At our recent Money Marketing In Focus conference, the FCA and Financial Services Compensation Scheme shared a stage to talk about the fallout from the freedoms and where we go from here. It is clear the advisers in the audience were focused on one in issue in particular: how unregulated investments are treated.
FSCS chief executive Mark Neale revealed that 80 per cent of all claims received by the lifeboat fund concerned unregulated products. By my count, it provoked at least five key issues that need to be tackled before we can begin to solve the unregulated investments problem.
- Should the FSCS continue to provide compensation to those who took out unregulated investments?
- Should advisers have to take additional qualifications to advise on unregulated investments?
- Should advisers have to pay more towards the compensation pot if they do advise on unregulated investments?
- Should the FCA regulate the product, not the advice, and provide a whitelist of all acceptable products outside of which no one could go?
- Should regulated advisers be allowed to recommend unregulated investments at all?
That this is just a selection of the potential debates to be had around ensuring a fair compensation system when it comes to unregulated products is a testament to how difficult the issue is to solve. Taking each of the points in turn, the cases for and against can often sound equally compelling, throw up even more questions and give rise to contradictions with other areas of regulation.
Should the FSCS continue to provide compensation to those who took out unregulated investments?
Advisers like the idea of caveat emptor. If you really want to buy into an African biofuels scheme, a Caribbean hotel complex or a car parking scheme investment, then knock yourself out, but don’t expect anyone else to pick up the tab if it goes wrong. Confirming the accuracy of a suitability report is essentially saying I understand the risks, and am willing to pay the price. This has been a campaign issue for trade bodies like Apfa in the past.
But speaking at the conference, FSCS chief executive Mark Neale raised a valid point: what if the consumer was in fact misled about the nature of the investment? The reason the FSCS picks up the tab now is because it judges the merits of the regulated advice, not the unregulated product. What if the adviser picked up a juicy marketing fee and then did a runner or went into insolvency? It looks unfair for the consumer to be liable for their losses in cases where they were blatantly mis-sold or worse, the victim of an outright fraud.
Should advisers have to take additional qualifications to advise on unregulated investments?
Advisers already need additional qualifications to advise on complex areas such as final salary pension transfers. Would it be such a stretch to apply this to high risk investments too? Much in the same way as many IFAs hold equity release qualifications without actively advising in the area, a significant number would surely sit the exams just in case an unregulated scheme was right for a particular client, even if they had no intention on recommending them on a regular basis.
Yet for every extra exam, CPD point and regulatory hoop to jump through, the cost of advice will increase, disenfranchising more of the people who would never have taken on a risky investment in the first place, limiting advice to exactly that ultra-wealthy group who have the financial security already in place to warrant looking at more esoteric options. What if a client is adamant a high risk scheme is right for them, but the adviser has not yet sat his exams? Would IFAs have to turn away new clients on a regular basis? Who would double check that all the unregulated product sales are actually being done by sufficiently qualified advisers?
Should advisers have to pay more towards the compensation pot if they do advise on unregulated investments?
Neale, and to a lesser extent the FCA, have been clear on this: we need to minimise how much the good firms are paying for the bad. Unregulated products, by their nature, have a greater risk of failure and therefore are more likely to cause liabilities for the FSCS. From next year, advisers will have another question on their regulatory return asking how many non-mainstream products they recommended so the FCA can see whether this could be used to risk-rate how much they pay in fees.
What if all the unregulated investments were the most suitable options for clients though? Should an adviser have to underplay a client’s risk profile for fear of an increasing levy down the track, or be penalised for not doing so? There is an argument that this creates a sort of reverse moral hazard; play it super-safe and you’ll never have to pay up. That is not to mention the practical difficulties of judging exactly which firms or sales genuinely present a greater risk of failure, and by how much levies should be adjusted accordingly.
Should the FCA regulate the product, not the advice, and provide a whitelist of all acceptable products outside of which no one could go?
If you wanted to completely minimise firm failures, this would be the surest way to do it. The likelihood of an adviser, or anyone else for that matter, falling into insolvency and passing the bill onto the FSCS would be slim to none if only the highest-rated instruments were allowed to be passed into consumers’ hands. As a result, the amount paid out in FSCS levies – the largest part of bills advisers receive from the FCA every year – would be dramatically reduced.
But the direct corollary of this is that as FSCS costs fall, the burden on the FCA that would be passed on would increase in equal measure. The time and expense the FCA would need to undertake in vetting a myriad of increasingly complex products would be huge. New products come onto the market all the time. Innovation would be stifled and there would be no sure-fire way to ensure that the people behind them were telling the regulator the truth. The FCA has said repeatedly it does not want to offer carte blanche to advisers justifying suspect recommendations with the excuse that the regulator said the product was okay.
Should regulated advisers be allowed to recommend unregulated investments at all?
A significant number of advisers still believe that there can never be a case for recommending an unregulated product. No matter how high-risk your client, how complex their needs or how much yield they need, a suite of regulated investments from trusted providers will do the trick, and it would be good for the reputation of the profession if potential clients knew that there was zero chance their adviser would lose it all gambling on storage pods.
However, a significant number also feel such a restriction would be limiting. Thorough due diligence should be able to take into account the entire market to find the most suitable portfolio for a particular client, not be artificially turned away from certain avenues or provide a watered down version of what the best advice would look like.
So what’s the answer
With all of these competing arguments swirling, it is little wonder that scant progress has been made to make sure the actual polluters pay more. But rest assured, the issue is high up the regulatory agenda.
Justin Cash is editor of Money Marketing. You can find him on Twitter @Justin_Cash_1