What do IFAs need to know about mental capacity?

by | Oct 24, 2022

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By Richard McDermott, Partner (Private Client) and Katy Ruddell, Senior Counsel (Banking & Financial Services), Farrer & Co

From a risk perspective, independent financial advisers (IFAs) will want to ensure their client has the capacity to give instructions and make decisions about their finances. However, the duty to be on the lookout for lack of mental capacity goes beyond that. Protecting vulnerable customers has been a key focus of the Financial Conduct Authority (FCA) for some time as the FCA wants vulnerable customers to experience outcomes that are as good as those for other customers. This article explores the red flags IFAs should be alert to that may indicate vulnerability associated with mental capacity and the steps that the IFA may want to consider taking when these are present.

What is vulnerability?


The FCA definition of a vulnerable customer’ is “someone who, due to their personal circumstances, is especially susceptible to harm, particularly when a firm is not acting with appropriate levels of care.”  Whilst the different types of vulnerability are wide-ranging, they are all underpinned by the concept of a person having the mental capacity to make decisions.

The legal test for capacity set out in the Mental Capacity Act 2005 (MCA) is a two-stage test:

  • whether the person has an impairment or disturbance in the functioning of their mind, and
  • whether this impairment makes them unable to make a decision for themselves.

The default assumption must always be that someone has capacity to make a decision, unless the converse can be established.


Guidance in the MCA Code of Practice elaborates on the test, confirming that a person who lacks capacity means, “a person who lacks capacity to make a particular decision or take a particular action for themselves at the time the decision or action needs to be taken.”  Aligning the FCA’s concept of vulnerability with the legal test for mental capacity indicates that vulnerability can be a temporary state or a permanent one, so IFAs will need to be alert to a possible ‘lack of capacity’ whenever they are dealing with or for a client and that this assessment must be carried out on an ongoing basis.  However, what signs should an IFA look for when making this judgement?

Who might be a ‘vulnerable customer’?

There are numerous ways in which a client can be vulnerable, and every case and client will be different. Helpfully, the FCA’s guidance on the fair treatment of vulnerable customers (FG21/1) identifies four drivers of vulnerability that risk an individual being more vulnerable than they otherwise might be.  These are:

  1. Health – severe or long-term illness, mental health conditions, disability or addiction.
  2. Life events – bereavement, relationship breakdown, domestic abuse, caring responsibilities, leaving care, migration, asylum, human trafficking, modern slavery or convictions.
  3. Resilience – inadequate or erratic income, over-indebtedness, low savings or low emotional resilience.
  4. Capability – low confidence in managing finances, poor literacy, numeracy or digital skills, learning difficulties, poor language skills or limited or no access to help or support.

IFAs, as part of a client’s suitability assessment, will need to ask their clients detailed questions about their personal and financial circumstances and when doing so an IFA should be alert to the drivers of vulnerability. As well as these, IFAs should also be aware of ‘warning signs’ that a client may be in a vulnerable position and/or at risk of losing mental capacity. These might include:

  1. Erratic or pronounced emotions which are inconsistent with the client’s usual disposition or situation.
  2. Decision-making that would lead to a poor outcome, either due to health issues impairing the client’s cognitive function or through third-party influence.
  3. Third-party instructions, particularly if the client is not copied into correspondence or the third-party resists allowing the client to attend meetings with the IFA.
  4. Incoherent instructions,particularly if the client seems incapable of giving clear instructions despite the IFA having tried to clarify them.
  5. Significant departures from previous instructions, (often long-standing ones) particularly when these arise suddenly without rational explanation.

When should an IFA intervene?

IFAs will ideally have a detailed vulnerable customer policy which they can refer to. Additionally, the FCA guidance includes examples of good and poor practice. However, the FCA’s parameters for vulnerability is broader than under the MCA (i.e., it goes beyond circumstances where the client has lost mental capacity) and IFAs may struggle to know when or how to intervene in a situation where a client is showing signs of vulnerability, or their capacity is uncertain.   As such, where an IFA identifies one or more drivers or warning signs, the IFA should carry out further investigations into the client’s vulnerability.


Subject always to duties of confidentiality, IFAs could also speak to family members, or where the driver is health related, best practice would be to suggest a capacity assessment with a suitably qualified medical professional.

Another and perhaps better option may be for the IFA to work with the client’s other advisers as a team. Issues of confidentiality may also be less of a concern if these relationships are developed at an early stage when clients can consent to allowing certain types of communication to take place between their advisers.  

In addition, capacity assessments are increasingly common, particularly when a significant planning exercise is being undertaken, other big decisions need to be made and/or there is the risk of the decisions being challenged (or a family argument breaking out) further down the line.  Clients are often receptive to the idea of undergoing an assessment, on the basis that it will make the decisions made/actions taken as robust as possible to any later challenge.  


A shifting landscape

The responsibility for identifying and protecting vulnerable individuals is shifting in three key ways.

First, the duty to be alert to risk drivers and identify vulnerabilities now lies with a broader range of practitioners and the expectations on how IFAs treat vulnerable clients has significantly increased over recent years.


Secondly, the range of circumstances in which a client is seen as vulnerable is considerably wider than previously. IFAs cannot only rely on the MCA capacity test and must be aware of the range of vulnerabilities a client may experience. This is a higher burden, but one that IFAs are well-placed to bear, and when it comes to ensuring that vulnerable clients are appropriately protected, it is a step in the right direction.

Thirdly, the Consumer Duty, which comes into force next year, expressly requires firms to provide additional care to ensure they meet the needs of vulnerable customers and that these customers consistently get good outcomes.

As such, now more than ever IFAs should be making sure that they are able to identify and react swiftly to signs of potential vulnerability.

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