Last week the Financial Services Authority (FSA) published the first proposals for discussion from the Retail Distribution Review (RDR). Although these plans do not apply to the mortgage market at the moment, it is possible things will move that way in the future.
Improving standards
The ideas seek to improve the current standards of professionalism, find more cost-effective ways of making advice available to a wider range of consumers, and improve consumer understanding of what they are getting for their money.
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The FSA’s key proposal is that the regulated investment advice market could be divided into two parts giving choices to firms and greater clarity to the consumer.
The first part can be summarised as ‘professional financial planning and advisory services’ – services offered by highly qualified advisers serving consumers who need the full range of advice. The FSA suggests there would be two types of adviser. The most highly qualified could agree their remuneration directly with the customer and not with the product provider as is often the case with commission now. These advisers would be referred to as ‘independent’.
Firms not meeting these conditions and getting commission from product providers could not call themselves independent; increased regulation would seek to address the risks of lower professional standards and potential conflicts of interest.
The other part of the advice market would be termed ‘primary advice’ and would provide advice on more straightforward needs using simple products. This would be cheaper and more easily explained to a consumer than full professional financial planning and advisory services.
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Clive Briault, managing director of retail markets at the FSA, says: “The proposals from industry, consumer groups, trade and professional bodies set out in our paper have considerable merit and are worthy of further exploration and debate.
“To move this ahead, continued engagement is vital. The major changes that have been proposed could have many consequences for the market and a full and lengthy debate during the six-month consultation period with consumers and industry is required. We will play our full part in continuing to facilitate and enable market-led change. Once it is clear that significant benefits can be achieved, this will be reflected in the final proposals.”
Critical
However, many in the industry have criticised the FSA’s proposition to limit the use of ‘independent’ to fee-charging advisers. The proposals appear to suggest you can be ‘independent’ even if your advice does not cover the entire product market. For example, a fee-charging adviser with links to just a handful of companies might be classed as independent – something bound to confuse consumers.
Critics argue there are already too many terms in the financial advice market – including mortgages – and there is a possibility that if more terms are introduced and their meanings are not obvious, consumers will be unsure of what they are getting.
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Chris Cummings, director-general of the Association of Independent Financial Advisers (AIFA), expressed his concerns that a re-definition of the term independent to just advisers charging a fee could lead to a resurgence of tied advisers. He added that consumer detriment would inevitably follow, as consumers faced confusion over what advice they were receiving.
He says: “Unless we are certain we are bringing about improvement and not just change, we need to think very seriously about doing it.
“Independent has come to mean something in the eyes of consumers and it is one of the few brands that we have educated consumers about in that they think advisers will advise across whole of market and not sell at them. I think if we don’t maintain independent as a brand we will have dilution and that is no good.”
Cummings’s views are backed up by a range of commentators and critics. Jonathon Cornell, technical director at Hamptons International Mortgages, says there are already too many terms in the mortgage market and these are confusing borrowers.
“I don’t think regulation helped as we had to stop issuing quotes and start issuing ‘statements of price’ and Key Facts Illustrations (KFI),” he says. “I very much doubt whether any borrower would understand what independent means in the new sense. Brokers can be described as whole of market even if they are working from a narrow panel of the major lenders. “
Consumer confusion
Cornell’s opinions are reflected by David Elms, chief executive of IFA Promotion, who says that the value of ‘whole market’ independent financial advice is long established and well recognised and the RDR’s proposal to change this definition to allow non- whole of market advisers to use the independent label is likely to lead to increased consumer confusion.
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Research by IFA Promotion’s website, unbiased.co.uk, shows that two-thirds of consumers believe ‘independent’ in the context of ‘independent financial adviser’ means the ability to have unrestricted access to the whole of market. Only one in 12 believe ‘independent’ means that the adviser does not receive commission.
“Many published pieces of research over the last 10 years have pointed to the fact that only a small percentage of consumers believe independence should be based on the payment method,” says Elms. “The vast majority of consumers believe that the term ‘independent’ should only apply to those advisers that can offer advice on products available across the whole of the market.”
HSupport
However an independent report commissioned by the Chartered Insurance Institute (CII) Group supports the FSA’s proposals. The report shows CII members strongly advocate a framework to raise standards for the public benefit and encourage professionalism and trust across the intermediary sector. Among many recommendations, the CII report suggests clearly defined tiers of service from professional through to primary or generic advice.
The Association of British Insurers (ABI) also supports the FSA’s proposals. In particular, the ABI has recommended that the role of commission be reduced and that the training and qualifications of advisers should be strengthened.
Bypassing mortgages?
Clearly at discussion stage, the RDR is currently focused on the investment world and there no plans for this to automatically read across into mortgages, unless called for by the market. It would be wise though, with the way things usually happen with the regulator, for the mortgage industry to keep an eye on what happens with the RDR as the changes could easily be widened to the mortgage market sometime in the future.
However, the Association of Mortgage Intermediaries (AMI) is hopeful that the RDR will bypass the mortgage sector for now and says there is no current expectation that a division in the investment market would necessarily follow through to the mortgage or general insurance advice sectors.
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Despite this, AMI and sister trade body AIFA have viewed the RDR as an opportunity to inject some new thinking into old problems, saying it is vital that all parts of the advice profession contribute to advancing a clear agenda for improving its reputation, professionalism, and explore new ways to ensure fair and appropriate remuneration. Indeed, AMI has been an active participant in RDR working groups though AIFA – whose chairman, John Gummer MP, believes the RDR has the potential to bring about the largest shake-up in the sector since the passing of the Financial Services and Markets Act.
Tracy Mullins, director of public affairs for AMI, says: “There is little mention of the mortgage market in the paper apart from the fact mortgage brokers might move into the primary advice market, which we have severe concerns about. It is not good news for the middle-market adviser, who could be squeezed out.”
Transparency
Looking at the aims of the review, high on the list is transparency and David Hollingworth of broker London & Country, says there will be no complaints from customers over detail being as clear as possible.
“Having said that the mortgage industry is already transparent. In the case of commission, a key part of the review, any fee paid by a lender is clearly stated on the individual KFI and importantly does not affect the price of the product versus buying directly from the lender.
“The biggest danger in pushing the advice market toward a fee-charging basis is the impact it will have on the availability of advice and the shrinkage in number of borrowers benefiting from mortgage advice.”
Since mortgage regulation came into effect in October 2004, it is at least clearer to the consumer before they buy what service they are getting as the Initial Disclosure Document (IDD) states in clear terms whether their adviser is searching the whole mortgage market or just a panel. The IDD also explains whether advice is being given or just information.
“However, often by IDD stage, the wrong impression has already been given by the company’s name or tag-line,” says Katie Tucker of John Charcol. “The FSA has unfortunately defined terms slightly differently to how consumers interpret them. ‘Independent’ is commonly understood to mean ‘searching the whole of the market’ when it in fact means that the broker has to offer a fee option. The FSA says that ‘whole of market’ can be used even if you are not selling from the whole of the market but use a ‘representative’ panel. It would be easier for consumers if the FSA’s terms themselves were clearer, fairer and less misleading.”
A retrograde step?
From an investment point of view, the proposed introduction of ‘primary advice’ will also enable advisers using the Customer Agreement Remuneration system to jettison the requirement to scour the whole market for the most suitable product and sell just a limited range of investments. Fidelity International says that if the contents of this paper were implemented today, advisers could receive higher remuneration, based on a narrower product set and still call themselves independent – and this would be a retrograde step.
“Primary advice also requires what the FSA describes as ‘simple’ products, but its approach looks overly simplistic and could open the door to mis-selling. An index fund is simple to explain but that does not make it low-risk,” says Richard Wastcoat, UK managing director, Fidelity International. “Under the criteria outlined in this paper for simple products, with-profits bonds would qualify. Even the FSA’s own example – guaranteed equity bonds – have been controversial. The paper appears to give the game away when it says although primary advice might not always lead to the most suitable product recommendation, it should lead to consumers purchasing a product that would provide more benefit than if they had not made any purchase at all.”
Despite widespread belief that the proposals will result in consumer detriment, there are some in the industry that believe some of the issues discussed in the paper are being approached the right way, although there are still some issues – such as the number of ways consumers can get advice and the terms banded around – that need to be clarified.
Essentially it could be argued that the problem is not the use of the word ‘independent’, but the fact there are so many layers of advice and so many terms used that clients do not understand what they are getting.
“The requirements for independence is for an intermediary to agree the charges with a client before going ahead with the work. If intermediaries are doing their job properly, whether they are charging a fee or commission is irrelevant,” says Ashley Clark, director of Need An Adviser.com. “You are either independent or you’re not. ‘Independent’ is a powerful term and should not be thrown away. I agree with the FSA to a certain extent of starting to focus it down, but we should already have our fees agreed with the clients. Introducing more terms is not going to help consumers.”
The RDR was launched in June last year by FSA chief executive, John Tiner. The problems in the retail market were also highlighted by FSA chairman, Callum McCarthy, in a speech made at a Savings & Pensions Industry Leaders’ Summit in Gleneagles last September.
During the six-month consultation period, which ends on 31 December 2007, the FSA will be actively seeking the views of industry, consumers, and trade bodies as well as undertaking further research. The FSA aims to publish a feedback statement in Q2 2008.
