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Alan Hughes: The FCA’s key messages on due diligence

Alan Hughes

In February, the FCA released Assessing Suitability: Research and Due Diligence of Products and Services. The paper is loosely themed around suitability but deals mainly with the role of research and due diligence in the assessment of it. As suitability is the cornerstone of both good advice and much of the FCA’s supervision of advisory firms, any communication that concerns it should be a compulsory read. Helpfully, the paper is short and concise. The key messages are:

1. Yet again the FCA has focused on a firm’s culture. In particular, it determined that where a firm had a culture of challenge it led to better quality research and due diligence and a higher probability of good client outcomes.

Culture can be a difficult concept to grasp. The FCA identified  it as unhelpful when research and due diligence are carried out centrally but a firm cannot demonstrate it has taken steps to ensure:

(i) Individual advisers have the ability to fully understand the benefits and risks of the centralised investment proposition and platform

(ii) Such research and due diligence is regularly updated

(iii) Advisers are appraised of such updates and given the opportunity to discuss and challenge the firm’s approach.

Without this the FCA may take the view advisers cannot fully understand the risks and benefits  of the solutions used, making poor consumer outcomes more likely.

2. File reviews should not be a tick-box exercise that demonstrates little more than the fact research and due diligence have been carried out. A file review should show that a proper assessment of the suitability of any recommendation has been undertaken by looking at the relevance of the research to that client and the suggestion made.

3. Platform due diligence is still an issue. Three obvious examples of firm failings were identified.

  • Firms’ due diligence should be focused on what is best for the client. The FCA found evidence of firms focusing on the service level provided to them as a reason for selecting a particular platform. If a firm does that, it must show how that issue is likely to adversely affect the quality of service it provides, otherwise the firm appears to be putting its own interests first.
  • The FCA also found evidence of a “status quo” bias at firms, in that once they have found a platform solution that works they stick with it. A solution may remain suitable for clients for a considerable period after it is first used but firms must be able to demonstrate this approach is periodically reviewed and assessed, particularly as the platform market continues to evolve at a rapid pace.
  • The most obvious failure identified by the FCA was firms “retro-fitting” research and due diligence to justify an outcome upon which they had already decided. There could not be a more obvious example of failing to put the clients’ interests before those of the firm. If the FCA finds evidence of that, firms should expect  short shrift and, at the very least, significant supervisory scrutiny.

What is lacking from the paper are clear steps a firm should take to identify and mitigate the risks identified by the FCA.

It  jumps around a little and almost represents a collection of the FCA’s evolving thoughts in this area “to be continued”, rather than reaching obvious and final conclusions.

It is clear, however, that robust systems and controls need to be in place to ensure research and due diligence are effective. This starts with the due diligence process itself (which may be conducted centrally; indeed, is likely to be) but must go further and explicitly provide for challenge and communication around the conclusions reached, periodic review of that work and a focus on how such research is relevant to recommendations made for individual clients.

A one-size-fits-all tick-box approach will not hit the mark here. File reviews will be particularly important in “closing the circle” and showing how the firm’s research and due diligence is genuinely applied to individual client recommendations.

The two recurring themes here are the culture of the firm and being able to demonstrate processes are more than superficial and are genuinely focused on good client outcomes, rather than simply meeting a compliance requirement. Nothing new but clearly something the FCA wants to continue to focus on.

Alan Hughes is partner at Foot Anstey LLP 

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Comments

There is one comment at the moment, we would love to hear your opinion too.

  1. Julian Stevens 4th May 2016 at 11:44 am

    Given the long, long list of assorted train wrecks, motorway pile-ups and melt-downs that the FCA and its predecessors have failed to see coming or, if they did see any warnings signs, that they failed to act upon, one might well summarise the FCA key message on the issue of DD as being: Do as we say, not as we do.

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