Choosing the right DFM operating framework

The PFS first raised concerns around Agent as Client (AaC) contractual agreements between financial advisers and their discretionary fund managers (DFM) back in the summer of 2019. The PFS’s concern was that some advisers were inadvertently exposed to risk as they expected it to be sat with their DFM and therefore didn’t have suitable contracts in place with their clients. There is still a great deal of confusion around the issue with many advisers unsure whether they should alter their business strategy or be taking other actions to ensure any risk is minimised. This article aims to help advisers better understand the advantages and disadvantages of both AaC and the alternative option, Reliance on Others (RoO) and help them identify which is a better fit for their business.

It’s important to say that both operating models offer advantages and disadvantages, and both can operate without issue in conjunction with an adviser’s business strategy. Under the AaC model, an adviser is effectively in-sourcing an investment process - hiring a firm with the regulatory permission, capability, expertise and scale to manage model portfolios on its behalf. The firm is the client of the DFM and the DFM doesn’t have a contract with the end investor.

Reliance on others - RoO (sometimes called Agent of Client) is an alternative contractual framework where the adviser and the DFM both take direct responsibility with the end investor for their part of the client process. This means that under RoO it is necessary for the DFM to have a direct relationship with the end investor.

For many advisers one of the key benefits of an AaC relationship is that it helps avoid any confusion for the client over roles and responsibilities, or worries for the adviser over client poaching and conflicts of interest with the DFM. Responsibilities are clearly separated and reflect each party’s strengths, with the adviser responsible for financial planning and investment suitability and the DFM for managing the investments day to day.

The RoO model requires the DFM to have a separate contract in place with all the end clients that are invested in their portfolios. This is less practical for DFMs that provide model portfolios to scale but a better fit for those providing lower volume and more bespoke services. Under AaC the adviser would need to have a contract in place with the end investor that appoints them as the agent and gives them the authority to appoint their chosen DFM. One advantage of this is that if the adviser subsequently feels the chosen portfolio is no longer suitable for their client, they can immediately withdraw them from it. However, it would be prudent for advisers to review their terms of business, marketing collateral and advice letters with a regulatory consultant or lawyer to ensure they clearly set out the scope of their capacity as their client’s agent.

With the AaC model the adviser retains the relationship with the end investor alone, which means they also ultimately retain the liability for their investments. Consequently, in the event the end investor is dissatisfied with their investment advice and wants to make a claim to the Financial Ombudsman Service, that claim would be against the adviser. The adviser in turn would need to claim against the DFM, if they we were at fault. Under RoO, because of the relationship between end investor and DFM, they would be able to claim directly against the DFM.

It’s it is therefore important that any AaC contract clearly sets out the DFM’s obligations, such as managing the investments within the relevant risk levels and only investing in instruments that are suitable for retail investors, regularly reviewing and rebalancing the investments in line with the investment mandate, and providing the adviser with information, disclosures, documents and reporting as required by Financial Conduct Authority (FCA) rules. The contract should also stipulate the liabilities if the DFM does not fulfil their contractual responsibilities or if a loss is suffered due to negligence. This will also help allay any concerns that Professional Indemnity (PI) insurers have on the risks involved as it demonstrates a lower risk to the business due to the robust processes and systems and resources of a professional investment firm.

It’s of key importance to both PI providers and the regulator that advisers understand the contractual relationship between firm, client and DFM and have all the necessary information available on process, risk management and suitability. A close working relationship between the adviser and DFM should help smooth the PI review process and ultimately minimise insurance premiums and deliver a compliant process.

If you’d like to delve a little deeper into this topic please join our webinar, where we’ll provide our thoughts on some of the most frequently asked questions such as:

The impact of Agent as Client on PI cover
Whether it affects 10 per cent drop reporting
What to look out for in your due diligence
What clauses to expect in your DFM contract

Date: 2 December
Start: 9:00 AM
Finish: 10:00 AM

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