FSA requests responses on Ucis by June 27, leaving open the inclusion of delta 1 certificates

Banks must respond to the UK Financial Services Authority by Wednesday with feedback on new rules that will clamp down on the sale of unregulated collective investment schemes. Whether delta 1 products will be caught by the new rules is unclear

Linda Woodall, head of the investment intermediaries department at the UK Financial Services Authority (FSA), has this week sent two letters to banks this week requesting their feedback on unregulated collective investment schemes (Ucis) by June 27.

"The unlawful promotion and mis-selling of Ucis is a key risk we have identified in the retail investment market," states the FSA. "Our concerns include how firms' behaviour further up the Ucis product chain may be contributing to the risk of Ucis being inappropriately marketed to retail clients."

The letters come in the wake of the FSA's Retail Conduct Risk Outlook of March 2012, and, along with that investigation, have revived the debate about what exactly constitutes a collective investment scheme (CIS). It appears clear that structured products do not qualify as they are exempted by dint of being debt instruments - an opt-out that, technically, also covers delta 1 certificates, according to sources.

"Delta 1 is not a debt obligation," says one London-based structured products banker. "It has no principal repayment obligation, and you need repayment of principal to be a debt instrument."

"If you issue a certificate and sell it to retail investors and it references a synthetic portfolio, it starts to look like a fund," says the banker. This is the point at which the FSA is looking to intervene, on the assumption that there are creators of investments, as well as distributors, that are happy for these investments to resemble funds. The rules at present can be interpreted such that a certificate that references a synthetic portfolio of equities could be deemed a CIS. If these investments are a CIS, they are unregulated and their sale to retail is a criminal offence.

"The letters are potentially relevant to some sections of the structured products market, where those structured products stray into territory that could be perceived to be CISs," says the banker.

The FSA has identified "significant failings by certain distributor firms in relation to their Ucis activities and are concerned there may be similar issues with other firms". Woodall states that dealing with the "inappropriate marketing of Ucis to retail clients is a priority".

The concerns highlighted in the letters centre around promotion, suitability, and systems and controls. "The majority of the firms we saw in our supervisory work could not demonstrate that they took reasonable (or, in some cases, any) steps to ensure their retail clients were eligible to receive Ucis promotions," states Woodall in one letter.

"The majority of firms we saw failed to demonstrate that they took reasonable steps to ensure that Ucis recommendations were suitable for their clients... The majority of firms that we saw did not have adequate systems and controls to support their Ucis activities."

The regulator has requested information on the addressee's Ucis activities since January 1, 2008.

The draft of new regulations preventing Ucis being marketed to retail investors will have most impact on the UK private wealth management sector, according to market participants.

"Rather than an evolution of regulation, it is more likely there will be a tightening of the existing framework, which may well be much more sector-related than tied to any specific product," said Emily Benson, director at investment consultancy boutique Kinetic Partners in London, after the draft was released in March.