For almost two decades, legislation has been the primary stimulus for change in financial services.
Initial reactions to CP121 have been mainly defensive but if the paper is implemented in full, it will lead to significant structural changes in the financial services industry. The longer-term outcome will be a shift in the balance of power away from product providers and tow-ards efficient distributors.
We believe CP121 heralds three fundamental changes to the status quo:
The elimination of polarisation and possible introduction of directly regulated multi-ties.
The requirement for IFAs to charge fees on a defined-payment basis rather than accept commission.
The possible introduction of a lighter touch compliance regime to encourage the provision of basic financial advice to low-income groups.
The most obvious outcome will be the emergence of the new category of advisers – multi-ties. How will they emerge? There are three clear possibilities:
Conversion from IFA.
Conversion from sole tied (including direct salesforce).
Shifting from IFA status to multi-tie is the key decision for IFAs so let us explore the parameters of the decision:
The biggest negative of remaining as an IFA is the possibility of having to ask the client to sign a cheque (plus VAT, and out of net income) for the advice. The final rules may permit the fee to be paid out of the product, but VAT could still be an issue.
The major advantage of becoming multi-tied is that the adviser's bargaining power is raised, and the result (for bigger IFAs anyway) is likely to be improved terms of business. This could be expressed in terms of higher commission, more indirect benefits (admin support, etc) or even a requirement for the product provider to supply capital – whether through direct equity investment (as restrictions on this are lifted) or otherwise.
The multi-tie route offers current IFA firms the opportunity for streamlined administration based on (and even provided by) a small number of product providers, and eliminates the need to demonstrate independence in regulatory terms.
The only apparent downside of becoming multi-tied is that the rest of the market becomes closed to the adviser. Even this can be mitigated in two respects.
First, product providers will be able to broaden their own product ranges by offering best-of-breed products from the wider market.
Second, there seems to be nothing to prevent big multi-tied advisers from retaining an independent arm within the same group.
This multi-tie/IFA structure contains its own market-regulated mechanism – any customer who wants to get independent advice across the whole market will have to be prepared to pay a fee for the service. The structure is inherently self-balancing, based on customer preference and market economics.
Given the availability of this structure, it is difficult to see why any big IFA would not want to adopt it. It is good for customers, regulators and advisers but it may not be so good for product providers, as we will discuss later.
The proposals have the pot-ential to breathe some new life into direct salesforces. There are two opportunities – product badging and second-tier advice.
The abolition of polarisation will enable providers to buy in products from other providers.
As well as making a more attractive product range available through a DSF, this has the potential for greater product efficiency for both the host of the DSF and the providers of market-leading products. Major beneficiaries could be the providers or specialist products, such as friendly society bonds and long-term care.
The second opportunity is more tentative. It may be possible to implement a less expensive advice process for the less well-off. There are millions of policyholders who received advice in the past but today are disenfranchised by the decline of DSFs in general and home service in particular.
There is a good social case for making this advice available but it does represent a potential regulatory minefield. A multi-product DSF devoted entirely to serving the needs of the low-income market may be able to trade more efficiently while referring higher-net-worth customers to another part of a group structure.
The altered financial services landscape will be more attractive to a range of other players.
The bancassurers, which have been bedevilled by the complexity and overheads of running a life insurance company, can get healthy margins by operating purely as a distributor. Barclays, the first bancassurer, has already started the process through its deal with Legal & General.
Non-financial services retailers have already established the disciplines nec- essary to achieve viability on very thin margins and are in a strong position to run a profitable customer-facing distributor on a multi-tied basis.
Entrepreneurs have an opportunity to build a strong mainstream brand around good financial advice in a streamlined and cost-effective way. The major obstacle is achieving the scale necessary to drive down unit costs to an economic level.
European financial services companies already have experience of operating effectively in a multi-tied environment and have scope to expand into the UK.
The key to unlocking all of these opportunities lies in the ability to deploy an efficient, disciplined and customer-focused sales process.
Successful stand-alone advisers will be able to command a high price so building a profitable sales operation based on them alone will become increasingly difficult.
No matter how the market for advice pans out, product providers are likely to come under severe pressure.
In the short term, there is likely to be a price war in the scramble to get supplier status to as many of the new multi-tied companies as possible. Even though the numbers are suicidal, this will still happen – look at the market for stakeholder pensions in the last couple of years.
This can only hasten the decline in financial strength and enforced consolidation among product providers.
Attempts to raise prices over time may incur the wrath of the regulators so product providers could be in a weak position until market consolidation gives them more bargaining power.
Ultimately, there is considerable scope for improvements in efficiency around core product lines and capabilities leading to the radical restructuring of what a product provider looks like.
Most of the manufacturing industry, led by the motor manufacturers, has already been transformed from a one-stop “we build everything” monolith to an extended network of specialist independent suppliers.
Barriers to entry in the marketplace will change. Those with strong distribution potential and management capability will find entry a lot easier.
New product providers, no matter how wonderful the product, will find things a lot more difficult because the current large open IFA marketplace will no longer exist.
The landscape is about to change radically. The removal of polarisation makes the market less artificial,the multi-tie structure shifts market power to the efficient providers of good advice and product providers will come under even more short-term pressure.
The eventual outcome will be a market that can operate more effectively but only for those who embrace the change and, in doing so, survive it.