New freedoms to how people can use their defined benefit pension funds create opportunities for wealth managers - and a few challenges. The UK regulator has recently weighed in on the subject. This commentary examines the state of play.

Last week the UK’s main financial regulator, the Financial Conduct Authority, recommended how firms, advisors and clients should deal with recent freedoms to shift money out of final-salary pensions into defined contribution schemes. With billion of pounds in play, this publication has noted in the past that pensions have become a sexier subject for wealth managers. Some commentators are concerned if people take out money from defined benefit pensions and blow money on consumption and end up without enough retirement funds. The potential for mis-selling and sharp practice is still a worry. (To see a feature about the reforms, announced about three years ago, see here.)

The FCA’s new paper, CP18/17: Retirement Outcomes Review: Proposed changes to our rules and guidance, sets out a number of changes, with a big focus on communicating effectively to clients and providing coherent options for people looking to use the pension freedoms.

More broadly, what should the industry do about how to handle pension transfers? In this article, Douglas Cherry, partner at Reed Smith, considers the issues. This publication is pleased to share these insights. It does not endorse all views of guest writers and invites readers to respond. Email tom.burroughes@wealthbriefing.com

The FCA continues in its obsession with pension transfers and ensuring that clients receive clear advice that is in their interests. A common criticism made by the FCA is the consideration of how advisers go about their assessments of the client’s position and then how that is documented and explained to clients.

Recent FCA Consultation and Policy papers relevant to pension transfer business set out the regulator’s concerns and highlight some areas for improvement.

Most recently, this has focussed on Defined Benefit schemes and the perceived risks and harms to clients in transferring from them. CP18/7 (1) considers these points and proposes changes including explicitly recognising a category of risk (the client’s attitude to investment transfer risk) to be addressed in any assessment of a client’s options by the firm.

CP18/7 also posits that advisors should be considering:

-- the risks and benefits of staying in the existing scheme and similarly, the risks of transferring;

-- the client’s attitude to any restrictions on their ability to access funds within a safeguarded benefits scheme; and

-- the client’s attitude to certainty of income throughout retirement and the likelihood the client may need to access funds in an unplanned way

These criteria reflect the current FCA preoccupation with the need to capture emotional views of the client (preferably in the clients’ own words) when gathering information sufficient to make a personal recommendation to that client. This emphasis on the emotional perspective is a common mantra from the FCA and now is being expanded (if the FCA proceeds with its CP18/7 suggestions) to specifically include transfer-risk relevant information from the client.

Coupled with this, is the secondary observation of the FCA that advisors should seek to rely less on metric-based tools as the principal driver behind personal recommendations being provided to clients, or at the very least review and enhance those tools to capture and assess the emotional language of the client on relevant topics.

Intersection with current practices
Advisors traditionally assess a client’s attitude to risk on a sliding scale, from some definition of cautious to adventurous (accepting that the precise labels applied by different advisers will vary, although retaining the general concept).

In order to avoid falling foul of the FCA in this area, and irrespective of the precise detail of any upcoming rule changes, advisors should consider now augmenting their current approach by ensuring there is greater emphasis on recording and reflecting the client’s own terms and attitudinal statements, and capture this in some detail. Failure to do so will (and has for many firms) draw significant criticism from the regulator, despite there being a lack of prescriptive guidance as to expectations.

In recent anecdotal observations, the FCA persists with aggressive criticism of what it deems deficient information retention and has taken enforcement action against firms and their appointed representatives without quarter where it perceives deficiency. This appetite is displayed across all areas of pension transfer advice both including and excluding defined benefit schemes; although in the latter case there is even greater concern and focus by the FCA.

The primary driver for this concern is the best interests of the client and whether advice provided around pension transfers meets those interests. The criticism has been around the process of information gathering, the factors being assessed, the absence of emotional-based evaluative statements from the client and the management of conflicts of interest.

The risks of regulatory deficiency
The FCA has expressed its dissatisfaction with advisers’ approaches to attitude to investment and transfer risk by finding investment recommendations to be unsuitable. In such cases there is clear impact on the individual and the firm in considering the position and either agreeing with the FCA assessment and making alternative arrangements to put things right, or engaging in further discourse with the FCA. In cases of unsuitable advice, the FCA will not hesitate to take enforcement action against firms with all that entails, including public outcomes, fines and potentially restrictions on a firm or individuals’ ability to conduct business.

Irrespective of individual cases, these anecdotal examples should be the catalyst for some focused consideration on the part of advisers to consider their advice processes and make changes if necessary.

The specific sector-focused review work undertaken by the FCA, coupled with the introduction in 2019 of the Senior Manager and Certification Regimes (“SMCR”) should heighten senior manager’s focus on this issue. The FCA readily takes both Supervisory and Enforcement action against those individuals for perceived failures.

Steps to take
To mitigate the risk of regulatory intervention, firms should now consider a review of the systems and controls they have in place around their advice process. This should focus on the information gathered by firms, how it is used, with an increased emphasis upon capturing pertinent information in the client’s language, in order to provide an informed basis of emotional assessment of their attitude to risk.

Given the direction of travel, firms would be well served to consider whether and how this review might incorporate information around clients’ attitude to investment transfer risk specifically. This is in contrast to the obvious focus on risks associated with the investments within a portfolio themselves and is particularly true in cases where Defined Benefit schemes are included in pension transfer advice.

Firms must consider whether current client documentation meets FCA expectations, review the clarity of recommendations made to clients and how the information gathered about their client is reflected in that recommendation. This remains a focus by the FCA and is considered fundamental to ensuring that the interests of the client are met in advice provided.

It may be advantageous to firms to consider combining this review with their approach to the impending introduction of the SMCR. This allows senior management to have active involvement in a fundamental review of core elements of the pensions transfer advice business. This detailed knowledge will likely assist in the description and apportionment of senior management responsibilities once the SMCR is rolled-out next year and assist the impacted individuals in ensuring their understanding is solid.

The key here is: do not wait. Act now to avoid disappointment and potential regulatory action later. The FCA will not become any less interested in this space and by considering current arrangements now, firms hedge themselves effectively against the possibility of regulatory intervention at some later point.