(1st published by Citywire New Model Adviser on 10 Feb, 2022 at:
Due diligence involves not just looking at the product or service, but also examining the provider and thinking about the risks the FCA has identified.
Advisers often call us for help, asking what the FCA actually expects in terms of research and due diligence. Where do I start? And what’s the difference between ‘research’ and ‘due diligence’?
Fortunately, the FCA has given clear guidance on what it expects to see. TR16/1 tells us it sees research and due diligence as a process carried out by an adviser firm to assess:
- The nature of an investment.
- The risks and benefits of an investment.
- The provider, to establish whether it is appropriate to entrust it with client assets.
The FCA also says, in TR14/5, that research and due diligence are two separate stages of the selection process:
“We expect firms to carry out research on… the market to identify the solution(s) that are in the client’s best interests, then conduct detailed due diligence on the recommended solutions”.
It illustrates this with two examples:
“For example, if a Sipp was suitable for a particular client, we expect the adviser to research the Sipp market, then carry out due diligence on the selected Sipp. In relation to the platform market, we expect firms to carry out research and draw up a shortlist of platform providers, then carry out due diligence on the shortlist.“
The FCA has identified the two stages as:
- Researching the market and drawing up a shortlist of products/services to meet client needs.
- Carrying out due diligence on the product or service to check it is appropriate. In particular, is it appropriate to entrust the provider with client assets?
This makes perfect sense – narrow the field then check the detail.
Most advisers are well experienced at assessing products and solutions, and there are some great research tools out there to help.
But how many advisers go on to check out the provider, in the FCA’s words, ‘to establish whether they believe it appropriate to entrust the provider with client assets’? (TR16/1).
This is a big deal. How do you establish whether it’s appropriate to entrust a provider with client assets? Where do you start?
The examples given in Prod (Product Intervention and Product Governance Sourcebook) of things to look at relate to financial strength and reliably checking how the provider will deal with the adviser or client.
In practice, however, it’s clear that the FCA is concerned with a much wider range of considerations. It has warned, in Dear CEO letters and other documents, of risks arising from poor governance and oversight, fraud and scams, poor safeguarding of client money and assets, failing to give best execution, inadequate technology and operational resilience, inadequate financial resources and conflicts of interest, among other issues.
If the FCA has raised these as potential risks to clients, advisers will also want to think about these in relation to the providers they recommend to clients. It is all part of establishing ‘whether it’s appropriate to entrust the provider with client assets’.
All of this looks set to come into sharper focus with the Consumer Duty and the new cross-cutting rule requiring firms to avoid causing foreseeable harm to customers. If the FCA has identified potential risks or harms to customers, advisers must take them seriously.
Of course, for an adviser, all of this is also consistent with Principle 2 (conducting the business with due skill, care and diligence) and Principle 3 (organise and control its affairs responsibly and effectively, with adequate risk management). Effective research and due diligence is part and parcel of running a well-managed business.
Due diligence involves not just looking at the product or service, but also examining the provider, thinking about the risks the FCA has identified and the things which are of concern to you and your clients.
Asking due diligence questions will help gather the information you need to assess these issues and a true due diligence system will include a comprehensive library of relevant due diligence questions, with responses from the providers you want to consider.