The FSA’s Retail Distribution Review, launched in June 2006, is now approaching implementation with the publication of the June 2009 consultation paper setting out the FSA’s detailed proposals. Although a change of government may lead to the split up of the FSA it looks highly unlikely any new consumer protection agency will allow this key strategy to be grounded.
“Even in these turbulent times , when there are many short term issues that we must all deal with, we are totally committed to following through with the RDR and the lasting benefits we believe it will deliver” Dan Waters, Director of Retail Policy and Themes, FSA
The RDR will (when it comes into force at the end of 2012) fundamentally change the way the ’s market for retail investments is structured and operates. It impacts on all regulated firms involved in producing or distributing retail investment products and services including IFAs, wealth managers, stockbrokers, retail fund managers and tied and multi-tied advisers. It does not appear to catch pure discretionary managers on the basis they provide no personal recommendations to clients - but many are like to conclude that to stay outside the RDR regime (and risk tripping themselves up) would restrict their commercial freedom.
The challenge ahead lies in taking the RDR proposals and implementing them in time for 2012. Although there seems to be general support in the retail sector for the original objectives - few disagree that there is a cultural change needed to rebuild the consumer’s trust in financial advisers – there remains concern over the practical application of the new regime in a number of areas.
Improving clarity about advice
Investment firms will be required to clearly describe their services as either “independent advice” or “restricted advice”. In order for a firm to bring itself within the definition of “independent” it will be necessary for it to consider and have access to the whole range of “retail investment products” comprising packaged products, unregulated collective investment schemes, investment trusts and structured investment products (“RIPs”). This has created a number of issues:
It will be difficult for wealth managers and private client brokers to meet this description since they do not offer a financial planning service across this spectrum but advise on equity portfolios. Conversely, an existing IFA could arguably meet this definition since bonds and equities are excluded from the definition of RIPs. Wealth managers and brokers will probably prefer not to lose their independent status given the potential significance of the “independent” brand in dealing with clients and intermedaries.
In order to consider all retail products within a relevant market firms need to obtain data for each of the financial instruments within the definition of RIP (a new extended definition introduced in the June 2008 review). At present there does not seem to be data readily available for certain instruments such as structured products or unregulated collective investment schemes – but data providers may move to fill this gap before the RDR comes into force.
Firms which use platforms will need to consider whether the platform operates on an “open architecture” (across the range of products in the market) basis. If it only operates a limited range of funds or only deals with those funds willing to negotiate lower charges, the firm is unlikely to be independent.
Adviser networks with branches choosing their own range of products will need to consider whether they are treated as a single firm (in which case they will not be independent if one branch offers a restricted range) or whether each branch is separate (in which case some may be independent and others restricted).
Adviser charging
Under the new rules firms can only be paid for advice and related services through “adviser charges” – and firms cannot receive any form of commission from product providers (even if it is intended that this be rebated). Clearly, commission based business models will require substantial change when the existing regime ends whilst the fee-based adviser is likely to see less radical challenges to its business model.
Those firms currently keeping any part of provider commissions directly (or indirectly where they offset against advice costs) will need to establish a customer charging structure and the new proposals set out a number of points for consideration. Fees can be paid directly or via deductions to a client’s investments.
The requirement that all firms providing advice must set out their charges up-front and agree them in advance with clients means that most firms need to describe their charges in more detail than they do currently: Statements of Fees and Commissions (“SOFACS”) will need to be altered.
The pricing disclosure regime covers total adviser charges and this causes problems for wealth managers in respect of RIPs which are market traded and whose price may fluctuate within short periods of time. For example, the purchase of investment trust shares will involve the payment of brokerage commission and it will not be possible to provide the cash amount of the brokerage commission with certainty prior to execution – if the market price moves, so will the cash commission.
Firms splitting fees or commissions with introducers are likely to need to disclose more information about the split.
Similarly, firms using platforms are likely to need to disclose the platform’s costs whilst platforms themselves may (because this still seems to be an area of uncertainty in the RDR) have to start charging IFA’s for the administrative services the platforms typically provide to IFA’s.
Professionalism
The FSA’s stated objective is “to deliver standards of professionalism that inspire consumer confidence and build trust so that in time, financial advice is seen as a profession on par with other professions”. All advisers must reach the Qualifications Credit Framework (QCF)) 4 or equivalent by the end of 2012. Higher standards for all advisers (both independent and restricted) is seen by most in the sector as the way forward but the deadline will be a challenge for many firms.
The FSA has decided there should be no “grandfathering” for existing practitioners to achieve the new higher qualification standard. The FSA is strongly encouraging those practitioners without a level 4 qualification to take action now and have made clear that advisers who fail to take action in time will have to leave the sector.
The proposals do contain an option for “exam averse” practitioners to sit an oral version of the written industry exams but the emphasis on them being to the same standard as the written exam is likely to limit their practical use.
Although there seems to be a consensus that the new exams should apply to all currently operating in (as well as new entrants to) the industry there is concern as to the ability of the FSA to find sufficient flexibility for experienced professionals rather than impose a syllabus that covers extensive material irrelevant to their roles.
What should RDR affected businesses be doing now?
The consultation period on the June 2009 consultation paper ends on 31 October 2009 and a feedback statement is due from the FSA in Q1 2010 – at which point the new rules will be set. Firms should already be assessing the implications to their business including:
considering whether they will be categorised as “independent” or “restricted” as they operate at present and if independence is important to them whether it is possible to bring themselves within this definition;
considering whether, and if so how much, they will need to change their charging structures and (in any event) the new customer documentation that will be needed; and
establishing plans (with the benefit of guidance from their industry and professional bodies) to ensure that existing practitioners without a level 4 qualification will reach this level in time for 2012.
What effect will all this have on the industry?
With the RDR preparing for take-off, the possible effects on the industry are now being considered in more detail. Although the changes look likely to improve the quality of advice for those that are willing and able to pay for it, the changes may have other consequences:
There may be a significant difference between what clients expect to pay for their advice and what advisers expect to charge them, even with the option to deduct the charges from the investment. A recent report from Legal & General found that investors thought independent advice was worth £67 per hour while their advisers said there advice was worth £170 per hour. This may discourage retail investors from dealing with IFA’s at all.
Many smaller firms servicing “middle ” may find that the drop in product commission makes their business unviable and will prefer to become tied agents providing restricted advice. Other senior IFA’s may retire rather than sit mandatory exams. A report published by Ernst & Young in September predicted that of the existing 35,000 IFA’s in the , as few as 10,000 would remain independent in three years time.
Only time will tell how these changes work through and although the outcome over the medium term is likely to be a professionalised retail financial services industry there is likely to be considerable turbulence on the way.
For further information on the changes and the implications of the Retail Distribution Review for your business please contact either Tim Goodman on 01926 884674 or Steven Janes on 01926 884752.
October 2009
We have taken care to ensure the accuracy of this publication. However, the publication is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.
