Why the Retail Distribution Review matters
Speech by Callum McCarthy, Chairman, FSA
FSA Retail Distribution Conference, London
27 June 2007
I believe the issues under discussion today are certainly among the most important that exist for the FSA; and are probably the most important. Let me explain why I believe this.
The first reason is the importance – social and economic – that ordinary investors, very many of whom find financial products and services difficult to understand, should have access to sound products and services and sound advice – advice that is impartial and understandable – on those products. This has always been the case, but in a world when many decisions which used to be taken for us – pensions, education, health – are increasingly being required to be taken by individuals the need is all the greater. Equally, in a world of increased longevity and – perhaps – longer retirement periods, the decisions are even more weighty than before.
The second reason is that there are many ways in which the present system for meeting these needs is not working well. I set out my concerns about this last September at the Gleneagles conference: I continue to believe that the analysis I then made is substantially valid: we have a business model for the retail distribution of financial services, particularly investment products, which is unattractive to both reputable providers and customers of those services, and which is of doubtful appeal to the intermediaries who distribute those services. The grounds for this belief is well known: a focus on business volume rather than quality; low persistency of policies; unclear identity between the interests of the firms and of their customers.
The third reason why I consider the retail distribution review to be at the top of the FSA's agenda is that regulation itself has not solved and many would claim has contributed to these problems. I take no pleasure at all in the present position: we have had polarisation and depolarisation; we have had – but no longer will have – the menu; we have – as a reaction to past mis-selling problems and the very large sums paid in compensation, not necessarily as the specific requirement of regulation – practices under which prospective investors receive excessive paperwork, the result of which is much more to protect the issuer or distributor than it is to afford useful consumer protection to the investor. There are, of course, many reasons which make the retail market a difficult and complex area for regulation: the problems of assessing product performance, against risk and over time; information asymmetry; the need to reconcile UK and EU approaches. But for all that these difficulties and complexities help explain the inadequacies of the past regulatory approach, they should not obscure them.
So we have activities of very large – and growing – social and economic importance; a business model which has so many unattractive features that many regard it as broken; and a regulatory regime which is a source of dissatisfaction – a combination which to me fully justifies the importance of this work. I am heartened by the way in which both consumers and the industry – those parts of the industry with knowledge of and interest in the retail market in particular – have responded to the importance of the issue. As Clive observed this morning, we have been reassured by the support we have received from the market that these issues do need to be addressed and that you are keen to do so. I disagree strongly with those practitioners, not all of whom are close to the retail sector, who criticise the FSA for our work on the retail distribution review, and our related work on, for example, the responsibilities of producers towards distributors or the prudential – that is, capital – requirements for advisers. The time is ripe for review of all these issues.
I do not think the issues are at all easy. Let me set out what I regard as central questions which together we need to answer. Top of my list is what is the business model which will allow firms who provide the retail customer with sound investment products accompanied by sound advice to do so profitably – that is on a basis which makes investment of capital and management time in such an activity attractive as an investment opportunity relative to other investment opportunities. For it is only if we make the distribution of investment products, done responsibly, a profitable business that it will thrive. Regulation cannot achieve this – though it may impede it. At present, I do not believe we in the FSA know enough about the costs associated with the business – and I am not sure that the firms themselves know enough. We – and they – need to be able to answer questions like what is a cost that a potential investor will pay for different products; what are the components of that cost; how much difference would a change to the regulatory regime make to those costs; how much difference would a change to compensation obligations make. We need to know answers to these and other questions if we and you are to identify what changes will make a real difference.
Second, I think there are important issues surrounding commission payments. Can commission – an effective way, if properly controlled, of incentivising a salesforce – really be reconciled with the provision of advice? Is it really in the interest of product producers, who have so much riding on their brand reputation, to continue to use commissions as an incentive when it so clearly risks inappropriate consequences?
Third, as extensively set out in our paper, and extensively discussed today there are many practical questions to be addressed on how exactly the proposals we have set out would work in practice. There is a raft of very practical questions: can we or the industry usefully define simple products in a way that makes sense, and does not result in new cumbersome product regulation? If we move to factory gate pricing, how do we avoid a growth in softing or other complex practices that obscure rather than make transparent product costs and distribution costs. Will a simpler structure of product and regulation be undone by further complexities in the tax system? We need to address these and other practical questions – as you have indeed been doing this morning.
I am heartened by what is reported in our Discussion Paper. But there is much to be done if we are to build on what has already been done. I can commit the FSA to this further work, and I believe you will also do so. My thanks for that.