This note outlines the FCA requirements applicable to firms providing investment advisory and discretionary portfolio management services, when such firms are assessing the suitability of the advice they give to clients. It focuses on the rules and guidance contained in chapter 9 of the FCA's Conduct of Business sourcebook (COBS 9), and also highlights non-Handbook guidance on assessing suitability published by the FSA, as well as further guidance published by other key UK and European bodies.
This practice note outlines the FCA requirements applicable to firms providing investment advisory and discretionary portfolio management services, when such firms are assessing the suitability of the advice they give to their clients. It focuses on the rules and guidance contained in chapter 9 of the FCA's Conduct of Business sourcebook (COBS 9), and also highlights non-Handbook guidance on assessing suitability published by the FSA, as well as further guidance published by other key UK and European bodies.
This note does not consider the suitability requirements contained in chapters 4 and 8 of the Mortgages and Home Finance: Conduct of Business sourcebook (MCOB) or in chapter 5 of the Insurance: Conduct of Business sourcebook (ICOBS).
This note does not contain material on simplified advice or the FCA's basic advice regime.
With effect from 1 April 2013, the FCA replaced the FSA as the main UK conduct regulator, and COBS 9 forms part of the FCA Handbook. The FCA is continuing the FSA's policy in this area.
Suitability is a well-established regulatory concept for the UK financial services industry. When the FSA introduced its first conduct of business sourcebook (COB) following the enactment of the Financial Services and Markets Act 2000 (FSMA) at the end of 2001, it based its new suitability rules on corresponding requirements contained in the rulebooks of the previous self-regulating organisations (IMRO, the SFA and the PIA). Its intention was to harmonise and simplify the suitability requirements in existence at that time.
In 2005/6, the FSA decided to reform COB, partly to reflect changes in the domestic regulatory environment (such as the end of polarisation in the retail market), but also to implement the Markets in Financial Instruments Directive (2004/39/EC) (MiFID). The FSA decided to use the relevant MiFID requirements as the nucleus of the new COBS suitability standard for all advice and discretionary portfolio management business covered by COB. It decided that the new, single COBS standard would also cover non-MiFID products such as life policies, pensions and other packaged products, and apply both to MiFID firms and non-MiFID firms covered by COBS. The FSA conduct of business sourcebook (COBS) came into force on 1 November 2007.
COBS was designated to the FCA when the FCA replaced the FSA as the UK's conduct regulator on 1 April 2013. COBS 9 contains the FCA's rules and guidance on suitability.
The FCA is taking forward the consumer protection strategy that was implemented by the FSA. In line with this, suitability is likely to be high on its regulatory agenda. In particular, the FCA is likely to follow the commitment made by the FSA to make earlier, more robust, supervisory interventions both at point-of-sale and earlier in the product manufacture process.
The FCA's new powers (under the Financial Services Act 2012) to make temporary product intervention rules are an important factor. The FCA can exercise these powers, for example, where there is widespread promotion or sales of a product to customer groups for whom it is unlikely to be suitable. For more information on the FCA's new product intervention powers, see Practice note, New UK regulatory structure: FCA product intervention powers (www.practicallaw.com/5-518-1026)..
In its Retail Conduct Risk Outlook (RCRO) for 2012, the FSA identified complexity in retail investment products and services as one of its highest priority retail conduct risks. Its concern was that complex products are more likely to be missold because they provide a greater opportunity to exploit consumers' comparatively limited knowledge or understanding of risk. It highlighted a number of areas that would be subject to ongoing regulatory focus over the next 12 to 18 months, including:
The development and marketing of structured investment products.
Traded life policy investments (TLPIs).
Unregulated collective investment schemes (UCIS).
Private banking and wealth management.
Exchange traded products (ETPs).
Absolute return funds (ARFs).
The FSA also identified investment risk profiling as one of its highest priority retail conduct risks. The FSA's concern was that advisers are selling consumers products and services that are not compatible with their risk appetite. It published guidance in March 2011 to help firms mitigate this risk, and initial indications were that this (together with supervisory action) had a significant impact on the industry. The FSA committed to continuing to monitor practice in this area, and it seems likely that the FCA will follow suit. (For more information on the FSA's guidance, which has been designated by the FCA, see FSA guidance on establishing the risk a customer is willing and able to take and making a suitable investment selection below.)
At a basic level, the COBS 9 suitability requirements seek to ensure that, where firms provide investment advisory or portfolio management services, they obtain enough information about their customers to be able to act properly for them, and that the business conducted for them, or on their behalf, is appropriate to their circumstances. Failure to obtain all the relevant information, or evaluate it properly, can lead to the recommended transaction or decision to trade being unsuitable.
The COBS 9 suitability requirements build upon Principle 9 of the FCA's Principles for Businesses (Principles) (PRIN 2.1). Principle 9 requires firms to take reasonable care to ensure the suitability of their advice and discretionary decisions for any customer who is entitled to rely upon their judgement.
Principle 6 of the FCA's Principles is also fundamental as it requires firms to pay due attention to the interests of their customers and treat them fairly. It is better known as the TCF Principle. (For more information on TCF, see Practice note, Treating customers fairly: an overview (www.practicallaw.com/7-379-7813).)
Other FCA Principles that are relevant include Principles 7 and 8 (see further High-level principles below).
Many of the rules in COBS 9 consist of copied-out MiFID text, and relevant requirements under the Insurance Mediation Directive (2002/92/EC) (IMD) are also integrated into COBS 9 for life policies. Additional guidance, mainly on retail non-MiFID product-specific matters, including pensions, supplements these COBS 9 requirements.
Although not part of COBS 9, COBS 2.1.1R is also an important provision in the context of suitability assessments. This rule requires firms to act honestly, fairly and professionally in accordance with the best interests of their clients. It is often referred to as the client's best interests rule.
The rules in COBS 9.1 set out the application and purpose provisions for the COBS 9 suitability regime.
COBS 9 applies to a firm that:
Makes a personal recommendation to a client about a designated investment (COBS 9.1.1R). (Designated investments include shares, life policies, units in collective investment schemes, and options and futures.)
Manages investments on behalf of a client (COBS 9.1.3R).
This includes a firm that is carrying on MiFID (or equivalent third country) business. For information on what is meant by the term "MiFID business", see Practice note, What is MiFID business? (www.practicallaw.com/3-380-4071).
A personal recommendation is a recommendation that is advice on investments. Advising on investments means the regulated activity specified in article 53 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) (RAO). For more information on advising on investments, see Practice note, Regulated activities: advising on investments (www.practicallaw.com/6-202-0197). For more information on what constitutes a personal recommendation, see When does a firm make a personal recommendation? below.
Managing investments means the regulated activity specified in article 37 of the RAO. For more information on managing investments, see Practice note, Regulated activities: managing investments (www.practicallaw.com/8-201-9782).
Where a firm is carrying on business that is not MiFID (or equivalent third country) business, COBS 9 applies only if either of the following applies:
The client is a retail client.
The firm is managing the assets of an occupational pension scheme, stakeholder pension scheme or personal pension scheme.
For information on what is meant by the term "MiFID business", see Practice note, What is MiFID business? (www.practicallaw.com/3-380-4071).
If a firm makes a personal recommendation to a professional client to take out a life policy, only those COBS 9 rules implementing IMD requirements apply (COBS 9.1.5R). The relevant rules are:
COBS 9.2.1R (Assessing suitability: the obligations) implements Article 12(2) of the IMD (and Article 19(4) of MiFID).
COBS 9.4.2R (Providing a suitability report) implements Article 12(3) of the IMD.
COBS 9.4.4R to 9.4.6R (Timing) implement Articles 12(3), 13(2) and 13(3) of the IMD.
COBS 9.4.7R, 9.4.8G and 9.4.9R (Contents) implement Article 12(3) and 13 of the IMD.
Firms carrying on insurance mediation activities will also need to refer to COBS 7 (Insurance mediation), which contains further rules implementing the IMD.
The effect of COBS 9.1.5R, and the fact that the IMD does not apply to an insurer (unless it is involved in mediation activities), means that COBS 9 does not apply to an insurer when it is making a personal recommendation to a professional client to take out a life policy.
The provisions of the IMD that require advice provided by an insurance intermediary to take into account the "demands and needs" of a customer and be based on a proper analysis of the market were integrated into the COBS 9 rules. Notes inserted after a particular rule indicate which IMD requirement(s) are being implemented (either in whole or in part) by that rule. Notes also follow COBS 9 rules implementing MiFID requirements. Where a Note refers to both MiFID and IMD provisions, this indicates that the FCA considers the relevant IMD provision to be covered (potentially at a high-level) by the relevant MiFID provision. For example, the rule at COBS 9.2.1R sets out the suitability assessment obligations on firms. The wording of this rule tracks that of Article 19(4) of MiFID, but the accompanying Note indicates that the rule implements both Article 19(4) of MiFID and Article 12(2) of the IMD.
Guidance in COBS 9.1 (COBS 9.1.8G) identifies the following related rules:
COBS 19 (Pensions supplementary provisions). This is relevant to firms making personal recommendations about pensions. COBS 19 includes additional provisions relating to suitability assessments and the contents of suitability reports.
COBS 7 (Insurance mediation). This is relevant to firms carrying out advised mediation of investment life policies. COBS 7 includes requirements relating to the basis on which certain recommendations may be made, including requirements relating to fair analysis and range and scope.
While it is usually straightforward to establish whether or not a firm is managing its clients' investments, it can be harder to determine whether or not a firm is making personal recommendations to its clients. It is important for firms to determine when they are making personal recommendations about designated investments since this will make them subject to the COBS 9 suitability regime. Firms are expected to have clear internal systems and control processes to enable relevant staff to make fair and consistent decisions on whether a suitability assessment is required. These should include training customer-facing staff on the boundaries between the different types of services being provided (for example, between investment advisory and execution-only services).
Firms that issue direct offer financial promotions (that is, financial promotions that contain an offer or invitation to enter into an agreement and specify the means by which the recipient should respond) should be aware that, if investment advice amounting to a personal recommendation is given in a direct offer financial promotion, the COBS 9 suitability rules will apply in addition to the financial promotion rules in COBS 4. For an overview of the COBS 4 financial promotion regime, see Practice note, COBS 4 rules: communicating with clients, including financial promotions (www.practicallaw.com/2-376-6277).
A personal recommendation is defined in the glossary as a recommendation that is advice on investments, or advice on a home finance transaction, and is presented as suitable for the person to whom it is made, or is based on a consideration of the circumstances of that person.
The glossary definition of the term clarifies that a recommendation is not a personal recommendation if it is issued exclusively through distribution channels (such as newspapers, magazines, radio or television broadcasts) or to the public. This underlines the fact that a personal recommendation has to be of a personal nature.
It is possible for a firm to provide information, opinions or commentary about markets, prices and instruments to a professional client without going as far as to "recommend" them or to provide a "personal" recommendation to the client. In such a situation, the position of the firm will be reinforced if it makes it clear to the client that, in providing the information, it is not providing a recommendation (whether personal to the client or not). The context of the communication may, therefore, be relevant. In other words, whether the information or opinion is presented as a suitable recommendation for the client and whether the client could reasonably assume that what was being said amounted to a recommendation may be relevant.
Statements that clarify the status of a communication may be relevant where this would otherwise be unclear or ambiguous. But, if it is clear from the circumstances that the firm is making a personal recommendation, a disclaimer, whether in the terms of business, a notification or otherwise, will have no effect. A firm cannot contract out of the requirements applying to the provision of personal recommendations if that is what it has given. To establish whether a disclaimer statement can change the nature of the communication, all the circumstances would have to be considered, and the proximity, prominence and timeliness of such statement may have a bearing on this.
It is generally likely to be easier for a firm to identify when a personal recommendation is being provided where the firm's client is a retail client than where the firm's client is a professional client. In this context, any notion of a disclaimer by the firm (stating, for example, that a personal recommendation is not being made) will be harder to sustain.
The central requirement (implementing the MiFID information gathering and suitability standard) is that a firm must take reasonable steps to ensure that a personal recommendation, or a decision to trade, is suitable for its client (COBS 9.2.1R (1)).
When making the personal recommendation or managing a client's investments, the firm must obtain the necessary information in three specified areas to enable the firm to make the recommendation, or take the decision, that is suitable for the client (COBS 9.2.1R (2)). This is often referred to as "know your customer" (or KYC) information. The specified areas are the client's:
Knowledge and experience in the investment field relevant to the specific type of designated investment or service.
Financial situation.
Investment objectives.
COBS 9.2.2R (1) clarifies that a firm must obtain from its client such information as is necessary for the firm to:
Understand the essential facts about the client.
Have a reasonable basis for believing, giving due consideration to the nature and extent of the service provided, that the specific transaction to be recommended, or entered into in the course of managing:
Meets the client's investment objectives.
Is such that the client is able financially to bear any related investment risks consistent with his investment objectives.
Is such that the client has the necessary experience and knowledge to understand the risks involved in the transaction or in the management of his portfolio.
The nature of the suitability obligation, and the range and depth of detail of the information required by a firm from a client, therefore depends on the nature and extent of the service being provided and the kind of client to whom the service is being provided. This means that there is an inherent flexibility in what necessary information must be collected.
As there are several types of service that are subject to the suitability requirement, the range and depth of information that may be considered necessary will vary from one service to another. In its Suitability and Appropriateness Guideline (the FSA-confirmed status of which expired in 2010), MiFID Connect gave a number of examples of broad categories of service for this purpose:
Ad hoc advice. An ad hoc review of a client's entire portfolio may require a firm to conduct a detailed review of the client's overall investment objectives, knowledge and financial situation. On the other hand, an instruction from a client to give a personal recommendation in relation to the merits of investing in a specific investment, without reviewing the client's entire portfolio, might involve a narrower review focused on the client's objectives, knowledge and financial situation in relation to that specific investment.
Ongoing advisory services (no exercise of discretion). Again, the provision of these kind of services could call for considerable variety in the level of detail required for a suitability assessment, as a firm may be advising on an ongoing basis:
on a client's entire portfolio or on a subset of total assets; or
on the client's overall investment strategy or within the limits of a client-determined strategy.
Discretionary portfolio management. To provide this service, a firm receives a mandate from a client and subsequently exercises its own discretion in managing the client's portfolio within the terms of the mandate. How detailed the suitability assessment should be will depend on whether:
the mandate refers to the client's entire portfolio or only part of it; and
the investment strategy is set by the firm or the client.
In the consultation papers it published before COBS 9 was implemented, the FSA explained that firms' obligations to obtain information about their clients are qualified in a number of ways. The formulation of the duty in COBS 9.2.2R is qualified by the words "necessary", "essential", "reasonable" and "due consideration". It suggested that this might affect the level of intensity of the suitability obligation for professional clients.
The FSA also referred to there being "an irreducible minimum level of information without which it is not possible to provide a personal recommendation" and confirmed that the requirement is not about collecting irrelevant information, but collecting such information as is necessary to achieve the outcome of a suitable recommendation.
A firm must obtain the necessary information for the purposes of assessing suitability in three specified areas, namely the client's:
Investment objectives.
Financial situation.
Knowledge and experience (relevant to the particular type of designated investment or service).
Firms must not encourage their clients not to provide information for the purposes of their assessment of suitability (COBS 9.2.4R).
COBS 9.2.2R (2) and (3) and COBS 9.2.3R set out in more detail the type of information a firm should obtain from a client in each of these areas. This is considered in the sections below.
The FCA provides specific Handbook guidance for firms advising on certain products that are outside the scope of MiFID (see Specific suitability considerations for certain non-MiFID products below).
The FSA published important non-Handbook guidance to help firms interpret this requirement in 2011 (see FSA non-handbook guidance on assessing suitability below).
Information about a client's investment objectives must include, where relevant, information on:
The length of time for which the client wishes to hold the investment.
The client's preferences regarding risk-taking.
The client's risk profile.
The purposes of the investment.
The qualification that firms should obtain information from a client in each of these areas "where relevant" reflects the inherent flexibility of the COBS 9 suitability obligations. A firm may, for example, conclude that the particular combination of a client, product and service means that information in some areas is not relevant and does not therefore need to be sought.
Information regarding a client's financial situation must include, where relevant, information on:
The source and extent of the client's regular income.
The client's assets, including liquid assets, investments and real property.
The client's regular financial commitments.
A firm providing investment advice (in the form of personal recommendations) to a per se professional client is entitled to assume that the client has the ability to financially bear any related investment risks consistent with his investment objectives (COBS 9.2.8R (2)). The same cannot be assumed:
Of retail clients or "opted-up" professional clients to whom a firm is making personal recommendations.
When providing discretionary portfolio management services to any type of client, where the requirement to obtain information about a client's financial situation applies to both retail and professional clients.
The amount of information on a client's financial situation that is necessary and relevant will vary, not only in terms of the type of product, service or transaction to be recommended or entered into and the nature and sophistication of the client, but potentially also depending on the scale of the proposed investment and range of financial products on which a firm intends to advise or provide discretionary portfolio management services. A firm may consider it requires much less information from a client seeking a personal recommendation on low risk, non-complex products (such as gilts) with the intention of investing a relatively small amount, than it does from a client interested in investing a large amount in complex structured derivative products. Another factor for firms to consider is whether a client requires a service to be provided on a focused ad hoc basis or an ongoing, regular basis. Services provided on the basis of the latter may require a firm to obtain significantly more detailed information regarding the client's financial situation.
Information regarding a client's knowledge and experience in the investment field includes information on:
The types of service, transaction and designated investment with which the client is familiar.
The nature, volume and frequency of the client's transactions in designated investments and the period over which they have been carried out.
The level of education, profession or relevant former profession of the client.
This information must be obtained to the extent appropriate to the nature of the client, the nature and extent of the service to be provided and the type of product or transaction envisaged, including their complexity and the risks involved. For example, a firm may be able to satisfy itself that a client who has made a professional career in the field of finance is more likely to understand the risks in complex products (such as derivatives and structured products) than an individual who does not have a similar background. Firms should also be aware that certain retail clients may face particular difficulties during the sales process, which could prevent or impact on understanding. For example, this might arise where the product or sales documentation provided is written in a language other than the client's first language, or if the client is illiterate.
A firm can assume that a professional client has the necessary knowledge and experience for products, services or transactions in respect of which the firm has classified the client as professional (COBS 9.2.8R (1)). The same cannot be assumed for retail clients.
The European Commission has provided additional guidance on this subject in the MiFID questions and answers it publishes on its website. In particular, it was asked what the position would be where a firm's clients were trustees of a trust, but only two out of the three trustees were experienced investors. The trustees were concerned that this would curtail the range of investments that the firm could recommend to them. The Commission's response was that firms in this situation should be able to rely on the trustees discharging their obligations to each other, including the obligation to share knowledge, if relevant, unless they have actually noticed that this is not the case.
It was also asked whether it was acceptable for a firm providing portfolio management for retail clients to focus on its clients' global understanding of the risk linked to the investment strategy rather than an assessment of their understanding about each individual product contained in the portfolio. In response to this, the Commission confirmed that portfolio management firms should assess not only their clients' understanding of the risks involved in the general strategy that will be applied by the portfolio manager but also the specific risks linked to particular products that are going to be used to implement that strategy. They should also assess their understanding of the effects in terms of risks of the interaction between the different products that will be included in the portfolio.
A firm is entitled to rely on the information provided by its clients unless it is aware that the information is manifestly out of date, inaccurate or incomplete (COBS 9.2.5R).
In view of this rule, firms will want to keep the client profile under review and consider when, and in what circumstances, they need to update client information. The frequency of any updating will vary from client to client depending on the client's individual circumstances, their level of sophistication and the types of products about which they receive investment advisory or discretionary portfolio management services. For example, where the information forms the basis of an ongoing advisory relationship for a retail client, a firm is likely to want to review the information regularly.
As the relationship between the investment firm and the customer develops, the firm could, for example, ask the client to inform it of any relevant changes affecting his investment objectives, risk profile, financial situation or capacity, trading restrictions, or the identity or capacity of his representative. If the firm becomes aware of a relevant change in the client's situation, it should request any additional information that appears necessary.
"Awareness" in this context means that the firm should be able to infer from the facts and circumstances that information is out of date, inaccurate or incomplete. For example, if a firm's client is only able to provide a set of company accounts that are, say, two years old, the firm might conclude that the information cannot be relied on because it is out of date. Likewise, if a client provides information about their income that appears to be contradicted by bank statements provided at around the same time, a firm should make further enquiries as it is reasonable to conclude that there is a discrepancy.
The FCA does not prescribe how firms should obtain the necessary information to assess suitability and document this. Depending on the type of service and complexity of the product, firms may require clients to complete a standardised questionnaire, a tailored questionnaire or a combination of both. Often such questionnaires are referred to as "fact finds". Their format and detail is up to the individual firms. Many firms also make use of risk-profiling and asset allocation tools to support and supplement or replace aspects of more traditional know your customer approaches.
It might be appropriate for firms to obtain the information in meetings with their clients, or during telephone conversations or e-mail exchanges. In wholesale markets, where contact between firms and their clients regarding some products and services is particularly regular or even constant, firms will need to determine how the necessary information can be most efficiently obtained. For more structured products or transactions, it is likely that the necessary information would be obtained in the course of negotiations and discussions with the client about the product or transaction.
The FCA does not prescribe when firms should obtain the information before the provision of investment advisory or portfolio management services. Firms, therefore, need to judge this for themselves on a case by case basis. In principle, the information could be obtained months before the firm provides the services. However, firms should bear in mind COBS 9.2.5R in this event (see To what extent can firms rely on information provided by their clients? above).
If a firm does not obtain the necessary information from a client to assess suitability, it must not make a personal recommendation to that client or take a decision to trade for him (COBS 9.2.6R). This does not mean that a firm cannot proceed to provide any other service to the particular client. FCA Handbook guidance confirms that, in these circumstances, the client could ask the firm to provide another service, such as arranging a deal or dealing as agent for the client. If this happens, the firm should ensure that it receives written confirmation of the instructions from the customer. In addition, the firm should also bear in mind the client's best interests rule and any obligation it may have under the rules relating to appropriateness in COBS 10 when providing the alternative service (COBS 9.2.7G).
COBS 9.3 contains guidance on assessing suitability. It states that a transaction may be unsuitable for a client:
Due to the risks of the designated investments involved, the type of transaction, the characteristics of the order or the frequency of the trading.
In the case of managing investments, if it would result in an unsuitable portfolio.
The guidance also covers churning and switching. This is the practice of a firm switching a client between products because there is a financial incentive (such as the payment of commission from a product provider) for the firm to do so, rather than because it is in the client's best interests. The guidance states that:
A series of transactions that are each suitable when viewed in isolation may be unsuitable if the recommendation or the decisions to trade are made with a frequency that is not in the best interests of the client.
Firms should have regard to the client's agreed investment strategy in determining the frequency of transactions, including the need to switch a client within or between packaged products.
(COBS 9.3.2G.)
Firms recommending certain products that are outside the scope of MiFID will need to consider the following rule and guidance when conducting suitability assessments.
A firm recommending a small friendly society life policy need only, for the purposes of assessing suitability, obtain details of the net income and expenditure of the client and his dependants (COBS 9.2.9R (1)). A friendly society life policy is small if the premium does not exceed:
£50 a year; or
(if payable weekly) £1 a week.
The firm must keep for five years a record of the reasons why a recommendation is considered suitable.
A firm making a personal recommendation to a retail client about income withdrawals or the purchase of short-term annuities should consider all the relevant circumstances, including:
The client's investment objectives, need for tax-free cash and state of health.
Current and future income requirements, existing pension assets and the relative importance of the plan, given the client's financial circumstances.
The client's attitude to risk, ensuring that any discrepancy is clearly explained between his attitude to an income withdrawal or purchase of a short-term annuity and other investments.
(COBS 9.3.3G.)
This guidance contains a clear articulation of the standards firms are expected to meet because the FCA believes that there are continuing sensitivities about the selling of these products.
When considering the suitability of a particular investment product that is linked directly or indirectly to any form of loan, mortgage or home reversion plan, a firm should take account of the suitability of the overall transaction. The firm should also have regard to any applicable suitability rules in MCOB (COBS 9.3.4 G).
The FSA published a great deal of non-Handbook guidance on assessing suitability. Key materials are highlighted in the sections below.
In March 2011, the FSA published finalised guidance (FG11/5) on assessing suitability. This looks specifically at the elements of COBS 9.2.2R that require firms to take account of a customer's preferences regarding risk taking and their risk profile, and ensure that they are financially able to bear any related investment risks consistent with their investment objectives. (The guidance does not, therefore, purport to cover all aspects of a firm's suitability assessment.)
The FSA's guidance considers:
How firms establish and check the level of investment risk that retail customers are willing and able to take (in the wider context of the overall suitability assessment).
The potential causes of failure to provide investment selections that meet the risk level a customer is willing and able to take.
The role played by risk-profiling and asset allocation tools, as well as the providers of these tools.
It also includes examples of good and poor practice demonstrated by firms.
For a checklist of key dos and don'ts based on this guidance, see below. The FSA's guidance has been designated by the FCA under the FS Act 2012 as having continued effect for FCA-authorised firms.
In July 2012, the FSA published finalised guidance (www.practicallaw.com/0-520-2489) (FG12/16) on assessing suitability: replacement business and centralised investment propositions (CIPs).
FG12/16 reflects the FSA's findings from thematic work on the increasing use of CIPs by firms in preparation for the RDR. While the original focus of the FSA's review was on CIPs, it also identified findings of wider relevance relating to replacement business.
The FSA's guidance, which also includes examples of good and poor practice, highlights a number of actions for firms, including:
Firms either selling or intending to sell CIPs should consider the needs and objectives of their target clients when designing or adopting a CIP, ensure that they are not "shoe-horning" clients into the CIP, and establish a robust risk identification and control system to mitigate risks that might arise from the specific characteristics of their CIP.
Firms providing investment advice should ensure that they have robust processes and controls when recommending the replacement of an existing investment.
Firms conducting replacement business should consider reviewing a number of areas to ensure that they are acting in their clients' best interests and treating them fairly. These areas include their replacement business sales process and the controls that are in place to mitigate the risk of unsuitable replacement business recommendations. sets out a number of actions for firms
The FSA consulted on a draft version of the guidance in April 2012 in GC12/6.
Alongside FG12/16, the FSA published a summary of feedback to GC12/6. The summary provided an overview of the feedback, the FSA's response to that feedback, and it outlined the areas where the FSA amended the guidance in the light of the feedback. These amendments include:
A new footnote highlighting that the guidance applies equally to firms, regardless of whether they provide an independent or a restricted advice model after the implementation of the RDR.
Reference (in chapter 3 of the guidance) to the FSA's March 2011 guidance on assessing suitability. This clarifies that investment risk is a factor to consider when making a replacement business recommendation.
Clarification of the FSA's expectations where due diligence is conducted by a third party and of what the FSA was referring to in its comments on "non-traditional investments".
The FSA's guidance has been designated by the FCA under the FS Act 2012 as having continued effect for FCA-authorised firms.
The FSA published a number of suitability assessment templates (together with accompanying explanatory notes and FAQs) following thematic work it undertook in various areas. It anticipated that firms would use the templates in different ways; for example, when undertaking file reviews as part of the firm's compliance monitoring procedures, or as a checklist for advisers to ensure they give suitable advice. Key examples of these templates are:
Structured investment product advice suitability assessment template, explanatory notes and FAQs (October 2009).
Investment advice and platforms suitability and disclosure assessment template and explanatory notes (March 2010).
The FSA published a number of factsheets about assessing suitability. Many of these were produced with smaller firms (mainly financial advisers) in mind, but they contain information that is equally relevant to larger firms.
The factsheets highlight examples of good and poor practice, which are designed to help firms consider their own processes for assessing customers' needs. Firms are encouraged to consider the relevance of these examples to their business, as there may be other ways of achieving the same outcomes and complying with the FCA rules and Principles.
The FSA published a series of seven factsheets following its review of firms' quality of advice processes in late 2007. It added examples of good and poor practice to these from time to time.
Improving the quality of your advice process – Quality of advisers (August 2008).
Improving the quality of your advice process - Assessment of customer needs (November 2011).
Improving the quality of your advice process – Recommendations (including research) (August 2011).
Improving the quality of your advice process – Management information and systems and controls (September 2011).
Improving the quality of your advice process – Impartiality of advisers (August 2008).
Improving the quality of your advice process – Communicating with customers (particularly when preparing and issuing suitability reports) (February 2011).
Improving the quality of your advice process – post-sale (including reviewing customers) (February 2011).
Other relevant factsheets include:
Knowing your customer and assessing their needs (October 2008).
Does your "know your customer" information show the full picture? (August 2008).
Start thinking about your money (August 2011).
Possible agenda for initial customer meeting (August 2008).
Attitude to risk – an adviser prompt (not exhaustive) (October 2008).
Management Information Self Assessment Tool (August 2008).
Management Information: Monitoring the advice given within your firm (December 2010).
Guide to management information to monitor the quality of advice (October 2008).
The FSA published a number of good practice guides for smaller firms, which are encouraged to read them and consider how they can apply them to their businesses. Relevant guides include the following:
Based on the FSA's guidance in FG11/5, Checklist, Assessing suitability (www.practicallaw.com/6-517-8740) sets out a list of key dos and don'ts for firms when they are establishing the risk a customer is willing and able to take and making a suitable investment selection.
Firms are required to provide suitability reports to their clients in certain situations under COBS 9.4. The obligation mainly arises when firms are dealing with retail, rather than professional, clients. The glossary defines a suitability report as a report that a firm must provide to its client under COBS 9.4, which, among other things, explains why the firm has concluded that a recommended transaction is suitable for the client.
This obligation reflects MiFID, which requires that clients are provided with "adequate" reports on the service provided by those firms required to assess suitability. The FCA considers that reports are important both for consumer protection and market discipline purposes since a written record of why a particular recommendation was made provides:
Customers with a record, if they need a reminder, some time after purchase, of how and why the financial product was intended to address their needs.
Customers with a basis to raise questions and, if necessary, pursue any problems at a later date.
Firms with a tool to monitor their internal compliance arrangements because it allows a cross-reference to be made between the customer fact-find conducted by them and the recommendation given to the customer.
FCA supervisors can also make use of these written records when conducting reviews of firms to assess compliance with the suitability requirements.
The table below sets out when a suitability report must be provided to a client (COBS 9.4.1R and COBS 9.4.2R).
Circumstances | Obligation to provide suitability report to retail client? | Obligation to provide suitability report to professional client? |
If a firm makes a personal recommendation to a client and the client: | Yes | No |
(a) Acquires a holding in, or sells all of part of a holding in: | Yes | No |
| Yes | No |
| Yes | No |
| Yes | No |
(b) Buys, sells, surrenders, converts or cancels rights under, or suspends contributions to, a personal pension scheme or a stakeholder pension scheme. | Yes | No |
(c) Elects to make income withdrawals or purchase a short-term annuity. | Yes | No |
(d) Enters into a pension transfer or a pension opt-out. | Yes | No |
If a firm makes a personal recommendation in relation to a life policy. | Yes | Yes |
Firms are not obliged to provide a suitability report in the following circumstances:
If the firm, acting as investment manager for a retail client, makes a personal recommendation about a regulated collective investment scheme (CIS).
If the client is habitually resident outside the EEA and the client is not present in the UK at the time of acknowledging consent to the proposal form to which the personal recommendation relates.
In respect of any personal recommendation by a friendly society for a small life policy sold by it with a premium not exceeding £50 a year or, if payable weekly, £1 a week.
If the personal recommendation is to increase a regular premium to an existing contract.
If the personal recommendation is to invest additional single premiums or single contributions to an existing packaged product to which a single premium or single contribution has previously been paid.
(COBS 9.4.3R.)
Although the FCA uses the term "report", which is consistent with MiFID terminology, firms have flexibility over the type of document that they produce and the content of that document, provided they deliver the desired outcome. For example, the FSA considered that it would be acceptable to incorporate the suitability report information within a comprehensive financial plan drawn up for the client. However, if firms choose to do this, the part of the plan that serves the purpose of a suitability report should be prominent and firms should pay attention to the way it is laid out and take care to draw their clients' attention to the most significant parts of it, including any product recommendations and associated risks.
COBS 9.4.7R requires that suitability reports must, at least:
Specify the client's demands and needs.
Explain why the firm has concluded that the recommended transaction is suitable for the client having regard to the information provided by the client.
Explain any possible disadvantages of the transaction for the client.
Guidance on this rule states that a firm should give the client such details as are appropriate according to the complexity of the transaction (COBS 9.4.8G). The FSA decided to use the IMD terminology of "demands and needs", rather than "personal and financial circumstances", because it considered that this would help the integration of the IMD and non-IMD elements of the requirement. It did not believe that using this terminology in the context of the whole requirement obliges firms to cover in the suitability report any aspect not already envisaged by the other rules in COBS 9.
Where a firm is providing a suitability report in the course of insurance mediation activity, the information must be provided:
In a durable medium, which is available and accessible to the client.
In a clear and accurate manner, comprehensible to the client.
In an official language of the member state of the commitment (that is, where an individual policyholder has their habitual residence or where a corporate policyholder is established) in which the contract of insurance is made or in any other language agreed by the parties.
(COBS 9.4.9R.)
Where a firm is making a personal recommendation to a retail client about income withdrawals or purchase of short-term annuities, the explanation of the possible disadvantages in the suitability report should include the risk factors involved in entering into an income withdrawal or purchase of a short-term annuity. These may include:
The capital value of the fund may be eroded.
The investment returns may be less than those shown in the illustrations.
Annuity or scheme pension rates may be at a worse level in the future.
When maximum withdrawals are taken or the maximum short-term annuity is purchased, high levels of income may not be sustainable.
(COBS 9.4.10G.)
Where the suitability report requirement applies, a firm must provide a client with a suitability report within the timescale specified in the table below, which reflects the rules in COBS 9.4.4R, COBS 9.4.5R and COBS 9.4.6R).
. | Relevant investment product covered by COBS 9.4 | Timing of provision of suitability report |
A | Any product other than those in B, C, D or E below. | When the transaction is effected or executed, or as soon as possible afterwards. |
B | Personal pension scheme or stakeholder pension scheme where the rules on cancellation (COBS 15) require notification of the right to cancel. | No later than the fourteenth day after the contract is concluded. |
C | Life policy, unless the necessary information is provided orally or immediate cover is necessary (see D below) | Before conclusion of the contract. |
D | Life policy where the firm gives the necessary information orally or gives immediate cover. | Immediately after conclusion of the contract, in a durable medium. |
E | Life policy sold by telephone. | Immediately after conclusion of the contract, in a durable medium. Suitability report must comply with the distance marketing disclosure rules (COBS 5.1). |
The FSA published a number of materials outside the FSA handbook containing guidance on its requirements and expectations of firms relating to suitability reports. In particular, these emphasise that suitability reports must be fair, clear and not misleading.
The materials include the following factsheets:
Improving the quality of your advice process – Communicating with customers (particularly when preparing and issuing suitability reports) (February 2011).
Suitability reports (January 2011).
Do your Suitability reports tell the right story? (January 2011).
The FSA also published a good practice guide on suitability reports.
Checklist, FCA suitability reports (www.practicallaw.com/1-518-1090) summarises good practices that were identified by the FSA in relation to the preparation and issue of suitability reports.
COBS 9.5 sets out record keeping and retention requirements for firms to evidence their compliance with the suitability obligation. When formulating its rules, the FSA decided that it was able to largely rely on the high-level record keeping rules in the Senior Management Arrangements, Systems and Controls sourcebook (SYSC), supplemented in COBS 9 only by rules on retention periods. In line with this, FCA Handbook guidance in COBS 9.5.1G states:
Common platform firms are required, by SYSC 9, to keep orderly records of their business and internal organisation. (Common platform firms cover all firms, except insurers, managing agents and Lloyd's.)
Insurers, managing agents and Lloyd's are required, by SYSC 3, to take reasonable care to establish and maintain such systems and controls as are appropriate to their business.
All firms should have record keeping policies and procedures in place and take reasonable steps to ensure that they adhere to these policies and procedures in practice.
The FCA does not prescribe the format and content of suitability records. The type and extent of records that firms keep evidencing compliance with the suitability obligation will vary from firm to firm and client to client. This is consistent with firms' suitability assessment processes, which will vary from client to client depending on the nature of the client, the services being provided by the firm and the type of product or transaction involved. Guidance in COBS 9.5.1G clarifies that the suitability records kept by a firm may be expected to reflect the different effect of the COBS 9 rules for retail clients and professional clients, including in respect of the information about the client that the firm must obtain and whether the firm is required to provide a suitability report to the client. For example, records of the client information a firm uses to assess suitability for professional clients can include the firm's use of information it has previously obtained for a different purpose.
For example, the records a firm will need to evidence a suitability assessment for its investment advisory clients will not be the same as those needed for its discretionary portfolio management clients. Similarly, because there will be differences between a firm's retail client suitability assessments and its professional client suitability assessments, the related material recording the firm's assessments and personal recommendations will also differ. This flexibility is particularly relevant in the context of services provided to professional clients in wholesale markets.
The FSA considered what material might satisfy a firm's record keeping obligations in a proportionate and beneficial manner where personal recommendations are made to professional clients, including in routine trading communications. It recognised that, where possible, firms that provide personal recommendations to professional clients will wish to avoid having to re-establish and make a further record of those clients' investment objectives for each routine trading recommendation the firm makes concerning the most basic or standard form of any financial instruments (such as a plain vanilla bond or option). This may arise in circumstances where the client's commercial objectives are clear and the particular transaction does not raise additional considerations.
The table below sets out the minimum retention periods for suitability records, as required under COBS 9.5.2R.
Suitability records concerning: | Minimum retention period |
Pension transfer | Indefinitely |
Pension opt-out | |
Free Standing Additional Voluntary Contribution | |
Life policy | Five years |
Personal pension scheme | |
Stakeholder pension scheme | |
MiFID business | |
MiFID-equivalent third country business | |
Any other case | Three years |
There is an exception to the suitability record retention requirement in respect of non-MiFID business. Under COBS 9.5.3R, a firm need not retain its records relating to suitability if both the following conditions are satisfied:
The client does not proceed with the recommendation.
The records do not relate to MiFID or equivalent third country business.
The FSA considered that MiFID did not allow it to extend to MiFID business the flexibility for non-MiFID firms not to retain records if a client decides not to proceed with a recommendation.
The FSA published a significant body of material on suitability outside of the Handbook. This reflects the fact that, over the years, through thematic work and its day-to-day supervisory activities, it identified widespread failings in a number of industry areas. It, therefore, published a range of supporting materials to help firms better understand their regulatory obligations under its rules and Principles and set out clearly its expectations of them. The FCA is carrying forward the FSA's work in this area and, therefore, this material continues to be relevant for firms.
This material includes finalised guidance, factsheets, frequently asked questions (FAQs), and examples of good and poor practice. Key materials are highlighted in the relevant sections of this note (for example, see FSA non-handbook guidance on assessing suitability and FSA non-Handbook guidance on suitability reports).
Further information on the FSA's thematic work on advice and suitability (including links to the relevant findings reports) is contained in Practice note, Advice and suitability: FSA thematic work (www.practicallaw.com/3-383-9928).
Recent enforcement action also provides a useful steer on the regulators' expectations of firms. For more information on action taken by the FSA, see FSA enforcement action in relation to suitability failings below.
MiFID Connect was a joint project set up by 11 trade associations to help their members implement MiFID. MiFID Connect published a Suitability and Appropriateness Guideline, which the FSA subsequently confirmed. The guideline is a non-exhaustive statement of the measures that firms subject to MiFID may adopt in complying with the requirements as to suitability (and appropriateness) under the rules implementing MiFID in the UK.
The guideline's confirmed status expired in August 2010 and, as a result, it is not currently confirmed. This means that the FCA will not necessarily take the guideline into account when exercising its regulatory functions.
For more information on FCA confirmed industry guidance, see Practice note, FCA confirmed industry guidance (www.practicallaw.com/7-422-4489).
The Commission publishes questions and answers (Q&A) on MiFID on its website. A number of these relate to the MiFID suitability requirements and, where appropriate, the views expressed by the Commission are set out within the body of this note.
In April 2011, the European Securities and Markets Authority (ESMA) published a MiFID Q&A document that endorsed the Q&A previously adopted by its predecessor, the Committee of European Securities Regulators (CESR), as amended. This document is continually edited and updated as and when new questions are received. The date each question was last amended is included after each question for ease of reference.
The ESMA MiFID Q&A document contains one question in relation to suitability that provides clarification on the steps a firm can take to continue to ensure that it can rely on information provided by the customer (on the basis that the information is not manifestly out of date, inaccurate or incomplete). For more information on this, see Reliance on information provided by customers above.
As touched on elsewhere in this note, the FSA carried out a great deal of thematic work on the quality of advice provided by firms. For more information on this work, see Practice note, Advice and suitability: FSA thematic work (2007-13) (www.practicallaw.com/3-383-9928).
In delivering its consumer protection strategy, the FSA committed to backing up its earlier supervisory interventions with stronger enforcement and a focus on securing redress for consumers. This has been evidenced by a number of recent enforcement actions resulting from advice and suitability failings in the wealth management sector, which have netted over £30 million in fines and well over this figure in compensation for customers. These and other recent enforcement cases have focused on the following:
Failures to properly assess customers' financial circumstances.
Failures to ensure the suitability of funds recommended in the light of the customers' investment objectives, financial circumstances, investment knowledge and experience.
Deficiencies in training and monitoring of sales staff and processes.
For more information on these and other interesting enforcement actions resulting from advice and suitability failings in firms, see Practice note, Advice and suitability: FCA and FSA enforcement action (www.practicallaw.com/7-513-1511).
It seems likely that the FCA will continue the FSA's policy in this area.
The suitability, or not, of a financial product or service can become extremely important in the context of legal proceedings. Over recent years, a number of disgruntled investors have brought court actions against their advisers (usually following substantial financial losses). Their claims have typically been based on the contention that they have been sold products or services that were not suitable for them. Known as misselling cases, they offer useful insights for firms wishing to avoid the pitfalls that others have succumbed to.
For more information on these misselling cases, see Practice note, Claims for financial misselling under English law (www.practicallaw.com/7-523-0182).
On 19 December 2012, ESMA published a supervisory briefing on requirements in MiFID and the MiFID Implementing Directive (2006/73/EC) relating to suitability (ESMA/2012/850).
ESMA intends this briefing to act as an accessible introduction for supervisors to the MiFID rules, and to serve as a starting point when deciding on areas of supervisory focus.
The briefing summarises the key elements of the rules, explains the associated objectives and outcomes, and includes indicative questions that supervisors could ask themselves, or a firm, when assessing firms' approaches to the application of the MiFID rules.
ESMA states that the briefing is not intended to constitute new policy.
The Commission published its legislative proposals to amend MiFID in October 2011. These proposals tweak the existing MiFID suitability requirements but do not fundamentally revise them.
The following changes are proposed:
The provisions currently contained in Article 19 of MiFID will move to Article 25 of the re-cast directive (entitled Assessment of suitability and appropriateness and reporting to clients).
Investment advisory firms will be required to specify in reports how their advice meets the personal circumstances of their clients (new Article 25(5).
Investment advisory firms will be required to inform their clients whether they will provide them with an ongoing assessment of the suitability of the financial instruments recommended (Article 24(3)).
For more information on these proposals, see Practice note, MiFID II: legislative proposals: provision of investment advice (www.practicallaw.com/0-509-5291).
In December 2011, ESMA published a consultation paper (www.practicallaw.com/2-517-0449) on guidelines on certain aspects of the MiFID suitability requirements. ESMA is concerned that recent evidence and supervisory experience indicate that full and effective compliance with the MiFID suitability requirements is not as consistent or as widespread across EEA member states as it could or should be. This compromises both MiFID's and ESMA's investor protection aims.
The consultation closed on 24 February 2012 and ESMA published the responses it received on 29 February 2012.
In July 2012, ESMA published its final report on its suitability guidelines. The report contains feedback on ESMA's consultation and includes the text of the near-final guidelines.
The guidelines cover:
Information given to clients about the suitability assessment.
Arrangements necessary to understand clients and investments.
Qualifications of investment firm staff.
Extent of information to be collected from clients.
Reliability of client information.
Updating client information.
Client information for legal entities or groups.
Arrangements necessary to ensure the suitability of an investment.
Record keeping.
The guidelines apply to investment firms (including credit institutions and UCITS management companies when providing investment services), and national regulators (who must incorporate them into their supervisory practices).
National regulators had to confirm their compliance or intention to comply to ESMA within two months of the official translations of the guidelines being published on ESMA's website, which took place on 21 August 2012. The guidelines applied 60 days after the end of this period. They may lead to the FCA making amendments to COBS 9.
Following a February 2012, consultation report, in January 2013, the Board of the International Organization of Securities Commissions (IOSCO) published a final report on suitability requirements relating to the distribution of complex financial products. The report was prompted by concerns about the assessment of customer suitability in relation to the distribution of complex financial products arising out of, and in connection with, recent market turmoil. It also supported the call by the G20 for action to review business conduct rules.
The report, which aims to promote customer protection, sets out nine principles that cover the following areas:
Classification of customers.
General duties irrespective of customer classification.
Disclosure requirements.
Protection of customers for non-advisory services.
Suitability protections for advisory services (including portfolio management).
Compliance function and internal suitability policies and procedures.
Incentives.
Enforcement.
The precise application of the principles, together with the explanatory notes accompanying them, will be a matter for policy makers at national level, reflecting their assessments of different groups of customers in their jurisdiction.
The report does not seek to provide a definitive list of complex financial products, but rather a set of criteria that help to identify such products. The term "complex financial products" is used to refer to financial products, whose terms, features and risks are not reasonably likely to be understood by a retail customer (as that term is defined in individual jurisdictions) because of their complex structure (as opposed to more traditional or plain vanilla investment instruments), and which are also difficult to value (that is, their valuations require specific skills and/or systems, particularly when there is a very limited or no secondary market). The term generally includes, but is not necessarily limited to, structured instruments, credit linked notes, hybrid instruments, equity-linked instruments and instruments whose potential pay-off is linked to market parameters, asset-backed securities (“ABS), mortgage-backed securities (MBS), collateralized debt securities, and other financial derivative instruments (including credit default swaps and covered warrants). The term does not include conventional equities, conventional bonds, plain vanilla unit trusts and mutual funds and exchange-traded standardized derivatives contracts.
The report makes it clear that the term "distribution" is intended to be interpreted broadly, to capture not only selling by intermediaries, but also activities connected with selling, such as advising, recommending and managing discretionary accounts or individual portfolios, which result in holdings by investors of complex financial products.
Markets in Financial Instruments Directive (MiFID) (2004/39/EC):
Articles 19(1), 19(4) and 19(8) (Conduct of business obligations when providing investment services to clients).
MiFID Implementing Directive (2006/73/EC):
Recitals 56, 57 and 58.
Article 35 (Assessment of suitability).
Article 37 (Provisions common to the assessment of suitability or appropriateness).
Article 52 (Investment advice).
Insurance Mediation Directive (IMD) (2002/92/EC):
Articles 12(2) and (3) (Information provided by the insurance intermediary).
Article 13 (Information conditions).
A number of the FCA's Principles for Businesses (Principles) (PRIN 2.1) are relevant to the FCA's suitability requirements.
Of most significance in this context is:
Principle 9 (Customers: relationships of trust) - a firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.
Also relevant are:
Principle 6 (Customers' interests) - a firm must pay due attention to the interests of its customers and treat them fairly.
Principle 7 (Communications with clients) - a firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading.
Principle 8 (Conflicts of interest) - a firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.
For further information on the Principles, see Practice note, The FCA's Principles for Businesses (www.practicallaw.com/7-201-4191).
The FCA's rules and guidance on suitability are set out in COBS 9.
Depending on the specific circumstances, rules and guidance in the following parts of the FCA Handbook may also be relevant:
COBS 2.1.1R: Client's best interests rule.
COBS 7: Insurance mediation.
COBS 8: Appropriateness (for non-advised services).
COBS 19: Pensions supplementary provisions.
