The ABI’s proposals for factory gate pricing of investment products have so far created rather more heat than light. Part of the problem seems to be the febrile atmosphere created by some commentators arguing that some current business models are broken and the FSA being sufficiently alarmed by these opinions to initiate a major review.
Until the retail distribution review discussion paper appears on June 27, we will not know whether the ABI factory gate pricing proposal has gained much traction. Even then, it is highly likely that the FSA will seek at least another 12 months before coming to a definitive view. That is not much help if you are trying to plan your business for the future.
In reality, any changes to adviser remuneration are likely to take much longer than that to work through because regulatory inter-vention takes time to be absorbed and other market forces such as the impact of changing technology may be even greater.
The first thing to note about the ABI paper is that it excludes protection and mortgage products. This is an odd approach and the FSA might be mindful of the difficulty in scoping the final outcome of its retail distribution review.
In recent years, we have seen that what constitutes suitable advice is sufficiently widely drawn by the FSA that advisers can switch, in a comparatively short space of time from recommending one type of product to another. How many businesses find that mortgage business is above plan, protection static and investment product sales below plan?
Despite appearances, an economist would say that these products are closely substitutable. That economist would also point out that the market for advice is inverted, that is, product providers compete for distributor capacity. They do not compete for end-user consumers.
So, in a world where the ABI factory gate pricing system is adopted without any other regulatory changes, we can expect two main effects.
First, more transparent pricing for investment products would depress their sales further and cause an increase in sales of protection and mortgages over what they would have been. This is because advisers would find the sales of those products relatively easier. Second, since product providers are competitive, we must expect them to compete under a factory gate pricing regime.
The ABI paper suggests that very strong monitoring would be required to prev-ent product provider and adviser manipulation. This suggests a lack of confidence on feasibility.
So, the net effect of simply adopting factory gate pricing on the present scope would be some acceleration of existing trends and a challenge to innovators to regain the effects of the competitive tool given up.
It would be nice to think that the product providers would compete on their quality of service and the value for money of their products. But in inverted markets, service to the adviser might gain some traction. Sadly, service to the consumer will not.
An implication of these risks is that to make factory gate pricing function as its proponents intend, the FSA would have to introduce some very prescriptive and deft rules to deter abusive innovation. It is hard to conceive such rules in advance and as the indirect benefit rules illustrate, they would be problematic at best.
The FSA may prefer to rely on principles. They could do that now with some existing practices but collecting the evidence would be very resource-intensive. Moreover, what kind of industry do we want? Is it one that relies on policing for its reputation or one that serves the interests of customers?
If the FSA agree with this analysis, they should ask the industry to do more work to broaden out their suggestion to embrace a wider range of retail products. If successful, this would head off the risk of further market distortion between investment and other retail products. But it would not address the reality that product providers compete for access to distribution. Neither would it recognise explicitly the impact of technology on the way the market functions. These require a broader ranging approach that perhaps only the FSA can address.
Richard Hobbs is managing director of Beachcroft Regulatory Consulting.