Back to basics

It will be a surprise to few in our industry that those firms involved in defined benefit pension transfer business have been under increasingly intense scrutiny over the past 18-24 months. ATEB has been engaged by many of those firms to assist them in dealing with the Regulator’s requirements for information, sample file checking, full blown past business reviews and right up to acting as the Section 166 Skilled Person to undertake an in-depth review of the firm’s processes where the FCA so required.

ATEB has long experience of working with firms and the regulator in this way and, as a by-product of doing that work, we have been able to keep bang up to speed with the FCA’s ever-moving concerns and priorities, to understand regulatory thinking and see the likely direction of travel.

That is no less true in relation to the pension transfer work we have been involved with over the past 18 months or so. We firmly believe that there are some important lessons to be learned and the purpose of this article is to share our conclusions so that firms can address any issues that might apply.

It’s not just about DB

The above introduction might seem to signal that firms that do not have pension transfer permissions can breathe a sigh of relief and read no further. Or you might read below and think there is nothing new here. These issues have come up in every suitability review ever done. That reflects an industry that has operated under the same fundamental suitability rules and regulations since 1989 – over 30 years and still apparently not getting it right. At least not consistently enough for the regulator’s liking, which could make for rather depressing reading or could have the potential for a positive wake up and smell the coffee moment.

Failing to recognise that moment would be a mistake! The message coming out loud and clear from our work is that there are fundamental things that some firms are simply not getting right and those are applicable more broadly to the quality of advice processes and implementation in many firms. So please – read on!

A new way of looking at cases

So, the rules remain essentially the same at heart, but it is clear to us that the FCA is coming down hard on firms – rules are being interpreted very strictly indeed. And the move away from the halfway house finding of ‘unclear’ means that unless a case is clearly suitable, it is considered unsuitable.

In relation to transfer advice, the FCA has been looking at four main aspects.

  1. Information
  2. Suitability of transfer
  3. Suitability of investment
  4. Disclosure

As can be seen, in transfer cases it is explicit that there are in fact two recommendations – one in relation to the transfer and the other covering the investment advice.

What do these aspects mean in plain English?

  1. Know your client (KYC)
    This does not need much explanation. This is basic stuff that every adviser knows how to do. Or do they? See below.
  2. Suitability of the recommended course of action
    Every recommendation has as a first stage – here is the generic action I recommend (transfer, switch, invest, disinvest and so on) …
  3. Suitability of implementation
    … and a second stage where the specifics of the recommendation are identified (which provider, which platform, which wrapper, which funds)
  4. Material compliance
    Historically, ‘disclosure’ has always been about the basics of compliance – terms of business, client agreements, were they compliant and issued when required? But the FCA has broadened the remit of ‘disclosure’ to include the adequacy of explanation of key points of the recommendation with the aim of answering one very specific question – is it reasonable to assume that the client understood what was recommended sufficiently to make an informed decision? Although now newly allocated to the ‘disclosure’ section, ensuring client understanding has always been a requirement. See below.

There really is nothing new here. This approach has a long and strong provenance in terms of assessing suitability of advice. And the above process described readily translates to ALL financial advice. Let’s take a closer look at aspects 1 and 4.

Back to basics

Information / KYC
The FCA has coined the term ‘MIG’. An abbreviation of Material Information Gap. These can be purely factual – e.g. the KYC does not state when the client intends to retire. A MIG can also arise from a lack of clarity or some apparent discrepancy in the KYC – e.g. the client’s required income is stated but does not clearly match the current or projected expenditure information. These types of gap are not uncommon in our experience and are hard to excuse even in trainee advisers.

Yet it is the third, more subtle gap that appears to catch even experienced advisers out. For example, consider a client who is stated in the suitability report to want to transfer so as to access tax free cash to repay a mortgage or other loan. The FCA have criticised this on the grounds that there was no evidence that the client was having difficulty maintaining the loan or was under any pressure to clear the debt. And in any case, the argument would go, repaying a mortgage that is subject to a very low rate of interest, as many do currently, and giving up ‘valuable’ final salary benefits does not make financial sense. It appears that the possibility of a client simply having an emotional desire to ‘finally get rid of the mortgage millstone’ does not occur to the FCA file reviewers. But, if the file provides no hint of this, why should it?

This type of problem would not exist if the fact-find discussion included appropriate challenge to clients in relation to what they want and why that is sometimes different to what they need. In the mortgage case described above, the challenge would be around why the client wants to take a big irreversible decision to transfer a valuable benefit, which often carries significant financial downsides, simply to repay a loan that the client is having no problem maintaining and which carries a minimal interest cost. The client would respond, there might be some further ‘exchange of views’ following which the discussion and its outcome would be clearly documented in the client file and replayed in the suitability report.

Often, the problem starts with the design of the firm’s fact find and other documents e.g. risk profiling tool. If the client is asked an unclear question, the answer will probably be unclear. One of the most common examples is around current or required income where a figure is asked for but it is not clear whether the response relates to single or joint income, before or after tax, if future income is in today’s or real terms and so on. The question should make this clear. Here is a real life example of how not to ask a question.

“What is your target income? In deciding upon your target please allow for the effects of inflation, investment risk and your tax position.”

At first sight that seems very clear. But the document only provided space for a number so there is no means to identify what, if any, allowance the client has made for inflation, investment risk (whatever that means – a target is a target regardless of investment risk, which is only relevant to how achievable a target might prove to be!) and tax. As a result, the question might as well not have been asked because the number on its own, is effectively rendered meaningless.

The mortgage repayment scenario described above is but one example of what we have seen in FCA reviews. The point here is first that there is a rule (COBS 9.2.6) which states:

“If a firm does not obtain the necessary information to assess suitability, it must not make a personal recommendation to the client or take a decision to trade for him.”

The FCA shows no hesitation in applying this rule and declaring a rule breach in cases where there are MIGs. Experience tells us that the missing or unclear fact, and even soft information like the client’s feelings about ‘getting rid of the mortgage’, is often known to the adviser – it just didn’t make it to a clear file note.

Back to basics #1 if it isn’t written down, it doesn’t exist!

As indicated earlier, this heading still captures whether all the ‘compliance stuff’ was done as and when it should have been but importantly ALSO now encompasses whether the recommendation was clearly explained in the suitability report in a balanced manner.

Achieving that requires that the client is informed about ALL relevant aspects, e.g. advantages and disadvantages, benefits and costs.

Overall, the suitability report must explain:

  • why the recommended transaction is suitable for the client
  • any disadvantages
  • everything in a way that is ‘fair, clear and not misleading’

Any key aspect that is simply not covered is problematic. As we have written about previously, it is not enough to merely state the transfer value comparator or critical yield – the implications for that client must be explained.

Any aspect covered in a manner that is not accurate is problematic, e.g. inaccurate statements or illustrations based on incorrect charges.

Pension switches – the next ‘big thing’?

As stated earlier, although the FCA’s new firmer and segmented approach to assessing suitability has thus far been seen in relation to pension transfer advice, the rules around suitability apply equally to all types of advice.

The regulator has focused heavily on transfer advice in recent years, but it is not unreasonable to believe that focus could be turned on replacement business – in particular, pension switches. After all, a pension transfer is just a special kind of replacement business, subject to some additional rules. Otherwise, all the same suitability requirements apply to pension switches. The same four aspects apply – with transfer being changed to switch:

  1. Information
    … have you identified all the information you need to know?
  2. Suitability of switch
    … many switches result in increased costs – is the switch really justified?
  3. Suitability of investment
    … if the switch is justified, is the firm’s CIP always the right solution?
  4. Disclosure
    … does the client fully understand the implications of switching? Have all the implications and disadvantages been clearly explained.

Back to basics #2there is often nothing wrong with a client’s existing plan – if it ain’t broke, don’t switch it!

Back to basics #3switching is not a prerequisite for providing ongoing service!



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

In our experience, good advice starts with clear objectives and lots of discussion with the client, not just about the what but also the why? Hard facts alone are not enough. They need to be accompanied by context and background that asking “why is that?” and “where do you want to be?” type questions will provide. In some cases, firms’ fact find documents don’t help, often encouraging closed ‘fact getting’ questions and failing to encourage open questions and free text notes sufficiently. Information that is missing, unclear or that is only in an adviser’s head cannot contribute to a later assessment of suitability of the advice. It has been said countless times over the years but that does not make it any less true – if it isn’t written down, it doesn’t exist!

Action Required By You

Review your fact find document. Is it a ‘questionnaire’ or a tool to support gathering client information. It should not be considered as a list of questions to ask or even the order in which topics should be discussed with the client. Does it have enough free text notes space? Are notes sections stubbornly blank in many cases? Redesign your fact find document if required and consider fact find refresher training for advisers. Identify and quantify client objectives. Discuss and challenge where appropriate. If you discussed it, document it!
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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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