The assessment of MiFID II suitability is one of the most important requirements for investor protection in the MiFID framework. It applies to the provision of any type of investment advice, whether independent or not, and portfolio management.

Investment firms providing investment advice or portfolio management must, under Article 25(2) of MiFID II and Articles 54 and 55 of the MiFID II Delegated Regulation, provide suitable personal recommendations to their clients or make suitable investment decisions on behalf of their clients.

The Guidelines in the Final Report build on the text of ESMA’s 2012 MiFID I Guidelines on suitability (“2012 Guidelines”), which have been largely confirmed and broadened in order to:

• consider technological developments of the advisory market, notably the increasing use of automated or semi-automated systems for the provision of investment advice or portfolio management (robo-advice);
• build on supervisory experience on the application of suitability requirements (including the 2012 Guidelines);
• take into account the outcome of studies in the area of behavioural finance; and
• provide additional details on some aspects that were already covered under the 2012 Guidelines.

The Guidelines support a consistent and harmonised application of MiFID II suitability requirements.

Sustainable Finance

The European Commission have stated that “[…] firms should ask about their clients’ preferences (such as environmental, social and governance factors) and take them into account when assessing the range of financial instruments and insurance products to be recommended, i.e. in the product selection process and suitability assessment.”

Accordingly, ESMA has included, pending changes to the legal framework, a good practice for firms addressing this issue. The good practice will contribute to raise firms’ and supervisors’ attention and awareness of this issue. ESMA will monitor the European Commission legislative proposals and will consider making focused amendments to the Guidelines to reflect changes to the MIFID II delegated acts on the topic of sustainability.

Next Steps

Publication of the English version of these ESMA Guidelines on 28 May 2018 triggered a two-month period for the FCA to notify ESMA whether they comply or intend to comply with the Guidelines with effect from the end of October 2018 at the latest.

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The FCA seems happy with the outcome of a review of suitability it undertook last year which captured 1,142 individual pieces of advice given by 656 firms.

The review looked at pension and investment personal recommendations delivered by firms to retail customers during 2015 – it did not consider how firms met the suitability rules when managing investments.

The FCA found that ‘suitable advice’ was given in 93.1% of cases reviewed. The FCA describes this as a ’positive result’ which they attribute to the RDR. In addition, 2.5% of cases were described as ‘unclear’ due to inadequate information on file – which the FCA regards as a breach of COBS 9 (‘Suitability’) as the firms responsible were unable to demonstrate that suitable advice had been given.

The exercise also looked at disclosures (relating to firms’ charges and services, product information and suitability reports) although the findings were less positive with only 52.9% of cases being deemed ‘acceptable’ in respect of all three areas.

We are advised that there will be a communication programme rolled out over 2017/18 which will share further details of these findings including examples of good and poor practice. We are also warned that there will be a repeat of the review in 2019 which will “measure how the sector has responded to our findings and communications plan”. This review will not only look at suitability of advice and compliance with the disclosure rules, but also compliance with any new relevant rules, including those under MiFID II, PRIIPs and IDD.

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Firms providing discretionary and/or advisory portfolio management services

Suitability in Wealth Management: Further FCA Visits

An article in Regulatory Roundup 71 (pdf) drew attention to a thematic review (TR15/12) that the FCA had published on wealth management firms and private banks concerning the suitability of investment portfolios.

The review assessed 150 files from 15 firms and, whilst some improvement had been identified (over the past six years the Regulator has completed three separate phases of work in this area, culminating in the publication of TR15/12), the comment was made that many of the sampled firms “still need to raise their standards – in some cases substantially …”.

There were two key messages arising from the publication:

• Firms should take note of the findings and ensure that they are able to demonstrate how the portfolios they manage are suitable; and
• Senior management are expected to consider whether any of the concerns raised are reflected in their own firms’ practices and to take any necessary action.

The FCA’s May edition of ‘Regulation round-up’ revisits the findings within the thematic review as a “Hot topic”. The article advises that the FCA now expects all firms to take the findings on board and to consider how they can consistently demonstrate suitability across their clients’ files – taking the necessary steps when any shortcomings are identified.

By way of encouragement, the FCA comments that it is preparing to “visit a number of firms” at the end of the year to see what action they have taken. We are promised that this will remain a focus of the FCA’s work until firms across the sector can demonstrate that they are delivering suitable investment portfolios.

Actions

Those firms that still have consideration of the findings in TR15/12 on the “to do” list should take heed of this FCA Regulation round-up article and consider what steps need to be taken. Without a doubt, after both the publication of a thematic review publication and a ‘hot topic’, any firm on the receiving end of one of the promised visits that is found wanting in the area of “suitability” – or, worse still, hasn’t made an attempt to meet the FCA’s expectations – can be sure of some form of punitive action by the Regulator.

How can we help?

Aside from being able to offer a complete range of services to wealth management firms, Complyport has specialist expertise in business conduct, including ‘suitability’ (COBS 9). Complyport has experience of undertaking Skilled Persons Reviews (“s166”) and is proud to be a member of the FCA’s Skilled Person Panel specifically for ‘Conduct of Business’. If we can be of assistance to you in your review of ‘suitability’ and its associated processes then do please contact us at info@complyport.co.uk

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A consumer is “any natural person acting for purposes outside his trade, business or profession”.

Sometimes a question we are asked is whether an investment professional, say a portfolio manager, that makes an investment in a personal capacity would satisfy the definition of a consumer and hence an eligible complainant.

FOS has clarified that in this scenario an investment professional would be regarded as an eligible complainant on the basis that there is a difference between someone acting in their professional business capacity and that same person acting solely as a consumer using/buying a financial service of which they also happen to have a working professional knowledge.

Below is a copy of an ‘Alert’ that was sent out to Complyport clients in June of last year which summarises the changes and highlights areas that firms should have been considering. If your firm is an Alternative Investment Fund Manager, please note that the term ‘eligible complainant’ can also apply to an investor in an Alternative Investment Fund (unless it is a closed-ended corporate AIF).

Alert – June 2015

Background
Changes are being made to the Disputes Resolution Sourcebook: Complaints Sourcebook (“DISP”) of the FCA Handbook. The changes mean that certain professional clients, and not just retail clients, will be able to have their complaints referred to the Financial Ombudsman Service (“FOS”) if not otherwise resolved.

The new regime applies from 9 July 2015 (in respect of complaints received from that date).
Firms who have previously fallen outside the remit of the FOS may now have to apply the ‘complaints rules’ to some but not all professional clients.

What is a Complaint?
Under the FCA Rules, a “complaint”, subject to certain provisos, is defined as “any oral or written expression of dissatisfaction, whether justified or not, from, or on behalf of, a person about the provision of, or failure to provide, a financial service, or a redress determination, which:

1. alleges that the complainant has suffered (or may suffer) financial loss, material distress or material inconvenience; and
2. relates to an activity of that respondent, or of any other respondent with whom that respondent has some connection in marketing or providing financial services or products, which comes under the jurisdiction of the Financial Ombudsman Service”.

Who is an Eligible Complainant?
Presently, one of the requirements in DISP 2 (which sets out the scope of FOS jurisdiction) is that the complainant must be an ‘eligible complainant’.

An eligible complainant is:

• A consumer (a “natural person acting for purposes outside his normal trade, business or profession” (i.e. an individual)).
• Micro enterprises (fewer than 10 employees and turnover or annual balance sheet of €2m or less).
• Charities with annual income less than £1m
• Trustee of a trust with net asset value of less than £1m.

Accordingly, an individual, whether classified as ‘retail’ or an ‘elective professional client’ would be a ‘consumer’ and on the face of it, be covered by the FOS. The rule (DISP 2.7.9(2)) applying to exclude professional clients from the definition of eligible complainant is overridden by a new rule (DISP 2.7.9A), so that an individual, if acting outside his trade, business or profession will qualify as a ‘consumer’ and will be covered by FOS even if classified as an ‘elective professional client’.

The term ‘eligible complainant’ can also apply to an investor in an Alternative Investment Fund (that is not a closed-ended corporate AIF).

Implications
There will be several implications for firms caught by the rule change, including (amongst others):

• Required updates to Compliance Manuals and Monitoring Programmes;
• Required changes to Senior Management Arrangements, Systems and Controls documents;
• Updates to firms’ terms and conditions explaining the rights of clients to use the FOS;
• Potential changes to firms’ websites, general literature and financial promotion disclaimers;
• Required training for firms’ personnel ensuring identification of relevant complaints;
• Procedure and policy documents to deal with complaints including timeframes to follow;
• Complaints reporting to the FCA;
• Payment by firms of a FOS levy fee together with notification to the FCA that the firm is no longer exempt from FOS fees; and
• Potential payments of case fees to the FOS dependent upon the number of complaints received by a firm.

Complyport Services

• Training courses and briefings for responsible staff are available
• Clients using ComplyTracker and ComplyTrainer will receive updates

Complyport can assist you with:

• Building your firm’s complaints procedures;
• Updating training requirements
• Updating relevant literature including websites and terms and conditions of business; and
• Notifications and reports to the FCA as required.

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Robots jump on attitude to risk which in relative terms is simple to capture with a psychometric questionnaire, but what of other attitudes? Attitudes to paying tax (or not), to charges and the perceived value of guru investment managers, types of savings vehicles, restrictions and commitments, these will all be important when making a recommendation. Opinions on social and ethical issues, and those arising from learned experience will all point to potentially different conclusions.

Overlay the fact that, for individuals, some attitudes and beliefs trump others and it becomes clear that the challenge for the robo programer is enormous. Marrying this with a requirement to work within a regulatory rulebook adds to the challenge. The response so far has been, not to build an all singing bionic adviser (it’s too big a job), but rather “restricted” parts. Arms and legs rather than a brain.

An arm might be a discretionary portfolio reflecting a particular attitude to risk and term. Simple to build and maintain, it is relatively easy to work out whether or not a specific objective is achievable and the probability of achieving it. Some may argue that this is simply replicating a traditional managed fund, albeit with a little more transparency and a different set of tax consequences. Now the customer does the selection taking the adviser out of the loop.

A leg might be a quotation engine comparing non-complex products such as term assurance. Here the moving parts are simple but understanding affordability and the levels and types of cover, while balancing these with other needs, adds a layer of complexity that is not, so far, seen in the robots available.

The danger of using separate mini robots rather than a joined up machine, is that users address one need in isolation to others. Invest rather than pay down debt. Perhaps buy a product that isn’t needed. The Financial Advice Market Review (“FAMR”) recognises the need to broaden access to advice. Robo advisers are a potential solution but while they remain fragmented parts of the advice process, they present a different set of risks. For customers who understand and know what they want, with cash sitting around, the robo investor is a potential option. But these are precisely the people already catered for and not the object of the FAMR.

For those who have worked hard and done the right thing, with modest savings, cashing in pensions or selling existing assets which may be fit for purpose, the robo adviser presents a potential mis-buying opportunity. Getting the disclosure right in a world where people click accept without reading the terms will be as important as programing the advice engine itself. It has the potential to become a turning point in future FOS cases.

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This is not the first time the regulator has reviewed the suitability of client portfolios – the FSA expressed its concerns in a ‘Dear CEO’ letter in June 2011 and this was touched upon in a speech by Clive Adamson at the FSA Asset Management Conference in September 2012 (see Regulatory Roundup 31 and 44). The purpose of the thematic review was to determine whether asset management firms had acted on the previous concerns expressed.

The thematic review assessed 150 files from 15 firms, with follow-up visits to a number of them.

Some improvement was identified but there was also a wide variation in the performance of wealth management firms sampled and “many still need to raise their standards – in some cases substantially…”.

This is best illustrated by the finding that whilst one-third of firms sampled raised no substantial concerns, the remaining two-thirds either fell substantially short of expected standards or required some improvements. In terms of the 150 customer files reviewed, around 59% were either deemed to indicate a high risk of unsuitability or were unclear (as in insufficient information to make an assessment or where information presented was inconsistent or confusing). By way of comparison, the previous work undertaken indicated that 79% of files fell within the high risk/unclear category.

Customers’ risk appetite is a recurring theme and the review comments that in a significant number of firms, a customer’s attitude to risk was not recorded on the client file. In other cases, examples were found of customers who gave conflicting or inconsistent responses on their risk appetite and capacity for loss.

The publication makes it clear that:

• Firms should take note of the findings and ensure that they are able to demonstrate how the portfolios they manage are suitable
• Senior management are expected to consider whether any of the concerns raised are reflected in their own firms’ practices and to take any necessary action.

With the above in mind, Annex 2 of TR15/12 provides a table of ‘good’ and ‘poor’ practices found which wealth management firms may find of interest. Areas include effective monitoring, governance and controls and, of course, risk appetite and the matching of the customers’ portfolios.

HOW CAN WE HELP?

Complyport offers a complete range of services to wealth management firms. Our service provides you with independent guidance, ongoing support and the appropriate level of oversight to ensure your firm has the knowledge to maintain compliance and keep abreast of regulatory developments. Complyport does not simply provide pro forma documentation to wealth management firms and leave them to it, all service offerings are bespoke to your firm’s individual requirements.

When choosing Complyport, firms will benefit from:

Initial Assessment
Your firm will be appointed designated experts who will carry out an assessment. This involves a review of current arrangements, identifying gaps or areas where procedures may be improved. We will report our findings and help you build a framework that will meet regulatory requirements. If necessary, we can tailor all supporting manuals, policies and procedures. Alternatively, for firms that require less support, our service can be light touch.

ComplyTracker
As an option, ComplyTracker is our proprietary compliance management system designed to reduce the administrative burden that inevitably falls upon busy staff. The single system caters for firms in-house compliance needs and allows processes to be streamlined. Managed efficiently and simply accessed to demonstrate clear audit trails, the system reduces paperwork and provides a secure storage facility within a controlled compliance environment which reduces the chance of documentary loss or monitoring oversight.

Monitoring Programme
Complyport is well versed in implementing bespoke compliance monitoring programmes that fit with the regulatory obligations relevant to the firm. Whether a firm decides to complete their monitoring on ComplyTracker or use a paper-based monitoring programme, we will help you build a compliance monitoring programme that is appropriate to the nature and scale of your business. We can also provide an independent written assessment of your compliance with your monitoring programme and procedures and evidential records at a frequency agreed with you.

Expertise
Depending upon your own resources and expertise you may ask us to:

• Assist with liquidity, capital and other prudential obligations
• Review corporate governance and supervision arrangements
• Help with file reviews
• Provide registration and filing solutions
• Review your CASS procedures
• Review your TCF procedures
• Help with complaints monitoring or handling
• Review Anti-Money Laundering procedures
• Provide training support
• Review financial promotions
• Support with CRD IV obligations
• Provide a level of regular helpdesk support.

Consultancy
Our experts include lawyers, accountants, former regulators and advisers (chartered). Occasionally you may need specialist support to develop new business ideas or improve a particular aspect of your business or you may simply want an opinion on a complex matter of regulation. Firms can have access to our consultants and expertise on a retained, project or hourly basis as needed.

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As will be known, the rules on ‘suitability’ are found in COBS 9 and apply to a firm making a personal recommendation or when managing investments and is relevant to both retail and professional clients – albeit that certain assumptions can be made in respect of the latter (see COBS 9.2.8). For the avoidance of doubt, COBS 9 is also applicable to non-MiFID business, but only to the extent that it relates to retail clients or the management of certain pension schemes.

Feedback and the near-final guidelines have now been published (if you experience problems with the ESMA link on the left, please copy and paste http://www.esma.europa.eu/system/files/2012-387.pdf into your web browser). The guidelines shouldn’t come as too much of a surprise and cover areas such as record-keeping; the need not to rely unduly on a client’s self-assessment in relation to knowledge, experience and financial situation; and the use of questionnaires as a useful tool but they should not be a substitute for a physical meeting.

The guidance is aimed at both market participants and competent authorities – with the latter having to notify ESMA whether they comply or intend to comply with the guidelines. The FSA issued finalised guidance on ‘Assessing suitability’ in March 2011 so whether the Regulator will issue any further communication on the subject as a result of the ESMA publication remains to be seen. The guidelines can be found in Annex II of the paper.

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A recent consultation paper (CP) issued by ESMA suggests that this is not simply a UK/FSA issue but rather that full and effective compliance with MiFID suitability requirements are not as consistent or as wide-spread across EEA member states as it could or should be. Areas of weakness noted include failing to collect the necessary information and failing to correctly interpret what information has been provided; overlooking the client’s education level; effectively letting the client decide on the suitability of an investment; and poor record keeping. (Please note, it appears that links to the ESMA website do not open on some web platforms. If you cannot access the document using the link please copy and paste the following address into your web browser: http://www.esma.europa.eu/system/files/2011_445.pdf).

The purpose of the CP is not to introduce new rules but rather to set out guidelines “to enhance clarity and foster convergence in the implementation of certain aspects of the MiFID suitability requirements”.

The guidelines include, but are not limited to, ensuring that the client actually understands the questions being asked; not relying unduly on the client’s own assessment of knowledge and experience (so presumably not simply asking the client to tick a box that best meets their needs etc.); and explaining to the client why certain questions are being asked and the importance of accurate and sufficient information.

The draft guidelines do not contain any radical proposals and probably many firms will already be following a similar approach. However with suitability being an FSA focus, firms should consider reviewing the (draft) guidelines in the light of their own business processes in order to identify – and if necessary remedy – any potential gaps. The consultation paper is fairly short (26 pages) and those firms that want to cut to the chase can go to section V on page 19. The consultation period ends 24 February. ESMA expects to publish its final report, and final guidelines, in Q2 2012.

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Although not necessarily part of the review, a Final Notice issued to Credit Suisse (UK) Limited contains examples of suitability failings.

The Notice itself does not focus on COBS 9 failings – nor indeed even mentions COBS – but rather quotes FSMA s206(1) and Principle 3 (“A firm must take reasonable care to organise its affairs responsibly and effectively, with adequate risk management arrangements”). However as the words ‘suitability’ and ‘suitable’ between them make over forty appearances in the 15 page Notice it would seem reasonable to summarise that the heart of the matter was suitability and COBS 9. As might be expected, based on previous Final Notices, the failings cited included not having adequate system and controls in place.

The concern centred around the suitability (or the systems and controls in place in respect of the suitability) of advice regarding SCARPs to its private banking retail advisory customers.

Firms that provide advice – and COBS 9.1.3 reminds us that the concept of suitability also applies to a firm which manages investments – may wish to review the Notice and use it as a comparator against their own processes and procedures.

Section 2.3 of the Final Notice reinforces the importance of having adequate records in place e.g. on investment concentration “.. often no documentation available …”; on the use of leverage “… often no documentation available to evidence the rationale for recommending leverage …”; and in 17 of the 24 SCARP transactions reviewed by a skilled person there was “… insufficient evidence of consideration of the Customer’s overall portfolio … when determining whether the transactions were suitable for the Customer”.

The above illustrates ‘if it’s not written down then it doesn’t exist – especially in the eyes of the FSA’, a maxim which equally applies to areas ranging from board meetings to compliance monitoring.

Not for the first time the failings include a firm not having in place adequate systems to determine an investor’s attitude to risk. We would remind firms that the FSA published finalised guidance in March on ‘assessing suitability’ which includes establishing the risk a customer is willing and able to take. Although the guidance does mention ‘retail customers’, the suitability requirements of COBS 9 also apply, in the case of MiFID business, to professional clients subject to certain assumptions that can be made (see COBS 9.2.8).

For its failings, the firm suffered a penalty of £5.95m after the traditional 30% (Stage 1) discount.

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Some firms may now have received a ‘Dear CEO’ letter from the FSA dated 14 June on this very subject.

The letter sets out the results arising from a review of 16 firms (a sample which included discretionary investment managers), with no less than 14 of them being judged to pose a high or medium-high risk of detriment to their clients (the letter advises that the FSA “are involved in ongoing regulatory action with these firms”).

Some, if not all, of the findings were fairly basic e.g. inadequate client classification; out of date, or absent, KYC; and inconsistencies between portfolios and the client’s investment objective and attitude to risk. The letter goes on to suggest that firms may wish to assess the suitability of client files if not recently done. Complyport clients will be aware that ‘Suitability’ already features in the recommended programme of monitoring devised by their consultants.

Note that recipients of the letter are expected to respond to the FSA to the effect that they have read and understood the content of the letter and considered the implications for their firm by 9 August.

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