Is advice still a ‘loss-leader’ despite FCA rules?

Concerns have been raised about how effective the FCA’s cross-subsidy rules are in stopping vertically integrated firms from running advice propositions at a loss and propping them up through product and platform charges.

Rules for vertically integrated firms were introduced under the RDR to stop them “unreasonably” cross-subsiding the cost of providing advice from other parts of the value chain, for example, through their products.

Firms would no longer be able to pitch advice as a “loss-leader” that would get investors to buy their own products.

The FCA stated “the allocation of costs and profit between the adviser’s charge and product cost should be such that any cross-subsidisation is insignificant in the long term”.

In December the FCA proposed “long-term” should be defined as no longer than five years. New entrants to the advice market may be allowed a more generous payback period if it would take longer to make the returns on their initial capital.

The FCA said: “By removing uncertainty on the meaning of long term, we expect to see more firms investing in advice services which will increase competition for consumers seeking advice.”

The regulator has also clarified advice charges have to cover the “total” advice-related costs, so firms have to ensure they cover overheads that were split between their advice and other services.

Platforms also fall under the rules if they make personal recommendations on their own products.

We would not be in a sitation where we broke the rules. Our board would not let us and the FCA certainly would not

The consultation on the updated cross-subsidy rules has now closed. It received just six responses, according to the FCA. The rules will come into effect shortly subject to board approval.

Loss-leaders linger

But it seems looking at advice arms in vertically integrated propositions, some could still be interpreted as loss leaders, or at best as making a negligible contribution to profit.

Money Marketing recently found St James’s Place advice arm, SJP Wealth Management, has made increasing losses since at least 2012. Losses in 2015 stood at £25.7m compared with profits for the overall group of £140.6m in 2016. SJP declined to comment.

Old Mutual-owned advice network Intrinsic is also making an overall loss.

Intrinsic Financial Services is the parent company of Intrinsic Wealth, Intrinsic Financial Planning, and Intrinsic Mortgage Planning.

Intrinsic Financial Services reported a total loss of £11.5m in 2015.

The firm’s accounts noted: “As a result of continued emphasis upon growth in the network from recruitment, together with the attendant investment in infrastructure to support the advice business which it services, the company is continuing to report losses.”

The losses for the wealth business were £1.3m.

The financial planning business lost £1.28m in 2014, but returned to a £984,000 profit in 2015. Advice profits have come in below £1m going back to 2012 and the mortgage planning arm made a profit of £1.4m in 2015. These figures compare with an overall Old Mutual Wealth profit of £307m.

Intrinsic chief executive Andy Thompson says losses are due to reinvestment in the business and do not represent a permanent cross-subsidy. He says: “We are very conscious of the fact the rules are there. It’s not only what would be required of us from a regulatory point of view, it’s just good business that you need to make the advice business stand on its own two feet and actually make money.

“Is there cross-subsidy going on? You have short-term advice losses funded through manufacture, which breaks even over a period of time, versus a situation where a parent is investing in a business, either as they have just acquired it, or see it going through some kind of transformation or transition with the business funding for growth. Those are two different things and it’s important we are clear on which is which.”

Thompson says Intrinsic has an annual meeting with the regulator regarding its business plan, and three other personal meetings during the year, in which compliance with the rules will be confirmed.

He says: “We certainly would not be in a situation where we broke the rules. Our board wouldn’t let us, neither would our parent company, and certainly the FCA wouldn’t.

“When we are sitting down with the regulator having those conversations I can assure you those conversations are appropriately challenging. You might get away with it once but no more than that.”

Marketwide implications

SJP and Old Mutual Wealth are not the only vertically integrated firms that would need to be aware of unwarranted cross-subsidy.

Though it does not consider itself a vertically integrated firm, Hargreaves Lansdown owns the Vantage platform, has a range of products and employs around 100 advisers. It makes around 75 per cent of group operating profit through Vantage, with a 46 basis points profit margin on platform business in 2015.

Standard Life, Aviva, Prudential and Zurich all have significant stakes in multiple parts of the value chain, where structures that would face cross-subsidy implications could be any parent company transactions, asset management, direct-to-consumer or advised platform, or discretionary fund management services

The Lang Cat consulting director Mike Barrett says: “It’s probably easier to list the firms who are not doing some kind of vertical integration.”

FCA action?

Firms the size of SJP, Old Mutual Wealth and Standard Life will be on a permanent supervision account from the FCA, meaning they will have oversight from dedicated staff members. Money Marketing understands, as part of the regulator’s usual supervisory activities, staff reponsible for vertically integrated firms have to maintain oversight of how firms comply with all aspects of the adviser charging rules, including cross-subsidisation.

The FCA says it cannot comment on any specific actions taken regarding cross-subsidy rule breaches, though it has the power to withdraw authorisation, issue fines, or even bring criminal prosecution if unauthorised business was conducted alongside cross-subsidy breaches.

But does it use these powers, or have the ability to collect the data it needs to validate them?

Threesixty compliance director Russell Facer says: “It’s a challenge. How much does the FCA put into supervision? The information that comes through Gabriel doesn’t ask for charging structures. It could have a picture of some stuff through the suitability review, but that’s not going to tell you a great deal about an advice side which may look fine but is being kept alive by other parts of the business.

“It may be anecdotal evidence as opposed to FCA findings.”

Syndaxi Chartered Financial Planners director Robert Reid also notes the technical difficulties of confirming allegations of cross-subidy that breaches FCA rules.

He says: “They will need to look at the group of companies as a whole. There might be four companies making a loss and one making a thumping profit. You’d then need to stand up any transfers taken from the one making a profit, and if they keep the advice afloat. Then you can ask questions: Why are you running it like this? You often have companies running a loss for different reasons. The fact is there aren’t enough resources out there to pick up the bad ones.”

The case for inaction

Part of the problem is the FCA also has to make a judgement on whether clients are affected by any cross-subsidy, particularly if it means they can receive cheaper advice as a result.

Barrett says: “I often hear MM’s beloved readers say ‘why doesn’t the FCA act?’

“The client outcome is more important. With SJP and the other firms involved there are strong measures in place to service existing clients. Clients are actually very happy with what’s going on. There’s an interesting argument of does the means justify the end? There’s obviously a breaking point where the customer could achieve what they wanted to achieve better, for lower cost by going elsewhere.”

The Consulting Consortium advisory director Phil Deeks, who was working as a technical specialist at the FCA when the rules came in, says: “If you look at the original intention of the vertical integration rules, the FCA was concerned a large vertically integrated firm would basically put lots of IFAs out of business, that they were going to charge 0.5 plus 0.5, blowing the IFA out of the water.”

Deeks says in the early stages of the rules, reaching a break-even point in five years was a useful rule of thumb for the regulator, though there were occasions where a longer period would be sensible.

But he says there is little evidence that vertically integrated firms have used this period to gain an unfair advantage over advisers when it comes to fees. He says: “It was targeted at firms with no intention of recovering cost at the time. But those mischiefs that they were worried about haven’t really happened. Large vertically integrated firms haven’t really competed on price.

“So if the regulator is taking a view that the mischiefs they were originally concerned about aren’t happening, does it then become less concerned about a more technical breach that isn’t taking advisers out of the market? This was always one that was going to take a period of time before the FCA started looking at it again. Looking at where we are now post-RDR, it might be that they want to look again at the outcomes.”