How to use cashflow modelling under the product rules

  • Describe what the prod rules expect of financial advisers
  • Describe what capacity for loss actually means, and how cashflow tools help
  • Identify how cashflow tools can help with charges
How to use cashflow modelling under the product rules

Cashflow forecasting has been part of many people’s financial planning toolkit for many years, particularly since Dynamic Planner launched UK’s first online cashflow planning tool in 2004.

For many reasons it has recently increased in popularity again.

Cashflow forecasting can take many forms, from a spreadsheet showing incomes and outgoings each year, to a stochastic tool projecting the impact of contributions and withdrawals on a client’s capital.

There are many cashflow planning tools on the market, and many more homemade spreadsheets.

Of course, as with any form of investment advice, it is very important that it is done well.

Many tools would not meet the standards set by COBS let alone the newer PROD rulebook, designed to help advisers meet the standards set out in Mifid II.

Future projections

Starting with COBS 4.5A 14, which states that any future projection must be based on appropriate assumptions, supported by objective data and not simulated past performance.

If a cashflow tool takes in a historical index of returns and does a future projection by sampling returns from this index without any model or assumptions for how this might change in the future, then the tool is using simulated past performance and can not be used for future performance.

A cashflow tool which requires an adviser to input a percentage growth rate is leaving the adviser to deal with an extremely complex question of deciding on a future growth rate, including being able to show the impact of investment risk.

This might be fine for large organisations with in-house teams of assumption setters, but is likely to be a challenge for smaller firms.

PROD aims to “improve firms’ product oversight and governance processes and to set out the FCA’s statement of policy on making temporary product intervention rules.”

PROD2 is relevant to all firms (but is unlikely to be relevant to cashflow).

PROD3 is relevant to a range of organisations, including advisers making personal recommendations.

This article will explain what advisers should look out for when considering the PROD rules within cashflow modelling.

When looking at PROD, an investment adviser will be classed as a “distributor” as someone who is recommending “investment services” to “clients”.

PROD 3.3.1 states that “A distributor must: (1) understand the financial instruments it distributes to clients; (2) assess the compatibility of the financial instruments with the needs of the clients to whom it distributes investment services, taking into account the manufacturer’s identified target market of end clients; and (3) ensure that financial instruments are distributed only when this is in the best interests of the client”.

Parts 2 and 3 above can easily be complied with by doing an appropriate cashflow plan.

Such a plan could, if done right, show that the product is suitable in a range of circumstances, meets their needs and are in their best interests.