The Financial Conduct Authority (FCA) is concerned about the due diligence advisers perform on investment product providers and will continue to monitor the area, technical specialist for the regulator Rory Percival has said.
Speaking at the Defaqto investment outsourcing conference on Tuesday, Percival said advisers should think about what best practice should look like and not rely on the marketing material provided by the product providers when outsourcing their clients’ investments.
Percival said: “It is worth noting that due diligence is an area of concern for the regulator because it is an area that underpins a lot of problems of crystallised risk that we have seen in the past. It is an area that we would strongly recommend that firms think about.
“Over the coming months and into next year the subject of due diligence will continue to be on the agenda and my hope is the industry generally and participants within the industry will continue to talk about what good due diligence looks like and to move everybody forward in that respect.”
He said relying on the marketing material from discretionary fund managers (DFM) or other authorised firms was “not acting professionally and in the interest of the client”, but relying on facts was allowed.
“You can rely on what other firms tell you if it’s factual information. What you can’t take at face value is opinion.”
He told delegates that the FCA found it easy to pick examples, such as Keydata and Arch Cru where firms “weren’t undertaking adequate due diligence” around the investments that they were recommending.
However, how advisers and DFMs decide to share the due diligence after referring a client is up to them, he said, “so long as the client ends up with the right outcome. You have to have that discussion with the DFM to make sure that that works effectively.”
Similarly, to what extent an adviser has to monitor the DFM’s ongoing work depends on their own agreement with the client, but broadly advisers are expected to monitor whether the DFM remains the right fit for the client over time, he suggested.
Percival also flagged up problems with determining client risk tolerance, which the FCA was alarmed about, particularly when the risk level was defined by just a number. Clients found it difficult to understand what level of risk they were taking on without any description of what the number meant, Percival warned.
He said the regulator had found very few good risk descriptions in its latest thematic review into the issue. Using the measure of volatility, for example, he said, was more of a movement than an indication of the risk a client is willing to take, so is not broad enough.
He warned: “If you haven’t looked at your risk descriptions since we wrote that paper I would suggest revisiting that paper and revisiting your risk descriptions because good practice was very difficult to find. Percentage in isolation would be problematic because you then don’t have a broader idea of what level of risk that client is really willing to take.”
Although the regulator is happy about advisers using risk-rated funds, it has concerns about the use of mapping exercises when dealing with such funds as the client’s risk profile may not match the risk rating of the fund, Percival said.”If you’ve got a tolerance for loss that’s a three and you’ve got a portfolio that’s a three it doesn’t necessarily say that that’s right because there are other factors that need to be taken into account. By all means have risk-rated funds but be aware of the context in which they are recommended and whether they are relevant to individual clients,” he told advisers in the audience.
He further suggested the FCA had found that some firms were not using he right language when talking about capacity for loss, which should mean the “ability to withstand losses without materially affecting their standard of living”.
He said some firms were mistakenly identifying ‘tolerance for loss’ instead of ‘capacity’, which is a “numbers thing” not a “feeling thing”.
“It’s usually best to keep the two separate”, he said, “when they get conflated to gether you can run into problems as a result of that.”
However, he said: “We are not here to tell you every little thing about what you should and shouldn’t be doing and how you should be doing it. It’s much more about doing, thinking and making sure that the way you do it is robust.”
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