FCA Thematic Review TR15/12 Wealth management firms and private banks; Suitability of investment portfolios December 2015

Transcription

1 FCA Thematic Review TR15/12 Wealth management firms and private banks; Suitability of investment portfolios December 2015 How Adviser firms can help fill the suitability gap? Available to Adviser Clients of Diminimis 1

2 The Thematic Review Wealth management firms and private banks; Suitability of investment portfolios, whilst specifically reporting on the DIM and Private Banking sector, has raised a number of issues the adviser should be aware of. It is not clear, but it can be assumed, the operating framework under review is model A as described in the Diminimis Suitability Matrix (see page 8), where the client is adopted as a retail client and has a direct relationship with a representative of the DIM. In 2007 The Responsibilities of Providers and Distributors for the Fair Treatment of Customers (RPPD) outlined key aspects of what a product/service provider and distributor should cover when they deliver a solution to the same customer. MiFID II takes this forward with the requirement that everyone should have a greater awareness of the responsibilities of the whole delivery chain so this clearly impacts on the adviser/dim relationship. There are variations in how DIMs structure their services and how these can impact upon the obligations of the adviser. In the Review the FCA recognise The wealth management industry contains a variety of firms which have differing business models, service offerings, client acquisition strategies, delivery channels, corporate objectives and legacies. Se we would not expect them all to have the same oversight arrangements in place. It is the firm s senior management that is responsible for putting oversight arrangements and controls in place that are right for their business needs and ensure good outcomes for their customers (paragraph 3.6, page 8). Key findings from this review, which covered 150 files from 15 firms, include: Many firms did not adequately gather, record and update customer information to support the investment portfolios they manage on their behalf. Firms needed to do more to ensure that the composition of portfolios truly reflected the investment needs and risk appetite of their customers. Firms needed to ensure that their governance, monitoring and assessment arrangements were sufficient. It is the adviser who selects the DIM(s) to provide services to their clients therefore it would follow it is the adviser who is responsible for ensuring they have the appropriate oversight and controls in place within their business to manage their obligations within the operating framework. However, to learn from the examples of good and poor practice it is important to understand how the different operating frameworks allow the adviser to demonstrate the value they bring to the exercise (similar to applying the four eyes principle) and the challenges the adviser faces when researching, selecting and monitoring the DIM, especially if they select to take responsibility for most aspects of the service. The Thematic Review gave examples for good and poor practices under the following headings identifying what the FCA expects to be in place. The following table is based upon the Operating Frameworks as shown in the Diminimis Suitability Matrix (see page 8 of this document). 2

3 Thematic Review a) Governance & control environment. Expects robust arrangements, clear organisational structure with well defined, transparent and consistent lines of responsibility, effective processes to identify, manage, monitor and report the risks it is or might be exposed to, and internal control mechanisms. A firm must establish, implement and maintain adequate policies and procedures...to ensure the firm comply with its obligations under the regulatory system. b) Putting oversight arrangement in place. Expects firms to have adequate and effective front line control mechanisms that identify and reduce risk to customers. It is the responsibility of senior management for putting oversight arrangements and controls in place that are right for their business needs. Lessons for Advisers using the following Operating Frameworks. A B C Direct Hybrid; Reliance on others Agent as client When researching DIMs advisers need to cover this understanding how the DIM approaches the subject. Advisers need to reflect this in their business (Senior Person s Regime). Client investment suitability sits with the DIM but the interface between the adviser/dim needs to be clearly articulated. Identified accountability needs to be reflected in the controls and oversight. DIM will have to demonstrate this process. Is this consistent across teams within the DIM, across different offices? DIM can rely on the Adviser to provide the client information and conduct the assessment. The interface between adviser and DIM needs to be well monitored with regular communication, training needs identified and key MI identified and shared. Is it model portfolios or bespoke client portfolios? Adviser as professional client? Advisers need to understand what, if any, controls they have when using this service. What legal/regulatory requirements do they need to meet to comply with their obligations? What implications are there of being treated as a professional client? DIM is responsible for ensuring the model portfolio meets its articulated objectives but has no knowledge of the Adviser is responsible for ensuring their oversight arrangements reducing risk to their clients. As a professional client the adviser must ensure they are managing the risks on behalf of their retail 3

4 c) Carrying out effective monitoring Expect that, as part of monitoring, a firm should review how the overall portfolio meets the customer s circumstances, risk profile, objectives and expectations. d) Keeping customer information up to date. Expect firms to be able to show the key customer information they use to assess the suitability of the portfolio has been kept up to date. No specific timescales required but must not be manifestly out of date. Suggest 12 to 18 months should be the target. Expect firms to ensure the customer information they gather and record matches the underlying investment portfolio and they are in a position to demonstrate this. e) Investment objectives Must be clear & not contradictory. DIM will have to demonstrate this process. Consistency per team within the DIM? Responsibility of the DIM but how does this tie in with working with the adviser? If the investment manager is doing this what capacity do they have and to run the bespoke portfolios? Does the IM have the skill set to interpret the overall financial planning requirements e.g. income drawdown levels. establish and monitor. How does this tie in with working with the adviser? Does an IM have the correct skill set and wider understanding of the client requirements? ensure the portfolio continues to meet the agreed investment mandate but see d) below as relies upon the adviser to conduct the client reviews. Adviser will require specific MI from DIM e.g. turnover levels of portfolio Adviser will conduct the full review and report to the DIM any changes in the client situation that have an impact on the management of the portfolio. Will also confirm no change. Four eyes principle working on behalf of the Clarity provided by the adviser who has a wider understanding of the client s needs, establishes the objectives and articulates them on the client s behalf. Adviser is responsible for the ongoing monitoring regarding suitability of the selected portfolio. Adviser responsibility. What if.. the risk profile of the portfolio has changed due to market conditions? Adviser can only work in hindsight to the activity within the portfolios Adviser responsibility. Needs to be aware of shoehorning. Use of external tools largely historic volatility based? f) Risk appetite Clarity provided by the adviser 4

5 Must be clear and not contradictory. g) Matching the customer s portfolio with risk appetite Must be clear and not contradictory from client information or internal practices. h) Investment time horizon Must be clear and not contradictory. establish and monitor. How does this tie in with working with the adviser? establish and monitor. How does this tie in with working with the adviser? establish and monitor. How does this tie in with working with the adviser and financial planning objectives? i) Restrictions on portfolios Responsibility of the DIM. What systems and controls are in who has a wider understanding of the client s needs, establishes the objectives and articulates them on the client s behalf. Having received a comprehensive investment mandate from the adviser the DIM can construct a suitable portfolio for the Clarity of terminology & understanding of what risk levels mean to bot the adviser and the DIM. This interface is critical to the success of working together. Adviser will make it clear from the client s financial planning objectives. Adviser will make clear in the investment mandate and will Adviser responsibility when matching client s objectives, KYC requirements, timescales etc with selected portfolio. Does the adviser understand the tools being used the methodology, limitations. How this links with the DIMs approach? Adviser responsibility. What is the basis of portfolio selection at outset? External tools or internal analysis? Historic volatility + what? What controls and oversight are in place to ensure on going adherence? Who is responsible? Adviser responsibility to ensure the time horizon of the investment strategy is in line with client s objectives. 5

6 If applied must be adhered to with appropriate controls in place. j) Capacity for loss * Must be reviewed regularly. k) Portfolio turnover Expect firms to be able to show that the transactions executed within a customer s investment portfolio over a period of time are suitable and have been carried out in the best interests of the customer. A firm should have regard to the customer s agreed investment strategy in determining the frequency of transactions. Expect to see the rationale behind why the trades are made. Transaction charges can create a conflict of interest which needs to be managed. place? establish and monitor. Does this sit readily with the IM s skill set? monitor but would also be part of the review process conducted by the adviser on the DIM. monitor at reviews to ensure adherence. Clarity provided by the adviser who has a wider understanding of the client s needs, establishes the capacity for loss and articulates this on the client s behalf. DIM has responsibility but the Adviser will cover this in their research and DD but will also monitor ongoing for conflicts of interest, decision making/rationale for changes and impact on portfolio performance. Acting on behalf of the client to ensure the portfolio is being managed in line with expectations. Adviser responsibility to take into account in selecting the service style and the model (if these are appropriate for a client who has requested specific restrictions). Adviser responsibility Most model portfolios run on a platform do not incur DIM transaction charges so the portfolio will be monitored for overall performance. However, there is scope for adviser fees to be levied on transactions on some platforms. Points f & g are critical as this is where, based upon factual information, the solution needs to incorporate human characteristics that are variable, open to interpretation and are likely to change over varying timeframes. Being able to map a clients understanding and expectations by the adviser and the 6

7 investment manager is a challenge. This requires discussion with the client and a number of tools exist within the industry to help bring structure to this discussion. However, the Regulator has identified a number of issues across various communications in the DIMs/advisers use of tools (risk profiling, asset allocation); May be helpful but must be fit for purpose. It is used only in the circumstances, and for the target market, for which it was designed. Users understand how the tool works and any limitations of the outputs it generates; including to what extent the tool will help them meet their regulatory requirements. The customer is able to understand and engage with the process as designed. Conflicting or inconsistent responses need to be addressed. It is the DIM/adviser who takes responsibility for the use of any tool. It is not a tick box exercise Therefore it is imperative there is a good understanding by the adviser of the investment managers approach to investing, portfolio construction and risk management processes to enable the adviser to clearly articulate the processes to the client in order to correctly establish expectations. How this is done under the different operating frameworks will depend upon the adviser and DIM working relationship. Not mentioned in the examples of good and poor practice but raised in the section on Relevant rules, guidance and reference material are the following topics (see document for full list and references); Final notices being clear and not misleading in the services being provided. FCA Handbook; Clients best interest rule. Assessing suitability. Information disclosure before providing services. Churning & switching. Rule on inducements. Conflicts of Interest. *By capacity for loss we (FCA) refer to the customer s ability to absorb falls in the value of their investment. If any loss of capital would have a detrimental effect on their standard of living, this should be taken into account in assessing the risk they are able to take. Conclusion The Thematic Review demonstrates the weaknesses in the skill set of the discretionary investment manager in the context of understanding the wider client financial planning scenario, the need to document and the ability to analyse the client information from a financial planning perspective. By going through 7

8 the good and poor practice highlighted this document supports the view that the combined skill sets of an adviser firm and a DIM, when correctly established, are complimentary and to the clients benefit. In the correct operating framework the client s outcome from two professional firms working together on their behalf should be much closer to meeting expectations. However, where the relationship is not established correctly the potential to exacerbate the suitability gap is significant and thereby the possibility of the client s assets not being managed to their expectation greatly increased. The Diminimis Suitability Matrix (Adviser or DIM, it is not both). When two regulated entities work together to provide a service to the underlying investor, the responsibilities of each party must be clear to both. There must also be clarity regarding their responsibilities to the investor. The Diminimis Suitability Matrix outlines the basic operating frameworks for an adviser and DIM to work together. Each of the following aspects of the service provision has different implications in terms of accountability and responsibility for the Adviser Firm. Which model fits in with their client service proposition is the decision of the Adviser Firm. The DIM must take responsibility accordingly. Whilst this Matrix gives a high level overview there are a number of variables that need to be considered and each DIM may have their own approach. DIM Suitability Investment Suitability Ongoing Suitability Selection of DIM Appropriateness of DIM service Suitability of portfolio construction Suitability of portfolio selection Suitability of transactions Ongoing suitability of portfolio Ongoing monitoring of DIM service On-going monitoring of DIM selection Model A Direct DIM adopts the client as a retail client Model B Hybrid Reliance on others. DIM adopts the client as a retail client but relies on adviser for client information and Adviser Adviser or DIM DIM DIM DIM DIM Adviser Adviser Adviser Adviser Adviser or DIM Adviser or DIM DIM Adviser Adviser Adviser 8

9 assessments Model C Agent as Client DIM does not have a direct relationship with the underlying investor Model D Outsourced Solution Adviser Adviser Adviser Adviser Adviser or DIM Adviser Adviser Adviser Adviser Adviser Adviser Adviser Adviser Adviser Adviser Adviser Model A The advisory firm arranges for the client to have a direct (contractual) relationship with the DIM. The DIM takes full responsibility for all aspects of client investment suitability. Pros; The client investment suitability sits with the DIM, thereby allowing a lighter touch by the adviser in terms of controls and oversight. Cons; The client experience will require duplication of information, several meetings at outset so not efficient from the advisers perspective. Concern may arise out of personal connections developing directly with the DIM personnel. Operating framework variations DIMs may require the Adviser to select a pre-determined investment strategy from a range provided by the DIM. The local investment manager may then have flexibility to vary this strategy within pre-defined caps and collars. As a result the Advisers responsibility and accountability changes and may be more onerous. Model B The advisory firm arranges for the client to have a direct (contractual) relationship with the DIM but the DIM relies on client information and assessments by the adviser (Reliance on others). Pros; The client investment suitability sits with the DIM as in A. The client take on process can be more straightforward and efficient for both the adviser and the DIM, possibly making the client experience more straightforward. The DIM representative can meet with clients if required to do so. Cons; Not all DIMs like to operate in this manner and the interface between the DIM and the Adviser must be well understood. Must not be mixed up with the approach of model C. Model C The advisory firm arranges for the investment management to be carried out by the DIM but on the basis that the client does not have a contractual relationship with the DIM. Instead, the DIM treats the advisory firm as its client, which is acting as the agent of the end investor. 9

10 Pros; Complete protection of the advisers client base as the DIM will not have any details of the underlying investor. Take on process very simple. Supported by many of the Wrap Platforms. Cons; The adviser needs to be clear on what legal and regulatory requirements they need in order to be the client of the DIM. This is not clear in the current rules. As the adviser is taking full responsibility the controls and oversight required needs to be very thorough. In addition, the DIM may treat the Adviser Firm as a Professional Client whereas the Adviser s client is a retail In this case the Adviser firm is accepting the lowest level of investor protection and there is potential for conflict between this and the advisers responsibility to their retail clients. Model D investments. This is the only true Outsourcing option. It can only be used by advisory firms who hold the relevant permissions for managing The new Research and due diligence question sets produced by Diminimis and published in conjunction with the Personal Finance Society asks appropriate questions of DIMs to enable advisers to have the relevant information in order to assess and evaluate the responses. This will give guidance to advisers on the oversight and control arrangements for their firm to adopt. Disclaimer; The document is designed for clients of Diminimis who understand the various operating frameworks and the resultant obligations an adviser will be responsible for. For further information please contact me at david@diminimis.com 10