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Time for disclosure overhaul

In the seven years since the disclosure regime started, fundamental changes to product structures and provider behaviour arising from price competition mean that a review is long overdue.

The various reviews of this subject are focusing on simplifying the presentation of charges, illustrating the long-term impact of inflation and unbundling advice and product costs, but there is a more urgent priority.

This is to define a watertight set of rules for all product types that are not open to interpretation and do not give providers any discretion in deciding what they disclose.

To make sure providers cure their habit of stretching the rules to the limit, it is also important to police the system to make sure that no providers gain an unfair commercial advantage.

Problems concerning charge disclosure exist in almost every segment of today&#39s market and are distorting competition as much as the cynical manipulation of orphan estates.

IFAs have every right to assume that quotes are accurate but the unfortunate truth is that, far too often, explanations of charges and key feature quotes understate the impact of charges and expenses.

The market for fund supermarkets is a classic example of how price pressure has encouraged new providers to sail into the disclosure wind to gain competitive advantage. One of the most disturbing problems concerns the extent to which some providers are seeking to manufacture confusion among unsuspecting investors.

This is often achieved by making a passing reference to fund and dealing expenses but not giving themanything like the same prominence as annual and initial charges.

In too many cases, supermarkets lead with charges rather than total expense ratios and ignore the possibility of dealing costs on unit purchases and switches.

It is possible that Oeics may have encouraged some supermarkets to camouflage these expenses. Some IFAs have suggested that this is reasonable, as

Oeics do not have visible dealing expenses.

However, Oeics cannot avoid incurring such expenses and make a dilution levy instead. Although this is not an explicit charge, it is no reason for trying to ignore this expense by burying it in the fund&#39s prospectus.

Finally, some supermarkets even try to create the impression that they are offering a free service when the service is funded by a share of the annual and even initial charges deducted by the underlying investment funds.

Many of these problems arise because the absence of a specific set of tailored rules has encouraged too many new ent-rants to place their own interpreta-tion on the regulations to achieve competitive adv-antage. Similar problems exist in the self-invested personal pension market, which has historically enj-oyed a reputation for transparency.

Sipps often seem friendly and innocent on the surface but point-of-sale disclosure rarely provides even a hint of how transaction fees, admin fees and commission-related charges can escalate if the Sipp trades its assets frequently.

Although Sipps typically disclose assuming a representative portfolio, this rarely assumes any trading and does not get close to disclosing the full extent of the likely charges.

Sipps that invest in unit trusts, Oeics or institutional funds also tend to ignore fund and dealing expenses in the same way that some fund supermarkets do.

Some have excused these tactics as it is unavoidable without a far-reaching set of tailored rules but the with-profit bond market is a different matter altogether.

There is guidance for this class of business but the wide discretion allowed means that competitive pressures have a stronger influence on reduction in yield than the expenses that dilute investment returns.

Most IFAs would like to believe the RIY accurately reflects the extent to which expenses will dilute investment returns but there are good reasons for believing that the reality is different.

We have all seen examples of with-profits bonds where the RIY is less than the commission payable, let alone all the other costs that must be covered.

For example, life office acquisition costs, admin and fund management exp-enses, provision of capital and last, but by no means least, payments to shareholders (typically 10 per cent of bonuses).

A recent visit to The Exchange common trading platform showed me that, on a £20,000 bond, not a single proprietary provider was disclosing an RIY of more than 1.4 per cent (0.9 per cent for mutual offices). (Source: CTP – March 27, 2002. Quotes based on £20,000 single contribution into with-profits bond, 10-year term, full commission).

The reality is the true costs will be 50 per cent – 100 per cent more than the RIY disclosed to consumers. When one considers this alongside the current state of equity markets, it is hardly surprising that pure unit-linked bonds and

Isas are having such a tough time competing against with-profit bonds.

All in all, a fundamental review is in order as it is clear that the current rules do not effectively cover products such as supermarkets and Sipps.

Also, in some markets, providers even seem to be letting competitive pressures determine what they disclose.

Providers could easily help to resolve this position by reviewing their disclosure principles but

I suspect that we will have to wait for the FSA to restore order.

In the meantime, IFAs have a critical role to play. Rather than accept key features quotes at face

value, they need to evaluate them for reasonableness to identify products that do not add up.

Of all the things that add value in the advice chain, making sure that clients are not duped by providers who choose to underdisclose charges is the most important.

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