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Nailing the due diligence process

Nailing the due diligence process

(First published in Personal Finance Professional, Autumn 2020)

“Listen up class, here are the subjects that will come up in your mocks,” is how the FCA’s Dear CEO letter to IFA firms back in January should be read. No precise detail but enough to get ready.   

And whilst the announced suitability review has been pushed back into 2021, savvy firms will be using the extra time to make sure they’re well-prepared.

The FCA letter raised concerns in four areas, with “suitability” the underlying theme. This article focuses specifically on one element – the role of research and due diligence in ensuring suitability and, in particular, when reviewing discretionary investment management services (commonly called DFMs).

Research and due diligence is not new. The FCA (and FSA before it) have been talking about it for many years (eg RPPD in 2007), and look set to continue. Back in 2016, they published TR16/1, Assessing Suitability: research and due diligence of products and services, saying:

So the first bit of homework for advisers is to make sure your firm’s research and due diligence processes are up to scratch. Fortunately, TR16/1 is a short and easy read (only 5 pages), so well worth a look at the good practice examples to check how your firm compares.

But what does “research and due diligence” actually mean?

For starters, “research” and “due diligence” are two completely different things: TR14/5, Supervising retail investment advice: Delivering independent advice explains the difference like this:

Clearly, there’s a two stage process:

  • “Research” is about assessing potential products or services against client needs –specifically, assessing the nature of the investment, its risks and benefits, and how it fits with the customer’s needs and risk appetite (see TR16/1 1.3.ii and RPPD 1.24(1)). By contrast,
  • “Due diligence” is about assessing the provider, to establish whether it is appropriate to entrust the provider with client assets, including checking the financial strength of the provider and its service reliability (see TR16/1 1.3.ii and RPPD 1.24(2)).

So research on its own isn’t enough: it must be underpinned by due diligence. And it must be documented to evidence the process a firm went through in deciding on a recommendation for an individual client or, in the post-PROD world, in designing an investment proposition for a particular client segment.

Historically, doing this properly for discretionary managers has been difficult – there’s a lot to think about and knowing where to start can be hard. But the PFS produced a Good Practice Guide in 2015 (with updates since) in conjunction with consultants Diminimis to help advisers though the process.

Before simply issuing a due diligence questionnaire to a DFM, sit down and think about what’s important to your clients and to your firm – what are you looking for, and what kind of service do you want? How does the DFM’s investment approach match yours? Do the philosophies and cultures of the firms align? How would things work on a day-to-day basis? Where does your firm fit into the relationship and, fundamentally, what would be your firm’s regulatory responsibilities?

Clearly, it’s a lot more complicated than just asking about price and performance… Think about your experience of working with DFMs (or the experience of other advisers) – what’s gone well and what hasn’t? What do you need to make the relationship work for you?

Once you’ve worked out what’s important, you can choose appropriate questions to get the information you need.

And tools are available online. The DD|hub system (free for advisers) holds a comprehensive library of due diligence questions with responses covering more than 30 investment services. It includes all the PFS/Diminimis questions “out of the box”, or you can pick your own questions if you want to focus on something in particular. And in most cases you get immediate answers, online, presented in a consistent, easy to compare format – no more having to wade through long “standard packs” looking for answers.

The built in tools also help you keep track as you review the responses plus a full audit report at the end of the process, to make your life easier and evidence your assessment, if you’re ever called upon to do so, by the FCA, your PI insurers or otherwise.

Crucially, you can also get updates to help meet the PROD monitoring requirement. Simply choose to “follow” a DFM and get an alert when any of their responses change, so you can check for any issues and get an early “heads up” on things which might affect your firm or your clients.

The FCA have made clear that suitability is going to be a continuing theme, and that robust research and due diligence is a fundamental component of suitability. Due diligence doesn’t have to be difficult, though – it does require thought and care, but technology can help streamline the process.

Chris Jones is a director of DD|hub, www.ddhub.co.uk.

Chris Jones

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