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Lessons for U.S. Advisors—and Regulators—on Risk, Suitability From Overseas

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Regulators around the world are taking steps to enhance confidence in their financial systems and improve consumer protection. Leading the charge is the UK’s Financial Conduct Authority, the successor to the Financial Services Authority, which is overseeing a major process-oriented and principles-driven transformation of the financial services industry that began early last decade.

  • Treating Customers Fairly established principles-based process criteria that advisory firms must meet to demonstrate that they are treating customers fairly. TCF has caused a major rethink of business models. The FCA has been taking a very strong stance; for example, the head of the Conduct Business Unit said last month, “It is particularly striking to me that when we have done business model analysis we have seen how much of the business models of major institutions are being driven by aggressive product sales. If that remains the business model, there is always going to be a high risk of misselling of products.”
  • The Retail Distribution Review has imposed progressively higher professional standards, set criteria for “independent” advice and banned commissions for independent advisors beginning in January 2013.
  • At a more detailed level, the March 2011 guidance paper set standards for advice suitability with regard to willingness and ability to take risk – risk tolerance and risk capacity. This followed an analysis which found that unsuitability with regard to risk accounted for half of unsatisfactory reviews and that only two of the 11 risk profiling tools examined were acceptable.

The cumulative effect has been to require a very substantial investment by advisory firms in upgraded training and new systems and processes, and major attitudinal change. Many medium to large advisory firms have been struggling to find a sustainable business model. Two major banks have withdrawn from the general advice market in the past six months and it is estimated that advisor numbers in the U.K. will decrease by 25% over the next three years.

On the other hand, high-end financial advisors are significantly more optimistic about their future. Most are already above the level of professionalism required by the FCA and see themselves having a significant advantage over the banks and life companies, which are struggling to meet the new standards and have lost the confidence and trust of both the regulator and the public.

Elsewhere, regulators are moving in the same direction. The EU’s Markets in Financial Instruments Directive (MiFID) includes strengthened consumer protection provisions which member states are required to implement. The Australian regulator is implementing recommendations from the Future of Financial Advice report, which included the banning of commissions. India banned front-end commissions on unit trusts/mutual funds more two years ago.

In the U.S., the focus has been on fiduciary standards, which elsewhere are broadly required of advisors under Common Law. Recently, however, the SEC approved two new rules promulgated by FINRA: 2090 Know Your Customer and 2111 Suitability, to replace rule 2310 Recommendations to Customers, to be effective starting in July 2012. While these two rules do not provide the same level of detail as the FCA’s suitability guidance paper, they do indicate a heightened concern with consumer protection and come on the back of a steady stream of enforcements arising from a failure to deal properly with risk tolerance.

Regulators generally are mindful of the example being set in the U.K. and are using it as a guide for their own jurisdictions. Additionally, institutions that operate globally will come under internal and external pressure to implement the higher standards required in the U.K. across their global operations.

The winds of change have been blowing a gale in the U.K. and are rising elsewhere with suitability around risk being a key concern.


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