Suitability and Appropriateness of Investment Advice

Faisal Sheikh

25 years: Wealth and risk management specialist

In this video, Faisal discussed the two types of assessment that advisors working in this space are required to carry out, namely the "suitability test" and the "appropriateness test." He also explained the circumstances in which these tests apply and how exactly they are performed.

Wealth Management

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Suitability and Appropriateness of Investment Advice

9 mins 12 secs

Overview

For a wealth manager to be able to give investment advice to a client, the client has to undergo suitability and appropriateness assessments first. Suitability requirements include checking the client's knowledge and experience, their financial situation, and their objectives. Appropriateness requirements also includes understanding the client's relevant knowledge and experience in certain financial instruments. Their past performance enables the wealth manager to judge whether the financial services and instruments envisaged for the client are appropriate for them.

Key learning objectives:

Understand the Suitability Assessment requirements and how is it performed
Understand the Appropriateness Assessment requirements and how is it performed
Understand the Investment Advice record keeping requirements for Wealth Management firms

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Summary

What are suitability requirements?

Client knowledge and experience

Consideration must be given to the types of investments with which the client is familiar as evidenced by their trading history. In addition, the volume and frequency of the client’s transactions with the respective investments will need to be taken into account before assessing suitability.
Client financial situation

The firm will also need to establish whether or not the client can demonstrate that they have sufficient income to ensure that any losses on investments will not cause financial distress. This will be determined by assessing the client’s assets as well as any regular financial commitments they may have.
Client investment objective

The Wealth Management firm must ensure that the proposed investment is consistent with the client’s investment horizon. The firm will also need to be aware of the client's risk preferences, risk profile and risk tolerance.

MiFID II also enforces the requirement to provide individual investors with suitability reports about the investment services available to them.

What are appropriateness requirements?

Wealth managers must assess if the financial instrument or service is “appropriate” for the client in the case of complex products defined as anything other than equities, bonds and money market funds

The firm will assess the individual client’s relevant knowledge of and experience in financial instruments, including:

Types of service, transaction and the regulated investments with which the client is familiar with as evidenced by their trading history in the specific product
Nature, volume, frequency of the client’s transactions with regulated investments as evidenced by their trading history
Level of education and profession of the client as relevant to the product traded. For instance, a career in Investment Banking could demonstrate knowledge of complex derivative products

If the service provided is an execution-only service, then the appropriateness test is deemed to be unnecessary provided that the following conditions are met:

The client wants to invest in non-complex financial instruments such as shares traded on regulated markets, bonds, debt instruments, investment funds or money market instruments
The service is performed on the client’s initiative
The client is made aware that the investment firm is not automatically obliged to perform the appropriateness test

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Faisal Sheikh

Faisal is a wealth management professional has spent almost 30 years working in the field of risk management, risk control, internal auditing in the financial services and public sector. Most recently, Faisal was the Head of Risk for the Wealth Management business of UBS in the UK. He has also extensive international experience across Europe, the Americas, Asia and Africa. He has also a served as CISI operational risk expert panel member.

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