19May

Rory Percival, a former technical specialist at the Financial Conduct Authority (FCA), has warned advisory firms of the dangers of relying on risk profiling tools when assessing clients’ attitudes to risk.

Back in 2010, the Financial Services Authority audited the 11 principal providers of risk profiling tools, and found that nine of these firms had products that were ‘not fit for purpose’. Mr Percival acknowledged that improvements had been made since then, but still added a note of caution, by saying:
“None of [the risk profiling tools] are perfect or are guaranteed to provide you with the right answer to a client’s risk profile in every scenario.
“They generally involve a [suggested] asset allocation for [a chosen] level of risk – and my main concern is how they vary from one provider to the next.”
Backing up his comments about how asset allocation can vary between providers of risk profiling tools, he said that he had recently conducted his own research into six of the main providers. He found that a client with a cautious (low) attitude to risk could be recommended to invest anything between 35% and 65% of their portfolio in equities, depending on which provider’s tool was used.
Mr Percival said regarding this:
“That’s quite a big difference and it concerns me – so you need to look at that aspect.”
Mr Percival added that, due to the way that Part II of the European Union’s Markets in Financial Instruments Directive (MiFID II) was worded, it was more important than ever that firms ensure that they have robust systems in place for assessing client risk profiles. MiFID II comes into force in the UK in January 2018, and the UK will still be a member of the Union at this time, so the nation’s advisory firms need to ensure they are ready for the implementation of this Directive.

Mr Percival added:

“Sometime between now and January [advisers] are going to need to assess [whether] the risk profiling tool is fit for purpose.”

Neither Mr Percival nor the FCA is saying that advisory firms cannot make use of risk profiling tools when assessing clients’ attitude to risk. However, firms must conduct their own due diligence to identify which are the best tools to use, and in any case, must not slavishly follow the results obtained from these tools when making their recommendation. Advisers need to ‘know their client’, and need to be confident that the recommended asset allocation is appropriate for each individual.

Recommending higher risk investments to clients who are not willing to accept much risk to their capital does of course put firms at risk of having complaints against them upheld. If the Financial Ombudsman Service feels that the recommended asset allocation was unsuitable for a client, then it will not hesitate to order the firm to compensate the client for any losses suffered.

Mr Percival worked at the FCA for 10 years before leaving to start his own business. He remains a respected name in the compliance arena and is still much in demand as a guest speaker at financial services conferences and events.

The information shown in this article was correct at the time of publication. Articles are not routinely reviewed and as such are not updated. Please be aware the facts, circumstances or legal position may change after publication of the article.