Chris Jones explains how to prepare for the FCA’s upcoming suitability review
The FCA’s Dear CEO letter in January gave financial advisers extra time to get prepared for the suitability review of retirement advice, which has been pushed back to 2021.
The FCA letter raised concerns in four areas, with “suitability” the underlying theme. Here, we focus specifically on one element – the role of research and due diligence in ensuring suitability and when reviewing discretionary investment management services (commonly called discretionary fund managers or DFMs).
Research and due diligence is not new. The FCA has been talking about it for many years and looks set to continue. Back in 2016, it published TR16/1, Assessing Suitability: research and due diligence of products and services, which said:
“We undertook this project [because] previous thematic work and instances of consumer harm have shown that the poor quality of an advisory firm’s research and due diligence is one of the three root causes for poor consumer outcomes. The other two root causes are incorrect risk profiling and costs, for example, in relation to replacement business (where a client switches an existing investment or sells it and invests the proceeds in a new product under the recommendation of an adviser).”
So, the first bit of homework for advisers is to make sure your firm’s research and due diligence processes are up to scratch. Fortunately, TR16/1 is a short and easy read (only five pages), so it’s well worth a look at the good practice examples to check how your firm compares.
But what does “research and due diligence” actually mean?
For starters, “research” and “due diligence” are two completely different things. The paper, Supervising retail investment advice: Delivering independent advice, explains the difference like this:
“We expect firms to carry out research on the whole of the market to identify the solution(s) that are in the client’s best interests, then conduct detailed due diligence on the recommended solution(s).” Clearly, there is a two-stage process:
- Research is about assessing potential products or services against client needs –specifically, assessing the nature of the investment, its risks and benefits, as well as how it fits with the customer’s needs and risk appetite (see TR16/1 1.3.ii and RPPD 1.24(1)). In contrast:
- Due diligence is about assessing the provider, to establish whether it is appropriate to entrust the provider with client assets, including checking the financial strength of the provider and its service reliability (see TR16/1 1.3.ii and RPPD 1.24(2)).
Research on its own is not enough: it must be underpinned by due diligence
Process
So, research on its own is not enough: it must be underpinned by due diligence. And it must be documented to evidence the process a firm went through in deciding on a recommendation for an individual client or, in the post-Product Intervention and Product Governance Sourcebook (PROD) world, in designing an investment proposition for a particular client segment.
Historically, doing this properly for discretionary managers has been difficult – there is a lot to think about and knowing where to start can be hard. But the PFS produced good practice guidance in 2015 (with updates since) in conjunction with consultants Diminimis to help advisers though the process (thepfs.org/74824).
Before simply issuing a due diligence questionnaire to a DFM, sit down and think about what is important to your clients and to your firm – what are you looking for and what kind of service do you want? How does the DFM’s investment approach match yours? Do the philosophies and cultures of the firms align? How would things work on a day-to-day basis? Where does your firm fit into the relationship and, fundamentally, what would be your firm’s regulatory responsibilities?
Clearly, it is a lot more complicated than just asking about price and performance… Think about your experience of working with DFMs (or the experience of other advisers) – what has gone well and what has not? What do you need to make the relationship work for you?
Once you have worked out what is important, you can choose appropriate questions to get the information you need.
And tools are available online. The DD Hub system (free for advisers) holds a comprehensive library of due diligence questions with responses, covering more than 30 investment services. It includes all the PFS/Diminimis questions out of the box, or you can pick your own questions if you want to focus on something in particular. And in most cases, you get immediate answers, online, presented in a consistent, easy to compare format – no more having to wade through long ‘standard packs’ looking for answers.
The built-in tools also help you keep track as you review the responses, plus there is a full audit report at the end of the process to make your life easier and evidence your assessment, if you are ever called on to do so, by the FCA, your PI insurers or otherwise.
Crucially, you can also get updates to help meet the PROD monitoring requirement. Simply choose to ‘follow’ a DFM and get an alert when any of their responses change, so you can check for any issues and get an early heads-up on things that might affect your firm or your clients.
The FCA has made it clear that suitability is going to be a continuing theme and that robust research and due diligence are a fundamental component of suitability. Due diligence doesn’t have to be difficult and does require thought and care, but technology can help streamline the process.
To find out more, visit: www.ddhub.co.uk
Chris Jones is a director of DD Hub
