The private banking and wealth management industry faces increasing regulatory challenges as 2012 unfolds. It is quite clear that the UK’s new consumer-facing regulator, the Financial Conduct Authority (FCA), will be a different animal in nature and outlook from the Financial Services Authority (FSA).
Suitability
The FSA has already begun the process of turning itself into the new regulator, and the wealth management industry is feeling the effect of this.
In particular, there has been a strong focus on suitability, that is the FSA’s requirement that firms establish the risk that a customer is willing and able to take, and making a suitable investment selection.
In June 2011, the FSA sent a "Dear CEO" letter which identified significant and widespread failings in firms on suitability.
Following thematic work, the FSA findings included that 79% of client files reviewed had a high risk of unsuitability or the suitability could not be determined, and that 14 out of 16 firms were judged to pose a high or medium-high risk of detriment to their customers.
The concerns included KYC data missing or out of date, inadequate risk profiling, failure to apply MiFID client categorisation, poor record-keeping on clients’ financial situations, and failure to obtain data on knowledge, experience and investment objectives.
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Enforcement
Unsurprisingly, the FSA has brought a number of enforcement cases in this area. The FSA has focused in particular on more complex offerings such as structured products and UCIS, where it is harder for firms to demonstrate suitability.
The FSA has fined firms for having inadequate sales documentation which do not accurately describe the risks of a product, and where inadequate training was provided to sales advisers, and also taken action for unclear information provided to investors in relation to the scope of available cover under the Financial Services Compensation Scheme.
The FSA has brought enforcement cases, even though there was no finding that products sold were unsuitable or that consumers had suffered loss.
The FSA will focus on inadequate systems and controls, and the risk of loss. Good record-keeping is fundamental to demonstrating suitability.
Often firms’ knowledge about customers is retained in the heads of advisers, but not recorded on file.
This is not good enough when the FSA reviews files on an inspection visit, as the FSA will base its findings on the information contained in the file.
The FSA has also noted that where firms have suitability reports, they may be based on a standard template and applied rigidly, without taking into account the circumstances of the individual customer.
As well as bringing enforcement cases, the FSA can also issue public warnings about certain products. In November 2011, the FSA warned against traded life policy investments (known as "death bonds") which invest in US life insurance policies.
The FSA stated that firms should not be selling these products and that it intended to ban the products from being marketed to retail investors. Issuing public warnings (and banning the sale of products) is a tool that the new FCA is expected to use more than its FSA predecessor.
The future
Looking to the future, the incoming chairman of the FCA, Martin Wheatley, gave some clear indications in a speech to the BBA in January 2012 of how the FCA will operate in the retail product area.
There will be a close examination of a firm’s culture, from product governance to sales, that firms are acting in the best interests of their customers.
Tools used will include mystery shopping and "our culture will be to ask the difficult question, the ones that sometimes regulators shied away from, of you, of ourselves, of consumers’ behaviour."
Firms will need to be ready for this more intrusive approach.
Ian Mason is a partner in the financial services group of Baker & McKenzie
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