Suitability standards continue to spread around the world, with Canada enacting its ‘Client focused reforms’ in October. The new Canadian rules codify how know-your-client, know-your-product and suitability determinations should be applied.
Meanwhile, in the United Kingdom new executive accountability rules are giving sharp teeth to any bite from the regulator as it enforces the MiFid II suitability standards, which also apply throughout Europe.
And in Australia, new laws will mean that financial product issuers will be held accountable for the suitability of the products they sell. These laws are modelled on the UK’s PROD rules (product governance) which came into effect there in early December 2019
The elements of suitability
For financial advice to be suitable five elements must be satisfied:
- The client must be ‘known’— including their financial risk tolerance and risk profile
- The product must be ‘known’ — including its best and worst possible outcomes
- A reasoning should connect a client to a product — completing the statement ‘This product is suitable for this person because …….”
- The client gives their informed consent to proceed — based on a proper understanding of the offer before them
- The arrangements are subject to regular review — to account for changed circumstances
‘Suitable’ does not mean, or equal, ‘best possible’. Indeed, a range of quite different alternatives could be suitable for a client once this process has been worked through.
These elements are common across many different jurisdictions, but each is at a different stage in implementing an articulated suitability standard. Currently, the United Kingdom is the most advanced.
Canadian ‘Client focused reforms’
The Canadian Securities Administrators’ client-focused reforms were passed in October 2019, after several years of discussion and review. The final rules are significantly less rigorous than the draft rules, leading some critics to argue that the focus on the client became a little blurred by the lens of industry self-interest.
Nonetheless, the new rules provide for:
- Enhanced know-your-client provisions — requiring a depth of inquiry that is appropriate for the financial products being considered
- New know-your-product provisions — requiring an understanding of the basis of a financial product’s returns and how it is to be monitored for significant changes
- A suitability determination — requiring the advisory firm to explain how its knowledge of the client and the products has been applied to produce advice that ‘puts the client’s interest first’
Interestingly, part of the suitability determination is that the firm must show it has assessed a ‘reasonable range of alternative actions’. This is likely to be problematic as the new rules are applied as it is potentially confusing in both intent and execution. The UK regulator specifically says this step is unnecessary, even though it oversees far more rigorous suitability standards.
There is a two-year transition period before the new rules apply.
United Kingdom’s Executive Accountability rules
New laws took in effect in the UK in December to hold executives and staff of financial services firms personally and criminally liable for bad acts or poor conduct that harms clients.
The Senior Managers & Certification Regime (SMCR) has sent shivers down many spines in the UK — with good cause! People who breach these rules can be charged with criminal offences that carry jail-time and huge fines as punishment. They deserve to be taken very seriously indeed.
The rules require that every:
- Individual who touches advice in any way must have a personal ‘accountability map’ detailing exactly what they are responsible for.
- Organization must produce a firm-wide accountability map to explain how all those individual maps combine to cover everything the firm does
Accountability for every small step of the advice process must ‘belong’ to a named individual. This effectively closes two age-old loopholes:
- When things go bad it is discovered that no-one was accountable for something so everyone can say “It was not my job”
- Everyone in a firm being able to say “But I did not know”
These rules give the UK regulator incredibly sharp teeth as it enforces the MiFID suitability standards and the product governance regulations. Combined, these rules make the UK the world’s most defined and rigorous suitability-based regulatory regimes, which is now in full operation.
Australia’s new product governance rules
Australia has largely copied the UK’s product governance rules as it begins to move toward suitability-based standards and away from its traditional disclosure-based regime. The move is long overdue, with Australia the home of some truly shocking financial advice scandals which have robbed many people of their financial security and futures.
The new rules will make financial product issuers responsible for defining who is a suitable customer for that product. They must monitor who the purchasers of the product are and have processes are in place to ensure the product is not sold to unsuitable customers (other than in rare circumstances).
This is an enormous change, for both Australia and the UK, as it reverses the traditional caveat of ‘let the buyer beware’ where the client was often held responsible for their own ignorance.
Under these product governance rules it is the seller who must be ‘aware’. And it is the seller who bears the responsibility and accountability for failures in suitability.
The Australian rules were introduced in 2019 with a two-year transition period.