Review of retail distribution in the UK
Speech by John Tiner, Chief Executive, FSA
FSA Retail Intermediaries Sector Conference, Birmingham,
14 June 2006
Thank you Jeremy; you’ve painted some interesting pictures of the future. I'll return to those shortly. But first, let me add my welcome to you all; the agenda for today looks both topical and thought-provoking and I'll do my best to add to this.
The Scenarios – what is this work about?
Let me start by explaining the background to the work we commissioned from KPMG - in other words, why did we ask Jeremy and his team to construct possible scenarios for the future? I think this is important because, in my view, it is rather different to the work we generally ask external parties to do.
Usually, we commission external research with very specific aims or objectives and with a clear intention that the output will feed into a particular policy initiative or supervisory assessment. Familiar examples here would be the cost/benefit analysis that we are bound by the Financial Services and Markets Act to undertake if we want to bring in new rules (such as the menu or the IDD) - or if we are required to bring in a whole new regime (such as MCOB or ICOB). On the supervisory side, you may have picked up on our growing use of external parties to perform the mystery shopping elements of our thematic assessment work.
KPMG's scenario work was, in fact, initiated by the FSA’s Retail Intermediaries Sector Team, with the broad objective of thinking about what the future might look like for UK distribution. So why did I agree to them doing this? Well, for those of you that are not familiar with our sector teams, the FSA has nine small teams focusing on various parts of the financial services landscape such as banking, insurance and asset management. Another focuses on what we call "retail intermediaries". In non-FSA speak, this team looks at firms involved in distribution to retail consumers, so primarily (but not exclusively) it looks at financial advisers, mortgage and general insurance intermediaries. The role of the sector team is to gather, monitor and understand market intelligence, market developments and any other issues that are impacting, affecting and shaping the sector. This is a team that is using its eyes and ears externally to help inform our risk assessments and our judgments on priorities internally.
Against this background, I was interested to hear that the Retail Intermediaries sector team had picked up what they considered to be an increasing amount of industry comment reflecting the opinion that the current distribution model was under some strain and that things needed to change. Comments such as “the current distribution model is broke” were on peoples’ lips. In fairness, however, the team was quick to point out that for every statement such as this, you could always find a quite contradictory account elsewhere without too much effort.
This all prompted the team to start thinking about what the future might look like if change really was in the air - and what change could bring. My executive team was also keen to have a debate with the sector team on what the future might hold. I agreed as, in our desire to be a forward-looking regulator, we must think proactively about what the future may hold and what risks to the FSA's objectives this may present for us. It is also important that, in defining our future regulatory priorities, we attempt to take account of how these could play out in a world where market structures may not look the same as they do today. We accept that the impact of regulation can potentially affect market structure. This is something we need to understand better, both in looking at today's market and future structures that may develop over time.
In preparation for this debate, the sector team decided to appoint an independent party - after selection, KPMG - to develop and road-test scenarios with a selection of market players to assess their plausibility. The sector team also felt that, by using a third party to feed back to the FSA on an anonymous basis, interviewees would be more frank about what the issues are and what they thought might happen in the future. This also helped to test whether the industry comments about the need for change in the market were based in true sentiment or were just "chatter". After all, if the majority of interviewees had turned round and said that this was an odd exercise to be doing as the status quo was likely to continue, then this in itself would have been interesting. Indeed, much of the thoughts the market players shared with us on the future went on to be captured in the scenarios you have seen today.
However, let me be clear. The scenarios are not - and were never intended to be - the FSA’s forecast of what the sector might or should look like. As you know, the FSA has no role in directing the market as such. But the scenarios have been useful in helping us think about what the future might hold and how this may manifest itself as risks to our objectives.
The Scenarios – what was our reaction?
So, what was the reaction of my executive team to the scenarios when presented to us? Well, I can certainly tell you that the objective of "stimulating a lively and challenging debate" was met! And, perhaps, mirroring some of your own reactions today, different people in the room bought into different elements of the scenarios to different degrees. Overall, however, and I do want to repeat that these are not the FSA's views on the future, we did manage to achieve a broad consensus that each of the scenarios KPMG presented represents a plausible vision of the future - even if there are also many others you can think of. Indeed, when the Practitioner Panel and Smaller Businesses Practitioner Panel saw the work, they had as many diverse views as we did.
My executive team did not necessarily see the scenarios for each sector as mutually exclusive. We discussed whether the two scenarios on the Financial Advice side could combine and result in greater financial advice coverage across the UK. Could an increasing presence of banks and multi-ties servicing the "mass market" (as portrayed in Scenario 1) drive Scenario 2 whereby IFAs move to serve – or should I say continue to serve – primarily more affluent consumer segments, perhaps through new technology such as Wraps? Adnitor's proprietary research shows that the assets on intermediary platforms were approximately £16 billion at the end of 2004. Datamonitor estimate the growth of platforms to be £150 billion by 2008.
On the GI side – and I should re-iterate here that we only refer to retail personal lines – we think it is interesting to note in Scenario 1 that consumers may start to focus on quality as well as price. Our experience here so far is that consumers do not usually have an informed view on quality - until such time as they come to make a claim - but if, as the scenario suggests, this does start to occur, then surely all to the good? For Scenario 2, no doubt many of you have already been pondering as to whether the "Aggregator" is going to be a significant player in the market or simply another channel that may or may not succeed.
As for the mortgage sector within the timeframe of this work, we found it interesting that there was a lack of evidence to develop a credible second scenario, based on a more malign environment. This does, of course, chime with our own published assessment of the outlook in the UK for this sector, as portrayed in our 2006 Financial Risk Outlook. There are also some interesting observations about the impact of HIPS, on which you'll no doubt have your own views.
We are interested in your thoughts on the scenarios. I'm sure you'll take the opportunity today to discuss these with us or, if not, perhaps you could find the time to send us an e-mail at retail.intermediaries@fsa.gov.uk. I also hope that you find opportunities today to discuss them among yourselves.
The scenarios – what did they tell us?
So, is there anything particular that we, the FSA, have taken away from this work? Well, it has shown us that, regardless of whether change occurs, there is still a crucial role for advice in the UK. Non-advised sales of course have their place, particularly for purchases of more straightforward products. But financial advisers continue to account for more than 60% of total life and pensions sales in the UK. A Mintel survey shows that of those consumers who have sought, or intend to seek, advice, almost a third turn to IFAs. There is clearly greater scope for financial advice to reach consumers, particularly in a world where consumers continue to find financial products daunting, notwithstanding our work - and the work of others - to tackle financial capability. This is particularly pertinent in a world where the individual is increasingly being asked to take on more responsibility for their long-term planning, including how to provide for their retirement, healthcare, and dealing with debt. The United Nations population division forecasts that by 2050, 34% of the UK population will be over 60, compared with 21% today. Hence we might reasonably expect increased demand for retirement planning in the years ahead.
You may have seen the results of a major baseline survey that we published earlier this year, which revealed that people from all sections of society are poor at planning ahead, whether for retirement or for an unexpected event. It also showed that many people are poor at choosing products, and that younger people are less financially capable than their elders, yet face some of the greatest demands on their financial capability.
One of the quantitative results of the baseline survey showed that, when purchasing a financial product, only 21% of consumers considered taking professional advice or even searched actively for the best buy. So there is, quite clearly, a key role for the provision of financial advice.
What the scenario work also suggests to us is that the firms within the retail intermediaries arena will surely continue - as now - to share the aims of the FSA for the sector. The dialect of the FSA often springs from the language of statute. The focus of our work is around identifying and mitigating risks to the objectives set down for us in the Financial Services and Markets Act. These are "maintaining confidence in the financial system"; "promoting public understanding of the financial system"; "securing the appropriate degree of protection for consumers"; and "reducing the extent to which it is possible for a business to be used for purposes connected to financial crime".
Allow me to translate, again, from FSA-speak. For the retail markets, what we are trying to do (as you will see in the way we describe our aims in our annual business plans), is to "improve our business capability and effectiveness", "promote efficient, orderly and fair markets" and "help retail consumers achieve a fair deal".
Helping retail consumers achieve a fair deal
I would like to spend a few moments taking stock of two of these aims. Starting with the latter - helping retail consumers achieve a fair deal - this is an area where the FSA has performed a lot of work over the past few months in order to reach a view on where we think the market is. Suffice it to say that the thematic reviews carried out so far reveal a number of concerns, and I will comment on some of those key reviews in a moment. In summary, there have been mixed results both within and across reviews, but from financial promotion issues through to disclosure through to the sales process, our findings have generally been disappointing.
Our findings, especially the disappointing results for some of the current higher-profile products (such as equity release and PPI), mean we have been revisiting several pieces of work, and reviewing these topics again. We do this in the hope that our initial findings of good and bad practice that we have seen will have been taken on board by firms and that we will see an improvement in standards.
Let me remind you of some of the findings we have published so far. On financial promotions, we have done several pieces of work. In November we announced that we had found shortcomings in the way that financial advice firms were marketing venture capital trusts. Firms were not giving investors a balanced view of the advantages and risks of investing in VCTs in their web-based promotions – often failing to mention that the investment had to be held for three full years to qualify for tax relief; and failing to mention that the investment was in small, unquoted companies, with attached risks. On the general insurance side we found that many products were being promoted on the basis of price alone, using a headline such as "save 20% on your home insurance" - but these headline claims can be unrepresentative of what most consumers would be offered, or subject to significant limitations - or both.
We've also undertaken work on financial promotions in particular product areas; for instance, in August 2005 we presented results of the work we carried out on marketing for critical illness insurance. Since then we've reviewed promotion of other protection products. Common issues that needed addressing were for firms not to use small print when qualifying prominent claims; to always ensure that promotions note that term assurance quotes are dependent on circumstances; and to ensure that promises are clear, fair and not misleading.
On disclosure, in the last eighteen months we have carried out thematic reviews looking at standards in financial advice, mortgage and general insurance firms. In financial advice firms, a mystery shopping exercise involving a total of 130 assessments revealed that, in only 58% of cases, firms were providing both the IDD and the Menu to consumers and, in only 42% of cases, firms were supplying these to customers at the right time. In August 2005, we published our findings of our mystery shopping exercise which involved 82 shops to 62 mortgage lenders and brokers. Again, this work was undertaken to establish whether firms were providing the Initial Disclosure Document and the Key Facts Illustration. Findings here showed that firms were non-compliant in 55% of cases. Finally, in the General Insurance arena, a survey found that 281 of 453 Initial Disclosure Documents reviewed from medium and small sized general insurance intermediaries did not comply fully with FSA requirements. We also found that 42% of the statements of customer's demands and needs that we reviewed did not meet our requirements.
Furthermore, our work in 2005 on sub-prime mortgages revealed that many firms were unable to show that they had followed the required procedures relating to suitability of advice. From a sample of 210 cases across 31 firms, 60% lacked sufficient information in key areas, and 8 out of 10 files did not have enough evidence to show that advice was suitable. There were also a small, but worrying, number of instances where fraud was suspected and we took action on these.
However, it is not all bad news. We were encouraged by the findings of our review of claims handling, and it seemed that firms had been able to implement the requirements of our new rules without undue difficulty. In addition to this, when we investigated complaints handling practices in small financial advice firms at the end of 2005, we found no evidence that firms were "fobbing off" complaints, but we did find issues that needed addressing. We looked at a sample of 51 firms and 412 files and found that in the majority of cases, the decisions being made by small firms to reject or uphold complaints were appropriate. However, we did find that firms were not always meeting the time limits within which complaints should be dealt with, and were not adhering to their own internal complaints handling procedures. This meant that deadlines were not met in a significant number of cases, which is clearly disappointing.
I should mention that, as a further part of this probing of the quality of advice being given by retail intermediaries, we have just completed a substantial piece of work looking at advice given by financial advisers in a random sample of 100 firms. The aim of this project was to review how consumers of financial products receive advice, and to ascertain whether the way in which advice is provided is a major contributory cause of mis-selling. I can tell you today that, whilst we did find examples of good practice, again, disappointingly, there remain some significant challenges for firms. In particular, we identified that improvements are needed in the areas of training and competence, processes for establishing clients' goals and risk appetite, the production of clear suitability letters, and in systems and controls for monitoring the advice process. There is also a need for firms to be clearer in distinguishing between offering "full advice" and "limited advice". The substantive detail will be published very shortly, and I would encourage all firms involved in the provision of financial advice to read the findings and take action if appropriate for their particular business model.
I am sure that, through the publication of our findings of various reviews, the sector can make strides in addressing our concerns. Not least because we have been making efforts to frame results in helpful ways, such as by illustrating examples of good practice and bad practice. And, as I mentioned, we will be reviewing many of these areas again to feed back to you on the progress you have made. We do appreciate that different parts of the sector have been at different points on the learning curve given that you have had less time to absorb and apply mortgage and general insurance regulation than the financial advice regime (perhaps, disclosure under depolarisation aside). But that time is now over, and we expect all firms within the retail intermediaries sector, regardless of size or activity, to be delivering fair treatment to consumers.
We believe that the fair treatment of consumers can be and should be aligned with firms’ commercial objectives in terms of customer service and retention, and it is this alignment that is at the forefront of our shift towards a more principles-based approach to regulation. We want to give firms more flexibility to decide for themselves how best to run their businesses, while remaining compliant with our regulatory objectives. We also want to provide greater clarity about the things that really matter to us, and to engender a shared appreciation of the regulatory outcomes we are seeking to achieve. So the focus shifts from the means to the end.
The most visible example of principles-based regulation at present in the Retail market is of course the Treating Customers Fairly initiative. We recognise the scale of the challenge firms face in trying to embed this principle within all that they do. Since the launch of the Treating Customers Fairly initiative, and through our supervision of firms in the sector, we have seen many encouraging and positive examples of real progress being made. Inevitably of course, there are also other examples where firms have a long way to go.
As we set out in this year's FSA business plan, we will be publishing a further update on TCF during July. This will cover the progress made during the last 12 months, and sets out our future plans and the immediate next steps. At around the same time we will also publish reports on other major workstreams we have undertaken in 2006 – on management information; issues on Treating Customers Fairly in the Mortgage and GI sectors; and as I mentioned earlier, a report covering our work on the Quality of Advice. And the results of our further work on equity release and PPI will be available in the next few months. We will need to step back to identify the main themes emerging in the retail distribution market as they impact on our consumer protection objective.
Promoting efficient, orderly and fair markets
Let me turn now to our other shared aim – that of promoting efficient, orderly and fair markets. And let me explain what I see as the FSA's role here. Actually, I will start by telling you what I think the FSA's role is not. We are not, as you know, a price regulator. Nor do we have a remit in directing, dictating or endorsing market structures – we must simply work with the market however it chooses to structure itself. But, in terms of efficient markets, I do think we have a legitimate interest in ensuring that we have an intermediaries sector that reaches as many consumers as possible; that offers quality advice to those consumers; and that is sustainable in the long-run. Like you, we want an advice sector that is here today, here tomorrow – and here for many years to come.
I would like to pause a moment on the sustainability issue. This is something that is currently at the forefront of our minds – not least because we have all witnessed one of the larger financial advice networks rather visibly exit the market recently.
We are all aware of indications that pressures on the advice sector are likely to get worse before they get better. For instance, a Datamonitor report shows that between 2003 and 2005, gross annual turnover for regional-based and single outlet IFA firms fell by 23.9% and 25.7% respectively. We at the FSA (in conjunction with the independent Financial Services Practitioner Panel) are trying to understand our contribution to those pressures. We commissioned Deloitte last year to conduct a ground-breaking study to measure the real costs of financial regulation for firms in, amongst others, the investment advice sector. The study identifies the costs that are incurred solely as a result of the obligations under the Financial Services and Markets Act and those that firms would still incur even if regulation was not in place. The results of this work are due imminently. And the forthcoming Practitioner Panel survey of firms will give us further helpful information here.
But in any event, regardless of regulatory imperatives, and going rather wider than regulatory issues such as depolarisation, it is clear that economic and market pressures have created an absolute necessity for firms to understand and manage their financial position; to be clear on the economic drivers behind their businesses and to plan for the future.
Sustainability has clearly been on your minds as well. Returning to the genesis of the scenario work, we had already picked up on the various debates before they were repeated several times by a large majority of the market interviewees. We heard debates about whether the current market structure is robust enough to deliver economically viable business models over the long-term. Discussions are had about the role that your remuneration strategies do or do not play in all of this. We are also alert to those that say regulation has been – and continues to be - an unwitting influence in the shape or structure of the market – in areas or in ways where there was no intention for it to do so.
It is clear that we all have an ongoing obligation to keep working to ensure that the UK benefits from a healthy retail distribution market, which ultimately serves the needs of the consumer. This has always been a priority. We are aware of helpful discussions between some groups of industry participants. But I would like to suggest that, alongside this, the time is perhaps right for us to stand back and take stock of what the issues really are in the retail distribution sector (particularly on the financial advice side); why they are emerging or gaining momentum now; and what, if any, impact these issues may have on the future.
For our part, we hope that this will help the FSA understand more about the risks to its objectives as presented by this sector – and, as a consequence, allow us to think about what we should be doing more of, less of, or what we should be doing differently.
On your part, I hope you see this as a real opportunity to build consensus around whether the issues that you perceive as inhibitors to an efficient and sustainable market are, in fact, the real issues on which you need to focus? Perhaps, in doing so, we can validate some truths or explode some myths along the way?
A review of retail distribution in the UK
Let me recap. Whilst there are certainly firms in the market who meet or exceed the FSA's standards, and in doing so can justifiably claim to have embedded Treating Customers Fairly into their business, there are still far too many who fall some way short. In many cases, it may be that the enthusiasm and good intent of senior management has failed to translate into real understanding at working level. I recognise that the term "senior management" may not mean much to an owner/managed firm but I am aware that we are trying hard to relate in the right way to this type of business model.
So, we believe that there are serious challenges to be faced in the retail intermediaries sector from growing economic and market pressures, as well as complying with regulatory standards. Together, these may or may not affect sustainability or drive changes to market structure. We will have to wait and see. Many of these effects will only manifest themselves in the longer term. In the meantime, however, the FSA will continue to monitor developments and think about how these may affect risks to our objectives.
As part of this, I am announcing today that the FSA's intention is to carry out a review of the future of retail distribution in the UK. We believe that this should be primarily focused on the Financial Advice sector, but we need to be mindful of any read-across to the mortgage and general insurance sectors.
To be clear, this review is not about the FSA compiling its views and dictating solutions. A significant part of it will be to work with industry participants to define what the issues are. Until we do this we cannot begin to look at what, if anything needs to be done, or who is best placed to do it. The FSA continues to favour industry solutions, and we remain firmly committed to acting on issues only where no market solution is available. But let us not get ahead of ourselves. We will be looking to facilitate a discussion with you on our thoughts and ideas for the review as soon as we are in a position to do so.
At a minimum, it will need to include participation by the Trade Associations, representing product providers, distributors and advisers – where we recognise that there is work of this nature already underway – and, of course, their members. I want us to try and reach a collective understanding of what the drivers of structural change might be and how these might reshape the market: for example, drivers such as regulation, customer needs, remuneration models, capital constraints, IFA demographics. We need to understand the consequences of new or emerging market structures for consumers, firms and the FSA and to understand the steps the industry and/or the regulator should be taking to secure a market place which is economically sustainable, attracts scarce capital and talent and which is able to meet the changing needs of consumers from across the socio-economic spectrum. Admittedly, this may be Utopia, but I rarely see dangers in aiming high. Our provisional aim is to publish its findings and conclusions in the second quarter of next year.
On that note, I think it may be time for me to sit down. I am very much looking forward to hearing from our selection of market speakers about their views on the future so, without further ado, I think I'll hand back to Stephen.