Yesterday’s FSA Retail Conduct Risk Seminar on assessing suitability went under the title ‘Establishing the risk a customer is willing and able to take and making a suitable investment selection’. The words ‘willing and able’ are key. The FSA and FOS are placing increased emphasis on the capacity for loss investors are able, as well as the degree of risk they are willing, to take.
The seminar followed up the finalised guidance of March 2011 (under the same snappy title), with the FSA taking the opportunity to emphasise that they were alarmed by the number of quite fundamental mismatches between investors and investments revealed by their review work. The guidance was described as being aimed at the ‘low hanging fruit’; a starting point to ensure firms get the basics right and a platform for the firms’ more sophisticated approach to assessing suitability by reference to their particular business model and client base.
In the introduction, the FSA’s Head of Conduct Risk, Nausicaa Delfas, acknowledged that many of the recent problems with suitability arose because clients were chasing better returns in the low interest, post credit crunch environment. This created clients who wanted to take greater risk to achieve better returns but were often not able to. The asymmetry of information and understanding between the adviser and the client placed a burden on the adviser to be sure that the client was not simply saying – and hearing – what they wanted to.
During a role play example of an advisory client meeting, the FSA emphasised the importance of establishing a client’s attitude to risk and, through detailed questioning and a well planned and thorough conversation with the client, the amount of risk the client is able to take. This ought to reduce the prospect of risk ‘creep’ whereby a client, liking what he hears about the returns possible, agrees that he is, say, a medium risk investor which then enables the adviser to recommend products or asset allocation which includes elements of far greater risk than the client’s true attitude to, and ability to take, risk should allow.
During panel discussion, the FSA confirmed that ‘capacity for loss’ is a distinct concept but related to attitude to risk and it ought, therefore, to be considered separately. Caroline Mitchell, Lead Ombudsman for investments and pensions reinforced the message by noting the FOS’ interest in testing an investor’s prospects of replacing losses as a key component of capacity for loss. The panel, whilst recognising the relevance of ‘risk need’ (i.e. to meet investment objectives), repeated the message in the guidance – that a client’s expectations may have to be managed.
Unlike the two PRA speeches yesterday, none of the suitability seminar speeches has yet been published on the FSA’s website, suggesting the FSA did not believe it was saying anything new. The FSA’s message, however, was clear and from now on we can expect a less forgiving approach to any ongoing suitability failings. Firms must use appropriate risk profiling tools properly and engage in full, structured discussions with clients to establish (and document) all relevant aspects of suitability and then make a recommendation of a suitable investment. If an instinctively cautious client ought to be advised to leave their money where it is, advisers may end up spending a lot of time, conducting substantial KYC, to no avail. In a post-RDR, adviser charging environment, I can see a new type of complaint arising – fees paid for nothing!