5.3. Appropriateness assessment
5.3.1. Requirement to assess appropriateness
When Dealing in Investments as Principal, Dealing in Investments as Agent, or receiving and transmitting orders for a Client, an Authorised Firm must ask for information about the Client's knowledge and experience in relation to the type of Investment or Investment Service concerned to assess whether the Investment or Investment Service are appropriate for that Client.
Guidance: Client engaged in a course of dealings If a Client engages in a course of dealings involving a specific type of Investment or Investment Service through the services of an Authorised Firm, the Authorised Firm is not required to make a new assessment on the occasion of each separate Transaction. An Authorised Firm complies with COB 5.3 provided that it makes the necessary appropriateness assessment before providing the relevant service.
5.3.2. Exemption from requirement to assess appropriateness
An Authorised Firm is not required to assess appropriateness if:
- (a) the service provided to the Client:
(i) only consists of the execution and/or the reception and transmission of orders;
(ii) relates to the Investments specified in COB 5.3.3 below; and
(iii) is provided at the initiative of the Client;
- (b) the Client has been clearly informed that in the provision of this service the Authorised Firm is not required to assess the appropriateness of the Investment or Investment Service provided or offered and that therefore he does not benefit from the protection of the rules on assessing appropriateness; and
- (c) the Authorised Firm complies with its obligations in relation to conflicts of interest.
5.3.3. Exempt Investments for the purposes of COB 5.3.2
The Investments that are exempted in accordance with COB 5.3.2(a)(ii) are:
- (a) Shares admitted to trading on an Authorised Investment Exchange or other authorised and regulated exchange; or
- (b) bonds or other forms of securitised debt (excluding those bonds or securitised debt that embed a Derivative); or
- (c) other non-complex Investments.
Guidance: Non-complex Investments An Investment is non-complex if it satisfies the following criteria:
- (a) it is not a Derivative or a Security giving the right to acquire or sell a transferable security or giving rise to a cash settlement determined by reference to transferable Securities, currencies, interest rates or yields, commodities or other indices or measures;
- (b) there are frequent opportunities to dispose of, redeem, or otherwise realise the Investment at prices that are publicly available to the market participants and that are either market prices or prices made available, or validated, by valuation systems independent of the issuer;
- (c) it does not involve any actual or potential liability for the client that exceeds the cost of acquiring the Investment; and
- (d) adequately comprehensive information on its characteristics is publicly available and is likely to be readily understood so as to enable the average Retail Client to make an informed judgment as to whether to enter into a Transaction in that Investment.
5.3.4. Nature of appropriateness assessment
(1) The Authorised Firm must assess whether the Client has the necessary knowledge and experience in order to understand the risks involved in relation to the relevant Investment or Investment Service.
(2) An Authorised Firm must not Deal in a Derivative with a Retail Client, unless the Authorised Firm has carried out an appropriateness assessment of the Retail Client and formed a reasonable view that the Retail Client has:
- (a) adequate skills and expertise to understant the risks involved in trading in the type of Derivative; and
- (b) the ability to absorb potential significant losses resulting from trading in the Derivative due to leverage.
Guidance
(1) For the purpose of forming the reasonable view referred to in COB Rule 5.3.4 (2) in relation to a Retail Client, an Authorised Firm needs to consider at a minimum whether that Retail Client:
(a) has sufficient knowledge and experience in relation to the Derivative of the type offered, having regard to factors such as:
(i) how often and in what volumes that Retail Client has traded in the relevant type of Derivative; and
(ii) the Retail Client’s relevant qualifications, profession or former profession;
(b) understands the characteristics and risks, including those relating to the underlying reference and the degree of volatility of the markets or prices affecting that underlying reference;
(c) understands the impact of leverage, due to which there is potential to make significant losses in trading in a Derivative; and
(d) has the ability, particularly in terms of net assets and liquidity available to the Retail Client, to absorb and manage any losses that may result from trading in the Derivative offered.
(2) To be able to demonstrate to the AFSA that it has undertaken a proper appropriateness assessment, an Authorised Firm should have in place systems and controls that include:
(a) pre-determined and clear criteria against which a Retail Client’s ability to trade in a Derivative can be assessed;
(b) adequate records to demonstrate that the Authorised Firm has undertaken the appropriateness assessment in respect of each Retail Client; and
(c) in the case of an existing Retail Client with whom the Authorised Firm has previously traded in a Derivative, procedures to undertake a fresh appropriateness assessment if:
(i) a new Derivative with a materially different risk profile is offered to that Retail Client; or
(ii) there has been a material change in the Retail Client’s circumstances.
(3) Where an Authorised Firm forms the view that it is not appropriate for a person to trade in a Derivative, the Authorised Firm needs to refrain from offering that service. As a matter of good practice, the Authorised Firm should inform the Client of the firm’s decision.
5.3.5. Client's knowledge and experience
When assessing the appropriateness of the Investment or Investment Service for the Client, the Authorised Firm must consider the Client's knowledge and experience by taking into account, to the extent appropriate for the circumstances:
- (a) the types of Investment Service, Investment and Transaction with which the Client is familiar;
- (b) the nature, volume, and frequency of the Client’s Transactions in Investments and the period over which they have been carried out;
- (c) the level of education, and profession or relevant former profession of the Client; and
- (d) the Client's knowledge and understanding of any associated risks.
5.3.6. Professional Clients
An Authorised Firm may assume that a Professional Client has the necessary knowledge and experience for the purposes of COB 5.3.4.
5.3.7. Warning the Client
If an Authorised Firm considers that the Investment Service, Investment or Transaction is not appropriate for the Client, it must issue a warning to the Client that it is not considered to be appropriate.