Late in 2016, Kevin Moss and Chris Pearce looked at the suitability process for complex investments for the ValidPath network.
As part of that review they considered the third party due diligence used to support investment decisions in tax efficient products and while those reports provided very useful information, it became apparent that there were flags that were being missed. Flags that an investment committee would want to see.
And the more schemes that were looked at the more it became clear how linked this area of the investment sector is in terms of the investment companies themselves, their underlying investments and the providers of supporting administrative services.
This impacts issues such as governance and conflicts of interest and it especially puts the spotlight on exit strategies and valuation.
We also found there were issues in relation to the monitoring and administration of existing schemes where clients of our own member firms were impacted.
Due diligence coverage is also not universal. It’s fair to say that the growth orientated schemes would prefer greater exposure and we’ll aim to address some of the gaps there.
With structured products the issues are rather simpler even if the product is not.
It really is all about what the product say on the tin and how does that compare with the list of ingredients.
And to analyse that, it isn’t enough to have a basic understanding of derivatives or a term sheet, you need to be able to independently model the product and have knowledge of how these structures are put together – what the layers of risk are, from counterparty risk to investment risk.
There may be a layer of credit default swaps, for example, even if that is not how they are described in the documentation. And you need some understanding of how the credit default swap market works – scrutiny of the term sheet is absolutely essential.
While we follow a set procedure it is constantly evolving. For example, our questionnaire that we send to companies is always under review as new issues arise.
We also research those companies which we are reviewing using all the available public information we can get access to, such as at Companies House, before we generate their bespoke questionnaire. And we’ll take a close look at the biographies of the key personnel – which has proved to be quite illuminating.
But, the most productive process we use is simply what’s known as IKIWISI – I know it when I see it. That has led us to use a variety of techniques to look much deeper into complex products that just didn’t seem right for some reason.
To be clear, we are not trying to be risk adverse, we just want to make clear what the risks are and that they are badged correctly given the available information. It can’t be a perfect process, but the more diligent we are then the greater the likelyhood that any subsequent advice is able to meet the suitability test.