The Financial Conduct Authority’s technical specialist, Rory Percival, has recently raised concerns that over-compliance is pushing up costs in the financial services industry. Ian Stott, client director of services at the Consulting Consortium, looks at how wealth management firms can manage compliance proportionately to deliver cost-efficiencies.

The UK's Financial Conduct Authority’s technical specialist, Rory Percival, has recently raised concerns that over-compliance is pushing up costs in the financial services industry. Ian Stott, client director of services at the Consulting Consortium, looks at how wealth management firms can manage compliance proportionately to deliver cost-efficiencies.

Wealth management firms have been subjected to intense scrutiny from the regulator over the past year, yet continue to under-perform in areas such as suitability, disclosure and providing 'good consumer outcomes'. Wealth management firms largely slipped under the old Financial Services Authority's regulatory radar, but this is a stance that the FCA is keen to revise and firms are increasingly noticing that it is scrutinising the 'consumer-centricity' of their business models and culture.

The management of all compliance risks in line with the FCA’s expectations can be burdensome for firms. Wealth management businesses often have monitoring resources of limited quality. In a forbidding regulatory environment, it can be a daunting task to identify the areas that require risk-assessments and to allocate resources accordingly. Firms tend to be reactive, dealing with issues as they arise and apportioning resources after the fact, which can leave them on the back foot. If they

take a proactive proportional approach to compliance, ensuring that resources are sufficiently aligned with the regulator’s current areas of focus and expectations, firms can mitigate compliance risk whilst also reigning in increasing regulatory costs.

Is over-compliance a wealth management issue?

With any change in regulation comes a period of establishment where firms will decipher the rules, implement measures to enforce them and monitor their success. Although a necessity, this can sometimes lead to over-compliance as firms overcompensate to ensure that their processes and controls are not open to breaches. In addition, if the regulator has not provided guidance or best practice on how to implement controls, particularly on a very new approach, then firms can spend valuable time, and of course money, testing different methods and evolving controls as they see fit.

Compared to other regulated financial sectors, the potential for over-compliance in the wealth management sector is sometimes seen as being less of an issue. Rather, firms have a tendency to focus attention on the areas which are not high on the FCA’s agenda, often to the detriment of more concerning issues. Firms need to ensure that their culture and attitude to risk management clearly reflects the FCA’s treating customer fairly philosophy and the FCA’s focus on business models and its own Firm Systematic Framework. By removing controls and processes that are superfluous in some areas, as well as ensuring that there is no reliance on risk management systems that are out of date, firms can realign compliance resources to meet the expectations of the regulator.

Suitability and treating customers fairly

In order to take a proportionate approach, firms ought to be aware of the areas of regulatory focus for their sector. In wealth management, this continues to be suitability and the fair treatment of customers.

Aligning portfolio risk with attitude to risk

The FCA is still identifying instances that highlight the limitations and use of risk profiling tools that may contribute to unsuitable advice being provided to wealth management clients. In particular, it is still questionable whether risk-profiling tools are accurate enough to provide suitable risk profiles for clients and whether firms are placing the right emphasis on their usage in establishing a client’s attitude to risk (ATR). Advisers should follow best practice by assessing each client

individually and choosing a method that uses risk-profiling tools in combination with other fact-finding techniques. Firms should also consider reviewing their procedures, monitor advisers to ensure they are using the tools correctly and implement training if needed.

In addition, the regulator has been paying closer attention to asset allocation within portfolios, raising concerns that the distribution of assets is not always reflective of the relevant portfolio risk rating. Firms need to look into the underlying investments of their portfolios and make sure that these are truly reflective of risk-ratings and therefore in line with the clients' expectations to do with the risks to which their assets are being exposed. This raises the question of regular reviews of both portfolios and a clients' ATR – these should be agreed with clients and should be frequent enough to remain so.

Documentation and record-keeping

This remains an area where, generally speaking, firms are failing to meet the standards that the regulator expects. The key to good 'suitability' is an understanding of what the regulators will be looking for vis-à-vis advice and the provision of products. The FCA will assess:

(i) the fact-finding process and whether documents are comprehensive, complete and accurate;

(ii) whether the suitability report matches the fact-find, is complete and includes evidence of why certain recommendations were made; and

(iii) whether there is a process in place to review the documents periodically to take any changes in clients’ circumstances into account.

Firms should assess their current processes to ensure that all advisers are composing their documents correctly and also to ensure that monitoring and reviews are occurring regularly. This is because adequate documentation is the only way to prove to the regulator that this-or-that advice is suitable.

Proper and effective record-keeping can be hindered by out-of-date IT systems and inadequate bureaucratic systems and controls to manage them. Ineffective record-keeping played a big part in the recent Invesco fine of £18.6 million. The FCA concluded that Invesco’s manual paper based systems were slow, inefficient and left room for error. This in turn affected investment decisions and resulted in inconsistent and inadequate oversight. Firms should ensure that the way in which they manage the retention of records benefits from a clear oversight process and uses systems whose weaknesses have been identified and are being managed.

The FCA has its eye firmly on the protection of consumers from sharp practice; this should also be a prime objective for the wealth management sector. By taking a proportional approach that focuses more attention and resources on suitability and fair results for HNW individuals, firms can meet the higher expectations of the regulator while still managing to keep their compliance costs down to affordable levels.

* The Consulting Consortium, or TCC as it likes to be known, has been supporting businesses in the compliance and regulatory sectors for more than thirteen years. Its consultants can be reached at www.theconsultingconsortium.com or on +44 (0) 20 3008 6020.