In the digital world of finance, financial institutions are facing unprecedented challenges when carrying out suitability and appropriateness checks before selling products and services to potential investors. In an interview with Remonda Z. Kirketerp-Møller, CEO of client onboarding specialists muinmos, Mi Business Mag had the opportunity to gain further insight into why and how these checks should be carried out.
Financial brokers, banks, hedge funds and other investment firms are obliged by law (1) to carry out client suitability and appropriateness checks. However, a lack of efficiency and understanding in conducting these checks can massively increase the risk of providing an inappropriate service to clients, which can ultimately destroy the reputation of the financial institution.
The Importance of Conducting Client Suitability and Appropriateness Checks
Whether a financial institution is offering investment advice (whether independent or not), portfolio management or providing non-advice services such as execution-only services, the relevant suitability and/or appropriateness checks must always be carried out.
Remonda Z. Kirketerp-Møller, CEO of muinmos, states the importance of these checks for staying compliant with regulations. She says: “The purpose is to make sure the services are appropriate and suitable in order to protect investors, match the investor’s investment objectives, financial situation and knowledge and experience as the case may be, and to secure a stable financial system that works for all.”
Compliance means that businesses not only avoid getting fined (2) or shut down by regulators but that they also benefit from establishing a reputation as experts in their fields — this can only be done by offering investors the most appropriate and suitable services for their needs.
The consequences of offering a client a financial product or service that they don’t understand, or that is counter-productive to their needs, can be severe: “(Businesses) could lose both their money and their trust in the financial system.”But, according to Remonda, suitability and appropriateness checks should not just be seen as a preventative measure or a method of complying with regulations: “What is often overlooked, is that doing these checks correctly may, in some instances, secure more business and revenue for firms. So it is not just a matter of protecting firms from fines, or their clienteles from abuse. There is also a positive business case for doing this right.”
Suitability And Appropriateness
Suitability and appropriateness checks, while related, are actually distinct. The checks that a financial institution will need to make will depend on the type of service being provided:
Suitability checks must be conducted when a business provides investment advice and/or portfolio management, to ensure that investment advice and decisions to trade (including to buy or to hold) are suitable for the investor.
When a financial institution provides services without advice, such as execution-only services, it must ensure that the financial instrument envisaged is appropriate for the investor.
It’s a subtle difference, but a vital one.
Suitability testing, (3) for both professional and retail clients, assesses a client’s knowledge and experience of the types of services and instruments in which the investment advice or portfolio management is to be offered, their financial situation including the ability to bear loses and the investor’s investment objectives including the risk tolerance.
This information allows financial institutions to thoroughly understand an investor’s income, assets and risk profile, in order to ensure the right recommendations are made.
Remonda highlights that such checks are vital, stating: “Without sufficient information from the client to enable an assessment of the suitability, the investment firm will not be allowed to recommend or take a decision to trade.”
Where financial institutions provide investment services without advice and portfolio management, suitability requirements do not apply. Instead, appropriateness testing is needed. This involves assessing how appropriate the envisaged financial instruments services are for the investor and relies on determining the knowledge and experience of the individual investor. The investor must be in a position to understand the risks in trading in certain financial instruments and services.
The Suitability and Appropriateness Checking Process
Traditionally, checks are done manually. However, the method of processing client forms is not only outdated but also highly ineffective. The increased risk of human error often leads to costly and time-consuming mistakes. Remonda says that the process “does not take into account the domicile of the client, which means that, often, clients can be categorised incorrectly in the first place.” This can lead to an impact on the overall applicability of the suitability and appropriateness assessment.
Remonda continues: “The problem is that this is very knowledge-intensive work that cannot be expected to be correctly templated by each and every respective financial institution. There are constant changes in regulation, and most business is global nowadays, so the assessments will often need to cover several jurisdictions and asset types. The potential for errors is, therefore, very, very high. Ask yourself, why would you ever want to manually have to keep track of changes in regulation in, say, 10 different countries that you take clients from in the first place?”
The key challenges that many firms face in conducting client suitability and appropriateness assessments are a lack of knowledge (which leads to the implementation of ‘well-meant, but insufficient systems and procedures’) the speed of regulatory change and the cost and overhead of staying compliant.
Is there a solution?
muinmos partnered with Northrow (4) for a powerful combined, fully automated solution to support client onboarding that allows financial institutions to benefit from automated AML, KYC IDV checks and Client Suitability and Appropriateness assessments that reduce cost, manage risk and increase business opportunity and income for financial institutions.
Remonda says of the service: “With instant on-boarding, clients have to wait a much shorter time in order to know whether they can start trading with the financial institution. This lowers the number of potential investors who drop out during the onboarding process.”
RegTech is on the rise and there is a very real need for tech solutions that automate checks and support financial institutions looking to cope with constant changes in regulation. When asked about the future of the industry, Remonda concludes that establishing “the right level of cooperation between regulators, RegTech providers and financial institutions can promote financial stability and level the playing field in financial services, which could be truly world-changing and positive.”
Originally published on Mi Business Mag.