Prior to Investing

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Before providing you with an investment service, your firm is required to categorise you as a Retail or Professional client. You will normally be categorised as a Retail client, a category which includes the majority of individuals.
                                                  
As a Retail client you receive the highest level of investor protection. MiFID awards more protection to investors with less investment knowledge and experience (Retail clients), while investors with more investment knowledge and experience (Professional clients) are provided with less protection. Professional clients include banks, governments, pension funds, large companies and exceptionally some individuals.

In limited circumstances you can be treated as a Professional client. You may want to consider this to access products which are not available to Retail clients, or if you want to become a client of a firm that does not do business with Retail clients.

If you want to become a Professional client you need to feel confident that you are capable of making your own investment decisions, capable of assessing the risks that you incur, and do not need a high level of investor protection.

If you choose to be a Professional client, you will lose some of the regulatory protections that apply to Retail clients. The firm will explain this to you. For example, you will generally receive less information and fewer disclosures or warnings on a number of topics.

Before classifying you as a Professional client, a firm will first have to assess whether this category is appropriate for you. The purpose of the assessment is for the firm to establish that you are capable of making your own investment decisions and you are able to understand the risks involved.

Your firm will be able to categorise you as a Professional client only if you meet at least two of the following conditions:

  • you frequently carry out transactions;
  • you have a large portfolio;
  • you have worked in the field of investment services.

In broad terms, you are likely to receive one or more of the following types of investment services:

  • You are provided with personal recommendations on investments, products and courses of action (investment advice);

  • You buy and sell financial products without investment advice; or 

  • Your investments are managed by a firm on your behalf (investment management).

In this section we will explain the different types of services you may receive from firms and the processes they will follow to deliver the appropriate degree of protection to you.

When you receive investment advice, you are placing a higher degree of reliance on the investment firm than you would do in other circumstances such as in the case of simple non-advised transactions. You therefore need to have some comfort that the firm understands your individual needs and circumstances so that it recommends the right products for you. MiFID requires a process called the Suitability test, where the firm asks you some questions to reach an understanding of the types of investments that will be suitable for you.

As part of the Suitability test, you are likely to be asked questions about the following:

  • Your investment objectives

    • This can include questions about the length of time you wish to hold you investment, your risk appetite and profile, whether you wish to invest for income or growth, keep the capital safe and avoid any risk or accept a high level of risk.
  • Your financial situation

    • Information regarding your financial situation may be obtained through questions about matters such as the source and extent of your regular income, your assets, real estate property, any debts you have and other financial commitments. Information regarding your financial situation may be obtained through questions about matters such as the source and extent of your regular income, your assets, real estate property, any debts you have and other financial commitments.

  • Your knowledge and experience

    • Questions regarding your knowledge and experience can include the types of services and products you are familiar with; the nature, volume and frequency of your previous transactions; and your level of education, profession or former profession.

Information regarding your financial situation may be obtained through questions about matters such as the source and extent of your regular income, your assets, real estate property, any debts you have and other financial commitments.

If a firm does not, or cannot, obtain the necessary information to assess suitability, then it cannot make a recommendation. If you provide only limited information, this will affect the nature of the service the investment firm will be allowed to provide to you.

(a) the Appropriateness test

As we have described, when a firm is giving you investment advice, it must ensure that its advice is suitable for you.

When you are not receiving investment advice from a firm (or not relying on a firm to manage your investments) you will generally be expected to take a greater degree of responsibility for your decisions. When you want a firm simply to buy or sell an investment without providing you with investment advice or portfolio management services, a different set of protections apply. These protections are referred to as the Appropriateness test.

The test aims to protect those who may not understand or be aware of the implications and level of risk involved in a transaction, particularly where the products are 'complex' or where you have not taken the initiative to carry out the transaction.

Examples of 'non-complex' financial products include:

  • Shares admitted to trading on a regulated market
  • Money market instruments
  • Many types of bonds
  • Units in certain investment funds

Examples of 'complex' financial products include:

  • Options, futures, swaps, and other derivatives
  • Financial contracts for differences
  • Convertible bonds
  • Warrants

These examples are by no means exhaustive and merely indicative.

As part of the Appropriateness test, you are likely to be asked questions about your investment knowledge and experience.

  • If the firm concludes that you have the necessary knowledge and experience to understand the risks involved, then the firm may simply go ahead with the transaction.

 

  • If the firm concludes that you do not have the necessary knowledge and experience, or you have not supplied enough information to enable it to reach a view, then you will receive a warning from the firm saying that either the firm does not regard the proposed transaction as appropriate or that the information is not enough to enable it to determine appropriateness. If you insist on going ahead with the transaction, you must accept the risk.

 

 (b) Trading in 'non-complex' financial products on an Execution-only basis

The Appropriateness test does not apply in the case of some kinds of 'non-advised' transactions. This service can be described as Execution-only. The circumstances where the test does not apply are as follows:

  • the product involved in the proposed transaction is what MiFID calls 'non-complex'; and

  • you have chosen to contact the firm to carry out your transaction. This means that you are not responding to a personalised approach to you from the firm which was intended to influence you in respect of a specific product or transaction (for example in certain situations when you are buying shares on line).

     

You will be warned that the firm is not exercising any judgement on your behalf.

In such cases, you do not have to answer any questions about your investment knowledge and experience, financial situation or investment objectives. The firm may of course ask you questions for other purposes, particularly if you are a new customer.

Finally, when your investments are managed by a firm, you are reliant on the firm's decisions and choices. As the firm will not communicate with you every time it makes an investment on your behalf, it will need to have enough information from you at the outset to enable it to provide you with the required service. To achieve this, as in the case of investment advice above, the firm will carry out a Suitability test. If you do not supply the firm with adequate information it cannot provide the service of investment management to you. If you provide only limited information, this will affect the nature of the services the investment firm will be allowed to provide to you.

All information provided to you throughout your business relationship with a firm should be ‘fair, clear and not misleading’. This principle refers both to the content of the information and to the way it is presented to you.

Your firm should provide you with the relevant information in good time before you invest so that you can make informed decisions. Types of information you will receive before investing include:

Marketing communications: Whether or not you are a client of a firm, you may receive advertisements and other marketing communications issued by a firm. All advertisements and marketing communications have to be presented in such a way that you can identify them as being of a promotional nature.

Contracts: If you are a new retail client that a firm has taken on for the provision of investment services other than investment advice, you will be asked to agree in writing to a contract which will contain your and the firm's essential rights and obligations.

Information about the firm: A firm must give you general information about itself, including who regulates it and the services it offers to clients, to help you understand the nature of the services on offer and the risks involved.

Information on investment management: Where you have asked a firm to manage investments on your behalf, you should expect to receive information including a description of the management objectives and the related level of risk, what types of products or transactions may be involved in your portfolio and information about the valuation method and the frequency of valuations of your investments.

Information about financial products: You will receive information explaining the nature, risks and costs of financial products. Such information includes, for example, a description of the products' risks and whether prices/values may fluctuate. The amount of information will depend on the type of product, its complexity and risk profile.

Information about costs and charges: You will receive information about the direct and indirect costs and charges of a service or product, including any commission charged or paid. This should clearly show you the total costs. Sometimes, however, the precise amount of the total costs is not available at the time when the information is communicated to you. In such cases, you should instead receive sufficient information to see how the costs are going to be calculated, so that you can verify the total price once it is available.


Inducements

Inducements are payments or non-monetary benefits which a firm receives or pays out as a result of advising on or arranging investments for its customers. The firm is required to disclose to you, as its customer, the essential terms of any arrangements relating to such fees, commissions or non-monetary benefits in summary form. It may, on your request, provide you with more information. The aim of this requirement is to enable you to understand and be informed of any incentives which may reward the firm for promoting a particular product or service.

Before investing, it would be sensible for you to make sure that you know what the arrangements are if you need to make a complaint about the firm or seek redress, and which investor compensation scheme covers the firm. The firm should give you this information.



Last updated: Sep 07, 2016

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Prior to Investing

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