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David Ingram: Not recommending product due to knowledge gap not an option

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The FSA’s final guidance on independent and restricted advice was published this month with many advisers and principals hoping they could draw a line under all the questioning and make firm and final decisions over the future nature of their businesses but there are still crucial issues to be addressed.

There is one welcome piece of clarification, with the FSA confirming that where it has “identified high-risk products and recommended they should not reach retail investors in the UK, a firm would not need to consider them for its clients to meet the standard for independent advice”.

This means the FSA’s condemnation of life settlements should ensure firms can safely ignore them – unless they have non-retail clients for whom they believe the plans to be suitable.

This links to the FSA’s oft-repeated statement that it will consult on new rules for unregulated collective investment schemes during 2012 with the intention that it will “make clear our expectation that Ucis will be suitable for very few retail clients, if any”. This is a crucial point.

In a survey which we undertook among over 460 advisers, mostly principals, in the last quarter of 2011, we found 93 per cent of respondents wanted to retain independent status after the RDR, although only 89 per cent expected to be able to do so.

Of the six main models of restricted advice, the one most likely to be adopted by firms not expecting to be independent (54 per cent of those not expecting to be independent) was the multi-tie-style model – using the FSA’s draft disclosure wording: “We (can) only offer products from a limited number of companies.”

This group cited the expense of independence as being their main reason for not remaining independent.

Around 90 per cent of IFAs expecting to be independent is a total reversal of the market’s original expectation that hardly any firms would manage to achieve this goal when the definition of retail investment product was first published. It is, however, very much in line with other current surveys.

However, as things stand, we doubt the figure will be this high. Our own expectation is around 50 to 60 per cent of firms will be independent, using the post-RDR tests, unless the Ucis consultation is: a: widened to include some other complex and higher-risk products, b: produces the result which the FSA expects and, c: takes place soon enough for the results to be known in time for firms to take the results into account.

This is because of the detail behind the requirement to consider the full range of Rips.

There will be many reasons for advisers to decide not to use complex and higher-risk products but for those reasons to be valid, the adviser (just one adviser in the firm would be enough, based on the final guidance paper) will need to demonstrate an understanding of the rejected product(s).

In the survey, we asked advisers whether they had recommended or considered recommending a cross-section of Rips – investment trusts, VCTs and Ucis – in the last 12 months and, if not, what their reasons were for not doing so.

For investment trusts, 65 per cent had not considered making a recommendation in the last 12 months. Of these, 55 per cent stated this was because they had no suitable clients but they would consider the product in suitable circumstances.

This is pretty much the text-book answer and the relevant firms would be able to tick the “consider” box. The remainder had much less relevant reasons, all including the wording: “I would never consider them,” with a worrying 13 per cent stating this was because they had insufficient knowledge of the product.

As the complexity of the product increases, the proportion not considering it increases – for VCT, 74 per cent had not considered the product in the last 12 months, with 54 per cent of the rest giving the textbook response, although only 10 per cent of the “not considered” group cited their own lack of knowledge.

For Ucis, 87 per cent had not considered the product, with just 41 per cent of the remainder ticking the textbook response and 20 per cent saying this was through lack of knowledge.

Not recommending a product because you do not understand it seems like a common-sense option today but that understanding will be necessary after December.

There are currently very few methods of showing you understand the full range of Rips as they do not form part of the exam syllabuses of the professional bodies.

Recognising this, the FSA (in the form of technical specialist Rory Percival) has previously recommended the use of provider seminars to obtain relevant CPD.

The move to fees is a huge issue for many firms. Twenty-three per cent in our survey said they had yet to review their client proposition to ensure it will provide a good service to clients, at a profit, after the RDR. In fact, the figure may be higher than this as 19 per cent said they were still 100 per cent reliant on commission and only 8 per cent that they received direct payments from clients. The remainder still receive some element of commission while 7 per cent receive their income through commission offset.

Given that it can take several years (firms we have spoken to state anything from three to four years) to move from commission to a fee-based model, we believe more firms than expected will struggle to survive – let alone be independent – after the RDR.

So, look out for the Ucis consultation, it could be very important to the future of your business.

David Ingram is a partner at Aim Two, Three

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