Retail investment reforms are a call to action for the industry, says FSA

The Financial Services Authority's proposed new rules for theretail investment industry will impose a complete ban oncommission-based sales and require firms to tell customers from theoutset whether or not their advice is independent and how much itwill cost.

Investment advisers, whether independent or not, will have tomeet higher minimum standards, overseen by a Professional StandardsBoard, and abide by a new Code of Ethics that will ensure they actin the best interests of each customer, according to the plans.

The measures are set out in the FSA's long-awaited consultationpaper on delivering the results of the Retail Distribution Review(RDR). They will affect all regulated firms involved in producingor distributing retail investment products and services includingbanks, building societies, life insurers, wealth managers andfinancial advisers.

Announcing the proposals on 25th June, Jon Pain, the FSA'smanaging director of retail markets, said:

"The RDR is about regaining consumer trust and confidence in theretail investment market, building a more sustainable sector andmaking it easier for people to find their way around and get thehelp they need – this is more important now than everbefore.   

"We have today set out the specific changes we propose to maketo implement our far-reaching package of measures.  This is acall to action for the industry - all investment advisers need toconsider how they will respond and implement these wide-ranging andchallenging improvements by the 2012 deadline."

Clarity

Many of the proposed changes were outlined by the FSA inNovember last year. The requirement for firms to disclose inwriting the nature of the services they provide before giving anyadvice, for instance, is not new.

But the FSA has taken on board the need to make the categoriesof advice more easily understood. As a result, all firms sellingretail investment products must clearly describe their services aseither "independent" or "restricted".

The concept of independent advice remains unchanged from earlierproposals. To qualify as independent, an adviser must carry out acomprehensive and fair analysis of the whole of the relevant marketand provide unbiased and unrestricted advice.

The paper, however, gives some guidance on what is meant by therelevant market. Advisers operating in a relatively narrow field,such as retirement planning, need only review that specialistmarket to be able to give independent advice, as long as they makethis clear to the client from the start.

But for the majority of independent financial advisers (IFAs)who offer a non-specialised service, the new rules will mean theywill have to consider all retail investment products capable ofmeeting the client's needs before making a recommendation.

For many firms, this will mean covering a much wider range ofproducts than they do currently. Even more so because the FSA isproposing to widen the definition of retail investments beyond"packaged" products to include all retail investment products bestable to meet the client's needs.

Firms that use panels can still hold themselves out as providingindependent advice, providing the panel is sufficiently broad incomposition and regularly reviewed. And where the analysis of themarket is carried out by a third party, the firm will beresponsible for ensuring that analysis is suitably robust.

Restricted advice

For all non-independent advice, the FSA has chosen a newumbrella term, "restricted advice". This label covers firms thatadvise on their own products or on a limited range of products,such as bank advisers and other single-tied and multi-tied adviserfirms.

It also includes "basic advice" – streamlined advice oncharge-capped stakeholder savings and investment products, oftenprovided by supermarkets and other retailers.

"Guided sales", which the FSA now calls "simplified adviceprocesses", where the adviser provides a personal recommendation toassist consumers in making straightforward investment choices, canqualify as independent if the advice satisfies the whole of themarket test, but otherwise will be restricted advice.

Firms providing restricted advice must disclose this in writingand orally to the client in good time before providing the service.Importantly, those offering a restricted advice service (includingsimplified advice processes) will be required to meet the sameminimum professional standards as independent advisers. 

The FSA, however, does not intend to impose the samequalification requirements on firms offering "basic advice". In addition, it is not planning to make any changes to the currentregime for non-advised services, also known as execution-onlysales, where no advice or recommendation is given.

The cost of advice

The paper sets out in more detail the FSA's plan to introduce"adviser charging" for all independent and restricted advice,except basic advice services.

Instead of earning commission paid by the product provider,advisers will set their own charges and agree them with thecustomer from the outset. If the total cost is likely to differsignificantly from the firm's standard price list, this must bedisclosed as soon as practicable.

How advisers charge for their services – whether by fixed fee,an hourly rate or a percentage of funds invested – will be up tothem. But the paper warns that charges should not vary"inappropriately" according to the product or provider the firmrecommends.

Consumers can pay the charge upfront or choose to have itdeducted from their investment. The FSA will be consulting furtheron the responsibilities of providers offering this facility, inparticular to ensure that the adviser cost and the cost of theproduct are clearly differentiated and that payments deducted tomeet adviser charges are passed on in full to the firm.

Providers will no longer be able to advance finance to advisersout of their own funds (known as "factoring") as the FSA believesthis could influence the products firms recommend to clients. Andto reinforce the message, product providers will be banned fromoffering commission to secure sales and adviser firms fromrecommending products that automatically pay commission as from theend of 2012.

The FSA asks for views on applying the principles of advisercharging to providers who sell products directly to consumers. Theregulator believes this would create a level playing field betweenfirms selling their own products and firms giving advice.

The paper also asks for comments by 31st July on whether advisercharging should be applied to corporate pension schemes, both incases where advice on joining the scheme is given to individualemployees and where no such advice is given.

Inducements

The consultation also promises a tougher stance on inducementsgenerally. Rather than relying on firms' general duty to act in thebest interest of their clients, the FSA is proposing to be moreexplicit:

"For example, we want to be clear that we will not in futuretolerate retail investment product providers offering anyincentives to adviser firms that are not explicitly designed toenhance the services to the client," the paper states.

Any significant non-monetary benefit offered by providers, suchas access to trading programmes or the free provision of softwaresuch as customer relationship managing systems, would have to bemade widely available rather than being used to reward or influenceparticular firms.

The regulator will also be looking more closely at firms'internal payment structures and incentive schemes to make sureperformance is not solely measured in sales or weighted in favourof a particular product or provider.

Impact

The FSA estimates the initial cost of complying with the newregime at £430 million and subsequently £40 million a year,annualised at around £140m over five years.  This representsapproximately 0.3% of annual gross new business premiums and 1% ofindustry profits.

But Bruno Geiringer, a life insurance specialist at PinsentMasons, the law firm behind OUT-LAW.COM, warned that the changescould result in a dramatic fall in the number of independentfinancial advisers over the next few years.

"The price to pay for these improvements is likely to be a heavyone in the short term," he said. "The move to adviser charging willhave a significant effect on many firms' cash flow, and higherprofessional standards combined with the need to search the wholeof the relevant market could force many advisers to drop theirindependent status or leave the market altogether.

For those advisers – independent or not – that remain, therewill be additional costs in terms of capital funding requirements,systems development, retraining and new documentation," headded.

Wider application

At this stage, the proposals are confined to retail investments,but the FSA says it is considering the benefits of a widerapplication into the general insurance and mortgage markets toinclude the sale of pure protection products (life term, criticalillness and income protection insurance) and payment protectioninsurance (PPI).

Respondents have already expressed concerns that advisercharging will not work in these areas because consumers will simplynot be prepared to pay for advice. The FSA's concern, however, isthat not applying the principles of RDR could shift sales fromretail investments towards protection products and PPI, whereadvisers could still earn commission.

The FSA will be carrying out further research and analysis inthis area and will publish a report in early 2010. Additional workwill also be undertaken on whether detailed requirements are nowneeded to regulate the market for platforms and fundsupermarkets.

Timing

The consultation closes on 30th October. The FSA plans topublish its final rules early in 2010 and for the new regime totake effect from 31st December 2012.

This timescale causes Bruno Geiringer some concern. "The marketidentified the problem of commission bias as long ago as 1984 andonly now have proposals been put forward to address it," he said."The FSA now proposes to introduce the changes without any pilotscheme or market testing by the participants.

"Some changes are unquestionably right, such as the newprofessional standards, but others still need further refinement,"said Geiringer. "I hope the industry will take the opportunity torespond positively to this consultation to make the RDR workeffectively in practice".

Want more content like this? This story was written by the insurance and reinsurance legal experts at Pinsent Masons, the law firm behind OUT-LAW.COM. See our .

http://www.out-law.com/

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