Regulatory update: TR16 / 1 – Assessing Suitability: Research and Due Diligence

Posted: 29th March 2016

Background

The latest FCA thematic review, published on the 19th February, is part of the regulator’s broader work on suitability, and is focused on three key areas, namely how advice firms:

• Select products, funds, platforms and discretionary investment management services for clients
• Create panels and centralised investment propositions (CIPs)
• Consider, assess and recommend options for individual clients

Previous thematic reviews 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 of poor consumer outcomes in this space (the other two being incorrect risk profiling and cost). Due to ongoing concerns over firms’ activity in these areas, the FCA has undertaken this more granular thematic review.

Key findings

The regulator states that:

 “Many firms did not show consistently good practice across all products and services...we were disappointed to identify issues relating to platform research and due diligence, particularly having previously published our expectations around this topic” (TR 16 / 1)

The FCA further illustrated their concerns in the three aforementioned areas:

Selecting products, funds, platforms and investment management services

• Firms’ willingness to understand, contextualise and challenge their own bias towards products, services or providers led to a lack of objective consideration with regards to client recommendations
• Some firms’ inadequate management of conflicts of interest between themselves and their clients. In some cases, the service firms received from advice platforms was considered more important than the service received by the client
• Firms’ tendency to stop reviewing the platform options available once the firm becomes content with the service they are receiving from their existing platform. This again may mean decisions are not centred on clients’ needs

The regulator provides an example of how the above might manifest itself in practice; when carrying out due diligence, one firm reviewed the effectiveness of its advice platform based on criteria that would make its existing platform come out as the preferred option against others. The firm had therefore manufactured the outcome of its review and neglected its responsibility to clients in favour of avoiding perceived cost.

Creating panels and centralised investment propositions (CIPs)

• Firms who offered a CIP typically had a centralised function to carry out research and due diligence
• The FCA stated that firms who offer CIPs should ensure that individual advisers understand the benefits and risks of the CIP to enable them to identify what products are or aren’t suitable for clients – essentially, are the recommendations identified via CIPs ratified by the advisor in order to ensure they are suitable?

Considering options for individual clients

• In some cases, firms no longer adequately reviewed clients’ options because those firms no longer sought to review, question and/or challenge the sufficiency of the service of their providers – essentially, firms took the recommendations of their providers as read.

Regulatory next steps

The FCA will be publishing a second consultation paper on the implementation of MiFID II later this year. This will include requirements in relation to research on products and services.

The regulator is currently considering a range of methods to officially set out their expectations in this area, which will help firms raise standards and adopt good practices. This will be communicated at a later date.

Implications and considerations for firms

A key driver of good research and due diligence is a corporate culture of challenge. The better-performing firms in the thematic review had built on the idea of healthy challenge within their firms when it came to the big decisions and/or the regulatory concerns of staff. With this in mind, firms should consider the following questions in assessing and developing their approach in this area:

• Is the culture within your firm conducive to internal challenge?
• What are the escalation routes when individuals have concerns?
• What is the process for assessing and acting on these concerns?
• How (and how often) do you review the effectiveness of your CIPs’ model for generating recommendations?

This thematic review is just one part of a wealth of FCA activity taking place in the advice space at the moment. However, firms can obtain a significant indication of the FCA’s future supervisory approach with regards to research and due diligence from TR 16 / 1 – as with many thematic reviews before it; this will be a line in the sand.

Considering the questions above could provide either assurance, or the prompt a firm needs to start a more in-depth review of their approach.