I was in a meeting recently with four attorneys. The focus was to educate me on the regulations that apply to a UK based REIT. I am pretty well versed in what the HMRC wants. I had asked one of the two real estate attorneys to find me some Financial Conduct Authority (FCA) experts.
During the discussion the lawyer, who is a compliance expert mentioned that the FCA had published a new regulatory framework which will change the rules for unregulated collective investment schemes by the start of 2014. She was pointing out how the REIT is explicitly exempt from the new regulations. As you would, I asked how the rules would apply to other transactions. I then took the group through two specific examples. In both cases the regulations will have a dramatic impact. In my words – the era of retail property Joint Ventures (JVs) will end in the UK.
The two example are as follows.
First, assume that two people decide to come together for a joint venture. They decide that one person will put up the cash and the other person will source the deal, manage any refurbishment and otherwise run things. To provide a bit of liability protection they create a limited company where the two individuals are the shareholders. Under the new legislation, this will be seen as a banned activity given the use of a company.
I then suggested a different structure. The same two people and the same assumptions about the cash investor and the hands-on investor. Rather than set up a company to buy the property the two individuals go on title. In this case, the problem will be the investor making the decisions will need to be FCA registered as an investment advisor. The person in charge of the deal, the one without the cash, looks as if they are giving investment advice and that they have control over how the money is spent. It might be argued that the investment advisor problem has existed for some time so it is not a direct result of the new regulations.
The FCA document you want to read is PS 13/3. It is not that hard to find on the FCA website. While searching for the term on Google, the following info was found on the TheLawyer.com website (full link below).
FCA bans the promotion of unregulated collective investment schemes and close substitutes to ‘ordinary’ retail investors
Effective from 1 January 2014, the Financial Conduct Authority (FCA) will ban the promotion of unregulated collective investment schemes (UCISs) and equivalent pooled vehicles to retail investors. The new rules are published in Policy Statement PS13/3.
The FCA is emphatic in its view that unregulated pooled products should not be promoted to ordinary retail consumers, believing such investments are ‘niche, risky products almost certainly inappropriate for ordinary retail investors’. The new rules apply to the new concept of a ‘non-mainstream pooled investment’ (NMPI). NMPIs include UCISs, qualified investor schemes, traded life policy investments and special-purpose vehicles (SPVs) that do not fall into one of the newly created exemptions.
The regulator emphasises that, regardless of compliance with the black letter law of an exemption from the ban, firms have an overriding obligation to act in the customer’s best interests. The critical question for the firm before relying on an exemption is therefore whether the customer is capable of taking a proper decision regarding the NMPI…
The real sting in is in the tail. Some investors can be exempt and the PS 13/3 document has a chart to help highlight when exemptions will apply. The problem is not that individuals or offers could be exemplt. There is a general burden placed on the promoter to make sure the ivnestor is suitable and actually has the ability to understand fully what they are getting into. As many of the UK property investors know, there are some sharks out there who promote Get Rich Quick (GRQ) schemes. There is a funny line between thinking positive and appling one’s self to change the future and hucksters who suck money out of people for deals that will rarely ever perform.
Under the legislation, the promoter must keep documentation that shows how the investor’s suitability was tested before the ivnestor was allowed to invest. My take on this is if the investor later wants to dispute things, this will be a get out of jail free card for the investor. Any deal that has not gone to plan should be challenged on suitability and let the promoter demonstrate from the historical records that the investor was judged to be aware and able to correctly assess the risks.
I think this topic will stimulate some interesting debate on the various UK based online property forums. I suspect anyone promoting and setting up armchair investments or other ‘passive’ structures will now need to think seriously about the suitability burden and how they will maintain records that the FCA can inspect later. Any unhappy armchair investors will be able to ring the FCA and ask to have the promoter investigated.
If a JV partner has self certified as a High Net Worth Individual or Sophisticated Investor, does that still make it compliant?
And what difference will being registered with a Comsumer Credit licence make?
Thajks for sharing your knowledge, Ed Fowkes
The new regulations address this. If the prospective partner self-certifies, the person suggesting the investment has to take sets to verify the accuracy of the self-certification. In addition, a certified individual who is a member of either group still needs to be assessed as to the match between the investment and their needs. A low risk person who has no real knowledge of how the investment works would not be a good fit if the degree of risk was material.
At some level, the above is broadly similar to what an IFA must do before recommending an investment to a potential client. I am not saying you need to be an IFA yourself. Just that the duty of care sounds similar. The records maintained by the person operating the investment needs to document what was done to meet the requirements.
As to the consumer credit license? I do not know much about a consumer credit license. As that license deals with debt and the FCA’s PS 13/3 included equity investments, I would think there is a difference. Maybe the difference is more about type rather than intent.
Overall I suggest people read the PS 13/3 document closely and then seek professional advice if needed. The purpose of this blog entry and subsequent comments is to raise awareness rather than to give definitive regulatory advice.