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Advisers call on the FSA for clarity on capacity for loss

by Jun Merrett on Nov 28, 2012 at 10:47

Advisers call on the FSA for clarity on capacity for loss

A recent survey has revealed that many IFAs find the regulator’s guidance on how to assess and record investors’ capacity for loss unclear, so focus only on attitude to risk.

Advisers have called for more guidance from the Financial Services Authority (FSA) on assessing client capacity for loss, as a new survey shows the majority feel they have been left in the dark by the regulator.

The FSA has raised concerns that advisers are not properly taking into account capacity for loss, claiming in its 2011 guidance paper on investment suitability that some IFAs were ignoring the issue and focusing only on attitude to risk.

But advisers have argued the regulator needs to give more detail on what it expects from firms, with 73% respondents to a survey conducted by fund group Architas calling for clarity.

In its 2011 paper, the FSA said only that it expected advisers to have in place a ‘robust process’ for assessing investor attitude to risk, and said an example of good practice was one where risk attitude and capacity for loss were assessed separately.

Only 17% of those surveyed said the FSA’s guidance was clear, while 12% said they had not paid much attention to the recommendations.

'Alarming’ figures

Chris Hannant (pictured), policy director at the Association of Professional Financial Advisers, said the figures were ‘alarming’.

‘It is a substantial number and I would have thought [assessing capacity for loss] would be a touchstone that you come back to quite regularly because it might change,’ he said. ‘If you’re having a proper advice session, you cannot have that without discussing capacity for loss.’

However, he argued that many advisers may be adopting the right processes but failing to document it properly.

‘I wonder if it’s done implicitly rather than explicitly? The worrying thing for me is if the FSA says you’ve got to do this, and you can’t document or prove it [because you might not understand what you do specifically as a capacity for loss process], then you’re potentially for the high jump when things go wrong.’

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15 comments so far. Why not have your say?


Nov 28, 2012 at 12:02

Ahhh, once more we start chasing our own tails regarding an edict from the FSA. How do we document this? How do we set up a robust process to ensure this requirement is taken into account?

You can show many charts, ask many tick box questions, but it is a matter of feeling. If clients want to take more risk than is healthy for them, do not do it!

As the FSA is a bureaucracy who mainly deals with complaints and public protection, manned by a workforce who understands the tickbox mentality, but little about advising and client relationships, they are asking for the impossable. By formulating a robust system or approving a method they leave themselves open to critisism if it goes wrong. Trust me there many amongst us who would exploit any approved system in order to gain more sales to the detrement of client's welfare.

Just do what's right for the client, not your own income!

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Nov 28, 2012 at 12:14

Define Robust?

Use ATR questionnaire and output as a guide only

Have grown up conversation with the client

Ensure that the client is happy with the conclusions drawn

Document it - Have the client sign it

The regulator will always point to the rule book and say that they think it is clear etc etc.....

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Nov 28, 2012 at 12:23

Hickky I agree, the problem is the claims companies, today I have had so far three texts, I get about three a day at the moment telling me I can claim thousands of pounds.

They could not do this if we have received and followed a set down process by the regulator. It would be a change for the regulator to provide something other than guidance. The problem with guidance is you can sit on the fence and decide in retrospect and with knowledge of the outcome what you actually meant.

The problem with Guidance is:-

I know you believe you understand what you think I said


I’m not sure you realise that what you heard is not what I think I MEANT.

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Luke Skywalker

Nov 28, 2012 at 12:25

Surely if an adviser does not understand capacity for loss and it's distinction from ATR then they should not be advising.

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Julian Stevens

Nov 28, 2012 at 12:35

I cannot help but think this whole subject is largely surplus to requirement, not least in view of the reams and reams of risk warnings we already have to set out for clients.

1. The value/s of investments in funds of this type will (not merely may) go down from time to time.

2. You should approach investments of this type as a medium (not less then five years) to long term proposition.

3. Positive returns on investments of this type are in no way guaranteed.

4. If you encash this investment after only a short term, there is a strong possibility you could get back less than the sum/s invested.

5. The worst case scenario is that all the funds across which we will be spreading your investment/s collapse without value and you could therefore lose everything, though the likelihood of this happening is remote.

6. If you cannot face these risks, then investments of this type are not for you.

7. You should not commit all your money to investments of this type. It will be wise to maintain an adequate reserve of readily accessible cash savings in case of disaster.

For Christ's sake, how much more clearly does the risk of loss need to be explained and spelled out? Does it really need to be quantified down to the last penny? No, of course it doesn't. Except in the minds of some committee of arnchair theorists within the FSA who appear to be obsessed with achieving the unachieveable.

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Phillip H

Nov 28, 2012 at 12:45

Luke, could you please explain to me in simple terms (as if I was a client) the concept of capacity for loss and how this affects ATR (and perhaps how you doument it).

Understanding capacity for loss is one thing, proving you have accounted for it in the correct way is another.

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Nov 28, 2012 at 13:16

@ Martin IFA

You poor deluded soul, you believe the reams of warnings we give, and the quantified advice is any defense to a claims company?

They do not have to read anything, they do not even need to ensure any advice was given, or when, or even if a loss has occurred.

Trust me, the legal industry is so pernicious, lacking in ethics and venal that no matter what processes have been undertaken there will always be a counter argument.

As a society we need to put a full stop to the 'no win no fee' arangement, and limit the total amount paid for a single civil case under Legal Aid. Then we will stop the pernicious civil suits that ruin society.

Misselling is not about the rights or wrongs about the sale, its about adhering to the absolute letter of the procedural rules laid out after the event. If lawyers want to get you they will, regardless of the merits of your advice. It's laid down procedures that give lawyers a toehold. So lets abandon the reams and reams of regulation and stick to a few basic principals of honesty, considered advice, openness and training. All the rest is just guff to appease the legal profession, but does little to benefit the client.

Mind you what's the chance eh?

The FCA should take up this challenge, prosecute the greedy and send them to jail, and ensure the incompetant have no place in this industry.

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Luke Skywalker

Nov 28, 2012 at 13:28

Fair point Philip. What I meant by my comment is that we should understand the concept of capacity for loss as a basic concept, advisers who invest every last penny for a client with no regard for their ability to manage their finances through a period of loss - via adequate short term cash holdings - should not be advising. Their soul interest is in reaping as much fee as possible, not in giving sound advice.

Documentation is a pain in the..... Personally I use two questionnaire's one for risk the other for loss and discuss each with the client. Agreed not a simple process!

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Philip Wise

Nov 28, 2012 at 13:38

The reason it is clear is because the concept is flawed. Why should we be investigating a clients ability to accept a return of less than 0% per year? Surely we should be looking at our client's ability to accept a failure to achieve their goals? What does a less than 0% per year return have to do with the income someone will want in retirement, or with the failure to be able to pay school fees which have gone up by more than expected?

If the FSA had asked some practitioners, they could have come up with a practical way of dealing with this, but they didnt, so they have a flawed concept, which helps no-one.

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Nov 28, 2012 at 14:15

Hickky, thanks for that, made me smile and unfortunalty I have to agree.

True ID is Martin Evans PRISM Independent Financial Advisers, I was in FT Adviser last week supporting regulation of these claims companies as it has got out of hand.

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Jonathan Kirby

Nov 28, 2012 at 14:31

Capacity for loss is unfortunately the wrong phrase.

I prefer to use 'Capacity to weather a financial storm'.

If falling markets/income are going to have a significant impact on the clients standard of living then it is time to be wary for them.

On the other hand I have a very cautious client who, because of his amount of cash on deposit and small amounts invested in collectives, has a very high capacity to wait for times to improve and, if he lost the lot, wouldn't really notice it.

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Will Watling (Capita Financial Software)

Nov 28, 2012 at 17:37

ATR & CFL are two diff things. Generally ATR is a psychometric measure where as CFL is goal specific & therefore proportionate to the amount that goal represents of the client's overall wealth & income, etc. It is therefore possible to clearly state for any portfolio / goal what the projected stochastic loss over say any 12 months, may be. If you then ask the client in 12 months when you do their review if their fund has suffered a loss of X% whether they'll accept that vs the goals objectives, you'll get a clear response - it may mean they won;t be able to retire when they want, etc. The language used to express CFL therefore has to be clear & understood by any investor. Clearly having read all the comments above, this is a challenge we have as an industry, so I'd support any clarification of it to help advisers understand what's expected.

The issues we often see are:

a) where firms allow multiple tools to be used to assess the client's ATR & quantify them e.g. 1-10 but not quantification of CFL. Often the ATR tools map to different risk rated portfolios that don't share the same assumptions. I've seen one 'balanced fund have 25% equity exposeure with another having 65% - which is 'balanced? This can result in solutions being recommended that don't align with either the ATR or CFL.

b) where language used to explain the risk of a portfolio isn't understood by a client or aren;t specific enough so a claim can;t be defended later. e.g. fund X has a standard deviation (volatility) of 10.5% with +/- 10.5% either side. This is meaningless unless you state what the 'standard' is or a fund could fall by -5% each year but not by more than -5.5% p.a. & meet it's mandate. Ironically if it started to grow & it's volatility was then higher the fund manager would have to reign in the performance so the vol threshold wasn't breached! Do most adviser let alone clients fully understand that?

We do therefore need a consistent measure & terminology that everyone can understand & can be applied to any client, portfolio, goal, etc. I've come acorss 3 cases recently where aledgedly FOS found in favour of the client because 1 fund in a portfolio had lost more than the client was prepared to tolerate. I expect the adviser had explained about the portfolio's performance, but clearly the client had heard something diff.

Is there some equivalent to an APR (for loans) that we could use in the investment market which everyone would understand & disputes measured against?

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Julian Stevens

Nov 28, 2012 at 18:24

So CFL applies really only when an investment is to be made with a specific future redemption date in mind? Given that nobody's likely to invest money other than in the hope and expectation of growing their capital then, in the context of a long term commitment, the primary consideration is how much in the way of ups and downs in paper valuations along the way they're likely to find tolerable, rather than what the realisation value may be at any given date 7, 10 or 15 years hence. CFL doesn't really come into it.

When discussing ATR for a retirement income portfolio, I tend to take the liberty of suggesting to the client that, in this particular context, his time horizon is the rest of his life. None has ever disagreed with that suggestion. What that type of client wants is stablility of income and, to achieve that, a portfolio unlikely to suffer violent fluctuations in value is a given.

In response to questions about CFL, most clients will answer None ~ I don't want to lose any money at all, I want my money to grow. Isn't that why we all invest? Which brings us back to the issue of how much in the way of ups and downs the investor is likely to consider tolerable to achieve over the medium to long term a rate of return that's better than inflation.

What clients need to understand is that nothing is for nothing ~ if you want better returns than inflation (which you almost certainly won't get from cash), then you're going to have to accept some ups and downs along the way over the medium to long term. But, if you want your money out without loss within a specified time frame, particularly a fairly short time frame, then investments that, from time to time, are likely to fall in value as well as rise may well not be suitable.

it isn't rocket science but, as I see it, all this talk about CFL is attempting to make it so.

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Adam Owen

Nov 29, 2012 at 06:48

This article is missing a key point and appears not to have given the FSA a right to reply. The FSA followed up the March 2011 Assessing Suitability paper with a series of roadshows throughout the country. On this topic, more than any, the regulator have been very willing to engage and explain their position. If, as 73% of respondents to the survey suggest, the message has got out then maybe the FSA should take out some double page adverts in New Model Adviser promoting these rather than just publishing them clearly on their own website. Alternatively, advisers could just regularly check the FSA events calendar and book in to a local roadshow.

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Will Watling (Capita Financial Software)

Nov 29, 2012 at 15:43

Julian, I disagree. CFL does apply throughout the investment not just at the end. If the client's prepared to take more risk to hopefully get more return, then if they are unfortunate & do suffer a paper loss, does that mean they'll miss their retirement target? This may or may not be an issues to them depending on how much more they could invest to make up the difference & what impact that would have.

If a 'cautious' client doesn;t want to loose any of their portfolio then are they prepared to pay xbps for guarantees, etc where the CFL will be 0%. Over a long period of time that may give a better return. Don;t forget if your Adviser Charges are based on xbps of FUM, then you're also saying that you're prepared to see your income go up & down, or it could be guaranteed.

Horses for courses - hence the FSA's request to assess ATR & CFL separately.

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