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FI observer - why suitability remains such an issue for wealth managers

By Claire Nightingale and Jane Walshe | October 3, 2018

The FI Observer looks to provide insight into the risks associated to financial instituions.
Cyber Risk Management|Financial, Executive and Professional Risks (FINEX)

The FCA has worked hard to address the provision of unsuitable advice over the past few years, but despite some progress it still remains a major concern.

Back in 2015, a report from the FCA suggested that 60% of wealth managers were giving advice which was deemed unsuitable. Writing in its thematic review, it said that a number of firms had taken steps to ensure the advice it gave to clients was suitable. However, the majority of firms still had work to do to ensure the content of investment portfolios accurately reflected the requirements and appetite for risk of its customers.

Three years later and there has been some positive progress. Last year’s suitability review found that 93.1% of advice given was suitable, with only 4.3% of cases being deemed unsuitable. The remainder was classed as being unclear.

When it comes to disclosure the picture was less promising. Nearly half of firms (41.7%) were found to offer unacceptable levels of disclosure and 52.9% were deemed unacceptable.

Major concerns

There has been progress, undoubtedly, but suitability remains a serious concern for wealth managers. Research management and benchmarking firm Compeer’s latest review found that wealth managers still view suitability compliance as one of the major issues they face.

The study focused on interviews with chief operating officers and risk management figures in firms managing more than £600 million in assets. Interviewees were asked how their firm was managing compliance. The results were stark. The majority of firms were working on the basis of trial and error. 71% of respondents said they viewed compliance as an evolving process – one in which they repeatedly learned from their mistakes.

There was considerable variation in how long firms spent reviewing portfolios. Answers ranged from a few seconds to several days. Some said they were looking at the suitability of advice constantly while others said it was an annual process.

In many cases, it depends on the sophistication of the IT infrastructure at a firm’s disposal. Some were able to pull up a customer’s portfolio on their screen in a few seconds.

The report highlights just how variable the approach to suitability is from one firm to another and a lack of clarity about what the FCA expects and what new regulations require. This, in turn, leads to complexity, creates confusion and increases the risk that an adviser might unwittingly provide advice which is unsuitable.

This issue showed through in the FCA’s suitability review. Some suitability reports, it claimed, were overly long and complex. In part this can be attributed to firms doing everything they can to demonstrate compliance and to mitigate risk in the event that a complaint has been made.

It could also be down to a lack of certainty over what the FCA expects. Where firms are not sure, they are playing it safe. Achieving a greater awareness of what the FCA expects, and a simpler attitude to reporting, could help firms produce shorter, simpler and more concise reports.

To help matters, the FCA advises that all reports should cover the following key areas:

  • The client’s demands and objectives
  • Why the firm has concluded that a transaction is suitable for the client
  • An explanation of any possible disadvantages

The first point can perhaps be the most valuable. Much of the confusion around suitability appears to stem from concern about what the FCA expects. Compliance managers are scrutinising the minutiae of FCA guidance to understand the expectations being placed upon them.

Instead they can place the customer at the centre and put themselves in their shoes. Doing so can go a long way to making sure that advice remains the right side of suitable. It will help firms understand what investors need, what their risks are and to tailor their advice accordingly.

New technology

The process is evolving constantly. The rise of new platforms, automated advisers and cryptocurrencies create opportunities and challenges.

In the case of cryptocurrencies most advisers would deem these as being far too volatile to ever recommend to clients. However, such is the growth of the sector and the interest from potential clients that it can also be said that advisers owe it to their clients to familiarise themselves with the sector. If a client is determined to invest in cryptocurrencies it could also be in their best interests to have an adviser helping them to reduce their risk as much as possible.

The robo-adviser market also muddies the waters and the sector has come into the sights of the regulator in the last month. It criticised robo-advisers for providing advice which was unsuitable. The FCA reviewed a total of seven platforms offering online discretionary investment management and three providing advice exclusively through automated channels.

It found that firms were not making it clear what they were charging and were not properly evaluating a client’s status, experience levels and appetite for risk. Some, said the FCA, did not ask clients about their experience at all. Some firms allowed clients to disregard advice altogether and make investment decisions on their own whims.

The automated online advice sector is growing and evolving and there will inevitably be slips along the way but the FCA’s position is clear. The nature of the platform itself should not alter its obligations to provide suitable advice to clients.

It is an ongoing and evolving process. Firms are struggling to understand what is expected of them and the best way to demonstrate compliance. The rigour with which suitability is assessed often depends on the sophistication of IT platforms at the firm’s disposal. New technologies create a host of new challenges for the FCA but sometimes, the simplest solutions are the best. As long as firms keep the good of the customer at the heart of everything they do and see the issue through their eyes, they can go a long way towards fulfilling the FCA’s requirements.

Insurance protection

As scrutiny from the regulator remains intense, wealth managers may be considering the scope of their civil liability policies in the context of their overall risk management. In particular to what extent insurers will cover them in the event that a suitability issue is discovered and they are obliged to assume costs and reimburse clients in order to correct the error. While civil liability insurance policies generally operate on a “claims made” basis i.e. they are engaged when third parties bring complaints against an insured, policies can and regularly do expressly include extended cover, so called mitigation cover, so that a wealth manager can rectify a situation on becoming aware of an error before clients bring complaints, or may even be aware of an issue. This is absolutely key in circumstances where a wealth manager would be obliged or minded to remedy such a situation in any event and, in the absence of a customer complaint and without express mitigation cover, may be unable to recover such losses from insurers.

Suitability claims rank high in frequency of the types of losses that wealth managers sustain which fall within the scope of a civil liability policy. These losses can be significant, particularly if the suitability issues are widespread, for example emanating from the operating practices of an entire business area. The process of reviewing client portfolios, assessing whether investments are unsuitable, and calculating likely loss in order to correct a suitability issue can be time consuming and complex, all the more so if the incident involves reporting to the regulator. As ever, robust internal processes to avoid these types of risks from occurring, and effective insurance cover in the event that they do, are key.

For more information, please speak with your usual Willis Towers Watson contact or email Claire Nightingale.

About Enforcd

Set up by a team of industry professionals and technologists with experience in regulation at the FCA, JP Morgan, UBS and Thomson Reuters, Enforcd is a global regulatory intelligence platform designed to help financial services firms embed a strong compliance culture, whose first client was The Bank of England. The platform pulls together key thinking in the industry on regulatory issues from over 20 leading law firms, and builds out a library of advice, analysis and news linked to qualitative themes founded on a central database of enforcement actions. These cases, from 30 regulators, are analysed by advanced algorithmic techniques and in-house compliance specialists to enable quick and easy identification. The power of Enforcd has been recognised by many leading insurers, including Willis Towers Watson and Liberty Mutual.

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