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Nic Cicutti: The case for an FSCS product levy – paid for by advisers

Nic Cicutti

Exactly how sophisticated are most investors? This may sound like a strange question, but I am moved to ask it after reading an article by Apfa senior policy adviser Caroline Escott, in which she proposes, yet again, a product levy to help meet claims on the Financial Services Compensation Scheme.

Escott’s article in last week’s Money Marketing goes further. She argues it is also time the amounts paid out in compensation – 100 per cent up to £50,000 of a claim – should be revised downwards and restricted to a percentage above a much lower £30,000 limit.

“Investment is not without risk and consumers must bear some responsibility for their decisions,” she suggests. A cap along the lines Escott recommends would not only “reduce the FSCS bill [but] also create more engaged customers”.

I will come back to the cap in a while. But first, let’s look at Escott’s product levy proposal. One thing it potentially has going for it is the suggestion the product levy should involve a “small surcharge for different product categories, depending on the risk of the product”.

Tied to a “white list” of products more appropriate for retail investors, with a much lower levy, this might help avoid cross-subsidies whereby cautious investors bail out those who choose riskier investments. Escott adds it “might even deter investors from investing in products that are not suitable for them”.

What is interesting about this argument is Escott approaches it from the perspective that it is investors who should be “deterred” and not advisers.

On the contrary, my own experience of most investors, going back to the question raised at start of this column, is they are for the most part unsophisticated, ignorant of the risks attached to particular investments and heavily reliant on the advice they receive from those they come into contact with.

All the evidence supports this view. Yes, there are some experienced investors and they lose money. But actually, the majority of clients are anything but sophisticated.

Last year, the Daily Telegraph identified up to £4bn of UK investors’ cash tied up in funds closed since 2009. Thirteen funds were suspended, meaning investors cannot withdraw their money at all.

According to the Telegraph, several of these funds – including Centurion Defined Return, Life Settlements and Argent, EEA Life Settlements and Managing Partners Traded Policies – invested in “death bonds”. The funds themselves supposedly offered secure, “low risk” returns.

“I would love to see what would happen if the adviser is told that given the risk profile of a particular class of investment, she or he will have to pay a massive upfront levy on that asset”

Keydata, which many advisers have distinctly unhappy memories of following the huge FSCS compensation levies they had to stump up, is another case in point. This was another death bond fund.

Savers were told HSBC was overseeing trading in the insurance contracts. In reality, huge chunks of money went into a US hedge fund. Again, all the evidence gathered subsequently points to thousands of punters with little or no clue of what they were getting into and heavily reliant on what they were told by their advisers.

Then there is the latest likely contender for a massive FSCS compensation bill, the Axiom Legal Financing fund, which vacuumed up almost £120m in funds before being suspended in 2012.

Axiom lent money to legal firms engaged in no-win, no-fee agreements. Only £12m was recovered from that black hole, of which barely £2.5m is available to pay back to investors after legal and other fees.

In one story I have seen, sources close to the investigation aimed at tracking down the money say while some advisers used Axiom as an opportunity to diversify a small minority of assets in a high-risk fund, others “put their clients’ whole life savings in to it”.

Underlying all these examples is one basic story: unsophisticated investors believe their advisers, who tell them these investments are low risk. They then turn out not to be.

Faced with that evidence, why on earth is Escott asking for investors to bear the burden of that astonishingly bad advice and not those who gave it to them?

If there is an argument to be made for a product levy in respect of investments – and for that levy to be risk-related – the person paying it should be the adviser, not the client.

I would love to see what would happen if the adviser is told that given the risk profile of a particular class of investment, she or he will have to pay a massive upfront FSCS levy on that asset. My guess is it would make most advisers think carefully before punting the latest crackpot scheme to clients.

What is also interesting about Escott’s proposal is that of reducing the £50,000 limit per investment firm. I have come across cases where as a result of demonstrably poor advice from an IFA, a client lost hundreds of thousands of pounds. Again, this was supposed to be a limited risk investment. The client complained, but was then limited to a £50,000 FSCS payout after the IFA went into default.

Yet Escott wants to reduce the £50,000 limit even further. At a time of such limited trust by most punters towards the financial industry, here is yet another wonderful example of positive and proactive consumer PR by Afpa. Not.

Nic Cicutti can be contacted at nic@inspiredmoney.co.uk

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Comments

There are 10 comments at the moment, we would love to hear your opinion too.

  1. I was prepared to disagree but came to the opposite view, not least because I told several of the sham schemes cited to b*****r off in the past, only to find the gullible and greedy had flogged this rubbish to customers and I along with other decent advisers end up footing the bill.

  2. With respect, I think you may not have grasped how this could work in practice Nic.
    The “product levy ” approach (which I think ought to more accurately be referred to as a “product and advice levy”) must be based on a PRODUCT levy paid at product level – not least because the vast majority of financial products are bought without any adviser involvement. So a standard deposit account for example might have a levy equal to e.g. 0.001% of the investment made – whereas a far higher risk product might have eg a 1% deduction. These product levies would serve two purposes – to create a fund IN ADVANCE, as well as also adding to the information the consumer (and advisers if applicable) may be able to use. All providers wishing to market a product would be required to supply full details to the body set up to determine relative risk and calculate the risk levies – a process which in itself would probably have cut off at birth some of the schemes you mention above, so a great improvement for consumers already.
    But so that advisers are also paying their way, an additional levy should also be payable where regulated advice is given, as of course the FSCS covers a failure of advice as well as a product; this levy again should be dictated by the recommendation being made and (perhaps) expressed as a percentage of the advice fee charged. This way the polluters are paying their way in advance and those advisers recommending the most risky solutions would be paying the most.
    (We all understand that ultimately its the consumer paying ALL the levies, wherever they are applied, but then one way or another that will always be the case and they are after all the ones receiving the protection)
    There would naturally be plenty of subjective opinion about relative risk – but reaching conclusions on such issues via a wide enough consensus using agreed analysis frameworks would have to suffice – the regulator already knows that some things are higher risk than other things, as do advisers, journalists and clients – so its merely extending this principle; I expect that a range of bands could be used rather than individual ratings each time to simplify it somewhat.
    And it could never be a worse scenario than we have now, in terms of the repeated apparent ease with which schemes can be set up and still fail, the lack of full consumer protection and also the out-of-nowhere unpredictable levies that are in the main applied to everyone in the advice community except the people who caused the problem!!!
    Id also suggest that far from reducing the limits on cover, a pre-funded scheme with a built in process that weeded out obvious non starters and charged a premium for higher risk products and advice, would allow the cap on protection to be raised, given that there ought to be less failures and more money in the pot to cover the genuine ones.

    • I agree Paul. Especially if the levy was charged AFTER any cooling off period directly to the clients bank account and NOT from the product as if it hadn’t been explained properly to the consumer, a complaint would be triggered just weeks after the missale.

  3. I agree absolutely with Nic’s statement that most investors……… are for the most part unsophisticated, ignorant of the risks attached to particular investments and heavily reliant on the advice they receive from those they come into contact with. The very idea of caveat emptor just doesn’t hold water.

    I disagree, though, with the idea of advisers paying any product levies, for the simple reason that, ultimately, the customer pays for everything.

    That said, there clearly needs to be some sort of scale to risk-grade products and funds with a view to highlighting to consumers that, generally speaking, those offering potentially higher returns than their plain vanilla counterparts carry more risk. The ultimate risk, of course, is of complete collapse and loss of everything.

    Such a scale could well go a long way to helping consumers understand just what the risk and reward emulsion actually means and steer them away from investments which, however attractive they may at first appear, may well not be at all suitable for them. That would surely be a step forward plus, of course, the FCA doing its job by mandating special permissions (and proper PII cover) for certain high risk investments.

    A levy five (or maybe more) times the size of that applicable to something more in plain vanilla territory would certainly focus the attention of potential investors and prompt a much more meaningful discussion of the correlation between risk and potentially higher returns.

  4. @Nic – You said Keydata money went in to a hedge fund and not the intended Life policies. Do you have evidence of this please? The FSCP’s Debbie Harrison checked out the Keydat investments and as part of CASS business school submitted a report saying it was a good investment in a portfolio of Life Policies and she had full access to the model it was based on. Walter Geronowicz of Meditron gave details of the policies held and there was NO mention of a hedge fund.

  5. Retail shops include a loading for shoplifting and spoiled goofs within their prices. In fact every business has to build in some assessment of unforeseen costs whether this be the cost of dealing with and compensating complainants or some other unquantifiable outgoing.

    When, some years back, I purchased a brand new property and was arguing with the builder in regard to defects, I was advised by a leading property expert that I enjoyed less rights than if I’d purchased an apple.

    This shows that you cannot get it right and that countrywide a variety of mechanisms are in place for both complaints and redress.

    This industry suffers far more than any other from constant interference from well-meaning people tasked with protecting the consumers interests. Advisers have to have sufficient capital adequacy , they have to have PII cover for bad advice/maladministration, they have to fund the FSCS with regular and emergency levies.

    All of this could go away if a product levy was imposed which – in tandem with a capital adequacy requirement would cover pure advice with no product arrangement – would ensure that the cost is spread appropriately across the consumer world.

    This also benefits consumers in that the industry becomes more financially sustainable and therefore increases the numbers of outlets and advisers able to service their requirements.

  6. Can you tell me where they sell spoiled goofs Alan?

  7. Or, come to that, unspoiled ones.

  8. Must have been a quiet week at your desk, to use this as an opportunity to have another dig at advisers as a whole. Your comments demonstrate why people like you should be kept well away from the negotiating table for this industry, as your views and logic are clearly not balanced in the slightest.

    By ADVISER, I presume you also mean PRODUCT DISTRIBUTOR, as you do not say this (unless I have missed something) and therefore you do not encompass direct purchases of products (from a provider) within your argument, no matter how limited you say they may be. That is, sales where ADVICE has NOT been sought.

    When companies/providers default, investor claims fall upon the industry by way of their FSCS levies, whether for advised sales or otherwise, yet you are suggesting that there should be some form of ‘advice’ levy only, paid for by ‘advisers’; where is the logic in your ‘debate?’

    If you mean that unadvised sales should also have a levy attaching to the company/distributor, from which they are sold, then why didn’t you say so (no need to answer as I know why and so do you Nic!)

  9. One problem Nic is that “Risk” takes many forms and is best calculated in hindsight. During the inflation of the 1970s, War Loan was a terrible investment falling to about 10% inflation adjusted of its issue price. ( Govermnment backed, income guaranteed). Some structures are risky because they are fraudulent, some because of issues with illiquidity ( often depending on circumstances – Prime Residential Property was maybe OK if you waited long enough – ) some because of volatility of the asset class, some because of inflation , some because of mismanagement – with profits bonds. How you forecast and raise a fitting levy would tax the brain of Einstein. Sensible diversification is the least worst solution – which means advice?

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