CeMAP

Module 1

UNIT 1

INTRODUCTION TO THE FINANCIAL SERVICES,

ENVIRONMENT & PRODUCTS

UNIT 1

SECTION 1: THE UK FINANCIAL SERVICES INDUSTRY

1.1 The Functions of the Financial Services Industry Bartering

2) Unit of account (a/c) = Measure product value

Sufficient in quantity

Acceptable to all parties

Divides to small units

Portable Store of value = can be saved and used later

5 properties Of £££

= exchange goods and services- Problem: Size of some transactions unmatched

MONEY (£££) :

Why use money?

1) Medium of exchange = Separate commodity to exchange for products

Means of achieving otherwise difficult objective e.g. mortgage

Protection from risk e.g. insurance Money from lenders

to borrowers

Convenience e.g. current a/c

Aim of Financial Services Industry

1.1.1 Intermediation

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

(1) Low interest rate (IR) given

(2) High IR charged

(2)-(1)Intermediaries profit margin

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

1.1.1

= cash rich- lend surplus fund to earn money

Surplus sector

e.g. banks & building societies (socs)

Financial Intermediary

Money lent to

Money lent to

Why use the financial intermediary?

Problem without … Solved with …

Geographical location

Aggregation

Maturity transformation

Risk transformation

Locating lenders & borrowers Easy to find

Potential lender might not have enough

Retail deposits are low, whilst loans are high - aggregate small deposits

Borrower may need fund longer than lender willing

Most deposits are short term, whilst loans for long term (e.g. mortgages: 20-25yrs) - range of deposit a/c – not all depositor funds w/d at same time

Individual depositors reluctant to lend all savings to individual/Co.

Allow spreading risk over variety of 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”

1.1.3 ‘Product sales’ intermediaries

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

E.g. Mortgage advisers, financial advisers, insurance brokers1.1.2, 1.1.3

FUND

Large payment out from insurance fund

Depositors

Small deposits made by each individual depositor

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

1.2 Financial Institutions

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)

1.2

<1980s: more defined boundaries between different financial organisationsE.g. retail banks, wholesales banks, life assurance companies etc

Foreign exchange market

Banker to government (gvt)

Lender of last resort

Issuer of bank notes

Advisor to gvt

Banker to banks

Manage UK gold & foreign currency reserves for Treasury

Makes funds available when banking system short of liquidity – maintain confidence

Financial cover ஃ when gvt in: - Deficit … BOE make automatic loan to gvt - Surplus …BOE may lend out as part of its general debt management policy

All major banks have a/c at BOE for: - deposit/obtain cash - settling clearing - other transactions … high influence on IR

Previously in charge of

Regulating banking sectorNOW: FSA (1/6/98)

Managing new issues of gilt-edged securities (gilts)

NOW: Debt Mgt Office (Treasury) … BOE avoids conflicts of settling IR

Functions of BOE

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

ஃ owned by shareholders:

Not Co. ஃ no shareholders

Since Building Society Act 1986 building soc could demutualise (convert into banks ஃ Ltd Co.) - need approval by members

Some demutualised (i.e. became proprietary organisations)

1.2.2

share Co. profit = dividends

contribute to decisions on how Co. run

1.2.2

Limited (Ltd.) Co.

Owned by members

E.g.Proportion of mutualisation

Member type

Small With-profit policyholders

Fully

Fully Depositors & borrowers

Life assurance Co.

Friendly society

Building society

e.g. Norwich Union, Standard Life

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

Proprietary Organisations

Mutual Organisations

1.2.3

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

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

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

Raise money via wholesale money markets

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

e.g.

Can raise up to 50% of their liabilities via wholesale banking

Top up deposits from branch networks as required

- Includes ~400 banks - recycle surplus cash held in banks(between banks, specialist money brokers)

London interbank offered rate (LIBOR) = IR charged

1.2.3

Retail Banking

Wholesale Banking

financial institutes

financial housesmain retail banksbuilding soc

e.g. if bank has opportunity to make substantial profitable loan but doesn’t have adequate deposit

ஃ can raise money quickly on interbank markets

- fixed daily - reference rate for corporate lending ‘LIBOR + specific margin’

1.2.4 Money Transmission

method

Automatic teller machine (ATM)

Telephone

InternetBranch includes

Credit & electronictransfers

Standing orders

Direct debitCheque clearing

Cash

1.2.4.1 Current a/c

- Basis of money transmission for most people- Money paid in & out by cash, cheque, electronically, overdraft

Features: cash card, direct debit but no cheque book or overdraft1.2.4

& Clearing Process

‘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:

state benefitpension

Changes to these a/cs overtime:

- 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

Association for payment & clearing services (APACS)

Cheque & credit card Co.

3-day process

Clear cheques & paper credits

Voca Ltd

Operates bulk electronic clearing (e.g. direct debits)

Name changed from Bankers’ Automated Clearing Services Ltd (BACS)

Clearing House Automated Payment Sys (CHAPS)

Electronic, same day interbank transfers for high-value wholesale payment

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

Association of major banks & building socs whichco-ordinates UK clearing services

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

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

1) Regulations

2) Directives

1.3

BUT influenced by EU policies & laws including financial services

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

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

The laws can be …

1.3.2 Regulations in UK

Level Effect

1.3.2

1st EU law Impact UK financials industry

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

3rd Regulatory bodies e.g. FSA

Monitor regulation & issue rules on how rules are to be met

4th Financial institutes & internal departments

5th Arbitration schemese.g. Financial Ombudsman Service

Customer complaints referred to

Ensure financial institutes themselves are operating legally & competently

1.3.3 Taxation

Why tax?

- If gvt general tax … less £££ for investment & loan repayment

… less attractive for investors to invest

1.3.3

Raise revenue

Control money supply

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

2) investors taxed

1.3.3.1

Domicile

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

= domicile of individuals father (or mother if unmarried) on date of their birth

Inheritance tax

Domicile UK? Inheritance tax

Residence – on worldwide (un)earned & (un)brought to UK

– on worldwide gains

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

Domicile of origin

Domicile of choice = change to different domicile

- Achieved by putting permanent roots in a different country & severing previous

Effects

Effects

Yes (birth/live 17 of previous 20 yrs in UK)

Any assets worldwide

No Only on UK assets

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

Capital gains tax (CGT)

Income tax

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:

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

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)

Income taxed NOT income taxedEmployment salary inc bonus, commission, taxable benefits

Pensions & retirement annuities

Profits from trade/profession

Tips

Interest on banks & building soc deposits

Dividends from Co.s

Income from trusts

Income from gvt & local authority stocks

Rents & other land & property income

Value of benefits (if total income + benefits >

£8500) – (Co. cars – tax based on CO2

emission rating)

Interest on National Savings Certificate

Capital part of purchase life annuity

ISAs & PEPs

Gift Aid payments

Proceeds qualifying life assurance policy

Gambling profits

Lottery prizes

Wedding presents & presents from employer

Retirement & redundancy money

Education grants to full time students

War widow pension

Some social security benefits

Housing grants

Interest on tax rebate

Redundancy pay & other losses (unless >£30000

ஃ excess tax)

1.3.3.2.1 Allowances

Personal allowance = income amount received each yr before tax

Blind Person’s allowance

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

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)

- 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

- transferable to blind/non-blind spouse

(’09/10): £1,890

Gross income – Pension contribution – Allowable expense Taxable income

Scheme set by employer/ to personal/stakeholder pension

Cost carried out by employment, allowances

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

Earned income Investment income

Gross income: Personal allowance:Taxable income:£2,440 at 10%:£11,085 (13525-2440) at 20%:Total taxable:

£20,000£6,475

£13,525 (20000-6475)£244 (2440*0.1)

£2,217 (11085*0.2) £2461 (244+2217)

Gross income: Personal allowance:Taxable income:£2,440 at 10%£34,960 (37400-2440) at 20%:£6,125 (43525-37400) at 40%:Total taxable:

£50,000£6,475£43,525 (50000-6475)

£6,992 (34960*0.2)£2,450

£9,686 (244+6992+2450)

Lower 2,440 10

Basic 37,400 2,441 - 37,400 20

Higher > 37,400 > 37,400 40

Not apply if individual non-savings taxable income is >£2,440.

E.g. 1 Married man aged 30 earns £20,000pa (’09/’10) building society income, & no other income. His has a personal allowance of £6,475

E.g. 2 A single woman aged 40 earns £50,000pa (’09/’10). She is employed and has personal allowance of £6475

£244 (2440*0.1)

- Most investment income taxed at source

Net rate0.8

Gross rate =

- Share dividends – receive net of nominal 10% tax

Net rate0.9

Gross rate =

(100%-20%)

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

Satisfy lower & basic rate taxpayers Higher taxpayer pays further 22.5% (32.5% total) Non-taxpayers can NOT reclaim 10%

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)

Employers supplied with tax code number for each employee

P40 given to employee by employer in Apr each yr

P45 to employee & HMRC by employer when leaving job

Previous yr:Tax deduction, NI contribution, tax code

Amount of ‘free’ pay incl allowances, benefits etc & over/under payments from previous yr

Given to new employer – for information about tax deductions

1.3.3.2.3 Self-Employed (inc business partners)

based on net profits

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

/Accountant/HMRC

How calc?

Total Revenue - total expenses - Capital allowance => Income tax paid to HMRC

1.3.3.2.4 Classification of Type of Income

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

Income Tax (Earnings & Pensions) Act 2003

Income Tax (Trading &Other Income) Act 2005

Covers income previous in Schedule E: - Employment income - Pensions - Taxable social security benefits

Covers incomes in other schedules

Part 2 Part 3 Part 4

- Trading income (from self employment)

- Property income - Savings & investment income incl interest- Dividends

Now:

– abolished

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

E.g. of investments income taxed at source

fixed-interest loans to Co.s

Interest from bank & building soc deposit

element of certain life annuities

Interest from certain finance Co. depositsDividends from UK Co.s

loan stocks

debentures

(not income tax liable but tax credit) Distributions from unit trusts

Income from trusts & settlements

1.3.3.2.7 Taxation of Proceeds from Life Assurance Policy

- 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

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

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

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

1.3.3.2.8 Taxation of Proceeds from Unit Trust

Collective investment under trust deed

- 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

- Income generated via share dividend

1.3.3.3 National Insurance (NI)

= tax on earned income

Class Rate

1

3

2

4

- 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)

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

- Paid monthly direct debit

- 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)

- 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

CGT not paid in some situations :

E.g.

ISAPEP (personal equity plans)

GiltsProperty disposed due to death (get inheritance tax)

National Savings certificate & PAYE scheme

Premium bond & lottery winnings

Foreign currency for personal expenditure

National, historic, scientific gift that is nations interest

Personal belongings, antiques, jewellery etc – if <£6000

Ordinary private motor vehicles

Main private residence

Gains on qualifying life assurance policies disposed of by owner

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

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

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

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

- 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)

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

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:

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

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

= 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.

- 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

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

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

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?

- 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

= bed & breakfasting

1.3.3.4.2 Roll-Over Relief (ROR)

- 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

= 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

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

-Tapering relief (scaling down) over final 4/7yrs before death80% (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)

Exemptions

Small gifts up to £250 per recipient in each tax yr

Donation to charity, political party, to nation

Transfer bet spouses during life & death

Wedding gifts up to £1000 (increased to £5000 for gifts from parents & £2500 from grandparents

Gifts on regulated basis from income which not affect donors standard living

Up to £3000pa for gifts not covered by other exemptions. Any remainder can be carried only forward 1yr

2) Potentially exempt transfers (PETs) = gifts made during persons lifetime

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

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

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 ஃpossession of certificate only proof of ownership ஃ title physically passes

subjects to VAT but current rate is 0%

- Business regulated for VAT if annual turnover > £68,000 (’09/’10)

- 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

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

Also paid by:clubs, societies, associations, trade & housing associations & by co-operatives

NOT: conventional business partnership, ltd liability partnership, self-employed individual

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

Interest on deposits

1/4/08 – 31/3/09Trading profitsCapital gainsIncome from lettings

- 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

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

- 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

1.3.4 Economic & Monetary Policy

= long-term objectives economic policies gvt trying to achieve- economic aggregates = total picture of economy as whole

Price stabilityUnemploymentBalance of payment equilibrium

Satisfactory economic growth

Foreign currency: expenditure = receipt £££ into country = £££ out

- Gvt aim: currency price stable

Gvt tries to expand economy so labour, land & capital

Need low, controlledinflation rate

Rising level of prices:Rate of money supply>growth of good/services

Economic output is growing in real terms over time & increasing standard of living

- Affects US & EU economy 1.3.4

= concern individual firms/consumerMicroeconomic objective

Macroeconomic objective

(0 inflation is undesirable unstimulated investment)

- Linked to exchange rate

ஃ not so … - high as to reduce export - low as to increase inflation

UK economy grew fast in 2000 – now onset of recession- 2006: annual growth of gross domestic product (GDP) at 3%

Measure of value of goods & services produced within country over specific period of time

- The four macroeconomic objectives work in 2 pairs:

E.g if unemployment growth

inflation improve balance of payment

- Impossible to achieve all 4

- low inflation rate for long periods of sustained economic growth

measured by consumer price index (CPI)

replaced retail price index (RPI)

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

GrowthEmployment

Inflation

GrowthUnemployment

Inflation

- Gvt aim: - aggregate demand in line with productive economic capacity

average annual rate of 2% (max divergence 1% either side)

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

E.g unemployment inflation

- Monetary Policy Committee decides IR BOE lend to banks/other institutes

How do the gvt keep inflation regulated?

1) 1.3.4.1 Monetary Policy – acts on money supply & IRs

1979: monetary policy more important in controlling economy

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

1) Money supply Inflation

Treasury can give BOE instructions in ‘extreme economic circumstances’

To control increasing £££ supply must control amount credit creation

credit creation by banks

determines other IRs charged to borrowers & paid to lendersAnnounce decision immediately

Minutes published 2 weeks later

History:

Method: (by monetary economists)

By manipulating IR* – influence demand for credit

* policy in UK2) Bank restrict amount lend

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

= Repo rate (Base rate)

- Change IR? direction? how much?

- Disadv:

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

1.3.4.1.1 Impact of IR changes

Sudden IR borrower unable to make repayment repossession

Pass rate to borrowers & others

- 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:

- In UK: fixed rate mortgages – short initial period variable rate – remainder of term

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

- Other EU countries: longer fixed term

– manipulate finances of public sector … influence

money supply & economy activity Gvt, local authority, public corporations

- Public sector provide national/regional services

Funds from private sector

- Changes in public & private sector affect the economy

Budget … Amount of tax … £££ to public sector spending

Result on economy

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

Gvt borrow to finance the deficit

- Outcomes:

Balanced = - Neutral

Surplus > - Employment- Money supply

Deficit < - Employment- Money supply (inflation)

2) 1.3.4.2 Fiscal Policy (MP)

e.g. education, healthcare, transport

Funds from individuals & firms via (in)direct tax

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

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

- 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

- Monetary policy – acts on economy as whole

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

1.3.5 Welfare & Benefits

1.3.5.1 Support for People on Low Incomes

- 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

1.3.5.1.1 Working Tax Credit

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

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

(= specifications)

= Top up of earnings on low incomes for disability/ cost of qualifying childcare

- Tax free benefit - Not dependent on claimant having paid NI contributions

LOOK AT APPENDIX (I)

1.3.5.1.2.1 Income Support Payments (ISP)

- 3 parts of payments:

1.3.5.1.3 Jobseeker’s Allowance (JSA)

Contribution based Income based- payable for 6 months- fixed rate- irrespective of savings/partners earnings- paid gross but taxable

seeking work for at least 40hrs/wk working <16hrs/wk 18 yrs – pensionable work not in full time education signed JSA agreement – steps to look for work

- credited NI contributions (NICs) every week receiving JSA

1) Personal allowance – cover day-2-day expenses of claimant, partner, children2) Premiums – additional payments to people with extra needs e.g. disabilities

3) Other additions – inc mortgage interest payments & other housing costs

dependent on having paid Class 1 NI contribution

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

1.3.5.2 Support for Bringing Up Children

1) During pregnancy2) During children growing up

1.3.5.2.1 Statutory Maternity Pay (SMP)

- from employer when woman becomes pregnancy while employed

- 2 rates:1) 1st 6 weeks: amount paid is 90% average weekly earnings2) Remaining: flat rate – subject to 90% of average weekly earnings

- Taxable

- NICs due on amount paid

2 types:

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 payablemust 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

1.3.5.2.2 Maternity Allowance

- Earliest payment begins: 11 weeks before baby due, latest: baby born

1.3.5.2.3 Child Benefit

- higher rate to eldest child, lowest to youngest

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

- Given if individual not able to claim SMP

- 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

- 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

e.g. self-employed, recently changed jobs

1.3.5.2.4 Child Tax Credit

- 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)

- to people with average earnings > NICs payable

- taxed & NI deducted (like normal earnings)

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

- 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

1.3.5.3.2 Incapacity Benefits

- depend on payment of Class 1/2 NICs – else may get income support

1.3.5.3.3 Attendance Allowance

- not means-tested & not dependent on paid NICs

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

- 3 levels:

1) Short-term lower rate - payable to 28 wks

- not subject to income tax

- terminally ill: highest rate from 28+ wk

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

3) Long-term rate- highest rate

- payable if sick > 52 wks- taxable

- for those 65+ years & need personal care as ill

- 2 levels:1) lower rate – need care by day & night2) higher rate – need help both day & night

1.3.5.3.4 Disability Living Allowance (DLA)

- Tax free

1.3.5.3.5 Carer’s Allowance

- not need to be relative to qualify- not depend on NICs- flat rate (+ for partners/children)- taxable & declared on tax returns

Patient: - receive DLA/AA/constant attendance allowance- not in hospital

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 etc2) Mobility component – if difficulty in walking/ not walk

- for people who need help with personal care &/or getting around

- for people giving up time/job to look after someone

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)

1.3.5.4 Support for People in Hospital/Residential/Nursing Care

- 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

- NI Act 1959 - intro earnings related pension:1961: Graduated pension scheme1978: State earnings related pension scheme (SERPs)2002: 2nd state pension (S2P)

- 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

- 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

- 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))

- pay-as-you-go basis, NICs from working population immediately paid out

1.3.5.5.1 Basic State Pension (BSP)

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

1.3.5.5.3 Pension Credit

- increasing each yr taking account of inflation

- 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)

- no. pensions & employment - chance of BSP above inflation- gvt proposes BSP in line with average earnings index not cost of living index – in 2012

SERPS

S2P

- ensure retired have total income of specific minimum amount- single person: £130/wk, couple: £198.45/wk

SECTION 2: FINANCIAL ASSETS

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

2.1 Deposits

2.1

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

- Why?

Adv

Capital secure – amount invested

intact

Readily accessible banks &

building societies

Inflation reduces value of capital (increased inflation causes value to reduce in real term)

Risk of loss of capital if institute becomes insolvent

(Financial Services Compensation Scheme)

Disadv

LOOK AT APPENDIX (II)

2.1.1 Bank a/c

1) 2.1.1.1 Deposit a/c

- Return via interest - variable (banks base lending rate)- calculate daily & added to a/c on periodic basis ( ¼ly, ½-yearly, yearly)

- 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

- no fixed term but need notice period to withdraw- 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

2.1.1

- Depositors (individual/corporation) invest £1- no max

- Some have higher IR, by may need minimum investment

– 3 types of interest bearing a/c:

- Higher IR than deposit a/c

- IR reflects current money market IR & vary according to amount invested

- 2 types:

- term deposit a/c = sum £££ invested for fixed period (e.g over night, 5yrs)- interest fixed over period & can not be withdrawn before

1) Fixed a/c

2) Notice a/c

3) 2.1.1.3 Interest Bearing Current a/c

- 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

- 10% taxpayers can reclaim additional 10%

- 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)

- 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

2.1.2 Building Society a/c

- Different from banks in legal structure:

- Access in 7, 30, 60, 90 days- If require immediate access: get penalty charge

(interest earned over notice period)

- Taxation (2.1.1.4)

2.1.2

- For investors’ with surplus funds for long time

- Competitive IR

- 2 types of a/cs:

Building societies = mutual organisations owned by members

Banks = limited co.s owned by shareholders

Ordinary share a/c

Notice a/c

- Instant access without penalty- Lower IR than notice a/cs

- Tiered IRs (higher investment higher rate)

- Short-term & immediate access

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

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

2.1.3

2) less protection by investors protection schemes – check via local regulatory

authorities

- Disadv: Higher risk than onshore investment, as:

1) adverse currency movements when converted back to sterling

- 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

2.1.4 Cash ISAs

2.1.4 & 2.1.5

= 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

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

- From post-office & NS&I website

- Low risk – all products guarantee return of any capital invested

2.3.1.1 Buying & Selling Shares

- Requirements incl:- Financial & other information - Co. must’ve traded for > 3yrs- > 25% issued shares in public hands - less rules & rigidity than main market

Main market Alternative Investment Market (AIM)

2 markets:

- Trade: gvt stock, share capital & loan capital, oversees, options

- Stock Exchange (SE) = London’s stocks & share market

- Allows Co.s to be quoted on SE

Listing Rules by FSA (acts asUK Listing Authorities (UKLA)

- Separate market on SE (since ‘95)- for new Co.s with potential to grow- Enable Co. to raise capital by issuing share- high public audience & high profile by joining

Types IR Age (yrs) Minimum Amount (£)

Other

Easy Access Savings a/c

Tiered, *(gross paid & income taxable) 11+ 100

Investment a/c

Variable, Tiered – 7 levels, * 7+ or parents if child <7

500 – 50,000

Income Bonds

Variable, Tiered, *, Interest paid until withdrawal

Monthly regular income, No term & capital withdrawn at any time

Guaranteed income Bonds

Guaranteed 1,2 or 5 yrs at a time, Fixed IR depending on term

16+ Interest paid monthly, net of basic rate income tax

Guaranteed growth bonds

Calculated yearly but added to investment at the end of the term

16+ Lump-sum investment, 1,3 or 5 year term

Guaranteed equity bonds

18+ Lump sum, fixed term investment with growth potential linked to FTSE100 while security on original investment

Savings Certificate

Gross interest- no liability to income or CGT ஃ attractive to higher rate tax payers

100 -15,000 Fixed interest certificate (FIC)= fixed IR on chosen term (2/5 yrs) Index linked certificate = value with inflation (terms 3 & 5 yrs)

Premium Bonds 100- 30,000 /person

Regular (monthly) draw for tax free prizes for investors, Prizes maybe worth lots of £££, Encash any time with 8 days notice

Children’s Bonus Bonds

Fixed for 1st 5yrs + bonus on 5th yr, final bonus on 21st birthday

16+ for <16 Lump sum for 5> yrs, Encash <21 yrs, No interest paid after 21yrs

2.2 Fixed-Interest Securities2.2.1 Gvt. Stocks

- Categorised according to length of time left until redemption date

2.2, 2.2.1

- <5 yrs- 0-7 yrs (UK Debt Management Office)

- 5 – 15 yrs - 7 – 15 yrs (UK Debt Management Office)

- 15>yrs = No redemption date - at gvt discretion - Gvt under no obligation to ever redeem

- Interest normally paid ½-yearly

Paid grossly – subject to income tax

= date gvt buys gilt back at original issue value (par value) [normal: £100]

- Gilt edged securities (gilts) = British gvt securities & represent gvt borrowing - Safe - as gvt not default interest or capital payments

- Interest paid at fixed rate = coupon

- Index-linked gilts = interest payments & capital value move in line with inflation

E.g. If gilts with coupon of 5% & redemption date 2021 = “Treasury 5% 2021”

E.g. If holder of £10,000 nominal of Treasury 5% 2021 £250 interest per 6 months

Short dated (shorts) Medium dated (mediums) Long dated (Longs) Undated

ஃ investors purchasing power of capital & interest received is constant (unlike other fixed interest stocks – inflation reduces purchasing power)

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

- Capital gains made on gilt sale are free of CGT

Price depends on: 1) Market IRs2) Nearness to redemption date3) Supply & demand

Gilts prices quoted: Cum dividend or Ex dividend

Buyer acquires stock itself & entitlement to next interest payment

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

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]

E.g. Higher rate taxpayer buys £100,000 par value Treasury 5% 2019 at price 80.0i.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]

Local authority can borrow £££ by issuing stocks/bonds (fixed term, fixed interest securities)

- Return of capital on maturity guaranteed - not as secure as gilts(as no gvt guarantee)

- Basic:20%- Higher: 40%- Non-taxpayer: can reclaim

- PIBs rank below ordinary a/c in priority of payment – if Co. becomes insolvent

- issued by building society to raise capital

2.2 Fixed Interest Securities

Gvt Stocks(2.2.1)

2.2.2 Local Authority Stocks

2.2.3 Permanent Interest- Bearing Shares(PIBS)

2.2.4 Corporate Bonds

- Higher risk than gilts – as no gvt backing ஃ tend to offer higher yields (profits)

2.2.2 – 2.2.4

- Secured on local authority assets

- Not negotiable (i.e. can not get lower price) & fixed return at maturity

- Guaranteed IR – ½ yearly

- Paid net:

- fixed IR – ½ yrly- paid gross – taxable

- Represent loans to commercial organisations

- Fixed redemption dates, specific redemption value & fixed IR- Brought & sold at prices reflecting market IRs

- Direct investment in shares is high risk (loss of all capital) , - mitigate by investing in a range of shares & products (3.2)

2.3 Equities & Other Co. Finance

- High number of ways, incl: corporate bonds (2.2.4), shares

2.3.1 Ordinary Shares (equities)

- Shareholders ‘own Co’ ஃ 2 main rights:

- Share trading prices depend on a number of factors:

- Share prices in:

2.3, 2.3.1

- Co. need to raise £££ to commerce/expand business

- Brought by private investors, most transactions made by institutions, life, pension funds

- Rights of shareholder differ from Co. to Co. ஃ specific rights in Articles of Association – found at Co.s offices or Co. House

1) Receive share of profit via dividends2) Participate in how Co. run – voting at shareholders meetings

Profitability of individual Co. Strength of market sector Strength of UK & worldwide economies Supply & demand for shares & investments

- short term – fluctuate- long term – outpaced inflation & provide higher growth than deposit type investments

2.3.1.2 Returns From Shares

2.3.1.2.1 Risk & Reward

- High potential for return – over long-term

2.3.1.2.2 Assessment of Financial Returns2 forms:

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

- useful guide to shares growth prospect

- 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

1) Capital growth2) Income

- Assess success of shares & future performance by:

- not normally amount of dividends to shareholder on each share(as Co. retains some profit for e.g. expansion)

1) Earnings per share

2) Dividends cover

3) Price/Earnings ratio (P/E)

= [Co.s net profit / No. shares]

= how much of profit distributed as dividends

= share price / earnings per share

= growth share prices= dividends received on share of Co.s distributed profits

2.3.1.3 Taxation of shares

… 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

- 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

2.3.1.4 Ex-Dividend

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

- measure price movements, show yields, ratios, total returns

- 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

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

2.3.1.6

SE rule: Existing Co., with shareholders, who want to issue more shares, 1st have to offer shares to existing shareholders (usually at discount)

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)

Increase the number shares & reduce the share price proportionally

Rights Issues

Scrip Issues (/Bonus Issue/Capitalisation Issue)

= Issue of additional shares, FREE, to existing shareholders

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

- shareholders not wanting to take up right, can sell right to someone else

- No extra capital is raised

2.3.1.7

1) Loan interest2) Preference shares3) Ordinary share dividends

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

Preference Shares

Other Shares

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

- Not carry voting rights unless dividends delayed

- Payment hierarchy:

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

2.3.2 Loan Stock

- issued on specific terms incl. interest payable, redemption date etc

Loan secured in some way e.g. on Co.s property (unlike loan stock)

- take priority over shareholders - not have right to vote at meetings

- Risk depends on Co.s prospects & strength

2.3.2

- Co. borrows from banks & other lenders

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

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

- Interest rather than dividends payable (whether or not sufficient profit made)

- Higher taxpayer: additional 20%- Non taxpayer: can reclaim

- Creditors = holders of these debts of issuing Co. (i.e. to who £££ owed)

- Paid net of 20% tax

Loan stock is higher risk than debentures - as no backing security

2.4 Real EstateResidential propertyAgricultural propertyCommercial & Industrial property

Types

Adv Disadv

= underlying fund invested to range of properties & shares in property Co.s

2.4

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

2.4.1 Taxation

Property acceptable security for borrowing

UK property market well developed

Rents ( ஃ capital value) tend to move with

£££ values ஃ good against inflation

Property management readily available

Risk of unable to find suitable tenants

Location very important

Property less available than other forms of

investment

Property market affected by economic conditions

Highly costly

- High risk for small investors ஃ spread risk:

Property bonds

Real estate investment trusts (3.2.2.3)

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

2.4.2 Buy-To-Let (BTL)

In recession: uncertain job market difficult to commit to large mortgage

Eased by renting market

2.4.1, 2.4.2

CHANGED

- 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)

- Overall trend in 30yrs: property prices increasing ஃ problem for 1st time buyers esp. SE UK

- 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

Why? - Stimulate growth in private sector of rental market

rental income excluded from borrowers income, when assessing ability to make mortgage repayments

- many schemes require agent to be member of ARLA involved in selecting suitable property, tenants, tenancy agreement, managing property

- Other costs e.g. wear & tear (10%/yr) (not incl. cost of furniture, fittings) offset against income tax (from rent)

- Gross rent needs to be 125-150% of monthly mortgage payment

2.4.3 Commercial Property

- Provides high rental income, steady growth in capital value

Adv Disadv

- Lenders carry out detailed investigation before lending:

2.4.3

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

Land & property quality

Reputation of builder, architect etc

Suitability of likely tenant

Require rental reviews (normally no

more than 5 years between reviews)Longer lease than residential property

More stable & long-term tenants

Lower initial refurbishment costs

Higher average value ஃ spreading risk more difficult

Generally not show spectacular growth

Higher borrowing IR

2.5 Commodities

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

- Lots of traders do not need the commodities, but make profit by speculating price movement via purchasing & selling

2.5

- Lots of opportunity - directly & indirectly:

2) Lots of trade via ‘forward contracts’

1) Investment in precious metals

binding agreement where 1 party must sell & other must buy specific amount of commodity at specific price at specific date

2.6 Foreign Exchange

= international market where currencies exchanged

Main participants: Banks, central banks, other financial institutions

= Exchange of currencies between countries

Foreign exchange market

- buying & selling over the whole world- 24 hour due to technology- millions of transactions per hour

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

Goods – raw materials from different countriesServices – financial services, individual to different country for jobs

Short term – Co. in surplus want to invest e.g. in country with current high IRLong 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

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

2.6

Due to:

1) international trading

2) Investment

of:

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

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)

Treasury Bills Gilts

Term Short (~91days) Long

Interest paid? No (zero-coupon’ securities. Instead issued at discount par value

Yes

- Difference compared to gilts:

- Low risk

- Can by brought and sold throughout term

Affected by:

Significant IR changes

Supply & demand- Prices tend to rise steadily until redemption date

- Strong secondary market by banking organisations

- 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

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

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

- 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

SECTION 3: FINANCIAL PRODUCTS

- 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

Adv for investor

Lower risk High choice

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

3.1, 3.2

LOOK AT APPENDIX (III)

- Categories of investment funds

Location (e.g. country)

Industry (e.g. technology, energy)

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)

Main forms of collective investments

Unit trusts Investment trusts

Investment bonds Open Ended Investment Co.s (OEICs)

3.2.1 Unit Trusts

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

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

3.2.1

3.2.1.1 Role of Unit Trust Manager

Managing trust fundValuing fund assets

Fixing unit prices

Buying back units from unit-holders

Offering units for sale

Incl. investors who wish to sell

- Manager generates profit via management fees & dealing in units

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

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

- Trust is divided into units

Manager obliged to buy back units (under trust deed)

3.2.1.2 The Trustee

- has overall responsibility to ensure investor protection

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

Roles

Set out trusts investment directives

Hold & control trusts assets

Ensure investor protection procedures adequate

Approve proposed marketing

Collect & distribute income from trusts assets

Issue unit certificate to investors

Supervise maintenance register of unit holder

Ensure manager complies with terms of trust deed

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

- 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

- Some managers moving to a single-price system – as better understood by investors- may impose exit charge if sold within 3/5yrs

- Calculated by manager daily by a method specified in the deed

- Directly related to value of underlying securities that makes up fund

= price investor buys units from manager

= price manager buys back units from investors

= minimum permitted bid price

- 3 Prices:

Offer price

Bid price

Cancellation price

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

difference between bid & offer price (5-6%)

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

Forward pricing

- prices published in the financial press are a guide to investors

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

= clients buy/sell in given dealing period at prices determined at end of dealing period

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

- Firms managers can use historical pricing

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

- Units can brought directly from manager/intermediaries via writing/telephone

recorded as confirmation

- gives purchase price (needed for CGT when units sold)

- 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

- varies: 0.5 – 2% of fund value- deducted on monthly/daily basis

- Purchaser receives 2 documents from the manager:

1) Contract note

2) Unit Certificate

= specifies fund, No. units, unit price, amount paid

= specifies fund & no. units held

- proof of ownership

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

3.2.1.6 Types of Units

Accumulation units Distribution/Income units= Automatically reinvest any income generate by underlying asset (for capital growth)

= Split off any income received & distributed to unit holders

May increase unit value in line with value of underlying assets3.2.1.7 Taxation of Unit Trusts

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

ஃ gross = £20 [£18/1-(10% tax)]

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

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:

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

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

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

ஃ when this income is paid out …

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

3.2.1.8 Risk of Unit Trusts

- Reduced risk as:

Investment type Risk

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

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

- Pooled investment = spread between 30-150 different shares

- Legal constitution: trustees have responsibility of proper management (reduce risk of fraud)

Cash fund Similar to deposit a/c (low)

Specialist fund (e.g. emerging market)

High

Overseas funds Added risk of currency fluctuations

3.2.2 Investment Trusts (IT)

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

- Share price dependent on:

Lower than Net Asset Value (NAV) per share

- 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)

High growth potential of rising market – but can cause losses (e.g. in 2000s)

3.2.2

- 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

Some extent on value of underlying investment (not so directly as unit trusts) Factors affecting demand & supply

= total value of investment fund / number share issued

Unit trust can NOT use gearing

3.2.2.1 Taxation

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

Net of 10%, with tax credit

- 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:

Higher taxpayer – 32.5% of grossed up dividends Lower & basic taxpayer – no further liability

- 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)

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

Main features

No corporation tax on income/growth – need to meet requirements

75+% of gross income derived from property rent

90+% net profit to shareholdersNo individual can have >10% shares

Can be held in ISAs, child trust funds, self invested person pensions

Single property REITs only allowed in special cases e.g. shopping centres

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

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

Remainder from development/other services

3.2.3 Open-Ended Investment Co.s (OEICs)

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

- Similar to unit & investment trusts (common FSA regulations on OEICs & unit trusts)

3.2.3

3.2.3.1 Legal Constitution of an OEIC

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

- 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

- 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

3.2.3.2 Investing in an OEIC

- 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

- deducted from income OEIC generates- e.g. 0.5% (indexed funds) & 2% (more actively managed)

- Lump sum, regular contribution, both

Initial charge – 3-6% value of individuals investment

Annual management charge – based on the value of the fund

Other administration costs – maybe deducted from income

3.2.2.5 Taxation (3.2.1.7.1 & 3.2.2.1)

- 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)

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

Cash ISA

Stocks & shares ISA

Life assurance

Bank/building society deposit a/c

Some taxable NS&I a/c excl. investment a/c & pensioners bonds

16+yrs 18+yrsOEICs Shares & corporate bonds

issued by Co.s on stock markets

Gilts & other gvt stocks of EES countries

UK investment trusts

No longer available

3.2.4

Types

- CGT

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

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

3.2.4.1 Tax Relief

Before 5/4/04: fund managers of equity ISAs could reclaim 10% deduction from dividends

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

Exempt from income & CGT

– benefit now removedExempt from income & CGT

3.2.4.4 Withdrawals

- Cannot go beyond the maximum amount for that year (even if withdrawals are made during that year)

- Most have no withdrawal period- Some fixed-rate cash ISAs do not allow withdrawal in specific period

3.2.4.3 Transfer Arrangements

- Personal equity plans (PEPs)

- 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)

stocks & shares ISA

3.2.5 Life Assurance Based Investment Products

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)

- 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

3.2.5

3.2.5.1.2 With-Profit Endowment

- Most common type of life assurance savings contract

ஃ investors shielded from losses (if market declining), but cannot make a profit in market growth ஃ rarely used

- 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

Reversionary Terminus2 types of bonuses

Some Co.s declare:

Declared each year

Most Co.s set at level they hope to maintain for some time

Smooth out short term market variation

Over years: IRs & other investment yields reduce ஃ reducing bonus

Bonus added to with-profit policy when death/maturity claim payable

Not part of policy benefit until death/maturity (unlike reversionary)

Intend to reflect level of investment gain Co. made over policy term

Currently: reduced stock value ஃ reduced bonus

- used for mortgage repayment (3.5.1.3.1.1)

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

ஃ Co. can change/remove terminus bonus rate

1) Simple bonus= annual bonus based on the % of sum assured

2) Compound bonus= new bonus based on the [sum assured + previously declared bonus]

Co. can NOT remove once allocated (providing policy runs to term end)

Low-cost endowment – variation of with-profit endowment,

Fixed benefit on death before end of term (life cover).- Cost taken from policy each month by cashing in units

At maturity date: policyholder receives amount equal to total value of all units allocated to policy

3.2.5.1.3 Unit-Linked Endowment

- links investment returns more directly to the stock market (even specific sectors)

- (compared to with-profit endowments):

Pool of units builds up

High potential BUT high risk

Premiums used to purchase units

Chosen fund:

Adv: In the long term unit linked shows better returns

Disadv: no guarantee of minimum return at maturity

3.2.5.1.4 Unitised With Profit Endowment

- Tries to combine security of with-profit endowment & reward of unit-linked endowment

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

**Difference compared with unit-linked endowment**

**Bonus**

Pool of units builds up

Premiums used to purchase units

Chosen fund:

Policyholder receives:

Benefit paid out on a claim

Cause unit prices to increase

Can NOT be removed once allocated(like reversionary bonuses)

dependent on the number of units allocated at the then current unit price

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

ஃ security

3.2.5.2 Investment Bonds

= collective investment vehicles based on united funds

- 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

Based on bid price on the day of surrender

- Adv

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

on death, policy ceases pay out – 101% of bid value on date of death

= value of all units allocated

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)

3.2.5.2.1 Taxation

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

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

- 20% CGT within fund – non-recoverable

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

- 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)

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

3.2.6 Child Trust Funds (CTF)

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

/£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

3 types of a/c

Deposit type savings Investing (in)directly in shares Stakeholder CTF- invest in a range of Co. shares (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

Annual max charge: 1.5%

3.2.6

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

Initial payment of £250 voucher by gvt to the claimant

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

No limit on charges

3.2.7 Structured Products

- many specified particular index level below which value capital fell steeply (e.g. heavy losses in 2000s & FSA concerned whether investors understood risks)

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

3.3 Insurance- Protect against financial adversity

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

- 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)

TypesNon-profit*

With profit*Unit-linked*

Unitised with profit*

Low costFlexible

Universal* In (3.2.5.1)

3.3, 3.3.1

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

- Premiums maybe:1) Payable throughout life – I.e. full term of policy2) Limited to fixed term (e.g. 20yrs) or specific age (e.g. 60yrs)

- Life Co.s build up reserve to enable payout

3.3.1.1.1 Low Cost (Minimum Cost) WOL

- Sum assured payable on death ஃ guaranteed death benefit

Sum assured < overall level of cover required. With bonuses added as policy continues, the value increases over time

When basic sum assured + bonuses > guaranteed death benefit, decreasing term assurance ceases

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

3.3.1.1.2 Flexible WOL

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:

WOL with-profit + Decreasing tem assurance

= Mix between life cover & investment cover

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

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 maintained for 10yrs

All units used up & premium increased to continue cover

Minimum requirement for policy to remain qualifying

Number units build up to substantial investment

Level of cover, for given premium, Co. expects to be able to maintain throughout life assureds' lifetime

- 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

- To calculate cover level, Co. makes assumptions about future growth rate of unit prices

3.3.1.1.3 Universal WOL

= unit-linked WOL extended by adding range of other benefits & optionse.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

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

- 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

3.3.1.2.1 Level Term Assurance

- Other uses: family cover until children leave home (but amount of cover would reduce due to inflation)

- Sum assured constant throughout term

- Used when fixed amount needed on death to repay constant fixed-term debt e.g. loan

3.3.1.2.2 Decreasing Term Assurance

- Used to cover outstanding capital on a decreasing debt

2 typesMortgage protection assurance

Gift inter vivos cover

Covers mortgage repayment

Sum assured = amount outstanding on repayment mortgage of same term, based on specific IRs

Sum assured (like mortgage) reduces more slowly at the start of the term than the end

Cover for gift made during donors lifetime (not after death)

No IHT unless donor dies within 7yrs

Sum assured set at the start of the policy, according to the amount of tax:

- Sum assured reduces 0 over term of policy

- Premiums maybe payable throughout term/limited to shorter period

100% cover & IHT for 3 yrs 80% (4th yr) 60% (5th yr) 40% (6th yr) 20% (7th yr) cover & IHT ceased

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

- Scaling down = tapering relief

Set against nil-rate band

3.3.1.2.4 Convertible Term Assurance

Rules to convert option:

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

Cov

er

Term

-- = level-- = increasing-- = decreasing

- Normal premium rate, whatever state of health assured

- Cost: additional 10% of premiums

Premium for new policy is current standard premium for new term & life assureds age

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

Same amount of cover throughout the term

Increasing cover throughout the term

Decreasing cover throughout the term

3.3.1.2.5 Renewable Term Assurance

- 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

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

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

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

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

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

3.3.1.4 Pensioner’s Term Assurance

Nearly all term assurance issued as pension term assurance & get 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

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

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

3.3.2 Ill-Health Insurance

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.se.g.

cancerstrokeheart attack

Permanent disability

Types of cover

Provision of long-term care

Alteration to living accommodation

Purchase of specialist medical equipment

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

3.3.2.2.1 Premium Rates

e.g. clerical, admin etc e.g. hairdresser, pharmacist

e.g. farmers, electrician e.g. coal miner, industrial chemists - as too risky occupations

Affected by many factors:

- 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

~ 4,13,26,52,104 wks

cheaperMinimum 4 weeks: prevent claim for minor problems e.g. colds

- Self-employed – should opt for short deferred period, as loss of income after short period of illness

- Occupation

Increasing risk ஃ premium more

expensive

Class 1: Class 2: Class 3: Class 4: NO COVER

= time elapse between onset of illness/injury & point when benefit payment commences

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

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

- 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

~ 60 – 65% pre-disability earnings (unless Incapacity Benefit)

- Cover is ‘permanent’

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

- Paid until death, return to work or retirement

ஃ insurer can not cancer cover even if numerous claims made

- 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

- General insurance, as an alternative to PHI Redundancy (not sacking/resigning)

No benefit if redundancy within specific period before starting of cover

ஃ short-term

- Annually available at the discretion of the insurer

3.3.2.3.1 Taxation

- 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

- Use: cover mortgage repayments/other essential outgoings

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

- Deferred period normally 1 month

- Restrictions

Actively & continued employment for minimum period prior to effecting plan

Redundancy know before taking out policy excluded

ஃ may increase/stop premium cover if poor claims experience

- Tax free

- No tax relief on contribution to policy – whether arrange group/individual

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 listsChoice of hospitalChoice of timeHigh quality accommodationChoice of medical consultant

Impatient charges Surgical/medical fees Outpatient charges

Operating Surgeon fee

Anaesthetic

Pathology/ Radiology Consultant

Home nursing

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

- Benefits in non-emergency

Reimbursement of

Ambulance

Nurse fees Accommodation

Standard of accommodationPremium rate depends on

Location

Type of hospital

Type of scheme taken out e.g.budget scheme - limit choice of hospital

Medical care cost varies throughout country

Age of person

High age high morbidity

3.3.2.4.1 Underwriting

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

3.3.2.4.2 Taxation

- 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

- Premiums subject to insurance premium tax

- Benefits paid are tax-free

it is and was an ’immediate needs annuity’ when it was taken out

3.3.2.5 Long-Term Care (LTC) Insurance

3.3.2.5.1 Benefits- Amount depends on degree of care required

e.g. washing, dressing, moving etc- Each LTC provider has own definition- Many follow Association of British Insurers definition

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

3.3.2.5.2 Taxation

– found out by knowing number activities of daily living (ADL)

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

Tax-free if: Taxable if:

Benefit paid directly to care provider for care of person protected under the policy

if on life of another basis & paid directly to care provider & used solely for care of person protected

policy if ‘pre-funded’

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

Does not qualify as an ‘immediate need annuity’

if any part of annuity benefits are paid to anyone other than care provider, or for any other purpose than for person protected

Only interest element20% at sourceHigher rate payer: further 20%

3.3.3 General Insurance

= all types not defined as life assurance

5 bands of losses

Personal situation Commercial situation

Property Liability

Loss, theft, damage to static/movable asset

Liability to 3rd party e.g personal injury

PersonalInjury, sickness, death of employee

PecuniaryDefaulting creditors

InterruptionBusiness not 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

3.3.3

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.):

3.3.3.2 Average

- Policyholder may underinsure

Why?

- even if claim amount < overall sum insured

Average

ஃ claim for £300 damaged carpet insurer pays £200 [(10000/15000)*300)]

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

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

- 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

= 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)

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 solde.g. swimming pools, sheds, walls etc

Cover for…Fire & lightening

Explosions, subsidence & earthquakes

Storms & floods

Damage by vehicles& aircrafts, animals

Damage by trees/branches/television aerials

Alternative accommodation

- 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

3.3.3.6 All-Risks Insurance (/Extended Contents Cover)

= indemnify policyholder for loss, damage or theft of items regularly taken out of home

= 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)

3.3.3.4 Accidental damage by professional removers Extended cover for specific property outside house

Damage to freezer contents due to electrical failure

Cover for:

- 2 categories:

1) Unspecified items

2) Specified items

= each item must have value<specific amount & not specified

– 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

- No effect unless certificate of insurance given to policyholder

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 /

1) 3rd Party2) 3rd Party, Fire & Theft3) Comprehensive

- Types of cover:

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

– evidence of contract of insurance

3.3.3.8 Travel Insurance

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

Cover for…

Cancellation due to illness/injury Missed flights due to transport delays

Delayed departures Medical expenses

Loss of possessions/passport

Personal accidentPersonal liability

Legal expenses

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

3.3.3.9 Insurance Premium Tax (IPT)

- IPT paid by policyholder as part of the premium

Insurer Tax authority

- 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

= Right (but not obligation) to buy/sell specific amount of assets (e.g. number shares) at specific price (exercise price) within specific period

= option to sell

3.4 Derivatives= financial product indirectly based/derived from another financial products

- 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)

- Forward contract = contracts between 2 parties, not traded

- Allows Co. to raise new capital

3.4

- Related to commitment to buy/sell that other product at a fixed price on a future date/between dates

- Main forms:

Options

- Call option = option to buyPut option

- 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

Warrants = Similar to call options, except generally issued by Co.s, & gives holder right to purchase that Co.s ordinary shares

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

3.5.1 Mortgages

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

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

3.5, 3.5.1

Wrong… Result for client

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

Lender, IR scheme Pay more than necessary

Protection Family is destitute

Investment provider Worst: mortgage not repaid at end of termBest: client miss out on possible surplus funds

Mortgage = house purchase loan

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

Mortgagee

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)

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

- Repayment is calculated in a way it remains the same throughout the mortgage term (ignoring IR changes)

Am

ount

Term

= interest= capital

1 2

Term Monthly repayments consisting of…

Capital Interest

1) Start Low High

2) End High Low

ஃ the proportion of capital & interest varies throughout term:

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

Borrower pays full capital at the term end

HOW??

Regular payments to saving scheme Other

Stakeholder pension planISA

Endowment assurance

Personal pension

- Borrower should be aware of risks: Mortgage repayment depends on investment plan achieving pre-determined rate of return

E.g. Legacy proceeds

If not achieved, value of policy/plan < total debt

- 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

3.5.1.3.1 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

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

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

3.5.1.3.1.1 Low Cost Endowment

- 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

- Problem: borrowers want to keep mortgage costs to the minimum

but which, including bonuses expected to be declared over the policy term

Premiums are higher

ஃ Low Cost Endowment suitable:

- Premiums are based on a sum assured that is lower than the mortgage loan amount

Should be sufficient to repay the loan

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

Additional benefit is calculated to be sufficient to makeup difference between:

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

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

ஃ Decreasing term assurance added to policy

Current level sum assured + reversionary bonuses) - Mortgage amount

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

Check whether policy is on target

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

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

- 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:

3.5.1.3.1.3 Performance review

1) Poor performance in 1990s 2) Concern over financial advice to understanding risk

3) Concern holders of endowment

not guaranteed

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

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

Why were reviews started in 1999?

3.5.1.3.2 Pension Mortgages

Adv Disadv

25% accumulated fund can be taken as tax-free cash sum when pension payments commence – can pay mortgage loan out of lump sum

Pension contribution qualifies for tax relief at persons highest rate of tax e.g. for higher taxpayers each £100 costs only £60 (no relief for endowment policies)

Funds of investment contribution not subject to CGT ஃ grow faster than endowment policy which subject

to income tax & CGT

Minimum age lump sum can be taken usually 50yrs (55yrs in 2010) ஃ term of mortgage must run until then else mortgage not paid earlier even if have funds

Only 25% can be taken as cash ஃ fund of 4x loan value required (remaining 75% for retirement pension)

ஃ maybe: total contribution > borrower can afford/permitted by regulation

Not automatically with life assurance (unlike endowment policy) ஃ separate policy required (after 6/12/06 – can not 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)

- ISA managers calculate the amount required to pay a lump sum at the end of the mortgage term

Adv Disadv

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

Fund free of CGT ஃ low cost of repaying mortgage

If funds growth rate > assured initial calculated ஃ mortgage repaid early

ISAs may not be available in long term ஃ may have to the change repayment vehicle

If the growth rate does not match initial assumptions ஃ final lump sum may have shortfall

In premature death, ISA value unlikely to be sufficient to repay ஃ require life assurance cover

– based on assured growth rate, levels of costs & charges

3.5.1.4 Mortgage Interest Options & Other Schemes

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

Type Description Disadv Other information

- How interest charged varies from lender to lender

3.5.1.4.1Variable Rate

Capital & interestMonthly payments vary (withoutlimit) according to IRs

Borrowers can not predict level of future payments

3.5.1.4.2Discounted

Discount off normal variable rate (e.g. 2% discount for 3yrs)

Penalty if repaid within certain period

3.5.1.4.3Fixed Rate

Fixed interest for specific period e.g 1-5 (later variable)

High arrangement feeRestrictions & penalty of changing lender

Popular for 1st time buyers

3.5.1.4.4Capped Rate

Variable but IR upper fixed limit Cap & collar = fixed lower & upper limit as well

3.5.1.4.5Base Rate Tracker

Variable rate linked to BOE base rate

Charged premium above base rate e.g. 0.95%

Review monthly & reflects cost of borrowing from Bank Of England

e.g. annual, monthly, daily

LOOK AT APPENDIX (IV)

Type Description Other information

3.5.1.4.6Flexible

Gives borrower scope to alter monthly payment to suit ability to pay quickly

(FURTHER INFORMATION BELOW)

2.5.1.4.7 Cashback

Lump sum paid to borrower immediately after completing mortgage

Fixed amount/% of advanceLower loan:value – get higher cashbackSome/all cashback repaid if loan redeemed in certain period

2.5.1.4.8Low-Start

Lower initial repayments (keep initial costs down)

Deferring capital instalments initially (after this period premiums will increase)

2.5.1.4.9Deferred Interest

Initially some interest not paid but added to outstanding capital

Useful for people expecting an increase in income(not useful for people borrowing high loan:value especially when prices may decrease negative equity)

2.5.1.4.10CAT-Standard

Charges, access, terms For those who want clearly stated limits

(FURTHER INFORMATION BELOW)

… continued…

3.5.1.4.6 Flexible Mortgage

Features

Interest calculated daily

Overpayment facility without charges

Underpayment facilities

Payment holidays

- lower interest paid- lower term

For people in temporary financial difficulty

‘Borrow back’ previous overpayments help further

- Allow draw-down funds

Take priority over subsequent charges

- Easier administration process

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

3.5.1.4.6.1 Current a/c Mortgage

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

- Provided with chequebook, debit/credit guaranteed card, salary credits

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

- Many lenders offer: flexible mortgages with fixed, discounted on capped rate for initial period

- Calculate interest on daily basis low interest payable & mortgage term

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

- 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

Limits on…

Charges

Access & Terms

Variable IR < 2% above Bank of England base rate & must be adjusted within 1 month when base rate is low

Interest calculated on daily basis

Variable-rate: No arrangement feesFixed- or capped-rate: not charged > £150

Maximum early redemption charges apply on fixed & capped rate loans

No separate charge allowed on mortgage indemnity guarantees

All other fees must be disclosed incash terms before customer commits

Normal lending criteria must apply Customer can choose on which day of month to pay

All advertising & paperwork straightforwardPurchase of related products can 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

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

- 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

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

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

ஃ Maximum permitted loan varies according to age:

If couple ஃ depend on the youngest partner – as the property not sold until 2nd individuals death

e.g. - 15-20% property value for 60yr - 50% for 75yr

- Borrower may use loan to purchase a lifetime annuity to augment retirement income

- 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)

- safeguard borrowers interests:

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

- interest not built up but paid monthly from the annuity

– established Code of Practice

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

- as the debt is not increasing ஃ not decreasing remaining equity HIP allows for a higher loan-to-value ratio

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

- Since 6/4/07: regulated by FSA

on death, Co. sells the property & gets the proceeds

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

- 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

secure rights of proceeds of any claim to low mortgage debt

As the borrower increases their share in the property, the mortgage element increases & the rental element reduces = stair casing

- Lenders can by law

insists, property subject to mortgage, insured by policy acceptable to lender

- has their interest as mortgagee noted on the policy

3.5.2 Other Secured Private Lending

- Borrower offers something of value as loan security

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

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

3.5.2

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

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

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

ஃ lender can take & sell the security asset in case of default

3.5.3 Unsecured Loans

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

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

3.5.3.1 Personal Loans

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

- Given by banks, building societies, financial houses

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

- 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

3.5.3.2 Overdrafts

– short-term temporary borrowing to assist customers over a period where expenditure > income

- 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

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

= Current a/c facility enabling customers to continue using a/c in normal way even though funds exhausted

- Limit set by bank

- Interest calculated on a daily basis

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

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

- 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

- If the balance paid in full within certain period (~25 days), no interest is charged

- Adv: - Attractive - Payment guaranteed – if acceptable by Co.

- Low retail bank charges – credit card vouchers paid bank a/c – treated like cash

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 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

3.5.3.3.2 Charge Cards

- Outstanding balance must be paid in full each monthe.g American Express & Diners Club

3.5.3.3.3 Debit Card

- At transaction: funds = amount spent

- Used to withdraw cash from ATM’s & can act as cheque guarantee cards

3.5.4 Commercial Loans

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

3.5.4

- Used by customers as a credit card

- Enable cardholder to make purchase (like credit card)

- Lending secured on Co.s property/other assets

– transferred electronically from cardholders current a/c retailers

= electronic fund transfer at point of sale

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

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

– agreed contribution invested for each member

At retirement: accumulated funds used to purchase benefit

- Level of benefit not guaranteed by employer

Personal/stakeholder pension plans (PPP/SHPs)Money purchase schemes

Available to employee members of occupational schemes

Available to >75yrs olds

3.6

- Employees maybe member of occupation schemes, 2 types:

1) Final salary (Defined benefit)

2) Money purchase (Defined contribution)

- 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

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

- Tax efficient ways:

Additional voluntary contributions (AVCs)

Free-standing additional voluntary contributions (FSAVCs)

Some are final salary, but most are money purchase schemes

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

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

Maybe taken by purchasing annuity

Can buy from other providers who give higher annuity rate = open market option

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

Can make regular w/d’s of capital from fund (has limits)

- Unable to reclaim 10% tax credit on UK dividend

- If the total of employer & employee contribution in a year exceed this, tax is charged on the excess

- 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)

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

3.6.1 Additional voluntary contributions (AVCs)

- Additional contribution to occupational scheme

Free-standing additional voluntary contributions (FSAVCs)

- Contribution to FSAVCs from taxed income:

- Since April 2006: all employees have been able to contribute to PPPs/SHPs3.6.1

- 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

= 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

ஃ employee receive full tax relief

- 22% tax relief- Higher rate taxpayers: need to reclaim additional tax

separately

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

3.6.3 Stakeholder Pension Plans (SHPs)

- For most people, but intended for people on lower earning levels, who do not have pension provisions, & rely on state pension

3.6.2, 3.6.3

- 20% tax relief at source- Higher rate taxpayer: need to claim additional relief via self-assessment

- 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

- failed: as purchased by people who more financially better off

Minimum contribution required not exceed £20

- Effect of charge restrictions means independent financial advisors do not receive commission

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

- Employees not obliged to join- Employer must provide payroll deduction scheme for those who join & pass employees’ contribution to the scheme

- 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

- 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

ஃ individuals may find it a problem in obtaining advice on SHPs

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:

4.1

High long term potential but short term risk

High liquidity & safety:

Cash Current a/c with guarantee card Secure, short-term investment

e.g. instant access deposits

Less flexibility & higher return investmentse.g. fixed term bonds

ஃ Income & savings e.g. Bank a/c, insurance

Move away from liquidity, & higher risk:

ஃ Borrowing: e.g. credit cards/personal loan

4.2 Financial Lifecycle

Retirement

High earning potential Low outgoings as kids leave home & mortgage paid offPension provisions

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

Better off financially2 incomes High borrowing to get larger house, cars, goods etcHigh credit-worthiness

Prior: convert income lump sum e.g. from capitalInheritance tax liabilities considered Cost of health-care & long-term care considered

4.2

Low lump sum/regular savingsRelative open a/c at birth (e.g SHPs)/laterSavings in NS&I products & building society

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

High borrowing e.g. mortgageMay have low income – if 1 partner gives up work to look after kidsLow savings Need protection of earners income against illness/deathShould start thinking about pension provisions

School-age young people

Teenagers & Students

Post education young people

Young family

Established family

Mature Household

4.3 Gathering Informationregulated by Financial Service Act 1986 Financial Services &

Markets Act 2000Needs & objectives of the client via fact-find

4.3.1 Clients Circumstances

4.3.1.1 Personal & family details

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,bonus, overtime etc

Private medical insurance, Co. car, pension etc

- give advice on future issues e.g. death, education fees etc

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

‘Know your customer’

LOOK AT APPENDIX (V)

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

- Income easier to calculate than expenditure

4.3.1.2.3 Assets

Ownership (joint/single) Purpose, type, size of investment Current value & projected value Rate & type of return Tax status of investment Options available & penalties Sum, lives assured & maturity dates

4.3.1.2.4 Liabilities

Lender Amount of loan Balance outstanding Original term & term remaining Type of loan (e.g. (un)secured) Amount monthly/periodic payments IR Repayment method Protection of capital/payment

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

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

4.3.2, 4.3.3

4.3.1.3 Plans & Objectives

- Soft & Hard facts

e.g. objectives, views, feelingse.g. personal, family, financial details

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

- Questions to help understand

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

- 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 **

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

4.4.1 Agreeing order of priority

Look at:

4.6 Implementing a Solution4.6.1 Presentation Recommendation

- Solution presented: client told what to do & why

4.6.2 Handling Objectives

Attempt to solve

– put it into perspective & stress other compensating factors (i.e. advantages of the chosen product)

4.6, 4.6.1, 4.6.2

- ‘keep it simple’

- Present in a planned way (step by step) to cover the required details

- Client needs to understand:

1) Product purpose & needs2) Benefits3) Risks & limitations4) Options within product5) Summary

‘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

Problem is specific & client unwilling to move?

4.6.3 Obtaining Commitment to Buy

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

4.6.4 Documentation

- Transaction records must be kept securely but accessible (pension contracts & life policies kept for 5 years)(opt-outs & free standing AVCs kept indefinitely)

4.6.3, 4.6.4

- 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

ஃ the whole process was a waste of time

contract is made void as the client failed to disclose some information on the form

- Adviser must explain the cancellation notice

right to withdraw from arrangement within defined period

Key features documents, Clients specific illustration, Product brochure (product features)

- Given to the client before the sale is closed - Provide all the information required to make a decision

Given business card

- Where MiFID business involved: retention of 5yrs

4.6.5 After sales care

- Review to find out if:

= instigating action by contacting client to discuss further needs

- Opportunity to recommend other products

- Record must be kept up to date to be efficient, and increase business

4.6.5

4.6.5.1 Proactive Servicing

4.6.5.2 Reactive Servicing

- acceptance procedure has delays & to keep client informed- deal with direct debits, policy delivery, cancellation notices, standard overview, require plan alteration

- Maybe previously agreed: e.g. next salary review, job change etc…or not

- Review: changes in circumstances, update appropriate records

= 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

– comply with FS&MA2000

SECTION 5: MAIN AREASOF FINANCIAL ADVICE

5.1 Budgeting

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

5.2 Protection

- Probability of dying: <65yrs in UK: 1 in 5 males20 – 65yrs: 150,000 males600,000 males off work ill for 6 months

= 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

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

LOOK AT APPENDIX (VI)

5.2.1 Family Protection

5.2.1.1 Losses due to death

- Loss of breadwinners income would reduce the families quality of life

5.2.1.2 Losses due to sickness

- Protection categories:

- 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

5.2.1

ஃ Life insurance required

5) Lump sum to pay for changes to environ/lifestyle e.g. alterations in house

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 care4) Lump sum to pay for private medical treatment

- Factors affecting the amount & cover required:

ஃ hard to get a stand alone insurance

5.2.2 Business Protection

5.2.2.1 Death of a Key Employee

- Method to determine sum assured:

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

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

- In the event of a claim, policy proceeds taxed as business receipt & subject to corporation tax

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

1) on multiple of persons salary (e.g. 5x/10x)2) estimate persons contribution to Co.s profit

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

- 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)

Scheme

Action

Effect on remaining partners

Other information

All partners enter into agreement

5.2.2.2 Death of a Business Partner

- On death: beneficiary of the partner (i.e. spouse) may want to withdraw shares

- Value maybe of ‘goodwill’

- Partnership = (Partnership Act 1890) relationship between persons carrying on a business with a view to profit

- maybe problem for remaining partners, as they have to sell partnership assets to pay deceased partners family

Automatic Accrual Method Buy & Sell Method Cross-Option Method

All partners enter into agreement

His share divided amongst remaining partners in agreed proportions

Family compensated by proceeds of life policy written in the trust

All partners enter into agreement

Partner’s legal representative obliged to sells his shares to the other partners, who are obliged to buy

Partner takes out life policy on his own life, in trust, for other partnersPROBLEM: those who inherit, receive cash (not business asset) ஃ no business inheritance tax relief

Those who inherit receive business asset & business inheritance relief

– insure each partner ஃ not realise value except if the business were sold

Partners legal representative have option to sells his shares to other partners who have options to buy

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

- If the sole-trader stops working

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

5.2.2.6 Sickness of a Self-Employed Sole Trader

- 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

business collapse

income will reduce very quickly & they may lose customers

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

Unsecured loans are now secured against property – even bigger problem if borrower defaults

Reduce overall monthly repayments

- as unsecured loans now subject to lower IRs & longer term

DiadvAdv

5.4 Investment & Saving- Provide income or capital sum

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

5.4.2 Level of Risk

stock market investment

5.4.3 Accessibility

gilts, shares

5.4.4 Taxation

- especially income & CGT

Regular saving scheme Lump sum

deposit a/c, unit trusts, regular premium to endowment/pension plan

legacy, moving £££ from one to another investment

No risk to capital High risk to capital (high return)deposit a/c

Instant/short access notice Not directly accessible until fixed maturity datedeposit a/c

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

- Things to assess:

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

5.4.5 Effect of Inflation

- Currently in UK: low inflation rate

e.g. investment paying 4% IR when inflation rate 3% RRR = 1%

- if IR < inflation rate, the RRR is negative

5.4.5

- Reduces the purchasing power of £££

- For investment to grow, must increase with inflation- equity-linked investments proven to offer growth rates above inflation rate

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

true purchasing power of invested funds

- People suffer £££ illusion – as they do not adjust inflation with IR:

ஃ Effect of low IR, on…

reduce investments purchasing power

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

3) increased demand for houses increase house prices threaten stability2) further problems if IR rise

5.5 Retirement Planning

- 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

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

- 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

- Gvt putting measures into place

5.6

5.6 Estate Planning

- IHT (1.3.3.5) – 40% on estate of deceased

1) Avoid having to pay:

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

Managing IHT:

Nil-rate band (£325,000 (’09/10) – anyone under this threshold is exempt

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

= 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:

- Married couples & civil partners can now use whole of both their nil-rate bands to pass property tax-free to relatives/others

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)

- % of nil-rates bands unused on 1st death can be carried forward & used to increase nil-rate band on 2nd death

5.7 Tax Planning

- Advise to get advice from a taxation expert if required

- Adviser should be aware when non-taxpayers can not reclaime.g. endowment & life policy – 20% CGT not reclaimableBUT 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

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)

- 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

SECTION 6: BASIC LEGAL CONCEPTSRELEVANT 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:

Appointed (i.e. named in the will) by testator (person making the will)Can also be the beneficiary of the will

Time consuming ஃ can appoint solicitor to carry out tasks

- if no will (or invalid):

e.g surviving spouse/relative

Responsible to deal with the estate as prescribed in the rules of intestacy (6.2.1)

6.1, 6.2

= legal authority to ensure the will is carried outExecutor(s) apply for grant of probate

Administrator issued a grant of letter of administration

- clear, unambiguous, signed by testator in presence of 2 witnesses

- Terms on the will are only undertaken when the testator dies - Before: can revoke (cancel) or modify at any time

Can NOT be a beneficiary

- To make valid – in writing, properly executed- minimum age: 18 yrs

- In the event of a marriage or remarriage or civil partnership

(usually for tax purposes) e.g. could reduce IHT

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

All beneficiaries must: - >18 years old - Agree to the terms of variation

- Will = declaration of the individuals wishes regarding what happens after they die- e.g. disposal of assets, instructions on burial etc

Recorded in a document = codicil

… will is automatically revoked unless specifically written otherwise

= no valid will- In the UK: 7/10 die intestate

- 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

6.2.1 Intestacy

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

- 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

6.2.1

- Distribution of the estate of intestate person has rules of intestacy

0 / 1st £200,000 + ½ remainder Remainder

/ / ½ of the balance.

Capital to the children when the spouse dies

1st £125,000 + ½ to trust Spouse gets income for life

/ 0 Shared equally

amongst children

0 0 All

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

- Settlor

- Beneficiaries

- Trustees

- 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:

Trustee Act 2000 – trustee required to:

6.3

- Beneficiaries may eventually become absolute owners of the asset

= 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)

= people/organisation who will benefit from the trust property

= people, appointed by settlor, who will take legal ownership of the trust property & administer property under the terms of the trust deeds

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)

- be aware of need for suitability & diversification of assets- obtain & consider proper advice when making investments- keep investment under review

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

- 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

- 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

- Taxation not corporation tax regime

6.4, 6.5, 6.5.1

- 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 associatione.g. borrowing limits on amounts & purpose

- (unlike Co.s) It is NOT a separate entity ஃ partners jointly own assets & liabilities (6.5.1)

- Partners have limited personal liability depending on the amount they invested & personal guarantees given

- Registered with Co.s House

- each partner taxed as self-employed with individual share of profits treated as their own income & subject to income tax

6.6 Law of Contract- Most business agreements are legally binding contracts – orally, writing, deeds

Basic requirements for contracts to be binding:

Offer & acceptance

Consideration

Capacity to contract

Terms of the contract are certain, complete, free from doubt

Intention to create legal relationshipLegality of object

Contract not entered into as result of misrepresentation, under duress or undue influence

Each party must have legal capacity to enter contract. Certain parties have limited power to enter contact e.g minors & people of unsound mind

Must be offer made by offeror & unqualified acceptance by the other party, communicated to the offeror

Subject of contract, by promisee (e.g promise to do/supply something) must be matched by consideration (usually payment of £££) by promisor

Contract not made for illegal/immoral purpose

6.6

Financial services capacity to contract depends on authorisation of FSA

- 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

- 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’)

= party fails to perform his side of contract & no legal excuse

To court:

Injunction

Seek damages

Order for specific performance

= injured party seeks financial compo for losses, to position if contract had not been breached

e.g. party to complete contract

= count order preventing someone from doing something

6.7 Law of Agency

Agent

- Important to understand how much power & authority vested in the agent

- Independent advisor is acting as a customers agent

6.7

= person who acts on behalf of another (principal)

- can conclude contracts on behalf of principle

– depends on rules & regulations

- Agent should only act within power given by principle – needs observing

- may act within apparent 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

= something done/said by principle to suggest agent has authority

6.8 Ownership of Property

– all other property

6.8.1 Joint Ownership

Type Feature If 1 person dies … Debt

* Banks mostly want in this form

6.8

2 types of property:

1) Realty

2) Personalty

- property is real if court restore to dispossessed owner & not merely provide compensation for the loss- distinguished as immovable e.g. land & real estate

1) Joint

tenant

Whole property ownedby each of the owners

All automatically transfer to

other NOT overridden by the

deceased’s will

Both equally liable for

whole debt

2) Tenants in

common

Each owner has

identifiable share in

property

His share goes to whoever is

entitled according to his in will

Each responsible for

portion of debt

*

6.9 Power of Attorney= Person given legal responsibility to act on behalf of another person

- Person who can not enter into a contract (e.g. minor/mental), cannot appoint an attorney

Must be registered with the Public Guardianship Office

(name change) Office of Public Guardian (10/2007)

Revoked with consent from Court of Protection

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

6.9

Donor = person making power of attorney

Attorney/Donee = person acting for him

- 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

Replaced by lasting power of attorney since Mental Capacity Act 2005 from 10/2007

6.10 Insolvency & Bankruptcy

- Insolvency occurs when an individual:

- Bankruptcy

- 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 dutiesCan dispose & get cash to pay off creditors

6.10

Liabilities > assets Cannot meet financial obligation within reasonable time

= 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

- Bankruptcy cancels most debts & is a fresh financial start 6.10.

1

Unable to borrow other than nominal amounts Must disclose when applying for mortgage ஃ more difficult or higher IR charged to cover lenders risk

- But affects future credit & employment

6.10.1 Individual Voluntary Arrangements (IVA)

= alternative to bankruptcy where debitor arrange with creditor to reschedule debt over specific period

- Increased market for firms assisting IVAs

Persuade bank to write off debt in exchange for reasonable guarantee of receiving repayment of the remainder

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

- Only set up if creditors representing > 75% of debt agrees to the arrangement

- Scheme supervised by a insolvency practitioner

Arrange interest to be frozen ஃ reduced amount of debt

UNIT 2

UK FINANCIAL SERVICES & REGULATIONS

UNIT 2 UNIT 1

SECTION 1: THE FSA

- Primary objective of the gvt:

Technology advancee.g. customers do own transactions electronically

Scandals/crisis

- e.g. collapse Baring Bank (1990s) & problems at Equitable Life- showed need for control & protection - against fraud & mismanagement

Respond to changes in lifestyle

Increased divorce & rights for shares in pension benefits

Developments in business methods

Innovation & complexity & increase no. in product design

ஃ consumer to understand features & benefits of product

- 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 awareness & demand for customer focused business approach

1.1 Financial Services & Marketing Act 2000 (FS&MA2000)

1980s & 90s: increased laws e.g. Financial Services Act 1986 – incl. self-regulation

1992: Baring Bank collapse – BOE & Securities & Futures Authority criticised

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:

1.1- 2 movements:

1) Deregulation

2) Lots of regulation

– e.g. banking & building societies in the mortgage marketBefore: gvt had a lot of regulation Later: barriers removed in 1980s – promote competition (high range & low cost)

unsuccessful

1998: responsibility for regulation of UK banking sector transferred from Bank Of England to FSA

Regulation of mortgage sales – under Mortgage code Compliance Board (to FSA in 2004)

General insurance – under General Insurance Standards Council (to FSA in 2005)

e.g. large banks provide lots of products – regulated by Bank of England

1.2 FSA’s Objectives Role & Activites

- 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)

Board (appointed by the Treasury) makes decisions

Objectives

Maintaining confidence in UK financial system

Ensure market fair, efficient & transparent

Securing appropriate levels of protection for consumers

Different level of risks relating to different investments

Different expertise of different consumers

Consumers’ needs for accurate advice & info

Principle: consumerstake responsibility of own decisions

Low scope forfinancial crime

Money laundering

Fraud & dishonesty incl e-crime

Criminal market conduct incl. Insider dealing

Promoting public understanding of financial system

Incl. Risks & benefits

1.2

– but has statutory powers under law (e.g. Banking Act 1987 etc)

– depends on

- Performance of FSA judged against:

Allocating resources efficientlyCost:Benefit

Taking a/c of responsibilities of those who manage firms

Taking a/c of international financial services & UKs competitive position

Facilitating competition

- Undertakes role by setting rules, training, guidance etc via a range of sourcebook

Sourcebook Include

High Level of Standards

Regulatory Process

Redress/ Specialist

Business Standards

- Principle for business- Senior management arrangements, systems, controls- ‘Fit & proper’ test for approved persons- Threshold conditions- Statements of principle for approved persons

- Rules & guidance for firms seeking authorisation & FSAs enforcement powers- Supervision manual: how FSA references & monitors compliance of authorised firms

- Investor complaints & compensation procedures- Arrangements for professional firms e.g. solicitors

- Money Laundering- 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)- Market Conduct: Investment markets ஃ important for investment firms e.g. insider dealing

1.2.5 Status of Provisions in FSA Handbook

Rules

1.2.6 Principles for Firms (Businesses) & Approved Persons (Staff)

1) Intergrity2) Skill, care, diligence3) Management & control4) Financial Prudence5) Proper standard of Market Conduct6) Customers’ interest7) Communication with client8) Manage conflict of interest fairly9) Customer relationship of trust10) Protection that firm must arrange

clients’ assets11) Relations with regulators of firms

– open & co-operative

1) Integrity2) Skill, care, diligence3) Observe proper standard of market conduct4) Deal with regulators open & co-operative

Significantly influential positions:

5) Business of firm organised & controlled6) Skill, care, diligence7) Steps to ensure business complies with standards & requirements

1.2.5, 1.2.6

= 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

1.2.7 Treating Customers Fairly (TCF)

Problem with rules & regulations: People aim to comply with the ‘letter’ of law rather than ‘spirit’

‘Fair’

1.2.7

ஃ use loop-hole FSA introduced TCF (develop ethics’)

- FSA undefined saying: ‘flexible, dynamic & varies with circumstances’

- ஃ definition lies with firms management

1) Consumer confident firm is fair2) Product meets needs of identified customer groups3) Consumer provided with clear info at all stages4) All advice suitable for customers circumstances5) Products & services perform as customer expects6) No unreasonable barriers e.g. making complaint/claim

- at every stage of business

- 6 improved outcomes:

- 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

- Senior manager must take responsibility that firm is complying with FSA regulations

1.2.8.1 Clear Chain of Responsibility

Senior manager

1.2.8.2 Systems & Controls

- Implemented by firms & must be documented & review regulations

Range of firm activities

Chains of responsibility

ComplianceAssessment & reporting risk

Reporting other management information

Competency & honesty of staffespecially approved person

Strategy for controlling business risk & recovering from serious problems

Audit of systems & controls by independent person

Adequate & accessible record of systems & controls kept securely

1.2.8

specific areas to specific individuals

- Records showing chain of responsibility required

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

= person has info not available to other investors & makes use of information e.g director knowledge of takeover bid

Honesty, integrity & reputation

Competency/capability

Financial soundness

1.2.9 ‘Fit & Proper’ Test for Approved Persons

- 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 recordsDisciplinary proceedingsKnown to go against regulations/law

Complaints/Dismissals

Insolvency

Current financial position

Previous bankruptcy/adverse credit rating

1.2.10 Prevention of Crime

- Market abuse:

= person knowingly gives false info to influence price a share for personal gain

- Money laundering (section 2)

1.2.9, 1.2.10

- judged by:

- meeting FSA training requirements

- Criteria:

Insider dealing

Market manipulation

Regulated Include …

1.3 FSA’s Approach to Regulating Firms & Individuals- 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)

1) Deposits2) E-money3) Insurance contracts4) Shares, Co. loan stocks, debentures & warrants5) Gilts & local authority stocks6) Units in collective investment schemes7) Rights under stakeholder pension schemes8) Mortgage contracts

- Permission given by listing the regulated activities & investments firm is allowed to carry out- via FS&MA2000 Part IV (Part IV permission)

2 categories

Securities

Contractually based

Shares

Debentures

Gilts

Life policiesPersonal pensions

Options

Futures

1.3

defined in FS&MA2000 (regulated Activities Order 2001) (RAO)

1) Accepting deposits 2) Effecting & carrying out insurance contracts (incl. funeral plans)3) Dealing in & arranging deals in investments4) Establishing & operating collective investment schemes 5) Advising on investments6) Mortgage lending & administration7) Advising on & arranging mortgage & general insurance

Activities

Investments

1.4 Capital Adequacy

- 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)

- Minimum requirement for capital adequacy is set by Basal Committee on Banking Supervision

Agreement: Basal Accord

- Minimum requirement by solvency ratio

= Institutes own funds as a % of risk-adjusted value of its assets i.e. how much institute can cover its risks

1.4, 1.4.1

- Aim of industry regulators: protect firms, customers, economy by establishing rules & principles

- Any losses (e.g. written off repayments) bourn by shareholders not depositors

Multi-national body under Bank for International Settlement Basal II (operational in 2007)

= capital requirement denominated as a proportion of the banks assets (e.g. loans), with allowances made for the perceived risk level of different assets

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

Basic approach: capital required = institutes gross annual income (average over 3yrs) x 0.15

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

Currently solvency ratio is at least 8% (of the banks own funds of risk-weighted assets)

Banks paid up share capital + any retained profits

Incl. capital requirements for operational risks

risk of loss from failed/inadequate internal processes, people & systems or external events e.g. earthquakes, fraud

For larger organisations: more sophisticated system (standardised approach) applied - may use different multiplying factors

ஃ Institute Services Directive (ISO) (1996) & Capital Adequacy Directive (CAD)

1.4.2 Capital Adequacy for Investment Businesses

1990’s: investment firms allowed freedom to provide same services as banks & other credit institutions

Category Deal with … Capital required

1.4.2

Markets in Financial Instruments Directive (MiFID) & Capital Requirements Directive (CRD)

Sets minimum capital requirements for investment firms, dependent on category

Own a/c dealers

Matched principle broker

Broker/Managers

Advisers/arrangers

Own a/c €730,000

Fulfil customers orders €125,000

Investments as agents or managers for customers

€125,000 or €50,000 (if no client £££ or assets)

Give advice/arrange investment deal

€125,000 or €50,000 (if no client £££ or assets)

1.4.3 Solvency Margins for Life Assurance Co.s

Principle of the technical methods & calculations of liabilities (valuation liabilities)

Paid up share capital

Statutory & free reserves

Profit brought forward after dividends paid

Cumulative preference share capital & subordinated loan capital – only up to 50% solvency margins

- Authorities in individual EU states (e.g. FSA in UK) can relax rules temporarily if requirede.g. in 2003: when stock market securities reduced

– FSA rectified by reducing prospective liabilities e.g. annual bonuses

- 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

1.4.3

- 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:

excess of Co.s assets over its provisions

Components of Co.s solvency margins

- Co. must maintain adequate solvency margins

1.5 Risk-Based Approach

= risk that investments fail to deliver hoped-for returns

FSA aims to reduce

FSA not take responsibility, but aims to educate consumer

• Impact factors

- Classification category: A – B – C – D

Risk: High Low

<1% institutes

Majority of institutesHigh impact firms,

65% market shares

1.5

- Types

Prudential risk – e.g. risk of firm collapsing as incompetent management Bad faith risk = risk due to fraud, mis-representation, mis-selling Complexity/unsuitable risk = risk of customer not understanding product

Performance risk

- 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

= effect of economy, industry, customer in specific event

e.g. firm collapsing, compensation loss availability

Redress: if customer made loss due to contravention of rule FSA involve courts

FSA can ask court to forfeit profit to FSA

1.6 Discipline & Enforcement

- FSA empowered to undertake:

e.g. falsifying document etc

- Person appointed to investigate can demand: Answer questionsProvide informationProvide documents

If not given ஃ FSA can apply to Justice of Peacefor search warrant

1.6.1 Enforcement Powers

- If FSA discover something, actions which can be taken:

- Customer can contact the Financial Ombudsman Service or Financial Services Compensation Scheme

- General investigation into business

- Specific investigation into authorised person

Variation of a firms permission of regulated activity of firm Withdrawal of approval to carry out some/all controlled functions Injunction Restitution Disciplinary action (e.g. private warning, published statement) in misconduct

can prevent person benefiting from action

1.7 FSA Conduct of Business Sourcebook

1.7.1 Approved Persons & Controlled Functions

Controlled Functions

Governing functions

Required functions

Systems & Controls function

Significant Management function

Customer function

Director

Non-executive director

Chief Executive

Director of unincorporated association

Partner

Director of small friendly society

Compliance oversightMoney laundering reporting

Duties of appointed oversight

EEA investment oversightApportionment & oversight

Dealt with by senior person who has overall responsibility of organising firm

Finance

Risk assessment

Internal audit

Designated investment business

Other business operations

Insurance underwritingFinancial resource

Settlement

(Trainee) Investment adviser

Corporate finance adviser

Pension transfer specialist

Adviser at Lloyds

Customer trading

Investment management

1.7, 1.7.1

Personal visits, telephone conversation

Newspaper adverts, internet sites

1.7.2 Advertising & Financial Promotion Rules

Incl.Adverts in media

Telephone calls

Marketing during visit to client

Presentationto groups

Types e.g.

1.7.2

Invitations or inducements to engage in investment activity

Non-written financial promotions

Written financial promotions

- 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

Promotion is clear, fair & not misleading1.7.2.1 Comparisons

- 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

- Clear & readily accessible

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 CompetenceAssess 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

1.7.3, 1.7.4

- From advertisement information found in fact find Record for advice etc

- Why?

Demonstrate compliance to rules

1.7.4.2.3 Maintaining Competency

- No specific amount of time (~50hrs/yr) on continuing professional development (CPD)

1.7.4.2.4 Record Keeping

- of employees competence & training, assessments, exams, meeting with supervisor

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

Incr

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f in

vest

or p

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ctio

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- ‘the person in the street’ 1.7.5

ConferencesPrivate study

Training courses

- Methods

- Must be retained for: - at least 3yrs after employee leaves the firm - indefinitely for pension transfer specialists

1) Eligible counterparty - Incl. large financial institutes (banks, insurance Co.s etc)

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

- Require limited service e.g. execution only

– issued as part of the initial disclosure documents (IDD)

- Adviser required to have a written agreement with the client which sets out the business relationship

- Client must be informed about the terms before information/advice given

Not required if the customer received one in the past & terms have not changed

Terms of business incl.

Status of advisor (1.7.5.2)

Service offered by advisorFull name of regulator

Summary of clients responsibilities

Detail of complaints procedure

Detail of payment for services provided

Firms authorisation with respectto handling clients £££

Duty of disclosure details of any ‘connected person’

Locus arrangement in case of advisor absence

Whether or not professional indemnity insurance held

= business letter

1.7.5.1.2 Clients Agreement

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

- Problem: commission bias (i.e. adviser gives the product with higher commission)

i.e. ended polarisation

June 2005: Depolarisation

Change: 3 types of advisers

Whole of market Multi-tie

Provide products from 1 provider

- Clients get 2 documents:

– must tell customer

Give advice on the whole financial services market & select appropriate product for the client & provider

Advise & sell product for 1 (or group) Co.

ஃ Jan 2002 – ‘Reforming polarisation – Making the Market Work for the Consumer’

= new way determining & explaining the way clients pay for advice (1.7.5.5)

usually panel of Co.s

Marketing groups

Offer product from limited range of specific providers

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)

Must have range of products

1.7.5.2.2 ‘Menu Approach’

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

- 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

Includes

Types of products offered

Product from whole of market?

Advice or recommendation provided?

Details of ownership & regulation

How to complain e.g. Ombudsman Services

How to get compensation from financial service compensation scheme

- Includes:

- Whole-of-market advisers have to offer (but not insist on) a fee based option (to show their decision is not influenced by commission)

- Client given Key facts about the cost of our services document at the start of a consultation

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

- When issued?

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

- Clear, concise & signed by the person authorised to give advice

- Provided for: unit & investment trusts, life policies, pension policies, pension transfers/opt-out,

ASAP after transaction & no later than cancellation notice

Before transaction effected

Within 14 days of transaction

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

In key features document (1.7.5.7)

- 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

1.7.5.7 Product Disclosure

Includes

Essential element of products

Risk factors Consequence of making product paid-up

Commission paid

Client specific information relating to chargesWhere additional information can be found

Tax information on maturity dates/before

1.7.5.7.1 Risk Disclosure

- FSA pointed out risks customers will face

- Key features of the product explained to the client in writing before the sale is concluded

If income/capital levels might vary

- 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

- 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

- Client can withdraw from the contract within a specific period of receiving notice (~4 days)

- direct post from product provider to client

- No commitment or loss during that period – signed & return to the provider

1.7.6 Stakeholder-Type Product

ProductsChild Trust fund

Cash deposit products

Medium term investment products

Smoothed investment fundStakeholder pension

- Simplified selling product model:

- can be terminated at any stage

- Maximum annual charge for investment product:

- Simple, low cost, risk controlled product for less financially sophisticated

- 1st 10yrs of life of a product: 1.5% - after (/throughout if before 6/4/05): 1%

- Controlling risk: limit proportion of shares in stakeholder unit-linked & with-profit products to 60% of the fund remainder into fixed-interest securities & cash

Adviser explains product nature

Assessment

Series of short questions

Customers savings & investment objectives

Risk assessment

1.7.7 Regulation of Mortgage Advice

- FSA rules on loans subject to 1st charge on:

- 2 types sales people:

MCOB rulebook incl:

MCOB Purpose Details

1.7.7

Borrowers property UK property Borrower/family occupy > 40% property

- determined by questions to filter mortgage selection

1) giving advice 2) those only giving information on products

1 Application & Purpose Explains scope of rules i.e. who it applies to & what type mortgage2 Conduct of business

standardsUse of terminology, charging rules, record accessibility by FSA

3 Financial promotions Distinguish between (non)real-time promotionNot contact customers at unsociable hoursDetails on promotions & say ‘Home maybe repossessed if not keep up with repayments’

4 Advising & Selling standards

Incl.: type of adviser i.e. independent etcSuitable products for customerRecords kept for 3yrsIDD information: whose mortgage offered, charges payable, FSA regulated details, claim & complain rules

MCOB Purpose Details

Details given when recommendation made & before application to lenderIncl. APR, amount monthly instalments, amount instalments if increase 1% IR

5 Pre-application Disclosure

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 sale

After 1st mortgage payment made, lender confirm: amount, 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 calculated11 Responsible lending Show customers ability to pay12 Charges ‘Excessive’ charges not allowed, early repayment charges

correspond to cost to lender & arrears charges reasonable to the cost of administration

Try reach agreement with client in arrearsCustomers in arrears given information in 15 days: FSA worksheet on what to do, missed payments, total arrears incl. charges, debt, additional chargesRepossession when all other measures fail

13 Arrears & repossession

1.7.8 Regulation of General Insurance

- FSA took control in 1/2005- rules to adviser in Insurance Code of Business (ICOB)

ICOB Purpose Details

1.7.8

1 The scope of rules Rules & types of activities covered (incl. to intermediaries)2 General rules Rules on communication, record keeping, inducement3 Financial promotion Advertisements clear, fair, & not misleading

4 Advising & selling standards

Information on status: [details of firms regulation (FSA), whole-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 rights6 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

SECTION 2: MONEY LAUNDERING

-1989: Financial Action Task Force on Money Laundering (FATF)

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)

2.1

= international body to fight against criminal money

- 30 members incl. EU commission & EU member states

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

2.2 Definitions

= crime specified in Vienna Convention United Nations Convention Against Illicit Traffic in Narcotic Drugs & other criminal activity as specified by each member state

2.2

- Specifies money laundering within EU treated under directive, even if activities to generate property took place in a non-EU country

= process filtering proceeds of criminal activity through series of a/c or financial products to give it apparent legitimacy

Money laundering

- EU’s 3rd Money Laundering Directive (2005) definition incl.

Property = asset of every kind, (in)tangible, (im)movable, as well as legal documents giving title to such asset

Criminal activity

- 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 Money Laundering Offences

- In PCA2002: 3 money laundering offences Concealing criminal propertyArranging Acquiring, using, processing

Ways to prevent staff money laundering

Procedures & accountabilities

EducationReporting

Money Laundering Reporting Officer (1.7.1)

Training

Identity evidence - for transaction >$15000 (~£10000) - different for life assurance policies (2.4)

Up to date procedures & records

Refrain from alerting investigated

Report at least once a year & assess firm’s compliance to sourcebook Strengthen deficiencies

- FSA assess money laundering using:

Joint Money Laundering Steering Groups guidance notes

FATFFinancial exclusion guidance (2.4.1)

2.3

= highlight developments in ML & deficiencies in rules

= steps to verify customer identity- made up of UK trade associations

2.3.1 FATF

- Work involved:

-‘Inter-gvt policy making body’ is not a law enforcer, but have responsibilities of individual countries

2.3.2 SOCA

- 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

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

Setting standards for anti-money laundering programs (40 recommendations) Evaluating the extent individual countries have implemented their standards Identifying money laundering methods

= public body sponsored by, but operationally independent, of Home Office

- Responsible to reduce the impact of serious organised crime

e.g. Serious Organised Crime Agency(SOCA) - in UK

* = Areas of concern

*

*

2.4 Client Identification

Entering into new business relationship New customer: when value > €15000/life assurance policy

- €1000/yr (€2500 single) premium If suspected of money laundering

- 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

2.4, 2.5

- Required when:

- If client is introduced via intermediary, written assurance by the intermediary is sufficient

- Standard format e.g Association of Independent Financial Advisers(FA)

- Transaction evidence kept for 5 years after the transaction has occurred

- Identification evidence kept for 5 years after the relation has ended

2.6 Reporting Procedure- Firm must appoint a Money Laundering Reporting Officer (MLRO)

Staff SOCA

- 1+ times a year the senior management gets a report from the MLRO

Assess firms compliance with sourcebook

Indicate how FAFT findings used

Information on money laundering submitted by staff

2.7 Training Requirement

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

2.6-2.8

– co-ordinate anti-money laundering activitiesReporting cycle

- Firms are required to:

SECTION 3: COMPLAINTS & COMPONSATION

- FSA statutory objectives (1.2) makes easier to complain

3.1 Firms Complaints Procedures

report to FSA on regular 6 month basis

- Eligible complainants: Private individual

Small business (annual turnover < £1million)

Charities (annual turnover < £1million)

Trustees of trust with assets < £1million

3.1

- Lots of legislations & firms to protect customers from fraud, but not 100% ஃ customer has to take responsibility

- 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

- Complaint can be received: oral/writing acknowledgement in 5 days

- same rules except hard complaints have deadlines & reported to FSA

Firms responds in final letter

if 8 weeks pass

Letter to explainInform customer of Ombudsman Service within 6 months of the date of the letter

- 6 monthly reports about progress of hard complaints

- Types of complaints:

Hard = allegation of financial loss, material distress - records kept for 3yrs

Soft = any other

– within 4 weeks of receiving complaint

(if not, send interim letter)

3.2 Financial Ombudsman Services (FOS)

- FSMA2000 integrated FOS in 12/2001

Deals with complaints (not make rules or give guidance)

Banking & Loan Division Insurance Division, Investment Division from 6/4/07 Consumer Credit Complaints

- Not incl. Pension Ombudsman

- Award up to £100,000 + reasonable costs

3.2

- 3 areas:

- 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

– put complainant in same financial position as if it had not occurred

3.3 Financial Services Compensation Scheme (FSCS)

- Sub-schemes:

Problem Main Compensation (maximum) Additional (maximum)

- No compensation for other losses (e.g.negligence, poor advise etc) via FSCS – could via civil courts

3.3

- Dec 2001: scheme for compensation if cost customer has lost £££ by insolvency of an authorised firm

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 default of bank/building society

100% of 1st £35,000

Claims against mortgage advice & arranging firms

100% of 1st £30,000 90% next £200,000 (i.e. max £48,000)

Claims against insurance intermediaries

Depends on circumstances

3.4 Pension Ombudsman

– not complaints about sales & marketing (3.2)

Mal-administration has led to injustice e.g. financial loss, distress, delay

- 1st addressed to pension schemes manager/trustee

Pensions Ombudsman Legally binding

- Communicate to Ombudsman via writing

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

Office of Pensions Advisory Services

Disagreement about facts/law

– within 3yrs of the event (excl. internal complaints procedures)

SECTION 4: DATA PROTECTION

4.1 Data Protection Act 1998 (DPA)

- Replaced DPA1984 (as UK law needed to comply with EU-DPA1995)

- Only included computerised data

- Gives control of private individuals use of personal data held by commercial organisation

4.1.1 Definitions

Data processor = person who processes personal data on data controllers behalf

4.1, 4.1.1

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

- DPA98 applies to ‘any structured set of personal data’

4.1.2 Data Protection Principles

8) Not transfer to country outside EU Economic Area unless data protection regime adequate

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

4.1.3 Enforcement

- by Information Commissioner (IC)

- IC can issue 2 types of notices to the data controller (if infringing terms of Act)

- Maximum penalty: £5,000- unless the case goes to Crown Court (unlimited fine)

4.1.3

– Responsibilities: educate the organisation & individuals about the Act & their rights take action to enforce the Act

= require organisation to take specific/refrain from action

1) Information notice = require controller to specify organisation will take to comply to Act

2) Enforcement notice

- 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

SECTION 5: OTHER LAWS & REGULATIONSRELEVANT TO ADVISING CLIENTS

5.1 Consumer Credit Act 1974

- from Apr 2008 all loans are covered

5.1

= 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))

Main elements of Act

Suppliers of loans & credit licensed by Office of Fair Trading

Clients must receive a copy of the loan agreement for own records

Prospective borrowers have cooling off period – unless agreement signed on the lenders premises

Undesirable/misleading marketing practices forbidden

Credit reference agencies must disclose information about an individual on request

- Introduced annual percentage rate (APR) system

IR

Additional costs & fees

= compares the price of lending ஃ total cost of borrowing

- 2 factors:

5.1.1 Changes

- 3 improvements described by the Department of Trade & Industry:

Law Act Changes

5.1.1

- due to 3yr review, to make law fair & competitive credit market: Consumer Credit Act 2006 (CCA06)

1) Enhance consumer rights & redress2) Improve regulation of consumer credit business3) Make regulations more appropriate for all kinds of consumer credit transaction

Primary CCA06 - Parts changed incl. Financial Ombudsman Service (4/2007)- New licensing regime & transparency provision (4/2008)

SecondaryConsumer Credit Regulation 2004 (CCR) (Advertisement)

CCR (Agreements) (Amendments)

CCR (Disclosure of Information)

CCR (Early Settlement)

- About form & content of adverts for credit: Simple, intermediate & full-credit advert to a single list, incl:- - new way to calculate APR & present prominently (2/3 of advert) - plain English & easy to read/heard - name of advertiser included - if secured loan ஃ advert clearly state the required security

- Make agreements signed by customers clearer & easier to understand ஃ change content & layout

- What information must be disclosed to prospective borrowers & the way

- Confirm entitlement of borrowers to rebate when all/parts of the debt repaid earlier & the way to change calculation etc

5.2 Unfair Contract Terms

5.2.1 Supply of Goods & Services Act 1982

- Terms mean services will be performed in reasonable care, time & charge

5.2.2 Unfair Terms in Consumer Contracts Regulations 1999

- 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

5.2

- 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

- Unfair terms are unbinding (the rest of contract may still be binding)

- Apply to all contracts after 1995 involving supply of services

- Contracts written in plain language

5.3 Rules on Occupational Pension Schemes- Remains separate from other financial services & even private pension schemes

5.3.1 Pensions Act 2004 (PA2004)

- Incl. 2 important elements:

5.3.1.1 Pensions Regulator

- More power, proactive & risk-focused 2 factors: likelihood, impact

- High risk situations require more monitoring

- 3 objectivesProtect benefits of members of work-based pension schemes

Promote good administration

Reduce risk

5.3, 5.3.1

- PA1995 introduced aspects of provision & supervision

- Public confidence reduced by Maxwell affair ஃ gvt needed to restore confidence by stopping fraud & improving administration

1) Establish of Pension Protection Fund (5.3.1.2)2) Transfer regulating responsibility: Occupational Pension Regulation Authority to Pensions Regulator

Powers

Investigating schemes

All schemes must make regular returns to regulator

Trustees/scheme mangers must give notification for any information changes

Informed quickly if scheme can not meet funding requirements

ஃ can remedy quickly

Putting things right

Specific action to improve matters

Fines/prosecution

Recovering unpaid

Disqualifying trustees who are not fit

Acting against avoidance

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

- to identify & monitor risk

incl.= prevent employers from deliberately avoiding pension obligations & leaving Pension Protection Fund to cover pension liabilities

- Actions: Contribution notices – require employer to make payment on debt to the scheme or

Pension Protection Fund

(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 health, retirement & survivors benefits

90% for pre-retirement member subject to overall benefit cap

Compensation funded in 2 ways: Take over assets of pension schemes with insolvent employers

Levy on all private sector defined benefit (element) schemes

Pension protection levy based on risk factors ~80% of PPF (incl. under-funding, credit rating)

Pension protection levy based on scheme factors (incl. number of active & retired members)

Administration levy – cover set up cost & undergoing cost of PPF

PPF Ombudsman levy –cover cost of PPF Ombudsman

Fund compensation levy (replaced Pensions Compensation Board levy)

- 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%

5 parts

5.4 EU Directives- 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

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, 5.4.1

– consolidated earlier directive

5.4.2 Investment

- 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

- 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

ஃ broaden markets across the EU

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

Types of Investment Activity

Receipt & transmission of investor orders on purchase/sale of specific investment

Execution of order on customer behalf Discriminatory management portfolio

of specific types of investments

Giving investment adviceUnderwriting issue of any specific investment

Investments

Transferable securities(stocks, shares)

Unit in collective investment

OptionsIR, currency, equity swaps

Money market instrumentsFinancial futures contracts

Forward IR agreements

- 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

5.4.3 Insurance

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:

5.4.3

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

- To obtain authorisation

Limit business activities to insurance onlySubmit scheme of operationRun by technically qualified peoplePossess minimum guarantee fundNotify identities of shareholders & amounts

- May need local legislation in the state where insurance is sold, in relation to marketing & contract

- Need harmonised EU laws, incl.

Principles to calculate assets & liabilities

- Policyholder can withdraw within the ‘cooling-off period’ ~ 14-30 days from the start of the contract

- Policyholders must be told essential characteristics of product in the Key features document (UK)

- Financial supervision of insurer by its home state – incl. valuation of assets, liabilities, verification & solvency

- Premium tax applied are those of state the insurance is sold

- Increased freedom of capital movement Choice, valuation, diversification & location of assets to support Co.s liabilities

= Statutory cancellation notice (UK)

- in the UK, premium tax to general insurance not life assurance

5.4.3.2 General Insurance

1988: 2nd Non-Life Council Directive – rules for cross-frontier non-life insurance - balance between freedom & customer protection

Across EU member states

1992: 3rd Non-Life Council Directive – completed process - head-office in one state & run elsewhere

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

- 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

- Co. can be authorised in 1+ classes e.g. general insurance – accident, sickness, land vehicles etc

= ‘activities of introducing, proposing or carry out work to come contracts of insurance or assisting in admin & perform of contract’

- Rules to protect clients funds (incl. client’s £££ in separate a/c’s)

Information of intermediary to client

Name & address

Regulation details

Intermediary hold 10% voting rights/capital of insurance Co.s or vice versa

Internal & external complaints procedureIntermediary independent/tied to insurance Co.

- To give advice on products recommended

- intermediary required amount is 4% premiums received/yr (subject to minimum €15,000)

- from a high number of contracts available on market- assess customer’s need (fact find)

5.5 CAT (charges, access, terms) Standards

- CAT-standard mortgage available on demand – may not be suitable

5.5

- Intended to help less knowledge investors choose suitable deal

- CAT withdraw for ISAs

Variable IR no more than 2% Bank of England base rate & adjusted within 1 month after base rate reduced

IR calculated daily

Arrangement fees: - variable-rate loans: not chargeable - fixed-rate or capped-rate loans: < £150

Maximum early redemption charges on fixed-rate & capped rate loans

No separate charge can be made for mortgage indemnity guarantees

All other fees disclosed in cash terms before customer committed

Limits on charges Limits on access & terms

Normal lending criteria must apply

Customer choose day of month to pay

All advertising & paperwork must be clear & straightforward

Purchase of related products cannot be made a condition of offer

5.6 Advertising Standards

- Must meet standards by British Code of Advertising under Advertising Standard Authority

Discuss offending advert with advertiser to change or withdraw

Legal action – via Office of Fair TradingNegative publicity

- Code requires advert is:

LegalDecent – not cause offence

Honest – not exploit people

Truthful

5.6

- 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:

5.7 Banking Code

- Debts with individual, executives & trustees (not business)

Under Business Banking Code

Under £1million

- Both codes compliance reviewed by Banking Code Standards Board

Products covered by code

Current a/c

Deposit & savings a/c

Cash mini-ISAs, TESSA-only ISAs & cash-deposit Child Trust Funds

Payment systems

Card services & cash machinesLoans & overdrafts, but not mortgages

Foreign exchange transactions

Code commitments

Marketing clear & not misleading

Chosen a/c / service information given to customer

Help customer e.g. send statements

Secure & reliable

Publicise code & train staff

Deal quickly & sympathetically if things go wrong

5.7- By British Bank Association & Building Society Association (March 1992)

- Voluntary, but most banks subscribe

- Aim: set good standards of banking practice

Business operation covered by Banking Code

New customers, products & servicesID proof

Information clarity

Charges

Rules

Terms & conditions

Communication

Requirements e.g. fair & clear

Changing a/c’s

Procedures

Bank information sharing

Bank, branch closure procedures

Advertising & marketing

Clear, fair, reasonable, not misleading

Personal details not passed on

Customers not have to be contacted

Card & PINs

Information in summary box card issued

Reduce/increase/ opt out credit limits

Running an a/c

Statement Cheques

Direct debits & standing orders

Dormant a/c’s rules

Personal infoconfidentiality

Disclosure required

Institution’s interestnot marketing

Customer’s permission

A/c protection

Cooperation

Customer’s responsibility

Borrowing

Repay ability

Refusal explanation

Guarantors seek independent legal advice

Rules on passing information to credit reference agencies

IR

Financial difficulties Sympathetic,

positive

Assistance

ComplaintsHow?

Timescales

- 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

where it will result in 1 Co. having >25% market share

Markets

where danger of restricted competition in specific market

Regulations

where major regulated industries may not be operating fairly

- Has sweeping powers to stop a situation causing damaging impact on competition e.g. prevent mergers taking place

END