Turning client suitability assessment into a science

Financial advisors in many countries are now required to offer financial products adapted to their clients’ risk profile. However, more than 10 years after the enactment of this new requirement, regulators are still complaining about the lack of compliance and scientific validity of risk profiling tools used today by financial intermediaries.

Why client risk profiling?

Following the financial crises in the 2000s, financial regulators strengthened investor protection policies. In particular, regulated firms providing investment advice are now required to attest to the suitability of their investors vis a vis their investments. Financial Advisors should know their clients, and even “have a deep understanding of [their] psychology” [1], in order to propose products suitable to their investor profile to them. In the European Union, client suitability assessment is regulated by MiFIDII, which came into force in January 2018.

[1] For Portfolio Manager, Guidelines on certain aspects of the MiFID suitability requirements, Final Report, ESMA, July 2012

What do regulators say exactly?

Under the European MiFIDII, investment firms are asked to run suitability tests by checking their clients’:

    1) Appropriateness: Financial experience and knowledge;

    2) Financial situation;

    3) Risk profile. A client’s risk profile often includes investment objectives, time horizon, risk tolerance and ability to bear losses.

Under the European MiFIDII, the whole client suitability assessment is only compulsory for portfolio management and investment advice. For other investment services, most of the time an assessment of appropriateness is the only requirement (DIRECTIVE 2014/65/EU (25)(2)(3)(4)).

In order to ease the implementation of these new requirements, the European Regulator has published additional guidelines and technical advice intended to help with the construction of compliant risk profiling tools.

Below is a summary of the technical advice provided by ESMA (MiFIDII) in 2014 (ESMA/2014/1569):

  • Consistency control: Financial intermediaries should take appropriate steps to control the coherence and consistency of their client’s risk profile with other client’s information.
  • Loss aversion assessment. Putting more weight on the level of loss rather than risk that the client is willing to take.
  • Recording and updating of client’s information at a relevant frequency.
  • Simple language. The investment firm should ensure that questions are likely to be understood by the client.

On top of the 2014 technical advice, it is useful to recall some complementary guidelines by ESMA on MiFID in 2012 [2]:

  • Using concrete examples. For instance, instead of asking a client whether he feels comfortable with risk-taking, the client can be asked what level of loss he would be willing to accept over a given period of time, either in the individual investment or his portfolio. ESMA gives the following example: ‘’ How would you cope with permanently losing 10000 euros on your 50000 euro investment?’’
  • Dissimulation of risk profiling scoring precise criteria. Information disclosed to the client should not allow for the manipulation of the risk profile assessment.
  • Tailor-made questionnaires. ”When questionnaires are used, they should, when and as they deem appropriate and also to the extent possible in terms of costs, be tailor-made.” Esma guidelines, 2012.
  • Taking demographic data into account such as age, marital status, family situation (number of children), employment situation or need for liquidity.

[1] See 25(4) for exceptions

[2] Guidelines on certain aspects of the MiFID suitability requirements, Final Report, ESMA, July 2012

When providing investment advice or portfolio management the investment firm shall obtain the necessary information regarding the client’s or potential client’s knowledge and experience in the investment field relevant to the specific type of product or service, that person’s financial situation including his ability to bear losses, and his investment objectives including his risk tolerance so as to enable the investment firm to recommend to the client or potential client the investment services and financial instruments that are suitable for him and, in particular, are in accordance with his risk tolerance and ability to bear losses.

Directive 2014/65/EU (25)

The assessment of suitability is one of the most relevant obligations for investor protection. It applies to the provision of any type of investment advice and portfolio management. In accordance with this obligation, investment firms providing investment advice or portfolio management have to provide suitable personal recommendations to their clients or have to make suitable investment decisions on behalf of their clients. Suitability has to be assessed against clients’ knowledge and experience, financial situation and investment objectives. Firms giving investment advice are required to disclose whether they will provide the client with on-going assessment of suitability of the product. Firms providing investment advice must also provide clients with a statement specifying the basis on which the investment recommended is suitable for the client.

ESMA 2012

How are clients' risk profiles assessed today?

To comply with this new regulation, Financial Intermediaries often opt for a paper questionnaire with few explicit questions. 85% of these questionnaires designed in-house [1] and they vary tremendously. In our analysis of 504 of these risk profiling questionnaires from 50 different countries (52% from the European Union), the number of questions varies from 1 to 25. 49% of them evaluated risk tolerance directly with the question: “What is your risk attitude?” or “Which option best describes your risk attitude?”. Only 54% took loss aversion into account.

[1] Global Private Banking and Wealth Management Survey, PwC, 2014

Why are regulators and scholars concerned about risk profiling today?

From a behavioral economics point of view, the field of financial advice is quite strange and not very useful. For the most part, professional financial services firms rely on clients’ answers to two questions:

How much of your current salary will you need in retirement?

What is your risk attitude on a seven-point scale?

From my perspective, these are remarkably useless questions.

Dan Ariely, professor at Duke University

Over the past decade, many academic and official reports, especially in Europe, have pointed out the lack of compliance and scientific validity of investor-profiling questionnaires.

In an analysis run by the UK Financial Services Authority (FSA) in 2011, 54% of questionnaires were judged unsuitable because of their failure to measure risk attitude.

In another report by the Autorité des Marchés Financiers (AMF, the French stock market regulators) in 2011, “one third of the audited questionnaires have an overall explanatory power that exceeds 25% (with a maximum of 37.6%), while another third fall short of 10%. (…) 10 of the 14 questionnaires deal with risk‐taking preferences but often in a superficial manner. Only 8 questionnaires attempt to quantify preferences regarding risk taking and the questions asked are often too vague to be of any real help for ensuring that clients are sold suitable products.”

Similar conclusions have been drawn from studies run by European Member States [1]:

  • The definition of risk is not clearly separated from the notion of loss;
  • Questionnaires do not integrate the basics of psychometrics, econometrics and behavioral economics to properly assess customer risk profile;
  • The scoring method of the questionnaire is often too simple and displayed to the client;
  • Most questions are judged either oversimplified or too technical or ambiguous;
  • There is a huge heterogeneity in the number of questions from one questionnaire to the other;
  • The consistency of answers is not controlled;
  • Firms do not make the effort to gather sufficient information about the client, especially his investment objectives and financial situation (education, profession,…);
  • Firms over-rely on their clients' self-assessment;
  • Firms attempt to evade their responsibility to give suitable advice by giving the impression that it is the client who decides on the suitability of an investment;
  • Data recording on the suitability process is poor;
  • Firms over-rely on poorly designed risk profiling and asset allocation tools.

A few years after the publication of these reports, regulators still have concerns about risk profiling compliance (FCA, 2014).

The high number of unsuitable investment selections we see in the pensions and investment markets is still a significant concern. It is a specific risk to our consumer protection objective (…) The level of failure in this area is unacceptable. We have taken, and continue to take, tough action to address these failings with individual firms.

FSA report 2011

The empirical evidence on the questionnaires used by the Italian investment firms available so far documents several shortcomings (Marinelli and Mazzoli, 2010). In general, the questionnaires are prepared and based on the business model of the investment firms, the characteristics of the products offered and the level of knowledge of the staff involved in the assessment and recommendation process. The main weakness refers to risk tolerance assessment, in most cases elicited only by requesting the risk-return expectations for future investments with respect to hypothetical investment situations.

Questionnaires comply to varying degrees with the recommendations of the various laws and regulations relating to MiFID regarding investment advice: MiFID itself, the AMF’s briefing paper, the Delmas-Marsalet Report, CESR guides, and the academic literature. Most of the MiFID questionnaires attempt to evaluate risk-taking preferences, but they are not always successful because of the ambiguity of the directive and its implementing decree, despite the clarification provided by the AMF’s briefing paper. Only one third of the questionnaires try in some way to quantify risk aversion. And yet quantitative measurement of risk-taking preferences is the only reliable way to ensure that suitable products are sold to clients.

AMF 2011

[1] Evaluation of MiFID questionnaires in France, AMF, 2010.

Assessing investor’s risk tolerance through a questionnaire, Consob, 2012.

Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection, FSA, 2011.

Why risk profiling implementation turns out to be so difficult for financial intermediaries?

Following the disastrous reports on investor profiling by financial intermediaries, regulators have consulted practitioners to better identify the difficulties of implementation of this directive [6]. Some factors are listed below:

  • Difficulties to apprehend and assess the subjective notion of risk.

Investors, and especially retail investors, tend to underestimate the level of risk that they are taking as well as their own risk absorbing capacity. They realize that there is risk in the proposed investment but they might not evaluate correctly the probability of the realisation of the risk in certain circumstances. Risk is an overly abstract concept to govern suitability. Investors might also act in an over confident way by considering that they are better than other investors at assessing risks and will do better. In addition, the investment firm itself, in good faith, might also underestimate the amount of risk which is being incurred by the client.

Esma guidelines 2012

  • Clients hold such questionnaires as intrusive, boring and time-consuming.
  • Financial advisers had implemented, in a formal or informal way, such client suitability procedures before and do not understand why they should spend money and time to change them.
  • Ambiguity of responsibilities in product choice based on the answers of the questionnaire.
  • Absence of training of Front Officers on basics of psychometrics, econometrics and Behavioral Economics which make them hard to build compliant and scientific tool.

Behavioral Finance as a solution to the burden of properly assessing the suitability of a client

Recent reports by both regulators and academic scholars have promoted the use of behavioral finance findings to solve the issue of client suitability assessment for financial intermediaries. Behavioral Finance includes in its models psychological factors which highly impact investment decisions, contrary to what is held by conventional finance. Popularized by Nobel Prize winners Kahneman and Tversky in the 1970s, behavioral economics have been very successful in the academic world for their application in finance, law and economics. However, behavorial economics have had limited applications in the field of business so far. Reports below highlight the benefits of using these theories to help financial advisors better understand their clients' psychology and needs.

It is clear, therefore, that in the face of such complexity, a wide range of tools is needed to assess risk tolerance. These tools must be able to combine the suggestions from classic economic literature with the indications of behavioural finance and of psychometrics.


To explain the steps needed to comply with MiFID requirements , it is helpful to review some of the advances in behavioural finance and experimental economics to explain individual behaviour with regard to financial investments. The findings of academic research, including theoretical analysis, econometric analysis and experimental economics, may help clarify the relevance of the concepts in MiFID and the related laws and regulations. More specifically, the cognitive biases found in decision‐making processes under uncertainty are bound to play a major role in understanding and, more importantly, implementing MiFID.

AMF 2010


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Directive 2008/10/EC. (2008). Official Journal of European Union.
Directive 2014/65/EU. (2014). Official Journal of the Eurpean Union.
Doncel, L. M., Reinhart, W., & Sainz, J. (2008). A behavioral approach to MiFID. Banks and Bank Systems, Volume 3, Issue 1.
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ESMA. (2014). Response form to the MiFID II/MiFID Consultation Paper.
(2012). ESMA/2012/387. Final report: guidelines on certain aspects of the MIFID requirements.
European Commission. (2011). Consumer market study on advice within the area of retail investment services. Final Report. http://ec.europa.eu/consumers/rights/docs/investment_advice_study_en.pdf.
European Commssion. (2011). Consultation on the review of the MIFID.
Faff R.W., H. T. (2004). An empirical investigation of personal financial risk tolerance. Financial Services Review, 13(1): 57-78.
Ferber, M. (2012). Review of the Markets in Financial Instruments Directive Questionnaire on MiFID/MiFIR 2. MEP.
FSA. (2006). Levels of Financial Capability in the UK. Results of a baseline survey.http://www.fsa.gov.uk/pubs/consumer-research/crpr47.pdf.
FSA. (2011). Assessing suitability: establishing the risk a customer is willing and able to tahe and making a suitable investment selection. UK.
Hübner, G., & Plunus, S. (2013). Accommodating profile dynamism in MIFIDII. Revue Bancaire et Financière.
Jung, E. a. (2008). Anforderungen an Finanzvermittler. German Consumer Affairs Ministry.
Marinetti, N. M. (2012). Risk Profiling and Current Suitability Practices: What Can Be Learned from a Sample of Italian Householders. Research paper.
Mazzoli, C., & Marinelli, N. (2011). An Insight Into the Suitability Practice: The Standard Questionnaire Dilemma. research paper.
Mazzoli, C., & Marinelli, N. (2014). Determinants of Risk-suitable Investment Portfolios: Evidence from a Sample of Italian Householders. International Journal of Finance and Banking.
McGoldrick, S. (2012). Making Sense of MiFID. FIXGlobal.
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(2014). Open hearing on MIFIDII. Paris.
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[1] For Portfolio Managers, MiFID (Directive 2004/39/EC). Other main regulations on risk profiling: FSA, Consob, AMF, HKMA, MAS, FINRA, IIROC…
ESMA Supervisory brief 2012_850 – 20_10_2009
European Parliament and Council Directive 2014_65_EU-12_06_2014-1
[2] MiFID guidelines for client’s suitability assessment apply to investment firms (as defined in Article 4(1)(1) of MiFID), including credit institutions that provide investment services, UCITS management companies, and competent authorities. Although they principally address situations where services are provided to retail clients, they should also be considered as applicable, to the extent they are relevant, when services are provided to professional clients.
[3] Guidelines on certain aspects of the MiFID suitability requirements, Final Report, ESMA, July 2012
ESMA Guidelines 2012_387 – 06_07_2012
[4] PwC, 2014
[5] Evaluation of MiFID questionnaires in France, AMF, 2011.
Evaluation-1 MIFID
Assessing investor’s risk tolerance through a questionnaire, Consob, 2012.
Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection, FSA, 2011.
FSA 2011
[6] Guidelines on certain aspects of the MiFID suitability requirements, Final Report, ESMA, July 2012