Playing by the PROD rules

In the next print edition, PROD rules come under the spotlight and Rory Percival, founder of Rory Percival Training and Consulting and former technical specialist at the FCA, gives his insight on what advisers need to act on. Here's a preview
by Gill Wadsworth

Book your place to hear Rory Percival's talk at 
Financial Planning Conference 2019

The FCA’s Product Intervention and Product Governance (PROD) rules came into force on 3 January 2018 and were born out of the European Markets in Financial Instruments Directive (MiFID II).

These important rules apply to all product providers and advisers regulating the “systems and controls firms have in place to design, approve, market and manage products throughout the product’s lifecycle to ensure they meet the legal and regulatory requirements”.

In short, financial planners and advisers within wealth management must be sure that what they put in front of a client is genuinely going to deliver value for money.

PROD builds on MiFID II’s suitability requirements for firms operating in the EU when they provide investment advice or discretionary portfolio management “to ensure that [when providing advice] any personal recommendations made or [when providing discretionary portfolio management services] any discretionary investment decisions taken on behalf of clients are suitable for each client”.

As noted, PROD applies to providers (manufacturers) and advisers (distributors), but for the purpose of this article we are looking specifically at the demands on advisers/distributors. According to PROD (3.3.1): “The target market identified by distributors for each financial instrument should be identified at a sufficiently granular level.”

The FCA does not give examples of what is meant by “sufficiently granular”, leaving it to each adviser to decide how to divide up their client base. How could advisers go about doing this?

Segmenting a client base

Rory Percival, founder of Rory Percival Training and Consulting and former technical specialist at the FCA, is speaking at the CISI Financial Planning Conference on 30 September 2019 on the topic of PROD.

He says PROD does not impose strict rules on segmentation. The rules only demand that segmenting be "sufficiently granular". In other words, advisers provide enough detail as to why a product is suitable for the identified target market. That does not mean that advisers are tied to those segments. If there are overlaps between family members, or indeed if products appear suitable to those outside of the corresponding segment, advisers simply need to have a documented process to justify the advice and recommendations they make.

Rory says, “Firms have to think about how to segment clients effectively to best group them into similar types of circumstances, so they offer similar services and platforms, but that doesn’t mean everyone in the segment is going to want or need the same things.” He believes that providing the right advice to individual clients based on their needs is more important than being restricted by segmentation. However, if done properly, “80 to 90% of clients will be suited to the products associated with their identified target market”.

Rory Percival

Confusion and compliance

Research from The Lang Cat, a financial services consultancy, reveals low levels of compliance with PROD at the end of 2018 , and high levels of uncertainty about compliance.

The firm published results of a question asked: "Are you able to evidence (to the standard required by the new PROD rules) the suitability of products and investment services you have advised on by client segments?" In June 2018, 64 financial advisers responded, and the same questions were repeated as part of a larger survey of 223 financial advisers, with the results published in November 2018. Just 17% of respondents to the first survey were able to say with certainty they were complying with PROD, rising to 39% in November.

Jumping to conclusions?

Part of the issue may be the lack of direction from the FCA on how to segment, or indeed the need to segment at all, according to Mike Barrett, consulting director at The Lang Cat.

Mike says: “There is a misnomer about PROD where people jump to the conclusion that they have to automatically conduct a client segmentation exercise. The FCA doesn’t mention that at all. It puts advisers down that path, but the rules only require them to have conducted an analysis of target clients based on the knowledge they have of their own clients, and the material provided by manufacturers.”

Mike says this need not be a huge undertaking, since financial planners and advisers will already have clear, established relationships with their clients. Targeting will have happened organically and just needs to be documented, he explains.

Qualitative considerations

Kusal Ariyawansa CFP™ Chartered MCSI, Chartered Wealth Manager and branch principal at Appleton Gerrard Private Wealth Management, says: “As an adviser and financial planner, granularity is achieved in establishing the purpose and outcome for each objective, based on the individual’s personal circumstances. Placing clients into boxes is something I am not comfortable with as every client is different. Yes, this could be broad, and you can say a young graduate would be in an obvious group compared to a semi-retired in drawdown. However, a meaningful financial plan is constructed in the skill and experience of the financial planner.”

For example, information on investible assets should be complemented by a clear understanding of the client’s objectives, since no two people will have identical target outcomes even if they have an identical sum to invest, says Philip Deeks, director of KPMG’s Risk & Regulatory Insight Centre.

“If one client has a windfall of £30,000 at the age of 30, they cannot be segmented in the same way as someone with a similar sum who is decumulating at retirement,” Philip says. Segmenting, then, requires both cold hard number crunching and a thorough understanding of individuals’ lifestyles, risk appetites and objectives, he explains.

Advisers may find segmentation challenging if they are working for a family that contains individual members with conflicting savings objectives.

The confusion over the PROD rules by some firms may prove problematic when it comes to identifying those products deemed inappropriate. Unsuitable products are not referenced in the rules. Instead, the FCA says advisers must put forward a product “only when this is in the best interests of the client”. The interpretation of this could be that anything deemed not in a clients’ best interests should be considered unsuitable.

Find out more at the Financial Planning Conference

The CISI Financial Planning Conference in October will explore PROD in detail. Rory says he will explain what the rules are, how they can be put into practice and why they will be so critical to advisers in the future.

Importantly, Rory will make clear that if a client feels they have been short served and their adviser or financial planner cannot demonstrate compliance, that firm may find the watchdog is keen to demonstrate a bite every bit as bad as its bark. By way of example, in August 2019, the FCA issued a first supervisory notice on SVS Securities, which refers to clear breaches of PROD. According to Rory, with so few advisers complying, this is unlikely to be the last company to fall foul of these important regulations.

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Published: 30 Aug 2019
  • Compliance, Regulation & Risk
  • Financial Planning
  • The Review
  • Rory Percival
  • PROD
  • Mifid II
  • Financial Planning Conference
  • financial planning
  • FCA
  • compliance
  • CFP

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