FSA warns on risk-profiling tools

The FSA has proposed guidance on assessing the suitability of investment advice and has warned that many risk-profiling tools could lead to flawed results.

In a guidance consultation paper, published this week, the regulator reveals that out of 11 risk-profiling tools assessed, it identified nine tools with weaknesses which could lead to “flawed outputs”.

The review included tools designed in-house by firms and those provided by third-parties, including platforms. The FSA declined to provide Money Marketing, Fund Strategy’s sister publication, with a list of the tools it identified as having weaknesses.

The FSA says: “Tools can usefully aid discussions with customers, by helping to provide structure and promote consistency. But they often have limitations which mean there are circumstances in which they may produce flawed results. (article continues below)

“Where firms rely on tools they need to ensure they are actively mitigating any limitations through the suitability assessment and ’know your customer’ process.”

The warning follows a review of existing data held by the FSA and new information collected from firms on the way they risk profile clients and allocate their assets.

The regulator says out of the 366 investment files it found to be unsuitable between March 2008 and September 2010, over half were deemed to be unsuitable because the investment selection failed to meet the customer’s risk profile.

The review included cases from previous thematic work and a sample of risk-profiling and asset allocation methodologies used by banks, insurers, IFAs, discretionary and advisory investment managers, networks, platform providers and third party tool providers.

“The high number of unsuitable investment selections we see in the pensions and investment markets is still a significant concern”

It acknowledges these figures may not reflect the quality of discretionary management or pensions and investment advice across the whole of the market, as the review in some cases focused on higher risk firms.

The FSA says: “The high number of unsuitable investment selections we see in the pensions and investment markets is still a significant concern. It is a specific risk to our consumer protection objective.

“The level of failure in this area is unacceptable. We have taken, and continue to take, tough action to address these failings with individual firms.”

The regulator found many firms it reviewed considered attitude to risk but did not take into account the client’s ability to absorb a fall in the value of their investment.

It also expresses concerns that client risk questionnaires often use poor question and answer options, have over-sensitive scoring or attribute inappropriate weighting to answers.

The FSA says it has also seen examples where firms are failing to have a robust process in place to identify customers that would be best served by putting their money in cash deposits due to an unwillingness to risk loss of capital.