One of the culprits of financial crises is mis-selling which has raised the eyebrows of market regulators. To protect the interests of investors and establish a robust financial system, regulations related to investment suitability were imposed on financial institutions to mitigate mis-selling risk. Investment suitability assessment is a process that reviews the client and product related information to assure the products are suitable to the clients in different aspects. Here are 4 key assessments for Investment Suitability. Product and Service Restriction In some countries, there is restriction on what sales activities could be carried out or what products could be marketed in these countries by different financial institutions. Similar restriction may also be applied to the country of domicile of the clients. For instance, clients with a certain country of domicile are restricted from buying certain products. Violation of the regulation may end up with criminal, financial or reputational risk of the institutions or the personnel of the institutions. Client & Product Risk Matching Before the financial institutions can suggest products or provide service to their clients, they have to conduct an Investment Risk Assessment (IRA) for their clients to obtain the Client Risk Profile (CRP). In addition, they also have to work out the Product Risk Rating (PRR) of their products. Then a matching process of CRP and PRR is conducted to make sure that clients are able to bear the risk of the products. In some situations, cases marginally failing the risk matching require further actions to be taken in order to continue the sales process. While the sales process of other failing cases may have to stop. Investment Knowledge & Experience The financial institutions also need to assess the investment knowledge and experience (K&E) of the client to determine if they could understand the products and its associated risk. The client investment K&E are captured in different asset classes and contained in the IRA. The corresponding K&E of the product is used for the assessment. Investment Objective While the financial institutions servicing the clients, they have to understand the investment objective of the clients before they make any investment proposal. For instance, if the investment objective of the client is retirement, institutions should propose products with lower risk and long term engagement, such as mutual funds. Some regulators require institutions to propose several investment options, and show the expected return, pros and cons of each option. So clients could make their own investment decision. Thank you for reading the article. Here are some other articles from FinTech Insights:
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