Customer suitability in the retail sale of financial products and services

Abstract

1. This report considers how supervisors and regulated firms across the banking, securities and insurance sectors deal with the risks posed by mis-selling of retail financial products, including related regulatory requirements, both with regard to disclosure of information to retail investors and requirements on firms to determine whether recommended investment products are suitable for such investors. A broad range of supervisors provided details of the regime in their respective countries. These supervisors included sector-based, functional regulators and integrated regulators. For the purposes of this report, we refer to an integrated regulator as one who regulates banking, insurance and securities activity.

2. Our review dealt only with requirements in respect of retail customers and products with a significant investment component. Our review therefore included investment-based or investment-linked insurance products, but not those insurance contracts that only insure against risk. Credit products sold by banks in retail settings were not part of this review.

3. An important part of our work was to survey some 90 financial firms around the world as to how they deal with customer suitability, and manage the risks posed by misselling. We received information from a wide range of firms and we are very grateful for their participation. A number of responses were from firms that operate in more than one sector and/or operate in more than one country or region.

4. Firms almost always treat a natural person as a retail customer. In many instances, even when there is opportunity to distinguish based on net worth or sophistication, firms err on the side of caution.

5. A key finding is that the notion of suitability is recognised in regulatory requirements across all sectors, but to a varying extent. There are some differences in its application by sector, and probably greater differences by country. The differences that do exist may stem, in part, from the fact that not all supervisors have consumer protection mandates.

6. In a minority of the 11 countries surveyed, a consistent suitability regime applies across all three sectors to products that have an investment component. Although it might be observed that such a regime is more frequently associated with countries that have an integrated regulator or a specific 'conduct of business' regulator across the sectors, even where there is substantial variance in suitability requirements between sectors, for example in those jurisdictions where each sector has its own supervisor, there is frequently strong cooperation between the sectoral regulators that helps them collectively to hold firms accountable for improper selling practices

7. In general, suitability requirements are more specific and enforcement remedies are more likely to be specifically prescribed by securities regulators, or those who have a conduct of business mandate. For example, the securities sector, particularly in the United States, brings the largest number of enforcement actions and imposes the broadest scope of penalties. However, supervisors also oversee firms' compliance with suitability standards through their examination and supervisory processes or other oversight and remedial approaches. This is particularly the case in the banking and insurance sector.

8. In most countries, a suitability requirement only arises when a firm makes a recommendation or provides advice ("advising") to a client to purchase a product. Where no recommendation is made, some jurisdictions require that disclosure be made, or that a client be "warned". Encouragingly, the vast majority of countries will not allow firms to 'contract out' of suitability obligations. An exception to this may occur where a client is deemed to be of sufficient net worth or sophistication that he/she is no longer regarded as "retail".

9. Most regimes require any advice given to be recorded in some fashion and require varying degrees of product information and other disclosures to be made at or before the
point of sale.

10. An interesting observation is that disclosure requirements for conflicts of interest (for example, ownership structures of the sales agent, or remuneration to be received) are generally less rigorous for sales of insurance than for other products.

11. In most countries, liability for mis-selling of products will fall to the sales agent, rather than the creator of the product. However a creator may be liable if an agent sells the product, under a jurisdiction's rules of principal and agency. Where a third party makes the recommendation, the suitability obligation will generally fall on that person, though we note that in one country the insurance supervisor requires the creator of the insurance product to satisfy itself that the third party performs its suitability function.

12. Most countries require firms across all three sectors to have dispute resolution procedures in place. In some jurisdictions an independent Ombudsman deals with unresolved disputes while in others an industry-based dispute resolution scheme is available. However, even within countries there can be varying financial limitations applicable to the availability of dispute settlement mechanisms.

13. Supervisors find that requiring firms to have a specific and "independent" compliance function can be a useful tool. Many supervisors mandate this, particularly in the banking and securities sectors. Similarly, many supervisors require key staff to be authorised or registered and for the conduct of sales staff to be supervised.

14. Two related matters that were addressed with supervisors were: what if any role did they play in educating or communicating with consumers regarding financial products and; whether there were any products or services outside their regulatory area of responsibility that gave cause for concern.

15. With regard to investor education, many regulators have websites containing useful information about investing generally and what to look for in selecting financial products and seeking financial advice. Given their focus, regulators with responsibility for conduct of business regulation appear to provide more information. In some cases, the website is but one part of a broad consumer education programme.

16. A number of regulators expressed concern about a wide range of 'financial products' which fall outside of their regulatory jurisdiction, but which displayed similar functionality and characteristics to regulated products.

17. Bearing in mind its more limited geographical scope,3 the survey on industry practice confirmed that investment firms, asset managers and banks apply robust suitability policies. Recommendations made to their customers are based on the quasi systematic collection of core information on the financial condition, objectives and risk tolerance of their customers. Insurance companies on the other hand generally have a less comprehensive suitability policy, sometimes as a result of less detailed requirements: they collect on average less information before making a recommendation, and fewer than half of the companies surveyed keep a record of recommendations made.

18. The compliance framework appeared also to be less rigorous in several insurance  companies. The investment products offered by insurance companies are less frequently the most risky types of investment products,4 and some companies noted that for most products sold, the nominal value of the initial investment was guaranteed. They nevertheless raise similar suitability issues. However the situation may significantly vary between countries and there are some minor variations across US states. New legislation entering into force after our survey was conducted should improve the situation in some countries.

19. Beyond the suitability policy, our survey also examined disclosure practices in firms, as disclosure helps customers to make better informed decisions and reduces the risk of mis-selling, even when no recommendation is made. In many jurisdictions, firms generally appear to provide useful information to the customer prior to a sale, particularly with respect to product features and direct costs.

20. However, only 60% of firms consistently provided information on conflicts of interest and remuneration. There was wide disparity even in this figure, with only 40% of insurers saying they provide such information.

21. When looking at the range of information provided to investors when making a sale or recommendation (eg information on product characteristics, risks, expected performance, costs, conflicts of interests), customers were more likely to be asked by the insurance sector to acknowledge that they had received and understood the information provided. However the range of information provided to customers was generally more limited in the insurance sector. In some cases, this would be a result of the type of product.

22. A more encouraging finding was the training that firms provide to sales agents and advisors. Almost all firms include compliance training as part of the overall training programme. Many firms appear to test their employees' understanding of regulatory and firm policy requirements. However, in looking at remuneration arrangements for agents and advisors, only 60% of firms take compliance issues into account in paying remuneration.