European advisers and wealth managers are still struggling to ensure investor suitability processes comply with MiFID II regulations, behavioural finance experts Oxford Risk warn.
Oxford Risk’s experience working with leading advisory firms across Europe enables it to identify best practice compliance with MiFID II regulations, and how many firms are risking potential issues with the regulator and clients by failing to follow this best practice.
It has issued its warning following additional guidance by European regulator ESMA highlighting a need for improvements in how the legislation is currently being applied to investor suitability assessments, with a focus on what firms are overlooking.
Oxford Risk says it is seeing “a lot of confusion” from advisory firms and in some cases, major firms are asking clients to sign off their own risk level even though the legislation specifically prohibits this.
ESMA’s latest Guidelines on certain aspects of the MiFID II suitability requirements published in April highlight how the requirements to account for investors’ sustainability preferences are the most inconsistently applied, Oxford Risk says.
Other common mistakes Oxford Risk sees include confusing risk tolerance with the right level of risk for investors, and not combining risk capacity and risk tolerance in determining overall suitability. Advisers and wealth managers also often incorrectly measure objectives and time horizons in relation to an investment and not the investor.
In addition, advisers and wealth managers often don’t measure investor preferences in a robust and scientific way, while confusing owning or not owning investments with having knowledge and experience relevant to the investing experience.
Oxford Risk is concerned that firms are not assessing suitability preferences in sufficient depth and emphasises the need to assess preferences more granularly than simple yes or no questions.
James Pereira-Stubbs, Chief Client Officer, Oxford Risk said: “The list of MiFID II requirements may be long, but the key to understanding the solutions is simple: it’s all about client insights. Better insights into a client’s financial, psychological, and emotional situation; better evidencing of these insights; and better presentation to clients of how these insights match up with suitable investments for them. Get this right and you not only meet the spirit as well as the letter of the law, but also have more engaged clients, better asset growth and higher retention”.
“Stepping back to consider how these requirements can be best met in the context of the legislation’s overall intent can pay enormous dividends for both advisers and their clients. Unfortunately, we see many banks resorting to a box check exercise leading to a lack of compliance and investors in the wrong solutions”
Oxford Risk urges wealth managers to address client sustainability preferences properly by adopting best practices and a methodology that adheres to the MiFID II regulation. Wealth managers need to be aware that whilst short-term sustainability preferences may change over time, a proper client sustainability assessment should accurately capture longer-term preferences removing the need for unnecessary exclusions and ongoing trades that may negatively affect client portfolio performance.
Based on market-leading behavioural research, Oxford Risk’s suitability and sustainability tools continue to evolve, providing solid scientific grounding to questions of how much sustainable investing is suitable, and how much assets should be weighted towards specifically environmental causes.
The company, which builds software to help wealth managers and other financial services companies assist their clients in making the best financial decisions in the face of complexity, uncertainty, and behavioural biases, has developed proprietary algorithms which rank products, communications, and interventions for their suitability for each client at a particular time.
It believes the best solution for each investor needs to be anchored on a holistic view combining stable and accurate measures of Risk Tolerance, an understanding of their overall financial circumstances, and knowledge and experience. Behavioural assessments of financial personality then add the opportunity for investors to learn about their own attitudes, emotions, and biases, helping them prepare for any potential anxiety that is likely to arise. This should be used to help investors control their emotions, not define the suitable risk of the portfolio itself.