If you recommend DFM services to your clients, you need to know how they might approach these 4 things differently to each other.

by Damian Davies on 09·06·2020

The lockdown has led me to dig deep into my kitchen cupboards and so far I’ve found:

• a tin of chickpeas that went off three years ago,
• a tin of ‘banana blossom’ (I have no idea what that is either!)
• A random jar of spices that I know I bought abroad but can’t remember where or when.

I reckon we all have something odd or ‘well-matured’ in our cupboards. 

Whilst it may be quieter with new business for you now, this is a great time to go through the cupboards of your business.  (please forgive me – that was a truly dreadful segue!)

One of the things that is worth reviewing is the relationship between you, any discretionary investment managers and clients.

BACKGROUND

Discretionary Investment Managers (DIM) have one of two relationships with you:

• Agent as client (AAC)
• Agent of client (AOC)

The subtle difference is whether the DIM has a relationship with YOU (AAC) or with YOUR CLIENT (AOC).

Distilling that down further:

• Agent as client means that whilst the knowledge and transaction is managed by the DIM, you as the adviser are making the ‘recommendations’ for the underlying investment transactions.
• Agent of client means the adviser is making a recommendation to use a DIM, and the DIM is then making recommendations for the underlying investment transactions.

It doesn’t really feel like one is better than the other, as each will potentially be appropriate for different circumstances.

What is important is that you take the chance to consider the implications for you and your clients.

If you are unsure, don’t beat yourself up.  It is a subtle distinction, and the speed with which some of these relationships get established, it isn’t surprising that not all parts are entirely clear. 

Now, however, is the time to review where you, your clients and the DIM stand on this.

If you do not know, we will happily undertake due diligence research for you to help you find out.

Once you know, you can then consider some of the implications:

1 - Responsibilities

AAC

Firstly, the investor needs to give their consent to the relationship.  This may sound obvious, but for the consent to carry any credibility, the adviser needs to explain to the investor how the balance of responsibilities sits and also what the implications are for each party. 

When it comes to suitability, the adviser needs to have enough information to know that a recommendation to a DIM is suitable.  Not only that, but the adviser must be able to ensure the investment proposition the DIM builds is suitable for the client.

The DIM then also has their own responsibility to ensure they build and manage an appropriate proposition that matches the requirements of the client characteristic and the overall strategy designed by the adviser.

To this end, PROD should be an adviser’s best friend as the DIM needs to be able to demonstrate their service is sold to the identified target market.

Lastly, and what sparked the idea behind this article for me, there is the responsibility of communicating.   Who communicates with whom, when, how, and so on. 

The perfect example of this will be the recent 10% value drop reporting.  As the investment relationship sits between the client and the adviser, the adviser should be making these notifications.  The adviser, however, may not be aware of the need to notify, as they are not controlling the investment directly.

It is a cloudy area, strewn with great potential for assumptions making things come unstuck, so it is essential advisers and DIMs know who has what responsibility for communication and when and how it is being delivered. 

AOC

The responsibilities are shared between the adviser and the DIM

• The adviser is responsible for the suitability of the recommendation to use the DIM in the first place.  The adviser is also responsible for the information they provide to the DIM, on which the DIM makes their investment decisions.
• The DIM is responsible for making the investment decisions that match the profile and strategy outlined by the adviser.

2 - Logistics

AAC

This relationship could be referred to as ‘the full adviser eclipse’, as the DIM and the investor may not even know anything about each other.

This gives great control over the relationship for the adviser.

AOC

At the very least, this relationship means the DIM relies on information about the client from the adviser or may even want to have a direct relationship with the client.

3 - Risks

AAC

There is some debate on this, and it’s a bit convoluted, so bear with me.

Due to the fact that the recommendations are being made by the adviser, the relationship between the DIM and the adviser is technically that of a ‘professional client’.

This means the underlying investor may lose some of the protections they would have had under the FOS as a retail client. 

The risks that need to be managed, therefore, are the risk that the investor might lose any right to cooling-off periods on investments and that they may not get access to the FOS or FSCS.

The truth is that these risks are not entirely clear, and the FOS have made sounds (anecdotally) that they would still class the relationship as a retail client, but this hasn’t been tested, so don’t bank on it!

If the relationship is managed through a platform, the platform is likely to be providing the FSCS cover. 

Realistically, the risk would be managed by agreements between the adviser and the DIM, so it is important that the advisers choose relationships with DIMs that can back up their commitments to these agreements.

Nonetheless, due to the uncertainty, the risk needs to be managed, and certainly any potential disadvantage needs to be disclosed to the clients.

AOC

The suitability obligations rest equally between the DIM and the adviser.  Quite often, the DIM will base their advice on the client information obtained by the adviser.

As such, there are really two levels of risk for the adviser.  Firstly, that the recommendation to use the DIM is suitable and secondly that the underlying recommendations are suitable.

This means that the DIM and the adviser are relying on each other a great deal, both for information and suitability.  This leaves quite a lot of room for ‘assumptions’ to cause problems down the line if not properly managed.

In term of the FSCS, this would likely be provided by each underlying fund.

4 - Agreements

AAC

This relationship means there will be an agreement between the DIM and the adviser.  This will usually have the adviser classified as a professional client. 

This agreement should also include details about communications with the investor.  This may be further complicated if wraps or platforms are used, as they could also be involved. 

There will then be another agreement between the adviser and the investor.  This needs to include provision for investor consent for the adviser to act as agent.

AOC

The tri-partite nature of the relationship means each party needs to understand the different responsibilities they carry.  As such, the DIM will want to clarify and confirm what information is required to fulfil their obligations.  The adviser will want to clarify and confirm what reporting and communication protocols will exist.  Most importantly, the client will want to know who is responsible for what parts of the recommendation process.

SUMMARY

There is no right or wrong answer on these relationships.  It may well be that you have an AAC relationship with some clients and an AOC relationship with others.

What is important is that you understand the risks, responsibilities and logistics for each relationship and have appropriate agreements in place to match.

Furthermore, it is essential that you match the characteristics of the service being provided with the characteristics of the clients the service is being provided to.  This will ensure full PROD compliance.