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.

Key concerns

  • 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

  1. 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.
  2. 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

  1. 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.
  2. 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.

Written warnings

  1. Under the previous regime, there were concerns regarding the method of disclosure of any clauses limiting suitability obligations owed to the Professional Client.
  2. 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.

  • Review the Client Agreement/Mandate and remove wording that permits the Firm to fully waive suitability assessment requirements for Professional Clients.
  • Identify existing Professional Clients who have been onboarded with a full waiver. The Firm will not be able to rely on this arrangement going forward.
  • Establish a plan to carry out a) a full suitability assessment
    or b) a suitability assessment limited to specific parameters, agreed with the Client. Implement a timeframe to complete this exercise. 

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
assessment to document why a product within that range is suitable for the Client.

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:

  • Level of sophistication;
  • Ability to absorb risks; and
  • Circumstances.
  • Update procedures to ensure there is a process for documenting the factors considered as the basis for limiting a suitability assessment.
  • Review and update procedures to ensure all recommendations and discretionary portfolios are supported by a suitability assessment.
  • Where the Firm is limiting its recommendations or discretionary transactions to a specific product range, implement controls to check the outcome of the  suitability assessment is consistent with a product within that range.
  • Introduce a register for declined business.
  • Review recommendations and transactions to check compliance with the limitations agreed with the Client under the Compliance Monitoring Programme.

When providing disclosures to Professional Clients regarding limiting suitability assessments, in relation to COBS 3.4.2(2) Firm's must:

  • Provide a separate stand-alone communication, i.e. not in the Client Agreement.
  • Provide the disclosure in good time before any recommendation or transaction.
  • Include in clear terms, the extent to which the suitability assessment will be limited, e.g. to suit specific investment objectives, needs or circumstances of the Professional Client, or any type or range of financial products.
  • Obtain express consent to limit suitability assessment being undertaken and provide for the Professional Client’s acknowledgment of their receipt and understanding of the warning.
  • Consider the need to provide updated disclosures if the limitations in the initial warning have changed, e.g. a new or different range of financial products are being provided.
  • Assess existing disclosures already provided to
    Professional Clients against the current requirements.
  • If current notices are insufficient, establish a stand-alone disclosure document that:
    • Clearly stipulates the agreed limitations;
    • Is provided in good time before any proposed recommendation or transaction takes place;
    • Enables the Firm to capture the Professional Client’s express consent through a signature; and
    • Provides a time period in which the Professional Client should respond to acknowledge their receipt and understanding of the content of the disclosure
    • Provides the Client with right to decline - establishing a client account should not be conditional on the Professional Client accepting such suitability limitation.
  • Establish an ongoing review process which includes:
    • a review of products held by, and services provided to the Professional Client;
    • assess compliance with the terms and limitations agreed in the initial disclosure;
    • identifies trigger events that should prompt the Firm to provide a fresh warning, for example if it offers a different range of products or services.

Guidance for the purposes of the suitability assessment outlines that Firms should obtain and have regard to the Client’s:

  • Needs and objectives – length of time for which the Client intends to hold the type of financial product, the age and stage of life.
  • Financial situation – Client’s assets, liability (including tax), income and expenses, general capacity to withstand losses arising from investing in financial products. 
  • Knowledge and experience – nature, volume, frequency of previous investments, level of familiarity with relevant financial products and financial services. If the Client is an individual, their occupation or profession, former professional experience and a level of financial education.

When recommending a financial product or executing discretionary transactions, the Firm should consider the overall effect on the Client’s investment portfolio.

  • Establish a suitability assessment report template which:
    • captures relevant information in accordance with the DFSA guidance;
    • avoids a tick-box approach;
    • includes open text boxes to document detailed assessments; and
    • requires supporting evidence, where necessary. For example, statements of assets and liabilities, evidence of net assets, portfolio statements.
  • Produce guidance to assist relevant Employees in completing suitability assessments.
  • Provide periodic suitability training to relevant Employees.

We have a dedicated team of experienced compliance consultants who can provide expert assurance and peace of mind. Get in touch to see how we can help your Firm.

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