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Trail of destruction: Mifid II threatens legacy payments ban

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Advisers could be banned from collecting any trail commission for legacy business as a result of Mifid II regulation, experts have warned.

Under the RDR, previously agreed trail commission is allowed to be paid on pre-RDR investment amounts where products are topped up after 31 December 2012, and on fund switches within a product.

Trail will also be effectively turned off next April for advised platform clients, when the two-year sunset clause on legacy payments between fund managers and platforms will expire.

But oncoming regulation from the European Commission, due to come into force in January 2017, could put an end to all trail paid to IFAs on retail investment business.

So what is it exactly that Europe are proposing on trail? What would be the implications for advice firms large and small? And given the significance of such a ban and the narrowing window in which to prepare, why is there still so much uncertainty around the issue?

Bleak situation

Investment Association retail markets specialist Mike Gould says: “When you look at Mifid II at the present time there is no provision for grandfathering of legacy business. The implication is that from 3 January 2017 when Mifid comes in the legacy business still having commission paid will have to stop on that date.”

The Mifid II directive states: “It is…appropriate to further restrict the possibility for firms providing the service of investment advice on an independent basis and the service of portfolio management to accept and retain fees, commissions or any monetary and non-monetary benefits from third parties, and particularly from issuers or product providers.”

While Mifid II does not mention anything about trail in particular, law firm Clarke Willmott partner Philippa Hann says “on the face of it, it will bring an end to trail commission to those offering advice on an independent basis”.

The industry is lacking clarity on the issue, with much of the Mifid II regulation yet to be set in stone and with no technical details released. However, as the regulation stands at the moment, it looks bleak for advisers relying on trail.

“I tend to err on the side of caution in the absence of clarification from the legislature and people have to assume it will be contrary to the requirements of Mifid II to continue to accept trail commission,” Hann says.

Gould adds: “I have discussed it with a couple of legal firms and that’s their understanding as well, it’s pretty much certain subject to any change by the Commission.”

The FCA has yet to release a consultation paper on Mifid II, but held a roundtable last month discussing the regulation and the impact on trail. Minutes of the meeting were not made available publicly, but the FCA says: “We have no plans to change the current rules on trail commission.”

How long is the trail? 

Following the RDR, the level of trail being paid out in the industry has dropped, as expected.

Figures from CoreData Research show the average advice firm receives 13 per cent of its business revenues from trail, down from 15.9 per cent in 2014 and 26.9 per cent in 2013.

However, while this is the average, “a strong portion” of adviser firms get more than 15 per cent of their revenue from trail.

When broken down by adviser assets the data highlights those firms with less than £25m in assets under management are more reliant on trail than their larger rivals. Of firms with between £5m and £25m in assets, 44.9 per cent still get more than 15 per cent of their income for trail. This compares to 1.3 per cent of those with assets of £250m or more.

But the report says many of these trail-reliant advisers “appear to be running the trail-gravy train to its final destination”. Some 59 per cent say they will not be in their current role in three to five years, compared to almost 77 per cent of non-trail reliant advisers.

Zurich UK Life head of regulatory developments Matt Connell agrees those businesses that are looking to survive long-term will not have a large exposure to trail commission.

“Any adviser firm that wants to survive for a significant period, so seven to 10 years post-RDR, has to have strong plan to survive without trail,” he adds.

The public interest case

There is some room for the FCA and the European Commission to change the current Mifid II regulation to allow for grandfathering of trail commission to continue.

“It is a possible that the Commission which is now look at making the rules will include a grandfather rule, but at the moment it’s not there,” says Gould.

The FCA could also campaign that it is in the public interest for trail commission to continue to be paid, says Connell.

“The Commission generally frowns on anything that goes over and above Mifid as they see it as a barrier to harmonisation of the market. Where the Commission feels strongly it is in the public interest and where one country is moving in the direction the whole of the EU is moving in, it is willing to make exceptions,” he says.

However, it may be difficult to claim clients continuing to pay trail commission is in the public interest.

The argument from the FCA would be that it creates a strong market, where contracts are enforceable and there is certainty in the market, rather than ever changing rules, says Connell.

“In the short term it’s the customer paying less money, which is always a good thing for customer, in the longer term it gives a more stable market where providers know where they stand,” he says.

Threesixty Services managing director Phil Young says the big issue that remains is whether the FCA has the appetite to enact a ban on trail commission.

Young says the dynamics with the FCA, Treasury economic secretary Harriett Baldwin and, to a certain extent, incoming pensions minister Ros Altmann mean the regulator is unlikely to place more restrictions on advisers.

With the FSA not having banned trail at RDR, the more economic liberal views from Baldwin and Altmann and the push-back on regulation coming from the EU more generally means any ban is unlikely, he adds.

“My gut feeling is that there is not a lot of appetite to implement something harsher than the current system, and as a result trail will continue to fizzle out over a period of time. It will be a long slow death rather than anything more than that.”

He adds any ruling on banning trail will likely be the task for the new, incoming head of the FCA not for outgoing chief executive Martin Wheatley, meaning a decision may be some time away. “We need to wait and see the change there.”

Drawn-out legal battle

Young argues any ban on commission could also become a litigious event, which would give the FCA another reason to back away from such a move.

He says advisers entered into contracts that were legal at the time and could have grounds to fight any change to those contracts.

“I can see a lot of lawyers making a lot of money out of arguing the toss. It could be an expensive, drawn-out legal battle.”

Compounding the issue is that a lot of the trail commission is paid out to consolidator firms that have acquired businesses with a high percentage of revenue in trail.

“The ones that have the biggest financial exposure will probably be the big consolidators that also have the funds to fund expensive legal campaigns on these sort of things,” says Young.

For advisers the biggest impact is losing that income stream, particularly for those relying trail.

“That was an income stream created within the rules as they stood,” says Connell, and advisers could argue they could have charged customers upfront but instead took the price of advice over the long term.

These advisers would argue that “they shouldn’t be penalised for that, that’s the argument in favour of keeping trail from before RDR came in,” adds Connell.

Firms that have modelled future profits on the income of trail are also going to be displeased at any ban, says Hann.

“I can see that a lot of firms are going to be unhappy. They have modelled their future profits on receiving this trail and entered into a contract in good faith and agreed with clients.”

Ultimately, the move may be too great for a dwindling area of the market, says Young: “It is a bit of a sledgehammer to crack a nut for all that is likely to be kicked up.”

Countdown to clarity

The timescales for any clarity on the issue appear vague. The European Commission was meant to report on final technical guidance on Mifid II by this summer, but this is now expected by the end of September or early October.

While the FCA has already released a discussion paper on Mifid II, it did not raise the issue of trail commission in the paper. It will work on a consultation paper to be released before Christmas.

“The ability to engage with staff is quite tricky, we’re looking at Q1 before we get something definitive,” says one regulatory source who wanted to remain anonymous.

“It has dragged on for longer than we thought. The advisers can’t engage until they know what the Commission themselves will accept or reject. We’re in limbo land.

“It is frustrating not knowing what actually they are doing, guidance has not been released. I’m not sure how much the average IFA has woken up to the facts of reform under Mifid II.”

Connell is expecting more clarity before the start of 2016, when the FCA should come out with a policy statement.

He says: “By the end of the year we expect that debate to have moved on.”

Adviser views

Dennis Hall, managing director, Yellowtail Financial Planning

There are some firms buying up a lot of books and maybe trying to convert that trial commission into ongoing fees on a platform.

Some firms are going to struggle and perhaps have trouble staying in business. They’d be expecting to receive a regular quarterly or half-yearly income trail which has been used to support their business. They will not have been quick enough in converting that into a fee-based proposition or scaling down their business sufficiently that they can match their income to their costs. It might be a difficult time for them.

Alan Smith, chief executive, Capital Asset Management

Banning trail altogether leads to further clarity around services provided and remuneration paid for that service, so advisers simply need be in a place to charge fees of clients who wish to pay and value that service.

But if it is terminated, ultimately who will benefit? I suspect clients will not receive enhanced policies, it’ll tend to be just retained by the product providers, so that’d be an issue for me.

Expert view

Some of the Mifid measures are in the form of regulation and the FCA cannot alter those. Mifid generally is a maximum harmonising directive, so the onus is on the country regulator to prove that something is in the public interest if they are going to add something on top.

In other areas, like insurance, there is no maximum harmonisation so the FCA can do what it wants, either sticking with the European regulation or choosing to go another way.

The Commission generally frowns on anything that goes over and above Mifid II as they see it as a barrier to harmonisation of the market, but where the Commission feels there is strong public interest and where one country is moving in the direction the whole of the EU is moving in, they may be willing to make exceptions.

The FCA can put that case to the Commission and as a result the Commission can either say “Yes it’s in the public interest” and allow it to go through, or say “No, it’s not in the public interest”, in which case the FCA can take the issue to the European Court of Justice. B

ut there is precedent, with the ban on commission for tied agents not being introduced for Mifid but it does exist in the UK. This is one where the UK has argued that it is in the UK public interest to go further.

Matt Connell is head of regulatory developments at Zurich UK Life

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Comments

There are 17 comments at the moment, we would love to hear your opinion too.

  1. The most important thing is that the client knows explicitly what service the adviser gives and how much they pay the adviser to provide it. I would suggest that the mechanism by which they are paid is secondary.

    It could also cause detriment for consumers with Investment Bonds as if the adviser remuneration is changed to a fee basis it will reduce their 5% annual allowance. Commission, which could have been set up on a customer agreed remuneration basis, doesn’t eat into the allowance.

    If MIFID II does ban it, the regulator must force the providers to enhance the terms for the client in direct proportion, rather than pocket it.

  2. Rt Hon Sir Arthur Streeb-Greebling 6th August 2015 at 9:47 am

    I think that insurance salesmen who sold these products, for which there is no justification for a standard rate taxpayer, should reflect on the detrimental effect that not selling the underlying collective OEIC, IT, etc has had on the client.

  3. I can think of numerous reasons why they would be justified and if you are an adviser, you should be ashamed for not knowing them!!

    • Rt Hon Sir Arthur Streeb-Greebling 8th August 2015 at 2:15 pm

      I suspect that you are unfamiliar with the recent FT analysis which showed that the internal taxation of collectives wrapped in ‘bonds’ ( Single Premium Life Insurance Policies) meant that a fund ( say:Invesco Perpetual High Income e.g.) suffers a diminution of average 30% c.v. the unwrapped direct holding.Undoubtedly the motivation for selling these products is/was (a) commission driven and, sadly as appears in your case (b) ignorance and lack of financial facility.

  4. Mifid II has quite profound implications for advisers – not only in respect of the possible loss of trail but also in other areas such as the beefing up of client reports and recommendations. Given the wish to ensure that folks have access to affordable advice, I would suggest that this Government review looks very seriously at the cost implications of Mifid II

  5. Stewart Tomlinson 6th August 2015 at 10:09 am

    If trail, or renewal, commission is banned surely it will include regular premium products such as term assurance, PHI and whole of life not just SP bonds? If it is banned it will be to the advantage of the insurance company who will merely trouser it!

  6. The more transparent we become, the more expensive it seems to get for the end consumer.

  7. Echoing Alan Smith’s point – the key issue is that we’re dealing with legacy products. If trail commission is ‘banned’ there is often no issue if the providers subsequently permit an ongoing adviser charge to be ‘turned on’ but what in reality happened after RDR is that such plans resulted in double charging given that providers don’t have this capability – as such, the cost of ongoing advice is being paid out of plan charges but those payments cease being made to the service provider (i.e. the Adviser) leaving the consumer to then pay again for that advice.

    It’s an issue with Bonds and it already affects plans with GARs – the cost of ‘at retirement’ advice is priced into the contract but is swallowed up by the provider – leaving the client to pay again!

    It also has presented the massive elephant in the room that, if your not giving advice, you can ‘fill yer boots’ with commission to your hearts content – leading to UCIS issues (15%+ commission!) and clients not understanding that the product they are buying is being sold by a non-advising tied agent.

    Why do those who give advice have to play to different rules (resulting in a competitive disadvantage) to those who arguably let the consumer infer they are being advised when in fact they aren’t – all risk passes to the client, the provider has no compliance issues and, I’ve seen first hand, earns a shed load more in commission.

    Hardly TCF if you ask me……….

  8. John Hutton-Attenborough 6th August 2015 at 10:42 am

    The real elephant in the room is whether the ban on trail commission will result in a reduction in the investment charges on the various products it applies to. A real unintended consequence of this ban could be that clients continue to pay the same fees without being able to benefit from any further on going advice. Is that TCF?

    • Exactly. I have numerous trust clients in “clean” charging Invesment Bond propositions. The charge within the bond is loaded to cover the “commission” to me which I have always fully disclosed. The clients know exactly what they are paying and just prefered the ongoing costs to come from the investment, rather than have to hold back cash in a trust environment.

      I have no problem with commission being switched off so long as charges within th eplan have to reduce by the same amount. If not, the client will have to pay twice or forego advice.

      You might say, end the contract and start again. Can’t do this due to chargeable event issues. The bond has always been advised on the basis that it will stay in place until it is to be distributed, probably by assignment, to beneficiaries.

  9. Quite right Mr Mallett. I was thinking of writing a list for the right honourable gentleman, but maybe he should undertake some CPD and work it out for himself. He also seems to forget about higher rate taxpayers, additional rate taxpayers and Trusts, but hey, only “insurance salesmen” recommend investment bonds.

  10. @Shailain Shah 10.24, you hit the nail on the head. Our costs keep going up and up and this is simply based on to the end users. I wonder how many advisers actually break down their advice charges into categories: Business costs, Regulatory responsibilities, PI, etc. Clients I do this for are astounded by what I have to pay along with the life long liability which goes with the territory. I have a few solicitor clients who simply laugh and say they would love to see their regulator try to pull that one on their profession.
    Still what can you do except carry on carrying on charging more for the same.

  11. apologies, I should have typed ….passed on to end users

  12. Well guess this will make it even less likely those with small sums to invest will be able to afford good financial advice and there was me thinking this was already a concern.

    Remind me who has been fined most and who are now backing out of the advice market?

    Glad I sold when I did.
    Good luck to all, you may well need it!

  13. Matt Connell, Head of regulatory developments at Zurich UK Life:

    “In the short term it’s the customer paying less money, which is always a good thing for customer, in the longer term it gives a more stable market where providers know where they stand”.

    So Mr Connell, are you saying that Zurich/Sterling is going to reduce the clients’ annual charges by 0.50% on all those investment bonds?

    No, didn’t think so.

  14. Like many of you I googled Streeb-Geebling only to be reminded that this was one of the great Peter Cook’s characters to those who responded to “him” chuckle chuckle!

  15. I personally think the time is coming, and rightly so in my opinion, that no adviser fees should be allowed to be taken from any product pre/post RDR Bond, OEIC, Pension etc. This would make it totally transparent to clients what they are paying for when they meet with their adviser on an annually basis (or more/less often). The client can decide if they are getting value for money.

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