knowledge | 8 September 2017 |
How Suitable are Your Suitability Processes?
MiFID firms and branches and fund managers with individual portfolio management take note! The Central Bank of Ireland’s latest “Dear CEO” letter, sets out its expectations in relation to the demonstration of compliance with ESMA’s Guidelines on certain aspects of the MiFID suitability requirements. The Central Bank expects boards to have discussed and considered the letter before 31 October 2017. Investment firms must also review their suitability processes in light of the Central Bank’s findings.
MiFID and MiFID II Suitability Requirements
MiFID imposes suitability requirements on investment firms in order to enhance investor protection by ensuring that firms which provide investment advice and portfolio management (“Firms”) act in the clients’ best interests. In accordance with those requirements, Firms must provide suitable personal recommendations to their clients or make suitable investment decisions on their clients’ behalf. Firms must assess suitability against a client’s knowledge and experience, financial situation and investment objectives. In order to achieve this, investment firms must obtain the necessary information from clients. ESMA published its Guidelines on certain aspects of the MiFID suitability requirements (“Guidelines”) on 21 August 2012.
The MiFID II Directive also contains provisions on suitability, which are set out in more detail in Commission Delegated Regulation 2017/565. A number of the requirements in the Guidelines have been incorporated directly into the MiFID II text. As compared with MiFID, MiFID II:
- extends suitability requirements to cover structured deposits;
- strengthens the requirement for Firms to consider the client’s risk tolerance and ability to bear losses;
- requires a Firm, when providing investment advice, to provide the client with a suitability report prior to the conclusion of the recommended transaction;
- contains further details on conduct rules for Firms providing a periodic assessment of suitability;
- requires Firms to assess, taking into account the costs and complexity, whether equivalent products can meet the client’s profile;
- requires Firms to analyse the costs and benefits of switching from an investment to another; and
- refers to the fact that the use of electronic systems in making personal recommendations or decisions to trade shall not reduce the Firm’s responsibility.
ESMA consulted on changes to its Guidelines on 13 July 2017 (here). MiFID II has been transposed into Irish law by the European Union (Markets in Financial Instruments) Regulations 2017. See our related briefing here.
The Central Bank recently completed a themed review which assessed Firms’ compliance with the Guidelines. The review focused on the information gathering phase of the suitability process.
According to the “Dear CEO” letter (here), the majority of inspected Firms failed to demonstrate full compliance with the Guidelines. Overall the review found that Firms need to improve the quality of information collected and how they utilise this information in the suitability processes.
The review found that:
- Firms could not demonstrate that suitability policies and procedures were implemented in practice;
- application forms did not contain fields for the collection of required information and/or were found to be incomplete;
- not all Firms could demonstrate that they had effective governance structures and appropriate tools to successfully implement and assess suitability. A number of Firms relied on client self-assessment of knowledge, experience and financial situation and failed to counterbalance self-assessment with an independent objective assessment;
- dependencies on basic IT systems for the management of suitability processes increased the likelihood of human error; and
- governance structures for the identification and treatment of vulnerable clients were absent or ineffective.
Action Points for Investment Firms
The Central Bank expects boards to discuss and consider its “Dear CEO” letter before 31 October 2017 and that the minutes of the relevant board meeting will record this. The Central Bank also requires each Firm to:
- review its suitability framework to ensure it meets and implements the relevant requirements and the Guidelines;
- take all necessary steps to ensure that the suitability policies and procedures are fully embedded within the Firm; and
- consider all good practices listed in Appendix 1 of the “Dear CEO” letter against the firm’s suitability framework and procedures.
As mentioned above, the MiFID II Directive and Delegated Regulation strengthen the suitability requirements set out in the MiFID Directive in a number of respects. Firms will need to ensure that they perform a gap analysis regarding the relevant requirements and that they review their existing policies, procedures and documentation to take into account the additional MiFID II requirements. This will need to be completed before 3 January 2018, the date the MiFID II framework starts to apply.
According to the Central Bank in its “Dear CEO” letter, best in class firms have already completed a detailed gap analyses on the MiFID and MiFID II suitability requirements and are in the process of implementing the latter. This includes updating client take-on forms to include the additional information required under MiFID II. Best practices also include introducing automated triggers to ensure that suitability is assessed on at least an annual basis.
Please get in touch with the contacts listed below, or with your usual contact at McCann FitzGerald, if you require further information on this or any other legal development.
Boards must discuss the "Dear CEO" letter by 31 October 2017
This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.