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Nic Cicutti: Is the FCA looking to nudge you off trail?

You might want to call it “nudge-with-a-threat” – with little time before one turns into the other.

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Whenever guests come to our house, we like to make them welcome. Aside from offers of tea or coffee, glasses of wine, food and the like, our downstairs loo carries a wide range of reading material to divert them during their stay.

Visitors can choose between magazines such as Good Housekeeping, Horse & Hound, Country Life and Scootering, as well a couple of dozen books on topics ranging from poetry to comedy to psychology and self-improvement.

The self-improvement section includes Malcolm Gladwell’s “The Tipping Point” and Richard Thaler’s “Nudge: Improving Decisions about Health, Wealth, and Happiness”, both of which advance similar ideas about human behaviour.

Essentially, the two authors imply that human beings do not make rational choices about their lives, they are “nudged” or “persuaded” into reaching those decisions by circumstances they do not necessarily understand or fully control.

In Gladwell’s case, the tipping point is the behaviour of others in a social network with the capacity to inspire and influence behaviour. For Thaler, the question is about framing an argument in such a way as to nudge them in to making the “right” decision (again, my emphasis).

Thaler describes this as creating a “choice architecture”, arranging things in a way that retains freedom of choice while still promoting what they believe is the appropriate path for people to take.

If you’ve stayed with me so far, you might be wondering what all the above has to do with financial services in general and financial advisers’ business practices in particular.

Well, I was reminded of Thaler’s nudge theory by the recent publication of the FCA’s board minutes for June, in which the regulator discussed issues facing the industry, including that of remuneration.

We already know that the FCA is unhappy with the potential for dealing bias in the trend among IFAs to levy charges only if a sale is made. This was also made clear by FCA chief executive Martin Wheatley in a speech last month.

What is also becoming evident is the growing sense of unease over trail commission, more specifically what Money Marketing described in an editorial last week as “the risk of ‘poor consumer outcomes’ from allowing trail commission to continue on pre-RDR business.”

Essentially, what appears to concern the FCA is the possibility that given its original acceptance of pre-RDR trail continuing to be paid indefinitely,
some advisers may be taking advantage of the fact by leaving their clients’ portfolios untouched and un-reviewed.

By doing so, they are avoiding the difficult arguments necessary to ensure continued trail payments post-RDR – or so the FCA believes may be happening.

There are several ways of looking at this question. One is to assume the FCA will simply carry out one of its thematic reviews and conclude that the current position with regard to trail commission is leading to these “poor consumer outcomes”. At which point, a retrospective sunset clause is indeed applied to pre-RDR trail.

As Money Marketing argues, this could be potentially disastrous: many advisers have built business models predicated on foregoing initial income in return for a recurring revenue stream from trail. That being the case, it is possible any move to insert a sunset clause into pre-RDR trail arrangements might lead to legal action.

But is this what the FCA is looking to do? My own guess is that the publication if its board minutes is designed to achieve something subtly different, namely to start “nudging” financial advisers into altering their behaviour with respect to trail commission.

Essentially, the aim is to promote the idea that trail is something that is negotiated, agreed and then earned by an adviser, in return for providing a tangible service than can be measured and reviewed – in just the same way as the performance of a portfolio is itself assessed on a regular basis.

Were advisers to move to that model of service and ongoing remuneration with their clients, it is unlikely that the regulator will have any argument with their charging structures. It is only in the event such a scenario does not happen that we can expect the FCA to move to the next stage of the process.

It is hard to argue with this point of view. Apart from anything else, it is clear from the FSA’s own statements over several years prior to the RDR coming into effect that it believed trail commission as something that should be earned through ongoing servicing of a client’s products and not simply paid as the by-product of a sale years before.

Nor is the idea of a sunset clause with respect to trail anything new: Skandia was arguing for one two years ago, suggesting that it take place five years after the RDR came into effect.

In that respect, rather than financial advisers reacting defensively to the FCA board minutes, they should be using it as the “nudge” they need to move to the next stage of their post-RDR business planning.

Without advisers changing how they operate, the alternative is for the FCA to create a pre- and post-RDR level playing field over trail. You might want to call it “nudge-with-a-threat” – and I don’t think there’s much time before one turns into the other.

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

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Comments

There are 24 comments at the moment, we would love to hear your opinion too.

  1. I regard myself (and I believe so do others) as a simple soul. A literalist. As such I see a lot of holes in this piece.

    Firstly you mention ‘tipping points and nudges’ Indeed these two theorists seem to take it upon themselves to be arbiters of what they believe is the appropriate path for people to take. How very arrogant.

    If we are quoting theories I rather favour Chaos Theory. Let’s just stop the common assumption that it is the duty of Patricians to guide the poor Plebs to a better way.

    That some IFAs only levy charges only if a sale is made, is in the opinion of some patently stupid (for who would work for free?) is one thing, but deciding that is to be effectively outlawed is quite another.

    I do agree that many are of the view that difficult arguments are necessary to ensure continued trail payments post-RDR. I can’t imagine why, other than thinking they were less than honest at outset.

    But retrospective actions of any sort are always unwelcome, hard to justify and often unjust and a sunset clause applied to pre-RDR trail would be no exception.

    That trail is something that is negotiated, agreed and then earned by an adviser, in return for providing a tangible service than can be measured and reviewed – in just the same way as the performance of a portfolio is itself assessed on a regular basis should always have been a given. Quite so. That some advisers didn’t see it as such was perhaps one of the issues that the Regulator wished to address. But retrospection is not the way.

    A great many of us remind our clients annually (or at valuation points) that we take a Funds Under Management Charge. (Indeed we often send them an invoice for it). The solution for a dissatisfied Regulator would seem simple. Just ensure all clients receive a letter (from the provider?) advising:

    “We hope you are aware that your adviser is receiving X% per annum in trailing commission on your investments. Are you getting a service or value for this? If not you need to have a discussion with your adviser. If the client then decides to take no action – well then so be it. You can’t wipe everyone’s botty all the time.

  2. The reading material in your loo must come in handy when the toilet roll runs out.

  3. But what benefit will accrue to consumers if providers are banned from continuing to pay advisers trail from legacy products?

    Providers have already made plain that the costs of converting their legacy products to accommodate adviser charging would be so great that they simply cannot do it. By the same token, it seems reasonable to assume that they won’t be able to change their systems to accommodate the rebating of trail to policyholders. So all that will happen is that, irrespective of what it’s what they would wish:-

    1. providers will keep the trail,

    2. policyholders will now have to pay fees for reviews and

    3. intermediaries (as usual, right at the bottom of the pecking order) will see their revenue streams damaged still further ~ less coming in and, due to endlessly escalating levies and compliance overheads, more going out.

    How is that combination of outcomes good for anyone except providers at the expense of customers and intermediaries? Didn’t the FSA realise that, on balance, banning trail is likely to cause more harm than good? Or did it realise this but just decided to ignore it on the basis of a blanket assumption that all intermediaries don’t bother to review old products?

    We still have to maintain records on all these old products and, thanks to the FSA’s pernicious denial to intermediaries of the protection in law of a longstop against stale complaints, we still carry the liabilities until our dying day. These liabilities contribute to what we have to pay year after year for our PI insurance.

    The FSA’s entire strategy appears to be based on a blinkered view of just one element of the equation whilst completely overlooking everything else. And will it listen to any representations or objections from the regulated community? Does it ever? Or will it, as usual, just steamroller through its predetermined agenda for endless change, with no regard for any collateral damage? Not so much a nudge as the typical waving of a big knobbly stick.

  4. Cut off all the trail and funds based and the value of my business is a big fat ZERO !!
    Over 18 years to build up a successful business with some commercial value destroyed in seconds !!

  5. Reading the article I reached the same conclusion as Harry….

    If the concern is that someone is receiving income in return for a service which is not being delivered (but which was agreed upon) then simply confirmation from the client that they are indeed receiving that service should suffice.

    This does, however, still leave the argument that those who took ‘deferred initial commission’ as trail in lieu of initial advice (as opposed to on-going advice) are being penalised…..

    Yes, the move to an agreed OAC in return for an on-going service is clearly in the clients best interest – but there may be unintended consequences if this outcome is legislated on.

  6. I couldn’t agree with DH more

    My business is now worthless after 15 years hard work.

    The FSA seemed to believe that if we are paid trail then we must provide a service for it

    I cant find anywhere written down that required any service whatsoever was needed to be paid trail

    The fact that we DID provide ongoing service was proably in hindsight stupid because the banks who sold bonds by teh bucket load taking 7/8% commission never provided any service did they ?

  7. should journalists be paid more than once if the same item appears in more than one publication?
    You could argue that as it only took one effort to pen it, one payment would suffice.

  8. As far as I can see, pre-RDR trail commission is a matter between my company and the provider. They agreed to pay it, we disclosed that to the clients and we did NOT promise any “servicing” in return for deferring some initial commission. Any retrospective actions by providers might very well breech the Agreement under which we placed business with them. Renewal commission is just that, fees are fees in return for carrying out agreed actions. Just let renewal wither on the vine!

  9. Wish I was retiring now 22nd August 2013 at 1:53 pm

    Agree with much of what Harry says in first comment, but I shall add one other factor.

    I deliberately took much smaller commissions than were on offer at the outset of numerous plans over many years. I did this in lieu of trail commission that would build “embedded value” into my business (I think that was the buzz phrase at the time).

    Bluntly, I took much less then, so I could enjoy a little more later in return for receiving remuneration for my ongoing servicing of those arrangements. For regulators to now strip away the income that I agreed with my clients by subsidising their initial costs through deliberately depriving myself of legitimate earnings up front, is bordering on theft in my opinion.

    Before the fee only bores jump all over this, please note that I didn’t sub 7.5% with no trail for 4% plus 0.5% trail (thereby making no difference to overall RIY). I did it by subbing 7.5% initial (on bonds) with 1% initial and 0.5% pa trail.

    I despise our industry now, I really do. I can’t wait to leave it

  10. It’s difficult to see why the FCA are bothering with this at all. Wasn’t RDR supposed to fix these ‘problems’?

    If it didn’t then who at the FSA messed up?

    If it’s an emerging issue then who at the FSA/FCA didn’t see it coming – in other words, who at the regulator messed up?

    In the overall list of risks where does this fit? Aren’t there more important things to address?

  11. You nudge if you want to, this IFA is not nudging.

    Best thing to happen would be banning trail and letting the courts decide if the FCA have exceeded their powers. I suspect they would be or this would have been part of RDR…

  12. You might want to call it “nudge-with-a-threat”
    You must be mistaken nic, the FCA is not an aggressive regulator.

  13. Nic, you may well have been better writing this article after having researched the contractual obligations that exist between Provider and Agent, before summising about the regulator’s hypothetical reactions!

    Now that would have been informed journalism rather than the ‘red top’ clap-trap and unwarranted scaremongering I am afraid you have delivered (although I am sure that was your intention!).

    Cannot believe MM have paid you for this article, they should be rightly embarrassed!

  14. @anon 2.49pm

    There is every likelihood that banning product providers from paying to market their products (commission) is a restriction of trade and also worthy of a visit to the High Court by a provider or two !

  15. So when you sub some initial for trail (lets say 3% at 0.5% recurring) after 6 years you’ve been paid (maybe add another for interest). What if the client keeps the product for 10+ years? You keep getting paid and the client keeps getting charged? That advice has cost them nearly twice as much as it would have had you just taken the full initial.

  16. Brigadier Hewson Bundlebrask 22nd August 2013 at 4:56 pm

    Which provider will be big enough to stand up to these totalitarian tossers and fight through the courts?

    Enough is enough, c’mon let’s fight back.

  17. The majority of “trail” commissions are already being kept from all the ex tied advisers who worked for about 80 insurance companies that have ceased trading/merged into the likes of Resolution of Life Assurance Holdings company (Windsor life) due to regulation changes and costs.
    These policies do not in effect pay any trail but the charges are being taken in full including commission costs on indexed policies.
    Windsor Life, Crown Life, GAN, Pru, COOP, Refuge, Colonial, Canno etc etc .
    The FCA does not want this to be paid but DOES NOT mind it being charged and retained by providers.

  18. @Matthew 4.55pm. Sorry, but your observation is incorrect!

    The product charging structure remains the same, it was simply the commission shape that changed.

    Rebates of commission were another matter altogether and it was those that changed the charging structure, not the initial/trail or full initial shape of commission.

  19. Answer this question honestly

    If all trail , adviser charges , renewal commission was stopped tomorrow and no ongoing service charges were allowed in any form.

    How long would your business last ???

  20. Any talk of a legal challenge against the FSA for exceeding its powers is futile because the FSA enjoys, indeed revels in, statutory immunity from prosecution other than for the most extreme breaches of responsible behaviour. And even then, it would almost certainly find a way to twist and wriggle out of any such accusations.

    On so many fronts, the FSA is all but outwith the laws by which the rest of us have to abide. It’s a law unto its own self.

  21. @ matthew
    If the trail is stopped, the client will be charged all over again.

  22. Hi Julian, hear what you say and having considered this further, I think that it would be the case that advisers would sue providers for breach of contract and it is certain that it would be an industry-wide collective case as it impacts on all of us (except lucky old Mr Bishop who teeters on his tightrope—Yawns!)..Who knows, it may actually bring us all together for a common cause at last, now there would be an unintended consequence if ever there was!

    If rules are imposed upon providers to cease payments and break such contracts by a regulator (and that is a very big ‘if’) then that is something that the providers will need to address with their peers, not us.

    Our contract is with the provider and is commercially binding.

    This is not to say that we are absolving ourselves of client responsibilities and just focusing on protecting our earnings, in fact I would expect that most IFAs’ and advisers who run their own practices (and benefit from the renewal stream) diligently look after their clients as a matter of course and often without remuneration. If clients are not happy with a level of service or the performance of a product, they will vote with their feet, same as with any other walk of life (pardon the pun!).

    It is for the above reason that those who made the initial earnings sacrifice (call it a gamble if you wish) and who continue to provide reassurance to their clients alongside suitable investments (hence the products are still in place) are now benefiting from the ongoing earnings stream…It is a tap that the client can turn off at any point remember!

    (another click for Nic on the old website :-)!)

  23. As I’ve pointed out elsewhere, the purpose of trail isn’t solely to pay for regular reviews (even though many intermediaries consider such service to be one of their long term responsibilities).

    What about the costs of maintaining file records? What about (thanks to the FSA) intermediairies’ open-ended, indefinite liability for the original advice? What about the fact that we have to pay for PII to cover those indefinite liabilities? And what about the fact that most clients don’t want to have to write a cheque for every review, preferring to have such costs built into the product?

    As usual, the FSA seems to be focussing on just one part of the equation to the exclusion of all others and assuming that it knows best, regardless of anyone else’s point of view, even if submitted in response to one of its sham “consultations”.

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