The way advice firms assess the amount of risk a client should take with their investments came under the spotlight this month, as the Financial Conduct Authority (FCA) published its latest guidance consultation on the financial advice market review (FAMR).
The FCA’s paper addressed important questions about how firms establish clients’ attitudes to risk. An important question is how these expectations apply to an array of face-to-face, streamlined and automated robo-advice services.
COBS rule 9.2.2R(2) says a client’s investment objectives ‘must include, where relevant, information on the length of time for which they wish to hold the investment, their preferences regarding risk taking, their risk profile, and the purposes of the investment’.
Last week the FCA reiterated its guidance from its predecessor the Financial Services Authority’s 2011 Assessing Suitability FG 11/5 report. This outlined that when assessing suitability, the client’s capacity for loss should be taken into account.
It stated: ‘If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk they can take.’
The regulator highlighted risks in the design of risk profiler questions. It said when questions are not clearly worded or the content is unlikely to be understood, clients may not give answers that accurately reflect the risk they are comfortable with.
If a question uses vague or complex language, or assumes a basic level of financial knowledge on behalf of the client, or is structured in such a way as to invite multiple answers, the data could be incorrect.
Kay Ingram (pictured above), director of public policy at national IFA LEBC Group, said getting a full appraisal of a client’s circumstances is a difficult task for fully automated services.
‘If you have a fully automated service, it is difficult to challenge and affect the decision-making process of the individual filling in forms, and to gauge whether they have understood what they’ve been asked and why,’ she said.
‘This is essential in establishing whether the client has the capacity for loss to absorb possible falls in value.’
The best-known automated investment provider is Nutmeg. Responding to the FCA’s remarks it was adamant its own process was not flawed.
‘We believe Nutmeg is already compliant with these requirements from the FCA,’ said Nutmeg’s head of financial advice Lisa Caplan.
‘Three of the concerns raised in the consultation were that language must be clear, investment objectives should include the client’s timeframe where relevant, and capacity for loss should be tested. All of these are things we cover.
‘It is possible some firms might need to revisit their risk profiling, especially when it comes to FCA requirements that are less definitive. We have checks built into our risk profiling questionnaire designed to highlight where customers do not appear to be fully engaged with the questionnaire. For instance, if a customer consistently chooses the “neither agree nor disagree” option.’
Ingram said LEBC offered a ‘bionic’ proposition, automating fact-finding, but with human contact at the end.
‘Robo advice is fine if you just want to put £4,000 into your grandchild’s ISA or put away £50 a month in savings,’ she said. ‘But for transactions that need more thought, such as ensuring you have enough money to retire, you need someone opposite you challenging the thought process. If not, how do you know the person filling out the form was concentrating?’
Keith Richards (pictured above), chief executive of the Personal Finance Society (PFS), said future ‘systemic failings’ could arise if clients with a wide range of financial comprehension, fail to understand each question.
‘This is important for fully automated services where a client may not get clarification on questions from an adviser,’ he said. ‘In these cases, risk assessment would rely on the client’s ability to understand and independently respond to the questions they are asked, which is where potential future systemic failings could arise.’
The FCA also flags what it sees as poorly worded risk descriptions as a danger to suitability.
One example the regulator gives is the use of textual statements such as ‘you are a sensible investor’, which it characterises as ‘misleading, judgemental, emotive or not objective’.
The FCA said: ‘Language such as this can inappropriately influence rather than validate the level of investment risk the customer is willing to take’.
The FAMR has seemingly uncovered flaws in the approach some firms take to categorising answers to client questionnaires. For instance, where the customer has the option of answering ‘neither yes or no’, which may lead to them being assessed as having an attitude to risk that falls in the middle of the risk spectrum.
This could fail to capture genuine non-answers in which a client has no idea how they would approach a particular scenario.
A greater problem for fully automated advice propositions is the client must rely on the questionnaire for an understanding of their exposure to risk. The client does not have the option of asking a trained adviser to clarify.
Ingram said: ‘Challenging clients and not just taking orders is key to achieving the right outcomes,’ she said. ‘We distinguish between hard and soft facts: the hard being things like age, salary, assets, and the soft being the state of your relationship with your partner and whether you might want to move jobs in the future.
‘If you want to avoid inheritance tax, a basic automatic service might tell you to start transferring money to your son, but if you have told an adviser your son is notoriously irresponsible with money, the recommendation will be different.
‘Advice is not just about picking funds, and the regulator doesn’t quite get that.’ It is likely many robos will have to rethink their initial fact-finding processes.
An important focus of the FCA’s paper was so-called streamlined advice. One of the FAMR’s stated aims is to create a framework for streamlined advice on a limited range of customer needs that will include illustrative case studies.
The FCA warned advisers its expectations would be no less exacting when it came to streamlined advice, in particular regarding investments.
‘In general we would expect that the more complex, highly concentrated or illiquid the product, the more likely it is firms will need more information about the client’s broader portfolio to meet the firm’s suitability obligations,’ the FCA said.
Another eagerly anticipated verdict was from the Financial Advice Working Group on amendments to the terms ‘advice’ and ‘guidance’. The review panel has recommended the terms stay as they are, albeit with greater clarity for consumers over their definitions.
In an introduction to the findings, Working Group chair Nick Prettejohn (pictured above), chairman of Scottish Widows, said there was ‘no evidence changing the terms will improve consumer understanding and no strong support for any of the alternative names.
‘There is strong evidence of traction with consumers once friendly explanations of the terms are used in conjunction with the terms themselves,’ he said. ‘There is greater traction when the explanations are used as a pair, rather than on their own.’
Consultant and former FCA technical specialist Rory Percival said: ‘The current terms are the best you are going to get. Knowledge and understanding among the general public of financial issues is not good and is not going to be much better for the foreseeable future.
‘It is similar to the independent versus restricted discussion, whereby restricted is best understood, but it is still not a fabulous result. All you can do is make it as clear as possible when explaining it to consumers.’
The FCA set out a timetable for the FAMR consultation, which features proposals on streamlined advice, fact-finding processes, employers’ fact sheets, and non-advised services. It aims to publish a full policy statement in December 2017.
Hugh Savill, director of regulation at the Association of British Insurers, said: ‘There is a long way to go before we can say affordable and accessible financial advice and guidance is there for everyone at all stages of their lives. In view of the major changes to the British pension system, this is a key objective.
‘The current timetable envisaged for the FCA to produce its final requirements leaves firms little time to get ready for the implementation of Mifid II in January.’
However, Percival disputed this. ‘The Mifid II paper came out last year, so while there is a question mark over the final rules, the bulk of the information is there,’ he said.
‘The latest FAMR guidance consultation is not necessarily setting out new rules so much as laying out guidance, so most firms will not have to make any substantive changes.’