Wealth Management Thematic Review December 2015 Thursday 07 Jan 2016

Wealth Management Thematic Review December 2015

Background and results

The FCA has published its thematic review on suitability of investment portfolios in the wealth management sector (thereview) this month (TR15/12).  The review set out to investigate how wealth management firms and private banks have implemented the regulator’s previous work in this area (the FSA carried out a previous thematic review on suitability in 2010 and followed this up with a “Dear CEO” letter in 2011 and approach document in 2012).  

The FCA reviewed 150 files from 15 firms as part of the review. In relation to the firms themselves, the FCA found that one third of the firms were considered to raise no substantial concerns, one third required some improvements to meet the FCA standards and the final third fell substantially short of the FCA’s expected standards. When looking specifically at the file review, almost a quarter (23%) of the files reviewed indicated a high risk of unsuitability and more than a third (37%) were unclear, while 41% show a low risk of unsuitability. While overall, the FCA did see progress on their previous work on suitability in the wealth management sector (previously the risk of unsuitable or unclear files was 79% as opposed to 59% in this review), there is clearly more work to do in this area.

Governance and oversight

The FCA is clear that delivering suitable advice and products to clients comes from the culture of the firm, and it expects firms to “have robust governance arrangements” to facilitate such a culture. The FCA found that some firms appreciated this and had senior management, compliance and other staff with a “common understanding of how customer interests were paramount in their delivery of portfolio investment management services”. As part of appropriate governance arrangements the FCA expects firms to have effective oversight arrangements in place so that risk to clients is proactively monitored and managed.

Good practice in this area included firms whose CEOs were actively involved in their compliance committees and where firms could demonstrate a "close working relationship between compliance and senior management". Examples of poor practice included a firm where the CEO "struggled to describe the culture within the firm".

Key messages

The review contains a number of issues which the FCA highlights for firms to consider together with examples of good and poor practice, including:

Over-reliance on tools – while the FCA appreciates that the use of tools (including risk profiling questionnaires) can be useful and can promote discussion between the portfolio manager and the client, there are risks involved (particularly when using automated tools). When it uses tools, the firm should ensure that they are only used for the circumstances they are designed for, for the intended target market and should always be sense checked. Examples of poor practice included an initial risk questionnaire for a joint discretionary account which had little or no input from the second account holder, leading to possibility that an inappropriate risk profile had been selected for the clients. Good practice included a risk profile which clearly demonstrated that the client accepted a high risk of loss and subsequent volatility.

Inconsistency – the FCA made clear its expectations that firms ensure that a consumer’s investment portfolio matches the underlying information it collects on the client. The FCA found in a number of instances there was material inconsistency between the information provided by the client and the client’s portfolio. Examples of poor practice included a client’s portfolio which held a high proportion of cash holdings (in excess of the model portfolio approach), despite the client’s risk profile document indicating that they had an aggressive risk appetite. Good practice examples included a client with a documented high tolerance for risk having their assets invested accordingly. The firm had also documented that this client had significant other assets and that this portfolio was to be managed in isolation to the client’s other assets.

Updating records – the FCA expects that firms providing discretionary and advisory portfolio services are able to demonstrate that the client information used to establish the portfolios has been kept up to date. If out of date information is used, there is a real danger that the investment portfolio will become inconsistent with the client’s circumstances, needs and risk appetite. Poor practice included instances where client information had not been updated for several years, and a negative attitude by client relationship managers towards keeping client information up to date (seeing it as a regulatory burden rather than an integral part of their service to the client). Good practice included firms who proactively contacted clients in order to update their records and who were able to demonstrate that they had systems in place to support this process.

Conclusion

The wealth management sector needs to ensure suitability remains a priority. The outcome of the review indicates that the FCA will continue its spotlight on wealth management firms and portfolio suitability especially in light of the forthcoming MiFID II changes.  The examples of good and poor practice in many cases reflect common sense and at least the FCA is focusing on practical guidance and examples.  As is so often the case, the FCA has said it needs to see evidence and firms who are able to document and demonstrate suitability will be in a much better position in being able to demonstrate suitability. Suitability must not only be done, but be seen to be done.