Should Financial Institutions Continue to Profile Clients Using the Average Score Method, or Opt for the “Decision Tree” Approach?
While most financial institutions profile clients and perform the suitability or appropriateness test on the basis of an average risk score, a recent decision rendered by the AMF (the French Financial Markets Authority) Sanctions Committee, followed by an administrative composition agreement, weakens this method.
Profiling a client in the context of providing an investment service — to ensure that a product is suitable or appropriate for the client’s needs and personal situation — can take as many forms as there are institutions.
One method widely used in the industry consists of assigning a number of points to each answer to a questionnaire: The more the answer reflects a willingness to be exposed to a high level of risk, the higher the score obtained. This system results in an overall score, which “averages out” the client’s answers but will not necessarily align with all the information provided in the questionnaire. Sometimes the client will provide some answers reflecting a willingness to accept high risk and other answers reflecting a lower risk, and the overall score will be an average.
This method can be contrasted with another approach, in which a “decision tree” is applied: A product or service will be considered suitable (or appropriate) subject to it cumulatively matches all the needs and objectives communicated by the client. It is no longer a question of retaining an average risk score, but rather of the product corresponding to the lowest common denominator of the answers that have been given.
On reading the decision rendered by the AMF Sanctions Committee on Oct. 24, 2022, one wonders whether the first approach described above — the average score method — is still supported by the AMF.
It is true that the decision concerned bond products, subscribed to in a significant way by retail clients. It is also true that, in this case, some of the clients’ answers appeared to have been misused. Further, it is true that some of the answers were materially contradictory. However, beyond the specificities of this particular case, the approach adopted by the AMF Sanctions Committee suggests that certain information (obviously risk tolerance and loss appetite, among others) should be considered “exclusion” criteria and should justify prohibiting the offering of certain products, even if the client’s average score would allow access to such products.
The regulations (in particular, the European Securities and Markets Authority’s (ESMA) “Guidelines on certain aspects of the MiFID II suitability requirements,” Section 49 et seq.) require that the answers provided by a client be monitored in order to detect possible anomalies and inconsistencies. However, it seems that, little by little, the AMF Sanctions Committee is moving beyond this requirement toward an approach that considers a product suitable or appropriate only when it corresponds to the cumulative data provided by the client (as already outlined in Section 80 of the ESMA guidelines mentioned above).
A recent AMF administrative composition agreement (March 15, 2022, n° TRA-2022-02 , second grievance § (iv)) seems to confirm this reading.
We will have to wait and see.
Regardless, the fact remains that these decisions encourage the use of overweighted criteria for certain questions or the addition of exclusion criteria when profiling a client to ascertain the suitability or appropriateness of a product.[View source.]