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FSA warns against a ‘box-ticking’ approach to DFM suitability

FSA warns against a ‘box-ticking’ approach to DFM suitability

Advisers must avoid taking a ‘box-ticking’ or ‘one size fits all’ approach when selecting a suitable discretionary manager, and focus on what is right for the individual client, Financial Services Authority (FSA) technical specialist Rory Percival has warned.

Percival reiterated the FSA’s stance that it is not prescriptive about who takes responsibility for suitability between the discretionary manager and the adviser who refers on investment business to them, as long as this is decided between the two parties. The most important thing is to be clear about who has responsibility for what, he said.

‘Our view is we don’t mind [who has responsibility]; you can split that among yourselves with suitability responsibilities between the advisory firm and discretionary manager. However, what we need you to do is make sure you are clear about whose responsibility it is to do elements within the suitability assessment,’ Percival told a room of intermediaries and investment managers at the Quilter Cheviot Investment Symposium.

‘We are completely neutral how you split responsibilities between the two parties. All we require is for you to be very clear between you who has what responsibility.’

He added that one of the regulator’s main concerns in this area is how the client’s risk level is assessed and the link-up between the risk profiling method and the risk definitions underpinning a discretionary portfolio.

‘How do you ensure that the way you assess the level of risk the client is willing to take matches up with the level risk that applies in the portfolio? Who is doing the assessment of the client’s risk profile – is that the advisory or discretionary firm? It does not matter which, so long as it is clear that the client ends up with the right solution.

‘One of the things that keeps me awake at night is the idea that advisory firms might assess the client using their mechanism for risk profiling as, for example, a cautious client and asks the discretionary manager for a cautious portfolio without further review whether that is the right match or not,’ he added.

Percival (pictured) also stressed that advisers must make sure they avoid taking a ‘box-ticking’ approach when deciding whether a discretionary manager is appropriate for the underlying client.

‘When it comes to due diligence, although we put a number of suggestions in the guidance about due diligence issues you might want to look at, I don’t want you to think it is an FSA checklist of things you have to do. There is no FSA secret checklist,’ he said. ‘What you have to do is the right things for your clients, and think about what it is you want to be the right solution for your client.

‘On the back of that, the due diligence you want to undertake is going to be very focused on your firm and your clients,’ he said.

Who has ultimate responsibility for suitability between advisers and DFMs has been something of a grey area between both parties, causing the FSA to outline rules last July.

Percival said the FSA recommends avoiding confusion by having a clear arrangement between the client, discretionary manager and adviser, which should be classified as a tripartite arrangement, formal outsourcing, or an agency model (see box below).

‘It makes sense to have clear letters of engagement with the discretionary manager to set out responsibility for who does what in the process,’ he said. ‘Having commonality in the language used in documentation and conversations between the client, the adviser and discretionary manager is also something to think about.’

Three types of arrangements between a discretionary manager, client and adviser (according to the FSA)

- Tripartite: Where the client has a direct contractual relationship with the

discretionary manager.

- Formal outsourcing arrangement: Where the adviser outsources investment management to a third party firm. In this context, the adviser firm needs to have permissions for managing investments.

- Agency model: Where the advisory firm acts as an agent to the client and refers the client on to the discretionary manager, but the client does not have a direct contractual relationship with the manager. The adviser firm is a client of the discretionary manager rather than the underlying client.

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