VCT guide

Suitability is a large and important topic, and what follows are guidelines to bear in mind when considering whether a VCT investment is a suitable investment for a client. Investments into smaller, unquoted companies are high risk and advisers need to spend time thinking about suitability and documenting the thought process in suitability reports when recommending a VCT. FCA classification VCTs are classified as alternative investment funds and retail investment products. An adviser who wants to advise their client to invest into a VCT requires retail permissions to advise on securities. They will have to determine whether an investment into listed securities is suitable for their client. Further information on legal and regulatory status is also set out on page 33. Tax capacity Although tax benefits alone should not be the primary driver for the investment, a prospective investor is likely to be an individual who is in a position to take advantage of the tax reliefs available from investing in VCTs. Therefore, if they are planning to purchase newly-issued shares in a VCT, the client should have an income tax liability that could be offset by the upfront income tax relief available for VCT investors. The client should also be aware that the tax reliefs can be withdrawn and that the shares might, at some point in the future, be worth less than they initially cost, although, where the reliefs are retained, income tax relief can limit losses. Attitude to risk In general, a VCT investment is likely to be suitable for clients with a high tolerance for risk. Where succession planning is relevant, you should also make the client’s intended heirs aware of the risks involved. While some VCTs may be riskier than others, all VCT investments should be considered as carrying the potential of a capital loss for investors. While this will never be a 100% capital loss when the income tax relief is taken Suitability The FCA rules on suitability reports require that advisers: √√ Specify the client’s demands and needs. √√ Explain why the firm has concluded that the recommended transaction is suitable for the client, having regard to the information provided by the client. √√ Explain any possible disadvantages of the transaction for the client. Concerns about the clarity and reliability of the information provided have led to questions about whether Key Information Documents (KIDs) are doing consumers more harm than good. Even so, provision of the KID is mandatory whenever a client is advised to buy a PRIIP. So, how do advisers take account of the KID when advising their clients and what areas should they be cautious about? Performance KID performance scenarios (derived from past performance data reflecting strong market growth over recent years) are overly-optimistic for many products, even in supposedly “unfavourable” and “moderate” conditions. Consequently, advisers should: • look for additional KID wording (stressing the indicative nature of the performance scenarios) that the ESAs have recently mandated for products “where adjustments...are necessary to reflect specific features of the PRIIP”; • ascertain whether a PRIIP’s issuer has provided further information outside the KID that seeks to put the KID performance scenarios into context; and • explain to clients that KID performance information may be over-optimistic and should be seen as an estimate rather than a reliable indicator of future results. Risk The KID’s Summary Risk Indicator is not a “summary” – rather than quantifying all risks relevant to a product, it focuses on historic volatility, relegating other risks to the small print. Consequently, advisers should: • look beyond the headline SRI number – research by the Association of Investment Companies shows that 70% of all VCT KIDs carry a summary risk indicator (SRI) of 3 (i.e. medium-low risk) even though the Money Advice Service describes them as “high risk”; and • pay close attention to the SRI narrative, especially those elements dealing with additional risks, capital guarantees and payment obligations or where the PRIIP issuer has a free-hand to explain the product’s risk classification. Costs Advisers will be aware of the discrepancies between PRIIP and MiFID II requirements regarding costs and charges and how they are disclosed to consumers. Particularly problematic – in terms of ensuring client understanding – is the disclosure of the “implicit transaction costs” incurred when the assets underlying a product are traded. If these costs are negative (as is frequently the case), advisers need to explain to clients why something that looks like a deduction has no impact on the overall amount they pay. The performance, risk and cost elements of the KID will be addressed in a consultation from the ESAs in late 2019. In the meantime, the only safe conclusion to draw about the KID is that advisers need to draw on wider sources of information (e.g. product prospectuses and third party commentary, research and ratings) in formulating their advice. Understanding the KID Thought Leadership LEAD REGULATORY POLICY ADVISER, PIMFA SARAH McGUFFICK 34 VCT CHARGES AND PRACTICALITIES