Introduction
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 existing third party due diligence covering tax efficient products and, while those reports provided useful information, it became apparent that they were quickly out of date and flags were being missed. The coverage was also not universal.
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.
With structured products the issues are rather simpler even if the product is not.
It really is about what the product says 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 i.e. what the layers of risk are, from counterparty risk to investment risk.
There may, for example, be a layer of credit default swaps that would not be clear unless you have some understanding of how that market works. So, scrutiny of the term sheet is absolutely essential.
Process
While we follow a set procedure it is constantly evolving. Its has moved away from a basic questionnaire, which the existing third party reviewers do reasonably well, to an approach that draws on extensive use of external data to check and verify governance and performance data.
For example, we aim to monitor the filings at Companies House of most enterprises that are linked to a provider. Searches may be done on the officers, owners, accounts and secured loans to look for discrepancies. This required us to develop our own digital tools as there may be almost one thousand linked companies at each of the larger managers.
Some of the data generated is easy to scan, such as whether accounts are filed late. But, often the most productive process employed 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 offers that just didn’t seem right for some reason.
To be clear, we are not trying to be risk adverse for the sake of it, 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.