The challenge of abandoning commission

3 June 2010 8:00 am

It has been almost four years since we launched our retail distribution review. Back in June 2006, we suggested that there were serious challenges to be faced in the retail investment sector from growing economic and market pressures which might affect the industry’s sustainability and market structure.

No one could have predicted the market turbulence to come in the following months and years but the need for a sustainable retail investment market - in which consumers justifiably place their trust - is of even more importance today than it was in 2006. And it is the need for change that has continued to drive us in our work on the RDR.

Earlier this year, we reached a key milestone when we published final rules in two areas. From the end of 2012, our new rules will bring to an end the current system of commission in the investment market. Instead of product providers determining how much adviser firms are paid, our rules require that adviser firms take responsibility for their remuneration themselves.

We are also changing the way that adviser firms describe their services. From the end of 2012, all investment advice will be described as either “independent advice” or “restricted advice” and there will be new standards in place to ensure that independent advice is genuinely that - advice based on comprehensive and fair analysis of retail investment products generally.

I would like to take this opportunity to make clear that the new rules on independence do not mean that IFAs will have to recommend more exotic products - such as unregulated collective investment schemes and highly complex structured products - as a matter of course.

Advisers can only recommend products which are suitable for, and in the best interests of, their clients so it makes sense that some advisers may find that they rarely recommend certain products.

What the new rules do require, though, is that advisers consider any retail investment product which could be suitable - ruling out products because they are not right for their clients, not just because they are unfamiliar.

But it is the change to adviser-charging that I want to focus on in the rest of this article.The industry is already making some progress towards our 2012 deadline but many firms still need to give serious thought to important questions such as how they intend to charge for their services. Moving away from commission does not just mean an adviser firm has to pick an amount, or a percentage figure, to charge - it has to ask itself what services it offers, and reflect those services in the charging tariff it devises.

In abandoning the habit of accepting commission set by product providers, some adviser firms will be taking responsibility for the level and pattern of their charges for the first time. This is an important role that has to be undertaken responsibly.

While I cannot overemphasise the importance of firms preparing for the changes to their system of remuneration, I am keen to put at rest the minds of advisers on another score. In requiring firms to abandon commission from 2013, we are not challenging your right to continue to receive trail commission for advice given in the past.

If, at the end of 2012, an adviser firm has a right to receive trail commission, we will not be seeking to interfere with that. And if, for example, an advisory business is sold, our new rules will not prevent entitlements to trail commission from being transferred to the new firm.

Of course, after 2012, it will not be possible to generate new trail commission entitlements and, over time, trail commission will peter out altogether in the investment market.

In requiring firms to abandon commission from 2013, we are not challenging your right to continue to receive trail commission for advice given in the past

Firms that want to generate recurring income by charging their clients ongoing fees need to consider what services they will offer in return for those fees - and to keep in mind that their recurring income will stop if a client chooses to take their business elsewhere. Again, this highlights the important new choices facing adviser firms.

Another practical matter I would like to mention is that of factoring and finance.

Our rules ban product providers from offering amounts of commission after 2012 and only allow charges to be deducted from the product if there is a clear mandate from the client to do so.

We have also banned product providers from factoring - or paying in advance - any money that they have been instructed to pass to the adviser over time. This is because, like commission, such factoring arrangements have the potential to create bias.

Importantly, though, the new rules are not there to constrain adviser firms from seeking out credit on commercial terms. Adviser firms will remain free to take out loans from different firms, including banks, adviser networks and even product providers. But, importantly, any credit received needs to be based on overall income rather than being based on income generated via a particular product provider.

In the future, we will be running a series of RDR roadshows for smaller IFAs to understand what changes they will need to make to be compliant with the new rules - keep an eye on fsa.gov.uk/smallerfirms for details, which will be available soon.

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