In its final report on the asset management market study, the FCA has signalled its intention to investigate the firms which control the flows of money between investors and asset managers.
It will focus on platforms’ and advisers’ influence and the impact on competition. Sensibly, it is treating the provision of investment management services, such as asset allocation and model portfolios, in the same way that it dealt with more obvious asset management functions.
However, talk about the FCA considering turning off all pre-RDR trail commission seems to have gained the most attention.
Subsequent online comments from advisers complaining about the development ensued.
A number pointed out the inability of providers to facilitate adviser charging, clearly concerned that they might be required to ask the client for a cheque. Others protested that providers would just keep the trail so the client would not benefit, overlooking the fact the FCA’s initiative is precisely to eradicate “dirty” share classes.
I find it hard to envisage a consultation process that would not require a life and pensions product to be enhanced proportionately. One consolidator bizarrely suggested switching off trail on funds would be illegal.
But the majority opined that trail was generated in return for servicing, and, since they still were, it should not be removed. Frankly, the entire edifice of adviser charging in the industry is based on the myth that trail was and is a payment for service. It was not. It was, and remains, at best an inducement and at worst a bribe.
Lest we forget, a “commission” was a reward for the introduction of a customer’s money to a product provider, not a fee for advice. The product may have been underpinned by investment funds but the commission was attached to the product, not the individual funds.
If you advised and did not sell a product, you did not get paid unless you had the gall to ask the customer to. Of course, virtually no one did. The client thought the advice was free. Some businesses laudably disavowed initial commission, indemnified or otherwise, and took them on the drip in the form of an ongoing renewal payment instead. But the clue is in the name. If the premiums were not renewed, irrespective of ongoing service levels, the payments ceased. Advice was a coincidental activity. Maintenance of the contract protected earnings.
Trail commission on unit trusts (Oeics did not appear until 1996) was first paid in the late 1980s. The launch of personal equity plans increased appeal for direct investments (that is, not wrapped in investment bonds) but the maximum investment was only £2,400 – equivalent to around £6,500 today.
At 3 per cent initial commission (or, as the industry preferred, “marketing allowance”) that was not a great reward for the sales effort. As if to compound the industry’s problems, it was hit by the 1987 stockmarket crash, which decimated sales of collective investments.
The unit trust world believed Peps’ tax-free status would encourage longer holding periods. If an adviser could sign up a regular contribution Pep with trail commission, he or she would get a much greater future income stream and it would be worth the struggle to sell regular contributions.
The inevitable result was that trail became ubiquitous. If you did not pay trail, you got no business. Trail was not added onto the price; the industry sacrificed a third of its margin to buy investment capital from intermediaries who would otherwise have stuck to high commission investment bonds.
Trail became an embarrassment that required justification, hence the invention that it transmuted into a fee for ongoing advice. Pointedly, under the FCA’s current rules, advisers do not have to provide an ongoing service for the trail commission. However, in the consultation process, the regulator has been informed that some clients are paying for trail commission on an investment product, while separately paying for advice.
Asset management market study respondents have also suggested trail commission payments may act as a barrier to competition and value for money. Where disturbance would otherwise switch off trail, those investments may remain in force irrespective of their efficacy.
Post-RDR, with no trail on new business, intermediated “clean” share classes devoid of trail payments should be the standard for all customers, legacy, intermediated or otherwise. However, fund managers have been faced with two barriers to migrating legacy money to clean share classes: unresponsive clients and threatening advisers.
Remarkably, until the study fund groups required a customer’s explicit consent to move money. The FCA has now allowed managers to move those unresponsive clients.
But for intermediated clients paying for full fat share classes, since there is no contractual requirement for fund groups to pay trail, they could just turn it off.
However, many asset managers’ responses reflected fears that, by switching off trail, they would lose future business from the associated advisers who would protest they were still servicing the customer. Fund managers want to get rid of trail, but they are looking for air cover from the regulator.
Commission still casts an ugly shadow over the market. It is time to eradicate it once and for all. That said, the regulator is keen to ensure there are no unintended consequences to enforcing a sunset clause. If you feel strongly either way, you should respond to the consultation process here.
Graham Bentley is managing director of gbi2