Capacity for loss assessment

We’ve been considering how well the question in the ALIFA template fact find works.   Currently  it reads;

“Would a material investment loss be difficult to recover from and substantially jeopardise your financial security? (If Yes, please clarify”……..Yes / No)

Our feeling has been that this has proved a fairly stark “brick wall” scenario. As an alternative we have trialled an open question to replace it, that creates a prompt to make notes / observations on what the clients capacity for loss is. While it aims to make a softer approach to the issue, if the quality of the notes are good, it may hopefully actually improve the outcome. We’re not suggesting major essays here, but the notes should have sufficient clarity to be able to be inserted into the suitability letter in due course.

It’s worth considering the FCA rule which perhaps unusually for them, sets out the issue fairly simply, this is COBS 9.2.2 – (paraphrased);

“Firms must…… have a reasonable belief……giving due consideration to the service / transaction to be recommended…..that the client is able financially to bear any related investment risks consistent with his/her investment objectives”.

In some ways it seems that “financially able to bear any related investment risks”, is a better description than the widely used “Capacity for Loss”

The revised question is;-

“Please describe here how your (the clients) circumstances will enable you to withstand the possible investment risks that may arise.”

Followed by a notes box, for observations on this aspect.

Some guidance on aspects / issues / background circumstances / for reflection in your notes. Perhaps things like;

  • If client says they’re balanced to speculative, but would lose sleep over a 5% fall, how does this square up?
  • What is plan B if XYZ goes pear shaped?
  • And if it does, what position is the client in to recover?
  • Can they ride out the bad patches?
  • Are there other assets / sources of income in the background?
  • How open might they be to adjusting their lifestyle?
  • Do they need to take much investment risk?

Probably lots more facets to consider, no doubt not all will relate to every client such is the variety out there…..

We would also add that the ALIFA template has been designed to be used as a discussion document with the client, and to weigh up the overall circumstances of the client rather than a more automated process. It wouldn’t work well for instance with any form of robo-advice, which depends much more on answers that are yes / no / maybe – which can then be scored.

We’ve attached a copy of the short “Attitude to Risk” fact find, and this together with the General and Servicing review documents which have all been updated, are available in the members area of the ALIFA website.