The Dalai Lama once said that “a lack of transparency results in distrust and a deep sense of insecurity”.
Although he was referring to a way of life, this could apply equally to the relationship between financial advisers and consumers.
Over the past few years, advisers have been inundated with data requests from the regulator in its attempt to increase transparency across the industry. These have included checking the progress of the RDR and the Financial Advice Market Review, investigating defined benefit transfers, and now a repeat of the Assessing Suitability Review.
The FCA’s previous Assessing Suitability Review, conducted in 2017, examined more than 1,000 individual pieces of advice from 656 firms. It found that most advisers (93 per cent) had a clean bill of health on suitability, with only 4 per cent deemed unsuitable and a further 3 per cent judged unclear. How-ever, 42 per cent were found to have breached disclosure standards over costs, charges and services.
Leader: Suitability shouldn’t be a struggle for well-run firms
At the time, the regulator said the findings would help it communicate good and bad practice, and focus its resources on firms and areas that posed the greatest consumer risk as it continued its work on suitability.
Fast-forward three years and the FCA is taking another look.
How is it different this time?
This latest assessment aims to focus on the advice that consumers receive around retirement income, and will involve a representative sample to build a view on this part of the market.
With the introduction of the pension freedoms changing the shape of the market, the regulator has stressed the importance of consumers getting “good advice” at the point they access their pension savings. It describes the suitability review as a “key element” of its advice strategy alongside work on issues such as scams and DB transfers.
Its other recent activity gives us a good idea of the areas of suitability it will crack down on this time. In a Dear CEO letter sent to firms in January, the FCA outlined the “key risks” for financial advisers, referencing high-risk and esoteric investments, and an “increasing number of cases where the actions of firms are resulting in significant harm to consumers’ financial wellbeing”.
Financial advisers ‘give people their lives back’
Many in the advice profession are expecting much the same approach as that taken in 2017, except with more files collected that focus on retirement risks. Others, however, are surprised at the need for a repeat, given the strong scorecard on suitability that came before.
SimplyBiz chief executive Matt Timmins says: “I didn’t think there was going to be a second review because, from our own business’s understanding, advisers are doing suitability really well, so I didn’t think it would be significant.”
Timmins suspects the regulator will focus on firms that do not use appropriate systems and controls this time.
“In other words, firms that don’t use a piece of technology to help them with the client journey.”
Predecessor regulator the FSA conducted its own suitability review in 2011. Since then, the science of risk profiling has progressed greatly, not just in terms of behavioural tools and techniques that can be used to have better
conversations with clients, but also in communicating and managing potential outcomes and risks more effectively.
The FCA has recently talked about miscalibration risk, which refers to situations where different tools and processes are used at various parts of the financial planning process for the same client, resulting in the definition of risk getting lost in translation.
Dynamic Planner chief executive Ben Goss says: “This risk is particularly acute in cashflow planning for a client in drawdown, for example, where the cashflow tool uses a different definition of risk and return than that agreed with the client during their risk profiling process.
“There is a general acceptance that well-calibrated tools are necessary to do this objectively and consistently. However, all tools and models have limitations and it’s important for firms, and tool providers, to communicate and manage these.”
B-Compliant director Jeremy Smith agrees that a tool is just the starting point.
“The key is to have a discussion that considers three elements: the client’s need to take risk, their desire to do so and their ability to take that risk.
“The need may be high due to limited funds and a high target. This might impact on the client’s desire as they may not have the ability to take that risk.”
Smith adds: “Desire is often driven by a greed or fear factor. ‘I want more’, or ‘I need more’. It is the conversation between the adviser and their client which, if sufficiently well documented, should evidence all of the above. It is about client education and understanding.”
However, with regard to a process, the FCA currently hasn’t signed off a particular piece of technology or tool that gives useful guidance on how advisers should gauge the risk a client is willing or able to take. The key thing the regulator looks at is whether the recommendation from an adviser matches the attitude to risk, but could that not be deemed subjective?
Threesixty managing director Russell Facer says it is unlikely the FCA will sign off on an approved tool
because all tools have flaws.
“I can’t see any regulator coming out with a ‘Here’s what we expect’,” he says.
“They’ll leave it open because they want market forces to drive some of that.
“It’s more about what the individual adviser or the firms are using and how they articulate that to the end client.”
Covering all the bases
The regulator will seek to demonstrate that the work done by the review is statistically significant and has covered enough of the sector to give it a good understanding.
KPMG director Philip Deeks says the FCA will want to ensure that the sample is wide enough to be valid, compared to last time where it ensured the sample was representative of the market.
“While we are not sighted on the precise methodology, it may be that the FCA has decided to broaden the scope to ensure it has engaged with every firm – for example, it may move to a smaller number of files for a larger number of advice firms,” he says.
Prior to the first suitability review, it is fair to say the FCA had struggled to obtain sufficient coverage of smaller advice firms, especially because the advice market remained so fragmented. However, in a recent speech, outgoing FCA chief executive Andrew Bailey explained that the regulator wanted to engage more with smaller firms.
As part of the latest Assessing Suitability Review, the FCA is requesting an “advice register” of all recommendations from firms, and then requesting specific advice files it would like to review.
Deeks argues that firms should already have an advice register in place and a complete advice file. The review should not require firms to generate information that is not already easily available, so hopefully the burden will not be too onerous for firms.
However, a board member at one major advice firm, who has received the suitability review letter, described it as a “massive workload”.
Money Marketing spoke to a network that was involved in the previous suitability review and has received the FCA’s letter this time around. It also describes the latest review as a mammoth task.
The firm, which wishes to remain anonymous, argues that, while the FCA is conducting the review in good faith, it is not taking the best approach. The network feels that it should not be lumped together with smaller advice firms to provide the same information.
“The data request was effectively ‘Can you give us your new business register for the past year?’ and, for me, that is thousands of lines of data. We gave it and we were happy to do the work but it’s probably disproportionate.
“I’ve likely given them more work to do than they really wanted. Had it been a more proportionate approach, I think they would have gone to small firms and said ‘Give us a year’s-worth of data’, but for large firms we probably could have given them two weeks of data and they still could have got what they wanted.”
‘Fair, clear and not misleading’
With so many reviews back to back, advisers are getting overwhelmed with regulation and often insert stock paragraphs in suitability reports to ensure they are covered. How will the regulator draw the line between information overload and sufficient detail?
Timmins says: “My understanding is that it isn’t looking to see if there is too much information. But there is a ‘Fair, clear and not misleading’ policy so, if the regulator deems there is stuff being thrown in there on the basis of a firm trying to cover its backside – which isn’t fair or clear and ends up misleading clients – then it will act.
“It may come back and say ‘Suitability review letters are too long, too confusing and contain information not relevant to the client and their specific plan, so you should as a sector focus on the content of the suitability letter and its relationship to that specific piece of advice.’
“I don’t think the regulator will be specific and say ‘You can/can’t include these types of paragraph.’”
Meanwhile, Deeks says that, while stock paragraphs have a role in making the process efficient, an adviser should still look to tailor each paragraph to ensure it accurately reflects the circumstances of the client.
“Unless this happens, there is a risk that spurious or irrelevant paragraphs undermine the effort the adviser has made to make sure that the letter reflects the client’s circumstances, the recommendation and why it is suitable,” he says.
As a simple example, Deeks says he is increasingly seeing firms challenge themselves to prioritise the key information needs of customers in a short covering letter and then add further details in an accompanying appendix to increase client engagement.
It seems the basis of suitability is already well documented around risk, price, performance and product features. The challenge for firms will be demonstrating that they really do know their client, their objectives and their needs.
In a recent speech at the Dynamic Planner conference, FCA director Debbie Gupta said the FCA wanted to see the client’s own words come through in the documentation, showing that the adviser had “actively listened to what is being
said; they have taken a holistic view of the client’s needs; and, where appropriate, they have educated the client or challenged them when it is clear that their wishes are not in line with their needs”.
B-Compliant’s Smith agrees that a good suitability letter should tell a story and include the client’s current circumstances with their goals, their timescales and their understanding of financial products.
“This should be using the client’s own words, especially for goals. The solution advised needs to tie this together in simple terms and with sufficient detail to meet the requirements of disclosure.
“It is not always an easy task, however, the personalisation brings the letter to life.”
Review will be driven by culture of individual accountability
The precise scope of the FCA’s second suitability review is unclear, but it is potentially very broad. The focus will be on initial and ongoing advice to consumers taking income in retirement, which comes as no surprise and reflects a continuing trend.
A critical concern, however, is defined benefit transfer advice. One might think this is narrow in scope – but the FCA is writing to more than 1,800 firms in relation to potential consumer harms resulting from unsuitable DB pension transfer advice. Compare this to the 88 DB transfers reviewed between 2015 and 2017 – where less than 50 per cent of advice was considered suitable. This feels like a serious escalation with severe consequences.
New rules and guidance are to follow in the first quarter of 2020, and the FCA refers to wide-ranging supervisory work on advice processes and client outcomes. Future enforcement action in this area feels inevitable.
If the FCA genuinely fears that the majority of firms advising on DB transfers are giving potentially harmful advice – despite the regulator’s work in this area to date – that would be striking.
What about those advisers who steer clear of DB transfers? There is still plenty to reflect on. Firms should expect continued scrutiny on charging structures – effective comparison of the initial cost of product entry is well entrenched into suitability processes – but they should be ready to justify charges for ongoing reviews, particularly if questions might be asked whether passive accumulation really justified that cost.
These are difficult questions that advisers might not have needed to reflect upon in bullish markets.
We can expect the FCA’s review to be driven by a culture of individual accountability, and by the new standard of personal conduct under the Senior Managers and Certification Regime. This brings particular challenges to smaller firms, which may be used to a light-touch supervisory relationship, and where senior managers may manage multiple roles and obligations.
Here the pressure for senior managers is greater, and the burdens of increasing Financial Services Compensation Scheme levies will result in more scrutiny on firms’ financial resources and adequate professional indemnity insurance.
The FCA is increasingly paranoid about insolvency risk and resulting customer detriment and capital requirements. Increasingly expensive PI insurance may, perversely, contribute to these risks.
In combination with this, SMCR compliance will be central to the FCA’s assessment of individual performance. With this in mind, senior managers should be thinking now: how do the FCA’s concerns apply to us, and what proactive action can we take to demonstrate that engagement?
To consider, document and implement may prove critical when the suitability review becomes that difficult supervisory visit.
Stephen Elam is a partner at Cooke, Young and Keidan
Conflicts of interest
Speaking at the Personal Finance Society’s annual conference in November last year, Gupta raised a new question from the regulator regarding how advisers charged drawdown clients, providing another potential clue to the direction of its latest review.
She said: “We do expect you to manage conflicts…. each level of withdrawal reduces the fee you receive, and over time that fee can drop significantly. At the same time client circumstances can become more complex.
“They may need more care from you. We would be concerned if long-standing clients were priced out of the market just when they needed you the most.”
How the FCA will judge whether this conflict has been managed in the files it collects is still unclear, however.
SimplyBiz’s Timmins says that, while he understands the theory behind Gupta’s comments, he has never seen the conflict occur in practice.
He says: “I think advisers are motivated by doing the best they can for their client, and not by how much they earn from a piece of advice. So, in my experience and with all the advisers that I know, I can’t imagine any adviser acting outside the best interests of their clients just so they can take a fee.”
Smith agrees: “I find it hard to imagine an adviser would try to retain invested funds at the expense of client income or lifestyle just to maintain the adviser’s income. Examples of that practice would be difficult to justify as being in the client’s best interests.”
PFS chief executive Keith Richards notes that the FCA has been crystal clear that it has concerns over fees for ongoing advice more generally.
“The FCA has urged advisers to look at how they charge for their services and consider the conflicts that arise. The family test should apply: would you be happy with another adviser charging a member of your family the same fees for the value they derive?” Richards says.
Deeks says, if the FCA reviews this area, it is likely to look at how the charging is structured, in terms of both style and quantum.
“How charging has been designed and articulated to the client in the suitability report will indicate the steps the firm has taken to mitigate this conflict,” he says.
“For example, a fixed annual ongoing charge will disproportionately represent a larger percentage as the pot reduces. Therefore, there may be a point at which a firm operating this model will either cease charging the fixed fee or swap to a percentage charge to ensure that the advice continues to represent value for money.
“There is also a finite point beyond which the pot is so small that it does not warrant ongoing advice as it will shortly be exhausted.”
Director, Robinson Insurance Services
There is little detail on the Assessing Suitability Review at present. I understand that some firms have been contacted with a request to provide files for review, but this appears to be larger firms.
The need for firms to ensure that advice provided is suitable, and that costs and charges are disclosed clearly, and that firms act in the best interests of clients, is aligned with the Mifid II environment, and indeed aligned with the fundamental principles of a professional IFA firm.
We have received a Dear CEO letter that emphasises the issues the FCA has already commented upon in the past, and these come as no surprise. Review of files is a good method of gauging the suitability of advice, as long as a broad sample is sought and specific feedback provided.
It makes sense to follow up on the impact of pensions freedoms in particular, and we are supportive of this in order to facilitate positive client outcomes
Glass half full or half empty?
Money Marketing understands that the 2017 review was purely exploratory, rather than conducted with a view to levying fines or bans on anyone caught out. Will this year’s review be done in a similar spirit?
“For me it depends on whether you are a glass-half-full or half-empty sort of person,” Threesixty’s Facer says.
“If the regulator comes back with some guidance or comments around good and poor practice, then firms can learn from it. But at the same time if it’s more of the same old stuff it needs to be a different approach.
“If you do the same things, you get the same outcomes.”
He adds that, if the FCA selects a file to review and it looks awful, it can’t overlook it.
But the aim is not to pick out individual firms, it is to find out what the profession is doing as a whole and then look at what it can do to improve on those areas.
“On the back of it, I don’t see it doing much fundamental change other than education.”
However, Smith says educating advisers is key and the FCA needs to explain where firms are going wrong and why, as well as identify good practice so others can learn from it.
“No matter how many reviews the FCA undertakes, there will be suitability issues identified,” Smith says.
“Advice does not always fit simple boxes; people do not fit simple boxes and as such there is always the challenge of suitability.
“A lot of issues are created by over-reliance on scripted suitability letters, where free formatting has been reduced to avoid errors and by doing so we miss out the important personal issues and nuances that drive clients to make the choices they do.
“However, where advisers can learn what the FCA sees as good practice, it builds confidence and, as long as not followed blindly, would benefit all.”