The co-author of the FSA’s recent ‘Dear CEO’ letter on suitability has urged wealth management businesses not to be afraid of running bespoke portfolios in the future.
Richard Scrivener, who recently left the FSA’s conduct and risk team to join consultancy Bovill, said he was concerned the regulator’s ongoing suitability review might cause firms to shy away from running bespoke portfolios in favour of models, which isn’t what the FSA is seeking to do, he said.
‘Don’t be afraid of bespoke portfolios. If it is a bespoke portfolio, say it is a bespoke portfolio and the regulator will see it as a bespoke portfolio.
‘As there is such a focus on suitability there may be a temptation to say, “We have to categorise all of our clients and slot them into a box”. But the problem with this is the regulator will look at the box and say “medium risk has been ticked, yet the client is 100% in overseas equities” and ask “why is that?” If a client wants 100% in overseas equity that is fine as long – as it says so in the client’s documentation,’ Scrivener explained.
Scrivener’s comments follow an FSA review of 16 wealth management firms in which the FSA concluded that 14 of the 16 posed a high or medium-to-high risk of detriment to their clients, with four out of five files deemed unsuitable for clients or their suitability could not be determined.
In addition, two out of three files were not consistent with the firm’s in-house models or the client’s documented attitude to risk. There was often no record of the client’s financial situation, or firms had failed to obtain enough information on the client’s experience and objectives.
Scrivener, who helped draft the recent ‘Dear CEO’ letter during his time at the FSA, said the regulator had been confused by firms putting information forward in client files under review without proper explanation.
The ‘Dear CEO’ letter was published in response to the findings from the review of wealth management firms alongside the FSA’s Assessing Suitability Guidance published back in March.
Scrivener said the FSA had taken issue with firms that have actively promoted their model portfolio ranges, stressing risk and investment committees as part of a detailed process as a unique selling point, and then delivered something different to the client.
‘If you are going to set this out for the client in your marketing blurb to get the client through the door, then at least follow this when you are actually delivering the service to the client. In certain circumstances, this was not the case,’ he said.
He said the FSA was not seeking to push firms towards a model approach, but rather stressed the importance of consistency in outcomes for consumers with similar circumstances and objectives.
‘There is clearly a need for accelerated vigilance and having highly detailed control mechanisms in place to make sure the outcomes you are getting for clients are consistent and suitable. What the FSA tended to see was clients with similar mandates and yet widely different portfolios, but nothing on file to say “this is why these are different”.’
He also pointed to laxity over the discretion awarded to portfolio managers within the same firm as another reason for inconsistencies. There had been evidence of confusion over the service the client had signed up for in relation to what they were actually receiving in terms of it being an advisory, discretionary or execution-only mandate, he said.
Scrivener stressed the multi-faceted nature of the suitability question, which includes the incompatibility between portfolios and the clients’ attitude to risk alongside an inability to demonstrate suitability, which could come down to out-of-date information.
There can be many reasons behind this, including whether procedures specify a uniform file structure, whether record-keeping is covered in staff training and client information is periodically updated.
Acquisitions and mergers of wealth management businesses can also make it harder for companies to refer to keep client information together in one location, Scrivener said.
Inadequate risk profiling tools can also lead to poor customer outcomes, he added. ‘What was being seen was if you have a risk profiling methodology that asks the client a series of questions and it gives the client the option to say “uncertain”, where does that result end up? Does it put the client in the middle ground or are you just not able to come up with a quantifier for risk?’ he asked.
Scrivener pointed to semantics of certain words used in risk profiling questionnaires, such as ‘are you a realistic or motivated investor?’, which might encourage the client to answer in the positive.
Your checklist to help determine if your portfolios are suitable:
By Bovill Consultants
- Ensure there is an audit trail by keeping a detailed and periodically updated file for each client.
- Review your record keeping procedures. Is it clear what information should be recorded when, where and how?
- Know exactly what levels of risk your clients are willing and financially able to take.Review the risk profiling tools you provide clients to improve transparency and remove ambiguity.
- Spot check sample client files to see if your procedures satisfy your suitability obligations.
- Look for and clarify any confusion between discretionary, advisory and execution-only portfolio management services.
- Make sure investment managers have read the firm’s written procedures and include them in the process by focusing on how they operate and then encouraging them to help to come up with solutions.