Introduction As one of Europe s largest financial services groups, The Royal Bank of Scotland Group (RBS) welcomes the opportunity to respond 1 to the questions raised by the Call for Evidence on Substitute Retail Investment Products. Executive Summary The creation of a more integrated market will be challenging, given the many factors that underlie the current market structure. RBS ackwledges that investment products offering comparable risk/return performance can be sold in a variety of forms. As a financial services group with a very large customer base, RBS understands that consumers can have very different needs and expectations. As a result, RBS offers a range of different products to suit its customers. The most important issue is that where an investment is recommended it is suitable for the customer and that in all situations (regardless of whether the product has been recommended or is sold on an execution only basis), the customer has full understanding of the nature and risks of the investment product they are about to receive and is happy to proceed on that basis. Additionally, people s choices of which products to buy can also be influenced by cultural and local differences. These differences will include attitudes in different countries to taking risk, to saving, making investments, general levels of financial sophistication, local taxation, local pension provision, the types of financial products that people tend to be familiar with, and whether people usually buy their properties or whether it is usual to rent (which will affect disposable income and how much people have available to invest). RBS is confident that the regulatory regime in the UK facilitates an environment in which consumers can invest in products suitable for their needs and objectives. In the UK, the FSA promotes a robust standard and consistency through regulation, being sufficiently empowered to address any perceived weaknesses in the UK retail investment and savings market in order to improve customer outcomes. One example of this in action is the Retail Distribution Review currently underway. As a result, RBS believes that the retail investment market in the UK does t require further intervention at EU level. There have also been many recent changes to the FSA s regulations resulting from implementing EU legislation, including MiFID, which cover investments on a broad basis. Consequently, there is already a significant degree of EU involvement. Finally, the Call for Evidence in its introduction states that substitute investment products are the subject of increasing attention and concern. RBS understands that the quotations referred to in the Call for Evidence on this point actually pre-date the implementation of MiFID. Given the very recent implementation of MiFID, RBS proposes that it is necessary to allow time for MiFID requirements to have effect before any conclusions can be made about possible discrepancies in investment regulations across the EU. In addition the Commission has commented at page 17 of the Call for Evidence on the differences regarding distribution under MiFID and the IMD. The fact that a separate consultation of the IMD is planned for later in 2008 may be a further reason that any proposals should be delayed to see if they would be addressed through MiFID or the planned review of the IMD. 1 The responses provided in tabular format relate solely to the UK. 1
Specific Questions 1. Do you see that different regulatory treatment of substitute products gives rise to significant problems? Please explain why you consider this to be the case. RBS does t see that different regulatory treatment of substitute products gives rise to significant problems. Whilst ackwledging that different treatments exist, there is usually a good reason for recommending one type of product over ather e.g. tax considerations or access to specific funds. (See the response to question 3.) One size of regulatory treatment does t fit all, despite the fact that the products may appear to be similar. However, this should be viewed positively. Whilst similar in some respects (e.g. financial aims or anticipated returns), products are constructed differently and these differences impact on the regulatory treatment and are relevant according to particular client needs. Placing the highest standards of disclosure on a basic product would be inappropriate for such a product and confusing for the consumer. One example is the prescriptive past performance data required for packaged products as opposed to unregulated funds or other products. In the UK, the Financial Services Authority (FSA) regulations are designed to ensure appropriate protection is provided for different products and that suitability guidance is clear. Additionally, the principle of Treating Customers Fairly is an FSA initiative to ensure that the spirit of the law is followed by encouraging an efficient and effective market and helping consumers achieve fair treatment. In our view, different regulatory treatments are appropriate for different types of products and there would be significant problems if the same regulatory treatment was applied across the board. 2. Do you regard the perceived concerns relating to different levels of product transparency and intermediary regulation as a significant threat to the further development of EU markets for retail investment products? strongly agree somewhat agree opinion somewhat disagree strongly disagree The responses within this paper expand on the reasons for this comment. 3. Is it appropriate to regard different retail investment products as substitutable regardless of the legal form in which they are placed on the market? Generally, it is t considered appropriate to regard all different types of retail investment products as being "substitutable" with each other. The various types of funds (UCITS, nationally regulated retail funds, unit-linked life insurance funds and exchange traded or listed funds) are reasonably comparable and could probably be "substitutable". In the case of these types of funds, the structure and features of the products are generally similar but otherwise the various investment products tend to be quite distinct. Products can really only be considered to be "substitutable" if they are reasonably similar and comparable and meet the needs of the consumer in a similar way. However, the features and characteristics of investment funds, insurance products and structured products are distinct and different from each other. It isn't simply the legal form of the product that might be different. For instance, there are differences between these products in terms of the following: 2
- ecomic objectives - spread / diversification of investments - risk profile - liquidity / holding periods - investment features and restrictions - type of return / protection of capital Within the UK, under the terms of the Financial Services Compensation Scheme, these differences are recognised, even in relation to the compensation levels that are set in the event of a provider/ issuer becoming insolvent. The level of cover depends on a variety of factors including the nature of the product itself. Each "package", taking account of these and other features, is priced differently. A different type of investment product might t necessarily be suitable for the investor or satisfy his particular objectives and needs. Currently, there will be differences in the regulation applicable to the issuer or provider, the product, the marketing and distribution of these types of products. It is t that there is regulation of these areas - there is regulation but the level and detail of the regulation, quite appropriately, varies taking account of all of these differences. In the UK, where we have a single financial services regulator for investment business, there is consistency in regulation where this is appropriate, but naturally and invariably the regulation applicable to different circumstances will vary accordingly. It is important that these tailored differences exist and that an attempt is t made to try and fit one size onto all the scenarios. Which of the products listed below should be considered as substitute investment products? UCITS funds Nationally regulated retail funds Exchange traded or listed funds Unit linked life insurance (especially which mortality risk level is small or nil) Retail tranches of structured tes Some annuities Some bank term deposits e.g. with embedded optionality or structured deposits) Others Investment Management Agreements, cash ISA / pensions, corporate & government bonds, with profits bonds, cash funds (typically t UCITS), hedge funds, national savings, limited partnerships, securities trading, ownership clubs, time share and Non UCITS Retail Schemes (NURS). If the measure of substitutability had merely been the needs of an investor to save money on a medium to long term basis whilst maximising the potential return through exposure to a variety of financial markets, we would have regarded these products as substitutable. However, we do t believe that this is an appropriate measure of substitutability. In reality, the circumstances will be much more complex. Each type of product's risk profile; level of liquidity available; structure/legal form; the type of return; tax considerations; availability of capital protection; ecomic objectives; investment features etc will be different and therefore the above products are generally viewed by RBS as t being interchangeable or directly substitutable. Products within a category (e.g. the various funds) may be substitutable but funds, annuities, equity ISAs and structured products are each quite distinct types of product, with different features and objectives and satisfying different investor needs. 3
What are the features/functionalities (holding period exposure to financial/other risk capital protection diversification) that lead you to regard them as interchangeable? There is a wide range of features that might make these interchangeable, but again subject to the risk profile and objectives of the individual customer. For example, the following features in combination might determine whether or t a product is interchangeable: term, return, guarantees, accessibility, risk, taxation, contribution limits (minimum & maximum), contribution frequency (regular or single), flexibility, convertibility, penalties and bonuses (maturity etc). For instance, UCITS, nationally regulated funds, listed funds and unit-linked life assurance investments have similar characteristics as they are open-ended contracts which should be held over the medium to long term with the ability to select funds with a similar risk profile. Structured Notes and Structured Deposits could be interchangeable in situations where full capital protection is required and the investments are for the same term and a similar index and benefit formula. However, they would t be interchangeable if just partial capital protection is required. Have you encountered any legal or other definition which would encompass the range of 'substitute investment products'? RBS has t encountered any definition which would encompass a range of 'substitute investment products'. 4. Which factors in your opinion drive the promotion and sales of particular investment products? Please use the table below to rank these factors in terms of importance (very significant; significant; opinion; insignificant) for each of the different products. In addition to completing the table we would welcome further explanation of your view as to which factors are particularly important for each product. RBS has chosen t to use the tabular format in its response as it believes it adds further clarity to provide a fuller response to this complex question. It is t possible to identify and prioritise which factors on their own are more important than others without ackwledging that their importance is relative, in accordance with the objectives and risk profile of a particular client. RBS also tes that Section 1.3 of the Call for Evidence suggests that some distributing entities may be tempted to promote products that best suit its own interests, as opposed to those of its clients if product selection is driven by compensation arrangements with the originator. In the UK, whilst this sometimes tends to be a perception that applies to intermediaries, one of the aims of the current FSA Retail Distribution Review is to review how remuneration is handled and to bolster current disclosure requirements and consumer protection. Under consideration at the moment are proposals such as Customer Agreed Remuneration/Factory Gate Pricing which will assist in creating greater transparency. We expect the review to result in a more transparent retail market in the UK, where services and remuneration are more clearly defined and product information more user friendly. RBS believes Member States should be left to address any perceived problems at national level rather than relying on EU involvement across all Member States. As ackwledged in the Call for evidence, tax regimes can have an influence in the sale of some products, however RBS agrees with the Commission that it should be left to Member States to correct any underlying distortions if this is necessary. 4
Currently RBS believes that there are adequate powers available to the FSA in the UK to regulate how products should be promoted, recommended and sold, their suitability for clients and redress and enforcement where the regulations are t followed. It is inevitable that matter how much regulation there is, some providers/intermediaries may t follow those regulations, but RBS believes that the current UK regulatory system, incorporating recent EU legislation, is sufficiently robust to address this. RBS does t believe further or different regulation will necessarily assist. Before considering any amendments to current requirements attention should be given to the effect of implementation of MiFID and the intended review of the IMD later in 2008. However, to assist the Commission, RBS has set out below some of the factors that are important for each product. UCITS Non-harmonised funds Unit-linked life Insurance products Retail structured products Annuities (Structured) Term deposits Pensions Taxation / fund choice / risk exposure / investment potential Taxation / fund Choice / risk exposure / investment potential Fund choice / investment potential / customer commitment (term) / capital protection / taxation Rate of return and level of capital protection required Level of income / post-death guarantee Simplicity and security / guaranteed return / shorter-term Taxation (personal & business) / contribution limits (lifetime allowance) / long-term commitment 5. Product disclosures: Do precontractual product disclosures provide eugh information to help investors understand the cost and possible outcomes of the proposed investment? Please use the attached tables to provide your evaluation of the adequacy of the information provided with regard to the following items for each category of investment product. Nature of information provided UCITS Nonharmonised funds Unit-linked life insurance funds Retail structured products Annuities (Structured) term deposits Product features A A A A A A A Direct costs A A A A A A A Pensions Indirect costs (or foregone A A A IA* A IA* A performance) Risks A A A A A A A Capital guarantee A A A A A A A Likely performance A A A A A A A Conflicts of interest A A A A A A A Compensation or fee A A A A A A A retrocession (A = Adequate; IA = Inadequate) * Since disclosure of fees is currently t obligatory, it can be difficult to compare structured products as they are invariably different and some can be complicated. It would be useful if the implicit charges could be disclosed such as the Launch Cost and any ongoing expenses. 5
6. Conduct of business rules: Do differences in conduct of business regulation result in tangible differences in the level of care that different types of intermediary (bank insurance broker investment advisor/firm) offer to their clients? While differences exist in conduct of business regulation, they do t in RBS opinion result in tangible differences in the level of care that different types of intermediary (bank, insurance broker, investment advisor/firm) are required to offer to their clients. One of the key aspects is to deliver investment material in a form that is clear, fair and t misleading and this obligation is imposed on all types of authorised business. See also the response to question 4 above. For which conduct of business rules (kw your customer, suitability, information/risk warnings) are differences the most prounced and most likely to result in investor detriment? Kw your customer Suitability or appropriateness UCITS Nonharmonised funds Unit-linked life insurance products Retail structured products Annuities (Structured) Term deposits* Pensions S S S S S D S S S S S S D S Risk warnings S S S S S D S Examples - information S S S S S D S Others S S S S S D S (S = Same; D = Differences) *Structured Deposits are t subject to full FSA regulation in the UK (though RBS treats them as such) which means that the kw your customer and suitability rules do t apply. However, this difference does t result in investor detriment. The lighter touch approach is appropriate given the nature of these products, including the fact that capital protection is provided. 7. Conflicts of interest: Are there effective rules in place to ensure effective management / disclosure of conflicts of interest (and/or compensation arrangements) by the different categories of product originators and/or intermediaries for the different types of investment product? Generally, all the potential issues raised in Paragraph 2.3 of the Call for Evidence, have been taken into consideration and addressed in the UK. In the UK, again partly through the implementation of MIFID, there are already effective rules and requirements in place to ensure effective management / disclosure of conflicts of interest across the financial services industry. This has been achieved by the imposition by the FSA of a combination of general principles (the FSA's Principles for Businesses) and detailed rules (for instance, those contained in Chapter 2 of the FSA's New Conduct of Business Sourcebook (COBS) and Chapter 10 of the Senior Management Arrangements, Systems and Controls Sourcebook and the disclosure obligations contained in COBS relating to firms, their services and the products being offered). Also, in the UK, where the intermediary acts as agent of the customer, under the general law (including case law and FSA rules), and w under MIFID, specific disclosure obligations are 6
imposed on the intermediary. If there are any perceived weaknesses, RBS is confident that the FSA s Retail Distribution Review will resolve these in the UK. For which type of product do you see a regulatory gap in terms of the coverage of conflict of interest rules? Please explain. In the UK and in relation to investment products, RBS believes there are material regulatory gaps in terms of coverage of conflict of interest rules as adequate provision is already made for this by the FSA Rules and the relevant legislation, as referred to in the paragraphs immediately above. 8. Unfair marketing / misleading advertising: Is the risk of unfair marketing / misleading advertising more prounced for some product types than for others? If so why? Yes, the risk could be more prounced for some product types as it depends on the complexity of the products. The more complex the product is, the more likely it will be that consumers may t be able to understand it and therefore the greater the likelihood that they could be misled. For example, term deposit versus UCITs will require different degrees of explanation which could lead to varying levels of consumer understanding. It will also depend on the existing kwledge of the consumer and their attitude to risk as to what is misleading. However, the FSA has implemented financial promotions regulations, partly through MiFID, which set out rules for advertising investment products to retail investors. Please refer also to the response to question 4. Can you point to concrete examples of the mis-selling of the different types of investment product resulting from unfair marketing / misleading advertising? The UK Regulators and law enforcement (in particular the Trading Standards Office) are best placed to provide any available information in response to this question. 9. Is a horizontal approach to product disclosures and/or to regulation of sale and distribution appropriate and proportionate to address the problems that you have identified? Can you specify how this objective of coherence between different frameworks would address the problems? What are the potential drawbacks of such an approach? RBS has t identified any particular problems in respect of current disclosure and/or regulation requirements in relation to sales or distribution. As ted in the response to question 1, one size of regulatory treatment does t fit all and the existence of different frameworks should be viewed positively. It is appropriate for certain types of basic, less complex products to be subject to less stringent regulatory requirements. Aligning the requirements will almost certainly result in over burdensome and unnecessary regulation which could impact on the viability of offering simple basic products and increase costs in the provision of advice, with clear evidence of benefit to the consumer. Please also refer to the response to question 5. 7
10. Can market forces solve the problems that you identified (fully / partially)? RBS is of the opinion that in the UK there are significant problems that are t addressed or being addressed by national regulations. As for reliance on EU-wide market forces, currently there are likely to be cultural and ecomic differences between states that may make any cross border market-force resolution of issues hard to achieve. For example, national attitudes to pension arrangements and the degree to which there is national government provision or there is an expectation on individuals to make their own provision, would make an EU-wide market-force solution unlikely. Are there examples of successful self regulatory initiatives in respect of investment disclosures or point of sale regulations? RBS is t aware of any self regulatory initiatives in respect of investments in the UK. Are there any constraints to their effectiveness and/or enforceability? RBS is t aware that there would be any constraints. To the contrary, any self-regulatory initiatives ought to be generally reinforced by being applied within the legal and regulatory framework. Where any requirements might t be met by trade bodies or firms alone, the regulatory bodies could intervene and/or be expected to offer regulatory assistance and/or guidance. For example, RBS refers to the Consumer Protection from Unfair Trading Regulations, coming into force in April 2008. Under these Regulations, enforcement action can be taken by the regulators against firms who publicise their membership of a trade body but do t comply with its Codes. In this way, the self regulatory initiatives are bolstered by legislation and by the regulatory authorities. Are you aware of effective national approaches to tackle the issues identified in this call for evidence? Again RBS is t aware of any significant issues of the type mentioned in this call for evidence that need to be tackled. In the UK, these aspects are all satisfactorily addressed by the authorities, by way of regulation and legislation. Should it be left to national authorities to determine the best approach to tackling this problem in their jurisdiction? RBS has t identified any problems of this type that need tackling by national or EU authorities. In addition, as mentioned above it believes that any issues that may generally arise would rmally be addressed by firms, trade bodies and the national regulatory authorities acting together and that this is the correct forum to address any concerns. Is there a case for EU level involvement? Please explain. RBS does t believe that further EU level involvement is required at this time. In the UK the FSA provides a robust standard and consistency in regulation. Many of the recent changes to the FSA s regulations result from implementing EU legislation, including MiFID and cover investments on a broad basis. So there is already a significant degree of EU involvement. 8
Additionally, as previously mentioned the FSA is currently reviewing the efficiency of the retail distribution marketplace and is engaging the industry and welcoming proposals to improve it. Finally, RBS would ask the Commission to consider the effectiveness of MiFID postimplementation and the review of IMD before coming to any conclusions. 9