Oct. 03, 2011
The UK’s Retail Distribution Review (RDR) has been a long time arriving. Zero hour for the end of commission-based advice to private individuals is roughly 15 months away; midnight on 31st December 2012, to be precise.
By that time the Financial Services Authority (FSA) is due to have ceased to be an independent body, with most of its roles, including consumer financial protection being subsumed within the Bank of England sometime in 2012. So will RDR, the FSA’s final bequest be appreciated by a grateful nation?
RDR could usher in a golden age of advising investors without the baleful effects of investment fund kickbacks to advisers. However, in truth, the outlook is not as sunny as that. There are some dangers to the reform process itself; RDR will probably survive these. There are also serious constraints to how radical the reforms can be. These are limitations that the investing public are going to have to live post RDR; hopefully, they will at least be aware that the new regime has limitations and not simply assume that their interests have gold-plated protection going forwards from 2013.
First, the reform process itself: presumably on the basis of why bark yourself if you own a guard dog, the UK Parliament is not legislating the RDR changes itself but allowing the FSA to go ahead with implementing reforms under its existing statutory powers. Given that RDR involves an important change to the way of life of millions of people, potentially, this doesn’t seem quite right. Furthermore, it looks as if attempting reform without an Act of Parliament will end in reducing the effectiveness of the RDR.
The FSA is coming to the end of its independent life little loved by the public at large and, at the same time, the changes resulting from RDR are going to affect powerful interest groups. That RDR will be implemented remains very likely but not a dead certainty. As recently, as July this year, the House of Commons powerful Treasury Committee called for a postponement of RDR ("Fresh Concerns Over Pension Switching" by Josephine Cumbo, FT 20th July 2011) and FSA officials have had to defend themselves before the committee against criticisms of insufficiently rigorous fact finding in the review process.
Questions about RDR’s effectiveness relate more to specific practical limitations rather than the principles of transparency that have inspired the reforms. Firstly, advisers will be able by agreement with their clients, to receive payment in the form of deductions from the client’s holding in a recommended fund. Although the adviser will at least have to make clear the level of the fee being paid in this way and this method of payment is likely to decline in the long run – as investors become more used to up-front fees – this is nevertheless a major concession to the financial advice profession.
Secondly, trail commission (the archetypal kickback) paid from funds to advisers in respect of old (pre 2013) investment decisions will not be banned. Although this form of kickback is generally deplored, as it can correspond to no appreciable ongoing service to clients on the part the advisers, advisers are legally entitled to these payments. One practical consequence of this survival of trail commission is that advisers with a substantial revenue stream from trail commission may be reluctant to recommend fund switches to clients from 2013 onwards. An Act of Parliament might have set a deadline for an end to trail commission payments once and for all.
Another form of kickback, the so-called renewal or legacy commission deducted from contributions to pension fund arrangements might also continue. In this case financial advisers will have the pensions industry to thank for lobbying the FSA that they needed more time to adapt their systems before they could dispense with legacy commission. It’s not clear if the pensions industry want even new pension plans to be allowed to incorporate legacy commission payments or at what point ‘time’ will be called on this kind of kickback entirely.
Lastly, the FSA has stepped back from imposing a ban on kickbacks from fund platforms to fund management companies although it is still considering whether to insist that these payments should be subject to public scrutiny. Banning kickbacks across the board would have been more logical, especially as fund platforms are increasing in importance; this approach is under consideration in the Netherlands.
Despite these limitations to RDR, all is not lost for UK investors. Fee-based advice will take hold and sooner rather than later fund management fees should begin to fall as the potential conflict of interest that trail commissions represent goes into decline. Financial advisers are not in danger of extinction as a species and the better they are in terms of service, the better their chances under the new regime.
One has to bear in mind that the UK reforms are still a big step forward (when they become reality) compared to the status quo and compared to most other European countries. In Germany and Switzerland, for instance, kick-backs for financial advisers are still their biggest source of income. In some instances, courts have imposed more transparency with regard to disclosures to clients. However, the governments of these countries are shying away from clear-cut reforms of the financials advise business. The UK example serves therefore, even though it may not be perfect, as a role model for most countries in the European Union.