Share the Wealth
FTAdviser article by Richard Brough, Associate Director at TCC, published October 2011
The wealth management sector has received the attention of the City regulator, and much of its recent guidance is not just limited to wealth manager businesses but has scattered across other areas of financial services.
Firms outside the wealth management sector, including IFA firms, should take note: there have been a number of cases publicised in recent weeks where IFA principals have been fined and banned for failing to ensure they collected and analysed adequate management information. This resulted in senior management failing to identify and review exposure to compliance risks and for failings in the file review processes.
The FSA’s last sentence in the Dear CEO letter sent to wealth managers informs them that: “Wealth management businesses can expect to see continuing and increased supervisory focus in the year ahead” which means that the regulator is preparing to review the sector and that the content of this letter will form the basis of future assessment.
In June this year the regulator made it clear what it expected to see from wealth management businesses. The areas the regulator wanted organisations to consider in this letter were:
- Does the firm have an assessment of a meaningful amount of sample file checks to evaluate?
- How accurate and what information is held on client files?
- What depth and quality of client information is recorded?
- How suitable is the client portfolio based on the documented client information?
When considering file checks it is essential to evaluate what standards are to be adopted. Is the organisation conducting a document check or quality of advice check? Then how will the checks carried out be verified and whether any external verification will be undertaken?
The design of the organisational systems will dictate the depth of the information recorded. However, the individual adviser will dictate the quality of information recorded, so how is consistency and efficiency achieved?
In addition to this work, the regulator is carrying out a project to assess advice given to clients who have been recommended to invest using a centralised investment proposition. The purpose of this exercise is for the regulator to assess organisational interaction with model investment portfolios, discretionary investment management and distributor influenced funds.
There is a significant amount of attention being focused on the use of these investment solutions being used by IFAs. If your organisation is using any of these investment solutions you need to maintain sufficient records of due diligence and consider any implications for consumers.
This work is beginning with a desk-based assessment, and then depending on the information may then result in file reviews and interviews. The trend towards the use of these types of investment has increased as organisations looking to develop a consistent outcome for consumers and prepare for the retail distribution review.
In order to ensure your organisation does not have to knee-jerk into action, it is worth considering what the regulatory concerns are. When reviewing the recent findings from the regulator there are four common themes apparent, which are: know your client, client classification, attitude to risk and investment objectives.
Evidently know your client is more essential than ever before. For many years now the regulator has criticised the information organisations collect to demonstrate know your client. Although there is no requirement to have this information in a factfind, there is more pressure to have information in a structured manner.
Information technology can assist by providing barriers to proceed, however as the consumer is central to the process, the adviser must be able to record sufficient information to support the recommendation so the use of such systems needs to consider any non-standard data.
The last client classification revisions were when the EU Markets in Financial Instruments directive, commonly known as MiFID, was introduced. It changed the landscape of client classification introducing a quantitative test for retail clients requesting to be treated as professional clients.
This was different from the previous classification of intermediate customer. What this means is that professional clients are considered to be more experienced, knowledgeable and sophisticated, and therefore able to assess their own risk. It was identified in the Dear CEO letter that some organisations had not adopted this change, which came into effect in November 2007.
Risk assessment has received much attention of late, especially since the regulator published the guide to assessing suitability. With the increased use of statistical and psychometric risk profiling tools it is becoming a sophisticated analytical process. Tolerance to risk is an uncertain and ambiguous quantity, but is the formula building the foundation of a sound investment risk strategy.
More often than not consumers need to take more risk than they would normally want to, to enable them to achieve their goals. This creates a conflict between what is acceptable risk versus achievable goals. It is the skill of the adviser to negotiate and balance this conflict ensuring that they take the customer along the journey with them. In deciding which investment strategy suits the consumer best, their needs and commitments with the adviser assistance is paramount to account and resolve these conflicts between parameters of risk required, capacity for risk and tolerance to risk.
Although today’s risk assessment tools are becoming sophisticated, they should be used in harmony with the consumer’s financial circumstances and deviations need to be recorded.
Increased attention and focus on the consumer’s investment objectives and attitude to risk has become headline news. The regulator has identified on numerous occasions inconsistencies between portfolio and attitude to risk, knowledge, experience and time horizons. Armed with the guidance issued on assessing suitability with specific focus on client’s risk, organisations need to review their work design to ensure that they would not be vulnerable to regulatory interventions.
Those organisations which continue to operate without taking notice of this guidance which could mean having to make a step-change in the way in which organisations deal with these risks, could be exposing the organisation and consumers to unacceptable risk. As previously identified, the growth of electronic tools has increased significantly in recent years and has become embedded in a range of financial services organisations.
This innovation requires an understanding on how to use the technology. The starting point is to discuss the acceptance of risk with the consumer and then consider the three core elements: risk required, capacity for risk and tolerance to risk.
Organisations really need take a look at their work design to ensure that the outcomes for customers are robust to regulatory scrutiny, repeatable so that a process can be unified and reliable.
Richard Brough is associate director of regulatory policy for The Consulting Consortium
Link to FTAdviser
Link to FTAdviser
