The Financial Times has reported that BNP Paribas is facing mis-selling allegations over fx derivatives to Spanish corporate clients. It also reports that Deutsche Bank staff have also been facing allegations of mis-selling financial instruments.
Both cases are familiar stories where clients ask for trades that do not strictly meet the banks own policies and which prompt internal discussion with compliance and the front office about whether the trades could or, more importantly, should go ahead.
It is a common occurrence in all sectors that a client will ask for something that the provider is uncomfortable supplying, but the relationship manager doesn’t want to refuse the client for fear of damaging the relationship or ‘leaving money on the table’. These are always tough moments; no relationship manager wants to deliver negative messages to clients.
For the bank / provider the issue is that booked P&L is never real booked P&L if there’s the chance of a future claim and lawsuit. At that point, the relationship will be damaged beyond repair and legal & regulatory costs can be significant. So, what’s the right approach in these instances?
Let’s look at the policies that sit behind some of these conversations.
First Client Classification. This really is basics. The FCA holds the view that it is rare for a client to want to give up regulatory protections and therefore pressure to opt up a client will almost always come from the regulated firm.
The difficulty for a regulated firm is when you know there are, say, retail customers that meet aspects of the opt up criteria but need to have more trading experience before they fully meet the criteria.
The rules here are pretty clear, you can’t start allowing a retail client access to more complex products available to them as a professional client until they have that experience. Doing so puts your business at risk of future claims from those retail clients if something goes wrong for them in future i.e., they lose money they will look to blame your business.
Back to the earlier point that booked P&L is not real P&L if there’s a risk of a future claim. Even if you think that claim is defendable you are still having to deal with the lost time defending your business which would be better spent bringing in real booked P&L.
In this scenario of the retail client without the right experience, onboard them, let them with non-complex instruments and build the relationship. Then when you and the client are really comfortable with what they are doing have the opt up conversation. If you do not want to deal with retail clients, and there are many firms that do not, then it is far better to stay well away from those retail clients who are skirting the opt-up boundaries.
Second, Appropriateness. This is by no means binary, and it can lead to fervent internal transaction-specific discussions.
We don’t yet know the facts in the BNP Paribas and Deutsche Bank cases but if the FT report of an average of six fx transactions a day with a Spanish wine producer wanting to hedge exchange-rate risk on their exports is right then that I’m sure you will agree that feels more than a little off. Even more so when some of the currency pairs were in markets where the client has little or no operations.
Some readers will know there are clients who may want to use their account for speculative trading as well as hedging. In many client relationships this is maybe perfectly fine. But where the client is only just opted up, or perhaps and as inferred by the FT, the client classification has not been done properly then you are building on sand. Your booked P&L might not stand the test of time.
If you are comfortable that your client classification is correct but still have some clarifications about whether the transaction is within internal policy read on. Remember properly classified Professional Clients can also makes claims of being mis-sold a product they didn’t need or understand.
It is not an uncommon situation where an internal investigation blames a few rogue individuals who lose their jobs. Needless to say, things should never need to get to this point.
If a transaction is or feels unusual for a client, it’s time to press pause.
Ask how comfortably you can meet appropriateness standards. Considering factors such as complexity of the product or instrument, the clients previous trading history with you in that product / instrument, and the potential maximum downside for the client. It should go without saying that if the maximum downside looks like it has potential to get remotely close to blowing up a client, steer well clear.
For corporate clients think about whether the transactions make sense and fit with their stated policies (for example in their Articles of Association) and whether they are really hedging. Whilst it might be legal in most places for corporates to speculate when this goes wrong it is usually the bank or provider who gets the blame.
There can sometimes be these debates about how likely the client is to complain if it goes against them. These discussions rarely add any value. A client will do what they need to do to protect their business, be that hanging a staff member out to dry or suing their dealer. Surely if you are having that discussion then you already know what the right answer is.
At the end of the day however much you debate about how you can get yourselves comfortable internally. Remember if there’s one thing we learn from behavioural economics, you cannot disclose your way out.
Have robust and objective challenges. Listen to compliance and listen to your own instincts. Often you will know your markets and clients better than anyone you talk to, and your own instinct is likely to be correct. Try and avoid the short-term bottom P&L view as that adds avoidable risk to the business as well as to yourself personally.