On 21 March 2011, the FSA published its finalised guidance on assessing suitability of investments (FG11/5).

The guidance is in response to a consultation which took place in January 2011 and also to the FSA's ongoing findings that certain firms' investment selections failed to account for risks a customer is willing and able to take.

The perceived high number of unsuitable investment selections, in the pensions and investments markets in particular, constitutes a "significant concern" for the FSA (2011/2012 Retail Conduct Risk Outlook). The guidance is therefore aimed at firms that provide investment advice or discretionary management services to retail customers, but is also relevant to providers of risk-profiling and asset-allocation tools (including those provided as part of a platform).

The guidance relates to chapter 9.2 of the Conduct of Business sourcebook (COBS), which deals with how firms ought to assess the risks that clients can, or wish to, undertake and on making a suitable investment selection. For example, COBS 9.2.1R requires a firm to take reasonable steps to ensure that a personal recommendation, or decision to trade, is suitable for its client. COBS 9.2.2R requires firms, among other things, to take account of a client's preferences regarding risk taking, their risk profile and the purposes of the investment.

In drafting the guidance, the FSA focused on the fitness of the various methodologies used for assessing customers' willingness and ability to take risks with their money, descriptions that firms attach to different categories in the investment – risk spectrum and the process for choosing investments. (The full guidance can be accessed here.) In summary, firms should in particular ensure that:

  • they have a robust process for assessing the risk a customer is willing and able to take, including:

– assessing a customer's capacity for loss;

– identifying customers that are best suited to placing their money in cash deposits because they are
unwilling or unable to accept the risk of loss of capital; and

– appropriately interpreting customer responses to questions and not attributing inappropriate weight to
certain answers;

  • tools, where used, are fit for purpose and any limitations recognised and mitigated;
  • any questions and answers that are used to establish the risk a customer is willing and able to take, and descriptions used to check this, are fair, clear and not misleading;
  • they have a robust and flexible process for ensuring investment selections are suitable given a customer's investment objectives and financial situation (including the risk they are willing and able to take, as well as their knowledge and experience);
  • they understand the nature and risks of products or assets selected for customers; and
  • they engage customers in a suitability assessment process (including risk-profiling) which acts in the best interests of those customers.

Whilst the FSA does not prescribe how firms establish the risk a customer is willing and able to take, or how they make investment selections, it nevertheless expects firms to consider whether they need to improve the way they assess suitability. Further, the FSA has warned that, as part of its intensive supervisory approach, it will look to see how firms have acted on the guidance. They will, in particular, be looking at whether firms have robust procedures, tools and risk category descriptions (where used) to establish and check the level of risk a customer is willing and able to take.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.