The challenge of Suitability

The fourth TCF outcome is a key challenge for advisers, because the suitability of advice is at the heart of the value proposition most advisers offer. Yet most advisers firmly believe their advice is suitable! "TCF need not be concerned with my ADVICE,” we protest, "but with the products, providers and "other people” that do the damage.”

Unfortunately the "real world” situation is not this straightforward. The issue of the suitability of advice is one that bedevils financial product consumers and regulators the world over. As for South Africa, it is worth looking at the comments made in the Financial Services Board’s pilot study on TCF, published December 2011. They conclude that:

• Intermediaries may not fully understand products;

• Risks may not be fully explained to clients;

• Sales incentives may affect advice; and

• Products sold may not be suitable.

Upon closer inspection we can break this list down into two component parts, name product complexity and incentive driven outcomes...

Product Complexity: The first component stems from the complexity of the financial product and the way it is marketed. This is a structural issue rooted in the decisions made by providers around the design and distribution of products. Intermediaries do not always understand the "bells and whistles” and risks involved in a particular product.

This uncertainty passes on to consumers, who in turn are unaware of the risks involved. What this means is that they cannot give ‘Informed Consent’. A consumer who is not fully informed of a product cannot engage with the product, product provider or broker in a meaningful and equal way.

The issue of "risk” is problematic. Intermediaries from around the world are grappling with the concept and beginning to accept that the traditional "low, medium or high” view of risk is no longer adequate. Given that most consumers can be described as "Cautiously Greedy” these traditional tick box approaches to risk cannot be relied upon to communicate critical issues to consumers, nor educate them as to their choices. We need to find a better way – a method that acknowledges the sometimes irrational behaviour of consumers and offers flexibility in the level of "education” required.

Incentives drive outcomes: The suitability component is more challenging. It states that incentives distort advice and that some consumers may get less than suitable advice because of the existence of such incentives. The incentive referred to: Commission! Ok – stop shouting – I realise this could never apply in your case. But guess what? Incentive driven outcomes are a reality – they are a bad thing – and will eventually be tackled by TCF and other regulatory interventions.

Incentives are clearly an important part of our industry and will remain so. But we may need to work harder, and be cleverer at, managing the potential conflicts that arise. Going forward we will have to monitor outcomes and results to ensure that clients’ interests are always put first, whatever the remuneration model.

How do we turn the suitability requirement into a positive? The answer lies in the advice process, which should look something like this… To ensure suitability in accordance with TCF Outcome Four, our process needs to:

• Establish the clients objectives and concerns;

• Establish the clients capacity and tolerance for risk;

• Reconcile inconsistencies between risk required, risk tolerance and risk capacity;

• Have a robust and independent process for researching products – or at least fully understand the range of products offered; and

• Have a structured way of educating and informing your clients so that they can make informed choices.

TCF Outcome Four is challenging and there are many issues we will have to address. Clarity of process is certainly top of my list!