Just three years after the implementation of the Retail Distribution Review (RDR), the Government is considering yet further regulatory reforms. We consider the changes being proposed following the Government’s Financial Advice Market Review (FAMR), and how the changes may impact on financial advisers and their professional indemnity insurers.
A combination of the RDR and mass exodus of most professional indemnity insurers has had a significant impact on the shape of the advisory market, particularly the size and profile of the advisory firms that still operate in this arena. Introduced in 2013 with the aim of ensuring a greater level of transparency and fairness in the investment industry with consumer protection its focus, the RDR saw:
- The restructuring of remuneration agreements and banning of commission on any new advice.
- The raising of the minimum level of qualification for advisers.
- A new two-tiered system where advisers were either “independent” (in which case they had to be able to advise in relation to the full range of retail investment products with no bias to one provider) or “restricted” and had to market themselves as such.
Just three years after these changes, the Government is considering whether to introduce further reforms to reverse or dilute some of the potentially unintended consequences of the RDR.
So what isn’t working?
The advice gap
This is one of the main drivers for change. It exists because investors are unable or unwilling to pay upfront for advice and the fees that giving such advice would attract mean that the work is no longer profitable for advisers. In the past, the ability to charge commission has presented the solution to this conundrum but no longer is that the case. Demand for financial advice has reduced as a result, and so has the supply, forcing many firms to close their doors.
FAMR and proposed reforms
While the FCA is keen to stress that the FAMR has not set out to target the RDR, it accepts that reforms found to have contributed to the advice gap will need to be reviewed. Of those considered, the reforms most likely to impact upon the RDR include:
- A new charging structure akin to commission.
- Creating a new basic tier of advice with lower qualification requirements for simple products.
The first proposal is aimed at increasing options for customers who do not want to pay upfront for advice, by allowing transparent fees to be built into simple products such as ISAs and simple pensions. While transparency is the key word here, the proposal is clearly at odds with the RDR’s stance on commission amid concerns that some advisers were putting their own interests above those of their clients.
The second proposal is said to reflect the view (not accepted by all) that there is little scope for simple products to go wrong and therefore that the RDR’s stringent qualification requirements are too onerous and not appropriate. However, this is again clearly at odds with the RDR, which aimed to improve the level of professionalism in the market by raising qualification requirements.
What would the changes mean?
If successful, these changes could boost both the supply of mass market advice and the demand from those willing to take it up. For smaller advisers, the ability to charge commission could provide a welcome route back into trading. For consumers put off from obtaining advice by upfront costs and/or lack of choice, the changes should also lead to greater flexibility. However, this is not without risk.
In particular, it is difficult to see how insurers’ appetite for participating in this market will change given the level of claims activity in the last decade and especially when the changes could mean greater risk flowing from less qualified advisers undertaking a greater spread of work and/or the risk of a return to the widespread reports of commission bias. It is easy to see how either of these issues could lead to increased fee complaints, Financial Ombudsman Service (FOS) disputes and/or professional negligence claims.
In view of the work that went into the RDR, its success in numerous key areas and of the early stage of discussions, it remains to be seen whether any of the above changes will come to fruition. This is particularly true in circumstances where the FOS has recently reported an impressive 22 per cent fall in investment advice complaints in the second half of 2015. However, the very fact that the changes are being considered must create some risk of yet further drastic reform in the advice sector. Given the short deadline of presenting its findings before the March budget, we will know the outcome of the FAMR soon enough. In the meantime, advisers should continue to protect themselves by strict compliance with all of the RDR rules.