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Rebate debate

For over a decade, fund platforms have been required to disclose charges and commission to investors. There has been relatively little change but the Markets in Financial Instruments Directive now brings a number of changes.

One part of this legislation requires all financial inducements paid by fund managers to be fully disclosed so that customers can determine whether they have had any influence on investment advice. In the context of the UK fund platform market, a key effect is that fund platforms will be required to disclose the rebate of fund management charges they receive from fund managers.

Over the last 20 years, fund managers have progressively transferred distribution and administration to platforms, and have increasingly paid part of their fund management charges to compensate platform providers for performing this role on their behalf. Deciding whether to retain or reinvest these payments has been complex and this is why platforms are structured in variety of different ways.

As an example, there can be different business models where the nature of both the charges and the services provided are different in each. For example:

  • Discount broker where the majority of the fund rebate is perhaps retained.

  • The advised sale where the fund rebate is reinvested.

  • The advised sale where some or all of rebate is retained by the provider.

    In the fund platform market, most platforms have retained rebates, as reinvestment of rebate is potentially complex without the use of mirror funds.

    It is also problematic for Isas and Peps where this is difficult to execute without breaching HMRC’s requirements for policing the subscription limits that apply.

    As a consequence, the disclosure of rebates has varying significance depending on how they are handled and how they feed in to the advice process.

    For example, if they are reinvested, then the influence on advice will be weak. However, the disclosure of rebates is more significant for platforms that distribute direct. This is because rebates can vary enormously between funds so that recommendations of high-rebate funds will always be open to question unless distributors have very effective conflict of interest policies.

    In the context of platforms such as Selestia Investment Solutions, the rebates are arguably of less significance as they are shared between the platform and adviser.

    In this situation, although the gross rebates received must be disclosed, it is the level of trail commission which is of greater significance in the context of investment advice.

    Commission differentials apply between asset classes rather than between different funds within the same asset class and that asset allocation can be determined by an independent and objective investment process, so the potential to affect investment advice is limited. Furthermore, nominated trail can be used to remove commission bias completely in fund recommendations.

    Despite this, there will be interest in rebates for a number of other reasons. They will clearly identify the platforms with superior bargaining positions and more sustainable business models.

    Sustainability is mentioned in the FSA’s platform factsheet as a feature advisers should consider in determining the suitability of a platform service.

    It will also make it possible to see through the fog that surrounds fund platforms to establish the respective shares of platform income taken by each of the key stakeholders. This produces some interesting outcomes.

    Figure 1 illustrates the fund total expense ratio, rebate payment and trail commission paid for each of the 10 best-selling funds on Selestia Investment Solutions (this accounts for over 25 per cent of funds under management) and the relative share of the weighted average TER retained by fund manager, platform and adviser.

    However, it is probably not fair to consider the share of the TER in isolation as there are other charges to consider. For example, fund and platform initial charges and any annual platform charges.

    Figures 2 and 3 illustrate the position for existing and new investors based on various assumptions designed to reflect the average position across the Selestia Investment Solutions platform.

    The position for existing investors is of interest but it probably misrepresents the position as it ignores the various initial costs. These are reflected in the position for new investors. These show a 22 per cent, 38 per cent and 40 per cent share between platform, adviser and fund manager.

    Overall, it seems likely that the disclosure of rebate payments will be of more interest to platforms, advisers and fund managers who will have a keen interest in who has the best terms. This could mean that this development may pass unnoticed by many consumers even though summary disclosure will be contained in key features.

    Although the impact on some advice models may be more significant it seems likely that the consequences for asset allocators may not be as significant unless this extra layer of disclosure confuses customers into thinking that extra charges apply. We can only hope that this outcome is avoided.

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