Cicero Policy Briefer

Issue 18, November 2007

Reforming retail distribution—a view from the regulator

By Amanda Bowe, Head of the FSA Retail Distribution Review

Our aims for the Retail Market are simple and fundamental—to help consumers to achieve a fair deal from the financial services industry and have confidence in the products they buy and the advice they take. We are tackling these issues in several ways, including our work to improve the UK population’s understanding of financial matters; through our Treating Customers Fairly work; and through our implementation of more principles-based regulation.

But we are all aware of some of the features of the retail investment market and the way that products are designed and distributed that make these aims difficult to achieve. It is the problems created by these features that we want to address through the RDR. We’ve always been of the view that the problems are not just confined to one sector, and it is important the review covers all the players—including banks, life insurers and asset managers, as well as IFAs. But the market is also developing and changing, and regulation must not inhibit this: I need only give the example of wraps to illustrate this.

The Thoresen interim report on generic advice published in October further emphasises how the market could change and the environment we’re now in, with more personal and less state responsibility and a gap that needs to be filled by advice, guidance and help with financial affairs.

We have no hidden agenda here, particularly in relation to small firms. Indeed, our announcement in October that we will be enhancing our strategy for small firm supervision demonstrates the importance of these firms to the FSA’s retail agenda—small firms are becoming a bigger part of the FSA’s work, not smaller. And we all know that they play a big part in the future of advice which is only likely to grow in light of some of the developments we anticipate. So we think there are opportunities in the paper for all firms, large and small.

What did the review come up with?

I’d like to focus on the ‘big ticket’ items that came out of the work of the industry groups, which were made up of practitioners and consumer representatives.

Sustainability of the whole distribution market

We’ve put forward some specific ideas for better and more risk-based capital requirements in adviser firms, potentially bringing the approach up to date and in line with the rest of the financial services industry. We want to improve standards of risk management and ensure firms have sufficient funds to cover the risks in their business. Financial resources are the way that exceptional costs, such as those that would arise from mis-selling claims, can be absorbed. It is very much in the interest of the market as a whole that firms can meet these costs from their own resources and not have to call on the compensation scheme the costs of which would be borne by the rest of you. While this is consistent with our requirements for product providers, banks and others, we know that anything we introduce here would need to be proportionate and straightforward.

We also want to find ways to help firms better manage their potential future liabilities. We know that the nature of investment products and the possibility of future action by either the FSA or the ombudsman creates uncertainty for existing firms and makes investment in the sector unappealing for others. We are proposing a couple of ways in which we could help with this by possibly introducing run-off cover for those that leave liabilities behind and by considering a limitation period within which complaints and claims could be made. So far, these seem to be welcomed initiatives.

Raise minimum professional standards

It is important to emphasise here that we are seeking to improve the professionalism and reputation of the market overall, for your benefit as well as that of consumers. This must be a shared aim. All those operating in this market, including bank staff, direct sales forces, independent and multi-tied agents have much to do here as do the product providers who are frequently relied upon by advisors for technical support and help. I am heartened by the efforts of many in the industry already taking these ideas and aims forward. It is important to emphasise that we are not only talking about qualifications in raising professionalism. While we may need to settle on one or other standard to help bring the package together, it might be the case that the market finds the right level appropriate to the roles being undertaken and we then conclude that this level meets our ‘appropriate’ test in a principles-based world. You can be sure that we recognise the importance of considering experience, continuing education and qualifications when thinking about the standards consistent with other professions and so that consumers can have confidence that they are dealing with people who are professionals and who act professionally.

Shifting incentive structures to make the adviser the agent of the customer

This shift is central to our proposals for Customer Agreed Remuneration where we are interested in a variety of arrangements that might meet this principle. We believe that the idea to redefine fees to mean any arrangement agreed with the customer can then include other things such as fund-based fees, factory gate pricing as well as the traditional hourly payments for advice. This is all consistent with the way the market is moving and the way consumers behave. But we need to understand more about the potential impact of this proposal. And it is worth clarifying again that the outcome we are seeking from customer agreed remuneration is not limited to the classic provider/IFA model. We are also interested in how it might apply to integrated businesses such as bancassurers and tied sales forces: how should we address the potential conflicts that also exist in those models?

So, as promised, we are undertaking work now to understand some of the practical implications of customer agreed remuneration. If you have thoughts, experiences, alternative proposals or ideas about these and how to transition from provider-led remuneration to customer-led remuneration, then please do share these with us. These proposals seem to me to provide a positive step forward for the advisor firms, giving greater control over businesses and client base. In turn, this gives more control over income profiles allowing the building of more sustainable and sellable businesses whilst giving customers greater clarity about the value of advice. For provider firms CAR provides similar benefits, allowing a more sustainable business, with improved persistency, more focus on quality products that are right for consumers, and competition based on quality and service rather than commission offered to distributors.

Improve consumer access good quality and economical investment advice

This is not intended to compete with full financial advice but rather to complement it. We presented these ideas in the discussion paper in part to fill what might be a further reduction in the provision of full financial advice and the increase in demand for advice that might arise from the national generic advice service. We would again be keen to hear from you how you think this could work in practice: what could we do to help you provide something to those customers whose wants and needs might not justify the time, effort and cost of full financial advice? We have said that these ideas are very green and that we will proceed with regulatory change here only if we are sure there is both demand from consumers and potential supply by firms. And we are clear that we would not design something that set out to give rise to consumer detriment, as some suggested early on. We can all learn from the lessons of the past.

Feedback so far has been mixed on this proposal—although one common message we have been hearing is the idea that this should not be presented to consumers as ‘advice’ but rather as a product sale and that only those giving full financial advice should be able to hold themselves out as advising customers on their financial affairs. We’ll see what other ideas come back to us during this feedback period.

The role of regulation

We have been up front in recognising that the retail investment market has been regulated for almost two decades, targeted at many of the problems we are seeking to resolve through this review. For example, we have had polarisation and depolarisation, the menu and the IDD, we’ve had wider disclosure and reporting. All of which have been aimed at tackling some of the inherent problems with the long term complex nature of investment products and the relationships that exist within the market. While much progress has been made, we have continued to find problems in the way firms comply with the rules and with the outcomes achieved for customers. This is why we say that regulation hasn’t resulted in sufficient progress towards a more efficient market and one that results in the consistent fair treatment of customers. And we know that regulation needs to keep abreast with market developments, as I’ve touched on already, and with other regulatory influences such as those emanating from the EU. This brings us full circle to why we are undertaking the RDR.

Next steps

Until we have the views from all those in the market with an interest in retail distribution, it would be premature—and inappropriate - for us to express thoughts about how we might proceed. Our feedback statement is likely to be published towards the middle of next year. This will include the feedback from the industry on what was in our discussion paper and findings from our own initial research. It could be that we then formally consult on specific changes to our rules, if required. But it is important to remember that not all the proposals will require regulatory change.

We want to find solutions through working with the industry to get the best package of measures to try and resolve the issues in the market and we hope that you will take up our challenge.

The proposals contained in the DP provide some possible routes for achieving these outcomes. But we know they are not the only routes and options available. They can be changed or set aside with new ones taken forward. It all depends on the feedback we get and the results of our research. If there are better ways to achieve a more efficient market we want to hear these. And we recognise that none of this can be delivered instantaneously—so this is a journey, which may take some time, but is one that I hope you agree is definitely worth taking.

Amanda Bowe is the Head of the FSA Retail Distribution Review and can be contacted here.

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