Rule on Inducements - COBS Provision

The JC’s Reg and Leg resource™ UK Edition →Go uptown In a Nutshell™ 2.3.1 A firm cannot give or take any benefit relating to client business except: (1) Client Benefits: one the client pays for/receives directly; or (2) Third Party Benefits: a third party pays/receives if: (a) No impairment: it does not impair the firm’s duty to act in the client’s best interests; and (b) Full disclosure: the firm fully discloses it before providing it; and (c) Service enhancement: it enhances the quality of the firm’s service to the client; or (3) Ancillary Benefits: one that facilitates designated investment business or ancillary services and doesn’t conflict with the client’s interests (eg custody, clearing or exchange fees, legal fees, etc.) Index: Click ᐅ to expand: Regulation Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

This is the [[FCA}}’s general Rule on Inducements —and more to the point, avoiding them — and as you’ll see it is cast with an eye to the client’s best interests. Compare with specific rules on use of dealing commissions, which some might say are no more than an articulation of these, but others would say are quite a lot more restrictive, but which relate only to firms which act as investment managers — potentially a key difference, because it would not catch a broker or dealer where it accepts orders from an investment manager who was not an FCA regulated {{cobsprov|firm]] (i.e., a foreigner).

To be clear, in this case the general rule on inducements would continue to apply to the broker: just not the more detailed use of dealing commissions rules.

Want to take your client to Wimbledon? Forget about it.

“Inducements” under COBS vs “inducements” under PERG

The FCA seems to use the word inducement in quite different ways, depending on which bit of the handbook it is thinking about. Under the COBS “Rule on Inducements”, an inducement clearly involves some sort of consideration: a benefit, concession, retrocession, or advantage that a customer (or investment manager) gets in return for it (or its clients’) business. By contrast, in the PERG rules about (especially as regards “inducements to enter into financial promotions” the regulator seems to be regarded much more loosely as not much more than a synonym for “strong invitation” or “incitement” (in our view an equally unhelpful use of a legal word with a clear meaning in an another context (being criminal law)) — but no quid pro quo, consideration or (cough) inducement seems to be needed — which is odd, because it is used together with the actual word “invitation”.

All a bit odd. Do you really “incite, counsel or procure” entry into a contract?

Research and benefits brokers provide to investment manager clients

Leaving aside the terribly tedious topic of research unbundling for a moment (I know — can you bear to?) a broker giving discounts and free research to an investment manager for whom it is accepting orders does not breaching the rule on inducements because the investment manager is its client. The investment manager’s clients are not, so there is no third party action here, at least not from the broker/dealer’s perspective.

But the investment manager in turn has its own inducement rules (see 2.3A.15), which make it clear that the investment manager must pass all the inducements on to its clients unless they are “acceptable minor non-monetary benefits” or third party research which is provided in accordance with the terribly tedious unbundling rules in COBS 2.3B.

Retrocessions for fund aggregators

If you are a MiFID entity there are these categories:

• Those providing portfolio management services or independent advice;
• Those not providing independent advice (basically anyone else)

For the first two there is an outright prohibition on retaining rebates under MiFID II. Everything must be passed in full through to the ultimate client. These entities therefore tend to opt for non-retrocession share classes open only to aggregators offering a certain volume that have a net management fee (so in other words the benefit of the discount naturally flows through to ultimate client and can’t be retained by the intermediary, and there’s no need for the brain damage of divvying up the rebate).

For others it isn’t prohibited but the firm would need to demonstrate (per COBS 2.3A.3 that the payment “enhances the quality of the service” it provides to its our client, and fully disclose it. The level 2 regulations interpret this strictly, and impose more procedural requirements, than many firms currently apply to third party payments and benefits.

A bit like PFOF?

Payment for order flow is the practice of an investment firm that executes client orders (typically a broker) receiving a fee/commission not only as an agent from the client originating the order but also from the counterparty with whom the trade is then executed. PFOF is not allowed because it does not satisfy the rule on inducements.

The read across is instructive: Some (but not all) of the points the [[FCA}} highlighted for {{tag|PFOF]] prevail here, if you substitute “firm” for “broker” and “MMF provider” for “market maker”

• It creates a conflict of interest between the firm and its clients because the firm is incentivised to pursue payments from “MMF providers” rather than to act in the best interests of its clients.
• Forcing MMF providers to ‘pay-to-play’ can distort competition and create barriers to entry and expansion.

See also

• FCA’s Perimeter Guidance Rules
• COBS 11.6.3 et seq. regarding (Use of dealing commission), and also corporate access.
• 2.3.1 - the Rule on Inducements
• Good article on rebates and retrocessions