Streamlining advice in the MiFID era – working with Segments

Compliance, due diligence and therefore research are increasingly dominated by MiFID. Helpfully, the FCA published the PROD rules, which readers will recall are a set of guidelines designed to assist in the successful adoption of MiFID.

Suitability is the heart of compliance, and many firms struggle in aligning client profiles with suitable investment strategies and profiled investments.

PROD stands for Product Intervention and Product Governance Sourcebook. These words are trying to communicate the importance of product governance, which is important for any firm, but becoming more essential as many firms merge or vertically integrate. The impact of failures in any investment can be hugely disruptive and harmful, as firms who chose to back Woodford will attest, or from a more personal perspective as someone who bought City Financial Absolute Equity as a punt (!). Coming back from a failure such as these can be hard. Holding up a strategy for a client means that funds have to perform (there is something about this in the following article). The pain of loss is greater than the joy of success!

Obviously, firms understand the value of good product governance, and if they didn't for some reason, the regulator has provided MiFID, a regulatory sledgehammer to remind them and threaten them in no uncertain terms if they fail to conform to these non-negotiable guidelines.

In relation to PROD:

1. Manufacturers' products (or distributors' portfolios) must be linked to their target market.

Bookending advice by referencing 1. the manufacturer's determination that investments are suitable for defined groups of customers, and 2. the other end of the shelf, confirmation that the client does indeed conform to a manufacturer's target market.

2. Central Investment Proposition

Due diligence used to be something that needed to be evidenced on a client-by-client basis, by features to demonstrate suitability and with reference to 'the whole-of-market'. MiFID turns this around and demands due diligence at the proposition level. It says that solutions should be researched for 'client types', and advice and recommendations can be made more consistent and streamlined. In working in this way, clients will always be considered in the context of other clients 'like them' and solutions will come, to use Boris Johnson's parlance 'oven ready'.

This allows due diligence to create a proposition or Central Investment Proposition before a specific client is considered.

It should be very liberating for firms – cut down on administration overall, and lead to more consistent advice. The key is to have systems and processes that are set up to support this way of working in an automated manner. A Central Investment Proposition must therefore be capable of producing MiFID compliant ex-ante and ex-post illustrations on demand. The new software under development at Synaptic is designed to be fully MiFID compliant and will allow research (ex-ante and ex-post) to be conducted on all manner of investments including Discretionary Portfolios, as well as assessing existing holdings via our automated valuations service.

The new software will allow firms to define segments, identify appropriate platforms, products, portfolios and funds, define adviser charging and capture special deals. Illustrations used to demonstrate suitability and the investment forecasts from Moody's can be created using the appropriate products and portfolios for a particular segment, or the whole-of-market as required. Obviously, the potential for streamlining advice on this basis is tremendous.

3. Segment

As some commentators have pointed out, there is no mention of 'segments' in the PROD document. However, they are all agreed that as soon as you talk about a 'type' of customer or client, the you are really talking about a segment. A problem we have encountered is the conflict between an understanding of 'segments' in the context of CRM vs PROD. In the CRM world the more data and precision you attach to a client the better, as you will make more 'informed' decisions in relation to them. The same is not true of PROD segmentation, the granularity of segmentation should match the firm's proposition only, and frankly it may suit the firm for this definition to be very broad.

What we have learnt from advisers looking at this is that segmentation works best if it aligns with life-cycle. So a typical firm may prefer to work in a single 'Retail Investment Client' segment, or identify additional segments such as 'Retail Investment Client (Accumulation) / Retail Investment client (at retirement or in drawdown)'. The point being that these types of clients have distinct platform / product / portfolio and charging characteristics that have been defined in advance of advice been given. To have it all configured in your research software makes meeting your regulatory requirements very easy.

Some attributes of a MiFID compliant research software solution:

Data

All the relevant data for the ex-ante and ex-post illustrations needs to be in place, or accessible. The 'Disconnected World' research and report (download for free) from the lang cat and Origo described in great detail the lack of relevant data available for the various illustrations and processes alluded to above. Synaptic has resources available through APIs to provide all the relevant data, including platform, product, portfolio (including discretionary), MiFID costs and charges and valuations, even fully formed ex-ante and ex-post illustrations.

Suitability

Suitability is the heart of compliance, and many firms struggle in aligning client profiles with suitable investment strategies and profiled investments. Synaptic provides a risk framework which is easy-to-understand for advisers and clients, clearly illustrating the likely outcomes of investments, but also the risk attributes that are used to discuss Capacity for Loss and the 'need to take risk'. Modern tools need to be able to risk-profile investments 'on-the-fly' for review purposes, as well as risk profile portfolios at point-of-sale (ex-ante).

Diagram

Reports

Most firms have their own reporting or manage their reports from their back office. The role of due diligence tools such as Synaptic is to provide the key analysis in beautiful report format that can work as a standalone item or provide illustrations that can be incorporated into existing workflows and reports.

If you are considering any of the challenges outlined in this article, please contact us on 0800 783 4477. We’d be delighted to share our plans with you.