Iknew theoretically that large finance firms—banks, financial product manufacturers and financial advisory firms—move to countries with lax regulation. But I am seeing this happen real time right now. In the next two years, I expect large boat-loads of suits to wash up on the Indian coast. They’ll all be escaping from rules that make cheating retail investors very difficult. The British regulator, the Financial Services Authority (FSA), has just raised the bar for investment advice and is continuing its practice of large-ticket fines to show that its teeth actually bite. A January 2011 FSA paper titled “Assessing Suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection” (http://bit.ly/fOb8by) lays out the results of an audit of advisory firms between March 2008 and September 2010. The report looks at the practical issues of implementing the suitability criterion in product sales and financial advice.
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What is suitability? The basic premise of adviser regulation is that the advice given and the products sold be “suitable” to the customer. Which means that an artist with irregular income flows not be sold a product that needs a regular infusion of funds. Or that a retired person is not sold a life insurance cover. FSA has taken this to another level by not just defining suitability but conducting audits to see if these rules are being actually followed, resulting in good customer outcomes. The FSA audit found evidence that more than half of those judged “unsuitable” were due to the fact that the products sold were unable to meet the risk a customer was willing and able to make. Willingness is a function of what somebody thinks she can do. Ability is what she can actually do. A diabetic patient may be willing to eat sweet stuff, but may not be able to. Translate that into finance and it means that a 70-year-old person with limited funds may want to take risk but his financial situation may not allow him to do that.
The findings resulted in a fresh set of fines on adviser firms that failed the suitability test. On 14 January, FSA fined Barclays Plc £7.7 million (Rs56 crore). The final notice can be read here: http://bit.ly/gm8JCV. Barclays’ crime? Around 12,000 customers, many of them close to retirement, were mis-sold two income-focused funds that lost money during the financial crisis. The problem that FSA or other regulators have with market-linked products is not that they lose money, but that they are sold as products suitable for people who cannot afford to lose money. The FSA said Barclays had failed to ensure that two funds, Aviva Global Balanced Income Fund and Aviva Global Cautious Income Fund, were suitable for its customers.
The failings, as documented by FSA, found the training material given to Barclays’ staff “inadequate”. It did not identify the types of customers the funds were suitable for. The sales briefs sent to advisers spoke about just potential benefits and not the risks. Product brochures had inadequate information and had statements that could mislead customers. It failed to put in place adequate procedures for monitoring of the sale of funds.
Barclays did two things—it apologised to the customers in both funds and said it would pay compensation. As step two, it closed down its financial planning business. On 26 January, Barclays announced that it would cut 1,000 jobs by closing its branch-based advisory service Barclays Financial Planning (http://bit.ly/hpArtx). Reason: a decline in commercial viability. The press note of the bank said: “Barclays has been conducting a detailed review of its financial planning advice over recent months. This review has concluded that, given the changes to the retail investment marketplace, it is unlikely that this business would be able to deliver a return that would justify the investment required.”
The timing of the FSA audit, the slapping of the fine on Barclays and the bank’s decision to shut shop seem to be linked. What I hear Barclays (and other retail-focused financial firms) saying is this: unless we are allowed to sell products that maximize our profits and not the financial well-being of the customers, we will not stay in that business. Or, we will move it to locations with no, low or lax regulation. India is still at the no-regulations stage. Even the basic definition of who should be sold what is not in place in India. We have no regulation that makes advisers responsible for what they sell, making us a zero regulatory cost market for the suits. The woollen suits are buying linen to make the cultural shift.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money and can be reached at firstname.lastname@example.org