Does your research and due diligence stack up?

Nothing stands still in the world of financial advice. Change did not end with the implementation of the RDR and it would be a mistake for firms to think that all those changes made to business models for RDR – charging structures, investment process and the rest – means that everything is now sorted.

The FCA has been working away in the interim to assess how firms have embedded the changes necessitated by the RDR. In its paper, TR16/1 Assessing suitability: Research and due diligence of products and services (February 2016), the FCA reports on the findings from its thematic review of how well firms are undertaking research and due diligence on the products and services that are recommended to clients.

The concern that was the catalyst for this review was the FCA’s assessment, based on other data, that poor research is one of the three root causes of poor client outcomes (the other two being incorrect risk profiling and costs).

The review primarily followed up on guidance paper FG12-16 Assessing suitability: Replacement business and centralised investment propositions (July 2012), in particular the Centralised Investment Proposition (CIP) aspect.

What is a CIP?
Quite simply, a CIP is a standardised approach to providing investment advice. Examples include model portfolios or discretionary investment management, either in-house or referred to a third party where the adviser has some say in the investment strategy adopted.

FG12-16 listed a number of requirements and it is useful to have a reminder of these.

  • Firms need to identify target clients for whom the CIP is suitable (and, by definition, have a methodology for advising clients who do not meet the CIP criteria);
  • Costs are an important factor in assessing suitability of products, particularly so with CIPs which are often more expensive than similar alternatives;
  • Ensure there is no ‘shoe-horning’ of new clients into the firm’s CIP and no mass ‘churning’ of existing clients into the CIP – particularly relevant if the firm has acquired another firm or a new client bank.

Findings
So, back to the recent review. It aimed to identify how firms research the market and ensure that they recommend suitable solutions for clients, including:

  • how firms select products, funds, platforms, and DFM services;
  • how firms create panels and CIPs;
  • how firms consider options for an individual client.

Only 13 firms were included in the review and the good news is that, overall, there were many examples of good practice. The FCA stated,

“In the main, we found that firms sought to achieve positive outcomes for clients when undertaking research and due diligence …”

Inevitably, though, some poor practice was also uncovered, ranging from inconsistency across different products and services to insufficient due diligence on platforms.

Particular mention was made of poor practice in relation to platform research and due diligence, with which the FCA said it was “disappointed” especially in the light of previous expectations around platform selection having been made clear.

Due diligence and Platform selection
FCA Factsheet no. 012 was where those ‘expectations’ were outlined.

  • Having appropriate criteria for selecting a particular platform;
  • Managing conflicts of interest – were the benefits to the firm a key factor in selection and/or use of a platform (training or other help, financial incentives, tools available);
  • Benefits to clients must take precedence over benefits to the firm.

The following statement from the factsheet is perhaps the one that might be of most concern to firms.

“Developments in the market could mean that your chosen platform provider(s) may not remain the most appropriate option for your business or your clients. You may need to carry out periodic reviews.”

There seem to be mixed views. At least one platform operator has suggested that the review did not go far enough and that firms should be digging much deeper into platforms before using them. But some firms have said it might create problems if firms feel they have to move clients to a different platform ‘every five minutes’!

Historically, many firms created panels of providers and products. These were relatively simple to research as, in most cases, the providers and products were pretty familiar, although the criteria used to decide some firms’ panels might have included more consideration of commission payable than was desirable. New clients got the product from the current panel and existing clients in products no longer on panel generally stayed where they were because of surrender penalties and costs of switching.

In recent years, as new providers and more ‘exotic’ products became available, it has become more complex to do research and undertake due diligence – structured products are a case in point.

Researching Platforms is patently at the higher end of complexity – not only do the features and costs need to be compared but more difficult to assess factors, such as the financial stability of the platform operator, need to be researched and considered. And concluding that a new platform should be available, especially if that means an existing platform is no longer to be used, has potentially far reaching implications for how a firm deals with clients on the existing platform. It is undoubtedly a much bigger logistical exercise to migrate clients from an existing platform to a new one, re-registration notwithstanding. And firms are understandably reluctant to build relationships with an ever expanding number of platforms as, at some point, this becomes inefficient for the firm and also arguably for its clients.

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

The regulator has not made a snap judgement about the impact of the RDR but neither has it been complacent. Firms should not be complacent either. The FCA has looked in recent months at the charging structures and disclosure in firms and found them wanting. Formulaic advice is also on the radar. And now they have looked at the research and due diligence carried out by firms and found room for improvement in this regard too.

Firms need to consider both the charging aspect and how they do research to ensure clients are advised to invest in suitable products.

With regard to platforms, it is debatable whether, in the past couple of years, there has been any ‘development’, any major innovation, any new player that makes consideration of changing platforms an imperative. However, firms do have an obligation to review the investment solutions that it recommends to clients, including the platform(s) used. Change is a constant in today’s world and firms need to ensure that processes and culture keep up.

Action Required By You

  • Review your research and due diligence processes. Are they really adequate? The degree of detail required should be proportionate to the complexity of the product or service;
  • Ensure the process is documented;
  • If research is done in-house, ensure that it is done by suitably qualified people with access to up to date and relevant information;
  • Ensure you can rely on the source of information used in research. For example, firms can rely on factual information, such as asset allocation, provided by other EEA-regulated firms.  However, firms should not rely on marketing material or on the provider’s opinion, for example, on the risk level of the product;
  • Consider the time and resource required and whether it might be more economic to use third party research;
  • Ask yourself if anything has changed that you might need to reflect in your CIP? If using platform(s), it is entirely possible that the platform(s) you currently use remain every bit as suitable now as they were when you selected them. Just make sure you know that is the case, and can prove it! Ensure that the market options are reviewed on a defined frequency and also if any new player or innovation comes to market;
  • Review your CIP – is it still valid and appropriate? Do all advisers understand the nature of the CIP and when it is and isn’t suitable;
  • Check this by reviewing the advice that drives out from the research. Is use of the CIP in danger of becoming formulaic advice?

About the Author

Steve is an ATEB Director and has a deep understanding of all matter regulatory, built up over his 30 years + in the industry. With a training background and a technical brain, he overseas numerous complex projects and client implementation work.

Contact Us

Explore more articles in this category

Other articles that you might be interested in