Should IFAs get discretionary permissions?


More advisers are looking to bring investments in-house, experts are predicting, but barriers to entry can be tough to overcome.

Events such as the commercial property saga of last year and disappointment with some external discretionary fund management firms are cited as some of the reasons why advisers would prefer to have more control over clients’ money.

But the need to achieve scale and pass regulatory hurdles such as Mifid II reporting standards could slow this trend.

So how many advisers think they have the necessary skills and confidence to take care of investments themselves? And at what price?

Grey areas

According to Platforum data 16 per cent of IFAs have discretionary permissions and 11 per cent of firms plan to get them in the next five years.

The proportion of outsourced advised assets, however, has almost doubled in the past four years, rising from 18 per cent in May 2013 to 30 per cent in April 2017.

Platforum head of intermediary research Miranda Seath says the IFAs that are using in-house expertise to run the money are doing so in order to make quicker decisions, take a greater share of fees and bolster their professional credentials.

Once they obtain permissions, Hallen Investment Services consultant Raj Hallen says IFAs could be able to compete against multi-managers and funds of funds.

He says: “Part of the reason to get permissions is a tactical play, like before Brexit when DFMs came out of sterling or commercial property.

“IFAs want to get discretionary permissions so they can apply decisions quickly and not email their clients all the time to protect or increase capital.

“Also, some IFAs may have been disappointed in the past by a DFM and maybe decide to do it themselves now with an additional fee.”

Strategic Solutions managing director Kevin Forbes says firms need to make it clear whether they are offering discretionary or advisory services.

He says: “Advisers with a centralised investment proposition may fall in that grey area between discretionary and advisory and that can be an issue.

“Some firms I know used to send out mails and switch clients without responding to them so I think there is a grey area where some get caught which we need to make sure it doesn’t happen.”

Nearly a year ago, Strategic Solutions started managing clients’ money with the launch of its new DFM business Casterbridge Wealth. Since launch in December 2016, it has taken on £150m in assets.

Forbes says: “We set up a separate company so other firms could use it, which they do already, without them thinking we are a vertically integrated firm.”

Can advisers manage money?

The risk of conflict of interest that can come from integrating advice and investment management is what leads some firms to set up separate entities or hire qualified consultants and investment managers.

Forbes notes that conflicts of interest can arise within some of the big non-independent DFMs.

He says: “So many DFMs out there get owned by large investment houses and I think there is a conflict of interest in the way they are charging too, such as Intrinsic running at a loss but Old Mutual not caring because they use Quilter Cheviot.”

Progeny Group managing director Neil Moles says including investment management within an IFA firm is a way for advisers to justify higher fees, but won’t necessarily result in better outcomes.

He says:What’s driving more advisers into asking for discretionary permission is vertical integration but that’s not the best outcome for clients. There are people far better than us at managing money.

“I am so thankful Vanguard launched in the market earlier this year in their direct platform, not that they will take all the business, but it challenges cost.”

Progeny Group, a national wealth manager with £800m assets, has a centralised investment proposition using Vanguard and Dimensional funds and a panel of DFMs. It also has discretionary powers to rebalance portfolios.

Moles says: “Charges are the problem with advisers, and how they justify their fees. They justify that by talking about investments. That’s not financial planning.”

Regulatory roadblocks

Experts argue the regulatory process to get discretionary permissions can become an obstacle for firms, especially in light of the upcoming MifidII requirements.

7IM head of platform Verona Smith argues size is one consideration to make before considering going in-house, but having an high level of compliance expertise is more important.

She says: “The firm needs to look at what they deliver to their clients, what their clients value and how they can achieve their objectives and then decide if outsourcing is for them or not. A major consideration will be the ever changing regulatory environment and specifically the impact of Mifid II.

“We have been seeing a number of the firms using the 7IM platform apply for their discretionary permissions and successfully embedding this within their client offering. Many other firms we work with have decided to outsource and again we have seen this successfully achieved.”

But Moles argues high capital requirements will put off many from making the change.

He says: “Firms such as Mattioli Woods and others are all going that discretionary route but it will fall apart as it did in the past. Thankfully it is very hard to do.

“Capital adequacy means that most firms can’t afford to do it as three months fixed cost is a lot to hold in cash for larger firms, so there’s a good barriers to entry but a lot of people are trying.”

Seath adds: “Under Mifid II, the new rule about notifying clients within 24 hours if a portfolio falls 10 per cent or more has been interpreted by some to apply to the holders of discretionary rather than advisory permissions. The discretionary firm would therefore be responsible for compliance.

“So for advice firms of a certain scale, likely to be £1bn assets upwards, buying a DFM might make more sense.”

Forbes says the set up of the DFM for Strategic Solutions wasn’t an easy task and argues it is more challenging for small firms.

He says: “We’ve spent hundreds of thousands of pounds to build it, a lot more than we thought. People who want to go through this route need big pockets.”

Forbes says there are firms also “struggling” to get permissions when they had a history of mis-selling products.

Forbes says: “It’s harder because there’s been a few DFMs recently that have been selling a lot of toxic products, a few have been shut down recently because they’ve filled themselves full of unregulated investments to just get back [into business] and that has spoiled the situation for everybody.

“The FCA liked us because we picked up the phone and talked to them instead of just sending legal letters, which seems disingenuous.”

Expert view

The questions to ask when going discretionary 

There are two ways for an adviser firm to seek and gain discretionary powers. Most apply to the FCA for a Variation of Permissions for their existing business. Some others may choose to set up a separate investment management company.

Applying for VOP is more cost effective and can be a quicker route to gaining the new powers, as it can cost £2,500 and the FCA have to authorise or decline the application within 180 days after acknowledging receipt of the VOP. Succession Advisory Services were granted VOP approximately 4 months after submitting their application.

The FCA takes a year to authorise or decline a new entity and the application costs for this are £5,000. Firms may wish to go down this route to keep the VAT issues separate and leave a clear business audit trail as the intermediation of advice is not subject to VAT whereas the discretionary service is.

You also need to have a Level 6 CF30 person with discretionary experience in place as this will help to expedite the process.

Generally, relying on an internal member of staff is not sufficient even if they have a level 6 qualification. I know of a business that was not granted discretionary powers as they relied on an internal member of staff who had a Level 6 qualification but was not deemed by the FCA to have the adequate required discretionary experience. Unfortunately they now cannot reapply for these powers for 18 months from the date they were denied approval for discretionary powers.

Some firms take on a CF30 with discretionary experience to be paid monthly rather than have the expense of employing an experienced discretionary manager on a full time basis.

Once you have been granted discretionary powers, you will need to communicate this to your clients and what this means to them. The best way to do this is at client annual reviews. The client can also sign the new discretionary management agreement at this stage.

The majority of clients will sign the agreement but it may take a year or more for a firm to get to this stage depending on the size of client bank.

If you offer a discretionary service you can charge a small discretionary fee, so you can increase the revenue streams which increases the value of the business.

Some companies can reduce their holistic planning fees if they apply these ones. They are driving the costs down, which is what the FCA is focusing on.