When the champagne corks pop on January 1, 2013, we will be welcoming in not only a new year but also a new era in financial services.
Assuming the retail distribution review can clear the final hurdles and avoid any last minute stewards’ enquiries, the date will mark a fundamental shift in the way in which investment products are sold in the UK.
As it stands, the financial industry faces some pretty significant challenges. There is a lack of trust, awareness and understanding, leading to poor perceptions in our marketplace. This ultimately leads to a lack of engagement.
For example, a survey in 2007 by the Personal Finance Society showed that only 14 per cent of respondents thought the financial adviser market was professional. This compared to the 48 per cent that saw accountants as being professional, while for doctors the number was as high as 74 per cent.
These results must be taken with a pinch of salt as the sample was taken from across MPs, whose own reputation over the last couple of years has fallen to new lows. Nevertheless, this is not the kind of perception we aspire to for our industry.
The RDR will introduce a number of new requirements, one of the most significant being the banning of commissions. The payment of commission for financial advice is seen as the single biggest inducement in the market today.
Plenty of evidence exists that suggests this is a valid area of concern. If you look back to the heady days of the insurance bond market, for example, sales in this product line outstripped those of equivalent direct mutual fund investments, even though the relative tax advantages of each product suggested the trends should be rather different.
In this case there appeared to be a positive correlation between the levels of commission paid on certain products and the levels of sales achieved for them.
The introduction of adviser charging will remove such inducements and many adviser firms now already work on a fee basis. These firms are more agnostic about the products they sell, whether it is an exchange-traded fund, investment trust, cash deposit or active mutual fund. This is because the fees they receive will not be linked to any of these products.
Adviser charging should create a level playing field for how products are distributed, meaning product providers will no longer be able to create any biases towards particular products or services. But is it naive to suggest this will sound the death knell for product biases?
I would argue that the RDR should focus not only on removing inducements caused by commissions but also on other activities that can cause potential biases. It would be unfair to force the majority of the adviser market to move into a new fee-charging model while new alternative commission-type models were also arising elsewhere. Indeed, there is a risk that with the banning of commissions, other models will emerge that provide commissions under different guises.
Therefore, for the RDR to achieve its objectives it should focus on all kinds of inducements that can create biases in the marketplace, monetary or otherwise.
One area that has received a lot of attention has been the development of distributor-influenced funds.
These are not inherently poor structures. Used properly, these vehicles could provide very efficient, open architecture solutions to a broad range of customers. They could offer efficient portfolio management services that in many cases will be more tax-efficient than managing individual funds.
But these structures will require careful management of potential conflicts of interest and therefore need tight controls. It will also be important to ensure that fee and remuneration structures are not used as a mechanism to drive additional fees or replace lost commission.
There is a risk here, however, that complex shareholding structures could arise that allow the payment of royalties. Effectively, these would just be commissions in another guise and would also have to be curbed. Although the FSA has been wary of these vehicles, there are many that already exist in place in the market and which are managed on exactly such a basis.
These funds do have a place in the market but the FSA is right to focus attention on the risk that they might simply be used to replace lost commission.
Shareholding structures between providers and distributors pose another risk.
Only by increasing levels of trust, improving professionalism and creating transparency will we be able to improve the perception of our market
I would not want to suggest that product providers and platforms should not be allowed to have any shareholding in an adviser firm, or vice versa.
For some advisers firms, owning and controlling a platform may be a preferred structure that allows greater control over the value chain and for the provision of enhanced propositions.
But it is also clear that this model has the potential to cause other forms of inducement or bias.
The regulator should be looking closely at this structure to ensure no other remuneration models develop that provide dividends, royalties or other back-door payments, again simply replacing the commissions previously being paid.
The restricted advice market could also be open to abuse. Granted, there will be additional disclosures required for advisers that are operating this model but some biases could still exist in the marketplace.
Restricted advice offers a mechanism for advice to be provided outside the whole of market basis, with some level of restriction on either the range of products or advice services offered.
For the RDR to succeed it must continue to allow independent financial advisers to thrive. If the restricted advice model becomes the de facto standard simply because it allows more exclusive relationships to be developed, again the RDR may have failed to remove some of the biases that have cast our industry in a bad light.
Non-monetary inducements exist in many forms, for example, training courses received for free, technology services provided at no cost and corporate entertainment that does not really add value to a business relationship.
The FSA has all such practices in its sights as it looks to address areas where conflicts of interest can arise.
It is important to understand that while the majority of our market looks to embrace the new world of remuneration, models might be developed that keep matters more opaque, with little in the way of disclosure. This risk should be as much a focus for the regulator as the issue of commission.
As an industry we need the RDR to achieve its original objectives. Only by increasing levels of trust, improving professionalism and creating transparency will we be able to improve the perception of our market.
Achieving these goals will be good for both the growth prospects and the reputation of the industry and for all those who work in it.