MiFID Supervisry Briefing Suitability 19 December 2012 ESMA/2012/850
Date: 19 December 2012 ESMA/2012/850 I. Backgrund 1. ESMA is required t play an active rle in building a cmmn supervisry culture by prmting cmmn supervisry appraches and practices. 2. This supervisry briefing has been designed fr supervisrs as an accessible intrductin t the Markets in Financial Instruments Directive (MiFID) 1 suitability rules, and as a useful starting pint when deciding n areas f supervisry fcus. It summarises the key elements f the rules and explains the assciated bjectives and utcmes. It als includes indicative questins that supervisrs culd ask themselves, r a firm, when assessing firms appraches t the applicatin f the MiFID rules. 3. The cntent f this briefing is nt exhaustive, des nt cnstitute new plicy, and des nt prmte any particular way f supervising the rules. It has been designed t be used in the way that best fits with supervisrs methdlgies (whether distributing the briefings internally, r passing them t external bdies, such as auditrs, fr example). II. Scpe 4. This supervisry briefing prvides sme further detail n the functin f the MiFID suitability requirements and is aimed at cmpetent authrities (as defined in MiFID). It is als meant t give market participants indicatins f cmpliant implementatin and applicatin f the relevant MiFID prvisins. 5. It applies in relatin t the applicatin f the fllwing MiFID prvisins: Article 19(4) f MiFID (2004/39/EC). Articles 35 and 37 the MiFID Implementing Directive (2006/73/EC). 2 III. Status f this dcument 6. This dcument is issued in terms f Article 29 f the ESMA Regulatin. 3 IV. Purpse 7. MiFID and the MiFID Implementing Directive place varius requirements n firms when they prvide investment advice r discretinary prtfli management services that d nt apply when 1 Directive 2004/39/EC f the Eurpean Parliament and f the Cuncil f 21 April 2004. 2 Cmmissin Directive 2006/73/EC f 10 August 2006 implementing Directive 2004/39/EC f the Eurpean Parliament and f the Cuncil. 3 Regulatin (EU) N 1095/2010 f the Eurpean Parliament and f the Cuncil f 24 Nvember 2010 establishing a Eurpean Supervisry Authrity (Eurpean Securities and Markets Authrity), amending Decisin N 716/2009/EC and repealing Cmmissin Decisin 2009/77/EC. ESMA CS 60747 103 rue de Grenelle 75345 Paris Cedex 07 France Tel. +33 (0) 1 58 36 43 21 www.esma.eurpa.eu
prviding ther investment services. Ntably, these include requirements t ensure that (when prviding advice) any persnal recmmendatins made r (when prviding discretinary prtfli management services) any discretinary investment decisins taken n behalf f clients are suitable fr each client. 8. The MiFID suitability rules give firms a certain degree f flexibility in cmplying with the duty t btain the necessary infrmatin abut the client s circumstances n the ne hand, and using this infrmatin in making recmmendatins r taking investment decisins n the ther hand. In mst circumstances, supervisrs will have t assess the adequacy f a firm s arrangements n a case-bycase basis, having regard t the prprtinality principle and a firm s peratinal framewrk. 9. This supervisry briefing is designed t help supervisrs make these judgements, and is structured arund the fllwing elements: determining situatins where the suitability assessment is required; btaining infrmatin frm clients; and the duty t ensure suitability when prviding investment advice r discretinary prtfli management services. 10. Each element includes an verview f the utcmes that the rules prmte, illustrates the ptential risks, and prvides examples f the srt f questins that supervisrs culd ask t test whether the utcmes are being met by firms. V. Briefing V.I. Determining situatins where the suitability assessment is required 11. Accrding t Article 19(4) f MiFID, when prviding investment advice r discretinary prtfli management services, firms must ensure that the specific transactin t be recmmended, r entered int in the curse f prviding a discretinary prtfli management services service, is suitable fr the client in questin. 12. On the ne hand, it is crucial fr the firm t put in place arrangements and prcedures t detect any situatin where the interactin between itself and the client r ptential client will require an assessment f suitability. In this cntext, since the suitability requirement can affect the firm s ability t sell certain types f (cmplex and/r risky) financial instruments t mst retail clients, it is imprtant t bear in mind the risk f imprper classificatin f the service as nn-advised althugh a persnal recmmendatin is given. 13. On the ther hand, given the wide scpe f the definitin f investment advice, firms that d nt intend t give advice shuld put in place either specific and sund internal systems and cntrls r fcused staff training in rder t apprpriately and cnsistently reflect the nature f the nnadvised service they are prviding. 3
14. Firms that prvide bth investment advice and nn-advised services must take care t avid situatins where it is nt clear n which basis the transactin has been perfrmed. 4 Fr example, if the firm advises the client that a transactin is unsuitable, it shuld cnsider carefully if it is in the best interests f the client t allw the transactin t prceed n an executin-nly basis. Firms shuld als cnsider what prcedures they shuld have in place t demnstrate that this is the case. 15. Firms shuld infrm clients, clearly and simply, that the reasn fr assessing suitability is t enable the firm t act in the client s best interest. At n stage shuld investment firms create any ambiguity r cnfusin abut their wn respnsibilities in the prcess. Questins n general implementatin Hw d the firm s arrangements and prcedures guide the interactin between staff and clients, having regard t the distinctin between advised and nn-advised services? What kind f safeguards are in place in rder t avid any persnal recmmendatin being made in situatins where a suitability assessment is nt envisaged? What happens if a transactin t be recmmended n a prduct distributed by the firm is deemed unsuitable fr the client? Hw d the firm s prcedures track and recrd the interactin between staff and clients, having regard t the distinctin between advised and nn-advised services? Hw are relevant staff trained n the suitability assessment? Where a suitability assessment is nt envisaged, what kind f internal systems and cntrls are in place in rder t ensure that the services given d nt amunt t advice? In the case f custmer-facing staff prviding nn-advised services, hw are they trained n the risk f inadvertently giving a persnal recmmendatin n a given financial instrument? V.II. Des the infrmatin n investment advice and prtfli management services, given t clients, include infrmatin abut the suitability assessment? Obtaining infrmatin frm clients 16. Accrding t Article 35 f the MiFID Implementing Directive which stems frm Article 19(4) f MiFID when prviding investment advice r discretinary prtfli management services, firms must btain the necessary infrmatin in rder t understand the essential facts abut the client s that they can assess whether the specific transactin t be recmmended, r entered int during the curse f prviding a discretinary prtfli management service, is suitable fr the client in questin. 4 See Questin and Answers - Understanding the definitin f advice under MFID (Ref: 10/293, published 19/4/2010) http://www.esma.eurpa.eu/system/files/10_293.pdf. 4
17. Therefre, a firm shuld btain all relevant infrmatin abut the fllwing aspects f a client s circumstances, as further detailed by Articles 35 and 37 f the MiFID Implementing Directive: investment bjectives (including, as relevant, hlding perid, risk taking preferences, risk prfile and purpses f the investment); and financial situatin (including, as relevant, surce and extent f regular incme, assets and financial cmmitments, and the client s ability t financially bear any related investment risks); and experience and knwledge (including infrmatin t enable the firm t assess the client s ability t understand the risks invlved in any transactin r in the management f his prtfli). 18. The firm shuld btain the infrmatin which is necessary and relevant fr the prspective investment activity f the client, giving due cnsideratin t the nature and extent f the service and the specific transactin in questin. 19. Mrever, a client s categrisatin is als relevant in this cntext since, where an investment firm prvides the service t a prfessinal client, it is entitled t assume that the client has the necessary level f experience and knwledge. Similarly, where that investment service cnsists f the prvisin f investment advice t a prfessinal client wh is cvered by Sectin 1 f Annex II f MiFID, the investment firm is entitled t assume that the client is able financially t bear any related investment risks cnsistent with the investment bjectives f that client. 20. Firms shuld determine the extent f infrmatin t be cllected frm clients in light f all the features f the investment advice r prtfli management services t be prvided t thse clients. 21. The firm shuld adpt arrangements and prcedures which enable it t meet the requirements f Article 35 f the MiFID Implementing Directive n an nging and cnsistent basis fr any client and irrespective f the channel f interactin used. In this cntext, it is particularly imprtant that clients are classified in a manner cnsistent with their persnal circumstances and that safeguards are in place in rder t avid the utcme that client prfiling is driven by the need t prmte a given financial instrument. 22. Firms shuld take reasnable steps t ensure that the infrmatin cllected abut clients is reliable. In particular, firms shuld: nt rely unduly n clients self-assessment in relatin t knwledge, experience and financial situatin; ensure that all tls emplyed in the suitability assessment prcess are apprpriately designed (e.g. questins are nt drafted in such a way that they lead the client t a specific type f investment); and take steps t ensure the cnsistency f client infrmatin. 23. Where an investment firm has an n-ging relatinship with the client, it shuld establish apprpriate prcedures in rder t maintain adequate and updated infrmatin abut the client. 5
24. Investment firms shuld at least: maintain adequate recrding and retentin arrangements t ensure rderly and transpar-ent recrd-keeping regarding the suitability assessment, including any investment advice prvided and all investments (and disinvestments) made; ensure that recrd-keeping arrangements are designed t enable the detectin f failures regarding the suitability assessment (such as mis-selling); ensure that recrds kept are accessible fr the relevant persns in the firm, and fr cmpetent authrities; have adequate prcesses t mitigate any shrtcmings r limitatins f the recrd-keeping arrangements. Questins What arrangements and prcedures has the firm set up t ensure that relevant and necessary infrmatin abut essential client facts is btained? What mechanism is used t btain infrmatin that gives due cnsideratin t all relevant and necessary facts abut the client? In particular, hw are relevant facts regarding investment bjectives (hlding perid, risk taking preferences, risk prfile and purpses f the investment), financial situatin (surce and extent f regular incme, assets and financial cmmitments) and knwledge and experience (ability t understand the relevant financial instrument and in particular the risk t be taken) assessed and used t determine suitability? Has the firm established sme general client prfiles with reference t the three relevant dimensins (i.e. investment bjectives, financial situatin, experience and knwledge)? If s, hw d the arrangements and prcedures f the firm lead t the assessment f each client within the varius prfiles established? Hw d these general categries cntinue t satisfy the need t take int accunt a client s particular circumstances? Is the infrmatin abut clients als matched cnsistently with the features f the services and financial instruments distributed by the firm? Hw is the intended hlding perid f the client cnsidered where the service prvided invlves illiquid financial instruments, t ensure that the instrument is suitable? Are clients asked t make any degree f self-assessment (e.g. in respect f their attitude t risk/knwledge and experience)? If s, des it seem reasnable fr the client t make such a self-assessment? Is the self-assessment cunterbalanced by bjective criteria? Hw are relevant staff trained n the way t btain relevant infrmatin frm the client? D relevant staff understand the rle they play in the suitability assessment prcess and d they pssess the skills, knwledge and expertise necessary, including suffi- 6
cient knwledge f the relevant regulatry requirements and prcedures, t discharge their respnsibilities? D relevant staff have the skills necessary t be able t assess the needs and circumstances f the client? What are the arrangements used t keep the client prfile updated? D these appear reasnable? Under what circumstances might the firm amend the client prfile? Des this invlve the agreement f the client? Has the risk f unjustified client prfile changes been cnsidered (fr example, t avid the situatin where the sales frce may have an interest in recmmending sme prducts which d nt match the client s prfile); and hw is it managed? What kind f internal systems and cntrls are in place in rder t ensure that the client prfile reflects all relevant facts abut the client? D these appear reasnable? Has the firm established adequate recrd keeping arrangements? Are recrd-keeping arrangements adpted by investment firms designed t enable firms t track ex-pst why an investment was made? Des the firm recrd all relevant infrmatin abut the suitability assessment, such as infrmatin abut the client (including hw that infrmatin is used and interpreted t define the client s risk prfile), and infrmatin abut financial instruments recmmended t the client r purchased n the client s behalf? V.III. Duty t ensure suitability when prviding investment advice r prtfli management 25. MiFID requires firms t assess that the specific transactin t be recmmended r entered int in the curse f prviding discretinary prtfli management services is suitable. 26. Therefre, a firm must assess if the specific investment decisin invlved meets the investment bjectives, financial situatin and knwledge and experience f the client in questin. 27. T this end (as nted abve), the firm shuld implement arrangements and prcedures which enable it t meet the requirements f Article 19(4) f MiFID and Articles 35 and 37 f the MiFID Implementing Directive n an nging and cnsistent basis fr any client - irrespective f the channel f interactin used. In this cntext, it is particularly imprtant that the features f the financial instrument invlved are assessed against the client s persnal circumstances, and that safeguards are in place in rder t avid an utcme where the suitability assessment is undermined by the need t prmte a given financial instrument. 28. In rder t match clients with suitable investments, investment firms shuld establish plicies and prcedures t ensure that they cnsistently take int accunt: all available infrmatin abut the client that is likely t be relevant in assessing whether an investment is suitable, including the client s current prtfli f investments (and asset allcatin within that prtfli) 7
all material characteristics f the investments cnsidered in the suitability assessment, including all relevant risks and any direct r indirect csts t the client. Questins - Understanding prducts befre the recmmendatin/transactin What apprach des a firm adpt in assessing the features f each transactin r prtfli in rder t ensure its suitability fr the client in questin? Des this seem reasnable? Hw des the firm select suitable investments when prviding advice r prtfli management services? Are the prcedures used capable f assessing all relevant facts abut the financial instrument? In particular, are features regarding cmplexity, pssible returns, risk, prspective financial cmmitment fr the client and liquidity f the financial instrument cnsidered, where relevant? Has the firm established sme general categries within different kinds f financial instruments? If this is the case, hw d the arrangements and prcedures f the firm lead t the classificatin f each financial instrument within the varius established categries? Hw d the categries assigned track relevant features f the financial instrument? What degree f discretin is left t relevant staff when assessing financial instruments? Is this degree f discretin reasnable? Has the risk f an unjustified assessment been cnsidered (fr example, where there is an interest t cnsider a given financial instrument as suitable fr as many clients as pssible in rder t favur its marketing)? What arrangements are used t keep the evaluatin f financial instruments updated? What kind f internal systems and cntrls are in place in rder t ensure the understanding f all relevant financial instruments is cnsidered? D these appear reasnable? Questins - Ensuring a recmmendatin/transactin is suitable fr the client Hw d arrangements and prcedures ensure that relevant infrmatin abut financial instruments is matched with the client s circumstances? Is the mechanism used capable f cvering all relevant financial instruments and transactins pssibly cnsidered by the firm when prviding advice r prtfli management services t any client? Hw are the risks f financial instruments assessed against the client prfile? 8
Hw is the liquidity f financial instruments cnsidered in relatin t client s hlding perid? Des the firm emply apprpriate recrd keeping prcesses t be able t demnstrate the suitability f its investment advice and decisins t trade (prtfli management services)? What arrangements and prcedures has the firm set up in rder t ensure that its emplyees r representatives d nt prpse unsuitable transactins r strategies t clients? What happens if a transactin that is prpsed by a client is deemed unsuitable by the firm, but the client wishes t prceed n a nn-advised basis (under MiFID s apprpriateness r executin-nly regimes)? Hw des the firm determine if allwing this is in the best interests f the client? What degree f discretin is given t relevant staff when assessing suitability? Is this degree f discretin reasnable? What kind f internal systems and cntrls are in place in rder t ensure that nly suitable prducts are recmmended t a client r are cnsidered within the prtfli management service? D these appear reasnable? 9