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Margin maker

The financial services industry has broadly welcomed the proposals in CP09/18, the majority of which can be a huge benefit to the industry.

I am also delighted Aifa’s Chris Cummings seems to have continued his Batman impression against the dark forces of the ABI and the BBA in convincing the FSA that anything less than independence must be clearly recognised as a restriction of consumer choice.

Did advance knowledge of The Joker AKA Stephen Hadrill’s impending defeat accelerate the announcement of his departure? And will Cat Woman Angela Knight be the next to flee Gotham?

A victory has been won but there is more important work to be done as we approach the final scenes of the drama that is the RDR.

While an enthusiastic supporter of so much of the document, looking at some of the small print, I fear that elements of the proposals may result in a situation where, in the future, Lord Turner or his successor many need to report to the Chancellor that while the operation, the RDR, has been a complete success, regrettably the patient, the UK savings ratio, has died. The source of this problem is the removal of the ability of big distributor groups to benefit from negotiating discounts.

The present proposals allow for discounts to be negotiated based on scale but require that all of the savings achieved in that way be passed on to the consumer. This effectively means there can be no margin to remunerate the wholesalers in our industry, networks and support groups.

By removing the ability of major distributors to earn any revenue from aggregating volume distribution, the market will be effectively converted into a cottage industry with no infrastructure to fund operational efficiency and improving customer services.

This would doubtless make the role of the FSA far more difficult as it would lead to an increase in the number of smaller firms that the regulator would need to supervise directly.

It should still be possible to separate the price of advice to the customer and implement adviser charging at the retail level but they should be allowed to purchase products from wholesalers who will use their scale to negotiate lower factory gate prices from manufacturers.

This is the natural role for wholesalers that operate across a wide range of other retail markets. To specifically exclude the wholesaler from earning any income must inevitably severely stifle competition. If not modified, is there not a risk that the Competition Commission or, worse, the EU, motivated by a European distributor that might see entry to the UK market constrained, could yet challenge key elements of the RDR?

Against this background, national IFA firms and perhaps banks’ IFA divisions would probably become the only option that could really leverage significant discounts from insurers, so consumer choice would again be constrained.

At present, networks and support groups are playing an invaluable role in championing the wider adoption of technology and improved operational services across adviser firms as well as implementing more structured approaches to key issues such as diagnosing client attitude to risk and matching suitable portfolios. This is a role suited to the scale which they can bring to such issues.

If the RDR proceeds based on the present proposals, these may, in fact, become the core roles of such businesses but it must be recognised that advisers are not famed for the amount they are prepared to pay for such support services and if these have to be paid for out of limited levels of charges that the adviser firms can negotiate themselves with the client, this may constrain both their willingness and ability to pay for such costs.

I am not advocating a blanket ability for the wholesaler to be able to absorb margin, as they too must be able to demonstrate the value they are adding in the brave new transparent world.

However, the ability to retain some of the margin they can achieve by delivering scale appears to me a reasonable price to pay for delivering lower cost to consumers.

Perhaps caps might be applied on the margin they can retain or a requirement that the retained margin be less than the discount achieved relative to the manufacturers direct to consumer offering.

If delivering better product terms, an activity at which networks and support groups have demonstrated themselves to be particularly adept, albeit previously manifested as better commission terms, ceases to be an activity they can earn from, the incentive to focus on driving down cost in this way will be lost.

This would be good news for insurers which will doubtless be able to maintain higher prices for their services. Consumers would lose out dramatically because there would be no incentive for those best able to deliver scale discounts to do so.

I am not advocating that the proposals be changed to protect networks and support groups but to protect consumers from the loss of these organisations’ ability to negotiate better prices from investment providers.

I believe the vast majority of what is presented in CP09/18 can bring a massive improvement in the way our industry serves citizens.

From the outset of the RDR project, the FSA has recognised the importance of avoiding the law of unintended consequences but constraining the ability of businesses to act as wholesalers and drive down price could undermine much of what the RDR process has the potential to deliver.

Finding a way to achieve scale discounts for consumers while still separating the cost of advice can maximise the consumer benefit, I hope the FSA takes action to ensure this.

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