Due diligence is becoming a key part of a firm’s compliance set-up.
More and more firms are looking to third parties to help reduce risk and create the best possible client experience.
Creating the perfect recipe for a robust due diligence process need not be particularly difficult or time-consuming. Let’s look at the key steps involved.
The natural starting point, and the one the FCA wants to be front and centre, is clients.
Everything you do in your business, including due diligence, is geared around clients. All the due diligence work you are expected to complete is to ensure that the third party services you use will lead to good client outcomes.
The regulator expects you to complete due diligence on the key partners you work with to help deliver your advice services.
Outside of the investment process, examples include accountants, IT support, software providers and compliance consultants.
The FCA expects you to look at the knowledge, experience and range of services these firms offer, and how they fit with your business model.
If a third party service cannot deliver all the guidance and support you need, in a way that you can understand, and integrate with the advice services you provide, then the relationship isn’t going to work.
With that in mind, you should always tailor any research to ensure this is bespoke to your firm’s needs.
In essence, it's about looking for a good fit that will enhance your service at every touchpoint a client has with you.
What about centralised investment propositions?
The FCA expects you to take a robust approach to due diligence on all the parties used in your centralised investment proposition (CIP), for example fund managers (discretionary or otherwise) and platform providers.
To meet the product governance (PROD) rules, you also need to fully understand:
- The product the provider offers;
- The literature and accompanying information provided;
- The services they provide;
- The charges they levy; and
- Their financial strength.
You then need to drill down to understand the target market each third party specialises in, for example:
- Fund managers - are the funds in line with the risk profile and capacity for loss of the target market?
- Platforms - will their services, communications and price meet the needs of the target market?
- Discretionary fund managers (DFMs) - will their management of money meet the needs of the target market?
All this due diligence is carried out at a generic high level. Once all the above are known and understood, you can then go on to agree (or disagree) with the target market these parties have highlighted, ensuring that only those products and services selected will meet the needs of your own client bank.
The individual file will then drill down even further to record and evidence the individual suitability for each client.
For example, your firm has drawn up a list of three fund managers you want to use as part of your CIP.
The individual needs on each file will show the client's specific financial objectives. By fully understanding these needs and objectives, the adviser can then research and select the most appropriate fund manager from the three providers who have been through your due diligence process.
The due diligence key principles
1) Understand the products and services being offered to clients, as well as the literature and supporting material.
2) Understand the target market described by the provider, and carry out your own research to decide whether you agree or disagree with the provider assessment of the target market.
3) Ask yourself whether the intended target market fits with your client bank.
4) Only use providers where you are satisfied that they are financially sound.
5) Only use providers where you believe their services will be of a standard to meet your clients'.
6) Only use providers where the charges incurred are deemed appropriate for your clients.
7) Select service and product providers to meet the needs of your clients foremost, but also consider the compatibility of these products and services with your own advice process, as well as the knowledge and skills of your staff.
8) Identify, avoid, manage and disclose any conflict of interests.
9) Review the providers, services and third parties you use at least annually, making sure they remain appropriate for your clients' and your business needs.
It's worth noting at this stage the FCA's stance on the use of generic due diligence material provided to you by the companies you're working with.
In its thematic review on assessing suitability published in 2016, the regulator said: “Firms can rely on factual information provided by other EEA-regulated firms as part of their research and due diligence, for example, the asset allocation.
"However, they should not rely on the provider's opinion, for example, on the investment's risk level.”
So, you may accept at face value the factual information provided, for example: "We have been in business for this many years", "our turnover is £x", or "we employ a particular number of staff in this many countries."
But the FCA expects you to vigorously challenge any opinion provided, for example: "This is a low-risk product", "our service is second to none", "this is a cost-effective product" or "This is a low volatility fund."
There are a number of tools that can help in the due diligence process, including: independent research tools, provider interviews, testimonials from other advice firms, recommendations from peers and trial periods.
By following the above steps, clients will always be served by the best possible solutions and services.