Eric Armstrong of Synaptic explains why MiFID II is a ‘game changer’ and how Financial Planners can build it into their client advice process efficiently and cost-effectively.
MiFID II is a game-changer for the industry in a variety of ways. It gathers up the warnings from multiple thematic reviews imploring advisers to employ better research methodology, while deploring the many instances where research was lacking.
The FCA’s Thematic Review 16/1 titled: ‘Assessing suitability: Research and due diligence of products and services’ was a definitive explanation of the FCA’s view that poor due diligence and research, coupled with a lack of ‘culture of challenge’ results in poor outcomes for consumers.
Cost and risk are two areas that due diligence and research should prioritise. The FCA has regularly warned against the danger of poorly administered tools and conflicts of interest emerging from over-reliance on providers’ or platform-based research, often centred on their own propositions.
Driving up levels of training and professionalism has transformed our industry for the better, but now is the time to heed the many warnings of additional regulatory scrutiny on its way, with its demands for better and more independent due diligence. It is time to ensure that your firm’s investment strategies are robust, repeatable, academically sound and appropriately aligned.
The real challenge for many advisers is MiFID II’s introduction of the concept of ex-ante and ex-post research, meaning suitability must be fully determined in advance of a transaction and at every review.
MiFID II introduces a new requirement for firms to provide retail clients, receiving an advisory service, with a suitability report specifying how the advice given meets the client’s circumstances.
Important points to reflect on:
- Responsibility to undertake the suitability assessment lies solely with the firm;
- Where products are packaged or bundled, there is an obligation to ensure the overall package or bundle is suitable. Research tools like Synaptic that track funds by share class according to avail¬ability by product are essential for accurate illustrations;
- Confirming that the suitability assessment relates to buying investments but also to hold or sell recommendations;
- Requiring firms to adopt policies and procedures to ensure that they understand the features (including costs and risks) of instruments selected for clients;
- Advisers must begin disclosing actual costs and charges associated with client invest¬ments, rather than estimates, as well as comparing growth projec¬tions with actual performance. Accurate growth forecasts from a stochastic model such as Moody’s’ suddenly become much more valuable;
- Risk tolerance is the measure of how much investment risk the client is willing and able to take;
- Attitude to risk is the client’s psychological willingness to take risk, measured by the scoring from the psychometric questionnaire;
- Capacity for Loss is the client’s financial ability to bear risk and cope with adverse outcomes. It relates to investment horizon, and the level of income, assets and liabilities. FCA policy also describes Capacity for Loss as the amount that a client can ‘afford to lose before having a material impact on [their] standard of living’;
- The expert assessment of the adviser, through fact finding, knowledge of the client’s circumstances and, increasingly, use of cashflow models provides the Capacity for Loss calculation. This is the lynch-pin of advice and compliance;
- Need to take risk is measured by the advisers themselves by evaluating clients’ investment goals, time horizon and the financial resources at their disposal;
- Reconciling attitude to risk, capacity for loss and the need to take risk is a key role of the adviser, and an area where substantial value can be added.
Synaptic software includes the A2R Risk Questionnaire, the most widely used ATRQ in UK. This can be used in conjunction with the supplementary Capacity for Loss Questionnaire, also provided.
For more information and insights, you can download Synaptic’s Risk White paper from the Synaptic website.