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The FSA must take a pragmatic approach to risk assessment

Not for the first time the regulator is rushing round like a demented ferret, not knowing what to bite first.

Has its latest work on risk been precipitated yet again by the banks and in particular the recent fine handed out to Barclays?

How relevant is this to IFAs? There is a big difference between a bank customer and an IFA customer. The bank customer is, in the main, a one-night stand while an IFA client usually has an ongoing relationship. It is not uncommon to have been with the same IFA for more than 10 years. IFA customers tend to be better off, better educated and have a better understanding than the typical bank customer.

Risk and defining risk is an imprecise science. I agree with the FSA that a risk-profiling tool is by no means the silver bullet but it is a good point from which to start a dialogue.

One can get philosophical about this amorphous term. I remember a quote from a client: “Harry, I don’t mind taking a risk as long as I don’t lose any money.” I think that encapsulates an attitude for an awful lot of people.

However, it is also invariably true that a person’s risk profile increases when they are making profits and declines when they are making losses. Again, using a personal example, a client at first seemed low risk until further investigation revealed he had a significant equity portfolio with a stockbroker containing some interesting holdings.

Until recently, cash was generally recognised to be bulletproof. Events have demonstrated this is not the case. We now know everything has a risk, it is just a matter of quantifying it – and that is where the difficulties start.

Analysis tools, standard deviation figures and volatility ratings can all be used. But again, regulatory guidance falls short. Whereas a bank might flog one bond to one client, IFAs may advise on a portfolio. Within this there may be higher risk funds. A £100,000 portfolio of 25 to 30 funds may have a mean volatility of four, which could be considered medium risk. But it may include a gold fund with volatility of over 10. That does not mean it is inappropriate, provided the mean of the whole is within the parameters agreed with the client.

Even with comprehensive paperwork, the regulator is not in a position to determine (for portfolio investments rather than individual investments) whether the risk profile is appropriate or not. There is still no way for it to assess accurately because a client is not a number and box-ticking does not cover it. Risk is an interactive and subjective matter and I would hope that underneath all the strictures coming from Canary Wharf, the decision-makers take a pragmatic approach.

The FSA must recognise there are grey areas and that a one-size-fits-all approach is not suitable. What may work for banks and the big distributors is by no means relevant to smaller IFAs.

Harry Katz is principal of Norwest Consultants

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Comments

There are 13 comments at the moment, we would love to hear your opinion too.

  1. Ah, so that oft trotted out defence of ‘it’s different for IFAs’ appears!
    Well, Harry – as an independent suitability consultant who reviews cases and systems & controls across the whole of UK retail market I can (unhappily!) report that it isn’t – I see failures in advice relating to ATR across all distribution channels – and I would suggest that even the wisest of us could review the Guidance Consultation issued and take something useful from it.

  2. Well said Harry, Spot on!!! Particularly the demented ferret bit !!

  3. Agree that Harry is – as usual – spot on. I suppose that’s what the I stands for in IFA, helping clients in an Individual way. Not that the FSA would ever understand. As for Madame Brutale, well, I guess that she is looking at the overall picture and hence, a bit like the FSA, can’t see the individual picture.
    Incidentally, how many of the FSA ‘big wigs’ have IFAs? – answers on a postcard please, but I suspect that it’s close to zero; indeed, would any true IFA condescend to having an FSA ‘big wig’ as a client?

  4. A good article, Harry, plenty of common sense here. Given that the FSA loves to gather data but, having done so, then quotes (and uses) statistics only selectively to suit its own perspective, it might be an idea to look at what types of client complaints are coming from where. At one end of the spectrum, we see the recent Barclays debacle, namely thousands of risk averse being persuaded to shovel their cash savings into funds that then fell severely in value. If any IFA firm has misjudged the suitability of a pair of funds equally badly and then mis-sold it to all and sundry, I’ve yet to read of it.

    One might reasonably expect the FSA to examine complaints data with care so as to establish just who is doing what wrong and, equally to the point, who, by and large, is not. In this case, that appears not to have been done so, instead, we see the FSA waving its big forefinger at everybody, as if we’re all as guilty as Barclays. Sure, there will always be a few instances of IFA’s putting together for clients portfolios with unsuitable volatility profiles, but I suggest this is rather more the exception rather than a common malaise. The data surely tells us that ~ of all complaints referred to the FOS, only 2% (and falling) is attributable to the IFA sector.

    So, once again, whilst there can be no argument with action being taken against bad advisory practice, there seems to be a failure to target such action towards the sector/s most at fault. IFA’s are being tarred with the same brush as the banks, which is simply neither fair or proportionate. But then, when did we ever get either of those from the FSA?

  5. Unhappily I have found myself opposing Harry’s cultivated views on a number of occasions during the past two years.

    Happily, I find myself in full accord in this instance.

    I would dearly love to know the underlying ethos that propels the FSA thinking because I have seen a number of demented ferrets bouncing off their cage walls in a far more focused manner than the FSA generally evinces.

  6. Risk is complicated.
    But nearly all the problems stem from concentration risk.
    we should start here first before getting bogged down in detail.
    Where we see clients in most trouble is where they have been “advised” to invest in one single product / plan with one provider or a huge % invested so.

    KISS – is always a good place to start.

  7. A curious (and sadly repetitive)argument that all IFAs are good and have sophisticated clients yet all banks are bad and have simple clients.
    And then suggests the FSA should avoid a one size fits all approach !
    Having worked with IFAs and in the Bank Wealth management sector for over 25 years i can confirm the obvious.
    There are extremes of competence and incompetence in both.
    The FSA is right to demand proper process for determining not only the clients attitude to risk but also his capacity for it. A point that seems to have been missed by many.

  8. To Paul Claireaux ~ Yes, of course there are incompetent IFA’s (I’ve had a few work for me in the past), but IFA’s generally aren’t subject to the same pressures from above to sell to all and sundry this month’s hot, high-commission product on which their employer has struck a “special” deal with the provider, conditional upon how many hundreds of thousands of pounds they can get their salesforce to shovel into it every month. With only the very occasional exception, that sort of whip-driven sales culture simply doesn’t exist in the IFA sector. Most IFA principals would be pretty keen to address any such activities PDQ, for the simple reason that people in their employ selling the wrong thing to the wrong people pose a danger to their business, the consequences of which, in this day and age of unprecedentedly large PII excesses, could break it.

    Compare that with the costs to Barclays of its mass mis-selling of those two Aviva funds ~ painful, yes, but not bad enough to break the business. Barclays’ reaction, in simple terms, has been Oh well, the FSA’s finally got its arse in gear and the party’s over. The costs from now on of having finally to do things properly are more than they’re worth, so let’s just wind things up, junk all the staff and get on with what makes us the most money.

    The whole culture is entirely different, even though it would be foolish to suggest that the IFA sector is not without its share of less than competent people.

  9. I agree that the culture in the IFA channel is “on the whole” better and less sales oriented. Barclays made some massive errors and I’m NOT looking to defend them.
    But a big bad mistake by a bank does not make all bank advice bad any more than one poor decision by an IFA to “mass sell” structured products makes all IFAs bad.
    I’m simply challenging the idea that these anti bank debates take us anywhere.

  10. Good article Harry

    However has anyone measured the tolerences, accepted variation level in our advice process?

    Using a simple weighing machine in retail to sell things has a tolerence, ie the machine for a specific job can only be expected to cost a limited amount, that level of machine has a margin of error, the working conditions have a margin of error, the scales have to tip, this is called a ‘cast’ this is allowed in the tolerence. So a weighed item can be wrong either way but would be acceptable, even though that is a very simple process with no involvement of the public.

    Think of our process, a client telling you what they feel and think, you interpreting this, most Police statements for a thing as simple as a car colliding with an object or someone throwing a punch are considered unreliable, but our clients giving their instruction for an investment is not given any tolerence? why?

    Then we use research by other firms including information by the provider and funds themselves to base a decision upon, so so far we have a member of the public, umpteen other companies info then our interpretation of it, we could be looking at a min 10 providers/wrap and possibly 3,500 or more funds.

    To me that cannot be an accurate process.

    How accurate can any selection be, using any of the current systems?

    So my question, is the regulator looking at grammes and picking fault in a process which cannot be accurate within 10kg using my scales analagy? They will do that forever if they are looking for an accuracy level which is impossible.

    Where is the research which shows the highest accuracy outcome expected in this process?

    Then where is the research showing the current accuracy and what is the difference?

    Which part of the process has the largest variances?

    If they dont know then will they ever have a positive result?

  11. Tristram Hawthorn 7th February 2011 at 9:52 am

    Working in the corproate IFA/EBC market, there are vast swathes of the industry churning GPPPs to Aviva and Scot Wids simply because they are the only two still paying commissions – it is laughable to suggest that IFA’s don’t put pressure on their staff to sell this months hottest product. I’d be very surprised if 75% of our erstwhile colleagues aren’t “filling their boots” with commissions from a dwindling number of providers pre RDR.

    People in glass houses (I work in one).

  12. Anonymous | 7 Feb 2011 9:52 am

    Report them if you are speaking fact as you must have proof. Otherwise you are as guilty.

    Or stop writing fiction.

  13. Bloody hell – for once I cant disagree with you on this one Harry !

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