Effective systems and controls are crucial for advice firms in managing risk and delivering good client outcomes.
It is an area the regulator is continually looking for firms to strengthen, through changes such as Mifid II. Indeed, the onus on firms to meet the FCA’s increasing expectations should not be underestimated.
And this comes at a time when we are seeing more advisers moving into discretionary fund management, adding further demands.
While the subject’s complexity and the various iterations of service makes it difficult to cover all elements in a single article, here is a snapshot of the issues facing such firms. In simple terms, they need to ensure that:
- Systems and controls are appropriate to the nature, services and size of the firm.
- Procedures are established and maintained to ensure they are robust and mitigate risk.
- Procedures and controls are regularly reviewed and evaluated.
- Where monitoring identifies deficiencies, measures are put in place to address them.
The following five areas are key to consider in order to meet the FCA’s requirements:
1. Conflicts of interest
Mifid II strengthened the emphasis on firms to prevent conflicts, while managing and disclosing those that cannot be avoided.
For discretionary firms, there is often greater exposure to these situations, particularly where the firm offers clients access to funds in which it has some involvementor to services provided by associates.
Firms should, therefore, have robust processes in place to ensure any potential conflicts of interest are monitored and, where necessary, rectified; all of which should be documented and signed off by senior management.
2. Policies and procedures
Firms conducting DFM business must establish, implement and maintain adequate risk management policies and procedures, which identify those they may be exposed to. Not only is this important to meet regulatory requirements, it is also good business practice.
Typical risks businesses may be exposed to include:
- Operational risks: The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk.
- Business risks: The risk that business performance will be below projections as a result of negative variances, such as market changes. For example, reductions in numbers of clients needing wealth management due to economic recession, etc.
- Compliance risks: The risk that laws, regulations and policies will be breached.
It is important the firm’s senior management approve, and periodically review, any policies and procedures a firm has in place, and not leave these solely to the subject matter expert within the business. Good quality management information needs to be gathered to help with this.
3. Client suitability
A key area of risk for any investment firm is the suitability of its client recommendations. For DFM firms, this will cover both its advice and discretionary decisions, along with any referrals between both arms.
The FCA has identified a number of concerning areas, such as inadequate risk profiling, out of date information held on file and failure to record the client’s objectives, which have led to unsuitable recommendations. It has also found many of these firms have no mechanism in place to identify these failings.
The message is clear: firms must have a business monitoring process in place that regularly reviews the quality of the service provided, both at firm and individual manager level.
4. Business monitoring
DFM firms should have appropriate reporting lines in place to ensure risks from the monitoring are reported to the decision makers. It would be expected that the individual holding the compliance oversight function oversees this process and ensures the MI gathered is discussed in appropriate senior management forums. Investment policy committee meetings could be an appropriate forum, given the decisions taken at them.
It is important to remember that, when an advice firm outsources activities, regulatory responsibility still rests with it and its management.
With this in mind, firms should ensure thorough due diligence is undertaken before final selection. Regular ongoing reviews should also take place to ensure the quality of service being delivered is not compromised.
Linda Preston-Todd is head of bespoke solutions at Bankhall