Suitability under MiFID II
All the current rules around assessing and documenting suitability remain firmly in place under MiFID II. You can read our previous articles on this subject here and here. However, many existing standards of best practice are being formalised into explicit regulatory requirements. The key ‘new’ points to note are as follows.
- Suitability must be assessed, and a report issued where investment advice has been given, irrespective of any transaction resulting (e.g. advice to hold a fund does not result in a new transaction but is still a recommendation and requires documenting in the same way as any other recommendation);
- Suitability reports must specify the advice given and how that advice meets the preferences, objectives and other characteristics of the client. COBS 9A.3.3 states –
“When providing investment advice, investment firms shall provide a report to the retail client that includes an outline of the advice given and how the recommendation provided is suitable for the retail client, including how it meets the client’s objectives and personal circumstances with reference to the investment term required, client’s knowledge and experience and client’s attitude to risk and capacity for loss.”;
- Introduction of periodic suitability assessments …
“Investment firms shall draw clients’ attention to and shall include in the suitability report information on whether the recommended services or instruments are likely to require the retail client to seek a periodic review of their arrangements.”
If it is agreed that a periodic assessment of suitability will be provided, then that must be done at least annually. See below.
Client Knowledge and Experience
In respect of assessing client knowledge and experience the rules are slightly more prescriptive.
“Investment firms shall ensure that the information regarding a client’s, or a potential client’s, knowledge and experience in the investment field includes the following, to the extent appropriate to the nature of the client, the nature and extent of the service to be provided and the type of product or transaction envisaged, including their complexity and the risks involved:
- the types of service, transaction and financial instrument with which the client is familiar;
- the nature, volume, and frequency of the client’s transactions in financial instruments and the period over which they have been carried out;
- the level of education, and profession or relevant former profession of the client or potential client.”
In our experience, the risk process used by many firms often does not address or assess client knowledge and experience, certainly not to this degree of detail and it is likely that many firms will need to review and amend their risk process accordingly.
Periodic assessment of suitability
- Firms providing investment advice must agree with a client whether a periodic assessment of suitability will be performed;
- If periodic assessment is to be performed it must be at least annually and the continued suitability confirmed in writing.
All tools that firms use to assess suitability, for example a risk questionnaire, must be fit for purpose (COBS 9A.2.9) Firms need to consider how they will assess fitness for purpose and identify understanding of the abilities and limitations of any tools used.