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FSA sets out DFM rules

The FSA expects adviser firms to clearly spell out their relationship with discretionary fund managers to clients where there is no direct contract between the client and the DFM.

The regulator has today published its final guidance on centralised investment propositions and replacement business following a guidance consultation in April.

Cips are defined by the FSA as a standardised approach to investment advice, such as model portfolios, DFMs, and distributor influenced funds. Replacement business means where advisers switch clients out of existing investments.

One of the main changes from the earlier guidance is the FSA has flagged up its expectations on how advisers should disclose their relationship with DFMs.

The FSA says it is aware of three broad structures firms adopt when using a DFM as part of a Cip. Adviser firms can arrange for the client to have a direct contractual relationship with the DFM, or hold the relevant permissions for managing investments and delegate the investment management to the DFM.

The third structure is where the DFM is carrying out the investment management, but there is no direct contractual relationship between the client and the DFM. Instead the DFM treats the adviser firm as the client, acting on behalf of the investor.

The FSA says: “In this case we expect the advisory firm to explain the position clearly to its clients. In particular it should emphasise it is not carrying out the investment management itself and the discretionary manager is not treating the end investor as its client.”

The guidance was triggered after the FSA carried out a thematic review into Cips. The regulator reviewed 181 investment files from 17 firms which recommended a Cip. It found the quality of advice to be unsuitable in 33 cases and unclear in 103 cases. The quality of disclosure was found to be unacceptable in 108 cases.

The FSA has reiterated in its final guidance that “it is unacceptable many firms are still not demonstrating the suitability of replacement business”.

The regulator says firms need to ensure the costs of the Cip recommended are clearly explained and in the client’s best interests.

Where clients are switched out of an existing product due to improved performance prospects, the firm should justify why it believes the new investment will outperform the existing one.

Firms also have to consider suitability based on tax implications and the client’s specific objectives. Firms should also be able to demonstrate why existing investments no longer meet the client’s needs.

Firms should also ensure they are not shoe-horning clients into a Cip and have controls in place to reduce the risk of unsuitable replacement business recommendations.

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Comments

There are 7 comments at the moment, we would love to hear your opinion too.

  1. Andrew Whiteley 5th July 2012 at 10:52 am

    so Mr client I have entrusted the management of your life savings to these Discretionary Fund Managers but I would like to point out that I am not carrying out the investment management on your behalf and the DFM will not be treating you as their client. Is that OK with you?

  2. Andrew -your forgot to mention that the DFM takes no responsibility for the performance – thats all down to you and so you are liable in the event of a complaint

  3. William Watling 5th July 2012 at 11:53 am

    If the DFM has no direct relationship with the client, how do they ensure the Capacity For Loss threshold (GC11/01) agreed with the adviser is breached, triggering a claim? How does the adviser know CFL threshold isn’t breached if the DFM can manage on a discretionary basis?

  4. Anon – Really, FOS have changed the rules have they and clients can complain about performance – News to me.

  5. The client can (quite rightly), complain if the poor performance was because their portfolio and their attitude to risk have not been kept in line.

    All the more reason to give this job to someone who knows what they are doing and can do it on a scaleable basis.

  6. Larry in London 6th July 2012 at 5:35 pm

    Oh dear. It is for this very reason, when the world was a lot less complicated than it is now, that with profits funds were invented. They really were the ‘one size fits all’ of the investment world. Clients got performance, the life assurance company made a profit and gave some of it to the client who invested more money which helped the insurance company deliver more performance and everyone was happy. Nobody gave a toss about WP funds being ‘opaque’ because they worked — everyone was a winner!

    Now, in the New Enlightenment, only the client is supposed to win and because of that he will ultimately lose everything.

    Doh!

    Love and kisses

    Larry

  7. “Clients got performance, the life assurance company made a profit and gave some of it to the client who invested more money which helped the insurance company deliver more performance and everyone was happy.”

    This is the dictionary definition of a Ponzi scheme. That is why there aren’t any around any more (at least not in a form that anyone can recommend).

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