“The rain wets the leopards’ spots but does not wash them off.” This Chinese translation of an age-old proverb may become a warning shot for the incoming FCA as they lead their self-proclaimed charge of interventionist regulation. With plenty of uncertainty still surrounding the long-term effects of the RDR implementation what we know for sure is it’s certainly raining regulation at present with a high number of threshold-focused directives shortly arriving.

 

For most of us involved in retail financial services, we have the RDR, FATCA, MAR & MAD, MiFID II, Gender neutral insurance and Solvency II amongst others to contend with and we now stand at the relative calm before the distribution turbulence that will surely follow.

 

This turbulence brings all sorts of issues and complications that need careful deliberation and strategy to ensure we’re well positioned to charter the stormy seas and bring sustainable success to our businesses.

The VAT chestnut: With RDR in particular we seem to have plenty of continued unintended consequences that need our attention, VAT and adviser charging with HMRCs ‘gateway to intent’ for intermediation provided guidance on whether firms charge or indeed register for VAT or not. Yet with the recent European Court of Justice recommendation that all DFM services pay VAT, this has set alarm bells ringing. The issue here, where advice is concerned, is to ensure clarity and evidence in all client communication particularly for suitability letters that reflect the client objections in full. The VAT litmus test is gateway to intent, ask “What have I done for the client” and gage client reaction: rejected recommendation (VAT-able) and aborted transaction (exempt).

For more on VAT watch Les Cantlay in action with Citywire’s David Sandham:

The bare-faced fee: Adviser charge facilitation provides a headache that may blow up in the face of product providers. The debate that once the product boundary is broken as fees are paid form the underlying product, brings plenty of tax consequences so eloquently laid out by the indomitable Rob Reid in a recent press article. http://www.moneymarketing.co.uk/regulation/rob-reid-rdr-adviser-charging-and-customer-loyalty/1057822.article

 

 

Don’t break the product boundary and charge direct? Easily said but this can be done if advisers customer service propositions are intelligently positioned. The effervescent Mark Paulson has advocated as much in his recent Money Marketing article: http://www.moneymarketing.co.uk/adviser-news/mark-polson-time-to-reject-provider-charging-and-go-direct/1060565.article

 

 

 

 

My NMA article also gives 7 key strategies to offer adviser charging value: http://citywire.co.uk/new-model-adviser/adviser-charging-seven-steps-to-convince-clients/a623255

 

 

Commission Mind-set: Where I see an iceberg that can sink a liner is in the commission mind-set many market participants continue to adopt. If we take adviser charging facilitation as it stands and apply the validation and decency limits that the regulators require, we currently have a Mexican standoff where product providers seem to think they still control the AC and a minority of advisers think switching may be the answer to fee generation. Add to this the debate around the nature of remuneration between platforms and distribution firms, we then have a perfect storm. My interview with Citywire covers key commission mindset issues:

 

 

 

 

What we seem to be missing is the fact that the RDR is almost MiFID article 26 gold-plated, where any changes to remuneration, charges and product need to ensure the client experience is enhanced and inducements are banned. This means that product providers must offer comprehensive flexibility on adviser and consultancy charging and verify and validate all fees paid.

FCA and Tickboxes: The very fact that Hector Sants is on record stipulating that the UK regulator will become a “tick box’ implementer of EU regulations and Martin Wheatley seems to be championing the ‘irrational investor’, supports the view that MiFID and its cousin no 2 will cement the case for placing client protection and fair and transparent charging first.

 

We then need to move on from a mind-set that promotes opaque practice (inducements such as soft commissions, marketing fees or kickbacks) and blindsides the issues that will surely cause a huge headache not only for clients but also for the industry.

Behaviour behaviour behaviour: We can do this by focusing on the attributes behavioural economics brings, and counter-intuit strategy by employing 3rd party dispassionate views, involving focus groups to gather the evidence and provide meaningful debate and making it personal by understanding the long-term implications of continued practice.

There are plenty of firms out there at present who have commendably sought answers to the challenges faced and with this brings innovative thinking and enterprising solutions which can build a robust and adaptive business model. An example of this is in the technological advancements being made to support fee based systems and platform re-registration. Yet we are in danger of entering 2013 and beyond with a ‘commission-hangover’ that will cause damage and dismay to the industry and client relationships.

The regulatory rain is coming, we may not be able to wash away any commission mind-set instantaneously but with strategies that engage behaviour, emotion and cultural change, we have an opportunity to understand, explore and apply organisational change that allows us to comply and compete.

 

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Post ‘R’ day, along with the inevitable distribution turbulence that will afflict business models, there is no doubt that one of the biggest challenges to the retail investment adviser (RIA): client relationship is clients will only give RIAs 30-40 minutes in their engagement meetings to convey the value for fee based advice and the fact that savvy clients will orphan themselves 2-3 years into a fee based relationship if they do not perceive service value.

Gaining the right people in the right position with the right skill set is just as crucial for advisories as is deciding on a restricted or independent distribution model.

Behaviour in any industry is unfortunately an elephant in the boardroom. When faced with enforced change and challenges we tend to get caught up in the hard facts and ‘serious business’ issues. Yet it is people who build business, people who work for business, people who regulate business and people who buy from business. Behavioural biases come with this territory, i.e. the current financial crises cause is down to a mix of dysfunctional behaviour and irrational reaction. Cause and effect then.

So what can be done about this? Well the first point is to recognise and understand behavioural economics and how it applies to financial services. The human mind is a wonderful tool, yet it does have its downside. Notable social scientists such as Daniel Kahnman, Amos Tversky and Richard Thaler have popularised the view that the human mind is fallible particularly when it comes to financial services. This can then help financial advisers identify the most effective and useful behaviours to build trusted client relationships.

Clients will need to understand quickly how their mind reacts to market movements and their capacity for and reaction to risk or loss. The brain effectively is hard wired to loose, it operates a faulty traffic light system: we invest when we should stay out and withdraw when we should stay in. Neuroscientists know that its dopamine that flows when we’re on a bull-run and adrenaline when the bears come chasing. A classic fight or flight response.

Indeed loss and regret aversion are two of the most devastating biases that need to be addressed. By ensuring they complete thorough client driven questioning at the fact finding stage and facilitating an open and comfortable environment where clients feel safe to offer information around their past experiences, risk tolerance and attitude, advisers will then be able to gain valuable information to include in their portfolio recommendations to ensure a personalised approach that will offer ‘safety stops’ so clients do not make the same mistakes over and over again.

For example it maybe better to stay invested when a paper-loss is made through a market crash than to cut and run. Encouraging client behavioural strategies such as a sleeping on decisions; a counter-intuitive approach, avoiding too much market information and ‘noise’ or spreading options through product choice and diversification can all facilitate favourable results in the long term.

Indeed advisers now really have to ‘walk their talk’ and ensure long-term goals are the focus and rules of thumb (or heuristic decision making) is avoided on both their and their clients part. This behavioural shift may seem basic, but it has been scarcely applied. Unfortunately the world is much the poorer for the myopic, overconfident behaviour that brought such financial devastation with it.

So by fine tuning their own behaviour, gaining awareness of behavioural economics principles, applying them to positively influence clients biases and encourage a healthy relationship with their finances, advisers can certainly add high value and ensure clients realise the worth of retaining their services.

Will simplified advice be abandoned?

With the Mexican stand-off over regarding the release of the FSA’s consultancy paper on simplified advice, we now have the guidance in concrete that this distribution channel will not be a quick win for the industry in gaining the middle market post RDR implementation but a service operating under the ever growing close scrutiny of the regulator with all the risks attached.

Although we knew that simplified advice would always be included with the adviser charging, remuneration and recommendation rules (COBs 6.1A & 9.2.1R) and it would not be a basic advice channel working outside the RDR, the fact that authorise and validate is key and the regulators tendency to bayonet the wounded may see off any valiant attempt at pioneering a state of the art streamlined distribution channel. Indeed we are already seeing smaller outfits such as Churchouse Financial planning throw in the towel on simplified advice.

The main problems may lie in the fact that clients who may want to orphan themselves post RDR due to knowledge of remuneration levels paid or a savvy understanding of the changing market landscape, also NEST auto-enrolment schemes give clients all they perceive they need for pension planning, the Money Advice Service is viewed as a conduit to financial planning and the fact that 49% of the ‘mass market do not have the means to invest may result in simplified advice being abandoned.

Yet Life companies, banks and the larger IFAs and wealth managers may still want to explore cutting edge technology that brings financial advice to the door step of mass market clients. The problem with this is the design and implementation may result in hybrid model which doesn’t actually serve the very market simplified advice was targeted; the potential RDR disenfranchised investor.

If simplified advice is to work, what truly needs to happen is a ‘flip funnel’ approach where the service (particularly technology) is designed around the clients not the business needs, the regulators need to become more inclusive in a ‘co-build’ strategy allowing both the market and the regulator input into service design, and certainly higher professional qualifications need to be employed for any individual delivering simplified advice to ensure market professionalisation is carried forward.

Bold and expansive technology driven to the customers needs should have emphasis on simplification such as transparency and simple product with initiatives such as the Social Market Foundations product ‘Kite marking’ adding great value to understanding and knowledge of product features and benefits.

Indeed simplified advice also gives a marvellous opportunity for the industry to address the elephant in the room, that of behavioural economics and how clients’ irrational behaviour may once and for all be addressed by a standardised service for the very market that desperately needs financial planning.

Regulators nudge strategy applied with industry communication and soft skills geared to coaching clients down a path of self discovery can lead to real understanding of how irrational biases such as inertia, procrastination and mental accounting can be managed and financial capabilities improved.

Easier said then done? Well, in other industries we are seeing early signs of how regulators and the market can come together in the US healthcare system, with, for example, President Obama’s radical new regulation to make healthcare affordable on a mass-market basis. Although heavily subsidised, this continues to result in pushback from the industry itself, but with regulatory nudging Americans may finally be able to enjoy something similar to the marvellous UK NHS system that we often take for granted.

More time and getting heads around the key issues from all corners of the market is therefore needed to really assess the benefits of simplified advice.

Yet with independent, restricted, specialist, generic, execution only, basic and primary advice being toyed with by most market participants in some shape and form and the RDR final straight ever looming, we may see simplified advice being placed on the back burner, or indeed abandoned. I hope not.

The FSA’s much awaited follow-up to CP10/29 for the role platforms play in financial services has today provided the industry with another indication for the move towards full facilitation of client inclusion and clarity in financial planning. There is no getting away from the fact that the product providers have had their day and now the RDR demands transparency and the industry must conform.

As ever there are a few issues to be mindful of. We need to ensure the rule book is understood. The Conduct of Business Sourcebook (COBS) needs to be lived and breathed by all market participants to get to grips with cutting edge strategies that will facilitate better client relationships and aid healthy engagement between industry and regulator.

Issues such as COBS 6.2.15R which focuses on adviser charging can lead some to think that if adviser firms were to remain ‘off platform’ then higher adviser charging is perfectly plausible and within the rules. It’s a grey area, as this platform paper is adamant that the reason for proposed cash rebate and product provider payments to platform bans should not interfere with the client and adviser relationship. At the end of the day the adviser charge has to be agreed with the client and with discerning clients comes the needs for advisers not only to remain competitive, but also to show value.

COBS 6.1E.1R is truly about transparency demanding full disclosure of fees/commissions from fund managers. Indeed COBS 6.1E.2G stipulates if a platform were to accept fees/commissions then obligations to notify the client under best interest principle 6 & 7 need to be adhered to negate any bias.

There are also the issues surrounding the independence ruling in that it is debatable if true independence status can be maintained if only one platform is used by an adviser firm for all or even the majority of their clients. This plus the fact that off platform investments must also be considered if ‘whole of market’ advice is given means (particularly where client segmentation is concerned) a one size fits all attitude and artificial investment spread are to be avoided. COBS 6.2A.4A & COBS 6.2A.4BG attacks independent firms who solely rely on rebates from funds on platforms.

Indeed platforms are defined as just that, platforms and not distributors. This definition is needed to ensure all market participants are under no illusions as to what the relationship should be when using a platform. This is a key area when considering supermarkets, as platforms must maintain impartiality on fund presentation, the paper therefore implies supermarkets may have had their day.

Where adviser charging (AC) is concerned, COBS 6.1B.9R ensures ‘platforms face the same requirements as product providers of they facilitate payment of advice charges’. The main aim is to ensure client inclusion for the decision to agree the amount of charging that applies. Where validation for clients instructions are concerned then COBS 2.4 is necessary to confirm the rules for reliance on others. The main concern we have is the issue concerning the cash accounts use for AC facilitation, definition on protection re ICAAP rules needs to be enhanced or at least mentioned to protect client money in event of liquidation for e.g.

COBS 6.1A.22R is all about ongoing services regarding AC and it is the advisers responsibility to ensure that fees are appropriately paid and for those clients who orphan themselves, then the advisers must stop the AC. engage’s Viability activity based costing software will aid clear fee monitoring and management to ensure advisers and their clients are accountable and all activity is validated in the necessary way.

So for some this paper may have been a damp squib with no ground-breaking revelations, but I think it’s another positive step in the direction for transparency within the industry, clarifying the need for caution for cost benefit analysis for rebate bans, definition for execution-only strategies as encompassed within the platform rulings, a penchant for unbundling and clarity for client communication via technology and indeed knowing how the COBS applies to not only Platforms but also to the RDR.

A quick summary:

 

 

 

Key issues

 

Comments

 1. Overview  1.     Payments by providers to platforms2.     Cash rebates to clients.  CP10/29wanted to enhanced transparency and disclosure on these payments but with no direct ban (see page 116). A ban was due though on cash rebates to clients.The position has changed to the extent that the FSA wish to ban both outright come Jan 1st 2013, but with work carried out by TISA and other industry bodies, the FSA will take further consultation with any ban starting no earlier than this date. NB the Aussie did a 180 degree turn around on allowing rebates in at the 11th hr in their regulatory ‘revolution’.
 2. Defining a platform and distributing products.  1.     CP10/29 defined platforms and service providers. Yet question marks remained over providers such as SIPPs/ISAs/CIS/AFMs & if Execution only applied to new definition.2.     Adviser Charging; to gain momentum on platforms, through cash a/cs.3.     Adviser firms use of platforms  1. PS11/9 defines ISAs that offer multi funds as platforms but Life co’s, SIPPs CIS, AFMs are not.i.e. those arrangements offered by private client investment managers that are adviser paid and ancillary are not incl.Execution-only is included to the extent that COBS 6.1E.1Rrequires disclosure to client of remuneration. i.e. best practice applies.2. Adviser Charging on platforms to follow product charging as per COBS 6.1B.9R i.e obtain and validate client instruction. Funding and servicing of client accounts need to be monitored and in clients best interests. (e.g. if client orphans themselves) BUTthere is no mention of escrow accounts or indeed ICAAP rulings! (Page 180).3. Independence standards need to be met when ensuring platforms are right for clients. i.e. no bias and restriction on platform recommendations. COBS 6.1E.1R=transparency of fee. Thus care needs to be taken with DFM/supermarkets that need not conform?Single platform use depends on the clients interests.
 3. Payments to platforms and consumers  1.     Product providers to platformsCP10/29 addresses potential conflict of interest here and recommend disclosure but no ban.2.     Cash rebates product providers to clients; Rebating seen as a style commission ‘throw back’  1.     Unbundling seems to be preferred in this paper with proposed ban on product provider payments in order to separate product and platform charges. The RDR objectives of consumer clarity of product charges therefore needs to be upheld. BUT before the ban maybe upheld, impact analysis needs to e completed.2.     Ban to go ahead. The objections to CP10/12 re cash rebating aiding fees, exactly the behaviour FSA want to cull. RDR rules stipulate that client, adviser and providers agree the cost of advice thus this may vary and rebates cannot cope with this and set by provider.
 4. Re-registration and capital adequacy.  1.     in-specie re-registration standards to be recommended to all nominee companies.2.     COBS 6.1G.1R re-drafted to reflect that not all firms maybe nominee based.3.     Re-registration to take place in reasonable time frame.4.     Share classes and bulk trfrs  The work conducted by TISA and the platform re-registration panel is to be commended and works well with the papers emphasis on ensured best practice and best advice for clients wanted independence of choice and transparency in comparison of available platforms features and benefits.Re the issue on share classes the ban on cash rebates does not mean a proliferation in share classes due to unit re-investment allowance. Re Bulk trfrs most platforms should facilitate re-registration, they’re big enough!
 5. Investing in authorised funds through nominees.  1.     Platform investors to have same access to funds as direct investors.2.     Key Investor Information KII a and associated costs of information for clients.  It is the general industry view the platforms have a rosy future and thus more business will be written and more funds available on platforms.Electronic fund information is to be encouraged with hyperlinks to repository of information on relevant fund information.Short reports as used in UCITS IV are to be recommended i.e. synthetic risk and reward indicator (SRRI) as part of KII. Short forms to be provided 1/4rly.Clients to be kept informed and engaged as is currently on voting rights i.e. CP10/29 proposals cancelled. BUT with key guidelines.
 6. Cost benefits analysis.  

  • Decrease in platform compliance costs from £174.6m to £103.8M (due to rebate ban)
  • One off cost £55.4m (platforms £40.4, £2.9 fund mgers, £12.1 intermediate fund holders).
  • Ongoing Costs £48.4m (£20.4 platforms, £28 intermediary fund holders –non for fund managers)
 What we need to watch out for and that is not factored in to the cost benefit analysis is the fact that advisers may increase their fees in accordance to the ‘missing rebates’.