An indelicate approach to regulation
EARLIER this week, the chief executive officers of wealth management firms woke up, rubbed the sleep out of their eyes, and found a letter from the Financial Services Authority on their doormat. The letter pertained to the results of the FSA’s wealth management review.
The review claimed that in a sample of 16 firms, 14 were judged to pose a high or medium-high risk of detriment to their customers, based on the number of client files which had a high risk of unsuitability or where the suitability could not be determined. Overall, 79 per cent of files reviewed had a high risk of unsuitability or the suitability could not be determined. 67 per cent of the files reviewed were not consistent with one or more of the following: the firm’s house models; the client’s documented attitude to risk; and the client’s investment objectives.
With many wealth management firms currently shouldering the expense of putting staff through training in order to achieve compliance with the outcome of the Retail Distribution Review that will come into effect from 1 January 2013, the FSA’s published letter will probably not be the most welcome arrival. The regulator’s bull-in-a-china shop approach to public relations may not have enamoured it to the industry, but there could be a silver lining for some wealth managers. According to Lee Robertson, chief executive of Investment Quorum, a boutique wealth manager, the report will benefit those on the right side of the fence. Robertson says: “We are probably going to see more of a split between wealth managers who take an active, personalised role in managing their client’s portfolio and maintain a long term view, and those who simply assess a client’s suitability for a one size fits all portfolio. We consider ourselves to be in the first category and it’s the latter who are really going to struggle when new regulations kick in.”
COMMUNICATING RISK
The bulk of the seven-page letter and appendix focuses on the inability of some firms to demonstrate that client portfolios are suitable. In assessing suitability, wealth managers are expected to establish the risk that a customer is willing and able to take and then make a suitable investment selection. However, establishing what constitutes adequate assessment of a client’s appetite for risk is a difficult thing to do. Gemma Godfrey, head of research for Credo Capital, says that there are a number of challenges when making this assessment. “Wealth managers need to obtain sufficient information about their clients, and also manage expectations. In doing so, they also need to avoid emotive language that could lead a client down the path to a particular choice.” Wealth managers also need to make sure that the information that they hold is current. But how current is current? “Wealth managers used to work on a time horizon of three years,” says Godfrey, “but this time scale is shrinking, and managers need to keep abreast of the requirements of their clients.”
CONSIDERATIONS FOR CLIENTS
Though the Dear CEO letter released by the FSA was intended by the authority as a boot to the posterior for below-par wealth managers – albeit seen by some as a boot on the head of managers already treading water – the letter also serves to remind clients what to be aware of when choosing who manages their hard-earned funds.
Wealth managers should temper the expectations of clients, who should not expect to be able to simply write a cheque for their portfolio manager and to receive one back in five years time with an extra zero on the end.
At the same time, customers should be aware that not all wealth managers are equal, and should be paying attention to the process. As Gemma Godfrey points out, “while it may be an attractive proposition to go for a manager that offers an easy sign-up with a minimum of effort, this isn’t necessarily a good idea. Clients should make sure that they’re aware of the process, and there is responsibility on both sides.”
POISON OR CURE
With wealth managers and independent financial advisers (IFA) dealing with regulation from all directions, the industry won’t relish public castigation from its regulator. But given the choice between another barrage of regulations and a sniping letter from the FSA, chief executives will probably have been more content with a letter.
What is clear is that the wealth management industry as a whole is heading for a shake up over the next year and the IFA sector is expected to shrink over the next 12 months by some 10-12 per cent. As a result, it will be the consumer that will be hurt the most, as competition decreases and costs are passed down the food chain with increased fees. Once again, regulation that meant to aid will instead hinder.