ESMA: how to assess the financial knowledge of clients in compliance?

Long relegated to the CSR policies of asset management companies, financial education has become a major issue since MiFID II. From now on, it is mandatory to scrupulously evaluate the financial knowledge of investors before selling them financial products. Is it possible to use self-assessment to achieve this? What should this knowledge test look like to be compliant? Discover the recommendations of ESMA, the European Securities and Markets Authority.

Financial literacy assessment: a regulatory

Articles 16 and 25 of the MiFID II Directive, as well as Articles 54 and 55 of the MiFID II Delegated Regulation, set out the framework for assessing the financial knowledge of clients:

“When providing investment advice or portfolio management services, the investment firm shall obtain the necessary information about the client’s or potential client’s investment knowledge and experience relevant to the specific type of product or service (…) to be able to recommend to the client the investment services and financial instruments that are suitable for him”.

Article 25(3) of the MiFID II Directive states: “If the information provided on his knowledge and experience is insufficient, the investment firm shall warn him that it is not in a position to determine whether the service or product envisaged is suitable for him”.

That’s it for the theory. In practice, the European regulator provides more information on how to assess financial literacy.

Evaluation of financial knowledge: ESMA

To enable firms offering portfolio management, advisory, and order execution services to comply with financial literacy regulations, ESMA has issued a series of recommendations from 2018[1].

1.      Do not use self-assessment

To be compliant with MiFID II, self-assessment and declarative questionnaires should be banned. ESMA considers that these assessment methods do not measure the client’s level of knowledge: “It is particularly important for firms to adopt mechanisms to avoid self-assessment and to ensure the consistency of the answers given by clients, to properly assess the client’s level of knowledge and experience”.

The best practice is to use questionnaires that are completed directly by the client at home, or in the presence of his or her counselor. The questionnaire can also be completed by the advisor, after collecting information from the client during an interview. On the condition that in case of an erroneous answer, the advisor does not modify the answer given by the client.

In all cases, companies need to ensure that the questions asked of their customers are likely to be understood.

2. Designing clear and understandable questionnaires

Clarity, completeness, and comprehensibility: these should be the keywords of the financial knowledge assessment questionnaire. Thus, ESMA urges to avoid using ambiguous, approximate, or excessively technical language.

Careful consideration should also be given to the order in which questions are asked, to gather information effectively, and to allow the client the opportunity to respond “I don’t know.

For even more clarity, the regulator recommends integrating design elements such as tooltips or pop-up windows into the questionnaire, which will allow the customer to obtain additional information. In the same vein, in the context of an online questionnaire, it is recommended to leave the possibility of accessing a human interaction (email, telephone, request for an appointment…).

3. Ensure the client’s actual level of financial knowledge

“Firms should take all reasonable steps to satisfactorily assess their clients’ understanding of the main features of the types of products they offer, as well as the risks associated with them,” ESMA says. To do so, it is important to assess the understanding of basic financial concepts, such as investment risk, concentration risk, or return. In this context, the use of indicative examples is encouraged, to illustrate different loss/return scenarios.

Ultimately, the information gathered through the questionnaire should enable firms to conclude that the advice given is appropriate for their clients, particularly based on their financial knowledge. To achieve this, ESMA recommends that measures be taken to address any inconsistencies in the client’s answers, for example by incorporating alert and blocking mechanisms in case of conflicting answers.

EDUprofiler: a safe and easy way to comply with regulatory requirements

Gamification represents a powerful lever to make complex notions affordable. Therefore, it is not surprising to see the financial world seizing this concept to democratize the world of investment among individuals.

With this in mind, the fintech Neuroprofiler has developed EDUprofiler. This fun e-learning platform allows you to assess the knowledge of individuals, by MiFID II requirements. With EDUprofiler, you can be sure that you are assessing your clients’ financial knowledge in full compliance, but you are also giving them access to a tool that will significantly improve their financial education. Ultimately, using the EDUprofiler will allow you to offer a wider range of financial products for sale! Does the idea sound interesting? Contact us and ask for a demo!