Cemap 1-final-copy

UNIT 1

UNIT 1
INTRODUCTION TO
THE FINANCIAL SERVICES,
ENVIRONMENT & PRODUCTS

SECTION 1: THE UK FINANCIAL SERVICES INDUSTRY

1.1 The Functions of the Financial Services Industry
Bartering = exchange goods and services
- Problem: Size of some transactions unmatched

MONEY (£££) :
Why use money?
1) Medium of exchange = Separate commodity to exchange for products
2) Unit of account (a/c) = Measure product value

Acceptable to
Sufficient all parties
in quantity

5 properties
Divides to small units
Of £££

Portable Store of value = can be
saved and used later

Means of achieving otherwise
Convenience difficult objective
e.g. current a/c e.g. mortgage

Aim of Financial
Services Industry

Protection from risk
e.g. insurance Money from lenders
to borrowers

1.
1.
1

1.1.1 Intermediation

Surplus sector = cash rich
- lend surplus fund to earn money
(1) Low interest rate (IR)
given Money lent to

(2)-(1)
Financial Intermediary e.g. banks & building
Intermediaries
societies (socs)
profit margin
(2) High IR Money lent to
charged

Deficit sector = fewer liquidity
- pay money to anyone willing to lend

Disintermediation = “cut out middle man”
e.g. company (Co.) raises funds from public by issuing shares

Why use the financial intermediary?

Problem without … Solved with …
Geographical Locating lenders & borrowers Easy to find
location
Aggregation Potential lender might not have Retail deposits are low, whilst loans are high
enough - aggregate small deposits

Maturity Borrower may need fund longer Most deposits are short term, whilst loans for
transformation than lender willing long term
(e.g. mortgages: 20-25yrs)
- range of deposit a/c – not all depositor
funds w/d at same time

Risk Individual depositors reluctant to Allow spreading risk over variety of
transformation lend all savings to individual/Co. borrowers … if a few fail to repay-
intermediary absorbs loss

1.1.2 Risk Management

Insurance = “means of shifting burden of risk by pooling to minimise financial loss”

Depositors

Small deposits made by
each individual depositor
FUND

Large payment out from insurance fund
e.g. car insurance payments for car accident
caused by a depositor from this insurance fund

1.1.3 ‘Product sales’ intermediaries

- Bring product providers (e.g. banks/insurance companies) & potential customers

E.g. Mortgage advisers, financial advisers, insurance brokers
1.1.2, 1.1.3

1.2 Financial Institutions
<1980s: more defined boundaries between different financial organisations
E.g. retail banks, wholesales banks, life assurance companies etc

NOW: distinction blurred/disappeared
E.g. bancassurance = banks owning insurance companies

1.2.1 The Bank of England (BOE)

- UK central bank
(Federal Reserve – United States)
(European Central Bank – Europe)

2
1.

Makes funds available when banking system
Manage UK gold & foreign short of liquidity – maintain confidence
currency reserves for Treasury

Financial cover ஃ when gvt in:
Foreign
Lender of - Deficit …
exchange BOE make automatic loan to
market last resort
gvt

Issuer of - Surplus …
bank notes BOE may lend out as part of its
Banker general debt management policy
to
Regulating banking sector
Functions government (gvt)
NOW: FSA (1/6/98) of BOE
Previously in
charge of
Banker
to banks
Managing new issues of gilt-edged Advisor
securities (gilts) to gvt All major banks have a/c at BOE for:
- deposit/obtain cash
NOW: Debt Mgt Office (Treasury) … - settling clearing
BOE avoids conflicts of settling IR - other transactions
… high influence on IR
Help formulate monetary policy (since 5/97) &
full responsibility for settling IR

Bank Monetary Policy Committee (MPC)
- meet monthly
- set base rate to ensure gvt inflation target met

1.2.2
Proprietary Organisations
Limited (Ltd.) Co. share Co. profit = dividends
ஃ owned by shareholders: contribute to decisions on how Co. run

Mutual Organisations
Not Co. ஃ no shareholders
Owned by members
Proportion of Member type
Some demutualised (i.e. became E.g. mutualisation
proprietary organisations)
Small With-profit policyholders
e.g. Norwich Union, Life assurance Co.
Standard Life Building society Fully

Friendly society Fully Depositors & borrowers

Since Building Society Act 1986 building soc could demutualise (convert into banks ஃ Ltd Co.)
- need approval by members
readily given as members get a high number of free shares

Problem: Carpet bagging = opening a/c in building soc to get subsequent shares

Solution: building soc protect long-term members by restricting opening of new a/c

1.2.2

1.2.3
Retail Banking
Common services (e.g. deposits, loans) to personal & corporate customers

E.g. High-street banks, building socs, supermarkets - Tesco
1.2.3

Wholesale Banking
Raise money via wholesale money markets

where financial institutes & other large Co.s buy & sell financial assets

Top up deposits from branch networks as required
e.g. financial houses
main retail banks e.g. if bank has opportunity to make substantial
building soc profitable loan but doesn’t have adequate deposit
ஃ can raise money quickly on interbank markets
Can raise up to 50% of their
liabilities via wholesale banking

London interbank offered rate (LIBOR) - Includes ~400 banks
= IR charged - recycle surplus cash held in banks
- fixed daily (between banks, specialist money
brokers)
- reference rate for corporate lending
‘LIBOR + specific margin’

- Main difference between retail & wholesale banking was in size – NOW: less distinction

1.2.4 Money Transmission & Clearing Process
Cash
Branch Internet includes
method Cheque clearing
Direct debit
Automatic teller Telephone Credit &
machine (ATM) Standing electronic
orders transfers

1.2.4.1 Current a/c
- Basis of money transmission for most people
- Money paid in & out by cash, cheque, electronically, overdraft

Changes to these a/cs overtime:
‘No frill a/c’, where customers paid fee for service bank provided

Due to high competition: a/cs had interest & benefits, no fees
- But still 1.5 million households not have current a/c

ஃ New type a/c: simple, basic ஃ encourage more people to open a/c including those on:
pension state benefit
1.2.4

Features: cash card, direct debit but no cheque book or overdraft

1.2.4.2 Clearing
= process, at the end of each business day, of settling between banks the
transfer of £££, due to customers using cheques, direct debit, debit card etc
ஃ transfer of net figure from 1 bank to another via a/c in BOE

- Due to automated transfer methods: cheque volume

- Most banks have clearing system with other banks
- those which do not: require an agency arrangement with a clearing bank

Electronic, same day interbank transfers Association of major banks &
for high-value wholesale payment building socs which
co-ordinates UK clearing services
Clearing House Automated Name changed from
Clear cheques Payment Sys (CHAPS) Bankers’ Automated
& paper credits Clearing Services Ltd (BACS)

3-day Association for payment Operates bulk electronic
process clearing (e.g. direct debits)
& clearing services (APACS)
Cheque &
credit card Co. Voca Ltd

1.3

1.3 The Role of Gvt
1.3.1 Influence of the European Union (EU)
- UK member since 1973

- not adopt euro ஃ UK has own currency & monetary policy

BUT influenced by EU policies & laws including financial services

- EU parliament & Council of ministers act on suggestions from EU Commission
to adopt EU laws

The laws can be …

1) Regulations - general application
- entirely binding
- apply to all states (unless specified otherwise)

2) Directives - objective must be achieved in specific time
- But how it is achieved is up to national authorities in each state

1.3.2 Regulations in UK

Level Effect
1st EU law Impact UK financials industry

2nd Acts of Parliament Set laws via subsidiary law (statutory
instruments)

3rd Regulatory bodies Monitor regulation & issue rules on how
rules are to be met
e.g. FSA

4th Financial institutes & Ensure financial institutes themselves
internal departments are operating legally & competently
5th Arbitration schemes Customer complaints referred to
e.g. Financial Ombudsman
Service

1.3.2

1.3.3 Taxation
Raise revenue
Why tax?
Control money supply

- If gvt general tax … less £££ for investment & loan repayment
… less attractive for investors to invest

2 levels of tax on investments (e.g. unit & investments trusts):
1) fund managers taxed
2) investors taxed

1.3.3

1.3.3.1

Country individual treats as home, even if they live for a time in another country

Domicile Domicile of origin = domicile of individuals father (or mother if unmarried) on date of their birth
Domicile of choice = change to different domicile
- Achieved by putting permanent roots in a different country & severing previous
Effects Domicile UK? Inheritance tax
Inheritance tax Yes (birth/live 17 of Any assets worldwide
previous 20 yrs in UK)

No Only on UK assets

Individual present for at least 183 days/tax yr in UK

Income tax – on worldwide (un)earned & (un)brought to UK
Residence Effects
Capital gains tax (CGT) – on worldwide gains

UK has double taxation agreement with other countries ஃ an individual is not
taxed 2 times on the same income/gains

1.3.3.2 Income Tax

= liability based on income received in a tax/fiscal year (6 Apr – 5 Apr next year)

Process of deciding income tax:
Budget delivered (each yr) containing taxation proposal

Finance Bill published

Approved by parliament & receives Royal Assent

Law made: new Finance Act (main law: Income & Corporation Taxes Act 1988)

R85 form – filled to declare individual (children & adults) does not need to pay tax & can
received interest from certain deposits gross, without tax deduction at source

- Children’s income from settlement by parents is treated as parents income for tax purposes
ஃ cannot set children’s unused allowance against this income

Income taxed NOT income taxed
Employment salary inc bonus, commission, Redundancy pay & other losses (unless >£30000
taxable benefits ஃ excess tax)
Pensions & retirement annuities Interest on National Savings Certificate
Profits from trade/profession Capital part of purchase life annuity
Tips ISAs & PEPs
Interest on banks & building soc deposits Gift Aid payments
Dividends from Co.s Proceeds qualifying life assurance policy
Income from trusts Gambling profits
Income from gvt & local authority stocks Lottery prizes
Rents & other land & property income Wedding presents & presents from employer
Value of benefits (if total income + benefits > Retirement & redundancy money
£8500) – (Co. cars – tax based on CO2
emission rating)
Education grants to full time students
War widow pension
Some social security benefits
Housing grants
Interest on tax rebate

1.3.3.2.1 Allowances

Personal allowance = income amount received each yr before tax
- Applies to all UK residence incl. children
- Not transferable to anyone else

(2009/’10) £6,475
£9,490 – people >65+ yrs
£9,640 – people >75+ yrs

For people >65yrs with income exceeding specific figure (£22,900 - ’09/10), personal allowance
reduces £1 every £2 income over threshold (not reduce below under-65 allowance)

Blind Person’s allowance
(’09/10): £1,890

- transferable to blind/non-blind spouse

Married couples allowance
- Applied before April 2000
(now withdrawn, unless 1 spouse is born before 6/4/’35)

Gross income – Pension contribution – Allowable expense Taxable income

Scheme set by employer/ to Cost carried out by
personal/stakeholder pension employment, allowances

Band Taxable income (£) (’09/’10) % taxed

Earned income Investment income Not apply if individual non-
savings taxable income is
Lower 2,440 10 >£2,440.
Basic 37,400 2,441 - 37,400 20
Higher > 37,400 > 37,400 40

E.g. 1 Married man aged 30 earns £20,000pa E.g. 2 A single woman aged 40 earns £50,000pa
(’09/’10) building society income, & no other (’09/’10). She is employed and has personal
income. His has a personal allowance of £6,475 allowance of £6475
Gross income: £50,000
Gross income: £20,000
Personal allowance: £6,475
Personal allowance: £6,475
Taxable income: £43,525 (50000-6475)
Taxable income: £13,525 (20000-6475)
£2,440 at 10% £244 (2440*0.1)
£2,440 at 10%: £244 (2440*0.1)
£34,960 (37400-2440) at 20%: £6,992 (34960*0.2)
£11,085 (13525-2440) at 20%: £2,217 (11085*0.2)
£6,125 (43525-37400) at 40%: £2,450
Total taxable: £2461 (244+2217)
Total taxable: £9,686
(244+6992+2450)

- Most investment income taxed at source at basic rate: 20%

Non-taxpayers get tax-free interest (by signing declaration)
Higher taxpayers pay further 20% of gross interest via tax return/coding

Net rate
Gross rate =
0.8 (100%-20%)

- Share dividends – receive net of nominal 10% tax
Satisfy lower & basic rate taxpayers
Higher taxpayer pays further 22.5% (32.5% total)
Non-taxpayers can NOT reclaim 10%

Net rate
Gross rate =
0.9

1.3.3.2.2 Employees
- Income tax paid via pay-as-you-earn (PAYE) system
– employers calc using tables by HM Revenue & Customs (HMRC)

How calc?
Employers supplied with tax code number for each employee

Amount of ‘free’ pay incl
P40 given to employee by employer in Apr each yr allowances, benefits etc
Previous yr:
Tax deduction, & over/under payments
NI contribution, P45 to employee & HMRC by employer when leaving job from previous yr
tax code
Given to new employer – for information about tax deductions

1.3.3.2.3 Self-Employed (inc business partners)

Total Revenue - total expenses - Capital allowance => Income tax paid to HMRC
based on net profits

- Self-assessment rules: taxpayer calculate own liability & sends it to the tax authorities for approval

/Accountant/HMRC

1.3.3.2.4 Classification of Type of Income

Before: Classified under schedules A, D, E & F – abolished

Now:
Income Tax (Earnings Income Tax (Trading &
& Pensions) Act 2003 Other Income) Act 2005

Covers incomes in
Covers income previous in Schedule E: other schedules
- Employment income
- Pensions
- Taxable social security benefits
Part 2 Part 3 Part 4

- Trading income - Property income - Savings & investment
(from self employment) income incl interest
- Dividends

1.3.3.2.5 Income taxed at Source

- HMRC collects income tax at source from person making payment, not the recipient

- Tax deducted at basic rate
- Further liability at higher rates collected by direct assessment on taxpayer

E.g. in PAYE – employee receives net of tax

1.3.3.2.6 Tax Paid Investment Income
- Investment income taxed at source

- Recipient has no further liability (unless higher rate taxpayer)
- Non-taxpayers reclaim by completing tax return

Interest from bank & element of certain
building soc deposit life annuities
loan stocks
fixed-interest E.g. of investments Income from trusts
loans to Co.s income taxed at source & settlements
debentures
Interest from certain
Dividends from UK Co.s finance Co. deposits
(not income tax liable but tax credit) Distributions
from unit trusts

1.3.3.2.7 Taxation of Proceeds from Life Assurance Policy

- Investors premium paid to Co.s life fund which given to different assets e.g. property, shares

- Basic rate tax on income (e.g. dividend, gilt interest, rental income)
- 20% capital gains tax(CGT) on profit when fund sold
- taxed at source

- Higher rate taxpayer further liability 20% of gain (ஃ total: 40%)

for non-qualifying policy

Qualifying policy rules:

1) Premiums paid ½-yearly / ¼-yearly/yearly, monthly for at least 10 yrs
- if cease before 10yrs or ¾ of terms agreed – non-qualifying

2) Premium in 1 yr must not exceed twice the premium in any other yr or 1/8 of
total premiums payable

3) Sum paid to death must be at least 75% total premiums payable

1.3.3.2.8 Taxation of Proceeds from Unit Trust

Collective investment under trust deed

- Income generated via share dividend

- Unit holders receive net of tax
- ஃ no liability to basic rate taxpayer
- further liability to higher rate taxpayer

- Gilt interest & dividends on foreign shares do not pay UK tax
Pay basic rate tax Pay corporate tax

- Exempt from CGT, although unit holder maybe liable if sell at profit

1.3.3.3 National Insurance (NI)

= tax on earned income

Class Rate

1 - 11% on earnings between primary threshold (£110/wk (’09/’10)) to upper limit (£840/wk (’09/’10))
- Reduced level of 1% on earnings above upper limit
- Employers pay 12.8% on employees earning above lower limit = secondary threshold
(£110/wk (’09/’10)) – but no upper limit
- Lower contribution if employees contracted out of state 2nd pension (S2P)

2 - Self-employed flat rate £2.40/wk- if profit exceed lower threshold (£5,075/wk (’09/’10))
- Paid monthly direct debit

3 - Voluntary contributions by people who otherwise not allowed full basic pension or
sickness benefits (e.g. career break, working abroad)
- Flat rate £12.05/wk (’09/’10)

4 - Additional contribution by self-employed in annual profits between minimum & maximum level
- Paid to HMRC ½-yearly with income tax
- Rate: 8% profits between £5,715 - £43,875 + 1% profits > £43,875

1.3.3.4 Capital Gains Tax (CGT)

= paid on net gain on disposal of physical & financial assts inc shares, unit trust

Sale, transferring/giving asset, received compensation for loss/destruction

CGT not paid in some situations :

Gains on qualifying life
assurance policies Property disposed due
Gilts to death (get inheritance tax)
disposed of by owner

Main private residence National Savings certificate & PAYE scheme

Ordinary private E.g. Premium bond & lottery winnings
motor vehicles
Personal belongings, antiques, Foreign currency for personal expenditure
jewellery etc – if <£6000 ISA
National, historic, PEP (personal equity plans)
scientific gift that
is nations interest

- If a loss is made on asset when it is disposed, individual can offset it against gains elsewhere

- How?
1st: Offset loss against gains in the year the loss occurred
Then: Residual loss maybe carried forward to future
years
But capital loss can not be carried back to a previous year
- Tax payable on net gains in tax year
(after deducting allowable capital losses in same/previous year)

- Each individual has annual CGT allowance (£10,100 (‘09/’10))

level of gains allowed in year before CGT start

incl. to trustees of mentally disabled & personal representatives: £5,050 (’09/’10)
- can not carry forward to next year if unused

- Capital loss can be carried forward but annual exemption can not

ஃ losses brought forward to extent required to reduce gain to level of annual exemption

residual losses then carried forward

1.3.3.4.1 Calculation of CGT
Rules:

1) Costs of purchase can be added to the purchase price, & selling costs deducted from sale price
2) Cost of improvements to assets can be treated as part of purchase price (not incl.
maintenance & repair cost)
3) Capital gains before 31/3/82 have different tax – value on 31/2/82 substituted for actual purchase price

Gains – Annual CGT Allowance – Losses  Taxable Gains

Subject to 18% tax

- Low rate of 10% on the first £1million of cumulative gains from disposal of trading businesses &
shares = Entrepreneur’s relief

To claim this relief: individual must own at least 5% of ordinary share capital of the
business (most property letting businesses are exempt from this relief)

E.g. Vanessa brought £50,000 units in unit trust ( May’04) & sold for £80,000 ( June ‘08).
At the same time she sold £10,000 shares that she brought for £12,000. What CGT
will she pay?

- Gain on unit trust: £30,000
- Annual allowance: £10,100 (9,600)
- Loss on shares: £2,000

- Taxable gain: £17,900 (30000 – 10100 – 2000)
- Tax at 18%: £3,222

- Problem: CGT is due on the whole gain in the year when gain realised, even if the gain made was
in a longer period, but only 1 annual exemption against years worth of gain

- some shareholders & unit-trust holders sell holding each year & then repurchase the
following day ஃ smaller gain covered by that years exemption = bed & breakfasting

Out-lawed in ’98 Budget: shares & unit trusts sold & repurchased within 30 days treated as if
these 2 transactions did not occurred

1.3.3.4.2 Roll-Over Relief (ROR)
= Assets disposed of are replaced by other business assets, on which ROR claimed

ஃ instead of CGT on original disposal, deferred until final disposal made

- Replacement asset must be brought between 1 year before to 3 years after sale of original asset
- Relief claimed up to the lower of either the gain or amount reinvested

1.3.3.4.3 Hold-Over Relief
= CGT on gain of gift of certain assets can be deferred until recipient disposes

- assets used by donor in his/family Co./group trade
- shares in transferor’s personal Co./unlisted trading Co.
- agricultural property – relief from inheritance tax
- assets where immediate charged inheritance tax

1.3.3.4.4 Payment of CGT
- CGT charged on gains from disposal in 6 Apr to 5 Apr next year
- CGT paid on 31 Jan at end of the tax year when gains realised
- Details of chargeable assets disposed during tax year included in individuals tax return

1.3.3.5 Inheritance Tax (IHT)
= Tax on estates of deceased, on…

1) On 40% of the amount estate exceeds nil-rate band (£325,000 (’09/’10)

- From 9/10/’07: surviving spouses/civil partners can increase their own nil-rate band
by the proportion of un-used nil-rate band from the earlier death of their spouse/partner

2) Potentially exempt transfers (PETs) = gifts made during persons lifetime
-Tapering relief (scaling down) over final 4/7yrs before death
80% (4th yr), 60% (5th yr), 40% (6th yr), 20% (7th yr) of max (if longer ஃ exempt)

- some lifetime gifts to Co.s, organisations, trusts not PETs but chargeable lifetime transfers: tax
decreased rate of 20% immediately due & full tax if donor dies within 7yrs (tapering relief)

Donation to charity,
political party, to nation
Small gifts up to £250
per recipient in each tax yr Transfer bet spouses during life & death

Exemptions
Gifts on regulated basis from income Wedding gifts up to £1000 (increased
which not affect donors standard living to £5000 for gifts from parents & £2500
from grandparents
Up to £3000pa for gifts not covered
by other exemptions. Any remainder
can be carried only forward 1yr

1.3.3.6 Value Added Tax (VAT)
= Indirect tax on sale of most goods/services in UK: 17.5%

Exemptions: financial transactions (loans, insurance) (not incl financial advice)
supply of health & education goods: not technically exempt as they have zero-rated tax

subjects to VAT but current rate is 0%
- Business regulated for VAT if annual turnover > £68,000 (’09/’10)
Adv: - VAT paid on business expenses can reclaimed
Disadv: - increase expense to customers (charged VAT)
- increase administration (collecting, accounting & paying VAT)

1.3.3.7 Stamp Duty
= Tax paid by purchaser with respect to certain transaction e.g. security, land

- Tax imposed on documents that give effect to the transaction – e.g. conveyancing of property
- Documents need stamping within a certain time period, else transfer not accepted
- % of purchase price

Stamp Duty Reserve Tax: on securities = 1.5% of market value for bearer instrument
shares = 0.5%

Financial instruments e.g. bonds, where name of owner not recorded ஃ
possession of certificate only proof of ownership ஃ title physically passes

From 13/3/’08: Transactions in a Stamp Duty Reserve Tax charge of < £5 are exempt

-Stamp Duty Land Tax - dependent on property value

Stamp duty rate (%) Purchase price of the property (£)
0 < 125,000 (150,000 in spec disadvantaged areas)

1 125,001 – 250,000
3 250,001 – 500,000
4 > 500,000

1.3.3.8 Corporation Tax
= Paid by limited Co.s on profit – within ‘accounting period’ (financial yr)

Trading profits
Also paid by: 1/4/08 – 31/3/09
Capital gains
clubs, societies, associations, trade
& housing associations & by co-operatives Income from lettings
Interest on deposits
NOT: conventional business
partnership, ltd liability partnership,
self-employed individual

- Co.s in UK pay corporate tax on worldwide profits
Co.s elsewhere only pay corporation tax on profits from their UK-based business

Co.s rate Profit (£) Rate When due
Small 0 – 300,000 21% ’09/’10 9 months after end of relevant accounting
period
Marginal 300,001 – 1.5 mil Marginal 9 months after end of relevant accounting
period
Main > 1.5 mil 28% ’09/’10 Quarter-yearly instalments half–way
through accounting period

1.3.3.9 Withholding Tax
= tax on income levied at service before that income received

E.g income tax on UK employees

- Tax levied, in specific countries, on income ((un)earned) by non-residents
ஃ income not leave country without being taxed

E.g. UK withholding tax of 20% on earnings of non-resident entertainers & sports people

- UK has double taxation agreement with 100 countries ஃ not taxed twice

1.3.4

1.3.4 Economic & Monetary Policy
Microeconomic objective = concern individual firms/consumer
Macroeconomic objective = long-term objectives economic policies gvt trying to achieve
- economic aggregates = total picture of economy as whole

Balance of payment Unemployment Price stability Satisfactory
equilibrium economic growth

Gvt tries to expand economy Need low, controlled
Foreign currency: so labour, land & capital inflation rate
expenditure = receipt Economic output is growing in
real terms over time &
Rising level of prices: increasing standard of living
£££ into country = £££ out Rate of money supply>
- Linked to exchange rate growth of good/services UK economy grew fast in 2000
- Gvt aim: currency price stable – now onset of recession
(0 inflation is undesirable - 2006: annual growth of gross
ஃ not so …  unstimulated investment) domestic product (GDP) at 3%
- high as to reduce export
- low as to increase inflation Measure of value of goods & services produced
within country over specific period of time

- Affects US & EU economy

- The four macroeconomic objectives work in 2 pairs:

E.g if unemployment growth
inflation improve balance of payment

- Impossible to achieve all 4
E.g unemployment inflation

- UK economic policy (until recently) was ‘stop-go’ = gvt cause fast and slow economic growth

Employment
Growth Inflation

Inflation Growth
Unemployment

- Gvt aim: - aggregate demand in line with productive economic capacity
- low inflation rate for long periods of sustained economic growth
average annual rate of 2% (max divergence 1% either side)

measured by consumer price index (CPI)

replaced retail price index (RPI)
derived in same way as harmonised index of consumer
prices (HICP): used in eurozone

How do the gvt keep inflation regulated?
1) 1.3.4.1 Monetary Policy – acts on money supply & IRs

History: Monetary policy was 2nd place to fiscal policy, as thought fiscal policy had more effect
on demand, whilst monetary policy just fine tunes economy

1979: monetary policy more important in controlling economy

Method: (by monetary economists)

1) Money supply Inflation To control increasing £££ supply
must control amount credit creation
credit creation by banks By manipulating IR* – influence demand for credit

2) Bank restrict amount lend * policy in UK

3) Borrowers required to provide minimum cash deposit to make purchase

- Monetary Policy Committee decides IR BOE lend to banks/other institutes = Repo rate (Base rate)

- Change IR? direction? how much?
Treasury can give BOE determines other IRs charged
instructions in ‘extreme Announce decision immediately to borrowers & paid to lenders
economic circumstances’
Minutes published 2 weeks later

1.3.4.1.1 Impact of IR changes

- Banks base rate is a variable rate – as it follows BOE IR

- Until recently, most IR on loans were variable

- Disadv: (especially in large transactions e.g. mortgage)
 Income is not variable ஃ difficult for borrower as:
Sudden IR borrower unable to make repayment repossession

- Due to high, active wholesale £££ market – lender get amounts at fixed rate

Pass rate to borrowers & others
- Disadv:
 borrower lose out if variable rate lowers below the fixed rate
 penalty if pay off mortgage within fixed rate period (protects lender)
 arrangement fee – charged by lender for reserving sufficient fund at fixed rate

- In UK: fixed rate mortgages – short initial period
variable rate – remainder of term
- Other EU countries: longer fixed term

2) 1.3.4.2 Fiscal Policy (MP) – manipulate finances of public sector … influence
money supply & economy activity
Gvt, local authority, public corporations
- Public sector provide national/regional services e.g. education, healthcare, transport

Funds from private sector

Funds from individuals & firms via (in)direct tax

- Changes in public & private sector affect the economy
- Outcomes:
Budget … Amount of tax … £££ to Result on economy
public sector spending
Balanced = - Neutral
Surplus > - Employment
- Money supply
Deficit < - Employment
- Money supply (inflation)

Gvt borrow to finance the deficit

Public Sector Net Cash Required (PSNCR)
= cash measure of public sector short-term net financing required

- Aim of gvt: Increase sustainable level of growth & employment

- Fiscal policy maintains sound public finances over the medium term

2 fiscal rules:
1) Golden rule = gvt borrow to INVEST, not fund current spending
2) Sustainable investment rule = public sector net debt, as proportion of GDP, is held
over the economic cycle at a stable level

- Fiscal policy outlined by gvt Chancellor of Exchequer in the annual Budget (March)

Pre-budget report – allow public to consult on policies Revenue plans
(incl individual & Co tax)
Gvt planned
expenditure

- Monetary policy – acts on economy as whole

- Fiscal policy – can have macroeconomic & microeconomic effects & target specific parts of economy

E.g. 1) Tax incentives to manufacturing Co.s to boost employment
2) Gvt grants to firms that move to underdeveloped geographic areas

LOOK AT APPENDIX (I)

1.3.5 Welfare & Benefits 1.3.5

- UK gvt provide assistance in need
- Lots of critics, as it is expensive. But the system is envy of other countries
- High number of benefits, but low amount £££ ஃ benefits are only to get individual out of extreme poverty

1.3.5.1 Support for People on Low Incomes
 (= specifications)
1.3.5.1.1 Working Tax Credit
= Top up of earnings on low incomes for disability/ cost of qualifying childcare
 People (16+yrs) with children, work 16> hrs/wk
 People (25+yrs) with no children, work 30 hrs/wk
- 16+yrs, work 16yrs/wk, disabled
- they/partner 50+yrs & work 16 hrs/wk & return to work after out-of-work benefit

1.3.5.1.2 Income Support
- Tax free benefit
- Not dependent on claimant having paid NI contributions
 Income lower than specific amount
 Saving < £16,000 (<£6000 ignored) – assume £1/wk every £250 above £6000 (deduct benefit)
 Working < 16hrs/wk (disability & working > 16hrs/wk)
 Not full time student
 16+yrs
 High Range can claim: >60yrs, single parent, disabled, unemployed

1.3.5.1.2.1 Income Support Payments (ISP)

- Amount of ISP depends on lots of factors: age, income, savings, partners/children

- 3 parts of payments:
1) Personal allowance – cover day-2-day expenses of claimant, partner, children
2) Premiums – additional payments to people with extra needs e.g. disabilities
3) Other additions – inc mortgage interest payments & other housing costs

1.3.5.1.3 Jobseeker’s Allowance (JSA)

Contribution based Income based
- payable for 6 months  seeking work for at least 40hrs/wk
- fixed rate- irrespective of savings/partners earnings  working <16hrs/wk
- paid gross but taxable  18 yrs – pensionable work
 not in full time education
 dependent on having paid Class 1 NI contribution
 signed JSA agreement – steps to look for work

- credited NI contributions (NICs) every week receiving JSA

1.3.5.2 Support for Bringing Up Children
2 types:
1) During pregnancy
2) During children growing up

1.3.5.2.1 Statutory Maternity Pay (SMP)
- from employer when woman becomes pregnancy while employed

 worked for same employer, without break, > 26 wks incl 15th week before baby due (qualifying week)
 average weekly earnings in 8 weeks up to qualifying week not less than lower earning limit
– level NICs become payable
 must have paid at least a specific minimum level of Class 1 NICs

- Payable for 39 weeks
- Earliest payment begins: 11 weeks before the baby due, & latest when baby born
- 2 rates:
1) 1st 6 weeks: amount paid is 90% average weekly earnings
2) Remaining: flat rate – subject to 90% of average weekly earnings

- Taxable

- NICs due on amount paid

1.3.5.2.2 Maternity Allowance
- Given if individual not able to claim SMP e.g. self-employed, recently changed jobs

- Paid by Department of Work & Pensions (DWP) – not employers

- Disadv: lower rate than SMP
- Adv: not subject to tax

Rate:
1) Standard rate to those earnings > lower earning limits
2) 90% average earning paid to earnings < lower limit but > minimum threshold

- High number of restrictions
- Payable for 39 weeks
- Earliest payment begins: 11 weeks before baby due, latest: baby born

1.3.5.2.3 Child Benefit
- tax free benefit to parents bringing up child

- not means-tested & not depend on NICs paid
- to each child <16yrs to 19yrs – if full time education/training
- higher rate to eldest child, lowest to youngest

1.3.5.2.4 Child Tax Credit
- help parents on low incomes (people earning < £66,000/yr maybe eligible)

- payable in addition to child benefit

- parent do not have to be working to claim

- paid to child’s carer

- paid until 1st Sept after child’s 16th birthday/20th birthday (if child in full time education, not
claiming income support/any tax credit, not serving custodial sentence of 4+ months)

1.3.5.3 Support for People Ill/Disabled

1.3.5.3.1 Statutory Sick Pay (SSP)
- Paid by an employer to an employee who is off due to illness for 4+ days

- paid maximum for 28 weeks (spells of sickness with < 8wks between them) = 1 spell
- to people with average earnings > NICs payable

- taxed & NI deducted (like normal earnings)

1.3.5.3.2 Incapacity Benefits
- claim if self-employed/ long period of sickness (>28 wks)

- depend on payment of Class 1/2 NICs – else may get income support
- 3 levels:
1) Short-term lower rate - payable to 28 wks
- not subject to income tax

2) Short-term higher rate - payable 29-52 wks
- taxable

3) Long-term rate - terminally ill: highest rate from 28+ wk
- highest rate
- payable if sick > 52 wks
- taxable

1.3.5.3.3 Attendance Allowance
- for those 65+ years & need personal care as ill
- not means-tested & not dependent on paid NICs

- 2 levels:
1) lower rate – need care by day & night
2) higher rate – need help both day & night

1.3.5.3.4 Disability Living Allowance (DLA)
- for people who need help with personal care &/or getting around
- Tax free
 usually for <65yr old
 need help for qualifying 3 month period & expect to need help for further 6 months
(unless terminal within 6 months)

2 components:
1) Care component – for daily tasks e.g. washing, cooking etc
2) Mobility component – if difficulty in walking/ not walk

1.3.5.3.5 Carer’s Allowance
- for people giving up time/job to look after someone
- not need to be relative to qualify
- not depend on NICs
- flat rate (+ for partners/children)
- taxable & declared on tax returns

 Carer: - between 16-65yrs
- spend > 35hrs/wk as carer
- earn no more than certain amount each wk
- not in full-time education (21+ hr/wk supervised study)
 Patient: - receive DLA/AA/constant attendance allowance
- not in hospital

1.3.5.4 Support for People in Hospital/Residential/Nursing Care
- some of patients needs met by NHS ஃ benefits reduced whilst claimant in hospital

- if in residential care/nursing home but can not afford the minimum charges
ஃ income support available

- if in private establishment, income support available if < £16,000
(worked out by adding fees for home + meals & subject to maximum benefit amount
dependent on the type of care received)

1.3.5.5 Support for People in Retirement

- 1st introduced in 1908

- current state pension from WW2 since NI Act 1946 (pension to employed people at 65
yrs)
- flat-rate pension = basic state pension
- not related to employee earnings

- NI Act 1959 - intro earnings related pension:
1961: Graduated pension scheme
1978: State earnings related pension scheme (SERPs)
2002: 2nd state pension (S2P)

1.3.5.5.1 Basic State Pension (BSP)
- provide little more than subsistence-level standard of living
- 25% of national average earning
- single person: £95.25/wk, married couple: £152.30/wk (’09/’10)
- pay-as-you-go basis, NICs from working population immediately paid out
- no. pensions & employment - chance of BSP above inflation
- gvt proposes BSP in line with average earnings index not cost of living index – in 2012

1.3.5.5.2 Additional State Pension
SERPS - aim: pension 25% average earnings (BSP) to 50%
- pay-as-you-go funding ஃ increased cost pressure

S2P - initially offered on earnings-related basis, changing to a full flat rate basis
- only to employed people paying Class 1 NI contribution, not self-employed
- obliged to be S2P unless contracted out (themselves (full contribution paid but rebate by
transfer to alternative pension arrangement) or employer (on membership of employer’s pension
scheme – pay lower NIC))

1.3.5.5.3 Pension Credit
- ensure retired have total income of specific minimum amount
- single person: £130/wk, couple: £198.45/wk
- increasing each yr taking account of inflation

LOOK AT APPENDIX (II)

SECTION 2: FINANCIAL ASSETS

- Less people hold financial wealth in cash, but invest to make profit (intermediary chain)

2.1 Deposits
- Deposit based investments: capital element fixed but investment income varies

- Why?

Adv Disadv
Capital secure – amount invested Inflation reduces value of capital (increased
intact inflation causes value to reduce in real term)
Readily accessible banks & Risk of loss of capital if institute becomes insolvent
building societies (Financial Services Compensation Scheme)

2.1

2.1.1 Bank a/c – 3 types of interest bearing a/c:

1) 2.1.1.1 Deposit a/c
- Depositors (individual/corporation) invest £1- no max
- Return via interest - variable (banks base lending rate)
- calculate daily & added to a/c on periodic basis ( ¼ly, ½-yearly, yearly)

- Some have higher IR, by may need minimum investment
- Deposits can be subject to notice withdrawal e.g. 7 days
- maybe waived subject to penalty e.g. Amount interest that could be earned over period
- Investment fund for emergency/other
- Less attractive long-term

2) 2.1.1.2 Money Market Deposit a/c
- Higher IR than deposit a/c
- IR reflects current money market IR & vary according to amount invested
- 2 types:
1) Fixed a/c - term deposit a/c = sum £££ invested for fixed period (e.g over night, 5yrs)
- interest fixed over period & can not be withdrawn before
2) Notice a/c fixed term but need notice period to withdraw
- no
- bank given same period of notice of change in IR (e.g. 7 days, 6 months+)
- for people with high amounts of cash to place on short-term deposit until required

3) 2.1.1.3 Interest Bearing Current a/c

- Provide immediate access to funds without loss of interest
- Range of services: cheque-book & guarantee cards, cashpoint facility
- Mass market caused by high competition between banks/building societies
- IR (may have lower rates on phone/internet)
- Some banks offered high-interest cheque a/c – have higher IR, but require higher minimum level
of investment (£1000-£10000)

2.1.1.4 Taxation
- tax on interest = 20% e.g. 4% gross interest ஃ net = 3.2%
- lower & basic tax payer – no further liability
- higher rate tax payer – liable for 20% more
- interest paid gross/can reclaim tax for non-tax payers who complete R85 form
- 10% taxpayers can reclaim additional 10%

2.1.2 Building Society a/c
- For investors’ with surplus funds for long time
- Competitive IR
- Different from banks in legal structure:
Building societies = mutual organisations owned by members
Banks = limited co.s owned by shareholders

- 2 types of a/cs:
Ordinary share a/c
- Instant access without penalty
- Lower IR than notice a/cs
Notice a/c
- Access in 7, 30, 60, 90 days
- If require immediate access: get penalty charge
(interest earned over notice period)
- Tiered IRs (higher investment  higher rate)

- Short-term & immediate access

- Taxation (2.1.1.4)

2.1.2

2.1.3 Offshore Deposits
= Investment medium, bank/building society/other form of investment based outside UK
in country with more adv taxation – “taxation havens” e.g. Canary Islands

- Disadv: Higher risk than onshore investment, as:
1) adverse currency movements when converted back to sterling
2) less protection by investors protection schemes
– check via local regulatory
authorities
- Maybe useful if investor needs £££ outside UK

- Interest paid gross

- UK resident must declare to HMRC
- can avoid tax by letting returns roll up & withdrawing £££ in future when become
non-resident

- Specific rules if investor resident/non-resident for UK tax

2.1.3

2.1.4 Cash ISAs
= Tax- efficient individual savings a/c

- Different forms (3.2.4) e.g. cash ISA – tax free interest on bank/building society deposit a/c
- maximum: £3,600 per tax year

2.1.5 National Savings & Investments
= Range of savings & investment products on behalf of gvt

- From post-office & NS&I website
- Low risk – all products guarantee return of any capital invested

- Different types if products for different types of investors (terms, IRs, tax)

2.1.4 &

2.3.1.1 Buying & Selling Shares
- Stock Exchange (SE) = London’s stocks & share market
- Trade: gvt stock, share capital & loan capital, oversees, options

2 markets:

Main market Alternative Investment Market (AIM)
- Allows Co.s to be quoted on SE - Separate market on SE (since ‘95)
- Requirements incl: - for new Co.s with potential to grow
- Financial & other information - Enable Co. to raise capital by issuing share
- Co. must’ve traded for > 3yrs - high public audience & high profile by joining
- > 25% issued shares in public hands - less rules & rigidity than main market

Listing Rules by FSA (acts as
UK Listing Authorities (UKLA)

Types IR Age (yrs) Minimum Other
Amount (£)

Easy Access Tiered, *(gross paid & income taxable) 11+ 100
Savings a/c
Investment Variable, Tiered – 7 levels, * 7+ or 500 – 50,000
a/c parents if
child <7

Income Variable, Tiered, *, Monthly regular income,
Bonds Interest paid until withdrawal No term & capital withdrawn at any time
Guaranteed Guaranteed 1,2 or 5 yrs at a time, Fixed IR 16+ Interest paid monthly, net of basic rate
income Bonds depending on term income tax
Guaranteed Calculated yearly but added to investment 16+ Lump-sum investment,
growth bonds at the end of the term 1,3 or 5 year term
Guaranteed 18+ Lump sum, fixed term investment with growth
equity bonds potential linked to FTSE100 while security on
original investment
Savings Gross interest- no liability to income or CGT 100 -15,000 Fixed interest certificate (FIC)= fixed IR on chos
Certificate ஃ attractive to higher rate tax payers term (2/5 yrs)
Index linked certificate = value with inflation
(terms 3 & 5 yrs)

Premium Bonds 100- Regular (monthly) draw for tax free prizes for
30,000 investors,
/person Prizes maybe worth lots of £££,
Encash any time with 8 days notice

Children’s Fixed for 1st 5yrs + bonus on 5th yr, final 16+ for <16 Lump sum for 5> yrs,
Bonus Bonds bonus on 21st birthday Encash <21 yrs, No interest paid after 21yrs

2.2 Fixed-Interest Securities
2.2.1 Gvt. Stocks
- Gilt edged securities (gilts) = British gvt securities & represent gvt borrowing
- Safe - as gvt not default interest or capital payments
- Categorised according to length of time left until redemption date = date gvt buys gilt back at original
issue value (par value) [normal: £100]

Short dated (shorts) Medium dated (mediums) Long dated (Longs) Undated
- <5 yrs - 5 – 15 yrs - 15>yrs = No redemption date
- 0-7 yrs (UK Debt - 7 – 15 yrs (UK Debt - at gvt discretion
Management Office) Management Office) - Gvt under no obligation
to ever redeem
- Interest paid at fixed rate = coupon
- Index-linked gilts = interest payments & capital value move in line with inflation
ஃ investors purchasing power of capital & interest received is constant
(unlike other fixed interest stocks – inflation reduces purchasing power)
E.g. If gilts with coupon of 5% & redemption date 2021 = “Treasury 5% 2021”
- Interest normally paid ½-yearly

E.g. If holder of £10,000 nominal of Treasury 5% 2021  £250 interest per 6
months
Paid grossly – subject to income tax

2.2, 2.2.1

- Not redeemable by investors before redemption date, but can be sold to other investors

Price depends on: 1) Market IRs
2) Nearness to redemption date
3) Supply & demand

Gilts prices quoted: Cum dividend or Ex dividend

Buyer acquires stock itself & While buyer acquires stock itself, forthcoming
entitlement to next interest payment interest payment payable to previous owner of
the stock (i.e. seller)

- Capital gains made on gilt sale are free of CGT

E.g. Higher rate taxpayer buys £100,000 par value Treasury 5% 2019 at price 80.0
i.e. pays £80,000 for stock

Receives annual interest: £5,000 [£2,500 per ½ yearly] (5% of £100,000 = £5000)
= represents yield 6.25% [5,000/800,000]

Interest paid gross but 40% tax paid ஃ net annual interest = £3000 [5000*0.4 = 2000, 5000-2000= 3000]
Later he sells stock for £90,000 – no CGT on gain of £10,000 [90,000-80,000]

2.2 Fixed Interest Securities

Gvt Stocks 2.2.3 Permanent Interest 2.2.4 Corporate
2.2.2 Local
(2.2.1) - Bearing Shares(PIBS) Bonds
Authority Stocks

- issued by building society to raise capital
Local authority can borrow - fixed IR – ½ yrly
£££ by issuing stocks/bonds - paid gross – taxable
(fixed term, fixed interest
- PIBs rank below ordinary a/c in priority
securities)
of payment – if Co. becomes insolvent

- Secured on local authority assets
- Represent loans to commercial organisations
- Not negotiable (i.e. can not get
lower - Fixed redemption dates, specific redemption
price) & fixed return at maturity value & fixed IR
- Return of capital on maturity guaranteed
- Brought & sold at prices reflecting market IRs
- not as secure as gilts(as no gvt guarantee)
- Higher risk than gilts – as no gvt backing ஃ
- Guaranteed IR – ½ yearly tend to offer higher yields (profits)
- Paid net:
- Basic:20%
- Higher: 40%
- Non-taxpayer: can reclaim

2.2.2 – 2.2.4

2.3 Equities & Other Co. Finance
- Co. need to raise £££ to commerce/expand business
- High number of ways, incl: corporate bonds (2.2.4), shares

2.3.1 Ordinary Shares (equities)
- Brought by private investors, most transactions made by institutions, life, pension funds

- Shareholders ‘own Co’ ஃ 2 main rights:
1) Receive share of profit via dividends
2) Participate in how Co. run – voting at shareholders meetings
- Rights of shareholder differ from Co. to Co.
ஃ specific rights in Articles of Association – found at Co.s offices or Co. House
- Direct investment in shares is high risk (loss of all capital) ,
- mitigate by investing in a range of shares & products (3.2)

- Share trading prices depend on a number of factors:
 Profitability of individual Co.
 Strength of market sector
 Strength of UK & worldwide economies
 Supply & demand for shares & investments
- Share prices in:
- short term – fluctuate
- long term – outpaced inflation & provide higher growth than deposit type investments

2.3, 2

2.3.1.2 Returns From Shares

2.3.1.2.1 Risk & Reward
- Shareholders in limited liability (LLB) Co. ஃ not liable for Co. debt as they are a separate legal identity
- Investment can reduce/loss if Co. liquidates
- High potential for return – over long-term

2.3.1.2.2 Assessment of Financial Returns
2 forms:
1) Capital growth = growth share prices
2) Income = dividends received on share of Co.s distributed profits

- Assess success of shares & future performance by:

1) Earnings per share = [Co.s net profit / No. shares]
- not normally amount of dividends to shareholder on each share
(as Co. retains some profit for e.g. expansion)

2) Dividends cover = how much of profit distributed as dividends
- e.g. if 50% profit as dividends: “covered twice”
- 2+ cover – acceptable by investor
<1 – company paying dividends from retained surplus from previous year

3) Price/Earnings ratio (P/E) = share price / earnings per share
- useful guide to shares growth prospect

2.3.1.3 Taxation of shares

- Dividends received net of 10% (tax credit equal to amount deducted)
- Non-taxpayers can not reclaim
- Higher taxpayer have to pay additional 22.5% ஃ 32.5% of gross

… introduced to smooth effect of abolition of advanced corporation tax (ACT) – 6/4/99

E.g. Higher rate taxpayer receives net dividend of £900 from UK shares
ஃ gross dividend is £1000 [900/(100%-10%)].

She pays further 22.5% of gross ஃ further £225 [1000*0.225]

- Gains subject to CGT
- may offset against annual CGT exemption allowance

2.3.1.4 Ex-Dividend
- Dividend paid ½-yearly on dividend date
- Lots of administration to ensure dividend paid on time

ஃ Payment process begins a few weeks before - ‘snapshot’ of shareholders anyone
purchasing shares between then & dividend not receive

between this period, share is ex-dividend (xd)
- share expected to fall approximately by the dividend amount on the day it becomes xd

2.3.1.5 Share Indices
- Stock Exchange Daily Official List gives closing price of previous days

FT & other newspapers
- 3 ways to measure share performance:

1) FT Ordinary Share Index (FT Index) = index of 30 major industrial Co.s share
- represent ~ ¼ market value of UK equities

2) FTSE 100 Index = index of top 100 Co.s, weighed according to market value

3) FTSE Actuaries All-Share Index = index of ~ 900 shares split into sectors
- measure price movements, show yields, ratios, total returns

2.3.1.6

Rights Issues

SE rule:
Existing Co., with shareholders, who want to issue more shares, 1st have to offer shares to
existing shareholders (usually at discount)
- shareholders not wanting to take up right, can sell right to someone else

Compensates for any fall in value of existing shares (which may occur
due to dilution of the holding as a proportion of the total shareholding)

Scrip Issues (/Bonus Issue/Capitalisation Issue)

= Issue of additional shares, FREE, to existing shareholders

- No extra capital is raised

- Achieved by transferring reserves into Co.s share a/c

Increase the number shares & reduce the share price proportionally

2.3.1.7

Preference Shares
= Shareholders entitled to dividends on Co.s profits at fixed rate

- Not carry voting rights unless dividends delayed

- Payment hierarchy: 1) Loan interest
2) Preference shares
3) Ordinary share dividends

Other Shares
Cumulative preference shares = if dividend not paid, entitled to dividend accumulation until
paid
Convertibles = securities issued by Co.s to raise capital which can be converted to ordinary
Co. shares at a later date

- before: issued in form of a loan (lower IR than normal as can convert to equity)
now: convertible preference shares

2.3.2 Loan Stock
- Co. borrows from banks & other lenders

- Loan stock & debentures are for long-term ஃ help in Co.s long term plan

- issued on specific terms incl. interest payable, redemption date etc
Loan secured in some way e.g. on Co.s property (unlike loan stock)

- Some loans stocks are converted to ordinary shares - (but no obligation)

- Interest rather than dividends payable (whether or not sufficient profit made)
- Paid net of 20% tax
- Higher taxpayer: additional 20%
- Non taxpayer: can reclaim

- Creditors = holders of these debts of issuing Co. (i.e. to who £££ owed)
- take priority over shareholders
- not have right to vote at meetings

- Risk depends on Co.s prospects & strength
Loan stock is higher risk than debentures - as no backing security

2.4 Real Estate
2.4

Residential property
Types Agricultural property
Commercial & Industrial property

Adv Disadv
Property acceptable security for borrowing Risk of unable to find suitable tenants
UK property market well developed Location very important
Rents (ஃ capital value) tend to move with Property less available than other forms of
£££ values ஃ good against inflation investment
Property management readily available Property market affected by economic conditions
Highly costly

- High risk for small investors ஃ spread risk:
Property bonds = underlying fund invested to range of properties & shares in property Co.s
Real estate investment trusts (3.2.2.3)

2.4.1 Taxation
Property income - allowable expense deductions  Income tax (Basic: 22%)

On disposal of property  CGT (can offset capital expenditure against CGT)

2.4.2 Buy-To-Let (BTL)
- Overall trend in 30yrs: property prices increasing
ஃ problem for 1st time buyers esp. SE UK Eased by
renting market
In recession: uncertain job market  difficult to commit to large mortgage

- Shortage of BTL in UK compared to EU as traditionally BTL mortgages had …:

 higher IR charged compared to the standard mortgage, as lenders
thought BTL was more to do with commercial loans
CHANGED  rental income excluded from borrowers income, when
assessing
ability to make mortgage repayments
Why? - Stimulate growth in private sector of rental market
- Encourage borrowing at competitive IR to sustain income & capital growth

- BTL mortgages scheme is a result of an initiative by the Association of Residential Letting
Agents (ARLA) & mortgage lenders (introduced by Alliance & Leicester, Halifax & Natwest)
- many schemes require agent to be member of ARLA involved in selecting suitable
property, tenants, tenancy agreement, managing property

- Gross rent needs to be 125-150% of monthly mortgage payment
- Other costs e.g. wear & tear (10%/yr) (not incl. cost of furniture, fittings) offset against
income tax (from rent)

2.4.3 Commercial Property
= Anything not residential e.g. shops, offices, hotels etc

- Provides high rental income, steady growth in capital value

Adv Disadv

Require rental reviews (normally no Higher average value
more than 5 years between reviews) ஃ spreading risk more difficult
Longer lease than residential property Generally not show spectacular growth
More stable & long-term tenants Higher borrowing IR
Lower initial refurbishment costs

- Lenders carry out detailed investigation before lending:
 Land & property quality
 Reputation of builder, architect etc
 Suitability of likely tenant

2.4.3

2.5 Commodities
e.g. metals, foodstuff, electricity, timber, timber, music, art

- Lots of opportunity - directly & indirectly:

1) Investment in precious metals
2) Lots of trade via ‘forward contracts’

binding agreement where 1 party must sell & other must buy
specific amount of commodity at specific price at specific date
- Lots of traders do not need the commodities, but make profit by speculating price movement
via purchasing & selling

2.6 Foreign Exchange
= Exchange of currencies between countries

Foreign exchange market = international market where currencies exchanged

- buying & selling over the whole world
Main participants: - 24 hour due to technology
Banks, central banks, - millions of transactions per hour
other financial institutions
2.5

- Changing price of 1 currency for another reflects demand & supply of the currency

Due to:
1) international trading of:
Goods – raw materials from different countries
Services – financial services, individual to different country for jobs

2) Investment
Short term – Co. in surplus want to invest e.g. in country with current high IR
Long term – individual & Co. buy shares & long-term loans to borrowers of other countries

- Currency speculators = trade in currency markets to speculate changes in exchange rates &
buying/selling at appropriate time

E.g. Exchange £1million to $, at 55p exchange rate (ஃ $1=55p) ஃ £1 million = $1,818,182 [£1,000,000/0.55]

Exchange $1,818,182 to £, at 57p exchange rate  Profit: £36,364

[$1,818,182 x 0.57 = £1036363.64, £1036363.64 - £1,000,000 = £36,364]

2.6

2.7 Money Market Instruments
- Term to describe a number of forms of short-term debt

- Interest is dependent on the amount invested/borrowed & amount repaid

2.7.1 Treasury Bills
= short-term redeemable securities issued by the Debt Management Office
(DMO) of the Treasury
- Fund-raising instruments used by the UK gvt. (similar to gilts)
- Low risk
- Difference compared to gilts:

Treasury Bills Gilts
Term Short (~91days) Long
Interest paid? No (zero-coupon’ securities. Instead Yes
issued at discount par value

- Can by brought and sold throughout term
- Strong secondary market by banking organisations Significant IR changes
- Prices tend to rise steadily until redemption date Affected by: Supply & demand
- Purchased in large amounts (mainly large organisations)

2.7.2 Certificates of Deposit (CDs)
- Method of facilitating short-term (~3/6 month) larger scale lending (£50,000+)

If required for longer period: ‘rolled over’ for further 3/6 months
- Issued by building societies & banks

- Interest:  Fixed rate
 paid with return of capital at term end

- Are bearer securities
= repayment on specified term will be made to certificate bearer on maturity date

- if require £££ before maturity date, can sell the certificate
- Can sold between banks to balance their liquidity position

2.7.3 Commercial Paper
= unsecured promissory note (i.e. a promise to repay funds that have been
received in exchange for the paper)

- Issued by businesses (e.g. pension funds & insurance Co.s), who want to borrow large amounts

- Offers cheaper borrowing opportunities for Co.s with good credit ratings
- if Co. has bad credit rating: Paper backed by letter of credit from a bank
that guarantees repayment
- Issue period: 5 – 45 days
- can roll over if required for longer period

Adv

Flexible IR is not fixed for a long period

LOOK AT APPENDIX (III)

SECTION 3: FINANCIAL PRODUCTS 3.1, 3.2

- help solve financial problems & meet financial needs

- ‘Packaged’ products supplied by product providers

3.1 Investments
- Main form of direct investment (Section 2)

3.2 Collective (/Pooled) Investments
= Arrangement where individual investors can contribute (via lump sum/
regular savings) to a large investment fund

Lower risk High choice

Adv for investor

Reduced dealing cost Services of skilled investment manager
at cost shared amongst investors

Location (e.g. country)
Industry (e.g. technology, energy)
- Categories of investment funds Type (e.g.shares, gilts, etc)
Other forms of specialisation (e.g. ethical investments etc)
Aim (to produce …)
income (& modest capital gains)
capital gains (& modest income)
Balance between growth & income

- Managed funds = manager invests appropriate proportion in a range of Co.s to meet
managed funds objectives

Chosen by people seeking steady growth, where risk loss is minimum
(e.g. pension provisions/mortgage repayments)

Unit trusts Investment trusts

Main forms of
collective investments

Investment bonds Open Ended Investment Co.s (OEICs)

3.2.1 Unit Trusts
3.2.1

= pooled investment created under trust deed places obligations on
the manager & trustee

- Investor may contribute via lump sum / regular contribution / both

- Lots of unit trusts in UK: total funds = £450 billion

- Trust is divided into units

- Open ended ஃ manager can create more units in response to demand

Valuing fund assets
Managing trust fund

3.2.1.1 Role of Unit Fixing unit prices
Trust Manager

Manager obliged to buy back units
Offering units for sale Buying back units (under trust deed)
from unit-holders
Incl. investors who wish to sell

- Manager generates profit via management fees & dealing in units

3.2.1.2 The Trustee

- has overall responsibility to ensure investor protection

Hold & control trusts assets
Set out trusts investment directives Ensure investor protection procedures adequate

Issue unit certificate to investors Roles Approve proposed marketing

Collect & distribute income from trusts assets
Supervise maintenance register of unit holder
Ensure manager complies with terms of trust deed

- Trustee roles carried out by institutions e.g. clearing banks/life Co.s

3.2.1.3 Authorisation of Unit Trusts

- Regulated under Financial Services & Market Act 2000 (UK)

- Authorised by FSA

3.2.1.4 Pricing of Units
= Total value of assets / No. units issued

- Calculated by manager daily by a method specified in the deed
- Directly related to value of underlying securities that makes up fund

- 3 Prices:
 Offer price = price investor buys units from manager

 Bid price = price manager buys back units from investors

 Cancellation price = minimum permitted bid price
- takes into account full cost of buying & sell

- when there are buyers & sellers of units, bid price > minimum level,
as costs reduced due to underlying asset not needing to be traded

- Unit trusts use bid price, offer price & bid offer spread

difference between bid & offer price (5-6%)
- Some managers moving to a single-price system – as better understood by investors
- may impose exit charge if sold within 3/5yrs

3.2.1.4.1 Historic & Forward Pricing

Before 1988: client brought & sold at price determined before start of dealing period

e.g if funds daily valuation is at noon ஃ dealing period: midday to midday (following day)

Historical pricing
- Now this is unacceptable, as it does not reflect what is happening in the market

Forward pricing
= clients buy/sell in given dealing period at prices determined at end of dealing period
- prices published in the financial press are a guide to investors

- Firms managers can use historical pricing
- but must switch to forward pricing if underlying market in which trust invested
moves 2% either direction since last valuation

3.2.1.4.2 Buying & Selling Units
- No need for secondary market in units of Stock Exchange, as unit manager must buy units
back if investor wishes to sell
Simple & more attractive for investors recorded as confirmation

- Units can brought directly from manager/intermediaries via writing/telephone
- Purchaser receives 2 documents from the manager:

1) Contract note = specifies fund, No. units, unit price, amount paid
- gives purchase price (needed for CGT when units sold)

2) Unit Certificate = specifies fund & no. units held
- proof of ownership
- To sell units, unit holder must sign form of renunciation on the reverse of the unit certificate send
it to the manager (new certificate sent to the unit holder if they still holds units)

3.2.1.5 Charges

1) Initial charges = cover cost of purchasing fund asset & commission payments to intermediaries
- typically covered by bid-offer spread

2) Annual management charge = fee paid for use of professional investment manager
- varies: 0.5 – 2% of fund value
- deducted on monthly/daily basis

3.2.1.6 Types of Units

Accumulation units Distribution/Income units
= Automatically reinvest any income generate = Split off any income received
by underlying asset (for capital growth) & distributed to unit holders

May increase unit value in line
3.2.1.7 Taxation of Unit Trusts with value of underlying assets

3.2.1.7.1 Income Tax
- Authorised unit trusts (except. fixed interest trusts) treated as Co.s for tax
ஃ Corporation tax on income (not growth within fund)

- Dividend income received already 10% taxed
 Lower & basic rate taxpayer – no further liability
 Non tax payer – not reclaim
 Higher rate taxpayer - further 22.5% of gross incomes (ஃ 32.5%)

e.g. Distribution of £18 net to shareholders:
ஃ gross = £20 [£18/1-(10% tax)]

- if higher taxpayer: further £4.50 taxed [20*22.5%]

- Income from overseas securities, cash & fixed interest securities have 20% corporation tax

ஃ when this income is paid out …
 Non taxpayer – reclaims
 Lower rate taxpayer – reclaim ½ (liable 10% & reclaim 10%)
 Basic rate taxpayer – no additional liability
 Higher rate taxpayer – further 20% of gross income

e.g. Distribution of £40 net to unit holder (from overseas)

ஃ Gross income = £50 (£40 / (1-20%))

- if higher rate taxpayer - pay further £10 (£50 * 20%)
- if non-taxpayer – reclaim £10 (£50 - £40)

3.2.1.7.2 CGT
- None within unit trust

- Maybe liable when unit cashed

- Reduced liability due to annual exemption allowance, taper relief

3.2.1.8 Risk of Unit Trusts

- Reduced risk as:
- Pooled investment = spread between 30-150 different shares
- Legal constitution: trustees have responsibility of proper management (reduce risk of fraud)

- Actual risk is dependent on the type of unit trust
(as different trusts for different investors for different risk profiles):

Investment type Risk
Cash fund Similar to deposit a/c (low)
Specialist fund High
(e.g. emerging market)
Overseas funds Added risk of currency fluctuations

- No guarantee that initial capital returned in full or specific income paid

3.2.2 Investment Trusts (IT)
3.2.2

= Collective investment, but unlike unit trusts, not unitised fund

- Not actual trusts, but public limited Co.s whose business is investing in stocks & shares

- To invest: Investor purchase shares of the IT Co. on the Stock Exchange
To cash in: Sell to another investor

- Closed ended = number of shares available is constant

- Share price dependent on:
 Some extent on value of underlying investment (not so directly as unit trusts)
 Factors affecting demand & supply

Lower than Net Asset Value (NAV) per share
= total value of investment fund / number share issued

- Discounted ஃ investor should receive higher income & growth level than obtained by
investing directly in the same underlying shares

- Can benefit from gearing = borrow £££ to take adv of business investment opportunities
(like other businesses)

Unit trust can High growth potential of rising market
NOT use gearing – but can cause losses (e.g. in 2000s)

3.2.2.1 Taxation
- > 85% of income received by fund managers must be distributed as dividends to shareholders

 Lower & basic taxpayer – no further liability Net of 10%, with tax credit
 Higher taxpayer – 32.5% of grossed up dividends

- CGT:
 Fund manager exempt
 Investors subject on sale of shares

3.2.2.2 Split Capital Investment Trusts (/Split-level trusts/ Splits)

= fixed term investment trusts offering 2+ different types of shares

- Most common forms of shares:
- Income shares = receive whole income generated by portfolio but no CG
- Capital shares = no income receives – but when trust wound up at end of fixed term,
share all capital growth remaining after fixed capital requirement

Also have intermediate shares

3.2.2.3 Real Estate Investment Trusts (REITs)

- Tax efficient property investment, which avoids disadv of direct property investment

- Available in UK in 1/2007 (previously in USA, Australia)

- Expected many property Co.s will convert to REITs
– subject to one-off charge of 2% of asset value

Remainder from
development/other services
75+% of gross income
derived from property rent
Single property REITs only allowed
No corporation tax on income/growth in special cases e.g. shopping centres
– need to meet requirements
Main features
Can be held in ISAs, child trust funds,
self invested person pensions
No individual can have >10% shares
90+% net profit to shareholders

3.2.3 Open-Ended Investment Co.s (OEICs)
3.2.3

= Pooled investment offered by a Co. that buys & sells shares of other Co.s, &
deals in other investment

- Issue shares (typically preference shares) can be brought & sold by investors
- Operates as Co. but can NOT borrow £££ to finance its activities, except for short term
purposes
- Popular in EU, available in UK since 1997
- Similar to unit & investment trusts (common FSA regulations on OEICs & unit trusts)

3.2.3.1 Legal Constitution of an OEIC
- Established under Co. Law, not under trust
- Must be authorised by FSA

Depository - oversees operation of Co. & ensure it complies with requirements for investors protection
Authorised corporate director – Manages OEIC

Buy & sell OEIC shares Ensure share price reflects underlying net asset value of OEIC

- types: income, capital growth, fixed interest access to oversees markets,
specialist markets, index tracking

3.2.3.2 Investing in an OEIC
- Lump sum, regular contribution, both
- Investor buys shares in OEIC

Open ended = Number of shares is unlimited
Value varies according to market value of Co.s underlying investment

- ‘Umbrella’ Co. – made up of sub-funds (different shares can be made available in sub funds)

3.2.3.3 Pricing of OEIC Shares

= Total value of OEIC assets / Number of shares currently issued - (like unit trust)
- only have 1 price

3.2.3.4 Charges
Initial charge – 3-6% value of individuals investment

Annual management charge – based on the value of the fund
- deducted from income OEIC generates
- e.g. 0.5% (indexed funds) & 2% (more actively managed)
Other administration costs – maybe deducted from income

3.2.2.5 Taxation (3.2.1.7.1 & 3.2.2.1) 3.2.4

- CGT - fund manager: not liable
- investor: maybe liable when OEIC cashed in (mitigation by exemption, taper relief)
3.2.2.6 Risk (3.2.1.8)

3.2.4 Individual Savings A/C (ISAs)
1997: gvt. decided existing tax-free saving scheme not sufficiently accessible to high population:
Estimate: <50% population in UK have £200 savings, whilst 25% have no savings

6/4/99 – ISAs introduced - develop saving habit & ensure tax relief on savings fairly distributed

OEICs Shares & corporate bonds
18+yrs issued by Co.s on stock markets
16+yrs
Bank/building Stocks & shares ISA
society
Cash ISA UK investment trusts
deposit a/c
Types Gilts & other gvt stocks
of EES countries
Some taxable NS&I a/c
excl. investment a/c
Life assurance
& pensioners bonds
No longer available

- Investor must be resident & ordinarily UK resident – tax purposes
- Only held in 1 name

3.2.4.1 Tax Relief
Exempt from income & CGT
Before 5/4/04: fund managers of equity ISAs could reclaim 10% deduction from dividends
– benefit now removed
Exempt from income & CGT

3.2.4.2 Subscription Limits 2008/09
- Maximum £7200/yr (no minimum), of which is in £3600 in cash
- Distinction between mini- & maxi- ISA is removed

3.2.4.3 Transfer Arrangements
- Existing cash ISAs, ‘TESSA-only’ ISAs & cash element of maxi-ISA  cash ISA
- In the future: possible to transfer funds from cash ISA  stocks & shares ISA (not vice versa)
- Personal equity plans (PEPs) stocks & shares ISA

3.2.4.4 Withdrawals
- Most have no withdrawal period
- Some fixed-rate cash ISAs do not allow withdrawal in specific period
- Cannot go beyond the maximum amount for that year (even if withdrawals are made during that year)

3.2.5 Life Assurance Based Investment Products
3.2.5

3.2.5.1 Endowment

= policy on which sum assured is paid out at the end of a specific term/early death
(some open-ended ஃ can receive proceeds when wanted)

- Most common type of life assurance savings contract
- Investment made by regular premiums to the life assurance Co. throughout the policy term

3.2.5.1.1 Non-Profit Endowment
- Fixed sum assured payable at maturity/early death
ஃ investors shielded from losses (if market declining), but cannot make a profit in market growth
ஃ rarely used

3.2.5.1.2 With-Profit Endowment
- Fixed basic sum assured & fixed regular premiums
- Premiums for with-profit are higher than non- profit endowments for same sum
- Additional premium = Bonus loading: entitles policyholder to share in Co. profits

- Co.s profits paid annually to policyholders
– bonus paid with policy benefits & sum assured

Co. can NOT remove once allocated Bonus added to with-profit policy
(providing policy runs to term end) when death/maturity claim payable

Declared each year Not part of policy benefit until
Reversionary 2 types of Terminus death/maturity (unlike reversionary)
bonuses ஃ Co. can change/remove
terminus bonus rate
Some Co.s declare: Most Co.s set at level they
hope to maintain for some time
1) Simple bonus Intend to reflect level of investment
= annual bonus based on Smooth out short gain Co. made over policy term
the % of sum assured term market variation
Currently: reduced stock value
2) Compound bonus Over years: IRs & other investment ஃ reduced bonus
= new bonus based on yields reduce ஃ reducing bonus
the [sum assured +
previously declared bonus]

Low-cost endowment – variation of with-profit endowment,
- used for mortgage repayment (3.5.1.3.1.1)

3.2.5.1.3 Unit-Linked Endowment
- links investment returns more directly to the stock market (even specific sectors)

Chosen fund:

Premiums used to
purchase units

Pool of units builds up

Fixed benefit on death before end of term (life cover). At maturity date: policyholder receives amount
- Cost taken from policy each month by cashing in units equal to total value of all units allocated to policy

- (compared to with-profit endowments):
Adv: In the long term unit linked shows better returns
Disadv: no guarantee of minimum return at maturity

High potential BUT high risk

3.2.5.1.4 Unitised With Profit Endowment
- Tries to combine security of with-profit endowment & reward of unit-linked endowment

Chosen fund:

Premiums used to
purchase units dependent on the number of units
allocated at the then current unit price
Pool of units builds up

Benefit paid out on a claim

Policyholder receives: Can NOT be removed once allocated
**Bonus** (like reversionary bonuses) ஃ security
**Difference compared with
unit-linked endowment** Cause unit prices to increase

ஃ Unit prices can NOT fall
&…
 the policy value (if held until death/maturity) is guaranteed … BUT…
 if cashed before, a deduction is made from the unit value

Depends on market condition at time of surrender
= Market value adjustment

3.2.5.2 Investment Bonds

= collective investment vehicles based on united funds

- Set up as single premium unit-linked whole-of-life assurance policies

- Pay lump sum to life assurance Co.  investor receives policy document

Shows premium of purchasing (at offer price) certain number of
units in a chosen fund, & that those units are allocated to the policy

- To cash in: policy holder surrenders value of the policy = value of all units allocated

Based on bid price on the day of surrender
- Adv
 easy to invest, surrender & switch to another fund (not get charged)
 range of funds – similar to those in unit & investment trusts
- some Co.s offer with-profit investment bonds (3.2.5.1.4)
 on death, policy ceases  pay out – 101% of bid value on date of death

3.2.5.2.1 Taxation

- Premium funds into internal life Co. funds ஃ the taxation is different from unit trusts

- 20% CGT within fund – non-recoverable

- high taxpayer: additional 20% - investment bonds non-qualifying (1.3.3.2.7)

- Since 6/4/08: single tax rate on CGT of 18%

- Policy holder does not get dividends/distribution (investment & unit trusts),
instead makes small regular capital withdrawal

- Basic rate taxpayers: tax free
- Higher rate taxpayer: can withdraw 5% of original investment/yr without tax liability
(can carry forward & accumulate to 100% of original investment)

3.2.6 Child Trust Funds (CTF) 3.2.6

= tax-free savings a/c for children born after 1/9/02

- Automatic to all children on Child Benefit, to encourage saving

Initial payment of £250 voucher by gvt to the claimant

/£500 – if child’s family eligible for full Child Tax Credit (1.3.5.2.4)
Open CTF a/c, which is open until 18th birthday (access when 18yrs)

Further additions by parents (max: £1200/yr: between child’s birthday)

- Parent responsible for a/c until child is 16yrs, after which child manages the a/c

- Range of CTF providers incl. banks, building societies, friendly societies etc

3 types of a/c

Deposit type savings Investing (in)directly in shares Stakeholder CTF
- invest in a range of Co. shares
No limit on charges Annual max charge: 1.5% (subject to gvt rules)

From child’s 13th birthday, £££ invested into a lower risk asset,
to protect claimant from market losses as 18th birthday approaches
- Must decide which type of a/c within 12 month or HMRC opens stakeholder CTF a/c automatically
- No income/CGT or tax relief

3.2.7 Structured Products
3.2.7

- Different forms: from one-off investment to generic

- Offer element of protection of capital invested, while allowing participation in underlying assets
- maybe high-performing but high risk (e.g. ordinary shares)
- also appeal to cautious investors

e.g. Issue 14 of Guaranteed Equity Bonds (from NS&I): 5yr bond offering return
that matches growth in FTSA-100, but with a guarantee of return of capital if index falls

- ‘Precipice bonds’ = type of 3-5yr high income bond
- provide v. high income yield on capital invested
- return of capital linked to performance of particular stock market index
- many specified particular index level below which value capital fell steeply
(e.g. heavy losses in 2000s & FSA concerned whether investors understood risks)

3.3 Insurance 3.3, 3.3.1

- Protect against financial adversity
- Sometimes compulsory (e.g 3rd party on vehicles) other times not, but best to (e.g. house)

3.3.1 Life Assurance Protection
3.3.1.1 Whole-of-Life (WOL) Assurance
= cover lifetime & pay out at death, provided policy remains in force
- Premiums maybe:
1) Payable throughout life – I.e. full term of policy
2) Limited to fixed term (e.g. 20yrs) or specific age (e.g. 60yrs)

- Life Co.s build up reserve to enable payout

- Co.s offer surrender value if policy cancelled
Small in relation to sum assured (in early yrs, smaller than premiums paid)

(For protection not investment)

With profit*
Non-profit* Unit-linked*
Types
Universal Unitised with profit*
Low cost * In (3.2.5.1)
Flexible

3.3.1.1.1 Low Cost (Minimum Cost) WOL
- Sum assured payable on death ஃ guaranteed death benefit

WOL with-profit + Decreasing tem assurance

Sum assured < overall level of cover required. When basic sum assured + bonuses > guaranteed
With bonuses added as policy continues, the death benefit, decreasing term assurance ceases
value increases over time

- Suitable for person seeking max life cover on permanent basis at minimum cost

3.3.1.1.2 Flexible WOL
= Mix between life cover & investment cover

– Method of paying for life cover by cashing in units at the bid price

Policyholder pays premiums of the amount they wish to pay/can afford

Buy units in chosen fund(s) & units allocated to policy

Policyholder selects level of benefits to have:
 High level of life cover - high number of units cashed each month & lower number remain attached
to the policy ஃ investment element of policy is low (depending on number units)
 Low level of life cover - low units cancelled ஃ higher investment

- Flexible, where cashing units pays for benefits – more options available:
e.g. take income, indexation of benefits & can add another life assured

- High level investment, but should not be thought of primarily as investment, but as a protection plan

3 level of covers (others between)

Maximum Balanced Minimum
Set at level where Level of cover, for given premium, Minimum requirement for
maintained for 10yrs Co. expects to be able to maintain policy to remain qualifying
throughout life assureds' lifetime
All units used up & premium Number units build up to
increased to continue cover substantial investment

- To calculate cover level, Co. makes assumptions about future growth rate of unit prices
- Initial life cover guaranteed for a certain period (~10yrs)

Co. has right to increase/decrease premiums/cover by taking account of increasing
costs/unit prices not growing as anticipated
- Death benefit guaranteed until next review (5 year/annually (for elder) interval)

Important to reveal shortfalls

3.3.1.1.3 Universal WOL
= unit-linked WOL extended by adding range of other benefits & options
e.g. permanent health insurance, critical illness cover, guaranteed insurability

- Additional cost met by cashing in more unit

3.3.1.1.4 Uses & Benefits
- Protect dependents against loss of financial support in event of death

- Tax-free

- Cover expenses on death

- Provide funds for payment of IHT

3.3.1.1.5 Joint-Life 2nd Death Policies (/Last Survivor Policy)
- WOL policy provides for fund for paying IHT – pay out on 2nd spouses death

Estate of 1st spouse

Survivor spouse – free IHT

IHT due when 2nd spouse dies & estate  family

3.3.1.2 Term Assurance
= sum assured payable only if death of life assured within specific term

- Protection over limited period with no investment element ஃ cheapest

- Use: personal & family protection, business situation (key person insurance)
- Term: few month  40+ yrs

- If life assured survives term – cover ceases & no return of premiums

- No cash value/surrender value at any time
- If premium not paid in certain period after due date (~30 days) cover ceases & policy
relapse
with no value
– most Co.s allow reinstatement in 12 months
- Normally premiums paid monthly/annually, although a single lump sum allowed

- Premiums same amount each month/year, even if sum assured varies each year

3.3.1.2.1 Level Term Assurance

- Sum assured constant throughout term
- Used when fixed amount needed on death to repay constant fixed-term debt e.g. loan
- Other uses: family cover until children leave home (but amount of cover would reduce due to inflation)

3.3.1.2.2 Decreasing Term Assurance
- Sum assured reduces  0 over term of policy
- Premiums maybe payable throughout term/limited to shorter period
- Used to cover outstanding capital on a decreasing debt

Covers mortgage Cover for gift made during Set against nil-rate band
repayment donors lifetime (not after death)
Sum assured (like mortgage)
reduces more slowly at the Mortgage No IHT unless donor
start of the term than the end protection 2 types Gift inter dies within 7yrs
assurance vivos cover

Sum assured = amount outstanding on Sum assured set at the start of the
repayment mortgage of same term, policy, according to the amount of tax:
based on specific IRs
100% cover & IHT for 3 yrs  80% (4th yr)  60% (5th
yr)
 40% (6th yr)Scaling downyr)tapering relief ceased
-  20% (7th =  cover & IHT

3.3.1.2.3 Increasing Term Assurance
- Sum assured increases each year, by fixed amount/% of original sum assured
- Use: cover effects of inflation on purchasing power

Same amount of cover
-- = level throughout the term

Cover
-- = increasing
Increasing cover
-- = decreasing throughout the term
Decreasing cover
Term throughout the term

3.3.1.2.4 Convertible Term Assurance
- Term assurance option to convert to WOL policy / endowment assurance without further
evidence of health

- Normal premium rate, whatever state of health assured

- Cost: additional 10% of premiums

Rules to convert option:
 Cancel term assurance & issuing new WOL/endowment assurance
 Option can only be exercised while the convertible term assurance is in force

 Sum assured on new policy cannot exceed original
– if higher cover level required ஃ subject to normal underwriting
 Premium for new policy is current standard premium for new term & life assureds age

3.3.1.2.5 Renewable Term Assurance

- Option at term end to renew policy for same sum assured without requiring extra medical advice

- New term same as previous term & new policy has further renewal option
(except up to maximum age ~65yrs) ஃ Age dependent

- Renewable & increasable term assurance = added option on renewal to increase sum
assured by specific amount (50%/100%) or previous sum

- Some Co.s offer renewable, increasable & convertible term assurance combined

3.3.1.3 Family Income Benefit

= family protection to replace income of death of breadwinner

- Provides income not lump sum
- Tax-free, regular (monthly/ ¼ly) from date of death to chosen term end

- Cover decreases over time ஃ Decreasing term assurance

- Alternative: beneficiary gets lump sum instead
- calculated at discounted value of outstanding payments

- Can increase instalment – against effect of inflation
- provide higher cover than normal family income benefit ஃ higher premium

3.3.1.4 Pensioner’s Term Assurance

Before A-Day (6/4/06): people with personal pension plans & stakeholder pension plans
to take out term assurance policies & get tax relief on premiums at higher rates

A-day: open to everyone, whatever pension arrangements

Nearly all term assurance issued as pension term assurance & get tax relief

Undermines principle of new pension regime ஃ in Pre-Budget Report (12/06): prevent
standalone term assurance being eligible for pensions tax relief

- Applications for life assurance completed before 6/12 & submitted to insurance Co. & receipt
recorded by midnight 13/12/06 – still get tax relief – provided sum assured no greater than
that applied for before 6/12/06

5/4/07 – insurers had to process this business ஃ medical evidence checked & commencement
date of cover settled

3.3.2 Ill-Health Insurance 3.3.2

3.3.2.1 Critical Illness Cover

= provide tax-free lump sum payment on diagnosis of 1 of a range of illnesses
Varies between Co.s
e.g.
Permanent disability cancer
heart attack stroke

Alteration to living accommodation

Provision of long-term care
Types of Purchase of specialist medical equipment
cover
Mortgage repayment Improving quality of life for terminal

3.3.2.2 Permanent Health Insurance (PHI)

= pays income when accident/illness prevents someone earning living by normal occupation

- Some Co.s provide PHI to housewives to pay for housekeeping etc

3.3.2.2.1 Premium Rates

Affected by many factors:

- Occupation
 Class 1: e.g. clerical, admin etc
Increasing risk
 Class 2: e.g. hairdresser, pharmacist
ஃ premium more
 Class 3: e.g. farmers, electrician
expensive
 Class 4: e.g. coal miner, industrial chemists
 NO COVER - as too risky occupations

- Other factors: age, amount, current health, medical history, sex, length of deferred period
Premiums for F>M
3.3.2.2.2 Payment of Benefits
- Commence after deferred period = time elapse between onset of illness/injury & point when
benefit payment commences

~ 4,13,26,52,104 wks
Minimum 4 weeks: prevent claim
for minor problems e.g. colds cheaper

- Self-employed – should opt for short deferred period, as loss of income after short period of illness
Employed – opt for long period. If individual receives sickness benefit by employer, deferred
period should match date sickness benefit ceases

- Set so: benefit income < working income
~ 60 – 65% pre-disability earnings (unless Incapacity Benefit)
- Cover is ‘permanent’ ஃ insurer can not cancer cover even if numerous claims made

- Can be cancelled if premiums are not kept up or policy holder gets a hazardous job

- Some policies allow benefits to be indexed before/during a claim – 3-7% (based on inflation)

- Paid until death, return to work or retirement
- PHI is a standalone policy, as a.. Pure protection plan
Unit linked basis
- Can be available on a universal a whole-of-life plan

3.3.2.2.3 Taxation of PHI Benefit

- Tax free when on individual basis
- Taxable as earned income when arranged by employer/group basis
- employer pays premium, tax deducted business
expense (ஃ no tax/NI)
- Scheme members pay income tax & NI on proceeds

3.3.2.3 Accidental, Sickness & Unemployment Insurance
Redundancy (not sacking/resigning)
- General insurance, as an alternative to PHI
- Use: cover mortgage repayments/other essential outgoings

- Level of income = monthly mortgage repayments paid for limited time (max 2yrs)

- Deferred period normally 1 month ஃ short-term
- Restrictions
 Actively & continued employment for minimum period prior to effecting plan
 Redundancy know before taking out policy excluded
 No benefit if redundancy within specific period before starting of cover

- Annually available at the discretion of the insurer
ஃ may increase/stop premium cover if poor claims experience

3.3.2.3.1 Taxation
- Tax free
- No tax relief on contribution to policy – whether arrange group/individual

- If arranged on a group basis, any contribution employer made is set as an expense ஃ corporation tax
– Classed as a benefit for employees earnings > £8500/yr

3.3.2.4 Private Medical Insurance
= protection plant to cover cost of private medical treatment

- Individual/group (mainly) basis by employer

Avoid NHS waiting lists
- Benefits in non-emergency Choice of hospital
Choice of time
High quality accommodation
Choice of medical consultant

Reimbursement of

Impatient charges Surgical/medical fees Outpatient charges
Ambulance Operating Pathology/
Surgeon fee Home nursing
Nurse fees Accommodation Radiology Consultant
Anaesthetic

- Way benefit paid varies between providers (full refund/impose upper limit in 1 year)

Type of scheme taken out
e.g.budget scheme - limit choice of hospital
Medical care cost varies
throughout country
Location
Premium rate Standard of accommodation
depends on
High age  high morbidity

Age of person Type of hospital

3.3.2.4.1 Underwriting
- Cover scheme may excluding certain events, pre-existing medical conditions, general

3.3.2.4.2 Taxation
- Premiums subject to insurance premium tax
- Benefits paid are tax-free

- Employers contribution to PMI – claim cost as allowable deduction in corporation tax
- regarded as benefits for employee
- maybe taxable if employee’s total income>£8500/yr

3.3.2.5 Long-Term Care (LTC) Insurance
3.3.2.5.1 Benefits
- Amount depends on degree of care required
– found out by knowing number activities of daily living (ADL)
- Each LTC provider has own definition
- Many follow Association of British Insurers definition e.g. washing, dressing, moving etc

- Normally: claimant has to be incapable of performing 2/3 ADLs before they can claim

- Higher number of ADLs not performed  require high amount of care  higher benefit level paid

20% at source
3.3.2.5.2 Taxation Only interest element Higher rate payer: further 20%

Tax-free if: Taxable if:
it is and was an ’immediate needs annuity’ Does not qualify as an ‘immediate need annuity’
when it was taken out
Benefit paid directly to care provider for
care of person protected under the policy
if on life of another basis & paid directly to care if any part of annuity benefits are paid to anyone
provider & used solely for care of person protected other than care provider, or for any other
policy if ‘pre-funded’ purpose than for person protected

No annuity but, premiums are paid to an insurance
Co. to insure against possible future events

3.3.3 General Insurance 3.3.3

= all types not defined as life assurance
5 bands of losses

Personal situation Commercial situation

Property Liability Personal Pecuniary Interruption
Loss, theft, damage to Liability to 3rd party Injury, sickness, Defaulting Business not
static/movable asset e.g personal injury death of employee creditors continue due to
one of other
losses e.g. fire
- Some policies combine 2+ types of risk
e.g. comprehensive motor policies – cover damage to policyholders & 3rd parties property

3.3.3.1 Indemnity
In the event of a claim, insured persons should be restored to the same financial position after loss that
they were in immediately before the loss occurred

ஃ Claimant should NOT benefit from the loss

- Life & personal accident policies are not indemnity contracts.
They are benefit policies, as the loss can not measure as a financial loss

Methods indemnity achieved (up to insurance Co.):
 Cash (cheque)
 Repair (e.g. motor insurance)
 Replacement – sometimes purchasing power of insurer may reduce cost
 Reinstatement – e.g. insurance Co. arrange restoration of damage to premises

3.3.3.2 Average
- Policyholder may underinsure

Insure for smaller amount actually required to replace/repair lost/damaged property

Why? - Unaware of appropriate figure/inflation
- Keep premiums down
- If:
 Complete loss occurs: amount paid out is limited to the sum insured, even if the cost was higher
 Partial loss occurs: unfair if policyholder is indemnified in full
- even if claim amount < overall sum insured

Average = claim scaled down in proportion of premium paid vs full premium

e.g. Policyholder insured for £10,000 contents (although the true insurance is £15,000)
ஃ claim for £300 damaged carpet  insurer pays £200 [(10000/15000)*300)]

3.3.3.3 Excess

= Deduction made from any claim payment on many GI policies

e.g. motor policies have excess of £100 on accident damage is part of cover
- avoids admin cost of dealing with small claims

- Maybe compulsory/voluntary to obtain reduction in premium

3.3.3.4 Building Insurance

Building = anything on premises left behind if property were sold
e.g. swimming pools, sheds, walls etc

Explosions,
subsidence Storms &
& earthquakes floods

Fire & lightening Cover for… Damage by vehicles
& aircrafts, animals
Alternative accommodation Damage by trees/branches
/television aerials

- Some cover subject to property not being left unoccupied for a specific period e.g 30 days
- due to risk of vandalism, theft, burst of water pipes etc.

3.3.3.5 Contents Insurance

Contents = anything you would take with you if property were sold
Cover for:
 3.3.3.4
 Accidental damage by professional removers
 Extended cover for specific property outside house
 Damage to freezer contents due to
electrical failure
3.3.3.6 All-Risks Insurance (/Extended Contents Cover)
= indemnify policyholder for loss, damage or theft of items regularly taken out of home

- 2 categories:
1) Unspecified items = each item must have value<specific amount & not specified
2) Specified items = items above single-item value limit & individually listed

- Require policyholder to take care of property

3.3.3.7 Private Motor Insurance

- 3 types (next slide) – variations in exact cover nature by different Co.s esp. comprehensive
- Large market ஃ lots of competition & lots of other covers e.g. roadside breakdown, courtesy car
etc

- Types of cover: 1) 3rd Party
2) 3rd Party, Fire & Theft
3) Comprehensive

Cover against 1 2 3
Death, injury, damage – when policyholder uses another vehicle / / /
& other drivers using policyholders car with permission
Death/bodily injury to 3rd party inc. passengers in car, hospital / / /
charges, emergency medical treatment
Damage to property / / /
Legal costs- in defence of claim / / /
Fire, lightening, explosion damage to vehicle / /
Theft of vehicle, incl. damage caused & attempted theft / /
Accidental damage to vehicle /
Loss/damage to personal items in vehicle /
Personal accident benefit /
Windscreen damage /

Road Traffic Act 1988: unlawful to use motor vehicle on public road unless there is insurance
policy with respect to 3rd party risk

- No effect unless certificate of insurance given to policyholder – evidence of contract of insurance

3.3.3.8 Travel Insurance

- Available for individual journeys (5 days-month) or on an annual basis

Delayed departures Medical expenses

Cancellation due to illness/injury Missed flights due to transport delays
Cover for…
Personal liability Loss of possessions/passport
Legal expenses Personal accident

- Cover for winter sports more expensive as it is high risk

3.3.3.9 Insurance Premium Tax (IPT)

- On some UK insurance premiums
- Rate: 5% of premium on most GI, except travel insurance which is 17.5%
- No premium tax on long term insurance and PHI e.g. life assurance
- IPT paid by policyholder as part of the premium

Insurer Tax authority

3.4 Derivatives 3.4

= financial product indirectly based/derived from another financial products

- Related to commitment to buy/sell that other product at a fixed price on a future date/between dates
- Convey rights (e.g.right to buy at a different price from current market price), derivates
themselves have value & maybe traded (e.g. ordinary shares, commodities, IRs, exchange rates)

- Main forms:
 Options = Right (but not obligation) to buy/sell specific amount of assets
(e.g. number shares) at specific price (exercise price) within specific period
- Call option = option to buy
Put option = option to sell
- Buyer of option contract pays purchase price (option premium) to seller (writer) of the contract

 Futures = Similar to options, except an obligation to buy/sell at specific price date
- On the range of financial products & commodities (e.g. coffee) & currency, can use as a
hedge against movement in exchange rate
- Forward contract = contracts between 2 parties, not traded

 Warrants = Similar to call options, except generally issued by Co.s, & gives holder right to
purchase that Co.s ordinary shares
- Allows Co. to raise new capital

3.5 Lending Products
3.5, 3.5.1

- Most large product purchases are done by borrowing £££, based on credit

3.5.1 Mortgages
- Large, long-term ஃ mistakes are serious ஃ advisor must choose carefully:

Wrong… Result for client
Lender, IR scheme Pay more than necessary
Investment provider Worst: mortgage not repaid at end of term
Best: client miss out on possible surplus funds
Protection Family is destitute

Mortgage = house purchase loan
- borrower mortgages property ஃ creates legal charge over title deeds or
lender, as security for loan

Mortgagor = individual borrower who transfers property to a lender for the duration of a loan

Mortgagee = lender (bank, building soc) who has interest in property for duration of loan

3.5.1.2 Repayment Mortgage (/Capital- & -Interest Mortgage)

= borrower makes monthly repayments to the lender

Partly interest Partly capital repayment

If IR increases  Monthly repayment increases (or can change mortgage term)

- Repayment is calculated in a way it remains the same throughout the mortgage
term ஃ the proportion of capital & interest varies throughout term:
(ignoring IR changes)

Term Monthly repayments
= interest consisting of…
Amount

= capital
Capital Interest
1) Start Low High
2) End High Low
1 Term 2

- The amount of capital outstanding decreases by smaller amounts each month at the
start compared with towards end of term

- 2 important factors:
 Mortgage will be repaid at the term end, provided IR changes have been allowed for, & all
repayments are made when due
 If borrower dies before term end, repayments continues/loan repaid ஃ life assurance is required

3.5.1.3 Interest-Only Mortgages
= Monthly repayments to lender are solely to pay interest on loan

- No capital repayments made to the lender during loan term ஃ capital remains outstanding

Endowment Borrower pays full capital at the term end
Personal
pension assurance HOW??

Regular payments to saving scheme Other
E.g. Legacy proceeds
ISA Stakeholder pension plan

- Borrower should be aware of risks: Mortgage repayment depends on investment plan
achieving pre-determined rate of return
If not achieved, value of policy/plan < total debt

3.5.1.3.1 Endowment Assurances
- With-profit & unit-linked endowments can be used for mortgages (adaptations required accordingly)

- Life policies can be legally assigned to a 3rd party, who then becomes the owner of the policy
& is entitled to receive benefits in the event of a claim

- some lenders require endowment to be assigned to them as part of the mortgage deal
- others require policy document to be passed to them, without formal assignment

3.5.1.3.1.1 Low Cost Endowment
- Borrowers prefer with-profit rather than non-profit, as it has a higher potential returns

Premiums are higher - Problem: borrowers want to keep mortgage costs to the minimum

ஃ Low Cost Endowment suitable:
- Premiums are based on a sum assured that is lower than the mortgage loan amount
but which, including bonuses expected to be declared over the policy
term
Should be sufficient to repay the loan

Not guaranteed ஃ basic sum assured is calculated using an estimate
of future bonus rates (~75% Co.s current reversionary bonus rate)

- If borrower dies before bonuses reach required level, they have an insufficient amount to repay

ஃ Decreasing term assurance added to policy

Additional benefit is calculated to be sufficient to makeup difference between:
Current level sum assured + reversionary bonuses) - Mortgage amount

- If total sum assured + bonus < loan amount at the end of term,
it is up to the borrower to fund the difference

Life Co.s help avoid this by including progress reviews of the endowment

Check whether policy is on target

- if not, recommendations are made: e.g. increasing premiums or other

- If total benefit at maturity incl. bonus > amount to repay loan

ஃ Surplus is given to the borrow – tax free

3.5.1.3.1.2 Unit-Linked Endowment
- Premiums are calculated as an amount sufficient to repay the loan at the end of term, if unit prices
increase at a specified conservative rate of growth

not guaranteed

- Policyholder can choose fund(s) to use for investment (recommendations made in managed funds)

- Borrowers responsibility to ensure policy sufficient to repay loan
- Life Co.s review

- Most Co.s provide facility to switch to cash fund, which protects against a market drop near term end

- Adv:
In a strong increasing market: may reach required amount before term end
 policy surrendered
 loan repaid early ஃ saving future interest & freeing from repayments

3.5.1.3.1.3 Performance review
Why were reviews started in 1999?
1) Poor performance in 1990s
2) Concern over financial advice to understanding risk
3) Concern holders of endowment

3.5.1.3.2 Pension Mortgages

Adv Disadv
25% accumulated fund can be taken as tax-free Minimum age lump sum can be taken usually 50yrs
cash sum when pension payments commence (55yrs in 2010) ஃ term of mortgage must run until then
– can pay mortgage loan out of lump sum else mortgage not paid earlier even if have funds
Pension contribution qualifies for tax relief at Only 25% can be taken as cash ஃ fund of 4x loan value
persons highest rate of tax e.g. for higher taxpayers required (remaining 75% for retirement pension)
each £100 costs only £60 (no relief for endowment ஃ maybe: total contribution > borrower can afford/
policies) permitted by regulation

Funds of investment contribution not subject to CGT Not automatically with life assurance (unlike endowment
ஃ grow faster than endowment policy which subject policy) ஃ separate policy required (after 6/12/06 – can not
to income tax & CGT get pension term allowance for this (3.3.1.4))

Not assigned to 3rd party (loan security) ஃ lender can not
take possession of the plan or directly receive benefits
from it

3.5.1.3.3 Individual Savings Accounts (ISA)

- Allow regular monthly payments to be made, but can not exceed annual limit

- ISA managers calculate the amount required to pay a lump sum at the end of the mortgage term
– based on assured growth rate, levels of costs & charges

Adv Disadv

Fund free of CGT ஃ low cost of repaying ISAs may not be available in long term ஃ may
mortgage have to the change repayment vehicle

If funds growth rate > assured initial calculated If the growth rate does not match initial assumptions
ஃ mortgage repaid early ஃ final lump sum may have shortfall
In premature death, ISA value unlikely to be
sufficient to repay ஃ require life assurance cover

LOOK AT APPENDIX (IV)

3.5.1.4 Mortgage Interest Options & Other Schemes

- Following products can be combined e.g. fixed-rate mortgage with cash-back

- How interest charged varies from lender to lender e.g. annual, monthly, daily

Type Description Disadv Other information

3.5.1.4.1 Capital & interest Borrowers can not predict
Variable Rate Monthly payments vary (without level of future payments
limit) according to IRs
3.5.1.4.2 Discount off normal variable Penalty if repaid within
Discounted rate (e.g. 2% discount for 3yrs) certain period
3.5.1.4.3 Fixed interest for specific High arrangement fee Popular for 1st time buyers
Fixed Rate period e.g 1-5 (later variable) Restrictions & penalty of
changing lender
3.5.1.4.4 Variable but IR upper fixed limit Cap & collar = fixed lower
Capped Rate & upper limit as well
3.5.1.4.5 Variable rate linked to BOE Charged premium above Review monthly & reflects
Base Rate base rate base rate e.g. 0.95% cost of borrowing from Bank
Tracker Of England

Type Description Other information

3.5.1.4.6 Gives borrower scope to alter (FURTHER INFORMATION BELOW)
Flexible monthly payment to suit ability
to pay quickly
2.5.1.4.7 Lump sum paid to borrower Fixed amount/% of advance
Cashback immediately after completing Lower loan:value – get higher cashback
mortgage Some/all cashback repaid if loan redeemed in certain period

2.5.1.4.8 Lower initial repayments (keep Deferring capital instalments initially (after this period
Low-Start initial costs down) premiums will increase)
2.5.1.4.9 Initially some interest not paid Useful for people expecting an increase in income
Deferred but added to outstanding capital (not useful for people borrowing high loan:value especially
Interest when prices may decrease  negative equity)
2.5.1.4.10 Charges, access, terms For those who want clearly stated limits
CAT-
Standard (FURTHER INFORMATION BELOW)

… continued…
3.5.1.4.6 Flexible Mortgage

Features

Interest calculated daily Payment holidays

Overpayment facility Underpayment facilities
without charges
For people in temporary financial difficulty
- lower interest paid
- lower term
‘Borrow back’ previous overpayments help further

- Allow draw-down funds
- lender will have limit on total borrowing
- some lenders provide chequebook – enable funds to be drawn

Take priority over subsequent charges

- Easier administration process

3.5.1.4.6.1 Current a/c Mortgage
- Allow borrower to carry out all personal financial transactions in a single a/c
e.g receive salary credits, pay standing orders, direct debit

- Provided with chequebook, debit/credit guaranteed card, salary credits
- Calculate interest on daily basis  low interest payable & mortgage term

3.5.1.4.6.2 Offset Mortgage
- Required borrower to have savings or other a/c with lender & enable interest on such
a/c to be offset against mortgage interest charged

E.g If borrower has offset interest-only mortgage: £80,000 & Saving a/c with lender: £25,000
ஃ can opt to waive interest on savings & enable interest to be charged on the net loan:
£55,000 (80,000 – 25,000)

- Offset interest payable on various savings a/c’s against interest charged on mortgage
& other (un)secured loans held with lender

- Many lenders offer: flexible mortgages with fixed, discounted on capped rate for initial period
- Early repayment charges not apply but arrangement fee may
- May have a conditional insurance product from lender with the loan

… continued…
3.5.1.4.10 CAT-Standard

No separate charge allowed on All other fees must be disclosed in
mortgage indemnity guarantees cash terms before customer commits

Interest calculated on daily basis Maximum early redemption charges
apply on fixed & capped rate loans
Charges
Variable IR < 2% above Bank of Variable-rate: No arrangement fees
England base rate & must be adjusted Limits on… Fixed- or capped-rate: not charged > £150
within 1 month when base rate is low

Access & Terms

Normal lending criteria must apply Customer can choose on
which day of month to pay
Purchase of related products can All advertising & paperwork straightforward
not be made a condition of offer

3.5.1.5 Methods of Releasing Equity
= Using excess value to obtain capital/income, which can be used for other purposes

Equity = excess of market value of property over outstanding amount of any loan(s) secured
against it (difference between: [property value – loan amount])

3.5.1.5.1 Home Income Plan (HIP) (/Lifetime Mortgages)

- Enable elderly homeowners, who do not have mortgage, to release equity to supplement
retirement income

- Customer takes interest-only loan, secured on property
Amount depends on property value & applicants age
- No interest payment to lender whilst applicant alive

Interest rolls up & repaid, along with original loan, when property sold on applicants death
(or 2nd borrowers death, if they are a couple)

e.g. 60yr borrower would accumulate more interest than 70yr ஃ 60yr not able to
borrow such high % of property value as 70yr old

ஃ Maximum permitted loan varies according to age: e.g. - 15-20% property value for 60yr

- 50% for 75yr
If couple ஃ depend on the youngest partner – as the property not sold until 2nd individuals death

- Borrower may use loan to purchase a lifetime annuity to augment retirement income
- interest not built up but paid monthly from the annuity
- as the debt is not increasing ஃ not decreasing remaining equity
HIP allows for a higher loan-to-value ratio
- Disadv:
 current annuity rates are decreasing
 when purchased, the borrower is locked into a fixed rate for life

- Main HIP providers joined Safe Home Income Plan (SHIP)
– established Code of Practice - safeguard borrowers interests:
 Applicant to get legal advice ஃ understanding risks, & beneficiaries get less inheritance
 Negative equity funded by lender i.e. amount to be repaid < price of property sold
 Borrower can remain in the house for life
 Plan must be portable i.e. can transfer loan to another property, but have to partly
repay if the value of the new property is insufficient to cover the loan

- Increased number of regulations since 2004

3.5.1.5.2 Home Reversion Scheme
= homeowner sells all/part of property to the Co., for income for life
- Customer can live in house for life  on death, Co. sells the property & gets the proceeds
- Since 6/4/07: regulated by FSA

3.5.1.6 Shared Ownership
= buy stake in the property & rent the remainder

e.g. borrower can purchase 25% stake in the property, fund by a mortgage  option of buying
subsequent 25% in the future

As the borrower increases their share in the property, the mortgage
element increases & the rental element reduces = stair casing
- Allows people on a low income to become owner-occupiers, even though can not afford
A normal mortgage

3.5.1.7 Related Property Insurance

- Borrower has covenant (= promise under terms of mortgage deed) to maintains the property
in a good condition

- Lenders can by law
 insists, property subject to mortgage, insured by policy acceptable to lender
- has their interest as mortgagee noted on the policy
 secure rights of proceeds of any claim to low mortgage debt

3.5.2 Other Secured Private Lending 3.5.2

- Borrower offers something of value as loan security ஃ lender can take & sell the
security asset in case of default

E.g. mortgage loan for house purchase, security could be the borrowers private residence

- Loans to fund lifestyle improvement (not related to house purchase) by:
 Remortgage for a larger amount against the increased equity in the property
(if the property value has increased)
 Further loan from exiting lender
 Second mortgage from a new lender

3.5.2.1 2nd Mortgage
= when borrower offers property for 2nd time as security while lender still has mortgage
secured on the property

- Original lenders charges take precedence over new lenders charges

ஃ in the event of a sale, by default, original lenders claim is fulfilled 1st & if there is a
surplus it is given to the 2nd mortgagee’s charge

- Lenders only offer 2nd mortgage if there is sufficient equity in the property

This is higher risk ஃ a higher IR is charged compared to the 1st mortgage

3.5.3 Unsecured Loans 3.5.3

= Relies on personal promise/covenant of the borrower to repay

- Higher risk for lender than secured loans ஃ higher IR charged & for shorter terms

- Building Society Act 1986: allow building societies to do unsecured loan (maximum 25%)

3.5.3.1 Personal Loans

- Given by banks, building societies, financial houses
- Normal term: 1-5yrs
- IR fixed & remains unchanged

- Borrowers suitability is assessed via credit scoring assessment
- Used for any purpose e.g. buy car consolidate credit card debts

- Purpose depends on whether regulated under Consumer Credit Act 1974

e.g. loans of £25,000/less are regulated by Act
– unless the loan is for house purchase/improvement

Removed by Consumer Credit Act 2006

3.5.3.2 Overdrafts

= Current a/c facility enabling customers to continue using a/c in normal way even
though funds exhausted
– short-term temporary borrowing to assist customers over a period where expenditure > income
- Limit set by bank

- Interest calculated on a daily basis
- Unauthorised overdraft: higher IR charged
authorised overdrafts: can be inexpensive, though may have arrangement fee

3.5.3.3 Revolving Credit

= Arrangement where customer continues to borrow further amounts whilst
still repaying existing debt

- Maximum & minimum limit set on the amount to be repaid daily

- Most common form: credit cards, other forms: personal loans allowing drawdown funds

- Due to technology there has been a high amount of development in cards (35yrs ago):

- have lots of information about cardholder & a/c …
- ஃ interact directly with retailers & banks, thus called smart cards

3.5.3.3.1 Credit Cards
= allow customers to shop without cash or cheque
Before: Credit card transaction were dealt with manually at the point of sale
Now: Retailers have terminals linked directly to credit card Co. computers
ஃ online credit limit checking & transaction authorisation
- Source of revolving credit – have credit limit & can use up to that limit provided a specific
minimum amount (3% of outstanding balance) repaid monthly

- Customers get monthly statement showing their outstanding balance

- If the balance paid in full within certain period (~25 days), no interest is charged
if it is not paid: remainder carried forward & interest charged at the current rate

- Expensive way to borrow – as higher interest than other lending products

- Usually charge if card used to obtain cash over counter/ATP/oversees

- Credit card Co.s charge fee to retailer for their service – deducted (~3%) of transaction value
when Co. settles with retailer

- Adv: - Attractive
- Payment guaranteed – if acceptable by Co.
- Low retail bank charges – credit card vouchers paid  bank a/c – treated like cash

3.5.3.3.2 Charge Cards 3.5.4

- Used by customers as a credit card
- Outstanding balance must be paid in full each month
e.g American Express & Diners Club

3.5.3.3.3 Debit Card
- Enable cardholder to make purchase (like credit card)
- At transaction: funds = amount spent
– transferred electronically from cardholders current a/c  retailers
= electronic fund transfer at point of sale
- Used to withdraw cash from ATM’s & can act as cheque guarantee cards

3.5.4 Commercial Loans
= loans to businesses for start-ups, expansions, refurbishment etc (2.4.3)

- Lending secured on Co.s property/other assets

- IR depends on risk lender believes involved – assured looking at Co.s past performance

3.6

3.6 Pension Products
- Individual who made NI contribution entitled to basic state pension (& additional state pension)

- Employees maybe member of occupation schemes, 2 types:

1) Final salary (Defined benefit)
- Employee receives pension calculated as a % of their final salary
- Longer employee scheme members gets a higher %
- Employers are finding this scheme more expensive – as people living longer

2) Money purchase (Defined contribution) – agreed contribution invested for each member

At retirement: accumulated funds used to purchase benefit
- Level of benefit not guaranteed by employer

- Individual may want to supplement retirement income by contributing to private arrangement

- Tax efficient ways:
Some are final salary, but most
Available to employee  Additional voluntary contributions (AVCs)
are money purchase schemes
members of occupational
schemes  Free-standing additional voluntary contributions (FSAVCs)
Money purchase
Available to >75yrs olds  Personal/stakeholder pension plans (PPP/SHPs) schemes

- Not pay CGT, income tax & no higher rate income tax on income dividends

- Unable to reclaim 10% tax credit on UK dividend

- UK, <75yrs – can receive income tax relief at highest marginal rate on contributions to
occupational & private pension schemes, up to a maximum of 100% UK earnings or £3600

- But: annual allowance limit: £245,000 (2009/10)
- If the total of employer & employee contribution in a year exceed this,
tax is charged on the excess

- Benefits normally taken from schemes when individual is 50+yrs (minimum age rise: 55yrs (6/4/2010))

- 25% of fund can be taken as tax-free cash but remainder taxable income

Before 6/4/06: compulsory to buy annuity by 75yrs Maybe taken by purchasing annuity
Now: draw down/pension fund withdrawal

Can make regular w/d’s of capital from fund (has limits) Can buy from other providers who give
higher annuity rate = open market option

3.6.1 Additional voluntary contributions (AVCs) 3.6.1

- Additional contribution to occupational scheme

- Sometimes: purchase additional years service in final salary scheme
Most: operate as money purchase arrangements & employee have limited choice of funds

- Employers cover some/all costs
- Contribution to AVCs are deducted from the gross salary ஃ employee receive full tax relief

Free-standing additional voluntary contributions (FSAVCs)
= money purchase fund provided by separate pension provider
(incl. Banks, building soc, insurance Co.)
- Attractive to employee who wants to keep financial arrangement independent from employer
- More expensive as employer does not bear the costs
- Contribution to FSAVCs from taxed income:
- 22% tax relief
- Higher rate taxpayers: need to reclaim additional tax
separately
- Since April 2006: all employees have been able to contribute to PPPs/SHPs

3.6.2, 3.6.3

3.6.2 Personal Pension Plans PPPs

= Individual money purchase arrangement provided by financial services

- Before 6/4/06: employees who are members of occupational schemes only contribute to PPP/SHP
if earnings < £30,000pa (Maximum contribution: £3,600pa)

Now: all employees can contribute an overall maximum of 100% UK earnings / £3600
- 20% tax relief at source
- Higher rate taxpayer: need to claim additional relief via self-assessment

3.6.3 Stakeholder Pension Plans (SHPs)
- Form of private pension available from 6/4/01

AIM of SHPs: take pressure off the state pension by encouraging individuals to make own arrangements

- For most people, but intended for people on lower earning levels, who do not have pension provisions,
& rely on state pension
- failed: as purchased by people who more financially better off

- SHP is a private pension scheme, but in some circumstances the gvt makes it compulsory
for SHP scheme to be provided by an employer
e.g. employer has 5+ employees & no occupational pension scheme
- Employees not obliged to join
- Employer must provide payroll deduction scheme for those who join & pass
employees’ contribution to the scheme

- Personal pensions rules:

 Charges can not exceed 1.5% fund value per annum for the 1st 10yrs of term & 1% after
 No exit & entry charges
 Minimum contribution required not exceed £20

- Effect of charge restrictions means independent financial advisors do not receive commission
ஃ individuals may find it a problem in obtaining advice on SHPs

To overcome: gvt made decision to make flowcharts (= decision trees) to
determine if SHPs are appropriate for the individual

SECTION 4: FINANCIAL PLANNING
& ADVICE PROCESS
- Lots of legal elements on relationship between adviser & client
- Customer should understand terms of business (terms of business letter)
- Mutual trust & confidentiality (DPA ’98)

4.1 Saving Pattern
- Pattern of how most savers & investors build up & hold their assets:

Cash  Current a/c with guarantee card  Secure, short-term investment
e.g. instant access deposits

High long term potential but short term risk  Less flexibility & higher return investments
e.g. fixed term bonds

High liquidity & safety:  Move away from liquidity, & higher risk: 4.1

ஃ Income & savings ஃ Borrowing:
e.g. Bank a/c, insurance e.g. credit cards/personal loan

4.2 Financial Lifecycle
Low lump sum/regular savings
School-age young people Relative open a/c at birth (e.g SHPs)/later
Savings in NS&I products & building society

Low number have surplus income (e.g. from work)
Teenagers & Students Some borrow: car, holiday, education

Low savings from employment (short-term access savings)
Post education young people Telephone-& internet-based financial services

High borrowing e.g. mortgage
May have low income – if 1 partner gives up work to look after
Young family kids
Low savings
Need protection of earners income against illness/death
Should start thinking about pension provisions
Established family Better off financially
2 incomes
High borrowing to get larger house, cars, goods etc
High credit-worthiness
Mature Household
High earning potential
Low outgoings as kids leave home & mortgage paid off
Pension provisions
Retirement
Prior: convert income  lump sum e.g. from capital
Inheritance tax liabilities considered
Cost of health-care & long-term care considered
4.2

LOOK AT APPENDIX (V)
4.3 Gathering Information
‘Know your customer’ regulated by Financial Service Act 1986  Financial Services &
Needs & objectives of the client via fact-find Markets Act 2000

4.3.1 Clients Circumstances
4.3.1.1 Personal & family details
 Full name, address, telephone number
 Date & place of birth - Tax/under writing reasons (not allowed racial discrimination)
 Marital status - Prefer both involved
 Family details - Financially dependents on client
- Client may become beneficiary of gifts/trusts or donor
- REFERRALS!!
 Children’s details - give advice on future issues e.g. death, education fees etc

4.3.1.2 Financial Situation
4.3.1.2.1 Employment Details
 Type: employed, self-employed, retired etc
 Part-/Full-time, temporary or permanent
 Profession
 Income/benefit income/net profit (self-employed)
Basic, commission, Private medical insurance,
bonus, overtime etc Co. car, pension etc

 Previous employment details especially if they have pension entitlement
 Share-option scheme & profit related pay schemes

- copies of payslips, P60, tax returns, notices of tax coding

4.3.1.2.2 Income & Expenditure
- Help identify:
- Implications e.g. premature death on family income & spending pattern
- Surplus income

- Income easier to calculate than expenditure

(some easier (rent, bills) others hard (holidays, food & drink))

4.3.1.2.3 Assets 4.3.1.2.4 Liabilities
 Ownership (joint/single)  Lender
 Purpose, type, size of investment  Amount of loan
 Current value & projected value  Balance outstanding
 Rate & type of return  Original term & term remaining
 Tax status of investment  Type of loan (e.g. (un)secured)
 Options available & penalties  Amount monthly/periodic payments
 Sum, lives assured & maturity dates  IR
 Repayment method
 Protection of capital/payment

4.3.1.3 Plans & Objectives

- Soft & Hard facts
e.g. personal, family, financial details
e.g. objectives, views, feelings

- Questions to help understand
 reasons behind existing arrangements & financial understanding
 interest in situation, motivations
 views on possible alternative solutions

4.3.2 Attitude to risk
- Client must understand what the risk is e.g. capital invested may increase/decrease

4.3.3 Clients Preferences
- What client WANTS may not be what they NEED ஃ help them EXPLORE financial
circumstances & make the right choice

4.4 Identifying & Agreeing Needs & Objectives
 Financially protect self/dependents in case of loss of income in short & long term
 Provide retirement income
 Protect/increase money invested & savings
 Saving tax

4.4.1 Agreeing order of priority
- Discussion between client & advisor to make action plan

4.5 Recommending Solution
** Put right £££ in the right form in the right hands at the right time **

Look at:
 State benefits – nature & level of entitlement
 Existing arrangements
 Affordability
 Taxation – ensure action does not increase/create tax
 Risk
 Timescale
 Flexibility – to deal with possible changes in clients circumstances

4.6,
4.6.1,
4.6.2

4.6 Implementing a Solution
4.6.1 Presentation Recommendation
- Solution presented: client told what to do & why - ‘keep it simple’
- Present in a planned way (step by step) to cover the required details

- Client needs to 1) Product purpose & needs
understand: 2) Benefits
3) Risks & limitations
4) Options within product
5) Summary

4.6.2 Handling Objectives
‘Qualify’ the objection: is it a real or false objection and how important is it??

ஃ Clarify the objection: “So what you’re saying is …”

Problem in understanding? - easily solved
Attempt to solve
Problem is specific & client unwilling to move?
– put it into perspective & stress other compensating factors
(i.e. advantages of the chosen product)

4.6.3, 4.6.4

4.6.3 Obtaining Commitment to Buy
- Closing is detected by the clients reaction & understanding of the proposal
ஃ ask the client if they are happy
- Complete application form –client/adviser can fill but the client must read it thoroughly
,

- Client must be informed of the consequence of non-disclosure

contract is made void as the client failed to disclose some information on the form
ஃ the whole process was a waste of time
4.6.4 Documentation
- Adviser must explain the cancellation notice
right to withdraw from arrangement within defined period

 Key features documents, - Given to the client before the sale is closed
 Clients specific illustration, - Provide all the information required to make a
 Product brochure (product features) decision
 Given business card

- Transaction records must be kept securely but accessible
(pension contracts & life policies kept for 5 years)
(opt-outs & free standing AVCs kept indefinitely)
- Where MiFID business involved: retention of 5yrs

4.6.5 After sales care
- Review to find out if:
- acceptance procedure has delays & to keep client informed
- deal with direct debits, policy delivery, cancellation notices, standard overview,
require plan alteration

4.6.5.1 Proactive Servicing
= instigating action by contacting client to discuss further needs

- Maybe previously agreed: e.g. next salary review, job change etc…or not
- Opportunity to recommend other products
- Review: changes in circumstances, update appropriate records

4.6.5.2 Reactive Servicing
= happens as a result of request from client

e.g. discuss recommendation after comment made in media or client circumstance changed

- Maybe requested by someone else e.g. next of kin to sort out death claim

- Record must be kept up to date to be efficient, and increase business – comply with FS&MA2000

SECTION 5: MAIN AREAS
OF FINANCIAL ADVICE

5.1 Budgeting
= To have sufficient funds for necessities & how much can be spent on other items

- Lots of savings products for future capital & income needs
- Need to ensure it will not put pressure on the current & future income
e.g. High IR on mortgage could increase the expenditure beyond means

- Not as necessary now (as credit available, but still got to repay)

LOOK AT APPENDIX (VI)

5.2 Protection
- Important to have precautions e.g lives, health - although low number of people do

- Probability of dying: <65yrs in UK: 1 in 5 males
20 – 65yrs: 150,000 males
600,000 males off work ill for 6 months

5.2.1

5.2.1 Family Protection
5.2.1.1 Losses due to death
- Loss of breadwinners income would reduce the families quality of life ஃ Life insurance required

5.2.1.2 Losses due to sickness
- Protection categories:
1) Income to replace lost income
2) Income to pay for someone to carry out tasks normally undertaken by ill person
3) Income for continual medical care
4) Lump sum to pay for private medical treatment
5) Lump sum to pay for changes to environ/lifestyle e.g. alterations in house

- Factors affecting the amount & cover required:
- ability of person to adapt to other type of work
- extent employer continue to pay salary during illness
- no. & age of dependents
- availability of help from family & friends
- nature & amount state benefits available

5.2.1.3 Losses due to Unemployment
- Harder for insurers to predict likelihood of loss of employment
ஃ hard to get a stand alone
insurance

5.2.2 Business Protection
5.2.2.1 Death of a Key Employee

- Big effect on Co.s profit, especially if the Co. is small
e.g. research & engineer with specialist knowledge

- Method to determine sum assured: 1) on multiple of persons salary (e.g. 5x/10x)
2) estimate persons contribution to Co.s profit

Amount of current x (Persons salary / x Time length Co.s take
annual profit Co.s overall wage) to recover from loss

e.g. Goran is the production director of a firm.
Gross profit: £4million
Goran paid: £50,000 pa
Firms total wage: £2million

Sum assured on Goran’s life: (50,000/2million) x 4million x 5yrs = £500,000

- Co. take out term assurance on the employees life for the period employee expected to
be the key person e.g. until retirement/contract end
- If term <5yrs: premiums allowed as a business expense (can be set against corporation tax)
- In the event of a claim, policy proceeds taxed as business receipt & subject to corporation tax

5.2.2.2 Death of a Business Partner

- Partnership = (Partnership Act 1890) relationship between persons carrying on a business
with a view to profit
- On death: beneficiary of the partner (i.e. spouse) may want to withdraw shares
- maybe problem for remaining partners, as they have to sell partnership assets
to pay deceased partners family
- Value maybe of ‘goodwill’ ஃ not realise value except if the business were sold – insure each partner

Scheme Automatic Accrual Method Buy & Sell Method Cross-Option Method
Action All partners enter into All partners enter into All partners enter into
agreement agreement agreement
Effect on His share divided amongst Partner’s legal representative Partners legal representative
remaining remaining partners in agreed obliged to sells his shares to have option to sells his
partners shares to other partners
proportions the other partners, who are
obliged to buy who have options to buy
Other
Family compensated by Partner takes out life policy on Those who inherit receive
information
proceeds of life policy written his own life, in trust, for other business asset & business
in the trust partners inheritance relief
PROBLEM: those who inherit,
receive cash (not business
asset) ஃ no business
inheritance tax relief

5.2.2.3 Death of a Small Business Shareholder
- Usually limited Co.s with shareholders often family/friends
- same schemes as (5.2.2.2)

5.2.2.4 Sickness of a Employee
- Can be a problem on profit
- Co. may need to fund salary of replacement

5.2.2.5 Sickness of a Business Partner
- Maybe able to continue to draw income from partnership, even if they do not contribute their skills
- Need to provide replacement income
- Remaining partners may want to buy his shares – if unable to return
- Possible need for income protection from critical illness cover + life assurance

5.2.2.6 Sickness of a Self-Employed Sole Trader
- If the sole-trader stops working  income will reduce very quickly & they may lose customers
 business collapse

5.3 Borrowing & Debt
- Mortgage is the largest financial transaction
- Need right lender & scheme
- Situation now: low IR & high house price inflation  increased borrowing
- An increase in IRs could leave people in high level of debt

A number of products & services to assist
e.g consolidation = a new loan incorporating existing mortgage +
individual’s unsecured loans

Adv Diadv
Reduce overall monthly repayments Unsecured loans are now secured against
- as unsecured loans now subject to property – even bigger problem if borrower
lower IRs & longer term defaults

5.4 Investment & Saving
- Provide income or capital sum
- Things to assess:

5.4.1 Regular Savings or Lump Sum
- Build savings by regular small amounts of disposable income

Regular saving scheme Lump sum
deposit a/c, unit trusts, regular legacy, moving £££ from
premium to endowment/pension plan one
to another investment
5.4.2 Level of Risk
No risk to capital High risk to capital (high return)
deposit a/c stock market investment

5.4.3 Accessibility
Instant/short access notice Not directly accessible until fixed maturity date
deposit a/c gilts, shares

5.4.4 Taxation
- especially income & CGT

Shares & unit trusts (both taxes) gilts (income tax not CGT)

- Important to consider tax regime of the product, & tax position of the investor

5.4.5

5.4.5 Effect of Inflation
- Reduces the purchasing power of £££
- For investment to grow, must increase with inflation
- equity-linked investments proven to offer growth rates above inflation rate
- Currently in UK: low inflation rate

- Real rate of return (RRR) = interest / growth rate

true purchasing power of invested funds
e.g. investment paying 4% IR when inflation rate 3%  RRR = 1%

- if IR < inflation rate, the RRR is negative  reduce investments purchasing power

- People suffer £££ illusion – as they do not adjust inflation with IR:
ஃ Effect of low IR, on…
Savers: think they are receiving low return on savings ஃ react to lower inflation
rates by putting their £££ into riskier assets to get higher return  problem at retirement

Borrowers: think they are gaining from lower monthly repayments ஃ may take higher
mortgages, as they think they can afford to

 Problem: 1) higher capital to be repaid
2) further problems if IR rise
3) increased demand for houses  increase house prices  threaten stability

5.5 Retirement Planning
- Gvt trying to get people to save for future, as there is inadequate funding for pensions
(basic state pension: only ¼ of the national earning levels)

- People do not understand pension products, or put income to use elsewhere

Saving gap = total short-fall in pension provisions
- varied between £27 billion - £33 billion
- 90% of people live to a pensionable age,
whereas before: only 66% (50yrs ago) & receive for 80 yrs longer

- Increasing, as moving occupational pensions from final salary scheme £££ purchase
schemes
- Gvt putting measures into place
e.g. stakeholder pension
- target income range: £9000-£20000 with low pension provision, but attracted others
- low charges & minimum contributions
- less sale, as the maximum charge providers can add is 1.5%
ஃ low marketing of the product & low commission for advisers

5.6 Estate Planning
5.6

- IHT (1.3.3.5) – 40% on estate of deceased
Nil-rate band (£325,000 (’09/10) – anyone under this threshold is exempt
Managing IHT:
1) Avoid having to pay:
 Reduce the estate to below the nil-rate threshold, by:
- making use of various exemptions to make it tax-free
- gift during ones lifetime ஃ potentially exempt
 Place the asset in a trust (trust property is no longer part of a settlor’s estate)

- It is not possible to avoid IHT by giving the property away while continuing to live in it.
Classed by HMRC: ‘gifts with reservation’ rule
= if the donor retains any benefit from the gifted assets, IHT is charged
- Loophole in the rule: - By placing the property in a trust

Closed in Schedule 15 of Finance Act 2004:
liable to income tax each year on the benefit of occupying/using the asset previously owned but
disposed after 17/3/86 (on annual rental figure: <£5000 – no tax charged)

- Married couples & civil partners can now use whole of both their nil-rate bands to pass property
tax-free to relatives/others
- % of nil-rates bands unused on 1st death can be carried forward & used to
increase nil-rate band on 2nd death

5.7, 5.8

2) Make provisions for paying - life assurance policy for anticipated IHT
- to avoid policy becoming part of the deceased’s estate ஃ IHT liable as well –
policy
should be written in trust for the benefit of the beneficiaries (need a valid will)

5.7 Tax Planning
- Advise to get advice from a taxation expert if required

- Ways to improve tax situation:
- Client use ISAs & friendly society policies – adv of tax-free growth
- Client expected to exceed annual CGT allowance  invest in CGT-free
e.g.gilt
- Adviser should be aware when non-taxpayers can not reclaim
e.g. endowment & life policy – 20% CGT not reclaimable
BUT unit trusts - not taxed on gains within fund & gains on units could be
avoided via CGT exemption

5.8 Regular Reviews
- Circumstances of clients could change very quickly ஃ allow for flexibility in the product
- 4.6.5

6.1,
6.2

SECTION 6: BASIC LEGAL CONCEPTS
RELEVANT TO FINANCIAL SERVICES
6.1 Legal Persons
= People who have separate legal existence ஃ can enter into contract/be sued
Incl. individual in personal/private capacity (e.g. executers, trustees) & organisations (e.g. limited Co.)

6.2 Personal Representative & Wills
= people who carry out procedures necessary to distribute the estate of someone who dies
ஃ the personal representative of the deceased

- if will is valid:
Executor(s) apply for grant of probate = legal authority to ensure the will is carried out

Appointed (i.e. named in the will) by testator (person making the will)
Can also be the Time consuming ஃ can appoint solicitor to carry out tasks
beneficiary of the will

- if no will (or invalid):
Administrator issued a grant of letter of administration
e.g surviving Responsible to deal with the estate as prescribed in the
spouse/relative rules of intestacy (6.2.1)

- Will = declaration of the individuals wishes regarding what happens after they die
- e.g. disposal of assets, instructions on burial etc
- clear, unambiguous, signed by testator in presence of 2 witnesses

Can NOT be a beneficiary
- Terms on the will are only undertaken when the testator dies
- Before: can revoke (cancel) or modify at any time
Recorded in a document = codicil
- To make valid – in writing, properly executed
- minimum age: 18 yrs

- In the event of a marriage or remarriage or civil partnership
… will is automatically revoked unless specifically written otherwise

- In the UK: 7/10 die intestate = no valid will
- Cost of writing a will is reasonable

- Advisers role: NOT writing the will but showing its benefits & recommending the client to draw up a will

- Beneficiaries can vary the way the estate is allocated = execute a deed of variation

All beneficiaries must: (usually for tax purposes) e.g. could reduce IHT
- >18 years old
- Agree to the terms of variation

- within 2yrs of death & HMRC must be informed within 6 months

6.2.1

6.2.1 Intestacy
Partial intestacy = valid provision for distribution of some assets but not of others

- Distribution of the estate of intestate person has rules of intestacy
- very specific & not flexible
- in many cases, not distributed as deceased would want & spouse not always get
- destination of the property under rules depends on the estates size & family circumstances

Rules:
Deceased have… Amount to…
Children? Spouse? Children Spouse Parents/ Siblings
0 / 1st £200,000 + ½ remainder Remainder
/ / ½ of the balance. 1st £125,000 + ½ to trust

Capital to the children Spouse gets income for life
when the spouse dies

/ 0 Shared equally
amongst children
0 0 All

6.3

6.3 Trusts & Trustees
(/settlement) Method that owner of an asset (settlor) can distribute/use the asset for the benefit of another
person(s) (beneficiaries), without allowing them to exert control over the asset while it is in the trust

- Beneficiaries may eventually become absolute owners of the asset

- Settlor = person who creates the trust & who originally owned the asset in trust (trust property)
- once in trust, asset no longer owned by the settlor (unless he is a trustee)
- Beneficiaries = people/organisation who will benefit from the trust property

- Trustees = people, appointed by settlor, who will take legal ownership of the trust property &

administer property under the terms of the trust deeds
- Named in the trust deed
- If they die: remaining trustees personal representative can appoint a new trustee
- Must be 18+ years old, of sound mind
- Must act:
 accordance to the trust deeds. If the trust deed allows the trustee to exercise power
(e.g. decide who will be beneficiaries) agreement between all trustees
 in the best interest of beneficiaries (e.g. fairly distributed)

Trustee Act 2000 – trustee required to:
- be aware of need for suitability & diversification of assets
- obtain & consider proper advice when making investments
- keep investment under review

6.4, 6.5, 6.5.1

6.4 Co.s
= legal entities, separate from shareholders or individual employees

- Shareholders of limited liability Co. are not personally liable for the Co.s debt
- Limited to the amount they invested in Co. shares

- Rules about what Co. can & can not do are set out in the memorandum & articles of association
e.g. borrowing limits on amounts & purpose
- When making a contract for lending to a Co., it is important to ensure the person signing is
empowered to do so & is authorised

6.5 Partnerships
= arrangement between people carrying on business together for profit
- (unlike Co.s) It is NOT a separate entity ஃ partners jointly own assets & liabilities (6.5.1)
- Should have written agreement – setting out details between partners incl. share proportions
of profits & what happens if 1 partner leaves etc. (5.2.2.2)

6.5.1 Ltd Liability Partnership (LLP) – since 2001
- Partners have limited personal liability depending on the amount they invested & personal
guarantees given
- Registered with Co.s House
- Taxation not corporation tax regime - each partner taxed as self-employed with individual
share of profits treated as their own income & subject
to income tax

6.6

6.6 Law of Contract
- Most business agreements are legally binding contracts – orally, writing, deeds

Subject of contract, by promisee
(e.g promise to do/supply something) Each party must have legal capacity to
must be matched by consideration enter contract. Certain parties have
(usually payment of £££) by promisor limited power to enter contact e.g minors
& people of unsound mind

Must be offer made by offeror & Financial services capacity to contract
unqualified acceptance by the other depends on authorisation of FSA
party, communicated to the offeror
Consideration
Capacity to contract
Offer & acceptance
Basic requirements for
contracts to be binding: Terms of the contract are certain,
complete, free from doubt
Contract not entered into as
result of misrepresentation, Intention to create
under duress or undue Legality of object legal relationship
influence

Contract not made for
illegal/immoral purpose

- Some contracts are recorded in a specific legal form
e.g. sale of land is made in writing
conveyances of land (transfer of ownership) is made in a deed

- There is usually no duty of disclosure between the parties to a contract

- Most contracts are based on caveat emptor (‘let buyer beware’)

- Exceptions
e.g. insurance contracts on principle of utmost good faith:
all material facts are disclosed
ஃ if not, contract maybe void

- Breach of contract = party fails to perform his side of contract & no legal excuse

To court:
 Seek damages = injured party seeks financial compo for losses, to
position if contract had not been breached
 Order for specific performance e.g. party to complete contract
 Injunction = count order preventing someone from doing something

6.7

6.7 Law of Agency
Agent = person who acts on behalf of another (principal)
- can conclude contracts on behalf of principle

- Important to understand how much power & authority vested in the agent
– depends on rules & regulations

- Agent should only act within power given by principle – needs observing
- may act within apparent authority = something done/said by principle
to suggest agent has authority
- if agent exceeds power – principle maybe liable

- if a 3rd party is unable to rely on the agents claims, that he (i.e the agent) has authority, the
3rd party can hold the agent liable

- Ratification = if agent exceed authority, principle can agree to event after

- Financial advisors operating as a Co. representative of a product, is acting as an agent of the
product provider

- Independent advisor is acting as a customers agent

6.8

6.8 Ownership of Property
2 types of property:

1) Realty - property is real if court restore to dispossessed owner & not merely provide
compensation for the loss
- distinguished as immovable e.g. land & real estate

2) Personalty – all other property

6.8.1 Joint Ownership
Type Feature If 1 person dies … Debt

1) Joint Whole property owned All automatically transfer to Both equally liable for
tenant * by each of the owners other NOT overridden by the whole debt
deceased’s will
2) Tenants in Each owner has His share goes to whoever is Each responsible for
common identifiable share in entitled according to his in will portion of debt
property

* Banks mostly want in this form

6.9

6.9 Power of Attorney
= Person given legal responsibility to act on behalf of another person

Donor = person making power of attorney
Attorney/Donee = person acting for him

- Person who can not enter into a contract (e.g. minor/mental), cannot appoint an attorney
- power of attorney ceases if the person becomes mentally disabled

Enduring Powers of Attorney Act 1885 created enduring power of attorney
– power continues if the donor
becomes mentally incapacitated
Revoked with consent
from Court of Protection
Must be registered with the Public Guardianship Office
Replaced by lasting power of
attorney since Mental Capacity (name change) Office of Public Guardian (10/2007)
Act 2005 from 10/2007
Allows an individual to make health, personal
& financial decisions for another person
- Established when donor is of sound mind,
- Only in force when donor is mentally disabled

6.10

6.10 Insolvency & Bankruptcy
- Insolvency occurs when an individual:  Liabilities > assets
 Cannot meet financial obligation within reasonable time
- Bankruptcy = persons state of being insolvent formalised under terms of count court order
- person can petition himself as bankrupt to a creditor
- amount of £££ owed for which person can be made bankruptcy is £750

- UK insolvency legislation: Insolvency Act 1986  Insolvency (Amendment) Rules 2002
- EU Regulation on insolvency proceedings (2000) affects UK legislation

- in 2007: 13,000 (7,300 voluntary) Co.s liquidated in the
UK 106,000 individual insolvencies of which 64,000 were bankruptcies
(remaining were individual voluntary arrangements (6.10.1))

- Enterprise Act 2002 (start 2004) – bankruptcy in force for 12 months
(during which person undischarged bankrupt)

- Persons possessions are surrendered to Official Receiver
Except clothing, household, work related duties
Can dispose & get cash to pay off creditors
- Bankruptcy cancels most debts & is a fresh financial start
6.10.
1

- But affects future credit & employment
 Unable to borrow other than nominal amounts
 Must disclose when applying for mortgage ஃ more difficult or higher IR charged to cover lenders
risk

6.10.1 Individual Voluntary Arrangements (IVA)

= alternative to bankruptcy where debitor arrange with creditor to reschedule debt
over specific period

- Only set up if creditors representing > 75% of debt agrees to the arrangement

- Scheme supervised by a insolvency practitioner

- Increased market for firms assisting IVAs

Persuade bank to write off debt in exchange for reasonable
guarantee of receiving repayment of the remainder

Arrange interest to be frozen ஃ reduced amount of debt

Legal protection from creditors if IVA terms are met

- Individual with IVA is not able to get credit while IVA is in place & their credit-worthiness is likely to
be impaired later

UNIT 2 UNIT 1

UNIT 2
UK FINANCIAL SERVICES
& REGULATIONS

SECTION 1: THE FSA
- Primary objective of the gvt: - economic & legal balance between need for businesses to make a
profit & rights of the customer

- EU laws have a direct & indirect effect on UK law

- FSA (established in 1998) = single regulator of the financial services industry
- passed Financial Services & Marketing Act 2000 (FS&MA2000)

regulatory legislation
- reactive rather than proactive (want to move to a proactive stance)
- result from:

Increased consumers’ financial Innovation & complexity &
awareness & demand for customer increase no. in product design
focused business approach
Developments in ஃ consumer to understand
business methods features & benefits of product
Scandals/crisis
Respond to changes
in lifestyle Technology advance
e.g. customers do own
- e.g. collapse Baring Bank (1990s)
transactions electronically
& problems at Equitable Life
- showed need for control & protection Increased divorce & rights
- against fraud & mismanagement for shares in pension benefits

- 2 movements: 1.1

1) Deregulation – e.g. banking & building societies in the mortgage market
Before: gvt had a lot of regulation
Later: barriers removed in 1980s – promote competition (high range & low cost)

2) Lots of regulation

1.1 Financial Services & Marketing Act 2000 (FS&MA2000)
1980s & 90s: increased laws e.g. Financial Services Act 1986 – incl. self-regulation
unsuccessful
e.g. large banks provide lots of products – regulated by Bank of
England
1992: Baring Bank collapse – BOE & Securities & Futures Authority criticised

1998: responsibility for regulation of UK banking sector transferred from Bank Of England to FSA

2001: FSA took control of most financial services industry under FS&MA2000
- incl. Regulation of professional & business behaviour of all parts of the industry
(incl. 800 insurance Co.s, 600 banks, individual employees & sole traders)
- also covers: solvency, capital adequacy, sales & marketing, crime, complaints etc

- Not under FSA in 2001:
 Regulation of mortgage sales – under Mortgage code Compliance Board (to FSA in 2004)

 General insurance – under General Insurance Standards Council (to FSA in 2005)

1.2 FSA’s Objectives Role & Activites 1.2

- Oversee regulation of financial services industry in UK

- Introduction of ‘principles-based’ regulation & revised conduct of business rules (1/11/07)

- FSA is a limited Co. (not gvt department)
– but has statutory powers under law (e.g. Banking Act 1987 etc)

Board (appointed by the Treasury) makes decisions

Ensure market fair,
efficient & transparent Different expertise of
different consumers
Maintaining confidence Securing appropriate levels
in UK financial system of protection for consumers Consumers’ needs for
– depends on accurate advice & info
Objectives
Principle: consumers Different level of risks
Money laundering take responsibility of relating to different
Low scope for investments
own decisions
financial crime
Fraud & dishonesty
incl e-crime Promoting public understanding of financial system
Criminal market conduct
incl. Insider dealing Incl. Risks & benefits

Allocating resources efficiently
Cost:Benefit

Taking a/c of responsibilities of those who manage firms
- Performance of FSA judged against:
Facilitating competition
Taking a/c of international financial services & UKs competitive position

- Undertakes role by setting rules, training, guidance etc via a range of sourcebook

Sourcebook Include
High Level of - Principle for business
Standards - Senior management arrangements, systems, controls
- ‘Fit & proper’ test for approved persons
- Threshold conditions
- Statements of principle for approved persons
Regulatory - Rules & guidance for firms seeking authorisation & FSAs enforcement powers
Process - Supervision manual: how FSA references & monitors compliance of authorised firms
Redress/ - Investor complaints & compensation procedures
Specialist - Arrangements for professional firms e.g. solicitors
Business - Money Laundering
Standards - Conduct of Business: Standards applied to marketing & sales of financial product
- (2007): New Conduct of Business Rules Book (NEWCOB)
introduced
- Training & Conduct
- Interim Prudential: Financial soundness & different types of firms (e.g. assets & liabilities,

reserves, reporting)

1.2.5, 1.2.6

1.2.5 Status of Provisions in FSA Handbook
Rules = binding obligations on authorised firms
- if not follow  enforcement action/actions for damages

Guidance = explain rules & indicate how to comply to them
- not binding ஃ firm not subject to disciplinary action if ignore

1.2.6 Principles for Firms (Businesses) & Approved Persons (Staff)

1) Intergrity 1) Integrity
2) Skill, care, diligence 2) Skill, care, diligence
3) Management & control 3) Observe proper standard of market conduct
4) Financial Prudence 4) Deal with regulators open & co-operative
5) Proper standard of Market Conduct
6) Customers’ interest Significantly influential positions:
7) Communication with client
8) Manage conflict of interest fairly 5) Business of firm organised & controlled
9) Customer relationship of trust 6) Skill, care, diligence
10) Protection that firm must arrange 7) Steps to ensure business complies with
clients’ assets standards & requirements
11) Relations with regulators of firms
– open & co-operative

1.2.7 Treating Customers Fairly (TCF) 1.2.7

Problem with rules & regulations: People aim to comply with the ‘letter’ of law rather than ‘spirit’
ஃ use loop-hole  FSA introduced TCF (develop ethics’)

‘Fair’ - FSA undefined saying: ‘flexible, dynamic & varies with circumstances’
- ஃ definition lies with firms management

- at every stage of business

- 6 improved outcomes:
1) Consumer confident firm is fair
2) Product meets needs of identified customer groups
3) Consumer provided with clear info at all stages
4) All advice suitable for customers circumstances
5) Products & services perform as customer expects
6) No unreasonable barriers e.g. making complaint/claim

- By Mar 2008: firms expected to have place management information systems to test if customers
are being treated fairly

- By Dec 2008: firms must be able to demonstrate to FSA customers are being treated fairly

1.2.8 Arrangements, Systems & Controls for Senior Managers
1.2.8

- Senior manager must take responsibility that firm is complying with FSA regulations

1.2.8.1 Clear Chain of Responsibility
Senior manager  specific areas to specific individuals

- Records showing chain of responsibility required

1.2.8.2 Systems & Controls
- Implemented by firms & must be documented & review regulations

Assessment &
Compliance reporting risk
Chains of Reporting other
responsibility management information
Range of
firm activities
Strategy for controlling business risk
Competency & honesty of staff & recovering from serious problems
especially approved person

Audit of systems & controls Adequate & accessible record of
by independent person systems & controls kept securely

1.2.8.3 Whistle Blowing

= procedure allowing employees to report serious inappropriate circumstances &
behaviour in the firm e.g. not complying with law

- Person has protection under Public Interest Disclosure Act 1998

1.2.8.4 Role of Oversight Groups

- Important activities of the financial service institute is kept under review
– ensure investments of shareholder & customer handled safely & honestly

1.2.8.4.1 Auditors

External auditors - especially concerned with published financial statements & a/c’s free
from misstatements, comply with law & accounting procedures
- independent of institute whose a/c being audited e.g. accountants
- conform to Auditing Practices Board & Accounting Standards Committee

Internal auditors - in-house members of staff or out-sourced
- review how firm is managing risk
e.g. appropriate controls established, suggest improvements,
check records are accurate & reliable

1.2.8.4.2 Trustees
= person/organisation whose responsibility it is to ensure any property held in the trust
is dealt with according to the trust deed for the benefit of the trusts beneficiaries

e.g. Unit trust trustee: legally owns trusts assets on behalf of unit holders
Occupational pension scheme trustee: rights & duties in Pensions Act of 1995 & 2004

1.2.8.4.3 Compliance Officers
= ensure firm complying with FSA laws & regulations

- Responsibilities incl:
 Ensure staff meet FSA requirements regarding recruitment & training
 Responding to & corresponding to FSA on compliance matters
 Products & publication compliance manual
 Maintenance of compliance records e.g. complaints register & promotions records

1.2.9 ‘Fit & Proper’ Test for Approved Persons 1.2.9, 1.2.10

- FSA established set criteria determining if person is ‘fit & proper’ for controlled functions
within the financial services industry under FS&MSA2000 (1.7.1)

Criminal records
- Criteria: Disciplinary proceedings
Known to go against regulations/law
 Honesty, integrity & reputation - judged by:
Complaints/Dismissals
Insolvency

 Competency/capability - meeting FSA training requirements

Current financial position
 Financial soundness Previous bankruptcy/adverse credit rating

1.2.10 Prevention of Crime
- Market abuse:
Insider dealing = person has info not available to other investors & makes use of
information e.g director knowledge of takeover bid
Market manipulation= person knowingly gives false info to influence price a share
for personal gain
- Money laundering (section 2)

1.3 FSA’s Approach to Regulating Firms & Individuals 1.3

- Financial service organisations must be authorised by FSA if it carries out regulated activities
with respect to regulated investments (1.3.1 & .2) & controlled functions (1.7.1)

defined in FS&MA2000 (regulated Activities Order 2001) (RAO)
Regulated Include …
Debentures Activities 1) Accepting deposits
Shares 2) Effecting & carrying out insurance contracts (incl. funeral plans)
Gilts 3) Dealing in & arranging deals in investments
4) Establishing & operating collective investment schemes
Securities 5) Advising on investments
6) Mortgage lending & administration
2 categories 7) Advising on & arranging mortgage & general insurance
Investments
1) Deposits
Contractually 2) E-money
based 3) Insurance contracts
4) Shares, Co. loan stocks, debentures & warrants
Options Life policies 5) Gilts & local authority stocks
Personal Futures 6) Units in collective investment schemes
pensions 7) Rights under stakeholder pension schemes
8) Mortgage contracts

- Permission given by listing the regulated activities & investments firm is allowed to carry out
- via FS&MA2000 Part IV (Part IV permission)

1.4 Capital Adequacy 1.4, 1.4.1

- Aim of industry regulators: protect firms, customers, economy by establishing rules & principles
- Different rules for deposit-takers, investment firms & life assurance Co.s

1.4.1 Capital Adequacy Regulations for Deposit Takers

- Institute must have sufficient capital to make unlikely deposits at risk

‘own funds’ i.e. bank own capital base from stakeholders
(ஃ different funds from deposits by customers)

- Any losses (e.g. written off repayments) bourn by shareholders not depositors

- Minimum requirement for capital adequacy is set by Basal Committee on Banking Supervision

Multi-national body under
Agreement: Basal Accord  Basal II (operational in 2007)
Bank for International Settlement

- Minimum requirement by solvency ratio = capital requirement denominated as a proportion of
the banks assets (e.g. loans), with allowances made
for the perceived risk level of different assets
= Institutes own funds as a % of risk-adjusted value of
its assets i.e. how much institute can cover its risks

Currently solvency ratio is at least 8% (of the banks own funds of risk-weighted assets)

Banks paid up share capital + any retained profits

ஃ % contribution of less risky asset has less risk-weighted total than more risky asset

- Basel II: is slightly more flexible to reflect the business of individual institutions
 Incl. capital requirements for operational risks

risk of loss from failed/inadequate internal processes, people
& systems or external events e.g. earthquakes, fraud

Basic approach: capital required = institutes gross annual income (average over 3yrs) x 0.15

For larger organisations: more sophisticated system (standardised approach) applied
- may use different multiplying factors

 Introduction of higher supervision system
e.g. ‘stress test’ – extent of sufficient capital if unexpected adverse economic
conditions occur

- Backed by disclosure requirements to ensure bank publish information for risk profile

1.4.2 Capital Adequacy for Investment Businesses 1.4.2

1990’s: investment firms allowed freedom to provide same services as banks & other credit institutions

ஃ Institute Services Directive (ISO) (1996) & Capital Adequacy Directive (CAD)

Markets in Financial Instruments Directive (MiFID) & Capital Requirements Directive (CRD)

Sets minimum capital requirements for investment firms, dependent on category

Category Deal with … Capital required

Own a/c dealers Own a/c €730,000
Matched principle broker Fulfil customers orders €125,000

Broker/Managers Investments as agents or €125,000 or €50,000 (if no client £
managers for customers ££ or assets)

Advisers/arrangers Give advice/arrange €125,000 or €50,000 (if no client £
investment deal ££ or assets)

1.4.3

1.4.3 Solvency Margins for Life Assurance Co.s

- Harder to determine from most other Co.s as liabilities relate to payment Co. may or may not have
at unknown dates in future (e.g. due to death claim) & depend on future mortality rates & IRs

- Life Directive (by EU, 2002) sets out:

 Principle of the technical methods & calculations of liabilities (valuation liabilities)
- Co. must maintain adequate solvency margins

excess of Co.s assets over its provisions

Paid up share capital
 Components of Co.s solvency margins Statutory & free reserves
Profit brought forward after dividends paid
Cumulative preference share capital & subordinated
loan capital – only up to 50% solvency margins

- Regulations are complex, but the basic rule: for policies with an investment risk (e.g. endowment
policies) require a minimum 4% solvency margin (lower for lower risk)
i.e. Co.s assets = 104% of values of liabilities

- Authorities in individual EU states (e.g. FSA in UK) can relax rules temporarily if required
e.g. in 2003: when stock market securities reduced
– FSA rectified by reducing prospective liabilities e.g. annual bonuses

1.5 Risk-Based Approach 1.5

- Types
 Prudential risk – e.g. risk of firm collapsing as incompetent management
FSA aims
to reduce  Bad faith risk = risk due to fraud, mis-representation, mis-selling
 Complexity/unsuitable risk = risk of customer not understanding product
FSA not take
responsibility, but  Performance risk = risk that investments fail to deliver hoped-for returns
aims to educate
consumer

- Assessment of risk:
• Probability factors = likelihood of problem occurring
- Business risk – e.g. business strategy, capital adequacy, a/c’s
- Control risk = quality of management, internal systems, controls
- Consumer relationship risk – e.g. marketing & advice practice

• Impact factors = effect of economy, industry, customer in specific event
e.g. firm collapsing, compensation loss availability

Risk: High Low
- Classification category: A–B–C–D
<1% Majority
High impact firms, institutes of institutes
65% market shares

1.6 Discipline & Enforcement
- FSA empowered to undertake: - General investigation into business
- Specific investigation into authorised person

e.g. falsifying document etc

Answer questions If not given ஃ FSA can
- Person appointed to investigate can demand: Provide information apply to Justice of Peace
Provide documents for search warrant

1.6.1 Enforcement Powers
- If FSA discover something, actions which can be taken:

 Variation of a firms permission of regulated activity of firm
 Withdrawal of approval to carry out some/all controlled functions
 Injunction  can prevent person benefiting from action
 Restitution  FSA can ask court to forfeit profit to FSA
 Disciplinary action (e.g. private warning, published statement) in misconduct
 Redress: if customer made loss due to contravention of rule  FSA involve courts

- Customer can contact the Financial Ombudsman Service or Financial Services
Compensation Scheme

1.7 FSA Conduct of Business Sourcebook 1.7.1
1.7,

1.7.1 Approved Persons & Controlled Functions

Director of Compliance oversight
Director of small unincorporated Money laundering reporting
friendly society association Duties of appointed oversight
Chief Executive Partner Required EEA investment oversight
functions Apportionment & oversight
Non-executive
director Governing Dealt with by senior person who has
functions overall responsibility of organising firm
Director
Controlled
Functions
(Trainee) Investment adviser Systems & Finance
Corporate finance Customer Controls
Risk assessment
adviser function function
Significant Internal audit
Pension transfer
specialist Management
function
Adviser at Lloyds Investment Designated investment business
management Settlement
Customer trading Other business operations
Financial resource Insurance underwriting

1.7.2 Advertising & Financial Promotion Rules
1.7.2

Adverts in media Invitations or inducements to engage in
Incl.
investment activity
Telephone calls
Marketing during Presentation Types e.g.
visit to client to groups Non-written Personal visits,
financial promotions telephone conversation
Written financial Newspaper adverts,
promotions internet sites

- Rules shifted to allow firms more discretion on marketing ஃ many existing provisions replaced

More flexibility, but their responsibility their rules conform to the principles
1.7.2.1 Comparisons Promotion is clear, fair & not misleading
- Must be meaningful & fair
- MiFID firms require details of information source & assumptions made in comparison

1.7.2.2 Past Performance
- Clear it refers to the past
- Warning: past performance is not necessarily a reliable indicator of future results
- Based on at least 5yrs (or period since investment commenced, not less than 1yr)

1.7.2.3 Unsolicited Promotions
- Only allowed for certain products (life assurance, unit trusts), not others (mortgages, life policies)
- Not made at unsolicited hours (9pm to 9am Mon – Sat, Sun)
- Caller must check recipient is happy to proceed

1.7.3 Record Keeping 1.7.3, 1.7.4

- Clear & readily accessible
- From advertisement  information found in fact find  Record for advice etc
- Why? Demonstrate compliance to rules

1.7.4 Training & Compliance (T&C)
- FSA published T&C sourcebook

1.7.4.1 Training
- Organise training at appropriate intervals, & evaluate
results
1.7.4.1.1 Assessing Competence
Assess employees has knowledge, skills & passed all modules

1.7.4.1.2 Appropriate Exams
List held by Financial Services Skill Council (FSSC) who set the standards for exams
ஃ accredit awarding bodies of specific exam
e.g. CeFA & CeMAP

1.7.4.2.3 Maintaining Competency
1.7.5

- No specific amount of time (~50hrs/yr) on continuing professional development (CPD)

Conferences
- Methods Private study
Training courses

1.7.4.2.4 Record Keeping
- of employees competence & training, assessments, exams, meeting with supervisor
- Must be retained for: - at least 3yrs after employee leaves the firm
- indefinitely for pension transfer specialists

1.7.5 Specific Rules for Financial Advisors
1.7.5.1 Rules about the Process of Advising Clients
1.7.5.1.1 Type of Customer
1) Eligible counterparty - Incl. large financial institutes (banks, insurance Co.s etc)
investor protection
Increasing level of

- Require limited service e.g. execution only

2) Professional client - Otherwise incl. in eligible counterparty, except require higher level
of service, e.g. advice
- Adviser can assume high knowledge & ability to accept risk

3)Retail client - ‘the person in the street’

1.7.5.1.2 Clients Agreement
- Adviser required to have a written agreement with the client which sets out the business relationship
= business letter – issued as part of the initial disclosure documents (IDD)

Not required if the customer received one in the past & terms have not changed
- Client must be informed about the terms before information/advice given

Service offered by advisor
Status of advisor (1.7.5.2) Full name of regulator

Whether or not professional Summary of clients responsibilities
Terms of
indemnity insurance held
business incl.
Detail of complaints procedure
Locus arrangement in
case of advisor absence
Detail of payment for services provided

Duty of disclosure details of Firms authorisation with respect
any ‘connected person’ to handling clients £££

1.7.5.1.4 Discretionary Investment Management Agreement
= required when client allows adviser discretion over investment choice (e.g. handling
investment) portfolio & can change without clients individual agreement to every transaction
- must specify limits of discretion adviser can operate as an investment manager

1.7.5.2 Status of Advisers & Disclosure of Status
1.7.5.2.1 Polarisation & Depolarisation
Adviser is independent or tied – must tell customer
Advise & sell product for 1 (or group) Co.
Give advice on the whole financial services market
& select appropriate product for the client & provider

- Problem: commission bias (i.e. adviser gives the product with higher commission)
ஃ Jan 2002 – ‘Reforming polarisation – Making the Market Work for the Consumer’
i.e. ended polarisation

June 2005: Depolarisation= new way determining & explaining the way clients pay for advice (1.7.5.5)

Change: 3 types of advisers

Whole of market Multi-tie Marketing groups

usually panel of Co.s Provide products
Offer product from limited from 1 provider
Must have range of products range of specific providers

- Clients get 2 documents:
1) Key facts about our service (1.7.5.2.3) = type of advice & products available
2) Key facts about cost of our services (menu) (1.7.5.2.2)

1.7.5.2.2 ‘Menu Approach’
- Client given Key facts about the cost of our services document at the start of a consultation
- Includes:
 Service provided by the firm
 Different firms offer customers different options for cost of advice
 Firm charges fee/commission or in between

Amount Where it is coming from, the amount &
how it compares to the market average
- Whole-of-market advisers have to offer (but not insist on) a fee based option (to show their
decision is not influenced by commission)
- If an adviser is tied to one product provider, however the products are not suitable, they are not
permitted to sell the product ஃ should tell the client to seek independent advice

1.7.5.2.3 Initial Disclosure Document

Product from whole of market?

Types of products offered Advice or recommendation provided?

Includes
How to get compensation from financial
Details of ownership & regulation service compensation scheme
How to complain e.g. Ombudsman Services

1.7.5.3 Suitability Requirements
- Do NOT give advice until a fact find is done & client understands the risks
- Depends on client situations & need

1.7.5.4 Suitability Reports
= explain why the product was recommended to the client
- Clear, concise & signed by the person authorised to give advice
- Provided for: unit & investment trusts, life policies, pension policies, pension transfers/opt-out,

- When issued? ASAP after transaction & no Before transaction Within 14 days of transaction
later than cancellation notice effected

1.7.5.5 Execution Only
= customer instructs the adviser to execute a specific transaction (ஃ not require advice)
– by giving full details of the product

- Advisers does not need to fully explain the nature of the transaction or risk
ஃ it is customers own responsibility

- Adviser required to obtain client signature:
 that it is an ‘execution-only’
 ‘non-execution only’ i.e. client wishes to effect transaction contravening
advice given

1.7.5.6 Charges & Commission

1.7.5.6.1 Disclosure Charges

- Basis & amount of charges disclosed in writing before the business is transacted
- maybe explained in client agreement
- charges on packaged products in ‘menu’ & key
features document

- If business on execution-only basis & written disclosure would delay transaction:

Firm makes disclosure verbally before transaction is executed

provide written confirmation

- If it is a ‘packaged’ product (e.g. life policy), adviser discloses, in cash terms, the amount
commissioned

In key features document (1.7.5.7)

1.7.5.7 Product Disclosure
- Key features of the product explained to the client in writing before the sale is concluded

Risk factors Consequence of making product paid-up

Essential element of products If income/capital levels might vary
Includes
Tax information on maturity dates/before Commission paid

Where additional information can be found Client specific information relating to charges

1.7.5.7.1 Risk Disclosure
- FSA pointed out risks customers will face
- Risks of all product disclosed – left to product provider
- ‘Most significant’ risks in Key Facts document – easy to understand

1.7.5.8 Cooling Off & Cancellation
- Client can withdraw from the contract within a specific period of receiving notice (~4 days)
1.7.6

- direct post from product provider to client
- No commitment or loss during that period – signed & return to the provider

- Full refund of any premiums paid (except if client cancels a lump sum unit-linked investment, where
£££ is invested & the value fallen)

1.7.6 Stakeholder-Type Product
- Simple, low cost, risk controlled product for less financially sophisticated

- Maximum annual charge for investment - 1st 10yrs of life of a product: 1.5%
product: - after (/throughout if before 6/4/05): 1%

Cash deposit products

Child Trust fund Medium term investment products
Products
Stakeholder pension Smoothed investment fund

- Controlling risk: limit proportion of shares in stakeholder unit-linked & with-profit products
to 60% of the fund  remainder into fixed-interest securities & cash

- Simplified selling product model:
Adviser explains product nature

Series of short questions

Assessment Customers savings & investment objectives
Risk assessment
- can be terminated at any stage

1.7.7 Regulation of Mortgage Advice
1.7.7

- FSA rules on loans subject to 1st charge on:  Borrowers property
 UK property
 Borrower/family occupy > 40% property

- 2 types sales people: 1) giving advice
2) those only giving information on products
- determined by questions to filter mortgage selection

MCOB rulebook incl:

MCOB Purpose Details
1 Application & Purpose Explains scope of rules i.e. who it applies to & what type mortgage
2 Conduct of business Use of terminology, charging rules, record accessibility by FSA
standards
3 Financial promotions Distinguish between (non)real-time promotion
Not contact customers at unsociable hours
Details on promotions & say ‘Home maybe repossessed if not keep
up with repayments’
4 Advising & Selling Incl.: type of adviser i.e. independent etc
standards Suitable products for customer
Records kept for 3yrs
IDD information: whose mortgage offered, charges payable, FSA
regulated details, claim & complain rules

MCOB Purpose Details
5 Pre-application Disclosure Details given when recommendation made & before
application to lender
Incl. APR, amount monthly instalments, amount
instalments if increase 1% IR
6 Disclosure at offer stage Lender provided detailed documents, incl. how long offer
remain valid, point of no withdrawal, charges
7 Disclosure at start of contract & After 1st mortgage payment made, lender confirm: amount,
after sale dates, method payment & details of related product e.g.
insurance, what customer do if falls into arrears
- annual statement issued: amount, term, changes,
type of mortgage

8&9 Lifetime mortgages Special rules to advising & selling
10 Annual % rate Describes how APR calculated
11 Responsible lending Show customers ability to pay
12 Charges ‘Excessive’ charges not allowed, early repayment charges
correspond to cost to lender & arrears charges reasonable
to the cost of administration
13 Arrears & repossession Try reach agreement with client in arrears
Customers in arrears given information in 15 days: FSA
worksheet on what to do, missed payments, total arrears
incl. charges, debt, additional charges
Repossession when all other measures fail

1.7.8 Regulation of General Insurance 1.7.8

- FSA took control in 1/2005
- rules to adviser in Insurance Code of Business (ICOB)

ICOB Purpose Details

1 The scope of rules Rules & types of activities covered (incl. to intermediaries)
2 General rules Rules on communication, record keeping, inducement
3 Financial promotion Advertisements clear, fair, & not misleading
4 Advising & selling Information on status: [details of firms regulation (FSA), whole-
standards market product, producer, how to complain, information in IDD,
combined initial disclosure document (CIDD)],
Fees
Advice suitability
Excessive charges
Unsolicited services – contract renewal
5 Product disclosure Product information, terms of contract, price, cancellation rights
6 Cancellation If customer cancels ஃ provider must return sums in 30 days
- can deduct charges
7 Claims handling Insurance Co. ensuring rules complied to if adviser acting on behalf
of them & customer must be told

2.1

SECTION 2: MONEY LAUNDERING

-1989: Financial Action Task Force on Money Laundering (FATF)
= international body to fight against criminal money

- 30 members incl. EU commission & EU member states

2.1 Proceeds of Crime Act 2002 (PCA2002)
- incl. all forms of crime incl. Money laundering, drug-crime

2.1.1 Terrorism Act 2000

= use of serious violence against person or serious damage to property or
electronic system with purpose of influencing gvt, intimidating public or advancing
political, religious or ideological cause (incl. money laundering)

2.2

2.2 Definitions
Money laundering = process filtering proceeds of criminal activity through series of a/c
or financial products to give it apparent legitimacy

- EU’s 3rd Money Laundering Directive (2005) definition incl.
 conversion of property, incl. knowing /and participating, to conceal origin to evade
legal consequences
 concealing true nature, source, location, disposition, movement, rights wrt ownership
 acquisition, use of property knowing at time of receipt it was derived from illegal activity
 participating, committing, attempt to commit, aiding, abetting, facilitating illegal activity

- Specifies money laundering within EU treated under directive, even if activities to generate
property took place in a non-EU country

Property = asset of every kind, (in)tangible, (im)movable, as well as legal documents giving
title to such asset

Criminal activity = crime specified in Vienna Convention United Nations Convention Against
Illicit Traffic in Narcotic Drugs & other criminal activity as specified by each
member state

- 31/8/06: Money Laundering Sourcebook deleted, & firms given flexibility to structure controls &
procedures around their specific risks (guidance from Joint Money Laundering Steering Groups)

2.3

2.3 Money Laundering Offences
Concealing criminal property
- In PCA2002: 3 money laundering offences Arranging
Acquiring, using, processing

Reporting
Education Training
Procedures &
accountabilities Money Laundering Reporting Officer (1.7.1)
Ways to prevent staff Identity evidence
Refrain from alerting money laundering
investigated - for transaction >$15000 (~£10000)
- different for life assurance policies (2.4)
Report at least once a Up to date procedures & records
year & assess firm’s
compliance to sourcebook Strengthen deficiencies

- FSA assess money laundering using:
Joint Money Laundering Steering Groups guidance notes
= steps to verify customer identity
- made up of UK trade associations

Financial exclusion guidance (2.4.1) FATF = highlight developments in ML & deficiencies in rules

2.3.1 FATF 2.3.1 – 2.3.4

- Coordinate international fight against money laundering
- Established in 1989
- Main office: Paris, 33 full members incl: EU, US, East Europe, Far East
- Work involved:
 Setting standards for anti-money laundering programs (40 recommendations)
 Evaluating the extent individual countries have implemented their standards
 Identifying money laundering methods
-‘Inter-gvt policy making body’ is not a law enforcer, but have responsibilities of individual countries
e.g. Serious Organised Crime Agency(SOCA) - in UK
2.3.2 SOCA
= public body sponsored by, but operationally independent, of Home Office
- Responsible to reduce the impact of serious organised crime
- Intelligence-led agency with law enforcement powers
- 3 priorities: drug trafficking, immigration crime, money laundering

2.3.3 Failure to Disclose *
- PCA2002: requires persons to disclose information about money laundering

2.3.4 Tipping off *
- Offence
* = Areas of concern

2.4 Client Identification
2.4, 2.5

- Required when:
 Entering into new business relationship
 New customer: when value > €15000/life assurance policy
- €1000/yr (€2500 single) premium
 If suspected of money laundering

- If client is introduced via intermediary, written assurance by the intermediary is sufficient

- Standard format e.g Association of Independent Financial Advisers(FA)

- Acceptable forms: current passport, national ID card with photo, driving licence, utility/tax bill

2.4.1 Financial Exclusion
- FSA guidance: If a person can not give the above evidence, then they can get financial services
by using a letter from a person in position of responsibility (e.g. solicitor, accountant, doctor)

2.5 Record Keeping Requirements
- For evidence for money laundering
- Identification evidence kept for 5 years after the relation has ended
- Transaction evidence kept for 5 years after the transaction has occurred

2.6 Reporting Procedure 2.6-2.8

- Firm must appoint a Money Laundering Reporting Officer (MLRO)
– co-ordinate anti-money laundering activities
Reporting cycle
Staff SOCA

- 1+ times a year the senior management gets a report from the MLRO

Assess firms compliance Information on money laundering
with sourcebook submitted by staff
Indicate how FAFT
findings used

2.7 Training Requirement
- Firms are required to:
 Make employees aware of money laundering procedures, legislation & MLRO
 Provide training on how to handle money laundering transactions & impact

2.8 Enforcement
- FSA can discipline firms/individuals if they breach money laundering laws
& can prosecute under the Money Laundering Regulation 2003

- 14 years imprisonment & fine
- 5 years & a fine for tip off or failure to disclose

3.1

SECTION 3: COMPLAINTS
& COMPONSATION
- Lots of legislations & firms to protect customers from fraud, but not 100%
ஃ customer has to take responsibility

- FSA statutory objectives (1.2) makes easier to complain

3.1 Firms Complaints Procedures
- FSMA2000: rules required firms to deal properly & promptly
ஃ firm must:
 appropriately & effectively handle complaints procedures
 make consumer aware of procedures (in business letter/initial disclosure document)
 aim to resolve in 8 weeks
 report to FSA on regular 6 month basis

- Complaint can be received: oral/writing  acknowledgement in 5 days

- Eligible complainants:
Private individual
Small business (annual turnover < £1million)
Charities (annual turnover < £1million)
Trustees of trust with assets < £1million

- Types of complaints:

 Hard = allegation of financial loss, material distress - records kept for 3yrs
 Soft = any other

- same rules except hard complaints have deadlines & reported to FSA

Firms responds in final letter – within 4 weeks of receiving complaint
(if not, send interim letter)

if 8 weeks pass
Letter to explain
Inform customer of Ombudsman Service
within 6 months of the date of the letter

- 6 monthly reports about progress of hard complaints

3.2 Financial Ombudsman Services (FOS) 3.2

- FSMA2000 integrated FOS in 12/2001
Deals with complaints (not make rules or give guidance)

- 3 areas:
 Banking & Loan Division
 Insurance Division,
 Investment Division
 from 6/4/07 Consumer Credit Complaints

- Not incl. Pension Ombudsman

- Free

- Funded by firm members (compulsory for firms authorised in FSMA2000) of FOS

- Deal with complaints if the firm can not – within 6 yrs of event giving rise to complaint

- Award up to £100,000 + reasonable costs
– put complainant in same financial position as if it had not occurred

3.3 Financial Services Compensation Scheme (FSCS)
3.3

- Dec 2001: scheme for compensation if cost customer has lost £££ by insolvency of an
authorised firm

- Sub-schemes:

Problem Main Compensation (maximum) Additional (maximum)

Default of insurance Co. 100% of 1st £2,000 90% if balance – no upper limit
If compulsory insurance: 100%
Loss due to firm insolvency 100% of 1st £30,000 90% of next £20,000 (i.e. max £48,000)
Loss of deposited funds due to 100% of 1st £35,000
default of bank/building society
Claims against mortgage advice 100% of 1st £30,000 90% next £200,000 (i.e. max £48,000)
& arranging firms

Claims against insurance Depends on circumstances
intermediaries
- No compensation for other losses (e.g.negligence, poor advise etc) via FSCS
– could via civil courts

3.4 Pension Ombudsman 3.4

- Created by Social Security Act 1990
– for occupational pensions & some personal pension schemes

- Secretary of the state for Work & Pensions appoints Ombudsman

- Decides about complaints & disputes of running pension schemes
– not complaints about sales & marketing (3.2)
Mal-administration has led to injustice  Office of Pensions Advisory Services
e.g. financial loss, distress, delay

- 1st addressed to pension schemes manager/trustee Disagreement
about facts/law

Pensions Ombudsman
Legally binding

- Communicate to Ombudsman via writing – within 3yrs of the event (excl. internal complaints
procedures)

SECTION 4: DATA PROTECTION 4.1, 4.1.1

4.1 Data Protection Act 1998 (DPA)
- Replaced DPA1984 (as UK law needed to comply with EU-DPA1995)
- Only included computerised data
- DPA98 applies to ‘any structured set of personal data’
- Gives control of private individuals use of personal data held by commercial organisation

4.1.1 Definitions
Data subject = individual whose personal data is processed

Personal data = ‘information relating living individual who can be identified from information/
combination of information in possession of data controller
Sensitive personal data = this data can only be processed if individual gives explicit consent
- incl. racial origin, religious belief, political persuasion, physical & mental health

Processing = all aspects of owning data- obtaining, recording, organising, disclosing, erasing

Data controller = legal person determining purpose data processed & way its done
- normal: organisation/employer
- ensure requirements of Act carried out

Data processor = person who processes personal data on data controllers behalf

4.1.2 Data Protection Principles 4.1.2

1) Processed fairly & lawfully – incl. controller tells the individual what & why data is processed
- data not processed unless subject gives consent or processing for following reasons:
+ perform contact with the subject or to protect the subjects interest
+ fulfil legal obligation or carry out public function
+ pursue legitimate interests of controller – unless this prejudice interest of subject

2) Obtained for specific legal purpose

3) Adequate (not excessive) & relevant to purpose its processed for

4) Keep accurate & up to date

5) Not kept longer than required

6) Processed in accordance with the rights of the subject
Incl:
- Right to receive (payment £10) copy of information held
– provided within 40 days of written instruction
- Right to correct
7) Controllers must take technical & organisational measures to keep data secure from misuse

8) Not transfer to country outside EU Economic Area unless data protection regime adequate

4.1.3 Enforcement
4.1.3

- by Information Commissioner (IC)
– Responsibilities:
 educate the organisation & individuals about the Act & their rights
 take action to enforce the Act

- IC can issue 2 types of notices to the data controller (if infringing terms of Act)

1) Information notice = require controller to specify organisation will take to comply to Act
2) Enforcement notice = require organisation to take specific/refrain from action

- IC can prosecute controller if they do not comply to notices

- 2 other criminal offences in the Act:
 failure to notify the IC. This is the way controller registers with the Office of the IC
(acknowledge data held)
 process data without authorisation from the IC

- Maximum penalty: £5,000- unless the case goes to Crown Court (unlimited fine)

SECTION 5: OTHER LAWS & REGULATIONS
RELEVANT TO ADVISING CLIENTS

5.1 Consumer Credit Act 1974
= Regulate, supervise & control certain types of lending to individual & provide borrowers
protection from unscrupulous lenders

- Regulated by the Office of Fair Trading (not FSA)

- Sets out the standards of how all lenders must conduct their business incl. safeguards potential
borrowers, must be made aware of nature & condition of loans & rights & obligations

- Affects most aspects of banks lending activities – incl. loans & revolving credit
Not all loans are included:

- Loans >£25,000
- regulated by Consumer Credit legislation (unless exempt (next slide))
- from Apr 2008 all loans are covered

Clients must receive a copy of the
loan agreement for own records
Suppliers of loans & Prospective borrowers have cooling
credit licensed by off period – unless agreement
Office of Fair Trading signed on the lenders premises
Main elements of Act

Undesirable/misleading Credit reference agencies must disclose
marketing practices forbidden information about an individual on request

- Introduced annual percentage rate (APR) system
= compares the price of lending ஃ total cost of borrowing

IR
- 2 factors:
Additional costs & fees

5.1.1

5.1.1 Changes
- due to 3yr review, to make law fair & competitive credit market: Consumer Credit Act 2006 (CCA06)

- 3 improvements described by the Department of Trade & Industry:
1) Enhance consumer rights & redress
2) Improve regulation of consumer credit business
3) Make regulations more appropriate for all kinds of consumer credit transaction

Law Act Changes

Primary CCA06 - Parts changed incl. Financial Ombudsman Service (4/2007)
- New licensing regime & transparency provision (4/2008)
Consumer Credit - About form & content of adverts for credit:
Secondary Regulation 2004
Simple, intermediate & full-credit advert to a single list, incl:-
(CCR) - new way to calculate APR & present prominently (2/3 of advert)
(Advertisement)
- plain English & easy to read/heard
- name of advertiser included
- if secured loan ஃ advert clearly state the required security
CCR (Agreements) - Make agreements signed by customers clearer & easier to understand
(Amendments) ஃ change content & layout

CCR (Disclosure - What information must be disclosed to prospective borrowers & the way
of Information)
CCR (Early
- Confirm entitlement of borrowers to rebate when all/parts of the debt repaid
Settlement)
earlier & the way to change calculation etc

5.2 Unfair Contract Terms 5.2

5.2.1 Supply of Goods & Services Act 1982
- Apply to all contracts after 1995 involving supply of services

- Terms mean services will be performed in reasonable care, time & charge

5.2.2 Unfair Terms in Consumer Contracts Regulations 1999
- Apply to any term in a contract between supplier & consumer, where supplier acting on
behalf of business, & the contract is not negotiated on an individual basis

- Office of Fair Trading is responsible

- Incl. contracts for land sale, tenancy agreements & mortgages
- under remit of regulation where supplier is not an individual & is acting
in the course of business
- Excl. person selling home, but covers builder selling new houses
5.2.2.1 Fairness
- Contracts should be fair, good faith, not cause significant imbalance on rights & obligations

- Contracts written in plain language
- Unfair terms are unbinding (the rest of contract may still be binding)

5.3 Rules on Occupational Pension Schemes 5.3, 5.3.1

- Remains separate from other financial services & even private pension schemes

5.3.1 Pensions Act 2004 (PA2004)
- PA1995 introduced aspects of provision & supervision
- Public confidence reduced by Maxwell affair ஃ gvt needed to restore confidence by stopping
fraud & improving administration
- Incl. 2 important elements:
1) Establish of Pension Protection Fund (5.3.1.2)
2) Transfer regulating responsibility:
Occupational Pension Regulation Authority to Pensions Regulator

5.3.1.1 Pensions Regulator
- More power, proactive & risk-focused 2 factors: likelihood, impact
- High risk situations require more monitoring

Protect benefits of members of work-based pension schemes
- 3 objectives Promote good administration
Reduce risk

Trustees/scheme mangers Informed quickly if scheme can
must give notification for not meet funding requirements
All schemes must make any information changes ஃ can remedy quickly
regular returns to regulator
Investigating schemes - to identify & monitor risk

Powers
Putting things right Acting against avoidance
Specific action to incl.
= prevent employers from deliberately
improve matters avoiding
Fines/ pension obligations & leaving Pension
Disqualifying trustees prosecution
Recovering Protection Fund to cover pension liabilities
who are not fit
unpaid

- Actions:
 Contribution notices – require employer to make payment on debt to the scheme or
Pension Protection Fund
 Financial support directions – require financial support in place for under-funded scheme

- Issue voluntary code of practice on range of subjects & expected standards of conduct

Provide practical guidelines for trustees, employers, administration etc

(4/2006): Must have knowledge of pension & trust law, scheme
funding& investment, trust deed & other important documents

5.3.1.2 Pension Protection Fund (PPF)

- Established by PA2004 to protect members of defined-benefit pension schemes whose firm
becomes insolvent with insufficient funds to maintain full core benefits for members

100% for existing pensioners incl. ill 90% for pre-retirement member
health, retirement & survivors benefits subject to overall benefit cap

- Taken over responsibilities of the Pensions Compensation Board to provide compensation for
defined-benefit & contribution schemes in fraud

- To ensure compensation retains value over time, payments increased in line with retail price
index (RPI) - up to a maximum 2.5%

Compensation funded in 2 ways: Take over assets of pension schemes with insolvent employers
Levy on all private sector defined benefit (element) schemes

5 parts
Fund compensation levy (replaced
Pension protection levy based on
Pensions Compensation Board levy)
risk factors ~80% of PPF (incl.
under-funding, credit rating)
PPF Ombudsman levy –
cover cost of PPF Ombudsman
Pension protection levy based on
scheme factors (incl. number of Administration levy – cover set up
active & retired members) cost & undergoing cost of PPF

5.4 EU Directives
5.4, 5.4.1

- Objectives set by EU but member states can achieve them by any method decided by
national authorities

5.4.1 Banking

- Apr 2000: 2nd Banking Directive – consolidated earlier directive

Gave institutions freedom to establish
& pursue business of credit institutes

 Defines credit institution: ’undertaking whose business is to receive
deposits/other funds from the public & to grant credit for its own a/c’
 Minimum funding (& other) requirements for institutions to be
authorised as credit institution
 Way institutes become authorised (e.g. FSA in UK)

 Activities authorised credit institutes can carry out – incl. acceptance of deposits,
lending, trading in money markets

5.4.2 Investment
5.4.2

- 1993 Directive on Investment Services in Securities Field
- Investment Services Directive (revised) – in force 1996

- Aim: enable investment firms to operate in different EU states in approximately the same way
ஃ broaden markets across the EU

- Firms must be authorised in their home state & can then operate in other states without
further authorisation

Obtain & retain by complying with certain roles:
e.g. - good administration & accounts
- safeguards on held data
- internal control mechanisms

5.4.2.1 Markets in Financial Instruments Directive (MiFID)

- Allow investment firms to operate throughout EU on single authorisation

Incl. securities & future firms, banks doing securities,
investment exchanges, alternative trading system

Excl. life assurance, pensions or mortgage business

Receipt & transmission of Execution of order
investor orders on purchase on customer behalf Discriminatory management portfolio
/sale of specific investment of specific types of investments

Types of Investment Activity

Underwriting issue of Giving investment advice
any specific investment

- UK firms are exempt from MiFID if:
 do not hold client £££/securities

 restrict business transmitting order & giving advice on transferable securities &
collective investment schemes

 transmit orders to authorised credit institutions, investment trust Co.s, collective investment
schemes & MiFID investment firms

Options
Transferable securities IR, currency, equity swaps
(stocks, shares)
Investments
Financial futures contracts Money market instruments

Forward IR agreements Unit in collective investment

5.4.3 Insurance 5.4.3

2 objectives:
1) Widest range of insurance products to EU citizens, while ensuring high
standard of legal & financial protection

2) Enable authorised Co. to act throughout EU

5.4.3.1 Life Assurance

1979 Life Directive – incl. life assurance, annuities, personal injury, incapacity to work, PHI

2nd Life Directive of 1990 – incl. rules to provide life assurance services

3rd Life Directive of 1992 (Life Framework Directive) – this EU directive incorporated into
Insurance Co.s (3rd Insurance Directive) Regulation 1994

2002 Life Directive

- Arrangements for regulation & supervision depends on why the policy is taken out:
1) If taken out on applicants own initiative – countries regulation where insurance Co. is
2) If taken out as rules of state – regulated & supervised by that state

Limit business activities to insurance only
Submit scheme of operation
- To obtain authorisation Run by technically qualified people
Possess minimum guarantee fund
Notify identities of shareholders & amounts

- Financial supervision of insurer by its home state – incl. valuation of assets, liabilities,
verification & solvency

- May need local legislation in the state where insurance is sold, in relation to marketing & contract

- Premium tax applied are those of state the insurance is sold
- in the UK, premium tax to general insurance not life assurance

- Need harmonised EU laws, incl.
 Choice, valuation, diversification & location of assets to support Co.s liabilities
- Increased freedom of capital movement

 Principles to calculate assets & liabilities

- Policyholder can withdraw within the ‘cooling-off period’ ~ 14-30 days from the start of the
contract = Statutory cancellation notice (UK)

- Policyholders must be told essential characteristics of product in the Key features document (UK)

5.4.3.2 General Insurance
Across EU member states

1988: 2nd Non-Life Council Directive – rules for cross-frontier non-life insurance
- balance between freedom & customer protection

1992: 3rd Non-Life Council Directive – completed process
- head-office in one state & run elsewhere
- Co. can be authorised in 1+ classes
e.g. general insurance – accident, sickness, land vehicles etc

5.4.3.3 Insurance Intermediaries
- Still want accessible & secure retail market – Directive on Insurance Mediator (Jan 2003)
- Before: insurance sector for wholesale rather than retail market

Insurance mediation = ‘activities of introducing, proposing or carry out work to come
contracts of insurance or assisting in admin & perform of contract’

- Employee of insurance Co. not incl. in definition
- Independent insurance intermediaries must get home authorisation (FSA in UK)
- Tied agents to Co. do not need direct FSA authorisation
- Need:
 knowledge, skill & training (Training & Competence sourcebook) (UK)
 good reputation = no criminal offence, not declared bankrupt
 should have personal indemnity insurance of at least €1mil/case & €1.5mil/yr
- expensive & difficult to get

- Rules to protect clients funds (incl. client’s £££ in separate a/c’s)
- intermediary required amount is 4% premiums received/yr (subject to minimum €15,000)

Regulation details
Intermediary hold 10% voting rights
Name & address /capital of insurance Co.s or vice versa
Information of
intermediary to client

Intermediary independent Internal & external complaints procedure
/tied to insurance Co.

- To give advice on products recommended
- from a high number of contracts available on market
- assess customer’s need (fact find)

5.5 CAT (charges, access, terms) Standards 5.5

- Intended to help less knowledge investors choose suitable deal
- CAT withdraw for ISAs
- CAT-standard mortgage available on demand – may not be suitable

Limits on charges Limits on access & terms
Variable IR no more than 2% Bank of England base Normal lending criteria must apply
rate & adjusted within 1 month after base rate reduced

IR calculated daily Customer choose day of month to pay
Arrangement fees: All advertising & paperwork must be clear &
- variable-rate loans: not chargeable straightforward
- fixed-rate or capped-rate loans: < £150

Maximum early redemption charges on fixed-rate & Purchase of related products cannot be made a
capped rate loans condition of offer
No separate charge can be made for mortgage
indemnity guarantees

All other fees disclosed in cash terms before
customer committed

5.6

5.6 Advertising Standards
- Must meet standards by British Code of Advertising under Advertising Standard Authority
- covers most advertising e.g. TV, radio, posters, internet etc
- set-up 1962, independent self-regulated body

- Take action against individual/organisation if they contravene:

Discuss offending advert with advertiser to change or withdraw

Legal action – via Office of Fair Trading
Negative publicity

Legal
Decent – not cause offence
- Code requires advert is: Honest – not exploit people
Truthful

5.7 Banking Code
- Aim: set good standards of banking practice
- By British Bank Association & Building Society Association (March 1992) 5.7

- Voluntary, but most banks subscribe
- Debts with individual, executives & trustees (not business)

- Both codes compliance reviewed by Banking Code Standards Board Under Business Banking Code

Under £1million
Deposit & Payment
savings a/c systems
Current a/c Cash mini-ISAs, TESSA-only ISAs
& cash-deposit Child Trust Funds
Products covered by code

Foreign exchange Card services & cash machines
Loans & overdrafts,
transactions
but not mortgages

Marketing clear Secure
& reliable Chosen a/c / service
& not misleading information given to customer

Code commitments
Deal quickly &
sympathetically Help customer
if things go wrong Publicise code e.g. send statements
& train staff

Requirements
Information in summary e.g. fair & clear
Clear, fair, box card issued Communication
reasonable,
Reduce/increase/ Rules Bank information
not misleading
opt out credit limits sharing
Personal details Procedures Bank, branch
Terms &
not passed on closure
Charges conditions
Card procedures
Customers
not have to & PINs IR
Advertising Changing a/c’s
be contacted
& marketing Assistance
Financial
Information clarity difficulties Sympathetic,
New customers, Business operation covered positive
ID proof products & services by Banking Code Statement Cheques

How? Complaints Running an a/c
Direct debits &
Timescales Borrowing standing orders
Rules on passing information A/c Personal info
protection Dormant
to credit reference agencies Repay confidentiality a/c’s rules
Guarantors seek ability
Refusal Disclosure required
independent legal advice Customer’s
explanation Customer’s
responsibility permission Institution’s interest
not marketing
Cooperation
- Open to interpretation, code suggests use of ‘common sense’
- Independent review of code began in Nov 2006

5.8 Competition Commission
= independent public body whose aim is to ensue healthy competition between UK Co.s

ஃ individual firms charge reasonable pries & supply good quality products

- 1999: Replaced Monopolies Commission due to Competition Act 1998

- Investigates issues of concern
- Referrals from Office of Fair Trading, regulators of utility Co.s & other public
service organisations

Areas of concern:

Mergers Markets Regulations
where it will result in 1 Co. where danger of restricted where major regulated industries
having >25% market share competition in specific market may not be operating fairly

- Has sweeping powers to stop a situation causing damaging impact on competition
e.g. prevent mergers taking place

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