The Financial Services Authority (FSA) has sought to settle the urgent question of where responsibility for suitability lies in the adviser-discretionary fund manager (DFM) outsourcing relationship in its finalised guidance. However, in a move welcomed by the industry, the regulator has resisted being too prescriptive.
The FSA’s finalised guidance on suitability in relation to replacement business and centralised investment propositions (CIPs) said both the introducing firm and the discretionary manager have an obligation to ensure a personal recommendation or decision to trade is suitable for the client.
The watchdog also stressed that where a client appoints an advisory firm as an agent to act on its behalf, the firm should deal directly with a discretionary investment manager. In this case, the advisory firm becomes the client of a discretionary investment manager, the guidance says.
‘The obligations on each party will depend on the nature and extent of the respective service provided. Both parties should be clear on their respective service, and ensure they meet the corresponding suitability and obligations. If either or both parties are not clear, there is a risk that clients may receive unsuitable advice and/or have their portfolios managed inappropriately,’ the FSA noted.
It believes the outsourcing relationship takes three distinct forms. First, where an adviser arranges for the client to have a direct contractual relationship with the discretionary manager. Second, where the adviser holds permissions for managing investments and delegates investment management to a third party. And third, where the discretionary manager does not have a contractual relationship with the underlying client, with the adviser acting as an agent for the client and having obligation to explain the position to them.
The guidance follows a review of 181 files from 17 firms in which the quality of advice was found to be unsuitable in 33 cases and unclear in 103 cases.
'Best papers FSA has written'
David Tiller, head of strategy and proposition at Standard Life Wealth, welcomed the regulator’s clarification, calling it ‘one of the best papers the FSA has written’. He believes it is good that the watchdog has provided a framework but not been too prescriptive, noting it has avoided ‘telling people how to run their businesses’.
‘It is very helpful they have identified different ways of contracting. Regardless of the nature of the relationship, both parties are responsible and you have to be clear to the client about who is responsible for what and the scope of the service you are providing,’ Tiller said. Paul Chavasse, head of investment management at Rathbones, added: ‘I don’t think it is going to kill questions, but it points out the types of issues you could consider. I would hope the average IFA and DFM could sit down and hammer out what their responsibilities are.’
Rathbones has historically conducted suitability assessments in all cases. While the adviser undertakes an initial analysis of the client’s wider financial situation, the firm will work with them and the client to align its suitability assessment for the discretionary portfolio with the adviser’s assessment of the client’s risk profile.
Chavasse also backs the FSA’s call for firms to consider the impact of suitability of additional charges when conducting replacement business, after it found some firms it reviewed could not quantify the additional charges associated with the new investment. Several failed to provide a comparison of costs and performance between a new and existing investment.
Other points raised in the FSA’s Finalised Guidance
The FSA has identified cases where firms have ‘shoe-horned’ clients into a ‘one size fits all’ product that are not suitable for their individual needs. Other examples include clients being switched from existing investments into a CIP without adequate consideration of whether the switch is suitable, or where a CIP was more expensive with few additional benefits.The FSA said firms selling CIPs must establish robust identification and control system to mitigates risks that could arise from specific characteristics of its CIP. They also need to assess the flexibility of the CIP in relation to the client’s objectives, the types of assets held and the use of tax wrappers