ATEB launches risk profiling process

We are delighted to announce that ATEB has launched a new risk profiling process. We believe that the innovative features we have built into the process cover all the regulatory requirements in an effective way, with several layers of validation to ensure that advisers and clients reach a good mutual understanding of the client’s risk profile. Read on to find out more about the reasons we designed our new process and how it works.


Know your client (KYC). It might be a catchy little phrase that you’d expect to hear in any gathering of compliance people but it’s much more. That advisers have a thorough understanding of their clients’ current situation and investment objectives is also the absolute foundation of all suitable financial advice. And a fundamental element in the KYC process is to identify the client’s risk profile.

COBS 9.2.2 (R) states, “The information regarding the investment objectives of a client must include … information on … his preferences regarding risk taking, his risk profile …”

Measuring the wrong thing?

As a consequence, most firms started using a third-party questionnaire to assess the client’s risk profile. There were quite a few ‘risk profiling tools’ available (a posh phrase meaning ‘questionnaire’!), and from some well-known brands.

These early questionnaires were pretty much based around trying to identify a client’s attitude to risk using volatility as a proxy for risk, i.e. basically asking the client how much volatility (s)he was prepared to take and then recommending investments that were likely to possess that level of volatility, often in isolation from any consideration of the level of volatility the client needed to take, which could, in some cases, be a lower risk investment.

Based on investment files found to be unsuitable between March 2008 and September 2010, the FSA rated half of these as unsuitable on the grounds that the investment selection failed to meet the risk a customer is willing and able to take. FG 11-05 stated …

“The level of failure in this area is unacceptable. Prompted by these results and our ongoing concerns in this area … this report considers:

  • how firms establish and check the level of investment risk that retail customers are willing and able to take (in the wider context of the overall suitability assessment);
  • the potential causes of failures to provide investment selections that meet the risk a customer is willing and able to take; and
  • the role played by risk-profiling and asset-allocation tools, as well as the providers of these tools.”

Risky risk tools

A key conclusion highlighted in FG11-05, and one that received widespread publicity at the time was that 9 out of the 11 risk profile questionnaires that the FSA looked at were flawed, often using poor question and answer options, with over-sensitive scoring or inappropriate weighting to answers. Such flaws could lead to a flawed assessment of the client’s risk profile, increasing the likelihood of advisers making unsuitable recommendations.

The weakness in the risk tools was exacerbated by the fact that many advisers simply believed the output from the tool must be ‘correct’ despite advisers often having an inadequate understanding of how the risk tools actually worked, what they were (and were not) designed to do and their limitations. To quote Little Britain, we refer to this as the “computer says ….” approach.

Still a problem

The bad news is that every FCA thematic review and paper related to suitability since FG11-05 has reported that problems with risk profiling persist. For example, as recently as December 2015, TR 15-12, which looked specifically at Wealth Managers and Private Banks, found …

  • “an inability to demonstrate suitability, for example because of absence of up-to-date customer information, inadequate risk profiling, or failure to record customers’ financial position and/or their investment knowledge and experience; and
  • a risk of unsuitability due to inconsistencies between portfolios and the customer’s attitude to risk, investment objectives and/or investment horizon.”

In the course of our compliance related work, ATEB reviews a large number of client files. Based on our research, we can confirm the FCA’s findings – it is clear to us that the risk process used by many firms still falls short of the regulatory requirements and guidance.

We see three main issues:

  • Many of the third-party risk questionnaires being used are still flawed, despite the regulatory guidance published in 2011 in FG11-05;
  • Many firms do not assess the client’s investment experience and knowledge adequately, or at all (required by COBS 9.2.1 and 9.2.2 R);
  • Many firms do not assess the client’s Capacity for Loss (CFL) adequately, or at all (required by COBS 9.2.1 and 9.2.2 R).

The latter two issues are not helped by the fact that many of the risk tools on the market do not cover knowledge/experience and/or CFL adequately or, in some cases at all. Read our previous article on CFL here.

Some of the tools still use questions of a type that the regulator previously criticised and which, in any case, are clearly flawed on a common-sense level. Consider the following questions. To protect the innocent, these are not directly quoted from actual questionnaires but are similar to real questions in order to demonstrate the point.

“Compared to others, how much of a risk taker are you?”

This question requires the client not only to make a judgement about themselves based on undefined and subjective multiple choice answers but also to make a judgement about ‘others’. It is an impossible question!

“Is it more important to you that your money keeps its buying power or that you don’t suffer a loss?”

This question expects the client to compare two non-opposing factors. Maintaining buying power is not the ‘opposite’ of not suffering a loss. It is like asking, “Do you prefer vegetables or holidays?”

The ATEB Risk Process – a different kettle of fish …

In response to the continuing difficulties of risk profiling, ATEB has created a risk profiling process. The process includes the use of two different brief questionnaires but these are used to drive a conversation with the client rather than to give ‘the answer’. We think of the ATR tools as “the stick in the sand”. We believe that risk profiling is a discussion not a questionnaire.

We list below the problems that currently exist in many ‘questionnaires’ and what we have done to avoid the problem.

Problem: Use of inappropriate questions.

Answer: Our ATR process does not have any such questions.

Problem: Use of labels that are subjective or have connotations (e.g. Balanced; Cautious).

Answer: We have created three label sets that we believe should have little or no propensity to sway a client’s decision inappropriately – so we offer the choice of using the names of fish, trees or rivers currently but, if these do not appeal, then other label sets can be created. The point being that the risk descriptions are much more important than the labels but the labels can play a useful part so long as they are neutral.

Problem: Risk descriptions that are subjective, too long and/or not readily comparable with one another.

Answer: We have formatted the risk descriptions into concise and comparable text, highlighting the advantages and disadvantages of each.

Problem: Centre bias – this is the phenomenon whereby people have a tendency to sit on the fence and select ‘average’ or whatever the middle option is.

Answer: Our starting point is to ask the client to select the most appropriate risk description from a non-ordered list, i.e. the middle option is not actually the middle option! As a result, the client does actually need to read the way each risk level is described in order to make their choice. The process then goes on to validate their initial selection by showing where their chosen risk level is on the risk scale – a discussion is called for if they are surprised where their selected risk level sits.

Problem: Very few tools make any assessment of a client’s investment experience and knowledge and few firms address this adequately or explicitly in their fact find.

Answer: We have created a specific tool to assess this aspect.

Problem: Capacity for loss is not, in our view, handled well by the risk profiling tools we have seen. Either it is not addressed at all, or is relegated to a couple of poor questions that do not actually do the job properly.

Answer: Our view is that ATR is subjective but CFL is a numerical fact. We have included some key questions in the ATR tool that will normally drive some further arithmetic to assess the actual CFL position. That arithmetic might be very straightforward in some cases, being done with a simple calculation on the proverbial envelope or could use a spreadsheet or even a cash flow modelling tool if required. Whatever is appropriate.

Important Note: ATEB news is intended to provide general information ONLY. The content, including any views expressed or guidance provided, does not replace the need to comply fully with FCA Rules and Guidance. Unless you have discussed news article content with ATEB, and specifically how it relates to your circumstances, then ATEB disclaims all liability and responsibility and actions arising from any reliance placed upon it. For the avoidance of doubt therefore, any reliance you place on such information without our consultation is at your own risk.

ATEB Compliance offers compliance and regulatory advice.

ATEB Suitability provides report writing software for the financial services market.

Our View

Risk profiling is an essential and important part of providing suitable advice. Many firms use a process and/or tools that are flawed.

Action Required By You

If you are interested to see if our risk profiling process could be of value to your firm contact your ATEB consultant or click here.

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About the Author

Technical Manager - Often referred to as the Oracle or the Sage, Alistair has a wealth of financial services experience. He is our go-to Technical Manager and enjoys nothing more than a complicated conundrum. Feel free to test his renowned knowledge by getting in touch.

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