CIP – things to consider

Fraser Donaldson – Insight Analyst (Investments)

Let's remind ourselves, a centralised investment proposition (CIP) is a set of investment solutions selected to appeal to a wide number of clients in terms of meeting their needs, objectives and suitability criteria. Based on deep client segmentation analysis, Defaqto is seeing more and more firms adopt this approach. So, what do you need to know about CIPs?

Greater consistency

The FCA agrees that constructing a CIP should lead to consistency of advice to similar groups of clients ‘assuming client segmentation is done thoroughly’. Most CIPs involve outsourcing some or all of the investment process to third parties, to some extent de-risking the adviser business in terms of investment decision-making.

However, what the regulator has made very clear is that the responsibility for the advice, suitability and due diligence on the selected outsourced partners still lies with the financial adviser.

It's worth noting at this point that the same rules apply to independent and restricted advice practices because restricted advice must meet the same suitability requirements as independent advice.

Regulatory concerns

Despite the regulators generally being in favour of operating a CIP model, they do have some concerns. Their main concerns are outlined in the Final Guidance paper FG 12/16 ‘Assessing suitability: replacement business and centralised investment propositions’, and come under three general categories:

• Shoe-horning
• Churning
• Cost

Let’s look at shoe-horning first. A firm will have constructed a CIP in order to meet the suitability requirements of the majority of its clients. However, despite there being efficiency and consistency benefits in standardising the approach to investment, it should be remembered that recommendations to clients should be based on individual client needs, objectives and circumstances. It would not be acceptable to the regulators for a client to be invested into the most suitable CIP option.

Either an investment is suitable for the client or it isn't. If there are better options for the client that are not covered within the CIP, the CIP needs to be extended to include appropriate options, separate research and thorough market due diligence needs to be undertaken, or the client needs to be referred on.

Again, this would apply to both independent and restricted firms, although it's reasonable to expect independent firms to be more prepared to go ‘off-CIP’ and provide the necessary whole of market research that goes with it.

In the regulators' mind, the phrase ‘one size fits all’ is one that will set alarm bells ringing.

Historically, churning is a word that brings to mind the practices of the old days when some advisers appeared to continuously and unnecessarily be buying and selling investments simply to earn additional commissions. In this context, we need to remember that when you build a CIP you can't just automatically transition existing investments into one of the new options.

Advisers need to evidence that the new option is going to be demonstrably better than the old. Given that the adviser firm is probably responsible for recommending the old investments, more often than not has taken trail commission on the understanding that portfolios will have been ‘managed’, it is going to be difficult to justify.

The promise of improved performance is perhaps the most difficult to justify as clear evidence of this needs to be given. If existing investments are doing their job, remain suitable, meet client needs and are likely to achieve expected client outcomes, then recommending a transition won't be easy to justify.

Finally, there's cost, which perhaps should more accurately be viewed as ‘value for money’. It should be obvious that it would not be possible to justify transition from one investment solution to another if there's no real difference in cost and no real additional benefit to the client for doing so.

Equally, if there are real benefits to be had (they need to be evidenced) and the new investment is perhaps slightly more expensive than the old one then there's a genuine judgement call to be made. 

It is in this situation that the concept of ‘value for money’ comes into play. If all options are made clear to the client, together with coherent justification, the final call will be the client's.

With these three considerations in mind, the regulators will expect adviser firms to:

• Collect necessary information on their clients’ existing investments and the recommended new investments, such as the product features, tax status, costs and the performance of the underlying investments
• Implement a robust risk-management system to mitigate the risk of unsuitable advice and poor client outcomes

There are also some other pitfalls to be wary of that have been clarified during the retail distribution review (RDR), but common sense should prevail here. These would include:

• Adviser firms should not be exerting pressure on their advisers to invest in one particular investment option over another; the client should be investing in the most suitable option available to the adviser; firms need to be careful of incentivising one solution over another or perhaps setting inappropriate targets for one over another; conflicts of interest could arise, leading to poor client outcomes
• The constituents of the CIP need to be selected from the whole of the market, and final selections need to be based on solid, in-depth due diligence
• Solutions remaining as part of the CIP need to be regularly justified through ongoing monitoring and periodic repeat of the due diligence process

Throughout the process all decision-making by the adviser firm needs to be justified and clearly articulated. In the eyes of the regulator, if the process of decision-making is not written down, it doesn't exist.