Retail Financial Services Gear Up For New Rules - Law Firm
The UK financial regulator is looking to raise standards in the market for retail products, but what do firms such as advisory companies need to think about in preparing for any changes? Experts from Taylor Wessing, the regulatory experts, take a look.
As the UK financial services industry braces for an expected rise in the amount of severity of regulations in the wake of the credit crunch, Taylor Wessing, the law firm, takes a look at some of the issues that companies such as independent financial advisors must confront.
The UK Financial Services Authority, the financial regulator, has proposed to shake up the way financial advisors operate in the UK retail market, to make the sector more efficient and enhance investors’ service.
In a paper known as CP09/18, the regulator sets out a number of objectives: Introduce a new distinction between "independent" and "restricted" advisory services; raise the bar for what constitutes "independent" advice; remove commission bias from the system; ensure advisors agree fees directly with clients on an equivalent basis, prohibit product providers from taking steps to influence advisor fees and raise professional standards for investment advisors.
These initiatives apply to “retail investment products”, which is a far broader class than packaged products and includes unregulated funds, all investment trusts, structured investment products and any other products that link to a pool or basket of underlying assets.
The new and improved distribution culture must therefore be applied across products that have traditionally been lightly regulated.
An end to independent advice?
Advisory firms will face a stark choice between offering “independent” or “restricted” advice. The FSA is prescriptive as to what this means for firms; for example, at a first client meeting a "restricted" firm must say: "I am a Firm X adviser offering restrictive advice, which means that my advice is restricted to advice on [product type / provider restrictions]". Many wealth and private bank advisers will likely wish to avoid this introduction. However, “independents” must meet a new, tougher, test: advice must be based on a “comprehensive and fair analysis” of the relevant market and be “unbiased and unrestricted”.
Firms can limit their independent advice to specific “relevant markets”, but given the narrow FSA examples (ethical or Islamic investments), this approach may not be open to many.
It does not seem that "independent" firms will be able to limit their "relevant market" by product type. In CP09/18 the FSA says it does not "expect to see all advisers recommending products such as structured investment products… as a matter of course. But… if a structured investment product would best meet the client’s needs and risk profile, then an independent adviser should have sufficient knowledge of these products to be able to recognise this and make a recommendation to buy this product."
The implication is that even if independent firms will generally not advise on these types of products (or want to), they will still need to be equipped to do so. Being thus equipped does not come easily or cheaply; the recent downturn has reminded firms of the importance of product selection, due diligence and adviser training and firms will need distribution channels in place with product firms so they can deliver across all of these products.
There are risks to be assessed here. It goes without saying that a firm having to stand ready to give "independent" advice on a product type that it is not fully prepared on is perilous, but the majority of independent firms will now need to meet this test across product types as diverse in source, type, investment objective, risk and duration as unregulated funds and structured products. This will be a challenge for many - perhaps an opportunity for some. - not least as it is not obvious where the "market" is for some of these products.
Independent firms can continue to use broad market-facing panels and models that have a mix of in-house and external products, but this usage must not undermine the “independent” test.
Firms should therefore be asking themselves: can we profitably meet the higher “independent” standard, especially given the wider retail investment products range? Could we coherently limit our “independent” service to a narrower market? What is the cost saving if we accept a '"restricted'" as opposed to '"independent'" model? Is a “restricted advice” label too negative, or can it be used as a positive differentiator? Will we need to update how we use panels and in-house products?
It remains to be seen whether the new labels will really help consumers distinguish between advisory offerings. The FSA's own research suggested the “restricted” label was only the best of the rest, meant different things to different people and was insufficient of itself to support the distinction. There is a danger of us travelling a long way to go not very far.
A change that will take the industry a long way from its current course is the surge towards adviser-driven charging. Advisers must agree fees directly with clients and not vary them without good reason across different product types or providers. A standard tariff sheet will need to be disclosed initially, with actual charges disclosed in cash terms when known. Charging strategies such as trail fees will be prohibited, unless payable in respect of ongoing services or to track regular contributions. In turn, product providers will not be able to offer commission or benefits to advisers, other than a simple facility to allow advisers to be paid out of invested funds (even then, providers will need to validate this with clients). So indemnity commission or other such pre-funding arrangements will have to cease.
What should you be doing about the changes to the charges regime? Advisory firms need to identify what charging method can sustain and even increase market-share. Sales processes and documentation will need to change accordingly. On the other hand, product providers will need to understand how the ban on provider-driven commission will impact sales channels and identify other sales-drivers going forwards.