We are currently at a crucial stage of the regulatory process in relation to Simplified Advice processes. The purpose of this briefing is to explain what Simplified Advice processes are, how they are categorised for regulatory purposes under the rules of the Financial Services Authority (“FSA”) and the regulatory obstacles that currently raise a question mark as to their future commercial viability.
What are Simplified Advice processes?
Simplified Advice is the term used by the FSA to describe a streamlined advisory process under which personal recommendations are made to retail consumers in relation to a defined group of low investment risk financial products. The need for streamlined advisory processes reflects a wider public policy objective of encouraging retail consumers to save for their medium and longer term financial needs1.
Simplified Advice processes are intended to operate as a middle tier service, falling somewhere between
comprehensive financial planning advice on the one hand and execution-only services on the other hand. In part, this recognises the fact that full financial planning advice continues to be the preserve of mass affluent and high net worth retail consumers and is unlikely to be attractive to other retail consumers, whether on cost grounds or because of the comparatively straightforward nature of their individual circumstances and needs.
One of the perceived advantages of Simplified Advice processes is that they can be delivered in a number of different ways, including through the internet, by telephone or on a face-to-face basis. This makes it possible to devise Simplified Advice processes that are fully automated with minimal human involvement.
How is Simplified Advice categorised for regulatory purposes?
Simplified Advice has developed as a distinct concept in the context of the FSA’s Retail Distribution Review (“RDR”), itself a radical and far reaching overhaul of the way in which investment products are sold to retail consumers through advisory channels. Although the FSA was previously more open to the idea of streamlined processes being
categorised as non-advised services, it has been clear for some time that its preference is for these processes to be treated as advisory in nature. This change of emphasis has been reinforced by a change of name to Simplified Advice2.
Since then, the FSA has confirmed on more than one occasion that it will not create a dedicated regulatory regime for Simplified Advice. This contrasts with the approach taken in 2005 in relation to Basic Advice, which was introduced as a new form of regulated advice to facilitate the sale of a limited range of charge-capped saving products. This means that Simplified Advice processes will be treated as a form of investment advice for regulatory purposes in common with full financial planning advice and other advisory services falling outside the scope of Basic Advice.
Interaction with European law
The concept of investment advice under FSA rules is derived from the Markets in Financial Instruments Directive (“MiFID”), which was implemented in the UK on 1 November 2007. Suitability requirements apply under MiFID wherever investment advice is provided to a client in relation to a specific type of product or service falling within the scope of the Directive3. These requirements are reflected in Chapter 9 of the FSA’s Conduct of Business Sourcebook (“COBS”) and will need to be satisfied wherever Simplified Advice relating to most types of investment product is provided to retail consumers.
The FSA has an obligation to apply the requirements of MiFID and this naturally limits its ability to disapply parts of its suitability regime in COBS 9. The FSA’s reluctance to create a dedicated regulatory regime for Simplified Advice may be explained, at least in part, by an unwillingness to run the risk of arguments that it has failed properly to implement MiFID.
What are the regulatory obstacles?
A number of UK retail banks and insurance providers have expressed interest in Simplified Advice as a potential customer offering and have invested time and effort in investigating the feasibility of business models based on Simplified Advice. The appetite of these firms to develop these models is likely to be closely linked to the way in which the new professional standards being introduced under the RDR and the FSA’s suitability regime in COBS 9 are applied in practice to Simplified Advice. These issues, which are the subject of ongoing debate between the FSA and industry, are discussed in greater detail below.
1. Professional standards
One of the fundamental changes introduced under the RDR is to require retail investment advisers to hold a minimum level of professional qualifications. This level will be set at Qualifications and Credit Framework (“QCF”) Level 4 or equivalent, which broadly equates to a first year degree level standard. Concerns have been raised within industry that requiring advisers who provide only Simplified Advice to meet this standard will make Simplified Advice processes commercially unattractive, whether on cost grounds or because of the staff retention issues that may arise where advisers are trained to a higher standard than that required to operate a Simplified Advice process.
While the FSA recognises that it may not be proportionate to expect advisers providing only Simplified Advice to be qualified to the same level as advisers providing full financial planning advice, it is concerned that allowing the former to operate at a lower qualification standard could undermine its efforts to increase professionalism in the retail advisory sector and confuse consumers. Any compromise may therefore be focused on tailored course content for these advisers at a uniform QCF Level 4 level rather than on the adoption of a lower qualification standard.
The FSA expects industry to put forward a proposal regarding course content for advisers providing only Simplified Advice and it is hoped that this will form the basis of a constructive solution. Some firms may be tempted
to focus their efforts on the development of automated processes for the delivery of Simplified Advice (for example, internet based models) that minimise human involvement in the advisory process and mitigate the extent of the issue.
2. Application of suitability rules
Significant concerns remain in relation to the application of the FSA’s suitability regime in COBS 9 to Simplified Advice processes and, in particular, how those processes would be viewed by the FSA and the Financial Ombudsman Service (“FOS”) in the conduct of their normal day-to-day supervisory and enforcement activities.
The FSA’s view is that Simplified Advice processes can be provided within its current suitability rules. However, it has thus far failed to engage with industry in any detail on how those rules would apply in practice to Simplified Advice processes, merely confirming that firms providing Simplified Advice will only reduce their potential liability by ensuring that they deliver suitable advice. This is
attributable, at least in part, to a lack of agreement at industry level regarding the design and structure of Simplified Advice processes and the types of investment product that they would be able to recommend. In light of this, it seems clear that any attempt to engage the FSA on the regulatory treatment of Simplified Advice processes will first require industry to reach consensus on a form of Simplified Advice model, including the types of investment product that it would be capable of recommending.
Understanding how the FOS would examine questions of suitability in the context of customer complaints is clearly crucial to any firm that decides to develop a Simplified Advice process. Both the FSA and the FOS will ultimately be required to take into account the same
regulatory rules so it can only make sense for them to work together to develop a common understanding of how the COBS 9 suitability regime should apply to Simplified Advice processes.
There must be a real concern that Simplified Advice processes will fail to get off the ground in the absence of a greater degree of clarity as to the practical application of the COBS 9 suitability regime and the associated enforcement risks. Assuming industry is able to reach consensus on a form of Simplified Advice model, the FSA and the FOS will need to play their part in overcoming this regulatory obstacle by working with industry to achieve a degree of consensus on these matters. This inevitably raises the question of how the FSA’s suitability rules should be applied to Simplified Advice processes and, in particular, what firms should do to ensure that they deliver suitable advice to customers.
What do the suitability rules require?
Under COBS 9.2.1 R, a firm is required to take reasonable steps to ensure that any personal recommendation that it gives to a client is suitable for that client. The qualified nature of COBS 9.2.1 R suggests that it is not necessary for a Simplified Advice process to produce suitable outcomes all of the time. In this respect, further support may be drawn from the analogy with the best execution
duty imposed on firms elsewhere in COBS, which requires firms to take all reasonable steps to obtain the best possible result for their clients, taking into account various specified execution factors. While the best execution duty is set at a higher standard than the obligation under COBS 9.2.1 R (being an obligation to take all reasonable steps), it is widely regarded as being focused on the process used by a firm to obtain best execution rather than whether best execution was actually obtained on a trade-by-trade basis. All of this suggests that a Simplified Advice process need not produce a 100% rate of suitable personal recommendations to meet the requirements of COBS 9.2.1 R, the test being whether the overall process involves reasonable steps to ensure that the recommendations it produces are suitable.
COBS 9.2.2 R (1) requires a firm to obtain from the client the information that it needs to understand the essential facts about him and have a reasonable basis for believing, giving due consideration to the nature and extent of
the service provided, that the specific product to be recommended satisfies the various components of the suitability test. They include that the specific product to be recommended meets the client’s investment objectives, is such that the client is able financially to bear any related investment risks and is such that the client has the necessary experience and knowledge to understand the risks involved. The wording of COBS 9.2.2 R (1) illustrates the inherent flexibility of the suitability rules, making it clear that the information required from clients will vary by reference to the type of service that is being provided. This is particularly relevant in the case of a Simplified Advice process for which the intention is that only a limited rangeb of low investment risk financial products would be available for recommendation.
What factors will determine the level of information required?
A number of factors would be relevant to the determination of the level of information to be obtained in order to assess suitability under a Simplified Advice process. They include:
- The customers for whom a Simplified Advice process is likely to be appropriate and the information needed to ensure that other customers are unable to participate. This may involve obtaining information relating to a customer’s personal circumstances (for example, the customer’s level of personal debt) or the scope of the advice that was being sought. A degree of care would need to be taken to construct effective “filter” questions to take out customers for whom a Simplified Advice process would be inappropriate. Obtaining too little information would increase the risk of the wrong sort of customer being able to access the service while obtaining too much information could raise the wrong sort of expectations in the mind of the customer as to the nature of the service.
- The scope of the personal recommendations being given under a Simplified Advice process. Crucial here would be an explanation to customers of the limitations applicable to personal recommendations given under a Simplified Advice process. A clear explanation of these limitations should avoid the need to obtain the fuller level of information required to assess suitability under a full financial planning advisory service.
- The range of investment products available for recommendation. The features of the products that a Simplified Advice process would recommend will be a crucial determinant of the information that needs to be obtained from the customer to assess suitability. The more complex and/or risky the products being recommended, the more detailed the information that is likely to be required to be obtained from the customer to assess suitability.
- The nature of the personal recommendation given. The more detailed the recommendation made to a customer under a Simplified Advice process, the more information that will be required from the customer to ensure that the product being recommended is suitable. For example, a recommendation to invest in a particular product type without specification of the amount to be invested and the basis on which the investment is to be made (typically, lump sum or regular payments) should require less information to be obtained from the customer than a recommendation that included those details (as the latter would logically require a fuller understanding of the customer’s financial circumstances). A balance must be struck between providing personal recommendations with a sufficient level of detail to enable a customer to make an investment decision and a situation where the level of detail more closely resembles a full financial planning advisory service.
What does this mean in practice?
Firms who intend to develop Simplified Advice processes will need to start with a clear focus on the intended customer target market, the types of product that are likely to be suitable for recommendation to those customers under a Simplified Advice process and the key factors that will determine whether they are suitable for any individual customer.
The nature of a Simplified Advice process is such that there will inevitably be some customers who receive recommendations that are suitable on the basis of the limited form of advice that it offers but which would not be suitable in the context of a full financial planning advisory service. Accepting that this outcome does not automatically lead to a conclusion that a Simplified Advice process has failed to meet the suitability rules in COBS 9 will undoubtedly require a change of mindset on the part of the FSA and the FOS. This may be particularly challenging for the FOS, bearing in mind its tendency to examine questions of suitability under its “fair and reasonable” jurisdiction by reference to the full circumstances of the customer at the time of sale.
What is required is a proportionate regulatory approach for Simplified Advice processes that:
- takes into account the inherent flexibilityof the COBS 9 suitability regime;
- recognises the limited nature of the advisory service offered by a Simplified Advice process;
- accepts that the level of information required to assess suitability can, in principle, be calibrated at a lower level relative to that required for a full financial planning advisory service; and
- acknowledges that this will mean that the yardstick of suitable advice for Simplified Advice will be different to that applicable to a full financial planning advisory service.
Proper application by firms of the factors mentioned above will be crucial in persuading the FSA and the FOS to accept this approach. Of particular importance in this regard will be the ability of firms effectively to communicate the limitations of a Simplified Advice process to their customers and to demonstrate that they have understood those limitations.
Firms should also test and monitor the consumer outcomes achieved by a Simplified Advice process and use the information obtained to review the process and consider whether any improvements should be made4.
We hope that the FSA and the FOS will prove receptive to constructive debate and fresh thinking on the application of suitability requirements to Simplified Advice processes. It would be particularly unfortunate if an unwillingness on the part of the FSA and the FOS to accept the practical consequences that inevitably flow from the inherent flexibility of the COBS 9 suitability rules resulted in their ossification at the level of the fullest advisory service (namely, full financial planning advice). At the very least, this “one size fits all” approach could prejudice the future viability of Simplified Advice processes and stifle other forms of innovation in the advisory sector. It may also be inconsistent with the rules themselves, which have been deliberately crafted to be flexible at the level of the advisory service being provided.