regulated mortgages are exempt from CCA as they are regulated by the FCA.
Therefore, further advances are exempt, regardless of their purpose. Second
charge loans are covered by the CCA. A regulated mortgage contract is
defined as 40 per cent of the land used as a dwelling by the borrower and
family.
The main elements of the Acts provisions are as follows.
t
Suppliers of loans and credit as defined in the Act must be licensed by

the Office of Fair Trading.
Clients must receive a copy of the loan agreement for their own
records.
Prospective borrowers have a cooling-off period during which they can

review the terms of the loan and, if they wish, decide not to proceed
with the transaction. This applies to all loans regulated by the Act, unless
the loan agreement is signed on the lenders premises.
Undesirable marketing practices are forbidden: for instance,

advertisements must not make misleading claims.
Credit reference agencies must, on request, disclose information held

about individuals and must correct it if it is shown to be inaccurate.
One of the Acts most significant innovations was a system for comparing the
price of lending. This is the annual percentage rate (APR), which must be
quoted for all regulated loans. The APR represents a measure of the total cost
of borrowing and its aim is to allow a fair comparison, between different
lenders, of the overall cost of borrowing.
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The calculation of the APR is specified under the terms of the Consumer
Credit Act 1974 and it takes account of two main factors:
t
the interest rate whether it is charged on a daily, monthly or annual

basis;
the additional costs and fees charged when arranging the loan, eg an
application fee.
The result is that the APR is higher than the actual rate being charged on the loan.

Following a three-year review of consumer credit law, the government decided
to reform the Consumer Credit Act 1974 in order to better protect
consumers and to create a fairer and more competitive credit market. The aim
was to make improvements in three broad areas, as follows:
t
to enhance consumer rights and redress. Consumers are now able to

challenge unfair lending and have access to more effective options for
resolving disputes;
to improve the regulation of consumer credit businesses by ensuring fair

practices and through targeted action to drive out rogues;
to make regulation more appropriate for all kinds of consumer credit

transaction, and to extend protection to all consumer credit and to
create a fairer regime for business.
This reform was implemented through primary and secondary legislation. The
primary legislation is the Consumer Credit Act 2006.
The 2006 Act was introduced in three stages, the main elements of which were
as follows:
t
April 2007: The scope of the Financial Ombudsman Service (see

Section 3.2) was expanded to incorporate consumer credit disputes. At
the same time, the Unfair Relationships Test was introduced for new
agreements: this enables borrowers to challenge credit agreements in
court on the grounds that the relationship between themselves and the
lender is unfair. This replaced the previous concept of extortionate credit
and broadens the rest of the agreement to include relevant factors
other than cost, which might include, for example, the financial
skill/experience of the borrower.
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t
April 2008: The upper limit on the size of loans regulated by the Act
was removed (it had previously been 25,000), so that all new credit
agreements unless exempt are now regulated. The Unfair
Relationships Test, introduced a year earlier, was extended to cover both
new and existing credit agreements.
October 2008: New rules require lenders to supply borrowers with

more information about their accounts on an ongoing basis, for instance
annual statements, and arrears notices if they fall into arrears.
5.1.3 Other consumer credit regulations

The Consumer Credit (Advertisements) Regulations 2004 relate to
the form and content of advertisements for credit. They replace the old
distinction between simple, intermediate and full-credit advertisements, and
establish a single list of items of information that must be included in all credit
advertisements. They also introduce new provisions relating to the calculation
and presentation of APR in advertisements, including a requirement to display
the APR more prominently than other financial information. Other
requirements of the regulations are that:
t
all advertising must be in plain English and must be easily read or clearly
heard;
the name of the advertiser must be included;
the typical APR must be displayed, meaning that at least two-thirds of

those responding to the advert would qualify for it;
if a loan is to be a secured loan, the advertisement must state clearly the

nature of the required security.
The Consumer Credit (Agreements) (Amendments) Regulations

2004 seek to make the agreements signed by customers clearer and easier to
understand, by making some changes to content and layout.
The Consumer Credit (Disclosure of Information) Regulations 2004
specify what information must be disclosed to prospective borrowers, and the
way in which it must be disclosed.
The Consumer Credit (Early Settlement) Regulations 2004 confirm
the entitlement of borrowers, under regulated credit agreements, to a rebate
when all or part of the debt is repaid earlier than when it is due. They also
change the calculation method for such rebates.
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5.1.4 The EC Consumer Credit Directive

The Consumer Credit Directive was adopted by the European Council in May
2008, and legislation implementing its provisions came fully into force on 1
February 2011.
In the UK, the Directive has been implemented by six sets of regulations. The
implementing regulations apply to all consumer credit agreements regulated
under the CCA (other than agreements secured on land), but with
modifications for certain types of agreements.
The changes primarily affect creditors but also impact on credit brokers and
credit intermediaries.
The regulations implementing the Directive are as follows.
t
The Consumer Credit (EU Directive) Regulations 2010 these

make a number of amendments to the CCA and to secondary legislation
made under the CCA to implement various requirements of the
Directive concerning the right of withdrawal and the requirement to
provide adequate explanations. These explanations include the features
of the agreement and the cost and consequences of failure to make
repayments. Under the new regulations, the borrower can withdraw
from an agreement within 14 days following the conclusion of an
agreement (or, if later, once the borrower has received a copy of the
executed agreement), and must repay the credit plus interest for each
day the credit was drawn down.
The Consumer Credit (Total Charge for Credit) Regulations

2010 these set out how the total charge for credit and the APR
disclosed in advertising and consumer information must be calculated.
The new rules for the calculation of the total charge for credit include
some new assumptions and differ slightly from previous requirements.
The Consumer Credit (Disclosure of Information) Regulations

2010 these set out what information must be provided to consumers
before they enter into a credit agreement and the way in which that
information must be provided. The new regulations require precontractual information to be given in good time before the borrower
enters into the agreement, and the information must be clear and easily
legible. The information must be in a standard format to aid
comparability and consumer understanding, and the borrower must be
able to take it away to consider and to shop around.
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t
The Consumer Credit (Agreements) Regulations 2010 these

set out what information must be included in a credit agreement and
how it must be presented, and include requirements on the signing of a
credit agreement. They largely replace previous regulations on the form
and content of agreements. The new rules do not prescribe a certain
format, or the order of information, but they do prescribe the
information that must be included and covers the provision of copies of
executed agreements.
The Consumer Credit (Amendment) Regulations 2010 these

regulations amend errors that were identified in the EU Directive
Regulations, the Disclosure Regulations and the Agreement Regulations.
The Consumer Credit (Advertisements) Regulations 2010

these set out what information must be included in advertisements for
consumer credit agreements and how that information must be
presented. They largely replace previous regulations on advertisements.
Under the new Advertisement Regulations, if an advertisement includes
an interest rate, or any amount relating to the cost of credit, it must
include a representative example, including a representative APR. The
example must be clear and concise and must be more prominent than
the information that triggered the inclusion of the example. The APR
must reflect at least 51 per cent of business expected to result from the
advertisement.
Other key changes include the following.

t
The borrower must be notified of changes in the interest rate under the
agreement in writing before the change takes effect.
The borrower is able to seek redress from the creditor in certain

circumstances if he is unable to obtain satisfaction from the supplier of
the goods or services. This applies in cases where the CCA would not
normally provide for such redress, and where the value of goods or
services is more than 30,000 and the credit does not exceed 60,260.
The existing right to settle a credit agreement early is extended to a

right to make partial early settlements at any time.
The borrower can terminate an open-ended agreement at any time

subject to giving one months notice. The creditor must give two
months notice of termination of credit and must give justified reasons
for termination.
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t
The borrower must be informed if the debt is to be sold to a third party.
Credit intermediaries must disclose the extent to which they are acting
independently or work exclusively with one or more creditors. Any fee
payable to the intermediary must be disclosed up front.
If an application for credit is declined based on information supplied by a credit

reference agency, the creditor must notify the borrower of this and provide
contact details of the credit reference agency.
The Financial Services Act 2012 amended the Financial Services and Markets
Act 2000 (FSMA) to give the government the power to transfer regulation of
consumer credit regulation to the FCA. The government intends to use this
power so that the FCA takes over consumer credit regulation effective from
1 April 2014, the date that the OFT, the current regulator, will cease to exist.
5.2 Unfair contract terms

5.2.1 Supply of Goods and Services Act 1982
The Supply of Goods and Services Act 1982 applies to all contracts (except
those entered into before 1995) involving the supply of services, including
those for the supply of financial services. Its terms mean that, in the absence of
anything specific, the following provisions are automatically deemed to be
included in all such contracts.
t
The service will be performed with reasonable care.
The work will be done within a reasonable time.
A reasonable charge will be made.
5.2.2 The Unfair Terms in Consumer Contracts

Regulations 1999
The Unfair Terms in Consumer Contracts Regulations 1999 apply to any term
in a contract between a supplier of goods and services and a consumer, where
the supplier is acting on behalf of their business and the contract has not been
negotiated on an individual basis. Various qualifying bodies have the power to
act under the Regulations, depending on the nature of the contract and the
industry it covers. They include the FCA, OFT, utility regulators, the
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Information Commissioner and trading standards services. The FCA has had
powers under the Regulations since 2001 for the following contracts:
t
mortgages and the selling of mortgages;
insurance and the selling of insurance;
bank, building society, and credit union savings accounts;
life assurance;
pensions;
investments;
long-term savings.
It can also intervene against firms that are not authorised and regulated by the
FCA where their business affects the financial services sector.
The following contracts are the responsibility of the Office of Fair Trading
(OFT):
t
personal loans;
hire purchase;
credit cards and other credit products.
A contract that has been drafted in advance and which does not offer the
consumer an opportunity to influence the terms of the contract is regarded as
one that has not been individually negotiated and will therefore fall under the
terms of the regulations. Contracts for the sale of land, tenancy agreements
and mortgages can fall under the remit of the regulations where the supplier
is not an individual and is acting in the course of business: a person selling his
own home would be excluded from the regulations but the legislation would
cover a builder selling new houses.
The main areas covered by the regulations are as follows.
5.2.2.1 Fairness
The main requirements are that all terms in regulated contracts should:
t
be fair;
adhere to the requirement of good faith (see Section 5.2.2.3);
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t
not cause a significant imbalance in respect of the rights and obligations

of the various parties to the contract to the detriment of the consumer.
5.2.2.2 Plain language

The written terms of a contract should be expressed in clear, easily
understood language. If there is any doubt about the meaning of a written
term, then the interpretation most favourable to the customer will be adopted.
5.2.2.3 Good faith
A term that causes a significant imbalance between the rights and obligations
of the various parties to the contract to the detriment of the consumer will
be deemed to be in breach of good faith.
It should be noted that any part of a contract that defines the main subject
matter of the contract does not fall under the regulations, as long as it meets
the plain language requirement. So, for instance, in the case of house purchase,
the regulations cannot be used to determine whether the price being charged
for a property is fair.
Examples of unfair terms might be:
t
a term that allows the supplier to terminate the contract on a

discretionary basis without the consumer being offered the same facility;
a term that allows the supplier to terminate a contract without

reasonable notice;
a term that limits the consumers rights to take legal action against the
supplier.
If an element of a contract is found to be unfair, the whole contract is not

necessarily invalidated. The contract may be allowed to continue if it can do so
without the unfair term. The term that is deemed to be unfair will not be
binding on the consumer.
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5.3 Rules regarding occupational pension schemes

The regulation of occupational pension schemes remains quite separate from
the regulation of other financial services, separate even from the regulation of
private pension arrangements such as personal pensions and stakeholder
pensions. Nevertheless, financial advisers should clearly have a good knowledge
of matters relating to occupational schemes, in order to be able to advise, for
instance, individuals who are members of such schemes or employers who may
be considering establishing a scheme.
5.3.1 Pensions Act 2004

The Pensions Act 1995 introduced changes to several aspects of pension
provision and supervision, not least of which related to concern about the
security of occupational pensions. Public confidence in occupational pension
scheme security had been severely dented by the Maxwell affair, where
pensioners funds were used to meet the companies general obligations. The
government sought to restore confidence with measures designed to prevent
fraud and to improve the administration of occupational schemes.
The later Pensions Act 2004 was, in part, a response to the worsening
pensions crisis in the UK. Two particularly important elements of the 2004 Act
are the establishment of the Pension Protection Fund (see Section
5.3.1.2) and the transfer of regulatory responsibility for occupational
pension schemes from the Occupational Pensions Regulatory Authority
(OPRA) to the newly created Pensions Regulator.
5.3.1.1 Pensions Regulator
The Pensions Regulator has wider powers than its predecessor and will take a
proactive and risk-focused approach to regulation. Its mission statement is that
it will work to improve confidence in work-based pensions by protecting the
benefits of scheme members and encouraging high standards and good
practice in running pension schemes.
Like the FCA, the Pensions Regulator has a set of specific objectives:
t
[2] 128
to protect the benefits of members of work-based pension schemes.

Work-based schemes mean all occupational schemes, and also any
stakeholder and personal pension schemes where employees have
direct payment arrangements;

t
to promote good administration of work-based pension schemes;
to reduce the risk of situations arising that may lead to claims for
compensation from the Pension Protection Fund.
The Pensions Regulator aims to identify and prevent potential problems rather
than to deal with problems that have arisen. It will do so by assessing the risks
that may prevent it from meeting its statutory objectives. These risks might
include inadequate funding, inaccurate record keeping, lack of knowledge or
understanding by the trustees, or even dishonesty or fraud. The Pensions
Regulator will consider the combined effect of two factors related to each risk:
the likelihood of the event occurring and the impact of the event on the
scheme and its members. Schemes that are judged to have a higher risk profile
will be more closely monitored than those with lower risk.
The Regulator has a range of powers that enable it to protect the security of
members benefits.
The Regulators powers fall broadly into three categories:
t
investigating schemes in order to identify and monitor risks. All

schemes must make regular returns to the regulator. In addition,
trustees or scheme managers must give notification of any changes to
important information, such as the types of benefit being provided by
the scheme. The Regulator also demands to be informed quickly if the
scheme discovers that it cannot meet the funding requirements, so that
remedial action can be taken at an early stage;
putting things right, which can include:

requiring specific action to be taken to improve matters within a
certain time;
recovering unpaid contributions from an employer who does not pay
them to the scheme within the required period (by the 19th day of
the month following that in which they were deducted from the
members salary);
disqualifying trustees who are not considered fit and proper persons;
imposing fines or even prosecuting certain offences in the criminal
courts.
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t
acting against avoidance, ie preventing employers from deliberately

avoiding their pensions obligations and so leaving the Pension Protection
Fund to cover their pension liabilities. The main actions the Regulator
can take are issuing:
contribution notices, requiring the employer to make good the amount
of the debt either to the scheme or to the Pension Protection Fund;
or
financial support directions, which require financial support to be put in
place for an underfunded scheme.
The Pensions Act 2004 requires the Pensions Regulator to issue voluntary
codes of practice on a range of subjects. The codes provide practical guidelines
for trustees, employers, administrators and others on complying with pensions
legislation, and set out the expected standards of conduct.
The Act also introduces new requirements for trustees to have a sufficient
knowledge and understanding of pension and trust law, and of scheme funding
and investment. Trustees also must be familiar with the trust deed and other
important documents such as the scheme rules and the statement of
investment principles. These requirements came into force in April 2006.
5.3.1.2 Pension Protection Fund
The Pensions Act 2004 established the Pension Protection Fund (PPF) to
protect members of private sector final salary (defined-benefit) pension
schemes whose firms become insolvent with insufficient funds to maintain full
benefits for all the members.
In addition to this responsibility, the PPF also assumes the existing
responsibilities of the Pensions Compensation Board, which compensates
members of both defined-benefit and defined-contribution (money-purchase)
schemes in cases of fraud and misappropriation.
The PPF will ensure that, where a company with an eligible defined-benefit
scheme becomes insolvent with an insufficiently funded scheme, members of
that scheme will still receive the core of the benefits to which they are entitled.
The PPF will provide compensation of:
t
[2] 130
100 per cent for existing pensioners including ill-health retirement and
survivors benefits;

t
90 per cent for pre-retirement members, subject to an overall benefit

cap.
To ensure that PPF compensation retains its value over time, pensions in
payment will be increased in line with the retail price index (RPI) up to a
maximum of 2.5 per cent.
Compensation will be funded in two ways: firstly, by taking over the assets of
pension schemes with insolvent employers, and secondly, by means of a levy on
all private sector defined-benefit schemes and the defined-benefit element of
hybrid schemes.
The levy is split into five parts:
t
a pension protection levy based on risk factors, including underfunding, credit rating and investment strategy. Eventually, this is expected
to constitute at least 80 per cent of the total amount collected by the
PPF;
a pension protection levy based on scheme factors, such as the

numbers of active and retired members;
an administration levy, covering the set-up cost and ongoing costs of

the PPF;
a PPF Ombudsman levy, covering the costs of the PPF Ombudsman;
a fraud compensation levy, replacing the Pensions Compensation

Board levy.
5.3.2 The Pensions Act 2011

The reforms in the Pensions Act 2011 focus on the auto-element into
workplace pensions for employees whose earnings exceed an earnings
threshold, and who are not already members of a pension scheme. Auto
enrolment began in October 2012.
The criteria for auto-enrolment are that the employee:
t
is not already in a pension at work;
is aged 22 or over;
is under state retirement age;
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t
earns more than the income tax personal allowance (9,440 for the tax
year 2013/14);
works in the UK.
Further considerations:
t
employees may be allowed to opt out if they wish but cannot be forced
or incentivised to;
eligible employees will have to be automatically enrolled into the scheme

provided by the employer or the Government-sponsored default
scheme called NEST (the National Employment Savings Trust);
a minimum of 8% of employees earnings will have to be paid into the

scheme, made up of an employer contribution of 3% and an employee
contribution of 4% and tax relief of 1%.
The requirements are being phased in gradually over a four year period and
initially only affect larger employers. Employers are required to offer a Pension
scheme which complies with the new rules but many employers already offer
schemes which meet or exceed the requirements.
The Act puts into law changes to the State Pension age timetable. From April
2016, womens State Pension age will rise faster than originally planned,
equalising with mens at 65 by November 2018. Between December 2018 and
October 2020, men and womens State Pension ages will be increased from 65
to 66.
The Act also changes the measure of inflation for revaluation and indexation
of occupational pension schemes from RPI to CPI.
5.4 EU directives
As mentioned in Section 1.1, directives issued by the European Union are
binding, as to the result to be achieved, upon each member state to which they
are addressed. What this means is that the objectives of the directive have to be
achieved but the choice as to exactly how they are achieved is left to national
authorities in each state. As a result, much of the UK regulation about financial
services is derived from European directives. Some examples are given below.
[2] 132
5.4.1 Banking
A significant EU directive issued in March 2000 (known as the Second Banking
Directive) consolidated the earlier directives that gave institutions the freedom
to establish and pursue the business of credit institutions (banks, building
societies and similar organisations) throughout the European Union. It
describes:
t
what constitutes a credit institution: an undertaking whose business is

to receive deposits or other funds from the public and to grant credits
for its own account;
the minimum funding (and other) requirements for an institution to be

authorised as a credit institution;
the way in which institutions can become authorised (through their

home states appropriate regulatory authority, ie the FCA in the UK);
the activities that an authorised credit institution can carry out, including
acceptance of deposits, lending of various kinds including mortgages,
leasing, money transmission, trading in money markets, portfolio
management and safe custody services.
5.4.2 Investment
The 1993 Directive on Investment Services in the Securities Field, commonly
known as the Investment Services Directive (ISD), came into force at the
beginning of 1996. Its aim was to enable investment firms to operate in
different European states in much the same way as other directives have
broadened the markets for banks and for the insurance industry, by providing
direct access to well-regulated markets across the EU.
In the same way as with credit institutions, firms that provide certain specified
investment services must first be authorised in their own home state. They can
then operate in the other member states without requiring further
authorisation from the authorities in those other states.
In order to obtain and retain authorisation in their home state, investment
firms must comply with certain prudential rules drawn up by the authorities in
the home state. The general nature of these prudential rules was first specified
in the ISD and later incorporated in a subsequent directive that replaced it
(MiFID, see below). They include, for example, requirements that investment
firms must have:
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t
sound administrative and accounting procedures;
adequate controls to safeguard electronically held data;
adequate internal control mechanisms, including rules about personal

transactions by their employees.
5.4.2.1 Markets in Financial Instruments Directive

The ISD has been revised by a new directive, the Markets in Financial
Instruments Directive (MiFID). A firm that is subject to MiFID has the right to
operate throughout the EEA on the basis of a single authorisation in its home
state. The aim of the directive is to make cross-border activity easier to
conduct by imposing a single set of rules across the EEA. Firms affected will
include securities and futures firms, banks conducting securities business,
recognised investment exchanges and alternative trading systems. MiFID does
not apply to life assurance, pensions or mortgage business.
MiFID applies to certain types of investment activity when they involve
specified financial instruments. The types of investment activity covered by
MiFID include:
t
receipt and transmission of orders from investors;
execution of such orders on behalf of customers;
investment advice;
discretionary portfolio management (on a client-by-client basis) in

accordance with mandates given by investors;
underwriting the issue of any of the specified financial instruments.
However, there is an important exemption from MiFID for firms that meet the
following requirements. UK firms are exempt from MiFID if they:
t
do not hold client money or securities; and
restrict their business to transmitting orders for transferable securities and

collective investment schemes and to giving advice on such investments;
transmit orders only to authorised credit institutions (such as banks),

investment trust companies, collective investment schemes and MiFID
investment firms (such as stockbrokers).
In broad terms, this should exempt advisers that do not hold client money and
do not advise on or arrange complex investments such as derivatives.
[2] 134
However, any firm making use of the exemption will not be able to engage in
cross-border business.
The specified financial instruments include:
t
transferable securities, such as stocks and shares;
units in collective investment undertakings, such as unit trusts;
money market instruments;
financial futures contracts;
forward interest rate agreements;
interest rate, currency and equity swaps;
options to acquire or dispose of the instruments mentioned in this list,

including options on currency and on interest rates.
Life assurance, pensions and mortgages are outside the scope of MiFID.
Because it is expected that most financial advisers will be exempt from MiFID,
this text will refer to non-MiFID situations, unless otherwise stated.
5.4.2.1.1 MiFID II
The European Commission launched proposals for reform in December 2010,
which are intended to tackle some of the issues that were missed in the
original MiFID.
MiFID II is expected to switch European regulation from a principles-based
philosophy to a more rules-based regulatory regime, much like that in the US.
It is also expected that it will extend the regulations across asset classes,
pushing non-equity products (such as bonds, structured products and over-thecounter derivatives) onto organised trading platforms. It will provide new
safeguards for algorithmic and high frequency trading activity, and impose
stricter requirements for portfolio management, investment advice and other
investor protections.
The aim of MiFID II is to promote competition, modernise market structures,
increase market transparency, reduce data fragmentation, enhance investor
protection and harmonise regulatory regime. This is the second version of the
MiFID directive, the actual provisions of which are not expected to go live
until 2015.
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5.4.2.2 Undertakings for Collective Investment in Transferable

Securities
Undertakings for Collective Investment in Transferable Securities (UCITS)
legislation provides a framework of investor protection and product control,
which allows open-ended investment schemes (OEICs) to be promoted to the
general public across the EU, irrespective of which member state a scheme is
authorised in. The current directive (UCITS IV) is the latest in a series of
directives, implemented on 30 June 2011.
The legislation lays down the principle of mutual recognition of authorisation
that facilitates the free circulation within the EU of the units of funds covered
by the directive. The funds must comply with various requirements, which
include having an adequate spread of risk among their underlying investments,
and a high degree of liquidity to enable investors to redeem their units on
demand. From July 2011, management companies established in any EU state
have been able to operate UCITS funds established in another.
5.4.3 Insurance
The two main objectives of a European single market for insurance are:
t
to provide all EU citizens with access to the widest possible range of

insurance products, while ensuring the highest standards of legal and
financial protection; and
to enable an insurance company authorised in any of the member states

to pursue its activities throughout the EU.
In setting out to achieve these objectives, the EU has always dealt with life
assurance and non-life insurance separately, in order to take account of their
different characteristics and also in acknowledgment of the close ties that life
assurance has with the long-term savings industry.
5.4.3.1 Life assurance
The first Directive relevant specifically to life assurance was adopted in 1979
with the aim of setting out how the right of establishment included in the
Treaty of Rome might be put into effect for life assurance companies.The 1979
Life Directive defined life assurance as including the following categories:
[2] 136

t
life assurance (ie policies payable on survival of a specified term, on

death, on survival of a term or earlier death, on death within a specified
term, on birth, or on marriage);
annuities;
personal injury, incapacity for employment and accidental death, when

underwritten in addition to life assurance;
permanent health insurance.
The second Life Directive, issued in 1990, laid down special rules relating
to the freedom to provide cross-frontier services in the life assurance field. It
covers individual policies and group life, but not group pension funds.
Arrangements for regulation and supervision of insurance policies fall into two
categories, depending on the reason why the applicant is taking out the policy.
t
If the policy is being taken out wholly on the applicants own initiative, the
regulations that apply are those of the country in which the insurance
company is established. Applicants who take out a life policy with an
insurer established in a different state are required to sign a declaration
confirming that they are aware that the regulatory rules of the other
country will apply.
If the applicant requires the insurance because of a specific rule of the state
in which they reside, then regulation and supervision is by that state, in
order to guarantee that the appropriate cover is provided.
In 1992, the third Life Directive sometimes also known as the Life
Framework Directive was adopted. Like all EU directives, its provisions had to
be incorporated into the legislation of all the member states. In the UK, for
example, its provisions were incorporated into insurance legislation (based
largely on the Insurance Companies Act 1982) through the Insurance
Companies (Third Insurance Directive) Regulations 1994.
In order to obtain authorisation, a company must:
t
limit its business activities to insurance only;
submit a scheme of operation in a format specified in the Directive;
be run by technically qualified persons of good repute;
possess the minimum guarantee fund;
notify the identities of shareholders and the amounts of their

shareholdings.
[2] 137
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The financial supervision of an insurer is the responsibility of its home state;

this supervision includes valuation of assets and liabilities, and the consequent
verification of solvency. Local legislation may apply in the states where the
insurance is sold, in relation to advertising, marketing and contract matters.
Similarly, any premium taxes applied are those of the state in which the
insurance is sold (at present, in the UK, insurance premium tax applies to
general insurance but not to life assurance).
The Directive requires the harmonisation of national laws where this is
necessary for its principles to work smoothly throughout the EU. These
principles include:
t
the choice, valuation, diversification and location of assets used to

support the companys liabilities. Earlier rules requiring assets to be
located in the state in which the business was transacted were removed
in line with other measures designed to increase the freedom of capital
movements;
the actuarial principles applied in the calculation of assets and liabilities.
Policyholders must be able to withdraw from the contract within a coolingoff period of between 14 and 30 days from the time when they are informed
that the contract has been made. This rule is reflected in the UK through the
issuing to customers, by the insurance company, of a statutory cancellation
notice. Customers then have 14 days in which to return the notice to the
company and cancel the policy with a refund of any premium paid.
Policyholders must also be provided with clear and accurate information about
the essential characteristics of the products offered to them, to assist them in
choosing an appropriate product. This requirement is met in the UK by the
issue of a key features document (see Section 1.7.5.6).
In 2002, a fourth Life Directive was issued: the previous three Life
Directives (and certain other directives) were repealed and replaced by this
single directive that covers all aspects of life assurance. It is largely a
consolidation directive, bringing together the provisions of earlier directives
concerning the concept of a single licence and harmonising local rules on
authorisation and the regulation that is required to make the single-licence
system work.
[2] 138
5.4.3.2 General insurance

In 1988, the Second Non-Life Council Directive laid down rules for crossfrontier non-life insurance that balance the needs of freedom of service and
consumer protection. This allowed companies to supply insurance in another
member state without having to establish a branch or subsidiary in the other
state.
The Third Non-Life Council Directive, issued in 1992, completed the process
and now any insurance company whose head office is in one of the member
states can establish branches, and carry on non-life insurance business, in any
other state. That activity will be under the supervision of the competent
authorities of the member state in which the insurance companys head office
is situated.
Authorisation to carry out insurance business under the terms of this directive
is granted for a particular class of insurance (or even, sometimes, for some of
the risks relating to a particular class). Companies can, of course, be authorised
for two or more classes. General insurance risks are classified into a large
number of categories, including: accident; sickness; land vehicles; railway rolling
stock; ships; aircraft; property; and a range of types of liability.
In some cases, authorisation can be given for more than one class together: the
accident and sickness classes can be authorised as accident and health
insurance. There are, however, specific rules on compulsory insurances against
accidents at work, such as employers liability insurance in the UK.
5.4.3.3 Insurance intermediaries
As well as ensuring that insurance companies can operate throughout the
community, the EU also wants to ensure that retail markets in insurance are
accessible and secure. To this end, a Directive on Insurance Mediation
came into force in January 2003, the purpose of which is to establish the
freedom for insurance intermediaries to provide services in all states
throughout the EU. It was felt, prior to the development of this Directive, that
the liberalisation of the insurance sector had benefited the wholesale market
(large industrial and commercial risks) to the detriment of the retail market
(insurance for private individuals). The 2003 Directive replaces an earlier
(1977) Directive that first introduced plans to give insurance brokers and
agents the freedom to operate across the community, and a 1992
recommendation from the European Commission about qualifications to be
[2] 139
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required of insurance intermediaries. The 2003 Directive is now the sole

European statute governing insurance intermediaries.
Insurance mediation is defined in the directive as the activities of
introducing, proposing or carrying out other work preparatory to the
conclusion of contracts of insurance, or of concluding such contracts, or of
assisting in the administration and performance of such contracts, in particular
in the event of a claim. When an employee of the insurance company, or
someone acting under the responsibility of the insurance company (a tied
agent), carries out such activities, they are not included in the definition of
insurance mediation.
The Directive establishes a system of registration for all independent insurance
(and reinsurance) intermediaries. They must be registered with a competent
authority in their home state: independent financial advisers based in the UK
who are selling life assurance or general insurance must be registered with the
FCA.
Registration is subject to strict requirements regarding professionalism and
competence: intermediaries must have the necessary general, commercial and
professional knowledge and skills. Exactly what this means depends on the
relevant national authority, but it will almost certainly include a requirement
for appropriate training and a specified level of qualification, and possibly a
programme of continuing professional development. In the UK, the FCA have
set out their requirements in considerable detail in the Training and Competence
part of the FCA Handbook.
Insurance intermediaries are also required to be of good repute. Again, local
interpretations of this may vary, but minimum requirements are that an
intermediary must not have been:
t
convicted of a serious criminal offence relating to crimes against

property or other financial crimes;
declared bankrupt.
The Directive also requires that insurance intermediaries should hold

professional indemnity insurance of at least b1m per case and b1.5m in total
per annum. The whole question of professional indemnity insurance in the UK
has become very difficult in recent years: problems such as the pensions misselling scandal, and the failure of some mortgage-related endowments to
provide sufficient funds to repay policyholders loans, have made professional
indemnity insurance more difficult to obtain and more expensive.
[2] 140
Rules are also included to protect clients funds, including the requirement to
keep client money in strictly segregated accounts. This is backed up by a
requirement for intermediaries to have financial capacity of an amount equal
to at least 4 per cent of premiums received per annum, subject to a minimum
of b15,000.
The regulations specify in some detail what information an intermediary must
give to a customer. In relation to the intermediary, the following information
must be supplied:
t
name and address;
details of registration and means of verifying the registration;
whether the intermediary has any holding of more than 10 per cent of
the voting rights or capital of an insurance company;
conversely, whether any insurance company has a holding of more than

10 per cent of the voting rights or capital of the intermediary;
details of internal complaints procedures and of external arbitrators (eg

ombudsman bureaux) to which the customer could complain;
whether the intermediary is independent or tied to one or more

insurance companies.
In relation to the advice offered and products recommended:

t
independent intermediaries must base their advice on analysis of a

sufficiently large number of contracts available on the market to enable
them to recommend, in accordance with professional criteria, a product
that is adequate to meet the customers needs;
the intermediary must give the customer (based on the information

supplied by the customer) an assessment of the customers needs and a
summary of the underlying reasons for the recommendation of a
particular product. This requirement is satisfied in the UK by the use of
a confidential client questionnaire, or factfind, to obtain the necessary
information, and by the issue of a reason why letter to justify the
specific recommendation.
All information provided by an intermediary to a customer must be set out in

a clear and accurate manner, and must be comprehensible to the customer.
The requirements of this directive are closely reflected by rules in the FCAs
Conduct of Business sourcebook.
[2] 141
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The EU Commission issued a Consultation Paper on proposed revisions to the

existing Insurance Mediation Directive on 28 February 2011, and was aiming to
issue a legislative proposal in late 2011, widely known as IMD2.
The aim of IMD2 is to provide better consumer protection and greater legal
clarity and certainty than the current IMD provides.
It is anticipated that there will a review of conduct of business rules for the
sales of insurance products in the EU, and this along with the review of MiFID
and a new Directive on Packaged Retail Investments (PRIPS) which is to
focus on pre-contractual disclosure requirements will result in
modernisation, increased consumer protection, and the elimination of
obstacles to the functioning of the single market through greater
harmonisation. This, in turn, should result in an increase in choice for the
consumer through an expected increase in cross-border purchasing.
The European Commission published legislative proposals for IMD 2 on 3 July
2012. Key reforms proposed include:
t
An extension of the scope of the IMD to cover direct insurance sales as

well as professional claims management and loss adjusting;
Mandatory disclosure by insurance intermediaries of the nature (i.e. fee

and/or commission), basis and amount of remuneration received as well
as any variable remuneration received by individual employees;
Stricter requirements for the sale of life insurance products with

investment elements;
Additional information requirements for the sale of bundled products;

and
A simplified procedure for cross-border entry to insurance markets

across the EU, through the use of a single electronic database of crossborder insurance intermediaries.
The most significant reforms under the IMD 2 proposals for the UK insurance
market are the new mandatory remuneration disclosure requirements. These
are likely to have a major effect in connection with the sale of general
insurance because, although mandatory prior disclosure of commission has
been debated many times over the years, it has been strongly opposed by the
general insurance industry and has never been introduced under domestic
rules. These new rules may affect insurer and intermediary relationships and
commercial structures within the UK, as well as possibly leading to changes in
staff remuneration structures.
[2] 142
Certain additional information requirements proposed under IMD 2 are also

likely to have an impact on participants in the UK market, and the new
requirements in relation to bundling, tying and cross-selling will also be
relevant, although the FCA is already planning measures for packaged bank
accounts which cover bank accounts with ancillary insurance coverage.
However, a number of other developments under IMD 2 will have limited
impact in the UK:
t
Direct insurance sales have been regulated in the UK under the

Insurance: Conduct of Business sourcebook (ICOBS) since 2005 and,
consequently, the impact of the extension of scope of IMD 2 to direct
insurance sales will be more dramatic in other Member States;
In the life assurance investment sector, the impact will be limited due to
the comprehensive nature of existing FCA rules. Furthermore, the new
rules in respect of adviser charging, and the banning of commission-style
remuneration, that came into force on 1 January 2013 go much further
than IMD2 in any event.
5.5 CAT standards

The government has long been concerned that many financial products are:
t
too complex for financially unsophisticated customers to understand;

and/or
too expensive in terms of the charges levied by the product providers.
The government has tried to counteract this by introducing a set of charges,

access and terms standards (CAT standards) intended to help less
knowledgeable investors choose a suitable deal.
Originally, CAT standards were applicable to ISAs (at the product providers
discretion) but, following the introduction of the Sandler suite of simplified
products (see Section 1.7.6), CAT standards for new ISAs have been
withdrawn.
CAT standards for mortgages remain in force. These are standards that can be
applied to mortgage products, although lenders are not obliged to offer CATstandard mortgages and there is no guarantee by either the government or the
lender that a CAT-standard mortgage will be the most suitable product for a
particular borrower.
[2] 143
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CAT-standard mortgages are likely to appeal to borrowers who wish to have

clearly stated limits on charges. Examples of the limits set on charges and other
costs are that:
t
the variable interest rate must be no more than 2 per cent above Bank
of England base rate, and must be adjusted within one calendar month
after the base rate is reduced;
interest must be calculated on a daily basis;
arrangement fees cannot be charged on variable-rate loans and no more

than 150 can be charged for fixed-rate or capped-rate loans;
maximum early redemption charges apply to fixed-rate and capped-rate

loans;
no separate charge can be made for mortgage indemnity guarantees;
all other fees must be disclosed in cash terms before the customer
makes any commitment.
Other rules relating to access and terms include:

t
normal lending criteria must apply;
the customer can choose on which day of the month to pay;
all advertising and paperwork must be clear and straightforward;
purchase of related products cannot be made a condition of the offer.
Although the rules relating to CAT standard mortgages are still valid, there are
few if any lenders offering such products at the time of writing (April 2013).
5.6 Advertising standards

In addition to abiding by the rules laid down in industry-specific regulations,
advertisements for financial services and financial products must meet the
standards laid down in the British Code of Advertising under the supervision
of the Advertising Standards Authority (ASA).
The ASA was set up in 1962 and is an independent self-regulatory body, which
administers the British Codes of Advertising and Sales Promotion, the Radio
Advertising Standards Code and the Television Advertising Standards Code.
[2] 144
It covers virtually all advertisements, ie those that appear in:

t
the national and regional press, magazines and free newspapers;
posters, hoardings and transport sites;
direct mail leaflets, brochures, catalogues and circulars;
cinema commercials, videos, CD-ROMs and the internet;
pack promotions, competitions and prize draws;
television and radio programmes.
The ASA can take action against individuals and organisations whose
advertising contravenes the code. The first step is usually to discuss the
offending advertisement with the advertiser and, if an acceptable explanation is
not given, to require that the advertisement is changed or withdrawn.
A number of sanctions are used against offenders, ranging from the adverse
publicity generated by its adjudications to legal proceedings in the case of
persistent or deliberate offenders. This legal action is available through a
referral of the advertiser, agency or publisher to the Office of Fair Trading.
The Advertising Code requires that advertisements should be prepared with a
sense of responsibility to consumers and society, and should respect the
generally accepted principles of fair competition in business. Specifically, the
Code requires that all advertisements should be:
t
legal, ie containing nothing that breaks the law, or incites anyone to do

so, and omits nothing that the law requires;
decent, ie containing nothing that is likely to cause serious or

widespread offence, judged by current prevailing standards of decency.
Account is taken of the context of the advertisement, the medium used
and the likely audience. Particular care should be taken with sensitive
issues such as race, religion, sex or disability;
honest, ie not exploiting the credulity, lack of knowledge or

inexperience of consumers;
truthful, ie not misleading by inaccuracy, ambiguity, exaggeration,

omission or any other means.
Advertisers are permitted to express opinions, including opinions about the

desirability of their products, provided that it is clear that it is opinion and not
a statement of fact. Assertions or comparisons that go beyond subjective
opinion must be able to be objectively substantiated.
[2] 145
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5.7 Banking Regulation

5.7.1 The Lending Code
Prior to November 2009, the regulation of most aspects of banking operations
was based on the Banking Code, a voluntary code of practice adhered to by
most banks and building societies. The regulation of deposit and payment
products has, however, now been transferred to the FCA, based on its Banking
Conduct of Business Sourcebook (BCOBS see Section 5.7.2). As a result, a new
voluntary code, the Lending Code, has been established to replace those
parts of the old Banking Code that related to lending.
The Lending Code has since been revised (March 2011).
The Lending Code is a self-regulatory Code which sets minimum standards of
good practice when dealing with the following customers in the UK:
t
consumers;
micro-enterprises; or
charities (with an annual income of less than 1m).
It applies to lending in sterling, although subscribers are not precluded from

applying the standards to lending in other currencies.
Subscribers must at all times comply with the Consumer Credit Act 1974, the
Consumer Credit (EU Directive) Regulations 2010, the Equality Act 2010 and
other relevant legislation. Compliance with the code is monitored and
enforced by the Lending Standards Board.
The code covers most loans, credit cards, charge cards and current account
overdrafts (but not mortgages, which are regulated by the FCA).
Lenders who subscribe to the code agree to act fairly and reasonably in all
their dealings with customers by, as a minimum, meeting all of the following
commitments.
t
Subscribers will make sure that advertising and promotional literature is

fair, clear and not misleading and that customers are given clear
information about products and services.
Customers will be given clear information about products and services

before, during and after the point of sale, including how they work, their
terms and conditions and the interest rates and charges that apply to them.
[2] 146

t
Regular statements will be made available to customers (if appropriate).

Customers will also be informed about changes to the interest rates,
charges or terms and conditions.
Subscribers will lend money responsibly.
Subscribers will deal quickly and sympathetically with things that go

wrong and act sympathetically and positively when considering a
customers financial difficulties.
Personal information will be treated as private and confidential, and

subscribers will provide secure and reliable banking and payment
systems.
Subscribers will make sure that their staff are trained to put this code
into practice.
In addition to the above commitments, the code covers the following areas:
t
Communications and financial promotions communications

must be clear, fair and not misleading, and customers must be provided
with appropriate information at the right time to make informed
decisions. Plain language must be used to ensure that customers can
better understand the information being provided to them, avoiding
technical jargon or legal language. Financial promotions should comply
with relevant legislation and industry codes of practice, such as the
Consumer Credit (Advertisements) Regulations 2010.
Credit reference agencies (CRAs) subscribers should tell

customers applying for credit if a search will be made at a CRA, if a record
is kept of this and, if so, that this could impact on their ability to obtain
credit elsewhere in the short term. Customers should also be told that
details of their account, if opened, will be passed to CRAs and that such
information will be accessed and used by others.This must be accepted as
a condition of borrowing.The code also sets out which information about
a customers debts can be given to CRAs, but that the customer must be
given 28 days notice of the intention to disclose such information.
Credit assessment before lending any money, granting or increasing

an overdraft or other borrowing, subscribers should assess whether the
customer will be able to repay in a sustainable manner, considering
information from CRAs and any existing financial commitments. They
should also take into account the type of credit sought, how they have
handled their finances in the past, declared income, the purpose of the
loan and any security provided.
[2] 147
Unit 2
t
Current account overdrafts this section covers pre-sale

information; that it should be clear, fair and not misleading, and should
outline the availability of the overdraft , the qualifying criteria, and details
of charges and interest. It also covers point of sale and post-sale
information that should be given to the customer.
Credit cards this section covers pre-sale and point of contract

information that must be given to the customer, which includes: how
interest is calculated and charged; interest rates; how monthly payments
are applied; any promotional offers; the different interest rates applicable
to different types of transactions; Chip and Pin details; statements;
unauthorised transactions; credit limits, etc.
Loans the code states that if a person is declined for a loan, the
subscriber must explain the main reason why, and the customer must be
given contact details of any CRA used if the refusal to lend is as a result
of information supplied by them.
Terms and conditions customers must be provided with, and

encouraged to read, the terms and conditions for any lending product
before they commit to purchasing a product. Terms and conditions must
be in clear and intelligible language and in an easy to read format, and
borrowers must be told how they will be informed of any changes to
these terms and conditions once they become a customer.
Financial difficulties subscribers must be sympathetic and positive

when considering a customers financial difficulties, although there is an
onus on customers trying to help themselves. Furthermore, subscribers
should make available to customers information on their procedures
and systems for dealing with customers in financial difficulties. This
section also covers consolidation loans, the use of the right of set- off,
token offers and write-offs, debt recovery procedures, repayment plans
and interest charges and concessions.
Complaints subscribers should have a set of internal procedures for

handling complaints which should be clear and well-defined. On entering
a contract, customers should be informed about where they can find
these procedures. Customers should be kept informed about the
subscribers progress in dealing with a complaint and provide a response
within eight weeks (or an explanation as to why a final response has not
yet been reached). Details of how they can refer their complaint to the
Financial Ombudsman Service should also be supplied to customers.
[2] 148

t
Monitoring subscribers should appoint a Code Compliance Officer

who is responsible for co-ordinating an annual statement of compliance,
compliance visits and other contact with the Lending Standards Board.
5.7.2 Banking Conduct of Business rules

On 1 November 2009 the Banking Conduct of Business Sourcebook (BCOBS)
and the Payment Services Regulations (PSRs) (see section 3.5.1) were launched
by the FSA, the former regulator and predecessor to the FCA.
BCOBS introduced principles-based regulation to the deposit-taking products
and services for consumers. The Payment Services Regulations implemented in
the UK the EU Payment Services Directive, which prescribes the way that
payments are to be undertaken within the European Economic Area (EEA).This
regulation relates directly to the retail banking sector and should improve
protection for consumers.
The Banking Code is now redundant and those areas not covered by BCOBS are
now addressed by the Lending Code (see section 5.6), overseen by the Lending
Code Standards Board. The changes were required for a number of reasons:
t
With the FSA, as the competent authority for the UK at the time, taking
responsibility for the PSRs, it seemed common sense that it should also
take responsibility for customers core financial services relationships
through BCOBS.
There were concerns that the content of the Banking Code had
responsibility spread between a number of organisations, meaning no
one organisation had clear accountability: by the FSA taking control it
increased the FSAs (and now the FCAs) regulatory effectiveness.
The Treating Customers Fairly (TCF) principle did not have an

equivalent within the Banking Code, which could be detrimental to
customers. The FCA, however, has the ability to fine and suspend
operations of providers if it sees fit.
UK branches of credit institutions authorised in other EEA states

tended not to subscribe to the Banking Code. They are now subject to
BCOBS rules, which afford better protection for customers.
There was increased pressure from government and the public for more
controls over the financial services sector due to recent regulatory failures.
It has been necessary to bolster public confidence in the UK financial
services industry and further regulation may go some way to doing this.
[2] 149
Unit 2
There are six chapters to this Sourcebook:

t
BCOBS 1: Application The Sourcebook applies to a firm with respect

to the activity of accepting deposits from banking customers carried on
from an establishment maintained by it in the UK and activities
connected with that activity.
BCOBS 2: Communications with banking customers and

financial promotions This chapter requires a firm to pay regard to the
information needs of banking customers when communicating with, or
making a financial promotion to them, and to communicate information
in a way that is clear, fair and not misleading.
BCOBS 3: Distance communications and e-commerce This

chapter applies to a firm that carries on any distance marketing activity
from an establishment in the UK, with or for a consumer in the UK or
another European Economic Area state. It contains many of the
provisions of the Distance Marketing Directive.
BCOBS 4: Information to be communicated to banking

customers and statements of account This chapter contains details
about how a firm must provide or make available to banking customers
appropriate information about a retail banking service and any deposit
made in relation to that retail banking service.
BCOBS 5: Post-sale requirements A firm must provide a service in

relation to a retail banking service that is prompt, efficient and fair to a
banking customer and which has regard to any communications or
financial promotion made by the firm to the banking customer from
time to time. This includes dealing with customers in financial difficulty,
those that wish to move bank accounts, and lost and dormant accounts.
BCOBS 6: Cancellation This chapter sets out a customers rights to

cancel in various circumstances and when there are no rights to
cancellation.
5.7.3 Payment Services Regulations

Payment Services Regulations (PSRs) cover most payment services, including
the provision and operation of payment accounts. Payment accounts cover
accounts on which payment transactions may be made and where access to
funds is not restricted, for example in fixed-term deposits. The regulations
extend from information to be provided before a payment is made to the
remedial action firms must take if a payment goes wrong.
[2] 150
The PSRs conduct of business provisions only apply to payment services made
in euros or sterling, so primarily to sterling and euro-denominated accounts.
The Financial Ombudsman Service provides out-of-court redress, the Office
of Fair Trading (at the time of writing in January 2012) is responsible for
requirements relating to access to payment systems, and HM Revenue and
Customs is responsible for supervision of the anti-money-laundering measures
taken by businesses providing payment services.
The PSRs affect firms providing payment services and their customers. These
firms include:
t
banks;
building societies;
e-money issuers;
money remitters;
non-bank payment card issuers; and
non-bank merchant acquirers.
There is a new class of regulated firms known as payment institutions (PIs),

which must either be authorised or registered by the FCA. Authorised PIs are
to be subject to prudential requirements. Conduct of business requirements
apply to all payment service providers, including banks, building societies,
e-money issuers and the new PIs.
5.7.3.1 Electronic Money Regulations 2011
This is actually the second Electronic Money Directive (2EMD) and it aims to
encourage the growth of the electronic money market. It was implemented in
the UK on 30 April 2011.
Electronic money (e-money) is electronically stored monetary value issued on
receipt of funds for the purpose of making payment transactions, including
pre-paid cards and electronic pre-paid accounts for use online.
The issuance of e-money has been regulated since 2002; the Electronic Money
Regulations 2011 introduce a few new requirements for all electronic money
issuers (EMIs), and new authorisation/registration and prudential standard for
electronic money institutions. A summary of the new requirements are as
follows.
[2] 151
Unit 2
t
EMIs are no longer allowed to set a time limit on the e-money holders
right to redeem (although a proportionate fee can be charged for
redemption in certain circumstances).
EMIs are also not allowed to refuse to redeem e-money if it is worth

less than b10.
EMIs are not allowed to grant interest or other benefits related to the
length of time the e-money is held.
EMIs can provide payment services that are unrelated to the issuing of
e-money and engage in other business activities (subject to relevant EU
and UK law) without additional authorisation/registration with the FCA.
Businesses with average outstanding e-money not exceeding b5m can

apply to be registered as small EMIs, but will not be able to passport
to other EU states.
The initial and ongoing capital requirements for authorised EMIs have
been reduced.
All EMIs must safeguard funds received from customers for e-money so
that, if it becomes insolvent, the e-money issued will be protected from
creditors and can be repaid to their customers.
5.8 Competition Commission

The Competition Commission is an independent public body whose aim is to
ensure healthy competition between companies in the UK, based on the
premise that the existence of healthy competition leads individual companies
to charge reasonable prices and to supply a good quality product. It replaced
the Monopolies Commission in 1999 as a result of the Competition Act 1998.
The Competition Commission investigates issues of concern which are
referred to it by other authorities. Many of the referrals are from the Office of
Fair Trading, but it also deals with concerns raised by the regulators of the
utility companies and other public service organisations such as transport and
postal services.
The areas of concern addressed by the Competition Commission fall into
three main areas:
t
[2] 152
mergers: where a merger or takeover will result in one company having

more than 25 per cent of market share;

t
markets: where there is a danger of competition being restricted in a

particular market;
regulation: where the major regulated industries (financial services is

clearly one of them) may not be operating fairly.
If the Commissions investigations determine that a particular situation has a

significantly damaging impact on competition (or would do if it went ahead), it
has sweeping powers to implement appropriate remedies. It can, for instance,
prevent a merger from taking place, or require a company to sell off a part of
its business.
In 2008, the government allowed a merger between two major banking groups
(LloydsTSB and HBOS). This created a bank that controls about 25 per cent of
UK bank accounts and a similar proportion of the mortgage market. This
would normally have resulted in a referral to the Competition Commission,
but the government ruled that the need to stabilise the banking industry in the
face of the credit crisis outweighed concerns about reduced competition.
5.9 The Enterprise and Regulatory Reform Bill

On 23 May 2012, the government published the Enterprise and Regulatory
Reform Bill, the reforms contained within which are expected to come into
force in April 2014. The Bill proposes to reform some of the central features
of the UK competition regime, namely anti-trust [competition] enforcement
procedures, criminal cartel enforcement, market investigations and merger
control.
Key modification in the field of anti-trust enforcement include greater publicity
from the start of investigations, extending information-gathering powers, and
lowering the threshold for the imposition of interim measures on parties
subject to investigation.
In respect of criminal cartel enforcement, under current law, an offence is
committed if an individual is part of a cartel and acts dishonestly. Under the
proposals in the new Bill, the government proposes to remove the
requirement to prove dishonesty, materially increasing the risk of prosecution
for individuals involved in price-fixing or market-sharing arrangements.
In the area of market investigations, the OFT currently has to rely on voluntary
submissions of information during the initial stages of any market study it
conducts until it considers it has the power to begin an official investigation.
[2] 153
Unit 2
Under the new proposals, witnesses can be called and documents requested
as soon as it is announced that a market study is to be conducted.
5.9.1 Competition and Markets Authority

The Bill provides that the Office of Fair Trading (OFT) and the Competition
Commission (CC) will merge to create a new regulator, the Competition and
Markets Authority (CMA). The intention is to create a single, stronger
enforcement agency for competition policy that will take more decisions than
its predecessors.
5.9.2 Competition objective of the Financial

Conduct Authority (FCA)
The FCA has a new operational objective of promoting effective competition
in the interests of consumers, and it intends to use these powers to ensure
that:
t
There are no undue barriers to entry;
Consumers are empowered to engage in such a way as to drive

competition;
No single firm or small group of firms dominates the market; and
Firms focus on consumers genuine needs.
The FCA has said they will take bold and far-reaching action in this regard.The
government believe that opening up competition should be a priority for the
FCA in its first few years as regulator of financial conduct.
[2] 154

1.
A customer borrows 30,000, secured against his main private property

and uses it to fund a lavish wedding for his daughter. Is the loan regulated
by the Consumer Credit Acts?
2.
What do the Consumer Credit (Advertisements) Regulations 2004 say

about the way that the APR is mentioned in a written advertisement?
3.
Under what circumstances is a contract not governed by the Unfair Terms

in Consumer Contracts Regulations 1999?
4.
What are the conditions that, in the absence of anything specific, are
under the terms of the Supply of Goods and Services Act 1982
automatically deemed to be included in all contracts?
5.
The Pensions Regulator has jurisdiction over work-based pension

schemes. What constitutes work-based schemes?
6.
What levels of compensation are provided by the Pension Protection

Fund?
7.
What are the two main elements of the pension protection levy, by which
the Pension Protection Fund is funded?
8.
What are the most common forms of credit institution in the UK?
9.
What are the four categories of business defined by European life

assurance directives?
[2] 155
Unit 2
10. A UK insurance company provides insurance in France. The insurance is

a type that is compulsory under French law. Which regulatory authorities
are responsible for regulating that insurance business?
11. What activities are included under the EU definition of insurance
mediation?
12. Insurance intermediaries are required by EU law to be of good repute.
What does this mean?
13. What is the maximum arrangement fee that can be charged for a CATstandard discounted variable-rate mortgage?
(a) None.
(b) 100.
(c) 150.
14. Under the terms of the Lending Code, how will banks treat customers
who are experiencing financial difficulties?
[2] 156
Answers
1.
Yes. From 6 April 2008, the previous 25,000 limit no longer applies.
2.
The APR must be displayed more prominently than other financial

information.
3.
When the contract has been negotiated on an individual basis between

the business and the customer.
4.
The service will be performed with reasonable care, the work will be
done within a reasonable time, and a reasonable charge will be made.
5.
Work-based pension schemes mean all occupational schemes, and also

any stakeholder and personal pension schemes, where employees have
direct payment arrangements.
6.
100 per cent for existing pensioners and 90 per cent for pre-retirement
members, subject to an overall benefit cap.
7.
An element based on risk factors, such as under-funding, credit rating and

investment strategy. A pension protection levy based on scheme factors,
such as the numbers of active and retired members.
8.
Banks and building societies.
9.
Life assurance (ie policies payable on: survival of a specified term;

death; survival of a term or earlier death; death within a specified term;
birth; marriage).
Annuities.
Permanent health insurance.
Personal injury, incapacity for employment and accidental death, when

underwritten in addition to life assurance.
10. The French regulatory authorities.

[2] 157
Unit 2
11. Introducing, proposing or other work preparatory to the taking out of

insurance policies, or assisting in the administration and performance of
policies, particularly claims.
12. They must not have been convicted of a serious criminal offence relating
to crimes against property or other financial crimes, or declared
bankrupt.
13. (a) None.
14. Sympathetically and positively.
[2] 158
Index
Ind 1
Index
A
Advertising
Code [2] 5.6
consumer credit [2] 5.1.3
financial promotion see Financial
promotion
rules [2] 1.7.2
standards [2] 5.6
Agency
law of [1] 6.7
Agent
authority [1] 6.7
Alternative Investment Market
investment on [1] 2.3.1.1.2
Approved persons
concept of [2] 1.7.1
examinations [2] 1.7.4.1.2
FCA controlled functions
carrying out [2] 1.7.1
customer [2] 1.7.1.1.5
FCA-authorised firms, for [2] 1.7.1.1
governing [2] 1.7.1.1.1
meaning [2] 1.7.1
required [2] 1.7.1.1.2
significant management [2] 1.7.1.1.4
systems and control [2] 1.7.1.1.3
fit and proper test [2] 1.2.10
PRA controlled functions
governing [2] 1.7.1.2.1
required [2] 1.7.1.2.2
systems and control [2] 1.7.1.2.3
Principles for Business [2] 1.2.7
staff, principles for [2] 1.2.7
training and competence [2] 1.7.4
Attendance Allowance
eligibility for [1] 1.3.5.3.4
Attorney
meaning [1] 6.9
Auditors
external, role of [2] 1.2.9.4.1
internal, role of [2] 1.2.9.4.1
B
Balance of payments
equilibrium [1] 1.3.4
Bank accounts
accessibility [1] 2.1
deposit [1] 2.1.1.1
interest-bearing [1] 2.1.1
interest-bearing current [1] 2.1.1.3

money-market deposit [1] 2.1.1.2
overdrafts [1] 3.5.3.2
Saving Gateway [1] 2.1.5
savings [1] 2.1
taxation of deposits [1] 2.1.1.4
Bank of England
central bank, as [1] 1.2.1
Financial Policy Committee [2] 1.1.1
foundation of [1] 1.2.1
functions of [1] 1.2.1
Monetary Policy Committee [1]
1.3.4.1
Prudential Regulatory Authority see
Prudential Regulation Authority (PRA)
Royal Charter [1] 1.2.1
Banking
clearing banks [1] 1.2.4.2
Conduct of Business rules [2] 5.7.2
current account [1] 1.2.4.1
Independent Commission [1] 1.2.3
Lending Code [2] 5.7.1
Payment Services Directive [2] 5.7.3
Electronic Money Regulations [2]
5.7.3.1
regulation [2] 1.1, 5.7
retail [1] 1.2.3
Second Banking Directive [2] 5.4.1
wholesale [1] 1.2.3
Bankruptcy
process and effect of [1] 6.10
Bartering
process of [1] 1.1
Borrowing
government [1] 1.3.4.2
Bribery
offences [2] 2/9
Building society
accounts
accessibility [1] 2.1
nature of [1] 2.1.2
notice [1] 2.1.2
ordinary [1] 2.1.2
savings [1] 2.1
taxation [1] 2.1.2.1
carpetbagging [1] 1.2.2
demutualisation [1] 1.2.2
mutual organisations, as [1] 1.2.2
wholesale market, raising funds
on [1] 1.2.3
Ind 3
Business protection
business partner
death of [1] 5.2.2.2
sickness of [1] 5.2.2.5
key employee, death of [1] 5.2.2.1
sickness
business partner, of [1] 5.2.2.5
employee, of [1] 5.2.2.4
self-employed small trader,
of [1] 5.2.2.6
small business shareholder, death
of [1] 5.2.2.3
C
Capital adequacy
Basel Committee framework [2] 1.4.1
Basel II [2] 1.4.1
Basel III [2] 1.4.5.1, 1.4.5.2
deposit-takers, regulations for [2] 1.4.1
Directive [2] 1.4.2
investment business, for [2] 1.4.2
life assurance companies, solvency
margin [2] 1.4.3
operational risk, requirements
for [2] 1.4.1
prudential control, rules for [2] 1.4
risk weighting [2] 1.4.1
Solvency II [2] 1.4.6
solvency ratio, definition [2] 1.4.1
Capital gains tax
annual allowance [1] 1.3.3.4
calculation [1] 1.3.3.4.1
entrepreneurs relief [1] 1.3.3.4.1
exempt assets [1] 1.3.3.4
hold-over relief [1] 1.3.3.4.3
liability to [1] 1.3.3.4
losses carried forward [1] 1.3.3.4
losses, offsetting [1] 1.3.3.4
net gains, on [1] 1.3.3.4
not due, where [1] 1.3.3.4
payment of [1] 1.3.3.4.4
personal representatives, rate
for [1] 1.3.3.4
property, gains on [1] 2.4.1
roll-over relief [1] 1.3.3.4.2
taper relief and indexation, removal
of, [1] 1.3.3.4.1
trusts, rate for [1] 1.3.3.4
unit trusts, on [1] 3.2.1.7.2
Ind 4
Carers Allowance
Certificates of deposit
use of [1] 2.7.2
Charge cards
use of [1] 3.5.3.3.2
Child Benefit
Child Tax Credit
payment of [1] 1.3.5.2.4
Child Trust Fund
characteristics of [1] 3.2.8
Children
tax liability [1] 1.3.3.2
Clients see Customers
Collective investments
advantages of [1] 3.2
categorisation of funds [1] 3.2
forms of [1] 3.2
managed funds [1] 3.2
nature of [1] 3.2
open-ended investment companies
(OEICs) [1] 3.2.3 see also Open-ended
investment companies (OEICs)
risk [1] 3.2
Undertakings for Collective Investment
in Transferable Securities legislation
[2] 5.4.2.2
unit trusts [1] 3.2.1 see also Unit trusts
Commercial paper
use of [1] 2.7.3
Commodities
forward contracts [1] 2.5
trading [1] 2.5
Company
meaning [1] 6.4
memorandum and articles of
association [1] 6.4
Company cars
Company Voluntary Arrangements
use of [1] 6.10.2
Competition
regime, reform of [2] 5.9
Competition and Markets Authority
proposed [2] 5.9.1
Competition Commission
areas of concern [2] 5.8
role of [2] 5.8
Complaints
definition [2] 3.1
Index
eligible complainants [2] 3.1.1

Financial Ombudsman Service [2] 3.2
firms procedures [2] 3.1
information, publication of [2] 3.1.4.4
investigation of [2] 3.1
next business day, resolved by [2] 3.1.2
non-reportable [2] 3.1.2.1
Pensions Ombudsman [2] 3.4
procedures [2] 3.1.4
record keeping [2] 3.1.4.2
reporting [2] 3.1.4.3
root cause analysis [2] 3.1.4.1
reports [2] 3.1
requirements [2] 3.1.3
super complaints [2] 3.1.4.4
Compliance officers
responsibilities of [2] 1.2.9.4.3
Consumer credit
advertisements [2] 5.1.3
agreements [2] 5.1.3
annual percentage rate [2] 5.1.1
changes to legislation [2] 5.1.2
Directive [2] 5.1.4
disclosure of information [2] 5.1.3
early settlement [2] 5.1.3
Financial Ombudsman Service,
extension of scope [2] 5.1.2
regulation [2] 5.1
scope of provisions [2] 5.1.1
statutory provisions [2] 5.1
Consumer Protection and Markets
Authority
functions transferred to [2] 1.1.1
Contract
binding, requirements for [1] 6.6
breach of [1] 6.6
disclosure by parties [1] 6.6
law of [1] 6.6
Corporate bonds
nature of [1] 2.2.4
Corporation tax
charge to [1] 1.3.3.8
profits, definition [1] 1.3.3.8
worldwide profits, on [1] 1.3.3.8
Credit cards
revolving credit, as [1] 3.5.3.3
use of [1] 3.5.3.3.1
Credit institutions
investment services [2] 5.4.2
Credit unions
field of membership test [1] 1.2.2.1
mutual institutions, as [1] 1.2.2.1
ownership [1] 1.2.2.1
Customers
assets [1] 4.3.1.2.3
cancellation of contract [2] 1.7.5.9
categories of [2] 1.7.5.1
charges and commissions to [2] 1.7.5.3
circumstances [1] 4.3.1
client agreement [2] 1.7.5.5
commitment to buy, obtaining [1] 4.6.3
cooling off period [2] 1.7.5.9
employment details [1] 4.3.1.2.1
established families [1] 4.2.5
execution only [2] 1.7.5.8
financial life-cycle [1] 4.2
financial products, understanding
[2] 1.2.8
financial situation, details of [1] 4.3.1.2
income and expenditure [1] 4.3.1.2.2
information, gathering [1] 4.3
liabilities [1] 4.3.1.2.4
mature households [1] 4.2.6
money laundering, identification for
purposes of [2] 2.4
needs and objectives, identifying and
agreeing [1] 4.4
personal and family details [1] 4.3.1.1
plans and objectives [1] 4.3.1.3
post-education young people {1} 4.2.3
preferences [1] 4.3.3
priority order, agreeing with [1] 4.4.1
retirement [1] 4.2.7
risk, attitude to [1] 4.3.2
saving pattern [1] 4.1
school age young people [1] 4.2.1
suitability of advice to
reports [2] 1.7.5.6.1
requirements [2] 1.7.5.6
teenagers and students [1] 4.2.2
young families [1] 4.2.4
D
Data protection
data controller
definition [2] 4.1.1
prosecution of [2] 4.1.3
Ind 5
data processor, definition [2] 4.1.1

data subject, definition [2] 4.1.1
definitions [2] 4.1.1
Directive [2] 4.1.4
enforcement [2] 4.1.3
enforcement notice [2] 4.1.3
information notice [2] 4.1.3
personal data, definition [2] 4.1.1
principles [2] 4.1.2
processing, definition [2] 4.1.1
sensitive personal data, definition
[2] 4.1.1
Debentures
interest on [1] 2.3.2
use of [1] 2.3.2
Debit cards
use of [1] 3.5.3.3.3
Debt Management Office
gilt-edged securities, issue of [1] 1.2.1
Deposit-takers
capital adequacy regulations [2] 1.4.1
regulated activity, as [2] 1.3.1
Derivatives
futures [1] 3.4
meaning [1] 3.4
options [1] 3.4
warrants [1] 3.4
Disability Living Allowance
components [1] 1.3.5.3.5
Disabled persons
social security benefits [1] 1.3.5.3
Disintermediation
meaning, [1] 1.1.1
Dividends
payment process [1] 2.3.1.3
taxation [1] 1.3.3.2.1, 2.3.1.3
Domicile
taxation purposes, for [1] 1.3.3.1
E
Economic growth
macroeconomic objectives [1] 1.3.4
Economic policy
economic growth [1] 1.3.4
stop-go [1] 1.3.4
Ind 6
Employment and Support

Allowance
work capability assessment
[1] 1.3.5.3.3
Endowments
mortgages, repayment of
assignment [1] 3.5.1.3.1
low-cost [1] 3.5.1.3.1.1
performance review [1] 3.5.1.3.1.3
unit-linked [1] 3.5.1.3.1.2
non-profit [1] 3.2.7.1.1
policies of [1] 3.2.7.1
unit-linked [1] 3.2.7.1.3
unitised with-profit [1] 3.2.7.1.4
with-profit [1] 3.2.7.1.2
Enduring power of attorney
nature of [1] 6.9
replacement of [1] 6.9
Equities
meaning [1] 2.3.1
Estate
distribution of [1] 6.2.1
intestacy [1] 6.2.1
Estate planning
inheritance tax, minimising [1] 5.6
will, need for [1] 5.6
Eurobonds
operation of [1] 2.2.5
European Central Bank
function of [1] 1.2.1
European Parliament
role of [1] 1.3.1
European Union
binding Directives [2] 5.4
Consumer Credit Directive [2] 5.1.4
Council of Ministers [1] 1.3.1
European Supervisory Authorities
[1] 1.3.1.1
freedom to provide services in
[2] 1.4.2
influence of [1] 1.3.1
insurance market
harmonisation of national laws
[2] 5.4.3.1
intermediaries [2] 5.4.3.3
Life Assurance Directives [2] 5.4.3.1
Non-Life Directives [2] 5.4.3.2
objectives [2] 5.4.3
Investment Services Directive [2] 5.4.2
laws [1] 1.3.1
Index
Markets in Financial Instruments

Directive [2] 5.4.2.1
second version of [2] 5.4.2.1.1
Undertakings and Collective
Investment in Transferable Securities
[2] 5.4.2.2
F
Family protection
death, losses due to [1] 5.2.1.1
sickness, losses due to [1] 5.2.1.2
unemployment, losses due to
[1] 5.2.1.3
Financial advice
basic [2] 1.7.7
budgeting [1] 5.1
business protection [1] 5.2.2
estate planning [1] 5.6
family protection [1] 5.2.1
investment and saving, on [1] 5.4
loans, on [1] 5.3
protection against risk [1] 5.2
regular reviews [1] 5.8
suitability of
reports [2] 1.7.5.6.1
tax planning [1] 5.7
Financial adviser
after-sales care [1] 4.6.5
categories of [2] 1.7.5.2
charges and commissions [2] 1.7.5.3
ongoing charges [2] 1.7.5.3.1
client agreement [2] 1.7.5.5
commitment to buy, obtaining [1] 4.6.3
complaints procedures see Complaints
documentation, explanation of [1]
4.6.4 independent [2] 1.7.5.2.1
information about, giving to client
[2] 1.7.5.4
information, gathering [1] 4.3
needs and objectives, identifying and
agreeing [1] 4.4
objections, handling [1] 4.6.2
panels [2] 1.7.5.2.1.1
priority order, agreeing with client
[1] 4.4.1
proactive servicing [1] 4.6.5.1
product disclosure [2] 1.7.5.7

reactive servicing [1] 4.6.5.2
restricted advice [2] 1.7.5.2.2
Retail Distribution Review [2] 1.7.5.2
solutions
implementing [1] 4.6
presentation of [1] 4.6.1
recommending [1] 4.5
specialists [2] 1.7.5.2.1.2
status of [2] 1.7.5.2
suitability of advice
reports [2] 1.7.5.6.1
Financial assets
deposits [1] 2.1
Financial Conduct Authority (FCA)
approved persons see Approved
persons
competition objectives [2] 5.9.2
complaints procedures see Complaints
Conduct of Business Sourcebook
[2] 1.7
crime, prevention of [2] 1.2.11
discipline by [2] 1.6
dual regulation with PRA [2] 1.5.2
enforcement by [2] 1.6
enforcement powers [2] 1.6.1
Handbook
business standards [2] 1.2.4
high level standards [2] 1.2.2
prudential standards [2] 1.2.3
redress [2] 1.2.6
regulatory processes [2] 1.2.5
Sourcebooks [2] 1.2
specialist sourcebooks [2] 1.2.6
status of provisions [2] 1.2.1
objectives, role and activities [2] 1.2
Financial Stability and Market
Confidence sourcebook [2] 1.2.12
firms and approved persons, principles
for
staff [2] 1.2.7
insurance, regulation of [2] 1.7.9
investigations [2] 1.6
legislative framework [2] 1.1
money laundering see Money
laundering
mortgage advice, regulation of
[2] 1.7.8
Mortgage Market Review [2] 1.7.8.1
Ind 7
oversight groups, role of [2] 1.2.9.4

prudential supervision [2] 1.5.1
record-keeping rules [2] 1.7.3
regulated activities [2] 1.3.1
regulated investments [2] 1.3.2
regulation, approach to [2] 1.5
firms and individuals, of [2] 1.3
responsibility of [2] 1.1.1
risk-based approach [2] 1.5
role of [2] 1.2
senior managers, responsibility for
compliance with rules [2] 1.2.9
statutory objectives [2] 1.2
statutory powers [2] 1.2
systems and controls [2] 1.2.9.2
training and competence
assessing competence [2] 1.7.4.1.1
examinations [2] 1.7.4.1.2
importance of [2] 1.7.4
maintaining competence [2] 1.7.4.1.4
record-keeping [2] 1.7.4.1.5
rules [2] 1.7.4
sourcebook [2] 1.7.4
time limits [2] 1.7.4.1.3
training needs [2] 1.7.4.1
wholesale business [2] 1.7.4.1.6
Treating Customers Fairly, rules for
[2] 1.2.8
whistle-blowing [2] 1.2.9.3
Financial institutions
Bank of England [1] 1.2.1 see also Bank
of England
boundaries [1] 1.2.2
mutual [1] 1.2.2
proprietary [1] 1.2.2
retail [1] 1.2.3
types of [1] 1.2
wholesale [1] 1.2.3
Financial instruments.
Financial intermediary
meaning [1] 1.1.1
profit margin [1] 1.1.1
use of services of [1] 1.1.1
Financial Ombudsman Service
compensation limits [2] 3.2.1.1
complaints to [2] 3.2.1
consumer credit, extension to
[2] 5.1.2
Ind 8
establishment of [2] 3.2

process [2] 3.2.1
time limits [2] 3.2.1.2
Financial promotion
communication [2] 1.7.2
comparisons [2] 1.7.2.1
past performance [2] 1.7.2.2
rules [2] 1.7.2
unsolicited [2] 1.7.2.3
Financial Services Authority
Banking Conduct of Business
Sourcebook [2] 5.7.2
regulatory responsibility, former
[2] 1.1
Retail Distribution Review [2] 1.7.5.2
transfer of functions [2] 1.1.1
Financial Services Compensation
Scheme
customer eligibility [2] 3.3.1
deposits [2] 3.3.2.1
funding [2] 3.3.3
home finance [2] 3.3.2.3
insurance business [2] 3.3.2.4
insurance mediation [2] 3.3.2.5
investments [2] 3.3.2.2
sub-schemes [2] 3.3.2
Financial services industry
deregulation [2] 1.1
Financial Services and Markets Act
2000 [2] 1.1
functions of [1] 1.1
Sandler Report [2] 1.7.6
stakeholder-type products [2] 1.7.6
UK regulation [1] 1.3.2
use of money, facilitating [1] 1.1
Financial services products
accessibility [1] 5.4.3
advertising standards [2] 5.6
CAT standards [2] 5.5
financial life-cycle [1] 4.2
inflation, effect of [1] 5.4.5
investment and saving, on [1] 5.4
regular or lump sum [1] 5.4.1
risk [1] 5.4.2
taxation [1] 5.4.4
Fiscal policy
golden rule [1] 1.3.4.2
money supply, influencing [1] 1.3.4.2
public sector, finances of [1] 1.3.4.2
scope of [1] 1.3.4.2
Index
Fixed interest securities

corporate bonds [1] 2.2.4
Eurobonds [1] 2.2.5
Government stocks [1] 2.2.1
local authority stocks [1] 2.2.2
permanent interest-bearing shares
[1] 2.2.3
Foreign exchange
currency speculators [1] 2.6
investment [1] 2.6
market [1] 2.6
reasons for [1] 2.6
Futures
meaning [1] 3.4
G
Gilt-edged securities
index-linked [1] 2.2.1
investment in [1] 2.2.1
issue of [1] 1.2.1
loans to government, as [1] 1.2.1
Government stocks
H
Home income plans
equity, releasing [1] 3.5.1.5.2
Home reversion schemes
equity, releasing [1] 3.5.1.5.3
I
Incapacity Benefit
rates of [1] 1.3.5.3.2
replacement of [1] 1 3.5.3.3
Income Support
payments [1] 1.3.5.1.2.1
Income tax
bands [1] 1.3.3.2.1
child, on [1] 1.3.3.2
classification of income [1] 1.3.3.2.4
company cars, on [1] 1.3.3.2
employees, payment by [1] 1.3.3.2.2
fuel, on [1] 1.3.3.2
income assessable to [1] 1.3.3.2

income not assessable to [1] 1.3.3.2
income taxed at source [1] 1.3.3.2.5
investment income, on [1] 1.3.3.2.1
investments, basic rate for [1] 1.3.3.2.1
liability for [1] 1.3.3.2
calculation of [1] 1.3.3.2.9
life insurance policy, proceeds of
[1] 1.3.3.2.7
non-taxpayers, declaration by
[1] 1.3.3.2
PAYE system [1] 1.3.3.2.2
personal allowances [1] 1.3.3.2.1
rates [1]1.3.3.2.1
schedules [1] 1.3.3.2.4
self-employed, on [1] 1.3.3.2.3
share dividends, on [1] 1.3.3.2.1
statutory provisions [1] 1.3.3.2
tax-paid investment income [1]
1.3.3.2.6
tax year [1] 1.3.3.2
unit trusts, of [1] 3.2.1.7.1
proceeds of [1] 1.3.3.2.8
Individual Savings Accounts (ISAs)
cash [1] 2.1.4, 3.2.6
Direct [1] 2.1.5.10
eligibility to open [1] 3.2.6
equity [1] 3.2.6
introduction of [1] 3.2.6
Junior [1] 3.2.8.1
mortgage, use for repayment of
[1] 3.5.1.3.3
subscription limits [1] 3.2.6.2
tax-efficiency [1] 2.1.4
tax reliefs [1] 3.2.6.1
transfer arrangements [1] 3.2.6.3
withdrawals [1] 3.2.6.3
Individual Voluntary Arrangement
bankruptcy, alternative to [1] 6.10.1
Inflation
effect of [1] 5.4.5
low rate, aim of [1] 1.3.4
money illusion [1] 5.4.5
price stability [1] 1.3.4
Information Commissioner
Data Protection Act, enforcement of
[2] 4.1.3
Inheritance tax
charge of [1] 1.3.3.5
chargeable lifetime transfers [1] 1.3.3.5
Ind 9
exemptions [1] 1.3.3.5

life assurance policy for [1] 5.6
minimising [1] 5.6
nature of [1] 5.6
Insolvency
where arising [1] 6.10
Insurance
accident, sickness and unemployment
restrictions [1] 3.3.2.3
taxation [1] 3.3.2.3.1
use of [1] 3.3.2.3
all-risks [1] 3.3.3.6
average [1] 3.3.3.2
buildings [1] 3.3.3.4
Conduct of Business Sourcebook
[2] 1.7.9
cancellation [2] 1.7.9.7
claims handling [2] 1.7.9.8
distance communications [2] 1.7.9.3
firm, services and remuneration,
information about [2] 1.7.9.4
general rules [2] 1.7.9.2
identifying client needs and advising
[2] 1.7.9.5
product information [2] 1.7.9.6
scope of rules [2] 1.7.9.1
contents [1] 3.3.3.5
critical illness cover
range of illnesses [1] 3.3.2.1
total and permanent disability,
payment in case of [1] 3.3.2.1
uses of [1] 3.3.2.1
European single market [2] 5.4.3
excess [1] 3.3.3.3
Financial Services Authority, regulation
by [2] 1.7.9
general [1] 3.3.3
regulation of [2] 1.7.9
ill-health [1] 3.3.2
income protection
homemakers, for [1] 3.3.2.2
income, payment of [1] 3.3.2.2
payment of benefit [1] 3.3.2.2.2
premium rates [1] 3.3.2.2.1
taxation of benefits [1] 3.3.2.2.3
indemnity [1] 3.3.3.1
intermediaries [2] 5.4.3.3
life assurance see Life assurance
long-term care
benefits [1] 3.3.2.5.1
taxation [1] 3.3.2.5.2
Ind 10
use of [1] 3.3.2.5

mortgage, related to [1] 3.5.1.7
motor
comprehensive [1] 3.3.3.7.3
private [1] 3.3.3.7
third party [1] 3.3.3.7.1
third party, fire and theft
[1] 3.3.3.7.2
Non-Life Directives [2] 5.4.3.2
payment protection [1] 3.3.3.9
premium tax [1] 3.3.3.10
private medical
benefits [1] 3.3.2.4
cover, range of [1] 3.3.2.4
premium rates [1] 3.3.2.4
protection plan, as [1] 3.3.2.4
taxation [1] 3.3.2.4.2
underwriting [1] 3.3.2.4.1
regulation of [2] 1.1
risk management by [1] 1.1.2
travel [1] 3.3.3.8
types of [1] 3.3
Interest rate
Bank of England Monetary Policy
Committee, set by [1] 1.3.4.1
changes, impact of [1] 1.3.4.1.1
London interbank offered rate (LIBOR)
[1] 1.2.3
variable [1] 1.3.4.1.1
Intermediaries
financial see Financial intermediary
insurance [2] 5.4.3.3
product sales [1] 1.1.3
Intestacy
meaning [1] 6.2.1
rules for [1] 6.2.1
Investment
Investment Services Directive [2] 5.4.2
Investment bonds
funds [1] 3.2.7.2
income from [1] 3.2.7.2.1
nature of [1] 3.2.7.2
taxation [1] 3.2.7.2.1
Investment business
capital adequacy [2] 1.4.2
Investment income
tax-paid [1] 1.3.3.2.6
Investment schemes
taxation [1] 1.3.3
Index
Investment trusts
nature of [1] 3.2.2
real estate [1] 3.2.2.3
share price [1] 3.2.2
split-capital [1] 3.2.2.2
Investments
assets, building up [1] 4.1
collective
regulated [1] 3.2
unregulated [1] 3.2.4
deposit-based [1] 2.1
direct [1] 3.1
fund supermarkets [1] 3.2.5
platforms [1] 3.2.5
regulated [2] 1.3.2
short-term loss, risk of [1] 4.1
wraps [1] 3.2.5
J
Jobseekers Allowance
forms of [1] 1.3.5.1.3
L
Lasting power of attorney
introduction of [1] 6.9
Legal person
meaning [1] 6.1
Life assurance
companies, solvency margins [2] 1.4.3
Directives [2] 5.4.3.1
family income benefits [1] 3.3.1.3
harmonisation of national laws [2]
5.4.3.1
inheritance tax policy [1] 5.6
investment products
endowments see Endowment
investment bonds [1] 3.2.7.2
joint-life second death policies
[1] 3.3.1.1.5
last survivor policy [1] 3.3.1.1.5
pension term [1] 3.3.1.4
term
characteristics of [1] 3.3.1.2

convertible [1] 3.3.1.2.4
decreasing [1] 3.3.1.2.2
gift inter vivos cover [1] 3.3.1.2.2
increasing [1] 3.3.1.2.3
level [1] 3.3.1.2.1
mortgage protection [1] 3.3.1.2.2
pension arrangements, under
[1] 3.3.1.4
renewable [1] 3.3.1.2.5
uses of [1] 3.3.1.2
variety of [1] 3.3.1.2
whole-of-life
bases of [1] 3.3.1.1
flexible [1] 3.3.1.1.2
low cost [1] 3.3.1.1.1
purpose of [1] 3.3.1.1
universal [1] 3.3.1.1.3
uses and benefits of [1] 3.3.1.1.4
Life insurance policy
proceeds, taxation [1] 1.3.3.2.7
Liquidity
importance of [2] 1.4.4
systems and controls [2] 1.4.4.1
Loan stock
interest on [1] 2.3.2
use of [1] 2.3.2
Loans
advice on [1] 5.3
commercial [1] 3.5.4
credit cards [1] 3.5.3.3.1
lending products [1] 3.5
mortgages see Mortgages
secured
mortgages see Mortgages
personal, [1] 3.5.2
unsecured
charge cards [1] 3.5.3.3.2
credit cards [1] 3.5.3.3.1
debit cards [1] 3.5.3.3.3
overdrafts [1] 3.5.3.2
personal loans [1] 3.5.3.1
personal promise, relying on [1]
3.5.3
revolving credit [1] 3.5.3.3
Local authority stocks
Ind 11
M
Market abuse
aspects of [2] 1.2.11
Maternity Allowance
Monetary policy
Bank of England Committee [1] 1.3.4.1
economy as a whole, acting on
[1] 1.3.4.2
importance of [1] 1.3.4.1
instruments of, [1] 1.3.4.1
monetarist school [1] 1.3.4.1
Money
clearing process [1] 1.2.4.2
contribution of concept of [1] 1.1
issue of [1] 1.2.1
legal tender [1] 1.1
medium of exchange, as [1] 1.1
properties of [1] 1.1
store of value, as [1] 1.1
transmission [1] 1.2.4
unit of account, as [1] 1.1
Money laundering
authorised firms, requirements for
[2] 2.3
client identification [2] 2.4
criminal activity, meaning [2] 2.2
definitions [2] 2.2
Directive [2] 2.2
enforcement [2] 2.8
failure to disclose suspicion of [2]
2.3.3
Financial Action Task Force [2] 2.3.1
financial exclusion [2] 2.4.1
FSA enforcement procedures [2] 2.8
offences [2] 2.3
property, definition [2] 2.2
record-keeping requirements [2] 2.5
Reporting Officer [2] 2.3
reporting to [2] 2.6
reporting procedures [2] 2.6
terrorism, definition [2] 2.1.1
tipping-off [2] 2.3.4
training requirements [2] 2.7
Money market instruments
certificates of deposit [1] 2.7.2
commercial paper [1] 2.7.3
meaning [1] 2.7
Treasury bills [1] 2.7.1
Ind 12
Mortgages
advice, regulation of [2] 1.7.8
base rate tracker [1] 3.5.1.4.5
buy-to-let [1] 2.4.2
capped rate [1] 3.5.1.4.4
cashbacks [1] 3.5.1.4.7
CAT-standard [1] 3.5.1.4.10, [2] 5.5
choice of [1] 3.5.1
Conduct of Business rulebook
[2] 1.7.8
current account [1] 3.5.1.4.6.1
deferred interest [1] 3.5.1.4.9
definitions [1] 3.5.1.1
disclosure of information [2] 1.7.8
discounted [1] 3.5.1.4.2
endowment [1] 3.5.1.3.1
equity, releasing
home income plans [1] 3.5.1.5.2
home reversion schemes
[1] 3.5.1.5.3
lifetime mortgages [1] 3.5.1.5.1
meaning [1] 3.5.1.5
fixed rate [1] 3.5.1.4.3
flexible [1] 3.5.1.4.6
individual savings accounts, repayment
by [1] 3.5.1.3.3
interest
basis of charge [1] 3.5.1.4
options [1] 3.5.1.4
interest-only [1] 3.5.1.3
lifetime [1] 3.5.1.5.1
low-start [1] 3.5.1.4.8
Market Review [2] 1.7.8.1
offset [1] 3.5.1.4.6.2
parties [1] 3.5.1.1
pension [1] 3.5.1.3.2
regulation of [2] 1.1
related property insurance [1] 3.5.1.7
repayment [1] 3.5.1.2
rules for [2] 1.7.8
second [1] 3.5.2.1
shared ownership [1] 3.5.1.6
variable rate [1] 3.5.1.4.1
Mutual life assurance companies
demutualisation [1] 1.2.2
Mutual organisations
ownership [1] 1.2.2
types of [1] 1.2.2
Index
N
National insurance
classes of [1] 1.3.3.3
National Savings and Investments
childrens bonus bonds [1] 2.1.5.9
Direct ISA [1] 2.1.5.10
Direct Saver [1] 2.1.5.1
guaranteed equity bonds [1] 2.1.5.6
guaranteed growth bonds [1] 2.1.5.5
guaranteed income bonds [1] 2.1.5.4
income bonds [1] 2.1.5.3
investment account [1] 2.1.5.2
premium bonds [1] 2.1.5.8
range of products [1] 2.1.5
Savings Certificates [1] 2.1.5.7
O
Offshore investments
deposits [1] 2.1.3
Open-ended investment companies
(OEICs)
charges [1] 3.2.3.4
corporate director [1] 3.2.3.1
depository [1] 3.2.3.1
investing in [1] 3.2.3.2
legal constitution [1] 3.2.3.1
nature of [1] 3.2.3
risks of [1] 3.2.3.6
shares, pricing [1] 3.2.3.3
unit trusts, similarity to [1] 3.2.3
Options
meaning [1] 3.4
P
Partnership
agreement [1] 6.5
business partner
death of [1] 5.2.2.2
sickness of [1] 5.2.2.5
definition [1] 5.2.2.2
goodwill, value of [1] 5.2.2.2
limited liability [1] 6.5.1
meaning [1] 6.5
Pension Credit
payment of [1] 1.3.5.5.3
Pensions
contributions [1] 3.6
free standing additional voluntary
contributions [1] 3.6.1
mortgage [1] 3.5.1.3.2
NEST schemes [1] 3.6.4
occupational scheme [1] 3.6, 5.5
regulation [2] 5.3
statutory provisions [2] 5.3.1
trustees, requirements [2] 5.3.1.1
Pension Protection Fund [2] 5.3.1.2
Pensions Regulator [2] 5.3.1.1
personal [1] 3.6.2
products [1] 3.6
stakeholder [1] 3.6.3, 5.5
state [1] 1.3.5.5, 5.5
workforce, auto-enrolment [2] 5.3.2
Pensions Ombudsman
complaints to [2] 3.4
creation of [2] 3.4
Personal Independence Payment
Disability Living Allowance, replacing,
[1] 1.3.5.3.5
Personal representatives
capital gains tax rate [1] 1.3.3.4
meaning [1] 6.2
Pooled investments see Collective
investments
Power of attorney
enduring [1] 6.9
lasting [1] 6.9
nature of [1] 6.9
Precipice bonds
nature of [1] 3.2.9
Probate
grant of [1] 6.2
Property
buy-to-let [1] 2.4.2
commercial, investment in [1] 2.4.3
equity, releasing
home income plans [1] 3.5.1.5.1
home reversion schemes [1]
3.5.1.5.4
lifetime mortgages [1] 3.5.1.5.1
meaning [1] 3.5.1.5
shared ownership [1] 3.5.1.6
investment in [1] 2.4
Ind 13
money laundering, for purposes of

[2] 2.2
ownership
joint [1] 6.8.1
law of [1] 6.8
taxation of income from [1] 2.4.1
Proprietary organisations
ownership [1] 1.2.2
Prudential Regulation Authority
(PRA)
approved persons see Approved
persons
dual regulation with FCA [2] 1.5.2
responsibility of [2] 1.1.1
role of [2] 1.2
Public sector
finances [1] 1.3.4.2
golden rule [1] 1.3.4.2
sustainable investment rule [1] 1.3.4.2
R
Record-keeping
complaints [2] 3.1.4.2
money laundering investigation, for
purposes of [2] 2.5
rules [2] 1.7.3
training and competence, as to [2]
1.7.4.1.5
Regulated activities
authorisation for [2] 1.3
list of [2] 1.3.1
Residence
taxation purposes, for [1] 1.3.3.1
Retirement planning
importance of [1] 5.5
Risk
assessment [2] 1.5
client, attitude of [1] 4.3.2
collective investments, of [1] 3.2
financial services consumers, faced by
[2] 1.5
financial services products, fro
[1] 5.4.2
open-ended investment companies, of
[1] 3.2.3.6
unit trusts, of [1] 3.2.1.8
Risk management
insurance, by [1] 1.1.2
Ind 14
S
Savings
regular or lump sum [1] 5.4.1
Self-employed
sole trader, sickness of [1] 5.2.2.6
taxation [1] 1.3.3.2.3
Senior managers
arrangements, systems and controls for
[2] 1.2.9
chain of responsibility [2] 1.2.9.1
Serious Organised Crime Agency
establishment of [2] 2.3.2
Shares
Alternative Investment Market
[1] 2.3.1.1.2
buying and selling [1] 2.3.1.1
convertibles [1] 2.3.1.7
direct investment in [1] 2.3.1
ex-dividend [1] 2.3.1.4
indices [1] 2.3.1.5
main markets [1] 2.3.1.1.1
off-market trading [1] 2.3.1.1.4
ordinary [1] 2.3.1
participation in markets [1] 2.3.1.1.3
permanent interest-bearing [1] 2.2.3
preference [1] 2.3.1.7
prices of [1] 2.3.1
returns from
assessment [1] 2.3.1.2.2
risk and reward [1] 2.3.1.2.1
right issues [1] 2.3.1.6
rights [1] 2.3.1
scrip issues [1] 2.3.1.6
Social security benefits
Attendance Allowance [1] 1.3.5.3.4
Carers Allowance [1] 1.3.5.3.6
Child Benefit [1] 1.3.5.2.3
Child Tax Credit [1] 1.3.5.2.4
children, relating to [1] 1.3.5.2
Disability Living Allowance [1] 1.3.5.3.5
Employment and Support Allowance
[1] 1.3.5.3.3
financial circumstances, effect of
[1] 1.3.5
ill or disabled, for [1] 1.3.5.3
Incapacity Benefit [1] 1.3.5.3.2
Income Support [1] 1.3.5.1.2
Jobseekers Allowance [1] 1.3.5.1.3
Maternity Allowance [1] 1.3.5.2.2
Index
means tested [1] 1.3.5

need for protection, affecting [1] 1.3.5
Pension Credit [1] 1.3.5.5.3
Personal Independence Payment
[1] 1.3.5.3.5
persons in hospital, for [1] 1.3.5.4
persons in retirement, for [1] 1.3.5.5
persons receiving residential or nursing
care, for [1] 1.3.5.4
range of [1] 1.3.5
state pensions [1] 1.3.5.5
Statutory Maternity Pay [1] 1.3.5.2.1
Statutory Sick Pay [1] 1.3.5.3.1
Universal Credit [1] 1.3.5.6
Working Tax Credit [1] 1.3.5.1.1
Stakeholder products
Sandler Report [2] 1.7.6
selling [2] 1.7.6
types of [2] 1.7.6
Stamp duty
charge to [1] 1.3.3.7
Stamp duty land tax
charge to [1] 1.3.3.7
relief
multiple purchases, for [1] 1.3.3.7.2
zero-carbon homes, for [1] 1.3.3.7.1
Stamp duty reserve tax
charge to [1] 1.3.3.7
State pension
additional [1] 1.3.5.5.2
basic [1] 1.3.5.5.1
inadequacy of [1] 5.5
introduction of [1] 1.3.5.5
Statutory Maternity Pay
Statutory Sick Pay
payment of [1] 1.3.5.3.1
Structured products
forms of [1] 3.2.9
Guaranteed Equity Bond [1] 3.2.9
precipice bonds [1] 3.2.9
T
Taxation
insurance [1] 3.3.2.3.1
bank deposit accounts, on [1] 2.1.1.4
building society accounts, of [1] 2.1.2.1
capital gains tax see Capital gains tax

changes, effect of [1] 1.3.3
corporation tax [1] 1.3.3.8
domicile for purposes of [1] 1.3.3.1
Finance Bill [1] 1.3.3.2
income from property, of [1] 2.4.1
income protection insurance benefits,
of [1] 3.3.2.2.3
income tax see Income tax
inheritance tax [1] 1.3.3.5, 5.6
insurance premium tax [1] 3.3.3.10
investment bonds, of [1] 3.2.7.2.1
investment schemes, of [1] 1.3.3
investment trusts, of [1] 3.2.2.1
investors, affecting [1] 5.4.4
long-term care insurance [1] 3.3.2.5.2
money supply, control of [1] 1.3.3
national insurance [1] 1.3.3.3
open-ended investment companies
(OEICs), of [1] 3.2.3.5
private medical insurance [1] 3.3.2.4.2
purposes of [1] 1.3.3
residence for purposes of [1] 1.3.3.1
shares, of [1] 2.3.1.3
stamp duties [1] 1.3.3.7
statutory provisions [1] 1.3.3.2,
1.3.3.2.4
tax planning [1] 5.7
unit trusts, of [1] 3.2.1.7
value added tax [1] 1.3.3.6
withholding tax [1] 1.3.3.9
Terrorism
money laundering see Money
laundering
Treasury bills
meaning [1] 2.7.1
Trust
beneficiaries [1] 6.3
capital gains tax rate [1] 1.3.3.4
meaning [1] 6.3
settlor [1] 6.3
Trustee
investment by [1] 6.3
meaning [1] 6.3, [2] 1.2.9.4.2
occupational pension scheme, of
[2] 5.3.1.1
responsibilities of [2] 1.2.9.4.2
role of [1] 6.3
Ind 15
Unemployment
losses due to, protection against
[1] 5.2.1.3
low [1] 1.3.4
Unfair contract terms
consumer contracts, in
application of regulations [2] 5.2.2
examples of [2] 5.2.1.3
fairness requirement [2] 5.2.1.1
good faith requirement [2] 5.2.1.3
plain language requirement
[2] 5.2.1.2
statutory provisions [2] 5.2.1
Unit trusts
authorisation [1] 3.2.1.3
capital gains tax [1] 3.2.1.7.2
charges [1] 3.2.1.5
income tax [1] 3.2.1.7.1
manager, role of [1] 3.2.1.1
meaning [1] 3.2.1
proceeds, taxation [1] 1.3.3.2.8
risks of [1] 3.2.1.8
trustees [1] 3.2.1.2
units [1] 3.2.1
accumulation [1] 3.2.1.6
buying and selling [1] 3.2.1.4.2
distribution [1] 3.2.1.6
historic and forward pricing
[1] 3.2.1.4.1
income [1] 3.2.1.6
pricing [1] 3.2.1.4
types of [1] 3.2.1.6
Universal Credit
present benefit structure, replacement
of [1] 1.3.5.6
Warrants
meaning [1] 3.4
Welfare state
role of [1] 1.3.5
Whistle-blowing
procedures for [2] 1.2.9.3
Will
formalities [1] 6.2
meaning [1] 6.2
need for [1] 5.6
revocation [1] 6.2
terms of [1] 6.2
variation [1] 6.2
Withholding tax
meaning [1] 1.3.3.9
Working Tax Credit
availability of [1] 1.3.5.1.1
purpose of [1] 1.3.5.1.1
V
Value added tax
levy of [1] 1.3.3.6
registration [1] 1.3.3.6
Ind 16

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UK Financial Regulation

CeFA and CeMAP Module 1

These learning materials are up-to-date for examinations

The Institute of Financial Services may, from time-to-time, make

Typeset by John Smith

Introduction to UK Financial Regulation

Overview context and relevance to CeFA and CeMAP

Introduction to the Financial Services

Section 1 The UK financial services industry

Section 2 Financial assets

Section 3 Financial products

Section 4 The financial planning and advice process

Section 5 The main areas of financial advice

Section 6 Basic legal concepts relevant to financial services [1] 221

ifs School of Finance 2013

UK Financial Services and Regulation

Section 1 The Financial Conduct Authority

Section 2 Money laundering

Section 3 Complaints and compensation

Section 4 Data protection

Section 5 Other laws and regulations relevant to

ifs School of Finance 2013

Introduction to UK Financial Regulation

Introduction to UK Financial Regulation learning

Essential information: to introduce you to the rules and regulations

ifs School of Finance 2013

Module 1 overview context and relevance: explains the context

Study guidance and assessment preparation: describes how the

ifs School of Finance 2013

The structure of CeFA and CeMAP

ifs School of Finance 2013

CeMAP Module 2 Mortgages

Certificate in Regulated Complaints Handling (CeRCH)

Regulated Customer Care

Regulated Complaints Handling.

Further information can be found at http://www.ifslearning.ac.uk.

ifs School of Finance 2013

Introduction to CeFA and CeMAP Module 1

Policies and procedures

ifs School of Finance 2013

How to use this manual

ifs School of Finance 2013

Introduction to CeFA and CeMAP Module 1

It is your responsibility to ensure that you have the up-to-date

ifs School of Finance 2013

The tripartite system of regulation, introduced by the Labour

The FSA has been abolished.

There is an independent complaints system with a single complaints

ifs School of Finance 2013

Introduction to CeFA and CeMAP Module 1

The Bank of England

The Financial Conduct Authority

those businesses regulated by the PRA in relation to prudential

prudential regulation of those firms not regulated by the PRA.

Key responsibilities include the protection of consumers and ensuring those

to provide appropriate protection for consumers;

to protect and enhance the integrity of the UK financial system;

to promote effective competition in the interests of consumers.

ifs School of Finance 2013

Introduction to CeFA and CeMAP Module 1

Examination Results Analysis Sheet

ifs School of Finance 2013

A sample analysis sheet is provided below.

ifs School of Finance 2013