Platform diligence is essential, says Defaqto’s Gill Cardy, but there’s such a thing as too much complexity
I expect that this isn’t the first article (and it certainly won’t be the last) on the subject of due diligence, given that the Financial Conduct Authority is going to be talking to us about it in 2015.
However, it’s worth taking a look at what exactly due diligence is, given that the FCA is typically vague, or principles-based, about what it expects from the regulated community on the subject.
There will be particular areas where the regulator will focus: high risk or complex products, and those which add costs for the client. And it is in this last area where platform due diligence is particularly relevant.
Paying for More Than You Can Use
It’s an unfortunate urban myth that the FCA hates higher cost products or services. But there are two things about costs that the regulator really does hate with a passion:
- That consumers do not know about or understand higher costs; and
- That consumers do not benefit from the extra services provided for those higher costs.
One client was recommended a self-invested pension to benefit from the investment flexibility, but was then invested into one single balanced managed fund. Another example that might relate more specifically to platform advice would be the client who was recommended to invest on platform for all tax reporting functionality, but for whom the ability to undertake Capital Gains Tax calculations was irrelevant, given that all his investments were held in ISA and pension wrappers.
A Matter of Definition
So what exactly is due diligence?
It is, or course, the research and analysis of a company, person or investment which is routinely done in preparation for signing a contract or entering into an agreement or a transaction. It serves to confirm all material facts, including actual or potential risks, relating to the proposed transaction.
Interestingly, some definitions refer to the duty of each party to confirm each other’s expectations and understandings, and to each independently verify the abilities of the other to fulfil the conditions and requirements of the agreement.
This raises the intriguing prospect of a product provider undertaking due diligence on the firms or clients who introduce business to them. A couple of providers already do this – mainly in the model portfolio and discretionary fund management space – but making it a widespread practice would be an interesting concept.
Learning to Be More Forthcoming
By now we might be getting closer to understanding the thrust of the FCA’s thematic review. We already know that this will focus on the adviser’s role in the due diligence process, looking at how advisers assess products and services and what barriers they may face in the process.
It’s comforting to realise that the regulator does at least understand that advisers may face difficulties in undertaking proper due diligence. Advisers will welcome a clear statement of the regulator’s expectations of product providers when being asked about their products and services.
Good due diligence implies one party asking the right questions and a second party giving the right answers. However, in our regulated world, due diligence shouldn’t be a parlour game where providers only answer the questions they are asked, no more and no less. It should not be up to advisers to frame exactly the right question in precisely the right way in order to get the information they want. Providers who react in this way to due diligence enquiries could face a backlash from advisers unwilling to do business with such taciturn companies.
Focus on Client Outcomes
The regulator has also sought to remind us that in their view, some advisers are failing to put client outcomes at the heart of due diligence, and platform due diligence in particular. This is because the platform is paid for by the client, with the FCA clearly expecting advisers to be acting in the client’s best interests, and getting the client a good deal.
The FCA knows that adviser firms collect information packs from platform providers, to evidence undertaking due diligence.
There are two problems with this. Firstly, having received the information, we should do something with it. We should be inquisitive about its real meaning, and critical about what we are being told – not just collecting reams of brochures and reports.
The second problem is that, even if we do undertake proper analysis and research, it should be on the right subjects. For the regulator, the right subjects are those which relate the product research and eventual recommendations to the suitability of the proposed transaction for the firm’s clients, not the firm.
Yes, of course a firm may benefit from the advantages of platform use – but so should the client. More radically, if the platform saves an advice firm time in investment administration, portfolio construction, reporting and reviews, how does the firm pass on those cost savings to the client who has paid the price for all these facilities?
So what should advisers be asking?
First, take a step back and ask yourselves what you consider the purpose of the due diligence to be. Developing your research process requires a preliminary exercise in deciding within your business in general and for your clients in particular what good (and bad) looks like. These are the characteristics which you then deliberately seek out, or seek to avoid.
Setting high level research criteria with strong client-focused logic will focus the mind on what questions to ask, and what answers may or may not be acceptable.
Agree features, some of which would be applicable to all firms with which you do business (financial strength, years in business, profitability) and others which may vary according to the product being considered (annualised volatility, online functionality, discretionary fund manager links).
Some information, particularly factual data on pricing and product terms and conditions, is easily and cheaply available from commercial research providers.
Other information may be harder to find, including more qualitative information such as the provider’s target client segment, or future plans for product development.
Finally, agree a review schedule for this process. Review frequency is especially sensitive for platform advice where switching clients from one provider to another can be costly for both client and adviser, in term both of the time and the transaction charges involved.
Constant Change is Here to Stay
Platforms change, just like any other product. Features are added, and pricing inevitably changes – and suddenly a proposition that represents a good deal for the client now might be very different in five years’ time. However, a platform which suitable for new clients may not be sufficiently different in terms of features or charges to merit switching an existing platform client to the new preferred provider.
We have to wait to see what the FCA considers to be good or poor practice in adviser due diligence. But keep your client and what is right for their individual circumstances front and centre of your recorded platform due diligence process and you may not be too wide of the mark.