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Rory Percival outlines preliminary findings from Risk Profiling Tool Study

ABR editor Rob Kingsbury reports on Rory Percival’s presentation on risk profiling at the Thesis Asset Management ‘In pursuit of Excellence’ seminar this week

Rory Percival, ex FCA technical specialist, will be publishing a study on the six most commonly used risk profiling tools, with an intended publication date of July.

At the Thesis Asset Management ‘In pursuit of Excellence’ seminar, Percival provided some preliminary findings from the report to an audience of financial advisers.

Referring to the FCA’s recently published Assessing Suitability Review report, Percival said that while the suitability results were positive the regulator had flagged that “a lot of poor practice still exists around disclosure”. The FCA reported that 41.7% of the cases reviewed providing ‘unacceptable disclosure’.

One of the areas that the regulator still has concerns around, Percival said, was risk profiling as referred to by COBS (i.e. Attitude to Risk), in particular how firms are using risk profiling tools in assessing the risk the client is willing and able to take.

While the regulator did not provide details around this in the report, Percival outlined his perception of what the regulator’s three main concerns are around Attitude to Risk:

1. That the results of the tools used are not aligned with the client’s answers to the risk questions. Where that happens, he said, advisers need to clarify the discrepancy with their client and make a record of that clarification.

2. Clients may answer in contradictory way. For example, the client might answer some questions that suggest low risk and others as high risk. “Again you need to clarify with the client and record it. Without that clarification it will not be clear what the clients attitude to risk is and you will not have demonstrated suitability of the case,” Percival advised.

3. Unclear categorising of the risk in the risk descriptions. Percival said: “Descriptions need to be sufficiently clear for the client to understand what the investment journey may look like. To do that it needs some kind of quantification – what will the ups and downs look like.”

Review of risk profiling tools

Percival said his report is looking at the six most commonly used tools and assessing them against Finalised Guidance 11/5, Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection. This was the document that said 9 out of 11 risk profiling tools “didn’t work very well”, Percival said. “I’ve turned that guidance into a series of test and I’m judging the tools against that guidance.”

Giving some insight into what he had found so far, Percival said it had soon become clear when he started to analyse the tools “that none of them are perfect”.

The first test he conducted was around the questions asked of the client. Regulator concerns here, he said, were that “some questions were over complex, assuming levels of knowledge and competence and certain levels of mathematical ability that clients may not have, which might make it difficult for the client to answer in a way that genuinely reflected their risk profile.”

The first set of tools he had reviewed in this respect, he said, “looked pretty good. It looks like the firms have thought about wording the questions in a way the client is more likely to understand.”

However, a specific concern flagged by their regulator was ‘middle answers’ where the client is given a series of possible responses across a range from ‘strongly agree’ to ‘strongly disagree’. The concern here, he said, was that where people don’t understand the question or don’t have a view on the answer, they have a tendency to go for the middle option – “but that doesn’t really reflect what their risk profile is,” he warned.

As a means to mitigate ‘middle answers’, he said, one tool used different wording, such as the option ‘in between’, “which is a clearer indication to the client that it is a spectrum they are answering on”, while others flagged up if there are a particularly large number of middle answers being given, which could then be a discussion point with the client.

He added that in his analysis he had taken “an extra step” in this respect. “I think there are questions that clients might not answer in the right way for reasons unrelated to their risk profile. I will be highlighting cases where people may answer questions in different ways and what advisers can do about it.”

Risk descriptions and asset allocation

In respect of risk descriptions and the need to quantify them, Percival said that not all tools included the quantification that was needed. “And where they do, I think they could be materially better. I’ve seen examples of descriptions that adviser firms have created for themselves that are better than the ones the tools make available.”

Scoring was also an area where the regulator had concerns, he said, “notably around the way that the weighting worked”, in particular where certain factors fundamentally changed the way the scoring was applied. “For example, I’ve seen a tool where if you were invested for the long term the assumption was made that you were always high risk. That’s obviously a nonsense.”

A significant area of concern in his preliminary review of the tools, he said, was where risk profiling led into suggested asset allocation. “Notably the variation between one tool and the next in regard to the asset allocation for the same risk profile.”

He used the example of the percentage of an asset-backed investment, i.e. growth assets – equities and property, recommended against non asset-backed investments. “If you run the same person and the same scenario through each of the tools you can get very different asset allocations.” He said there could be as much as 30% difference in the proportion of the portfolio that it is suggested is invested in asset-backed investments. “That’s too big a differentiation for both to be right for the same person.”

Summing up, Percival said that overall while the tools in the market had evolved and improved since the FCA published Finalised Guidance 11/5 six years ago, and in the main rather than being standalone tools now most are integrated in the wider end -to-end advice process, “nevertheless, none of them are perfect”.

Percival added that the FCA will be publishing the MiFID II rules in June (after the General Election) with implementation on 3 January 2018, which as part of “turning existing guidance and good practice into hard-nosed rules” does focus on making sure financial planning tools are fit for purpose, risk profiling tools being the example given.

How advisers deal with the issues on a practical level all comes back to the Regulator’s core messages, he said: “Have the discussions with the client, be sure that you are clear with the client what their risk profile (ATR) is, that they understand what the ups and downs might be along their journey and also think about what the asset allocations should look like.”

Percival said his guide would be aimed at anyone using the available risk profiling tools and alongside the analysis on each tool, would highlight what advisers need to be considering and what actions they need to take to around suitability and disclosure. “There’s a ‘how to’ element to it, which hopefully will be useful to people,” he said.





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