The financial crisis has left many wealthy clients distrustful of bank relationship managers. Some clients have seen their net worth severely diminished to the point of despair. How is this possible when relationship managers (RMs) are supposed to be professional guardians of clients’ wealth?
Although many in the wealth management industry blame the current crisis for this problem, we believe the root cause is simpler. Losses are to be expected in risky investments - that’s why investing is not called money making. However, no wealth management principle justifies putting a client’s wealth at the risk of annihilation, no matter how high its promised return. But such behaviour is not uncommon in casinos.
Many RMs practise more salesmanship than guardianship. Their bosses steer them along with escalating revenue targets that form the foundation of a transactions-driven pay package. Over-selling financial products and leveraging up the exposures become the modus operandi in beating these performance benchmarks, while guarding wealth with prudence takes a backseat.
It is time to put the guardian back into wealth management. The industry must win back the clients’ trust. We remind RMs to first, do no harm. In practice, this means wealth preservation is priority number one. Wealth enhancement through risky investments should be of secondary priority. To help RMs rediscover the standard of care that their clients expect from them, we offer the following suggestions.
# Ensure RMs are well-trained. RMs play an important role in educating clients about the risks of the products. To educate clients, RMs themselves must be trained to provide a balanced view of the returns and risks to clients. Training is often provided by a product originator which may be another bank or an external fund house. It may emphasise a product’s selling points more than the risks. Banks must ensure that the training is rigorous and balanced. RMs should understand the risk factors of the products they sell and advice clients how to respond to changes in these risk factors.
# Ensure quality control over financial needs analysis. The Financial Advisers Act requires RMs to conduct financial needs analysis (FNA) of clients before recommending products. The desired outcome is that product recommendations fit clients’ investment objectives and capacity to bear risk. A client’s risk profile is typically evaluated using a risk profiler questionnaire. Successful risk-profiling must enable detection of clients’ aversion to losses. Banks should ‘stress test’ risk profilers to mitigate egregious inconsistencies. Where there is ambiguity, banks must ensure that the client fully understands the downside risk of the product.
In the haste to close a sale, a RM may hurry a client to fill the fact-finding form or let the client sign a blank form. Such sloppy practices cannot be condoned as they contravene the law, trivialise the prudent investor rule, and betray the trust of clients. We recommend that RMs write an Investment Policy Statement for each client to document the client’s objectives and constraints. The document presents a master plan against which product recommendations are appraised in fit-for-purpose tests.
# Adopt a multilayer sales and advisory process. Many RMs are young, inexperienced and hurriedly trained to push products without considering whether the products are suitable for clients. The relentless exhortation to meet revenue targets aggravates the situation. To rid mis-selling, the sales and advisory process must be strengthened.
For mass affluent and retail banking, we advocate a structure that involves three parties. RMs sell financial products and give basic investment advice. Investment consultants provide detailed explanations of product risk and return and conduct FNA for clients. Compliance officers check the quality of FNA and have the authority to stop the sale of any product if it is not fit for purpose or when FNA is incomplete or shoddy. This structure increases business cost. But should banks put a price tag on their clients’ trust?
# Present risk to clients. Every investment carries risks. In presenting a product to clients, RMs should highlight the extent of downside risks. The common practice of relying on a single rate of return (usually the historical average) to project an expected value over future periods is misleading.
This crisis reminds us that disasters do happen. Banks should employ simulation tools to illustrate how actual returns of an investment may deviate radically from the average. To be useful, the simulations should consider the impact of uncertainty across a wide range of scenarios, including ‘black swan’ events that are often brushed aside as too rare. Ironically, the crisis has now provided us with a treasure trove of abnormal market data for realistic scenario analysis.
# Sell risky products only to clients who can afford to lose. Structured products differ greatly in risk and complexity. Some are similar to bank deposits and are principal-guaranteed. Some take the short side of derivatives like credit default swaps and are not principal-guaranteed. Others not only short options on foreign currencies but are also highly leveraged. Despite the potential for unlimited losses, these leveraged products were flying off the shelves before the financial crisis. Some clients coveted structured products because they offered high yields, overlooking the principle that high returns come with high risks. Not all of these investors have the capacity to bear the risk of losing their capital.
Mis-buying of poorly understood products is as much to blame for the structured products debacle as mis-selling. Many clients operate a mental account for gambling and buy these products for a shot at the fast buck. Every RM must guard against the client’s gambling account washing out other accounts, such as retirement and children’s education, and eventually burning down the house.
# Name structured products fittingly. Structured products are often marketed as ‘deposits’ or ‘bonds’ when they are neither. The cash flows are dependent on uncertain outcomes such as stock prices or credit downgrades. Banks must stop using terms like ‘deposits’ or ‘bonds’ because buyers get the wrong impression.
We welcome smarter regulation. Harvard professor Elizabeth Warren’s proposal to set up a Financial Product Safety Commission is timely. She wants information about financial products to be disclosed in a manner that investors can appreciate. Banks should no longer get away with product information that is incomprehensible, and that appears more to complicate than illuminate. A market economy that thrives on full information is broken when disclosure is frustrated.
The wealth management industry needs to swiftly put its house in order. Rebalancing incentives from transaction revenue to assets under management would help steer behaviour from salesmanship to guardianship. RMs must be held to higher standards befitting professional guardians of wealth. They are the first, and sometimes the only, interface between clients and banks. This crisis, like all previous crises, will pass. The industry should reshape itself now for the future, or it won’t have one.
Fong Wai Mun is Associate Professor and Low Chee Kiat is Assistant Professor in the Department of Finance, NUS Business School, National University of Singapore. This is the fifth in a series of 12 articles on the global financial crisis by faculty of the NUS Business School.
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Restoring trust in bankers
The wealth management industry needs to re-tool
FONG WAI MUN and LOW CHEE KIAT
9 February 2009
The financial crisis has left many wealthy clients distrustful of bank relationship managers. Some clients have seen their net worth severely diminished to the point of despair. How is this possible when relationship managers (RMs) are supposed to be professional guardians of clients’ wealth?
Although many in the wealth management industry blame the current crisis for this problem, we believe the root cause is simpler. Losses are to be expected in risky investments - that’s why investing is not called money making. However, no wealth management principle justifies putting a client’s wealth at the risk of annihilation, no matter how high its promised return. But such behaviour is not uncommon in casinos.
Many RMs practise more salesmanship than guardianship. Their bosses steer them along with escalating revenue targets that form the foundation of a transactions-driven pay package. Over-selling financial products and leveraging up the exposures become the modus operandi in beating these performance benchmarks, while guarding wealth with prudence takes a backseat.
It is time to put the guardian back into wealth management. The industry must win back the clients’ trust. We remind RMs to first, do no harm. In practice, this means wealth preservation is priority number one. Wealth enhancement through risky investments should be of secondary priority. To help RMs rediscover the standard of care that their clients expect from them, we offer the following suggestions.
# Ensure RMs are well-trained. RMs play an important role in educating clients about the risks of the products. To educate clients, RMs themselves must be trained to provide a balanced view of the returns and risks to clients. Training is often provided by a product originator which may be another bank or an external fund house. It may emphasise a product’s selling points more than the risks. Banks must ensure that the training is rigorous and balanced. RMs should understand the risk factors of the products they sell and advice clients how to respond to changes in these risk factors.
# Ensure quality control over financial needs analysis. The Financial Advisers Act requires RMs to conduct financial needs analysis (FNA) of clients before recommending products. The desired outcome is that product recommendations fit clients’ investment objectives and capacity to bear risk. A client’s risk profile is typically evaluated using a risk profiler questionnaire. Successful risk-profiling must enable detection of clients’ aversion to losses. Banks should ‘stress test’ risk profilers to mitigate egregious inconsistencies. Where there is ambiguity, banks must ensure that the client fully understands the downside risk of the product.
In the haste to close a sale, a RM may hurry a client to fill the fact-finding form or let the client sign a blank form. Such sloppy practices cannot be condoned as they contravene the law, trivialise the prudent investor rule, and betray the trust of clients. We recommend that RMs write an Investment Policy Statement for each client to document the client’s objectives and constraints. The document presents a master plan against which product recommendations are appraised in fit-for-purpose tests.
# Adopt a multilayer sales and advisory process. Many RMs are young, inexperienced and hurriedly trained to push products without considering whether the products are suitable for clients. The relentless exhortation to meet revenue targets aggravates the situation. To rid mis-selling, the sales and advisory process must be strengthened.
For mass affluent and retail banking, we advocate a structure that involves three parties. RMs sell financial products and give basic investment advice. Investment consultants provide detailed explanations of product risk and return and conduct FNA for clients. Compliance officers check the quality of FNA and have the authority to stop the sale of any product if it is not fit for purpose or when FNA is incomplete or shoddy. This structure increases business cost. But should banks put a price tag on their clients’ trust?
# Present risk to clients. Every investment carries risks. In presenting a product to clients, RMs should highlight the extent of downside risks. The common practice of relying on a single rate of return (usually the historical average) to project an expected value over future periods is misleading.
This crisis reminds us that disasters do happen. Banks should employ simulation tools to illustrate how actual returns of an investment may deviate radically from the average. To be useful, the simulations should consider the impact of uncertainty across a wide range of scenarios, including ‘black swan’ events that are often brushed aside as too rare. Ironically, the crisis has now provided us with a treasure trove of abnormal market data for realistic scenario analysis.
# Sell risky products only to clients who can afford to lose. Structured products differ greatly in risk and complexity. Some are similar to bank deposits and are principal-guaranteed. Some take the short side of derivatives like credit default swaps and are not principal-guaranteed. Others not only short options on foreign currencies but are also highly leveraged. Despite the potential for unlimited losses, these leveraged products were flying off the shelves before the financial crisis. Some clients coveted structured products because they offered high yields, overlooking the principle that high returns come with high risks. Not all of these investors have the capacity to bear the risk of losing their capital.
Mis-buying of poorly understood products is as much to blame for the structured products debacle as mis-selling. Many clients operate a mental account for gambling and buy these products for a shot at the fast buck. Every RM must guard against the client’s gambling account washing out other accounts, such as retirement and children’s education, and eventually burning down the house.
# Name structured products fittingly. Structured products are often marketed as ‘deposits’ or ‘bonds’ when they are neither. The cash flows are dependent on uncertain outcomes such as stock prices or credit downgrades. Banks must stop using terms like ‘deposits’ or ‘bonds’ because buyers get the wrong impression.
We welcome smarter regulation. Harvard professor Elizabeth Warren’s proposal to set up a Financial Product Safety Commission is timely. She wants information about financial products to be disclosed in a manner that investors can appreciate. Banks should no longer get away with product information that is incomprehensible, and that appears more to complicate than illuminate. A market economy that thrives on full information is broken when disclosure is frustrated.
The wealth management industry needs to swiftly put its house in order. Rebalancing incentives from transaction revenue to assets under management would help steer behaviour from salesmanship to guardianship. RMs must be held to higher standards befitting professional guardians of wealth. They are the first, and sometimes the only, interface between clients and banks. This crisis, like all previous crises, will pass. The industry should reshape itself now for the future, or it won’t have one.
Fong Wai Mun is Associate Professor and Low Chee Kiat is Assistant Professor in the Department of Finance, NUS Business School, National University of Singapore. This is the fifth in a series of 12 articles on the global financial crisis by faculty of the NUS Business School.
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