10.5 - Advising and Selling

Advising and Selling: Suitability and Appropriateness

Suitability

Suitability applies when the firm has input in the trading decision, covering all customers except Eligible Counterparties (ECPs). It encompasses retail clients for all business and designated professionals for MiFID. Suitability is crucial when the firm provides:

  1. Personal Recommendation (Advisory Account): The firm suggests, but the client decides.
  2. Discretionary Account: The firm makes all decisions for the client, acting as an investment manager.

To ensure suitability, the firm needs client information to meet objectives and assess risk tolerance.

Client Information (Fact Find)

The fact find helps determine if the firm can meet the client's objectives and assess their ability to bear financial risk.

  • Objectives: Professional for MiFID, retail for designated.
  • Ability to Bear Financial Risk: Important for elective professionals (those who opted up from retail) but assumed for per se professionals (based on size).
  • Knowledge: Primarily a concern for retail clients.

Churning and Switching

Churning and switching refer to overtrading a client's account, which is inherently unsuitable.

  • Churning: Excessive buying and selling of securities.
  • Switching: Moving clients from one packaged product to another.

Churning and switching is unsuitable as it's overtrading.

Suitability Report

Now extends to all products, not just packaged ones, requiring firms to explain why a recommendation is suitable. This must be recorded in a durable medium. The report is very comprehensive for most products these days including shares and bonds.

Appropriateness

Appropriateness applies to non-advised (execution-only) services, especially for complex products. The firm must assess whether the client has sufficient knowledge to understand the risks.

Direct Offers

For direct offers (e.g., cutting out a coupon from a newspaper), the firm must ensure that even for execution-only services, the client possesses the necessary knowledge.

Even for clients who want to execute trades on derivatives on their own, the firm needs to know if it's appropriate for them to run their own account. The rule would require the retail client to give the firm much more detailed information about the client's trading history.

  • If the client provides insufficient information, the firm decides whether to trade.
  • If the client's information reveals a lack of knowledge, the firm must warn the client.

Outcomes of Insufficient Information

  1. Client Refuses Information: If the client doesn't provide sufficient information, the firm must decide whether to trade or not.
  2. Warning: The firm believes it is not appropriate based on the information the client has given them.

Decision Tree: Suitability vs. Appropriateness

  1. Does the firm provide management or advice?
    • Yes: Suitability applies.
    • No (Execution Only): Proceed to the next question.
  2. Is the investment a complex product?
    • No (e.g., USIT scheme): Neither suitability nor appropriateness applies. Non-complex products include shares, bonds, money market instruments, and USITs.
    • Yes: Proceed to the next question.
  3. Is it promoted through a direct offer?
    • No (Firm targets certain customers): Appropriateness applies.
    • Yes: Proceed to the next question.
  4. Is it going to retail?
    • Yes: Appropriateness applies.
    • No (Professional Client): Neither suitability nor appropriateness applies.