Inducements

Question 1

Briefly explain what inducements mean

Answer 1

Under MiFID II

A. Inducements are any benefits or incentives that a firm might provide or receive, typically in relation to the sale of financial products or services.

B. These can include commissions, fees, gifts, or any other type of benefit, which could influence the behavior of the firm or individual providing the financial service.

NOTE: MiFID II bans inducements (commissions/ incentives) for firms providing independent investment advice and portfolio management services to professional clients.

Question 2

Under MiFID II - what is the ban on inducements for professional clients and retail clients?

Answer 2

Below is the list of services that firms cannot get commissions for:

1. Professional client - providing independent investment advice and portfolio management services.
2. Retail client - providing both restricted advice and independent advice on investment advice and portfolio management services.

Question 3

What is the difference between independent investment advice and restricted investment advice?

Answer 3

1. Independent advice -
   A. Adviser looks at a wide range of products from different companies and recommends what’s best for you.
   B. Not influenced by commissions or incentives from product providers.
2. Restricted advice -
   A. Adviser only recommends products from certain companies or a limited selection.
   B. They may receive payments or incentives from those providers.

NOTE: Under MiFID II -
A. Inducements on independent advice is banned for professional clients. B. Inducements on both independent and restricted advice is banned for retail clients

Question 4

MiFID II prohibits firms providing portfolio management services from receiving any inducements related to their services to clients, except for minor non-monetary benefits.

What qualifies as these minor non-monetary benefits?

Answer 4

1. They must be capable of enhancing the quality of the service provided to the client.
2. They must not impair the firm’s duty to act in the best interest of the client.
3. They must be clearly disclosed to the client

Question 5

Under MiFID II - research and inducements are tightly regulated.

What are the guidelines around inducements for research provided to an investment firm?

Answer 5

1. Self-funded research –
   A. If the research is paid for by the firm from its own resources OR received in exchange for payment from a special research payment account (funded by client charges, not third parties), it will not be regarded as an inducement.
2. Exemption for smaller companies –
   A. FCA has ruled that companies valued at less than £200 million are exempt from the rules on research inducements.
3. Research payment accounts –
   A. These accounts must be funded by a specific research charge agreed with the client, and the charge should align with a research budget set by the firm.
4. Separation of charges –
   A. Research charges must be separately identified from transaction commissions.
   B. If there is any excess charge, it must be rebated to the relevant client.
   C. The research payment account cannot be used for internal research

Question 6

What is a research payment account and explain further and how this is funded?

Answer 6

1. The firm sets up a research payment account on behalf of the client.
2. The client agrees to pay a specific research charge into this account, and this money is only for the client’s research (nothing else).
3. The firm can only use the funds in that account for research that directly benefits the client.
4. The client must be fully notified about how much is being charged for research and how it’s used.
5. The funds cannot be used for internal research that benefits the firm, only for external research that helps the client.

Question 7

When a firm operates a research payment account, it must establish new policies, systems, and controls, along with additional disclosures to ensure transparency and proper management.

What do these include?

Answer 7

1. Quality assessment of research –
   A. Firms must regularly assess the quality of the research it purchases.
   B. Should use robust quality criteria, and ensure it contributes to better investment decisions for clients.
2. Clear policies for clients –
   A. Clients must be provided with detailed policies explaining:
   I. How the firm assesses the quality of research.
   II. How research benefits client portfolios.
   III. How costs are fairly allocated among clients.
3. Strong controls and oversight –
   A. The firm must have:
   I. Senior management oversight to assess the need for third-party research.
   II. A clear process for allocating the research budget in the best interests of clients.
   III. A transparent audit trail showing payments made to research providers and how those payments were justified based on quality criteria.
4. Regular reporting to clients –
   A. The firm must provide disclosures to clients:
   I. In advance of research charges.
   II. At least annually, updating clients on how their research payments were used.