How-to guide: Overview of the conduct of business rules - scope and application (UK)

Introduction

This guide will provide in-house counsel, private practice lawyers, and risk and compliance teams with an overview of the conduct of business rules (to be found in the Conduct of Business Sourcebook (COBS) of the Financial Conduct Authority (FCA) Handbook). COBS governs the relationships between firms and their customers.

This guide covers:

What are COBS rules and who do they apply to?
What are the core requirements for firms in the COBS rules?

This guide can be used in conjunction with the following How-to guide: Understanding the rules on communications with clients, including financial promotions.

Section 1 – What are COBS rules and who do they apply to?

1.1 What are COBS rules?

COBS rules apply to all firms authorised under Part 4A of the Financial Services and Markets Act 2000 (as amended) (FSMA) that carry on designated investment business and activities connected with it, from an establishment or through an appointed representative in the UK. COBS rules are business conduct standards created by the FCA to govern day-to-day relationships and interactions to protect clients and ensure they are treated fairly. COBS rules support principles-based regulation rather than prescriptive rules-based regulation. All FCA-authorised firms are also required to comply with the high-level guidance in the Principles for Business sourcebook (PRIN) when they are carrying on business.

COBS contains guidance for deposit-takers, long-term insurance businesses and some members of Lloyd’s; however, these are not considered in this guide. There are separate conduct of business sourcebooks (also not considered in this guide) for:

mortgage and home finance (MCOB);
general insurance distribution business (ICOBS); and
banking (BCOBS).

The COBS rules essentially follow the timeline of the client journey. This includes marketing and communications to clients, client contracts, and providing a right to cancel contracts. Certain sections, however, are included as stand-alone chapters (eg, the distance marketing disclosure rules at COBS 5.1).For the purposes of this guide, we will focus on the provisions of COBS 1 and 2.

1.2 Scope of application

The application of COBS is set out at COBS 1.1. In general, COBS will apply to a regulated firm which carries on (either directly or by its appointed representative (AR)) – see How-to guide: The appointed representatives regime explained – what it means in practice), designated investment business (see 1.2.1), or activities connected with it, from an establishment in the UK.

The general application of the COBS rules varies depending on the activities of a firm (Part 1) and its location (Part 2) – see COBS 1 Annex 1. The general application rule is also modified in the COBS chapters for specific purposes, such as the type of firm, its activities, connected activities and location. Guidance on the application provisions is set out at COBS 1 Annex 1 (Part 3). For example,COBS 4(Communicating with clients, including financial promotions) has extended the general application regarding territorial scope. Consequently, each chapter’s application provisions must first be reviewed on a case-by-case basis.

The application of the COBS rules differs depending on the categorisation of clients, and whether a client is a retail client, a professional client or an eligible counterparty (see COBS 3 for more detailed explanation of client categorisation). COBS rules afford greater protections to retail clients than professional clients, as they are generally presumed to have limited investment knowledge and/or experience.

1.2.1 What is designated investment business?

Designated investment business refers to carrying on certain activities by way of business eg, dealing in investments and often exercising discretion as to investment decisions on behalf of a client. Examples of designated investment business include arranging deals in investments, and safeguarding and administering investments. This includes investments in certain financial products such as equities, options, and futures contracts.

The full list of activities is specified in Part II of The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (as amended) (commonly known as the RAO) and schedule 2 FSMA. See also the FCA glossary definition of designated investment business which details the full range of activities caught by the term. The investments are defined in Part III of the RAO. For more details of the RAO’s list of specified activities and investments and what the term ‘by way of business’ means, see How-to guide: The general prohibition – beware the consequences of breach.

1.2.2 UK rules and MiFID II conduct of business requirements

What is known as ‘Markets in Financial Instruments Directive (MiFID) business’ in the FCA Handbook comes from the MiFID II Directive (2014/65/EU) which came into force on 3 January 2018 in the UK. This is a collection of laws regulating the buying, selling and organised trading of financial instruments. Following Brexit, the MiFID II regime was transposed with minor amendments to UK legislation and the FCA Handbook rules. More information on the ‘onshoring’ of MiFID II is set out in the Perimeter Guidance Manual (PERG) - see PERG 2 and 13 of the FCA Handbook.

In order to help firms, COBS also reproduces a number of provisions of the directly applicable Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms, referred to in the UK as the MiFID Org Regulation.

COBS 1.2 provides guidance to firms on the application of the provisions and how certain references in COBS are impacted by the MiFID Org Regulation which can assist firms to correctly interpret and understand the application of the provisions.

Section 2 – What are the core requirements for firms in the COBS rules?

2.1 Acting in the client’s best interests

Every regulated business should have acting in their client’s best interests at the core of their culture, and COBS 2.1.1.R sets out a requirement to act honestly, fairly and professionally in accordance with the client’s best interests. This rule underpins the requirement of PRIN 6 whereby firms should demonstrate a commitment to ‘treat customers fairly’. The Consumer Duty which came into force in July 2023 takes this further, and places the onus on firms to be proactive and continually assess and evidence the extent to which they deliver good outcomes for retail customers throughout the lifecycle of the products and services they provide to them (see PRIN 12 and more detailed rules in PRIN 2A). What is required to deliver ‘good outcomes’ includes taking steps to deliver value for customers and support customer understanding (see FCA Consumer Duty guidance). See also How-to guide: The FCA’s Consumer Duty: putting the needs of customers first and Checklist: Embedding the Consumer Duty: practical considerations.

2.1.1 Exclusion of liability

A firm must not, in any communication relating to designated investment business, limit any duty or liability (ie, exclude or restrict, or rely on any exclusion or restriction) it may have to a client under the regulatory system. Such liabilities cannot be delegated to others.

2.2 Requirements in relation to information disclosure

For the purposes of this guide, we are considering the information that firms must provide to their clients under COBS 2. However, firms should also be aware that additional information disclosure requirements are also set out at COBS 4 (in relation to communications with clients), COBS 6 (in relation to firms and compensation information (see section 2.2.2 below)), and COBS 14 (information about designated investments). Some of these are detailed below.

COBS 2.2 (which applies in relation to designated investment business other than for MiFID, equivalent third country, or optional exemption business, or insurance distribution activities) and COBS 2.2A (which applies to MiFID, equivalent third country or optional exemption business) details the information that firms must disclose to clients before providing services. This includes providing appropriate information in a comprehensible form about the firm and its services, and warning of the risks associated with designated investments. It should also detail proposed investment strategies and costs and charges to ensure clients are making investment decisions on an informed basis. It may be provided in a standardised format (see COBS 2.2.1R and COBS 2.2A.3R).

2.2.1 Shareholder Rights Directive requirements

COBS 2.2B applies to the extent that the firm is investing (or has invested) on behalf of investors in shares traded on a regulated market. For guidance as to scope of application, see COBS 2.2B.1. This section implements provisions of the revised Shareholder Rights Directive (EU 2017/828) (SRD II). It deals with a firm’s engagement policy, the information disclosure requirements, and the transparency of asset managers.

2.2.2 Information about the firm and compensation information

In addition to the required disclosures under COBS 2.2, a firm which makes personal recommendations to UK-based retail clients for retail investment products (other than in respect of MiFID, equivalent third country or optional exemption business or insurance distribution activities), must also comply with the rules in COBS 6.1A (Adviser charging and remuneration). This provides, amongst other things, that a firm must only be remunerated for a personal recommendation (and any other related services provided by the firm) by adviser charges: : commissions are not permitted. COBS 6.1ZA contains the equivalent provisions for firms carrying on MiFID, equivalent third country, or optional exemption business or insurance distribution activities.

2.3 Inducements

Firms must comply with the FCA’s inducement rules, which include the requirement that any payment or benefit given to or received from clients is designed to enhance the quality of service provided to a client. The term ‘inducements’ is not defined in the FCA glossary; however, it is generally interpreted to include some form of consideration that a firm gets in return for client business (eg, by way of fees, commissions and other non-monetary benefits).

The rules are designed to ensure that firms only act in the best interests of their clients and disclose payments (or non-monetary benefits) in a comprehensive, accurate and understandable way. The FCA’s inducement rules also include rules on prohibited inducements and exceptions to the prohibition. Guidance on inducements is set out at COBS 2.3 (relating to business other than MiFID, equivalent third country or optional exemption business and insurance-based investment products). The inducements regime is complex and different requirements may apply to different scenarios.

2.3.1 Inducement requirements

COBS 2.3.1R provides that a firm must not pay or accept any fee or commission, or provide or receive any non-monetary benefit, in relation to designated investment business carried on for a client unless it is as set out in COBS 2.3.1R(1)-(3) and is:

a fee, commission or non-monetary benefit paid or provided to or by the client or a person on behalf of the client; or
a fee, commission or non-monetary benefit paid or provided to or by a third party or a person acting on behalf of a third party which does not impair the firm’s duty to act in the best interests of the client, and the essential arrangements relating to the inducement are clearly disclosed to the client before the provision of the service provided certain conditions are satisfied (see COBS 2.3.2R(2) for more details on how a firm will satisfy the disclosure obligation); or
a proper fee necessary for the provision of designated investment business (eg, regulatory levies or legal fees).

2.3.2 Reasonable non-monetary benefits

Certain reasonable non-monetary benefits are permitted eg, promotions, training, hospitality, promotional prizes and conferences. These benefits are considered to enhance the quality of the service provided to a client and, depending on the circumstances, can be paid or received without breaching the client’s best interests rule. However, in each case, it will be a question of fact whether these conditions are satisfied (COBS 2.3.14G).

In interpreting the table of reasonable non-monetary benefits (COBS 2.3.15G), retail investment product providers should note that where a benefit is made available to one firm and not to another, this is less likely to comply with the client’s best interests rule. Any benefits of substantial size or value (such as adviser training programmes or significant software), if they are provided at all, should be made available equally across the firms they deal with.

2.3.3 Firms carrying on MiFID, equivalent third country or optional exemption business or insurance distribution activities

COBS 2.3A sets out the inducement rules for firms carrying on MiFID, equivalent third country or optional exemption business, or insurance distribution activities with respect to insurance-based investment products. Inducements are generally prohibited unless certain criteria are met – these are set out at COBS 2.3A.6R. Where the authorised person gives advice or provides portfolio management services, the rules are even more restrictive. The restrictions do not apply to acceptable minor non-monetary benefits (subject to satisfying the conditions which are contained in COBS 2.3A.19R) or third-party research received in accordance with COBS 2.3B and COBS 2.3C.

2.3.4 Inducements and research

COBS 2.3B provides the rules and guidance in relation to inducements and research. Adherence to these rules means third-party research is not an inducement if it is received in return for one of the following:

payment is made directly out of a firm’s own resources; or
payments from a separate ‘research payment account’ (RPA) transparently funded by a specific research charge to clients, with the clients' prior approval and provided certain procedural requirements are met (see COBS 2.3B.4). With a separately held account, firms must set a budget for research and regularly assess the quality of research received; or
from 1 August 2024, in return for joint payment for third-party research and execution services provided the firm meets the requirements relating to the operation of joint payments (see below).

UK regulation which derives from MiFID II formerly required brokers to price and supply their research separately from execution costs. Post-Brexit, the UK embarked on a programme of targeted reforms as set out in the Investment Research Review to improve the investment research market.

In April 2024, the FCA published Consultation Paper 24/7 (CP24/7) proposing changes to the existing rules governing how payments for investment research are made including a new option which would enable authorised firms who wish to pay for investment research to use bundled payments for third-party research and execution services, provided the firm complies with certain requirements.

Feedback to CP24/7 and the final policy position and Handbook Rules were published in July 2024 in Policy Statement PS24/9 - Payment Optionality for Investment Research. From 1 August 2024, firms are able to make joint payments for third-party research and execution services subject to compliance with the requirements (see COBS 2.3B.25R and COBS 2.3B.33G). The full scale of changes are set out in appendix 1 to PS24/9 and the new rules will affect among others, investment firms and market operators in the UK, asset managers and institutional investors such as pension schemes.

A separate consultation is planned to align the rules and research and inducements for fund managers, including AIFMs and UCITS managers under COBS 18. The FCA note their intention is to 'make the same option available in substance' and will consider the technical aspects of how best to achieve this in practice.

COBS 2.3C details the rules for firms providing both execution and research services to clients to price and supply them separately.

2.3.4 Recordkeeping

Recordkeeping requirements in relation to inducments are detailed at COBS 2.3.17R which set out relevant client disclosures and minimum retention periods. Firms will need to keep internal recordkeeping policies under review and ensure staff understand the specific disclosure requirements.

2.4 Agents and reliance

The increased use of outsourced investment advice and management means that advisers and discretionary fund managers (DFMs) can agree to conduct their arrangements for providing services with third parties. The two most common arrangements are ‘agent as client’ and ‘reliance on others’ and it is vital that all parties involved understand the practical implications of the relationship.

2.4.1 Agent as client (AAC)

The AAC model is where an advisory firm arranges for the investment management decisions to be carried out by the DFM on the basis that the investor does not have a direct contractual relationship with the DFM. Instead, the DFM treats the advisory firm as its client.

COBS 2.4.3R(1) provides that where a firm is aware a party with or for whom it is providing services is acting as agent for an underlying client in relation to those services, the underlying client is not the client of the firm. Here, the client is the person it is providing services to.

However, the rules allow for the underlying client to be treated as the client of the firm in respect of that business if either:

the firm has agreed in writing with the ‘client’ to treat the underlying client as the client; or
the firm’s ‘client’ is neither a firm or an overseas financial services institution and the main purpose of the arrangements between the parties is the avoidance of the duties that the firm would otherwise owe to the underlying client.

See COBS 2.4.3R(2).

Except for certain risk warnings, occasional reporting requirements and separate periodic statements, firms can notify, get consent, or enter into agreements with each underlying client via an agent. Either way, it is crucial for an adviser to understand exactly what the relationship is in every case to understand their regulatory responsibilities.

2.5 Reliance on other firms

The ‘reliance on others’ rule is an alternative operating model where the underlying investor has a direct, contractual relationship with the DFM and, in turn, the DFM relies on the information provided to it by the investor’s adviser.

COBS 2.4.4 provides that firms may, in certain circumstances, rely on other firms to have carried out the relevant checks to enable compliance with certain rules. For instance, firms can (in certain circumstances) rely upon information provided by other firms about an underlying client or the suitability of advice or recommendations provided to the underlying client. This would cover suitability or appropriateness assessments and could also cover certain KYC related checks. The firm providing the actual services would, however, remain responsible for concluding the services or transaction based on any such information or recommendations.

2.6 Consideration of optional additional products

Customers must actively elect to purchase optional additional products, described by the FCA in PS15/22 as ‘any type of good, service or right obtained in connection with, or alongside, a primary product – whether it is financial in nature or not’. The FCA note that separate baggage cover on a travel policy or accidental damage on a home insurance policy are optional additional products. These are insurance products which are purchased in connection with the primary product; however, there is a risk of customer harm, as customers may be ‘defaulted’ into making a purchase without their knowledge.

COBS 2.5 accordingly restricts the ability of firms to automatically ‘opt-in’ customers to purchasing such additional products where fees are payable and a firm must not:

Enter into an agreement with a client under which a charge is, or may become, payable for an optional additional product unless the client has actively elected to obtain that specific product.
Impose a charge on a client for an optional additional product under an agreement entered into on or after 1 April 2016, unless the client has actively elected to obtain that specific product before becoming bound to pay the charge.

An additional product may however be added with automatic renewals where the terms are substantially the same and the client actively elected to purchase the additional product in the first place or prior to the renewal. Failure by clients to change a default option such as a pre-ticked box on a website is not considered to be an active election. Firms must also ensure that their appointed representatives comply with COBS 2.5.

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