In spite of the wave of risk-rated funds being launched to the market, it appears that advisers are unlikely to get any more guidance from regulators in this area.
The FCA’s predecessor, the FSA, published guidance in March 2011 that gave details of a wide-ranging thematic review of providers of risk-profiling services – but since then the regulator has been noticeably quiet on this front.
But FinaMetrica co-founder Paul Resnik, one of the most vocal proponents of risk profiling, believes the FCA should revisit this area and give updated guidance to spur advisers to action.
“Two years on [from the last guidance paper], my sense is that there has been a gradual growth in awareness of what is required,” Mr Resnik says.
“I am conscious that, while several advisory firms have embraced the opportunity to rework their advising processes, for many others the issues have not risen to the top of their to-do lists. Perhaps a discussion paper from the FCA, with examples from current reviews of firms, including what they like and dislike about their suitability processes, would encourage greater diligence.”
Two years ago, in its guidance paper ‘Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection’, the FSA found that only two of 11 providers of risk-profiling tools met the regulator’s standards. The regulator was criticised by advisers for not publicising the names of those which did and did not pass muster.
The FSA’s research found that half of investment switching cases assessed by the regulator were unsuitable due to the adviser failing to take into account the risk each investor was willing to take.
The FSA called the findings “unacceptable” and promised “tough action” against companies failing in this area.
The key part of the guidance paper for advisers is that they cannot rely solely on the results of any risk-profiling tool to give them a perfect product match.
For example, a risk-profiling tool may give out a client a risk number 4, but the FCA would be likely to take a dim view of any adviser who assumed this automatically meant the client would be equally suited to both Artemis’s Strategic Bond fund and Newton’s Real Return fund – both rated 4 by Distribution Technology out of a possible 10, where 10 is the highest risk.
The subject of risk ratings has also come up in European regulation. When the key investor information document (Kiid) was introduced for all Ucits funds two years ago, it was heavily criticised for an overly simplistic approach to risk.
Each Ucits fund has a rating of 1-7 on its Kiid, based primarily on a volatility calculation. But this ‘synthetic risk-reward indicator’ (SRRI) only takes into account volatility, and there is no mention of risks such as liquidity.
Advisers claim this risk rating is simply not broad enough to capture the breadth of funds available or place the risk rating in any sort of context.
Morningstar’s director of international data and research strategy Andy Pettit says that such flaws could be addressed in a new version of the Kiid, due to be rolled out across all Europe-based retail financial products in the next three years as part of the Packaged Retail Investment Products directive (Prips).
“We would hope that Prips would improve our areas of concern,” Mr Pettit says.
FinaMetrica’s Mr Resnik points out the FSA was increasingly active regarding risk and fund suitability in the two years prior to its replacement.
In July last year it published a guidance paper regarding the use of centralised investment propositions (CIPs) such as model portfolios and discretionary fund managers.
Within this paper the regulator told intermediaries they must have “a reasonable basis” for recommending a client be placed with a firm’s chosen discretionary manager or model portfolio provider.
The FSA says in the guidance: “When the CIP solution is not suitable for an individual client, a firm must either recommend an alternative suitable solution or make no recommendation to the client. It is not acceptable to shoehorn clients into the CIP solution.”
In April the FCA published the long-awaited policy statement on payments to platforms from product providers.
Tucked away in the new handbook rules was a line declaring that advisers are responsible for ensuring platforms are compliant with the new rules on rebates, showing that the world of investment advice has gone far beyond a box-ticking approach to risk assessment of funds.
Nick Reeve is senior news reporter at Investment Adviser
WHAT THE REGULATOR SAYS:
In its March 2011 guidance paper the FSA, the predecessor of the FCA, explicitly stated: “Tools may not provide the right answer in all circumstances. So where firms rely on tools, they need to ensure they consider this risk and actively mitigate any shortcomings or limitations through the suitability assessment and ‘know your customer’ process.”
