Assessment of appropriateness and suitability

Introduction

European legislation, already transposed to our national legislation, demands companies that provide investment services to know their clients prior to offer them a product. The objective is to offer the investment package that are more suitable for the client. In order to do that, it is necessary to obtain certain information from the client about his knowledge or experience in the investment field. That information will allow the investment firm to make an assessment of which products to offer.

As it was previously stated, in order to make this analysis, CISs use the so-called Assessment of appropriateness and suitability.

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What is the appropriateness assessment?

The assessment of appropriateness aims to know the experiences and financial knowledge of the client. The objective is to know if the products that the client wants to hire fits the risk he can bear. Due to that, the questionnaire will include a study with the costumer’s profile, as well as the adequacy of the risk taken.

The assessment of appropriateness values the knowledge and experience of the client in the investment area. By collecting information about the education, profession and frequency or volume of his financial operations. The objective is that the firm can get an idea of the client’s financial skills. That is, whether he is able to understand the risks involved in an investment product or service. Among the questions included in the test, we highlight:

• Types of financial instruments, transactions and services that he is familiar with.
• Nature, volume and frequency of the transactions.
• Level of education and profession.

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Pre-marketing

Pre-marketing is a technique introduced to remove barriers to the cross-border distribution of funds. The aim in harmonising this practice is to increase its transparency and legal certainty.

What is the suitability assessment?

The evaluation of suitability presents even higher requirements than the assessment of appropriateness. By requirements we mean certain additional knowledge, in addition to those already ascertained in the appropriateness test. This test is mandatory when providing financial advice or portfolio management services. In other words, it is used when a personalized recommendation is to be made. In this regard, institutions must carry out a complete examination of the client in which information is gathered of his financial situation and investment objectives. Among the questions to be clarified in the suitability assessment, we highlight:

• Desired time horizon for the investment
• Preferences in relation to risk taking
• Purpose of the investment

This questionnaire aims to ensure that the recommendations made are the most appropriate.

The assessment of suitability aims to define the risk exposure that the client has. The risk exposure shows, principally, the degree of risk aversion of a costumer in relation to the existing financial products. This questionnaire aims to ensure that institution does not offer to their client products that they do not understand.

What are the main differences between the Assessment of appropriateness and suitability?

The biggest difference between the Assessment of appropriateness and suitability is in the type of investment service that will be provided.

The investment services collected by the regulation can be summarized as:

• Reception and transmission of client’s orders
• Execution of orders on behalf of clients
• Dealing on own account
• Portfolio management
• Placing of financial instruments without a firm commitment basis
• Investment advice

The regulation requires that a suitability assessment must be done when recommendations over a financial product are to be made. That is, when investment advice or portfolio management services are made. Therefore, a previous analysis must be done about whether the service that will be provided is financial advice or not. In this sense, what it should be analyzed is not the nature of the product offered to the costumer, but how it is offered.

The advice involves a process of making recommendations about concrete products. The institutions must offer the products that fit more to the client’s situation, based on their knowledge, experience, objectives and financial situation.

If the institution does not get the assessment of suitability from the client, it cannot provide him with the investment advice service.

On the other hand, the assessment of appropriateness is done when the services provided are different from the investment advice or the portfolio management. They are also mandatory, but if the firm does not get enough information, they can still provide the investment service. By warning the client that it has not been possible to determine whether the product or service fits him.

For certain investment services, firms do not have to make the assessment of appropriateness. Mainly when the service provided is the execution, reception and transmission of orders of non-complex financial products. However, firms should inform the client that they are not required to assess appropriateness for that service.

Conclusions

The investment firms must know their clients or potential clients, in order to offer them financial products. In order to do that they use the Assessment of appropriateness and suitability. These assessments are used by firms in order to obtain enough knowledge from the client in the investment area. When the service that the costumer is going to receive is investment advice, it is mandatory to make the suitability assessment. A company won´t be able to provide investment advice without making the suitability assessment. When the investment service is not investment advice or portfolio management, the companies will make the appropriateness assessment. It is less demanding, although it is still mandatory, and it allow to provide investment service, even in those cases where there is not enough information.

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