We are urging advisory firms to create policies that standardise the assumptions applied to stress test cashflow modelling tools.

Director, Vicky Pearce, said: “The way cashflow modelling is evaluated needs to be measurable and consistent, which means taking a firm-wide view.”

There are two types of cashflow modelling currently available to financial advisers. The most common and widely available are deterministic tools that calculate a future event without considering any variables. The results are simplistic and tend to overestimate the level of growth or the sustainability of income projected. Therefore, advisers must show the impact different market conditions/personal circumstances will have on a client’s investments.

Vicky added: “The FCA is yet to set clear and precise rules about cashflow modelling, so we are left to interpret the wider legislation to determine how these unregulated tools should be used in a regulated environment. The main area for consideration is the COBS4 legislation, specifically COBS 4.6.7, which refers to future performance. It requires advisers to ensure any information giving clients an indication of future performance satisfies certain conditions.

“The majority of financial planners see the value in cashflow modelling and as the popularity of these tools grows, it is important that firms act consistently. We recommend considering the assumptions used and documenting these decisions in the form of company policy, justifying why the conclusions have been reached.”

Cashflow modelling based on the stochastic, or Monte Carlo method, are harder to come by, but are built around random probability patterns that have the capacity to handle uncertainties and provide more realistic results.

Vicky concluded: “Whilst stochastic tools remain relatively rare and out of the budget of some advisory firms, great care should be taken with cashflow modelling. When it is used as a financial planning tool, there is a risk of future complaints if the COBS4 requirements aren’t met. We recommend focusing less on the package itself and more on the assumptions firms set and the stress testing undertaken.”

To find out more about creating policies to standardise the use of cashflow modelling, don’t hesitate to contact us on: (0161) 521 8641 or read our more in-depth blog here.

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