Some positive FCA feedback on conflicts of interest for Wealth Management firms

In welcome news for the industry, the FCA in late November 2014 expressed pleasure in reporting generally positive findings from its thematic review assessing whether wealth management firms and private banks identify and manage conflicts of interest that might arise when providing investment products manufactured within the same group/firm (in-house products - "IHPs").

In its thematic review, the FCA considered how Private Wealth Management ("PWM") firms manage conflicts of interest in relation to the use of IHPs when offering discretionary and advisory services to retail customers.  The FCA reviewed a sample of 18 PWM firms and focused on the use of IHPs in relation to business strategies and governance, identifying and managing conflicts of interest, management information, sales targets and remuneration, product selection (including product reviews and monitoring), and communications with customers.  As indicated in its approach to supervision of the PWM industry, the FCA took particular interest in firms' business models and strategies, as well as the way in which offerings were described to customers.

Other PWM firms not involved in the thematic review but which have access to IHPs are expected to consider their own arrangements in the light of the FCA's conclusions.

The FCA's findings

Generally, the FCA's review found that firms recognised the potential risks from conflicts of interest to their customers, their reputation and market integrity.  There was no evidence of any significant failure amongst the 18 PWM firms to identify and manage conflicts of interest in their use of IHPs in retail customers’ portfolios.  The FCA observed several positive trends:

• There was a heightened focus by senior management within firms on conflicts of interest in relation to IHPs and they had taken steps to identify and manage weaknesses in their controls, with some firms engaging independent consultants for further advice.
• Most firms were able to demonstrate that their compliance and risk functions had identified the potential conflict of interests that arise byofferingIHPs alongside third-party products:
  • all firms maintained a central risk log which recorded the conflict relating to the use of IHPs and any resulting mitigating actions;
  • firms had also established and maintained a conflicts of interest policy setting out the procedures and measures to manage conflicts of interest in the use of IHPs.
• There were no agreements between manufacturers and distributors that required distributors to distribute a particular volume of IHPs to customers, which suggested that firms were not putting their own commercial interests above those of the customer in distributing IHPs.
• There was no evidence of remuneration structures that could have biased investment decisions unfairly towards IHPs.
• Due diligence processes in selecting investment products and monitoring subsequent performance appeared to be consistent between IHPs and third-party products. There was evidence of firms terminating IHPs if the product failed to meet the defined criteria.

However, the FCA noted some lack of consistency, and some shortcomings:

• Firms did not articulate clearly enough howIHPs fitted within their business model and strategy, and were aligned with customers’ interests
  • almost all the sampled firms indicated that the investment of retail customers’ assets into IHPs did not form an explicit part of their business strategy – there was this a risk that senior management may not have fully considered how the use of IHPs is aligned with their firm’s overall strategy and customer interests.
• Several firms did not monitor the level ofIHPs in customer portfolios, which could help to indicate how effectively they are managing conflicts:
  • Senior management teams at most firms did not receive any management information about the overall level of investment in IHPs.
• Communications with customers were not always clear about the nature of the firm’s services and the extent to whichIHPs might feature in customer portfolios
  • It was unclear whether firms had considered, when describing the nature of the services, if their customers were likely to understand the terms used.

Next steps for firms

Given the generally positive assessment it seems that remedial measures are unlikely to be necessary; indeed, the FCA plans to give individual feedback to firms involved in the review but will not be proceeding with further thematic work on the subject. 

The FCA expects firms not involved in the review to consider whether their own arrangements meet the standards set out in the report, and all PWM firms should ensure that they are continuing to bear these risks in mind by keeping their arrangements under review and considering whether any action can be taken to further establish best practices in strategies, policies and procedures:

Recommendations for PWM firms:

• Where firms make use of IHPs, they should be able to explain how this forms part of the business strategy and aligns with customers' interests, even where IHPs do not form an explicit part of that strategy and are treated neutrally with respect to third-party products.
• Senior management teams should be receiving management information on the use of investment in IHPs, which should be fully integrated into conflicts management processes and procedures.
• Where useful, firms should consider engaging third parties to report on the effectiveness of conflicts interest arrangements and identify any gaps.
• Remuneration schemes which encourage bias towards products that are easier, quicker or more profitable to sell, but which may not be in customers’ best interest, are likely to fall foul of FCA requirements and should be avoided.
• Due diligence documents for IHPs should consider alternative options.
• Firms should continue to take a robust approach and terminate IHPs if the product failed to meet the defined criteria.
• Terms should be consistent and unambiguous in client communications: for example, firms should not state that they are ‘restricted’ but also ‘scanning the universe’ for ‘best of class’ products.
• When drafting terms and agreements, firms should consider whether customers, particularly retail customers, will understand the relationship between the manufacturer and distributor, the exact service offering and the likely level of IHPs in portfolios.
• Periodic client portfolio statements should clearly identify investments that are IHPs.