Andrew Fisher explains why the Retail Distribution Review means a better deal for investors seeking professional advice.

In September 2006, Sir Callum McCarthy, then chairman of the Financial Services Authority (FSA), made the following assessment of the financial advice sector: ‘We have, at present, a business model which is based on incentives that produce results which are unattractive to reputable providers and unattractive to their customers, and whose benefits to intermediaries are questionable.’

Sir Callum’s comments were made three months after the FSA launched the Retail Distribution Review (RDR). With widespread public mistrust of the financial services industry, in no small part due to an ongoing stream of mis-selling scandals, the FSA wanted to examine how financial advice could be delivered more effectively to consumers.
 
The story so far
The proposals detailed in the RDR’s feedback statement, published on 25 November 2008, were for consumers to:

• have a proper understanding of the services they receive when they take financial advice
• be more confident that their adviser is professionally qualified
• receive unbiased advice with clearly laid out charges that they fully understand.

This all sounds eminently sensible, and the proposals announced in the RDR should mean that the FSA is able to achieve these goals. And this represents a major victory for those who will be taking financial advice.

The problem that consumers face today is that the advice of many independent financial advisers is compromised. The majority of advisers earn their income from commissions paid by product providers for selling products such as investments and pensions. Advisers in these firms only get paid if they sell a product, and the amount they get paid will vary from product to product and provider to provider.

The risk for the consumer is that their adviser has a financial incentive to ‘give them advice’ to buy the product that pays the highest level of commission. This, for example, could explain the high sales levels of investment bonds, which are usually inflexible and not tax efficient, but can pay initial commission of up to nine per cent of the investment amount.

True independence
The FSA has recognised that ‘independent’ advice is potentially compromised while this conflict of interests remains. It is, therefore, replacing the existing criteria that allow advisers to call themselves independent with more stringent measures related to advisers being able to give genuinely unbiased advice, agree fees with clients and be better qualified. This should give consumers more confidence in the independence of the advice they receive.

Those firms that do not meet the requirements for providing independent advice will be deemed to provide ‘sales advice’, i.e. advice in relation to selling a product. This
will help to create a clear distinction for the consumer between whether they are receiving independent financial advice, which is in their best interests, or more limited advice.

The easiest way to ensure that all financial advice is in the clients’ best interests would be to remove the influence of commission. ‘The consumer does no better than the providers under the present remuneration model,’ says Sir Callum McCarthy. ‘This suffers from product bias, provider bias and churn. Product bias, in other words the customer not being advised to take action consistent with their priority needs, is arguably the most detrimental. Consumers are not always advised on transactions which fail to remunerate the adviser, or which offer little by way of commission to the adviser.’

Knowing where you stand
While the FSA has not explicitly banned commission in the RDR, for legal and practical reasons, it has proposed that any payments from a product provider to an adviser be agreed with the client beforehand and deducted from the amount invested. This increased transparency will explode the myth that commission-based advice is free.

The ‘old world’ pretence of ‘this advice is free for you because the insurance company will pay’ is over. Advisers going forward will be forced to show consumers how much their advice will cost and the consumer will have the opportunity to determine whether they consider it to be value for money.

So, if an adviser wants to sell a £100,000 investment bond to their client and they want to take ‘commission’ of seven per cent, they are going to have to agree with the client how much they are paid. They will also need to explain that this amount will come directly from the investment, in this instance leaving just £93,000 in the bond. This will greatly empower consumers because how many clients are going to opt to pay £7,000 for an hour or two of advice to buy an investment bond?

The value of this increased transparency cannot be overstated. While commission payments should currently be disclosed to clients, it is very easy for the actual costs of commission to be concealed. In the above example, if the client invests £100,000 in the investment bond and the adviser takes their seven per cent commission, yet on day one the bond is still worth £100,000, it is not clear to the client where the commission charges are coming from. The answer, very simply, is that they are paid from ongoing charges coming from the client’s investment, so it is the client who ends up paying.

Improving standards
The FSA’s Treating Customers Fairly document, published in 2006, highlighted
this issue, stating that ‘As part of our quality of investment advice processes work, in a significant number of “mystery shops”, firms failed to give accurate information to customers on how the firm will be remunerated.’

The RDR proposals will rectify this situation but the FSA also wants to improve qualification levels in the industry, particularly with regard to the industry benchmark qualification, the Certificate in Financial Planning, which is astonishingly low and needs to be raised – it is sometimes sarcastically compared with a GCSE in woodwork.

The FSA has recommended the adoption of a new Level 4 industry benchmark, this being considered equivalent to the first year of a degree course. This is a positive step, but Level 4 should only be used as a stepping stone to all financial advisers achieving chartered financial planner status, the highest in the industry. It is pleasing to note that the FSA has said that ‘it would be highly desirable to seek to move the minimum level of qualification for all new entrants up to honours degree-equivalent (Level 6) as soon as possible’.

Setting chartered status as the industry benchmark should give consumers more confidence in the quality of advice they receive, and the professionalism of the adviser. It will also help to put the financial advice industry on a more level playing field with other professions such as law, accountancy and medicine.

A long way to go
This proposed increase in qualification levels announced in the RDR sounds sensible, but it is also radical. A staggering 79 per cent of advisers have not yet achieved the Level 4 benchmark, and within this group the evidence is that the majority are not currently taking steps to improve their qualifications. This is why consumers should always ask their adviser how qualified they are.

This is another problem of the financial advice industry. Many advisers pass the minimum benchmark qualification and then do very little in terms of taking further professional examinations or personal development. The result is that these advisers do not always have the necessary skills or knowledge to advise their clients in a wide range of circumstances. Again, the RDR proposals are a significant step in resolving these issues.

While some of the proposals will take up to four years to be implemented fully, the financial advice industry is now on a path from commission-based product sales, made in the interests of the adviser, to independent fee-based financial advice, which is made with the clients’ interests to the fore at all times.

Consumers looking for a professional and truly independent service should rejoice, for they will soon be able to feel safe when seeking financial advice.

Andrew Fisher is chief executive of Towry Law