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Wealth Management, Risk & Regulation - the Terrible Twins

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1. Introduction

Risk and regulation stand like two towering giants over the Asset Management industry, exerting their respective pressures on Institutional and Private Wealth managers alike. Like the fabled Gog and Magog, the mythical giant guardians of the City of London, these modern-day leviathans are influencing the business environment in a way that demands more and more of the Asset Management industry as a whole. For the buy side of the industry, the combination of increased regulation, cost of compliance, volatile markets and downward pressure on assets is a challenging environment from which only the most resilient of firms will emerge unscathed.

Whilst all financial sectors have seen increased regulation, the wealth management sector is now firmly under the regulators spotlight and, perhaps with some justification, can feel that it is being singled out for special treatment.

As the pace of regulatory change is likely to increase, wealth managers need to develop a capability to respond to new regulatory requirements that is controlled, efficient, and proportional to the inherent business risk.

2. New Regulation for Wealth Managers

As well as the generic regulations such as “know your customer” (KYC), “treating clients fairly” (TCF) and “anti-money laundering” (AML), and market specific legislation such as Europe’s Market in Financial Information Directive (MiFid), UK based wealth managers are also having to contend with the impact of the Retail Distribution Review (RDR) and the FSA’s challenge, laid out in the “Dear CEO letter” sent out in June, for wealth management firms to ensure robust processes are in place in relation to the suitability of investment profiles.

RDR has seen wealth managers pushed into the same “holistic” financial planning model as IFAs, without acknowledging that the wealth management industry is incredibly variable from firm to firm, and some may not necessarily fit this model directly.

At the same time, following a review of the suitability of portfolios in a sample of 16 wealth managers, the FSA concluded in its “Dear CEO letter” in June that “significant, widespread failings” existed and, as a consequence, that there “is an unacceptable risk of customers of wealth management firms experiencing unfavourable outcomes”. It is fair to say that the majority of the industry players had not seen this coming, and that it represents a significant challenge to a large number of firms, who have to deal with several key themes, in a very short time-frame.

In summary, the FSA has called for wealth managers to make sure that in respect of suitability:-

  • client portfolios are meeting suitability requirements
  • client files and records evidence that suitability has been conducted to required standards at acceptable intervals
  • an appropriate control framework is in place within the firm to mitigate the risk of unsuitability occurring in the future
  • the firm itself has a robust governance model to control all of this within both its future planning, and day to day operations.
  • suitability issues have visibility throughout the firm, including at board level

Furthermore, the FSA has stressed that suitability will be an area of increasing supervisory focus. However, in the words of Dad’s Army’s corporal Jones. “Don’t panic!”

3. Dealing with the regulatory challenge

Interpretation and Assessment

The first challenge is to interpret the new regulations. This not as easy as it might at first seem. Interpreting new regulation to a level that allows processes, controls and system solutions to be defined and implemented is often difficult. Frequently, guidance is narrow and simplistic and requires professional judgement to be used in designing solutions that satisfy the intended purpose of the regulation. At the same time, the sheer volume of regulatory change can make it difficult to establish a baseline for risk management, with wealth managers getting little time to study emerging regulation and to adapt their business and operating models.

The firm’s risk and compliance function operating in an advisory capacity to the business clearly has an important role to play in the interpretation and assessment of new regulation. Having compliance and risk savvy personnel embedded in the business who understand how the firm operates will also help ensure that the inherent risks as they relate to the business are better understood. This in turn should drive an appropriate response in terms of solution design and resource allocation.

With this wave of regulation wealth managers are forced to prioritise initiatives by adopting a risk driven approach. The use of simple risk assessment tools such as business process mapping and risk and performance indicators can go a long way towards enabling firms to see the wood for the trees. Indeed this is one of the key themes. Firms need to recognise that whilst individual trees (specific processes) are important, it is the forest (i.e. the company-wide compliance) that is the key issue here.

A simple way to think of this is of a top-down and bottom-up approach that meets in the middle in a single unified framework. Senior management need a top-down governance model, whilst the firm also needs a bottom-up, ground-level set of procedures which are comprehensive and have qualitative and quantitative controls and reporting thereon.

The objective is to map the top-down view to the bottom-up processes so that they meet in the middle without leaving any gaps. This should naturally ensure that senior management have complete transparency over all of the business operations. This should make it far simpler to identify and resolve gaps arising from new regulation.


Whereas in the past wealth managers and their clients may have conducted business in a less formal way this style of interaction is no longer permissible. For many firms, this simple fact necessitates a massive cultural shift.

Whilst the volatile markets and the financial crisis have highlighted the necessity for wealth managers to be irreproachable in terms of suitability of investment profile, it is an area that has hitherto been relaxed. In some ways, the relationship between the wealth manager and the client has historically been like that of a long-term married couple. The marriage may not be perfect but both sides are content to turn a blind eye to each other’s foibles as long as there aren’t any nasty surprises.

Now the regulator is forcing the two sides to get closer. Both sides must invest more time and effort into the relationship to ensure that the wealth manager fully understands the client’s needs with respect to appetite for risk, investment objectives and investment horizon. Whilst the client is unlikely to be enthusiastic about completing ‘fact find’ forms, the relationship manager is likely to be even less enthusiastic about having to assess (and document) every interaction with the client from a suitability perspective.

Ensuring that front office staff place compliance and risk at the centre of everything that they do, from suitability, TCF through to client complaints, represents an enormous cultural challenge for many firms. In many cases, a fundamental change to a firm’s reward system is needed to align performance objectives and remuneration with risk management, development of risk focused education and training programs, and implementation of key controls and MI to support senior management oversight.

The implementation of a risk management culture needs to come from the top down. The CEO, in conjunction with the Board, are now expected and must play a greater role in risk management and promoter of integrated risk enterprise wide risk management programs. They are expected to lead the development of stronger risked based cultures, take responsibility for regulatory compliance and provide final sign-off at all levels within the business.

It is no longer sufficient to have the subject of risk as an item near the bottom of the agenda. Risk is an inherent and core issue with the industry now. Not only must it be discussed, but in detail, and not just when risk events occur, but before they do.

Risk must not only be seen to be discussed in a rigorous manner and with a prominent agenda role; the approach to risk is increasingly expected to be one of Risk Management and not simply Risk Measurement. This is not simply an exercise in semantics, rather it is analogous to the difference between Fire Prevention and Fire Fighting

4. Conclusion

One thing is certain; regulatory scrutiny will only increase. Organisations that are able to meet these regulatory requirements successfully will take market share through building credibility with regulators, whilst minimising the impact on profitability of the cost of compliance to their organisations.

Whilst the majority of wealth managers will undoubtedly need to make a significant investment in building an infrastructure that allows them meet their regulatory obligations, if approached correctly, this will result in more efficient processes, technology platforms and analytics. This can already be seen in some of the individual “trees within the forest” that have traditionally been the focus of compliance and risk (such as trade compliance).

The key piece of the puzzle is the one that enables you to see the whole picture. The framework that gives control over basic processes, but which also ensures transparency through the business to the senior management.

So whilst Risk and Regulation may be giants of influence in the industry, they are not necessarily menacing. If firms embrace the regulation (which ultimately can only be good for the industry as a whole), then perhaps they may be called the modern day Gog and Magog, in that they will help protect the business of the City of London for many years to come.

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