In its final guidance issued today, the FSA set out examples of good and bad practice it discovered around firms' use of model portfolios, discretionary fund managers and distributor-influenced funds.
It follows a thematic review by the regulator, which uncovered widespread failures at some firms.
The FSA said poor outcomes can occur if firms fail to:
- consider the needs and objectives of their target clients when designing or adopting a centralised investment proposition (CIP).
- consider whether the CIP is suitable for each client on an individual basis.
- establish a robust control system to mitigate risks which might arise from the CIP.
Considering the needs and objectives of your target clients
Best practice tips for firms using 'centralised' investment propositions
One firm used feedback from its clients and identified that they only required a simple, low cost CIP. It used this feedback to design and implement a CIP that provided a simple ongoing review service at a cost that was lower than the market average. Other firms engaged client-facing staff to provide guidance on their clients' typical needs and objectives when considering whether to offer a CIP.
Several firms inherited CIP solutions following mergers or acquisitions. Following these corporate changes, the firms failed to undertake any assessment to establish whether the CIP was suitable for the needs and objectives of their new, larger client bank.
Several firms segmented their client bank effectively and designed appropriate solutions to cater for each segment. This included:
- a preferred fund panel for transactional clients
- a suite of low-cost managed funds for clients with modest asset levels who required a low-cost ongoing service
- a model portfolio service for clients with a higher level of assets and investment experience, where the additional costs were appropriate
- discretionary fund management for clients who required bespoke investment management solutions.
Designing or adopting a CIP
Several firms carried out a review of their clients' typical needs, and formulated a list of key requirements before tendering for a third-party CIP provider.
Several firms adopted a CIP provided by a third party with whom they had an existing relationship. However, the intermediary firms failed to undertake any due diligence on whether the CIP solution adopted met the needs of their target clients.
One firm that was acting as an agent for its client referred the management of its CIP to a discretionary fund manager. However, the advisory firm did not adequately explain to the client that it was not responsible for the investment management and that the discretionary fund manager was not treating the client as its customer.
Constructing portfolios that are suitable for the risk profile of distinct client segments
One firm's CIP used model portfolios managed on a discretionary basis. These portfolios contained significant exposure to non-mainstream investments and higher levels of equity-based investments than were appropriate for the firm's clients, particularly those at the lower end of the risk scale. The firm did not provide evidence that it had adequately considered the needs, objectives and knowledge and experience of its clients, some of whom were not financially aware and were unlikely to understand the risks associated with the firm's complex investment strategy.
One firm offered an asset allocation process within its CIP; however, it neither offered an annual review to rebalance the assets nor did it explain the importance of rebalancing to its clients.
Ensuring a recommendation to switch existing investments into the CIP is suitable
In one firm, advisers would present their recommendation to transfer a client's existing investments to the CIP, and complete the necessary application forms, before analysing the features and benefits of the client's existing investment.
Ensuring advisers are competent and can identify when a CIP is and is not suitable
Several firms offered a transactional service to clients for whom the CIP was not suitable. Advisers received training on the CIP and were able to identify under what circumstances it would not be suitable.
In one firm, the advisers were not permitted to research or recommend any investments other than the CIP. All investment recommendations would pass to a central team of advisers to implement the CIP. There was no facility in place to adapt investment solutions to individual clients outside the range of CIP solutions and the firm did not have in place arrangements to turn away clients for whom the CIP was not suitable. As a result, all investment recommendations consisted of a CIP solution, creating a significant risk of unsuitable advice.
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