1. FCA thematic review TR15/12: suitability of investment portfolios

At the end of 2015, the Financial Conduct Authority (FCA) published a relatively short summary of findings from a thematic review of wealth management firms targeted specifically at suitability of retail investment portfolios. This was a follow up to guidance published in 2011 and work carried out in 2012, and so the expectation of firms was relatively higher. Results appear to show some improvement but a worryingly wide variation in quality across firms, including some still falling substantially short of expectations. Five of fifteen firms may be required to undertake significant remediation programmes.

It is clear from the paper that suitability remains a top priority with the FCA, but many firms are still not taking on board the basic requirements on such things as gathering, recording and regularly updating customer information which supports the portfolios being managed. That information then supports the fundamental question of whether the composition of portfolios truly reflects the investment needs and risk appetite of the customer in question, especially those who have a limited capacity for, or desire to expose themselves to, capital loss.

While reiterating the requirements of the previously published guidance, the paper has helpfully included useful examples of good and bad practice. The examples are direct and practical, and the FCA has suggested firms should benchmark their own performance against these. It would be prudent for firms to do this as a minimum.

Given the high profile afforded suitability by the FCA over such a long period of time, it is puzzling why 30% of the firms in the latest review should be found substantially wanting. It seems unlikely that they have deliberately ignored the guidance which leaves complacency and a lack of proactive action as the culprits. CEOs and compliance officers should be asking themselves some hard questions before the FCA comes knocking.

2. Financial Advice Market Review

The much anticipated Financial Advice Market Review (FAMR) was published in March amid expectations of some radical proposals to address a number of perceived issues. The immediate reaction was somewhat muted, with little in the way of high impact suggestions – leaving commentators sifting through the detail for a headline. However, while appearing understated in approach, there are some proposals that have potentially far-reaching implications for the adviser and investment management community.

The Review helpfully sets out its suggestions into three broad categories: ‘Affordability’, ‘Accessibility’ and ‘Liabilities and consumer redress’. Under Affordability it proposes the FCA should set up a dedicated team to help firms develop mass-market automated advice models, though it is difficult to see how this is markedly different from the current Project Innovate and ‘Sandbox’ approach. Without reliable and detailed individual guidance, firms may see this as a token gesture. Of much more interest was the suggested change to the definition of advice by adopting the Markets in Financial Instruments Directive (MiFID) wording, which refers to a ‘personal recommendation’ and is more restricted in its application. This would allow firms to give more pointed guidance, including about the merits of particular investments. On the other hand, it would also open the gate to unregulated firms doing the same.

Accessibility has a focus on employers and how more may be delivered through them. Ideas such as providing a factsheet on what they can do without straying into regulated advice, extending the £150 exemption payment for pension advice and more flexibility on payment for advice in instalments are included, as well as proposals to increase consumer engagement in their financial affairs. It will be interesting to see how employers (big and small) view this, especially if it’s at a cost.

Perhaps most controversial for advisers are the Liabilities and consumer redress comments concerning the Financial Services Compensation Scheme (FSCS), longstop and the Financial Ombudsman Service (FOS). The FAMR supports a review of FSCS funding with some suggestions but nothing new. There is rejection of a longstop for the simple reason it is not seen as being in the interests of consumers, so that door now seems closed. Recommendations around the FOS include ‘Best practice’ roundtables with industry, publishing additional data around uphold rates, and the report of the FOS-appointed Independent Assessor to be expanded to identify process improvements. At best these proposals can be considered light touch and many advisers will consider them a whitewash.

In the end, it is difficult to see how the FAMR says anything fundamentally new or moves things forward much. A missed opportunity?

3. IFAs, DFMs, suitability and responsibility

Recent research suggests that nearly half of independent financial advisers (IFAs) use a discretionary fund manager (DFM) to manage all or some of their client’s investments. This is a growing trend, along with IFAs starting to bring DFMs in-house or working more closely with, and possibly taking a stake in, a DFM firm that they refer clients to. This raises the question of who is responsible for what and is potentially creating a problem for the future.

Many IFAs will take the view that once the client is in the hands of the DFM, they have no further responsibility. Indeed, they may take the view that they are de-risking their business by using a DFM, and that is one of the reasons for using an external investment manager. Likewise, the DFM may be working on the assumption that the IFA takes the majority of the suitability risk and they ‘just run the investment’. In practice they could both be right and wrong. The truth will depend on a number of factors.

Perhaps something overlooked, particularly by smaller firms, is the legal basis on which an introduction to a DFM is made. Contracts and agreements should make clear what is happening and on what basis. If a platform is involved, their documentation should be compatible with the process, particularly where models are used.

Lastly, if the IFA provides information about the client to, or discusses with, the DFM, how much is being relied on to assess suitability (if at all) and who takes responsibility if it’s defective? 

Perhaps the most important thing in all of this is to be clear with the client. The acid test is whether a client understands who is taking responsibility for what and, by inference, who they are paying for what service. If something goes wrong, who gets the complaint? If firms are comfortable their clients could answer those questions, then they should be fine.

4. Retirement income market study and competition law compliance

On 11 March the FCA announced that as part of the Retirement income market study, it had reviewed a number of distribution arrangements and minutes of meetings. Concerns were raised as some of the meetings “appeared to operate without any competition compliance protocol to prevent the disclosure of commercially sensitive information.”

As a result, several letters were sent to firms putting them on notice of potential infringements of competition law, an action similar to that of the Competition and Markets Authority's (CMA) practice of sending warning letters. The firms involved have been asked to review arrangements, update their competition compliance protocols and ensure key staff receive competition law training. If firms engage with actual or potential competitors, particularly if distribution and marketing arrangements are in place, they should take care not to disclose any commercially sensitive information. How that will sit with new requirements under MiFID II that require distributors to provide information to product providers (the definitions of provider and distributor are potentially very wide) remains to be seen. No doubt the relevant FCA rules and guidance on this will give this appropriate consideration.

This is a first for the FCA and serves to illustrate they are taking their responsibilities seriously in this new area of regulation for them.

5. Robo-advice

Hardly a day goes by without robo-advice being in the news for one reason or another.  Despite the lack of a proper definition, commentators, experts, legislators and even the regulators make frequent reference to this ‘phenomenon’. The FAMR only encourages this.

Recent market volatility has focused the spotlight on how robo-advice services cope when investors get nervous. In the US, where services are more developed, there were noticeable increases in the number of calls from worried investors. Providers have been upbeat about how they have dealt with these and have reported that very few clients (less than 1% out of 63,000 accounts in one instance) have changed their risk profile or portfolio composition as a result.

With banks looking to re-enter the advice market and many firms talking about using robo-advice in whole or part for their services, what are the key compliance risks and considerations currently being highlighted? Former regulator David Severn has articulated some of the concerns, including the segmentation of consumer financial needs without attempting to see the big picture, resulting in products which fit poorly with their overall needs and leaving others unmet. He has also pointed out that action and emphasis at the moment seems to be on the ‘supply’ side, with a lack of reliable information on the ‘demand’ side, eg, how consumers actually make use of online financial services.

There is also a risk that in the haste to develop robo-advice services, regulation will fail to keep up, which will present threats for firms and regulators alike. One particularly sensitive touch point in this respect is the assessment of a client’s appetite for risk. Most advice firms will use a combination of risk assessment tools and an adviser’s skill to analyse and discuss the client’s needs. This is particularly important when the client’s attitude to risk conflicts with their capacity for loss and the risk required to achieve an investment objective. If the FCA accepts that this can be done by a questionnaire, does that mean an adviser can rely on the same without the usual discussion? There is a real danger that a two-tier regulatory requirement subtly develops around suitability where there is a lower expectation for the automated robo-adviser compared to what is expected for the thinking type.