Compliance Digest - 31st May 2024
Welcome to this week’s Compliance Digest. Here is a selection of issues that were highlighted in my various industry news feeds over the past seven days.
Undertaking cashflow modelling to demonstrate suitability of retirement-related advice
Factfinding and the Consumer Duty
FCA publishes Decision Notices against two individuals for acting without integrity in relation to pensions business
The FCA’s ambitious agenda for UK asset management
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Undertaking cashflow modelling to demonstrate suitability of retirement-related advice
Last week, we covered the FCA’s Thematic Review of the retirement outcomes review. One of the Regulator’s observations was the use of cashflow modelling In a paper published in March 2024, the FCA expands upon its expectations of how firms should use a cashflow modelling tool. Which tool you use is a decision for you and your firm, how you use it is of concern to the FCA.
The FCA states that its work on reviewing defined benefit transfer advice and its ongoing supervisory work identified concerns about how firms prepare and use cashflow modelling. Cashflow modelling should be an integral part of all pensions decumulation advice.
Many firms use cashflow modelling in retirement income planning. It can be a key step in providing suitable advice. It is used to project the income flows that different assets could generate and compare these with the client’s estimated retirement needs.
The FCA identified five findings which are expanded upon in the paper. These are:
1. Firms relying on information without considering accuracy
Firms are entitled to rely on information provided by clients unless the information is clearly out of date, inaccurate, or incomplete. Firms should consider if the information clients give them is consistent with their stated goals or expectations for retirement. This information is key to providing suitable advice.
A detailed expenditure analysis will indicate how much income a client will need in retirement, and how much of this expenditure is for essential items. An adviser can then assess how much essential expenditure is covered by guaranteed income, such as, state pension benefits or income from a defined benefit pension scheme.
Advisers should be prepared to challenge the figures provided and discuss how they may change over time. Ask the client to consider about future lump sums for, say, replacing cars or maintaining their home.
2. Using justifiable rates of return
The returns used within cashflow modelling are one of the most important parts of the model. The FCA expects firms to have a reasonable and justifiable basis for all assumptions they use in the model.
A client’s investment objective may rely on their investments achieving a certain rate of return. If the firm’s modelling is based on incorrect assumptions, there is a higher risk of poor consumer outcomes. The client is not likely to understand the risk that they will not achieve the returns they need to achieve their objective and so will not be in an informed position.
A discussion about how the client’s attitude to risk may change over time during retirement is an essential element to establishing the rate of return to be illustrated in the model.
3. Planning for uncertainty
Cashflow modelling is based on assumptions, and the FCA has this explained poorly by firms to their clients.
Cashflow modelling can be a useful tool to help clients plan for their future. If a client understands that returns are based on assumptions about how the market might perform (and their investment value may go up or down) they are less likely to withdraw more than they can afford from their pension or investments.
Firms are required to assess the client’s knowledge and experience of the recommended investment and to check the client’s understanding of risk. If the firm does not explain cashflow modelling clearly its recommendation may not align with the customer’s risk tolerance and capacity for loss. Customers could be misled about the sustainability of their pension.
4. Consumer understanding
When they get advice, clients may receive multiple communications from firms that refer to future outcomes. Using multiple growth rates across different communications is likely to confuse clients and lead to misunderstanding if not explained.
Here are some examples:
risk profiling tools often refer to the potential returns of the selected risk profile or the percentage fall a client may be willing to accept
key features illustrations will show projections where the pension provider has selected a rate of return which is aligned with the underlying assets
cashflow models will have their own assumed growth rates, which could be different from the above
As the adviser, it is your responsibility to explain to your client why each document states a different growth rate and what they mean. It is your responsibility to give your client sufficient information to make an informed decision.
5. Consider the output
Firms need to review the cashflow modelling outputs to draw conclusions about the client’s potential financial position before and during retirement. These outputs are key factors to consider in the firm’s suitability assessment.
If the firm fails to review the outputs:
the cashflow model given to the customer may be factually incorrect or misleading
it may recommend a solution that is not suitable for the customer’s needs or objectives
there is a higher risk that the financial plan will not work out as intended
this raises the risk of misunderstanding and poor consumer outcomes
As part of the advice process, firms need to interpret the output of cashflow models with their clients, and stress test them to illustrate different outcomes based on different scenarios as appropriate for the client.
Compliance Matters UK Limited can help you with using your cashflow modelling tool to make it work for you and your clients. Please contact us to arrange an initial discussion.
Factfinding and the Consumer Duty
Last week we also covered the FCA’s Retirement Income Advice Thematic Review within which is the Retirement Income Advice Assessment Tool (RIAAT). This document is based on the DBAAT which is used for assessing the suitability of Defined Benefit Transfers. The RIATT is the benchmark against which the FCA will review files.
If you look at the detail within the RIAAT, you will see that to complete it fully requires a significant amount of information about your client. All this circles back to KYC, how much do you know about your client and how much of it is written down?
I have said to a number of my IFA clients that if I could download the client information they held in their head, I would review perfect KYC. Now is the time to download this information. It is also the time to consolidate all your file notes and factfind updates into a brand new factfind that contains up-to-date information about your client.
The COBS requirement is to collect sufficient personal and financial information about your client to make a suitable recommendation. It is not to complete a formal factfind, and indeed, badly designed factfinds stifle the collection of the important ‘soft facts’ about your client. Having said that, it is your responsibility to record the information in a way that can be accessed easily by you and your support team.
And then there is your back-office system.
All back-office systems contain a factfind, do you use this, or do you still complete a paper factfind and scan it into the back-office system? Maintaining an up to date factfind in your back-office system will ensure that you and your support team will have access to your client’s details in real time, including the important soft facts that are key to your advice.
Where does the Consumer Duty fit into all of this?
Remember those four FCA outcomes?
1. Products and services
2. Price and fair value
3. Consumer understanding
4. Consumer support
A current, complete, and accurate factfind will enable you to understand your clients’ goals and objectives, their attitude to risk and, capacity for loss. Thus, you will be able to demonstrate how the products and services you deliver are suitable and represent fair value. You will know the amount of support your client needs to understand the advice that you have given them. And you will be aware if your client displays any characteristics of vulnerability you need to be mindful of, be that temporary or potentially permanent, and what you need to do to avoid causing foreseeable harm to your client. This all connects to a client’s financial well-being.
Compliance Matters UK Limited can work with you to make the most of the tools within your back-office system. Please contact us to discuss how we can add value for the benefit of your clients.
FCA publishes Decision Notices against two individuals for acting without integrity in relation to pensions business
The FCA has published a press release in relation Decision Notices and bans for Stephen Joseph Burdett and James Paul Goodchild from working in regulated financial services for recklessly exposing pension holders to unsuitable investments. It has also fined them £311,762 and £47,600, respectively.
Mr Burdett and Mr Goodchild previously held senior roles at Synergy Wealth Limited (Synergy) and Westbury Private Clients LLP (Westbury), respectively.
The FCA alleges that Mr Burdett's actions led to 232 personal pension funds worth over £10m being switched into high-risk investment portfolios that were obviously unsuitable for most customers. The portfolios were created and managed by Mr Goodchild at Westbury, with 39% of overall holdings linked to a single offshore property developer. The portfolios were unsuitable for most of the clients.
This connects to factfinding, KYC, and suitability. How do you evidence that the portfolio you recommend meets your clients’ ATR and CFL, Compliance Matters UK Limited can review you are a selection of your files and recommend improvements if necessary. Contact us for an initial consultation.
Our ambitious agenda for UK asset management
In a speech by Ashley Alder, Chair of the FCA at the Bloomberg Buy-side Forum, he spoke about the FCA’s agenda for the asset management sector.
Mr Alder said that a good understanding of the FCA’s approach is particularly important at a time where the relationship between regulation and its new secondary competitiveness and growth objective has attracted a lot of interest.
Regulation exists to enhance trust and confidence in our financial markets which is essential for a thriving, competitive financial services industry. The FCA does, however, recognise that the way in which it designs its rules to achieve this basic outcome can be the subject of different views.
The speech covered what was termed a ‘smarter regulatory framework,’ he stated that much of asset management regulation is contained in assimilated EU law through an alphabet soup of UCITS, AIFMD and some parts of MIFID, where the FCA is working through a process of repeal and replacement.
Other headlines were, private finance, non-bank financial intermediation and valuations, retail investments and the sustainability disclosure requirements.
The overall message is that we cannot grow sustainably without stable markets, and effective competition which raises quality, drives down prices and prompts innovation. Better outcomes for all consumers are good for growth. Each of these are part of the FCA’s overall aim to ensure that the asset management sector continues to thrive and grow, delivering for the end consumer and the UK economy as a whole.
If you have any questions in relation to any topics within this article, please feel free to schedule a call to discuss further.
Ian Ashleigh
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