By Daryl Roxburgh – President and Global Head BITA Risk® part of the corfinancial® Group
Consumer Duty is in the post – and due imminently! The deadline for new and existing products or services open to sales or renewals is 31 July 2023, with closed products and services coming under the rules at the end of July next year.
As with any new regulation firms will need to cope with an array of demands and challenges. It can feel overwhelming. But successful implementation actually makes for better business, better efficiency, and positive outcomes.
Getting the right outcomes should be the result of following the core principles that underlay Consumer Duty
- Understanding the client
- Foreseeable harm
- Consistent outcomes
- MI & oversight
The end result should be the ability to provide a better match of client and investment and the delivery of an investment outcome in line with expectations. Ongoing monitoring of portfolios should mean consistency when it comes to achieving expected outcomes or returns. And if it looks likely that something might impact that outcome then the monitoring will allow for early action and record what action was taken.
The provider also needs to tell their customers when they have something better or more suitable in their portfolio – and facilitate a switch if required.
Obviously, this entails work on the part of the provider to make sure that process efficiency and data analytics are powering the proposition forward as they should be. Getting that right makes it more likely that the investment choice is the right one in the first place. The monitoring meanwhile makes sure that outcomes for all investors are as close to expectations as they could be. None of this is easy but getting it right goes beyond compliance; a happy customer with a positive outcome is a returning customer which is good for business!
However, this array of positive outcomes will not happen by accident. Indeed, it needs to be designed into processes to make sure that a firm is both compliant and forward-looking. Much of this relies on proper data management and analytics – the devil is always in the detail!
The key, we think, is to support the client and make a good outcome more likely by having in place a robust tracking system, focusing on the investment management of a portfolio. This should provide warnings if something is not as expected and requires investigation so as to steer a better course in good time and provide that much-lauded good outcome for the client.
This may all sound like common sense, but it relies on having the right data and processes in place. Below we outline the seven steps that we think are key to getting an optimum outcome testing regime in place.
The seven-step process
1. Define the outcome:
Information on a client’s requirements for a particular portfolio can be assessed and used to match the client into the firm’s investment proposition. Factors can include attitude to risk, portfolio objectives, capacity for loss and other factors such as sustainability, liquidity and time horizon.
The combination of these factors defines the parameters for the expected outcomes and provides the guard rails for monitoring. All of this should be played back to the client in the investment proposal, to see if it meets their understanding.
The proposal then becomes an outcome checkpoint that can be referred back to.
2. Apply a set of objective and consistent tests relevant to that outcome:
The tests that check whether the portfolio is within the guard rails fall into two groups, leading indicators, and ex-post indicators.
Leading indicators look at how a portfolio is constructed and are essentially all about foreseeable harm. This includes factors like risk – volatility and tracking error – asset allocation, concentration risks, research list compliance, and asset checks such as high risk, rare holdings, and equity liquidity. Being alerted early to outliers against these tests enables rapid action.
The ex-post indicators, meanwhile, look at portfolio outcomes. Typically, one-year and three-year absolute and relative performance are checked, with options to calculate ex-post risk and tracking error. The idea is to reveal patterns in outlier performance and trends, and monitor deterioration and rectification. In addition to performance, yield can, where appropriate, be monitored against target.
3. Measure and record the test results so that deviation can be assessed and to inform actions for improvement.
All tests are run nightly, and the user has access to the results on their dashboard daily, giving calls to action. Results for every portfolio for each test are stored weekly providing trend reporting and historic checks at portfolio and enterprise levels.
The result is visibility and the ability to target significant, aged, and consistent issues because investment managers can see where issues lie, and how to assess and correct them.
4. Employ a consistent methodology for root cause analysis.
The first checks for root cause analysis, when the portfolio outcome is not in line with expectations, would be the current monitor tests’ statuses. After that, the past year’s history of test status and the known exceptions on the portfolio would be looked at. Lastly, a check of its performance against its peers for the same risk and objective for the same team and across the firm.
Together these provide a consistent framework for initial review.
5. Manage exceptions
Within every book of business, there are exceptions. Managing them at a granular level with standard reasons and free text justifications to make up structured data that can be analysed, makes sure that exceptions do not become the rule. This provides evidence of a review of issues with the portfolio and the actions agreed.
6. Routine reporting to review outcomes and manage areas of concern.
Reports can be run at any time giving flexibility, but routine reporting provides month-on-month and one- or two-year trend analysis. Used in this way and in conjunction with the number of days out analysis on failed tests, clear pictures of systematic issues can be identified and addressed.
7. Report on the outcome and check satisfaction.
Having captured the client’s requirements and setting their expectations at the start of the process, the annual review report plays back progress to the client and provides a checkpoint. Just as the investment proposal can be run at the desktop in seconds at any time, so can the annual review.
In the report, the current portfolio is compared to the assigned model and a series of checks is provided to the client:
- Performance against the expected range as set in the client mandate and investment proposal
- Asset allocation vs assigned model
- Monitor test status checks and known exception text where applied
- Trend reports on key monitor tests
- Manager comments on key sections
By following these seven steps the investment manager gains much better insight into the client’s needs and objectives and can measure against those parameters at any time.
Ongoing testing of the client portfolio against mandate, model and investment policy with leading indications also alerts to foreseeable harm that can be mitigated or documented.
In addition, enterprise helicopter views to identify systematic issues within the firm and aid their resolution, plus an annual client checkpoint that looks at performance against an expected range of returns, can be successfully carried out to show a positive outcome.