FCA frustrated by continuing shortcomings in wealth management sector but must accept subtleties of suitability
The FCA's thematic review report published today expresses concern about some wealth management firms who are still not getting suitability right despite five years of regulatory 'communications'.
The improvement observed has clearly not impressed the FCA – the proportion of files reviewed found to be 'high risk' or 'unclear' has only dropped from 79% (in 2010/12) to 59%.
But suitability is, by definition, a client-specific and fact-sensitive issue. Firms may have had to repaper client files in order to demonstrate in their records that they 'know their clients' but the essence of wealth management is a bespoke professional relationship, providing an on-going service to higher net worth, more sophisticated clients. When JP Morgan International Bank was fined for systems and controls failings relating to suitability, the Final Notice had to acknowledge that "having reviewed 1,416 client relationships..., the past business review… identified only one case in which there was an unsuitable investment." Knowing your client is taken as a given; documenting it is still seen by some as tick-box compliance.
The continuing challenge for firms is to ensure on-going suitability, particularly for smaller clients. The FCA says "firms need to ensure that their governance, monitoring and assessment arrangements are sufficient to meet their regulatory responsibilities in relation to suitability". Wealth management (especially discretionary investment management) is an on-going service. The RDR rules do not apply neatly because they deal primarily with advice ('personal recommendations') to invest in 'retail investment products'. Discretionary investment management is a service, albeit the increasing trend towards model portfolios makes the client experience similar to investing in a fund. In COBS 9, the FCA requires firms to ensure the suitability of a personal recommendation and 'a decision to trade'. Advisers charging for on-going advice may have an on-going suitability obligation but discretionary managers taking decisions to trade (or not to trade) certainly do.
MiFID II may yet bring some clarity here. Although model portfolios won't be treated differently, product (and service) governance rules will require all firms (providers and intermediaries) to ensure they have compliant 'governance, monitoring and assessment arrangements'.
The report makes little mention of the role of intermediary advisers. What used to be known (erroneously) as 'outsourcing to a DFM', typically involves discretionary managers relying to varying degrees on KYC, risk appetite and suitability assessments conducted by the adviser. It seems to be hard enough to demonstrate suitability to the FCA's satisfaction through a firm's own record keeping; it is even harder when the firm relies on another firm to ensure suitability. The regulator's main concern was a 'suitability gap' emerging between the two firms servicing the same client. The starting point for demonstrating suitability in intermediated business remains making very clear 'who does what'. The challenge will then be for both firms to meet the FCA's expectations on an on-going basis.
The FCA wants all firms providing portfolio management services to retail customers to review its findings, consider whether any issues apply to their business and take action where necessary. This is clearly a final warning.