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COB 3 Annex 4 Additional guidance on particular types of financial promotion

G

This annex forms part of COB 3.8.9 G (5) and COB 3.9.14 G. More than one table may be relevant to any one financial promotion.

33

Section I: Guidance relevant to specific non-real time financial promotions for particular product types

A

AVC Schemes (including FSAVCs)

B

Bond Funds

C

With-profits bonds

D

Pensions - phased retirement

Section II: Guidance relevant to direct offer financial promotions for PEP, ISA or CTF transfers and personal pensions and stakeholder pension schemes 3

E

PEP, ISA or CTF transfer3

F

Personal pensions and stakeholder pension schemes

Section III: Guidance relevant to specific non-real time financial promotions for products with identified characteristics

G

Guaranteed or protected products

H

High income products

I

Stock market products

J

[deleted]

Additional Voluntary Contribution Schemes (including Free Standing Additional Voluntary Contributions)

A financial promotion for an AVC scheme or FSAVC contract should contain a prominent warning that as an alternative:

(1) (for FSAVC promotions) an AVC exists, and that details can be obtained from the scheme administrator;

(2) (for AVC promotions) FSAVC contracts are available.

Bond Funds

A firm constructing a financial promotion for corporate bond funds or similar contracts should take account of the following:

(1) Clear description of the risk

Yields offered by bonds often reflect in part the risk rating of the issuer. Investment in such bonds brings an increased risk of default on repayment and this in turn translates into a risk that the capital value of the fund will be affected. Financial promotions for funds which invest in riskier bonds should clearly explain this point to recipients. The prominence and wording of the explanation should reflect both the risk profile of the portfolio held by the fund, and the prominence given to information about the yield on the fund. The main body of the financial promotion should state that the yield or the capital value of the fund (or both) can fluctuate, as the case may be.

(2) Quoting out of date yields

Financial promotions often feature prominently the yield on the fund. In some cases the actual yield being paid at the time the promotion is communicated is materially different to the yield quoted. Owing to lead times, inaccuracies can occur if the market is moving rapidly, but yields several weeks or months out of date are misleading. The promotion should quote the date at which the rate applied. It is misleading for financial promotions with a long shelf life to prominently feature a rate which may become invalid.

(3) Funds not fully invested

Yield figures should reflect the overall position of the fund allowing for any monies held in cash. Yields quoted on the assumption that the fund is 100% invested in bonds where a proportion is invested in cash would be misleading.

(4) Running and redemption yields

If a yield figure is to be quoted, then both the gross redemption yield and the running yield should be mentioned with equal prominence. This is to ensure that a balanced impression is given of both the short-term and the long-term prospects for the fund. When quoting the gross redemption yield, the main body of the financial promotion should also mention the fact that it is a prediction, and is not guaranteed.

A firm should take into account, and explain, any material differences between the yield figures.

(5) Describing the yield and growth prospects

A firm needs to be careful when describing the future yield or growth prospects of a fund. The prominence and tone given to descriptions of future prospects should reflect a reasonable assessment of the fund taking into account, for example, the redemption yield, whether charges are taken from capital, and the general economic climate.

With-profits bonds

1.

Particular areas of concern about financial promotion of with profit bonds are:

(a) failure to make it clear that a whole life with profits bond is unsuitable as a short term investment;

(b) unclear statements as to what factors will determine the cash-in value of the bond;

(c) reservation of the right to adjust the value of the contract by means such as Market Value Adjustment Factors without adequately explaining the significance or likelihood of such a procedure;

(d) use of a rate of bonus in a way that implies such a rate will apply;

(e) quotation of values based on existing bonus rates to lead recipients to anticipate receiving such amounts;

(f) reference to building society accounts in comparison with the bond without adequately explaining the differences between the two types of investment.

2.

Quoting a high initial bonus rate may suggest that it is achievable for all investors, whereas for example, the rate may only be available to investors who make a sizeable investment or who make their investment considerably earlier than the closing date. In addition, initial bonus rates are frequently subject to limiting factors, such as:

(a) establishment charges;

(b) monthly policy charges;

(c) fund management or investment charges;

(d) early surrender penalties or discontinuance charges;

(e) market adjustment factors.

Therefore where applicable firms should not include terms such as 'guaranteed', 'return' and fixed for the first year' without making it clear that the bonus rate may not be achievable.

Pensions - phased retirement

1.

Some promotions for phased retirement pensions tend to emphasise the various advantages but do not give adequate risk warnings, some of the important assumptions, or detail potential disadvantages. The following failures are typical:

(a) not including risk warnings in respect of performance and value of underlying units.

(b) not indicating that future annuity rates are not guaranteed and may be higher or lower.

(c) not disclosing any information about additional charges linked to the plan.

(d) not making any reference to protected rights being deferred to age 65 or 60 (in illustrations of pensions commencing earlier).

(e) not indicating how a surviving spouse is provided for.

2.

Four particular areas that need to be made clear are:

(a) Mortality

Compared with a conventional annuity, phased retirement normally provides higher residual sums on death. For survivors to age 75, this can result in a strain, as annuities will not have been purchased at an earlier age. This risk should be made clear.

If a spouse's or civil partner's 4pension is to be provided, it needs to be made clear whether each annuity is bought on a joint life basis and whether the annuity is bought on death or at age 75.

If protected rights pensions at age 65 or 60 are to be provided, it needs to be made clear how these are to be provided.

(b) Investment

The future investment returns on the residual funds and the future immediate annuity rates are unknown. The risk of this to the investor needs to be made clear.

Care needs to be taken to ensure that the impression is not given that postponing the purchase of an annuity will automatically be to the investor's advantage.

(c) Tax

Most of the financial advantage in phased retirement derives from utilising tax free cash sums to provide part of the investors pension payment. Therefore the investor does not have the benefit of the tax free cash sum at retirement, which can be a disadvantage. Any comparison with a conventional annuity should allow for the use of a purchased life annuity purchased with the tax free cash, or include a statement that the effect of the option to use the tax free cash to secure a purchased life annuity has been ignored.

Because the pension will usually constitute most of a investor's income, it will generally be correct to assume basic rate tax. Where the level of income makes it appropriate, higher rate tax may be allowed for; this can be done assuming an average tax rate or taking account of specific tax bands. If tax thresholds are assumed to increase, the rate must be consistent with the investment return assumed and the rate of increase in the target pension.

(d) Expenses

The costs in operating phased retirement are usually higher than for conventional annuities. These costs need to be disclosed, especially as they are relevant to any comparison with a conventional annuity. Particular reference should be made to the level of initial charge and annual management charge on unit-linked funds.

3

PEP, ISA or CTF transfers3

A direct offer financial promotion for a PEP, ISA or CTF transfer should include details of the likely advantages and disadvantages of transferring an existing PEP, ISA or CTF holding, including:3

(1) exit charges and any other costs associated with the transfer;

(2) initial set up charges;

(3) transaction details (ie are holdings liquidated or transferred intact), as permitted by the terms and conditions;

(4) the possibility (and likely effects) of shortfall, following cancellation;

(5) potential for loss of income or growth, following a rise in the markets, whilst the PEP, ISA or CTF transfer remains pending.3

Personal pensions and stakeholder pension schemes

Firms promoting personal pension schemes through direct offer financial promotions are reminded of the provisions of COB 5.3.

Guaranteed or protected products

1.

Equal prominence to guaranteed and not guaranteed benefits

Firms should give equal prominence to the description of benefits which are guaranteed and of benefits which are not.

2.

Guaranteed income but not capital

(a) A clear statement should be made where relevant benefits are not guaranteed.

(b) If any guarantee is given, the guarantor should be named.

(c) An equivalent annualised rate of return should be quoted if the cash rate is quoted.

3.

Guaranteed or protected amount payable at the end of the term

The words 'guarantee', 'protected element' or similar may be used to describe the minimum amount payable at the end of the term. This is usually provided at some cost to the investor and financial promotions therefore need to make clear what that cost is and how it is imposed.

4.

Counterparty risk

Firms should ensure that financial promotions for products with a protected element to them, which is not guaranteed, include an explanation of the associated risk of counterparty failure. Firms should avoid giving a misleading impression of the capital security.

High income products

1.

Income Term

If the word 'income' is used, it will be difficult for the promotion to avoid being misleading unless it:

(a) is used to indicate payments comprised solely of interest or dividend earnings; or

(b) is clearly defined at an early point in the promotion as having a different meaning, and in particular specifies the risk to capital necessary to achieve the payment.

2.

Problem of disclosure of risks

(a) If the rate of income available is at some capital risk or at the expense of growth, or the income or a portion of it comprises a return of capital, these facts should be clearly explained.

(b) If direct or indirect comparison is made with a deposit, there should be a prominent statement that the investment does not include the security of capital which is afforded under a deposit.

3.

High income bonds, high income unit trusts and similar types of collective investment schemes

(a) Some unit trusts achieve a high income by the use of derivatives such as put and call options. Firms should provide a statement to the effect that the high income is achieved at the expense of most of the potential capital gain.

(b) If it is claimed that the downside potential is less than that of a conventional unit trust, it should be made clear with equal prominence that if the fund goes down its potential recovery will be less than that of a conventional unit trust.

(c) Where an income figure is shown a clear statement should be made that the income is not guaranteed.

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Stock market products

Stock market products are those investments which offer returns linked to the price of equities or an index such as the FTSE 100.

(1) Potential for Growth

(a) Expressions like 'stock market growth' or 'the growth of the FTSE 100 Index' are frequently used and are potentially misleading if the product will not be investing in all the stocks which make up the index.

(b) Promotion of a product which is linked to growth in the FTSE 100 index should make clear that it does not include an allowance for any return or reinvestment of dividend income.

(c) Promotions should therefore make it clear that references to 'stock market growth' exclude any form of income payment.

(2) Amount invested

Some promotions quote returns in excess of the percentage increase in the FTSE 100 index, without mentioning that 100% of capital is not invested at outset.

(3) Gross returns and tax on underlying fund

Promotions showing guaranteed returns against the FTSE 100 index expressed in 'gross' terms are potentially misleading where the underlying funds of the firm concerned are taxable and the returns quoted are therefore unavailable to the investor because he will receive the benefits after tax has been deducted and which he cannot reclaim.

(4) Taxation of investor

The tax treatment in the hands of the investor should be made clear, in particular, whether the return will be treated as income or as capital gains where the investor may be entitled to a tax free exemption limit with the added benefit of indexation.

(5) Early Encashment

(a) The terms for early encashment need to be fully explained.

(b) Despite the minimum amount at the end of the specified term, an appropriate risk warning should be included where the value of the investment can fall if an investor wishes to encash the contract before the end of the term.

(6) Averaging

Contracts are normally based on the assumption that the index being used will rise. The use of the average level of the index will reduce the investment potential of the contract. Where the averaging periods cover more than the last six months of the contract term, it should not be implied that averaging is to protect against falls at the end of the term. It should be made clear that investors benefit only from some of the performance of the index and that one effect of averaging is likely to be to constrain the final level of the index used to calculate benefits.

(7) Maximum benefits

These should not be promoted as a particular feature if the economic circumstances required to meet those benefits require investment conditions more favourable than those which would need to prevail to achieve the higher of the growth assumptions specified by the FSA.