Cicero Policy Briefer

Issue 25, June 2008

The FSA Retail Distribution Review: measuring consumer outcomes

By Mark Twigg

In April 2008, the Financial Services Authority (FSA) published its latest proposals to reform the UK’s regulations covering the sale of retail investment products. The process has already run for over a year, following that now infamous speech in October 2006 by the outgoing FSA chairman, Callum McCarthy, when he first posed the question: is the retail distribution model bust? The RDR has contained many twists and turns since, and the recent Interim Report was no exception.

Having produced a discussion paper in June 2007 which was immediately vilified by the advisor community as representing a meal ticket for the high street banks—what with its overly complicated tiered advice structure containing a new ‘primary advice’ channel which would free advisors from the burden of current suitability requirements—the FSA was somewhat stung by the criticisms and has subsequently rowed back in search of a compromise. Though judging by the some of the stunned outburst in recent weeks the question has been raised; has the pendulum swung too far?

The key issue here is to assess to what extent the RDR will help the market to meet consumers’ advice needs. The FSA has to some extent lost sight of this by framing a debate which is focused more on price and structure of advice, rather than whether that advice actually addresses clients’ needs.

Making all advice ‘whole of market’

The point about structure is highlighted by the debate on insisting on financial advice being based on ‘whole of market’ recommendations. This specific proposal rather came out of the blue and went far beyond what many in industry had anticipated. In truth, this is not necessarily a good measure of an advisors’ independence. Nor is it a guarantee of good quality advice. What would you consider the better advice package: an advisor who offers a product recommendation based on the whole of the market place—but who is then able to skim over, for example, your wider tax and estate planning needs or potential eligibility to means tested state benefits—or one offering products from a limited range but who does so within the context of your wider holistic financial planning needs?

Furthermore, it is not clear whether insisting on ‘whole of market’ recommendations will sit very well with new developments in the retail investment market, the most significant of which will undoubtedly be the creation of the personal accounts in 2012. The Government seems to think that people won’t need financial advice when considering their options for opting in or out of the personal accounts. The common assumption is that the unregulated ‘Money Guidance’ currently in development at the FSA can do the trick. However, deciding how to fund your income needs for the last 30 years of your life is no small matter. Even under personal accounts people will have to decide whether they wish to opt out of the scheme, whether they want to make additional contributions, which funds they wish to invest in, and how they wish to use their fund at retirement. Faced with those choices there may be some—indeed, possibly many —who wish to take regulated financial advice.

Herein lays an important point. For many people, particularly those on low incomes with limited means, their long-term investment needs (and household finances) will not extend much beyond considering an investment in a personal account. If personal accounts form the individual’s major or only investment need, and the personal accounts seek to address those needs on the basis of only a limited range of investment options, then it clearly does not sit very well with the concept of forcing these people on modest incomes to seek more detailed—and more expensive—‘whole of market’ type advice. This new and potential huge market—the Department of Work and Pensions’ own impact assessment suggests that somewhere in the order of £4-7bn will flood into the personal accounts system every year—will need some form of simple financial advice which people on lower incomes can readily afford.

Consumer agreed pricing

The point about pricing is highlighted by consumer agreed remuneration (CAR). It sounds great in theory but in practice, what will consumers make of CAR and how will it materially change consumer outcomes? The FSA is to be applauded for having opened up this debate—but having done so it needs to press in, forming a clear vision in the final feedback statement expected in October. As the FSA has recently made clear, it will not be offering any direction to firms on what sort of pricing arrangements will be acceptable in the new distribution landscape. Speaking on 1 May, Amanda Bowe, head of the FSA review team, clarified that the FSA will allow a rather liberal pricing regime to exist under the new proposals:

 “We are not seeking to end the role for product providers in organising payments to advisers from clients’ accounts or investments.  So we are not stipulating that clients must pay fees by cheque (unless of course they want to), nor are we proposing to prevent product providers advancing payments to advisers and recovering the cost over time from charges on the investment or product. But in neither case can the provider play a part in deciding what gets paid.”

Asking an inexperienced investor to agree a method of remuneration—where the options available may well appear to be complex like those above, and the outcomes of such pricing models may well be poorly understood by consumers—will inevitably be a big issue for the RDR to overcome, given that the FSA clearly sees poor financial literacy to be a major problem in retail markets. After all, they currently have a team of over 100 people devising public policy in this area and it is generally accepted that any improvements in the public’s financial capability are not about to experience a major step-change, but will rather undergo more of a slow evolution. Just how can regulators expect investors to exercise any real power in a marketplace, including issues such as pricing, where information asymmetries (arising from poor levels of consumer financial literacy) will persist for many years to come?

Well over a year into the RDR process we have heard a lot of heated debate about the likely impact on providers and advisors. It is clear now that we need a major push in the next six months to better understand the consumer impact.

Mark Twigg can be contacted on +44 (0)20 7665 9537 or click here to email.