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Rule changes provoke mixed reactions among IFAs, but the protracted Retail Distribution Review aims to raise professional standards, clarify services to consumers, ditch commission and introduce fees. Neal Underwood investigates.
The Retail Distribution Review (RDR) was launched by the Financial Services Authority (FSA) in June 2006, to address the many problems it says it had observed in regulation of the retail investment market. At the root of what it is seeking to address are, says the FSA, insufficient consumer trust and confidence in the products and services supplied by the market.
The changes the FSA is proposing are set out in consultation paper CP09/18. The consultation paper details three measures that the FSA regards as most fundamental to delivering the outcomes it set out to achieve, and which will alter and improve interaction between consumers and the industry. These were to: improve the clarity with which firms describe their services; address the potential for adviser remuneration to distort consumer outcomes; and increase the professional standards of investment advisers.
The consultation period ended on October 30, 2009 and the FSA is digesting the responses it received. From the end of 2012, the authority aims to ensure that independent advice is truly independent and reflects investors’ needs, that people can identify and understand the service they are being offered, and that commission bias is removed from the system and recommendations made by advisers are not influenced by product providers. It also wants to ensure investors know the cost of advice and how they will pay for it. Last, all investment advisers will need to be qualified to a new, higher level, regarded as equivalent to the first year of a degree.
”I can see people who are nearer retirement not wanting to do the extra studying”
Skandia has had extensive discussions with advisers on the implications of the RDR. “RDR is an opportunity for financial advisers as long as they are prepared to adapt quickly to the changing rules,” says Peter Mann, chief development officer at Skandia.
“The focus now should be to carry out a full analysis of their business model and identify the changes that need to be made to thrive once the RDR proposals have been implemented. Tools such as AIFA’s [The Association of Independent Financial Advisers] online business academy provide advisers with excellent support in this area,” he adds.
David Thomson, investment director at VWM Wealth Management, says the firm did not participate in the consultation but has followed it closely. “We believe we are reasonably well placed. We’re a relatively new company, founded in 2003, so we don’t carry some of the baggage of older firms. We’ve always worked on a client-agreed remuneration package, so we often offset our fees with commission. Our fees vary on the amount invested and the amount of work involved.”
Thomson is broadly in favour of what the RDR is trying to achieve. “I could see some of our competitors leaving the industry, not because of fees but on the training side of things. I can see people who are nearer retirement not wanting to do the extra studying. Probably for these guys it will be more the training requirements.”
If it puts some of the competition out of business, that is no bad thing for VWM, says Thomson, who adds that it is looking at these types of firms with a view to possible acquisitions. “If there’s a one-man band who’s 50-plus in the Glasgow area we’re speaking to them. A lot are leaving it a bit too late. They’re tidying up operations but will it be too late to sell?”
On the subject of advisers moving to fee-based remuneration, Thomson describes it as “pushing at an open door, certainly with clients. I think many IFAs would see the same. There’s maybe some fear in moving from commission to fees; it’s more visible to clients, but our experience is clients are more happy with it.”
”RDR is an opportunity for financial advisers as long as they are prepared to adapt quickly”
Thomson also says that the Treating Customers Fairly (TCF) initiative has helped the firm in readiness for RDR. “I don’t know if TCF is a forerunner to RDR or running in parallel, but I would describe TCF as very much a professionalisation of your business. With that in mind we’ve beefed up our back office. It’s really an administration exercise to ensure clients get the service we promise them.”
Thomson says the RDR will not affect the investment solutions it puts before clients. “I don’t think it will change. We’re quite extensive users of wrap, which has its advantages and disadvantages, and we’ve spoken to the FSA about this. If it would be damaging to the firm and our clients to move that wouldn’t make sense - they’re being pragmatic about that.”
With regards to picking his own funds, Thomson says he can prove VWM’s clients are being serviced in the best possible way. “That’s how we’re justifying our ongoing fee,” he says. “We do provide the service and have the staff to do that. We provide an annual financial planning review to clients, although there’s a little less service to clients with less funds under management. The other thing that’s interesting, that RDR is bringing to bear, is lower cost funds.
“We use some passive strategies and offer a low-cost portfolio where we actively asset allocate but between passive funds and exchange traded funds [ETFs]. Interestingly enough, in the rising markets we’ve just had that’s been the best performer. I think RDR has been driving that; reducing the cost to the client and maintaining or even increasing our own fees.”
Jon Foster, director of Adviser Business Solutions (ABS), backs the RDR’s proposals. “In the UK, RDR needs to happen, simple as that. The regulator has identified there is a mistrust in the UK and we need to deal with it. It needed to be a fairly massive overhaul.”
In general, says Foster, the detail of the RDR is intelligent and sensible. “The requirement for higher qualifications is brilliant. For too long it’s been too easy to be an IFA. I also don’t buy into the argument that it’s going to force all the experience out of the market. If over the next three years you can’t get your head round doing a few exams I don’t know if you should be calling yourself experienced.”
Mann says financial advisers’ reputation with consumers will be further improved through the additional professional qualifications they will be required to hold post-RDR. “These additional qualifications will hold no fear for the majority of financial advisers, many of whom were already gaining additional qualifications long before the RDR began. However, it is important that financial advisers understand where they are today and what needs to be done to ensure they meet the new qualification requirements.”
There are, however, some parts of the RDR that are overly complicated, in Foster’s view. He says the key to restoring consumer confidence requires no more than the two-pronged approach of keeping things straightforward and removing the commission bias. “Generally we’re fairly positive. Unfortunately, how do we think IFAs are reacting? The problem the FSA has is most IFAs aren’t reacting. There’s even a Number 10 petition saying the FSA is set to destroy independent financial advice for all but the wealthy. That’s what the FSA is up against. To be fair they’re doing the right thing, but they’ve left themselves open to be hit with a big stick. Usually when there’s a change there are those that embrace it and those that do what they need to do. In this one you’ve got such a big change that you’ve got a group of people going up against it head on.”
In contrast with Thomson’s view, Foster says advisers should not be selecting funds for their clients.
”There’s maybe some fear in moving from commission to fees; it’s more visible to clients”
“In our view, IFAs shouldn’t have been picking funds for years,” says Foster. “They shouldn’t be making investment decisions. To meet even the TCF requirements is difficult for a multiple registered individual firm. For a one-man band it would be a compliance nightmare.
“Post-RDR the ability to sit there and pick your own funds will disappear. It’s always been this way for us. You’re selling advice. Ultimately a client is paying for your advice and expertise, not to flog them a product. As things stand at the moment not a huge amount will change for us. Some of the disclosure documents will change but the fundamental way we do business won’t change.”
“I would say to advisers who select their own funds and individual stocks: ‘If you’re such a great stockpicker why are you an IFA?’” says Carl Melvin, managing director of Affluent Financial Planning. “The reality is it’s a guess, albeit an informed guess. Whatever happens to the market happens to the market. Let’s not take the risk of pursuing that, and paying for it where the fund manager can lose you money.”
Melvin agrees that outsourcing through, for example, multi-managers can address some of the issues related to the RDR and TCF, but says that Affluent has always been very transparent anyway. “We’ve been fee-based for 10 years so we were already onside with RDR,” he says. “For us it’s more an evaluation of where we add value as a business. I’m not a stockpicker, not an investment genius, but I make sure I provide good service to clients. RDR has clarified to a lot of financial advisers where the value does lie.”
Melvin adds there has been a definite move by some advisers away from multi-manager and towards passive approaches. “Nine out of 10 active managers do a bad job, and the client looks to you as the adviser for an explanation.”
ABS supports outsourcing investment management, and indeed has its own Distributor Influenced Fund (DIF) range. “We’re much more comfortable having managers doing it for us and then monitoring the managers,” says Foster. “Yes, multi-manager will be popular but you’ve still got the problem with, if you use a platform, whether the IFA can call himself independent.” He notes that the FSA has raised a similar question with reference to DIFs. “I don’t think it’s down to cost. The biggest single issue they have with the DIF market is you have probably 60% that are unviable, only £1m or £2m in size.”
HSBC Global Asset Management forecasts the RDR will lead to increased take-up in passive investment solutions. Andy Clark, managing director, wholesale at the firm, says the RDR was the real catalyst for its thinking on index tracker funds. They have long been a tool for advisers, but HSBC is being more aggressive on fees and on growing its footprint.
”It needed to be a fairly massive overhaul”
“To some extent index trackers have been the poor relation. Because they don’t pay commission, some advisers feel that if they’re not choosing active funds they’re not doing their job. But now, even over 10 years, some clients have lost money, and they are asking the question of why they should be using active managers,” says Clark.
Clark adds that he believes in the long-term growth of the passive world. “Advisers and investors are demanding more for their alpha. The fund manager merry-go-round has slowed up recently but that will start again. That strengthens the argument for a passive approach. The number of funds out there is mind-boggling, and that too plays into the hands of passive providers.
“That’s partly why ETFs have exploded. RDR represents a seismic shift. Asset managers will need to rethink their business models. It will bring behavioural changes. If I was starting today as an adviser I would be concentrating on service provision and charging a fee for it. In the new world there’s a different, fee-based model.”
Historically there has been something of a polarisation of advisers into either the hard-line passive investor who believes in the concept totally to the exclusion of all other approaches, or the adviser who believes he can only add value by selecting actively-managed funds for clients.
According to Clark, though, some interesting conversations are now taking place. “Doors are opening,” he says. “It’s that middle ground, between those two extremes, that’s actively debating what to do with regards to RDR. What scares me the most is things like the massive boom in corporate bond flows this year. Who’s got their portfolio so stuffed with them? The best advisers are building portfolios for the long term. They shouldn’t be plugging products. Sector chasing is everything that’s wrong with the adviser industry.”
Foster, however, says he has some concerns over the regulator’s backing of passive funds, stressing that investment solutions should be about value, not just cost.
The RDR will also be a big driver of clients towards discretionary management, in the view of John Clougherty, chief executive of UK Fund Services at Aviva Investors. “I can’t see any scenario, if RDR is implemented in its current form, where it doesn’t lead to people using investment management firms to outsource. Advisers are not resourced up to do this themselves; there’s a higher degree of regulatory risk and oversight required. We will see a growth in discretionary management services. The trend towards things like fee-based advice was happening anyway, but the trend towards discretionary asset management was not going to be as fast if RDR hadn’t happened.”
Advisers will need to decide which investment solutions they wish to use to build a portfolio and make it clear how much they are going to charge under the RDR adviser charging regulations, says Mann.
Mann adds: “One of the important decisions will be whether advisers continue to research and select funds themselves, or turn to discretionary fund management services or multi-manager investment solutions. Multi-manager investment solutions are already growing rapidly in popularity with financial advisers and this is likely to increase post-RDR, as more financial advisers focus on the investment process and matching portfolios to risk profiles rather than standalone fund picking.
“I also think we will see a greater number of advisers using discretionary fund management services to manage portfolios that are matched exactly to the client needs they have identified during the advice process.”
”For too long it’s been too easy to be an IFA”
SEI is one of the firms advisers may choose to outsource investment management to, and it naturally welcomes the principles of the RDR. However, Joseph P Ujobai, managing director of SEI Investments (Europe), says there are practical considerations, specifically in relation to adviser charging for firms that give advice, to encourage the delivery of quality advice for consumers.
“The FSA should impose limits on commission payments rather than outlawing them completely,” says Ujobai. “We fully support the FSA’s drive for transparency and separation of product from advisory fee in the RDR and we agree with the need for more professional fee-based advice. However, we do not believe that there should be an outright ban on commission.”
SEI’s rationale behind this is twofold. While it agrees to the removal of product and trail commission fees, it says they should be removed only where they unduly influence the adviser from acting or offering advice in their client’s best interest. A complete ban of such fees may be counter-productive, says Ujobai, given some of the benefits to the consumer in paying trail commission fees to their adviser - for example, where commission facilitates the distribution of costs by allowing advisers to offset the smaller investor accounts with large investor accounts by using an asset-based charge, rather than a flat adviser fee that may be unsuitable for smaller investors.
Second, the firm says the separation and transparency of adviser and product fee, and hence removal or undue influence of the product provider, should not necessarily be focused on pricing schedules but should instead be focused on other evidence and practice of a firm’s delivery of unbiased advice. Examples of such a practice may be an adviser firm using an investment committee for product selection, or an adviser firm accessing a range of products in the market via a single platform to ensure consistency of pricing terms for those products.
“Adviser charging will make it very clear how much consumers are paying for the advice they receive, so advisers will need to be able to demonstrate the value of the services they provide,” says Mann.
“One of the clearest ways to do this is to ensure they have a defined investment process within their business which is focused on understanding their client’s risk profile, matching a well-balanced portfolio to that risk profile and then providing regular commentary on the performance of the portfolio, making changes where necessary.
”There’s even a Number 10 petition saying the FSA is set to destroy independent financial advice for all but the wealthy”
“An investment process along these lines makes it clear to the consumer what they are paying for - tailored portfolio construction, monitoring and review. Fund platforms can facilitate this process by providing online tools that enable a consistent process for identifying each client’s attitude to risk and matching a well-diversified asset allocation to that risk profile.”
While the RDR presents numerous challenges to advisers, it is also opening some doors. The Association of Investment Companies (AIC) says it welcomes the proposals to extend the scope of retail investment products to include investment companies. In its view, this should mean that investors taking independent advice are in a better position to consider the sector and to make comparisons, on the basis of cost and investment options, with open-ended products.
“This is a welcome boost for the investment company sector, whose low profile in some parts of the adviser community has long been seen as a challenge for the industry,” says Ian Sayers, acting director general of the AIC. “Any adviser wishing to be considered independent will need to consider the investment company sector, and the removal of commission bias will finally pave the way for a level playing field across the investment landscape.
“The review also presents a real opportunity for the many attractions of the investment company sector to be discovered by a new generation of independent advisers. Of course the success of these proposals will partly depend on the number of advisers who elect to follow the independent route, and we very much hope that the benefits of good independent advice are widely appreciated.”
“Advisers that are highly qualified, with a clearly-defined investment process, which is competitively-priced, will be well placed to grow their businesses post-RDR,” concludes Mann. “These businesses are likely to generate recurring income in return for ongoing advisory services and this ultimately will build greater value within the business. There will be challenges along the way, but greater rewards for advisers that can meet these challenges.”
