In 2016 the DFSA commenced a thematic review in respect of client classification and suitability, with particular focus on the approaches taken by Firms in respect of limiting the extent of suitability assessments performed on Professional Clients. In January 2018, the DFSA published the findings of the thematic review, and identified the following matters of concern:
- Failure to perform or document suitability assessments in connection with advice or discretionary transactions;
- Continued use of “suitability waivers” and other language in Client Agreements to limit liability, duties and obligations in respect of suitability; and
- Inadequacies in internal policies and procedures concerning relevant suitability obligations.
Further to the thematic review findings, in August 2019 the DFSA issued Consultation Paper No. 127 to make several amendments to the DFSA’s Rulebook to strengthen the current requirements relating to suitability, specifically in relation to the limitation of suitability assessments for Professional Clients. Proposed changes came into effect on 1 January 2020.
How do these changes impact your Firm?
The changes are not intended to have any retrospective effect however, Firms must consider what impact the changes will have on existing arrangements with Clients.
- Vague or generic language in warning notices to Professional Clients about limiting or excluding any suitability obligation of the firm; and
- Not drawing sufficient attention to the effect of the warning notices and not obtaining explicit consent.
The issue resulting from these concerns is that Professional Clients may be unknowingly providing consent to Firms limiting or excluding any duty of suitability owed to them completely without fully appreciating the consequences of what they are consenting to.
SUMMARY OF ISSUES
Full and partial waivers of suitability assessments
- Under the previous regime, a Firm could limit the extent to which it would consider suitability when making a recommendation to, or undertaking a transactions on a discretionary basis for or on behalf of, a Professional Client if the Firm had given a written warning stating that the Firm would not consider suitability (full waiver) or it would only consider suitability to the extent specified in the notice (partial waiver). The Professional Client had to agree to this waiver.
- In framing its proposals for full waivers of suitability assessment, the DFSA considered whether a distinction should be drawn between “Assessed” and “Deemed” Professional Clients. However such a distinction was not considered appropriate for the following reasons:
- Suitability requirements are not intended to apply to “Deemed” Professional Clients which are Market Counterparties;
- Some institutional clients may fall within the category of a “Deemed” Professional Client (e.g. pension funds and insurers) but may wish to rely on
recommendations or discretionary decisions made by a regulated Firm;
- Some categories of “Deemed” Professional Client (e.g. municipalities, local governments) may be sensitive to certain types of investment, and their needs may be better serves by obtaining a suitability assessment limited to specific parameters when investing in such investments; and
- Drawing distinctions is administratively cumbersome.
Scope of a limited suitability assessment
- In all cases, if the Firm limits its assessment, for example to a specific range of products, it should be for the benefit of the Professional Client, rather than to have a less extensive or quicker process for the Firm. For example, a Firm rating the risk of the products it offers and then recommending those products to Clients whose risk tolerances have been similarly rated would be inadequate where such recommendation is driven solely by the alignment of those ratings giving no consideration to any other Client-specific factors.
- In framing its proposals, the DFSA noted that limiting the product range may result in the Firm not being able to recommend any products within that range to some Clients.
- Under the previous regime, there were concerns regarding the method of disclosure of any clauses limiting suitability obligations owed to the Professional Client.
- The DFSA considered the need to improve the prominence of such disclosures provided to Professional Clients are for the following reasons:
- Warnings Disclosures are currently embedded into Client Agreements/Mandates;
- Disclosures are provided at the onset of a customer relationship and there is no requirement to provide an update if for example, the range of products change;
- Disclosures are not given in good time before any recommendation or transaction takes place;
- The extent to which the suitability assessment will be limited is not clear enough;
- Express consent to the limitations is not obtained;
Recommended actions for Investment Firms
Firms must review the key changes below and take action, where necessary.
Whilst many of the proposed changes are aimed primarily at Professional Clients, the changes should also be reviewed in respect of recommendations and transactions for Retail Clients. For example, information that should be obtained and considered is relevant to suitability assessments carried out for Retail Clients.
|KEY CHANGES||RECOMMENDED ACTIONS|
Firms will not be able to apply a full waiver of the suitability assessment requirements.
Partial waivers of the suitability assessment requirements shall remain for Professional Clients.
There is no distinction between different types of Professional Clients in applying the suitability assessment requirements. This means Professional Clients must have the benefit of a full assessment or an assessment limited to specific parameters.
Recommendations and or transactions carried out for or on behalf of a Market Counterparty shall continue to be exempt from the suitability requirements.
For a “Deemed” Professional Client, it may be possible to classify the Client as Market Counterparty in accordance with COBS 2.3.9.
If the Firm is currently limiting its recommendations to a specific product range, it must now conduct a proper suitability
In some cases, this may mean turning down business if the outcome of the suitability assessment is that such products are unsuitable. The basis for limiting the suitability assessment should focus on considerations relevant to the needs and objectives of a particular Professional Client, including the Client’s:
When providing disclosures to Professional Clients regarding limiting suitability assessments, in relation to COBS 3.4.2(2) Firm's must:
Guidance for the purposes of the suitability assessment outlines that Firms should obtain and have regard to the Client’s:
When recommending a financial product or executing discretionary transactions, the Firm should consider the overall effect on the Client’s investment portfolio.