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There are no short cuts when risk profiling
The Consulting Consortium’s head of Policy Rebecca Prestage outlines the pitfalls of cutting corners in client risk profiling
Getting risk profiling right is a key component in providing suitable investment advice and positive outcomes for your customers. Despite this, the regulator is still uncovering failings in the intermediary market on this issue, mainly brought about from an over-reliance on risk profiling tools.
In October last year, the Financial Conduct Authority (FCA) voiced its concerns over the use of risk-rated funds, pointing to evidence that advisers were using these as a shortcut to determine investment suitability.
Over reliance on risk- profiling tools
Although tools can provide a valuable aid in client meetings, by providing structure and consistency to risk profiling, they can only assess a client’s attitude to risk and capacity for loss and can therefore fail to take into account the overall investment objectives or other key factors that an adviser may consider when recommending a suitable product.
External systems may also have limitations that can impact the output. A study by the Financial Services Authority (FSA) in 2011 found that nine out of eleven tools had weaknesses that could lead to flawed results. All users, therefore, must be fully aware of what the tool is designed to do and any limitations in its functions.
Risk profiling tools should not be used as a stand- alone measure, but used in conjunction with other methods, such as a suitability assessment, and know your customer (KYC) processes to provide a complete picture.
Shoehorning risk categorisation
Categories within a firm’s risk profiling spectrum need to be clearly defined to help both advisers and their clients understand and categorise the appropriate level of risk. Risk categories are often vague, unclear or misleading for clients and a spectrum comprised solely of numbers can makeit difficult to understand the level of risk associated with a product.
A further issue with existing risk categorisation methodsis that they can focus too much on the risk a customer is willing to take and in doing so fail to take into account other needs or objectives, for example, the need for access or desired term of investment, potentially leading to unsuitable advice.
Product understanding and selection
Advisers need to have a thorough understanding of the relative risks of an asset or product, as well as the risk profile of its client, to form a thorough suitability assessment. By only undertaking one part of the process, this can lead to the delivery of unsuitable advice.
Automated investment selection tools can be a good starting point for investment selection, but all too often they fail to tailor recommendations to a client’s specific needs or take into account anything other than their risk profile. If using automated tools, firms should also have systems in place to allow the advice to be tailored to their client’s needs.
The current regulator, the FCA has said that it will not prescribe how firms are expected to establish the level of risk a customer is willing to accept, but has made it clear that it expects all firms to give thorough consideration to the scope and drawbacks of their chosen method and implement measures to address these. The regulator has already indicated that advice suitability, particularly around ensuring accurate risk profiling, is a key focus in helping to achieve positive outcomes for consumers.
For more information on The Consulting Consortium go to: http://www.theconsultingconsortium.com
