Keeping up with the compliance burden is a common complaint from intermediaries, especially smaller firms with limited resources. That load is only likely to increase in the coming months.
The RDR is one thing, but could the split of the regulator – into the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) – also complicate matters? And what about initiatives from further afield, such as Mifid from the EU and the Foreign Account Tax Compliance Act (Fatca) from the US?
Make no bones about it, the FSA is stepping up its efforts to police wealth managers, especially when it comes down to the issue of suitability.
“It is essential that wealth managers, discretionary managers and stockbrokers take into account a client’s preferences regarding risk taking and ensure their clients can bear any investment risks consistent with their objectives,” stressed FSA managing director Martin Wheatley last month.
“We also want to see firms maintaining adequate systems and controls to deliver suitable customer outcomes, protect client assets and manage conflicts of interest.”
Spotlight on suitability
RDR to one side, satisfying the regulator’s rules on suitability is top of the list for compliance professionals.
“If you go back two years, wealth managers, including the top-end investment managers and discretionary managers in particular, have probably not been the focus of the FSA, but now the spotlight has turned to that particular area,” says Mark de Ste Croix, head of compliance and legal at Raymond James.
Some time ago, the FSA undertook its first tranche of company visits looking specifically at suitability through a check on client files. From a sample of 16 firms, 14 were judged to pose a “high or medium-high risk of detriment” to their customers.
Clearly unhappy with the results, in June 2011 the FSA issued its so-called ‘Dear CEO’ letter to all firms outlining its key concerns, which included an absence of basic know-your-customer (KYC) information and inadequate risk profiling (see boxout page 33). This was followed in August this year with the announcement of a new thematic review, including further company visits.
So should wealth managers be expecting a visit imminently? De Ste Croix suggests that larger, national firms with greater AUM are more likely to be the regulator’s first port of call. However, Mark Wilkinson, head of sales and product strategy at software provider Dion Global Solutions, disagrees.
He says: “If you look at the approach the FSA has taken, it’s been to the whole market. The very notion of the ‘Dear CEO’ letter and why it has become so infamous is the fact that it had not even bothered addressing the letter. Intentionally or not, it said we don’t care who you are – you all need to look at this problem. This is quite an indictment of the way the FSA is looking at this issue.”
Whereas Arrow visits used to take up to a day, Wilkinson expects they could now take a week as the regulator takes a more systematic approach to assessing whether a business model is sustainable and whether clients’ wealth is managed end-to-end throughout the process.
Devil in the detail
A real danger for wealth managers lies in the definition of risk benchmarks – after all, one man’s cautious is another’s balanced. Wilkinson talks of diversity in the way suitability is approached.
“Everyone is monitoring how their portfolios align to strategic asset allocations, but what those asset allocations look like can be very different from firm to firm,” he explains.
“From that perspective, it will be interesting to know if the FSA deems any of them unacceptable or incorrect. Is there an acceptable way of defining even what a suitable portfolio is, let alone the process of monitoring whether or not your portfolios are aligned to it? One firm might have a risk-based model, another firm might have an asset class-based model and they are completely different. Is one of them better than the other? Is one of them unacceptable?”
Questions still remain then, though one certainty is that wealth managers can expect more from the FSA on this theme in 2013.
“Firms must be really thinking about how they can demonstrate that their client files and the recommendations they make fit with the FSA’s agenda,” remarks Stuart Campbell, associate director at risk and business consultants Protiviti.
“This means clear documentation, proper records, a clear audit trail, and a clear link of risk appetite to recommendations.”
European legislation
A recent survey from Protiviti found that around half of senior compliance professionals (from around 30 firms) believe that their company’s costs of compliance will increase by up to 20% under the new ‘dual’ regulatory regime once the FSA is split up.
At present, it is hard to say how the new regime will improve the clarity of regulation, though it should be pointed out that most firms will likely fall under the care of just one regulator – for wealth managers and discretionaries this will be the FCA, while the PRA will focus more on deposit takers.
But could it be misleading to focus too heavily on the actions of one local regulator when several of the most wide-reaching and important
legislative changes originate from further afield?
“The compliance burden will clearly increase as there’s a whole raft of regulations coming out, including Fatca, Mifid and AIFMD (Alternative Investment Fund Managers Directive), much of it led by Europe rather than the FSA,” comments de Ste Croix.
“The FSA will be the implementer of European rules and I think that will form 80% or more of its work over the coming years. That will affect bodies like Apcims which will be more focused on talking to Europe than the FSA.”
We do not have space here to outline how all these legislations will impact wealth managers, though you can find a full rundown of the key rules – including also Kiids and Ucits V (&VII) – featured in the July 2012 issue of Portfolio Adviser (see www.portfolio-adviser.com/pa/e-magazines/july-2012/main.swf).
How these legislations may impact intermediaries – and their compliance requirements – will depend on the size of the business and its client base. For example, a larger private client broker serving investors from the US must be more au fait with Fatca than a smaller IFA with just UK clients.
For any adviser, closer alignment with trade associations, whether that is Apcims, AIFA or the IFP, or joining a network is a good way of keeping abreast of upcoming requirements. Similarly, there are numerous technology companies that provide
front and back-office software to help keep track of trades and maintain client details.
Rule-based approach
Turning back to the UK regulator, whereas once the emphasis was on its wide-ranging principles-based approach, the mood has shifted more towards thematic reviews and an outcome-driven strategy. There has been speculation that its split will see UK financial services adhere to more of a formal rule-based approach, as typified in the US.
Whatever its future, commentators suggest we will see more focused, detailed and perhaps aggressive regulation in the UK – a warning to those that have so far been lax in keeping processes clear and concise, and client files up-to-date.
As de Ste Croix remarks: “I think we are in a rules-based environment already. The level of detail might change – for example, the CASS rules updated (see Regulation & Legislation on page 34) – but I don’t see that as a sweeping change in emphasis. The FSA is just tidying up and making things tighter in certain areas. It’s based on principles but those principles are formed into a number of rules.”
