Your Industry  

Regulator’s risk assessment requirements

This article is part of
Guide to Risk Profiling

In its 2011 final guidance paper on assessing suitability the regulator made it clear that to use a portfolio-picker questionnaire alone is no longer acceptable .

The paper is a must read for advisers and identifies some hot topics that advisers should consider when assessing attitude to risk. These include:

• how robust is your process for assessing the risk a customer is willing and able to take, including their capacity for loss;

• does your process appropriately interpret responses to questions or does it attribute inappropriate weight to certain answers;

• do all parts of your process pass the ‘clear, fair and not misleading’ test – especially questions and risk descriptors;

• do you have a robust process for ensuring investment selections are suitable that considers customer’s objectives and financial situation as well as their knowledge and experience;

• do you understand the nature and risks of the products or assets you have selected for customers; and

• have you sufficiently engaged the customer in the suitability assessment process.

The key point to take away from the regulator’s comments on this subject are that the investment outcome delivered by an adviser’s risk assessment should meet the suitability rules.

In addition, Paul Resnik, co-founder of FinaMetrica, says the regulator has stated that advisers need to be aware of the risk tools they use and are aware of any weakness that they may have.

The tools should therefore be used as part of a compliant investment advice process. He says the regulator wants clients who are advised to make informed decisions regarding investments.

They also want advisers to make informed decisions in the selection of the questionnaires/tools they use, he adds.

To conform to the regulator’s requirements, Mr Resnik says advisers need to be clear on the following key areas:

• ensure the questionnaire/tool they select is fit for purpose;

• understand how to use the questionnaire/tool as part of a compliant investment suitability advice process;

• knowledge of the benefits and the shortcomings of the questionnaires/tools they use; and

• have in place processes to compensate for those weaknesses.

Independence issues

When selecting a risk profiling tool, independence is a key issue regarding risk tool design and development, according to Mr Resnik.

Anecdotally, Mr Resnik says many product providers’ risk tolerance tools have been specifically configured for the provider products and funds. He says the issue of independence with regards to the questionnaire/tool provider is therefore an important factor.

This includes independence regarding freedom from ownership conflicts; allowing focus and specialisation in the area of risk tolerance without fear of tailoring of questions and reporting leading to ‘preferred’ portfolio recommendations.

Mr Resnik says independence usually comes at a price.

He says: “A good rule-of-thumb is if an adviser is paying a fee for the use of a questionnaire/tool then this can be a sign of independence; if the questionnaire/tool is free to the adviser, then the commercial motive of the tool must lie elsewhere in the process and the tool will not be independent of cross-subsidy or transparent.”