When a regulator issues a guidance consultation that includes the statement, “as we apply our intrusive and intensive supervisory approach,” you get the idea they mean business and the FSA has come out swinging in their latest guidance consultation on accessing suitability. From the opening paragraph the regulator takes a consumer focuses approach that is in my opinion is openly hostile to the financial services industry.
I am impressed. In the very high stakes game of reforming the UK’s financial services sector and feeling the pressure to act and prevent consumer exposure to another financial meltdown, the FSA provides guidance based on empirical data.
The FSA specifically calls to task the financial industry’s globally recognized business practice of quickly running a potential client through a risk tolerance profiler, assigning an often vague risk category or risk number, and then selling investment products that “fit” the assigned risk category. These flawed business processes were designed to meet the vaguely defined “suitability” standard for advisers providing personal recommendations or a decision to trade.
The regulator is loudly yelling, we know what caused consumers pain in the past and we are no longer going to tolerate the business as usual culture of the last 20 years. I do not believe it should be taken as a subtle point that the dates selected were March 2008 to September 2010. The FSA is taking full note that businesses have not changed their practices since the market meltdown.
I could not agree more with the regulators criticism of the suitability standard as it is executed in practice. All of their points are valid and backed by research. The recent market meltdown only emphasized the point that most consumers don’t understand the true risks to their futures of being in one risk category or another or owning specific investments.
It was due to these antiquated business practices that my partners and I founded Voyant. From our personal experiences, the entire client interaction between adviser and consumer was completely relationship based and these relationships were most often thin. As both owners of a software development and consulting firm specializing is custom development projects for large financial institutions and a personal investors, we realized that most financial advisers knew little about their clients’ real needs and consumers knew even less about their own needs and ability to take risks in the financial markets. We saw first hand how the industry was just doing the very least to it could to sell products and meet a minimum suitability standard. Voyant was started before the market meltdown. Our reasoning was simple. As the Internet made financial information more accessible to all, consumers would demand better service from their financial institutions and advisers. We developed Voyant as a technology based solution to allow advisers and consumers to collaborate on all aspects of a clients financial future and see with a higher level of detail the potential risks and possible rewards of different investment, savings, spending, and borrowing scenarios. The model was design so the consumer provides the financial data and personal information such as needs and goals, while to adviser provides the professional expertise. Voyant was designed for all type of planning and for all levels of wealth.
While we have had great success in the marketplace, we have come across stiff resistance to change from many large organizations unwilling to change their age old sell at any cost business practices. I have had numerous conversations with large enterprises that were unwilling to implement any type of meaningful engagement with their clients and wanted the entire discovery process to be no more than 6-8 questions, before the adviser began providing recommendations. My favorite risk profiler in the world is used in the UK and is exactly 8 questions long with arbitrary and almost meaningless results. I am stunned this meets any professional standard.
The FSA has obviously recognized this resistance and published this guidance to motivate these aspects of the financial industry. The cleverest aspect of this guidance was not to argue that organizations currently following the suitability standard should be subject to RDR in 2013 and fall under a fiduciary standard, but to specifically define a new level of service expected to even be consider suitable as of today. The guidance reads
“By ‘capacity for loss’ we refer to the customer’s ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk that they are able to take.”
This adds a whole new element to concept of suitability. The regulator is now specifically defining that for an adviser to meet the suitability standard they must have a deep understanding of a client’s financial condition. The commentary continues,
“Some firms unduly focus on the risk a customer is willing to take and fail to take sufficient account of the customer’s other needs, objectives and circumstances: for example failing to consider whether the customer would be better placed repaying debt, or failing to select an investment that meets a customer’s need for access or the term for which the customer wishes to invest.”
Having to consider debt as a measure of not only how a client should invest but whether the client should invest at all is something most product sales focused organizations are not prepared to do and creeps very close to a mandating almost holistic planning.
I believe this is the key. For all of the discussion in the guidance paper about the proper use and design of risk profilers, the regulator makes the point very clear that no only should the risk profiler used be fit for purpose but using this alone is not nearly enough. Enterprises and advisers from pension providers to private bankers need to take notice. This new suitability standard is tough. While new disclosures and charging structures might be on hold until 2013, the regulator expects the business practices surrounding advice and guidance associated with an RDR compliant firm to be in effect today for all firms. Change needs to be made now or firms risk drawing the condemnation or more of the regulator.
While UK advisers are going to feel the immediate direct impact of this new definition of suitability, this guidance could reverberate globally. Numerous regulatory bodies around the globe including the Securities and Exchange Commission (SEC) in the United States are struggling to decide proper business processes and professional standards that should be used by financial advisers in wake of the recent market meltdown. The arguments are similar if not identical. The SEC is mandated to report to the US Congress on January 21 its recommendation on whether all levels of advisers in the US should fall under a fiduciary standard. The SEC could make the move to push for the fiduciary standard or they could follow the FSA’s lead and just redefine what is suitable advice. In all cases, change is still coming to the global financial services industry.
