Retail Distribution Review: Preparing the ground for debate
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Stephen Bland, Director of Small Firms, FSA
Association of British Insurers
12 July 2007
I'm very pleased to be here today, to take part in the first public discussion of our paper since we launched it at our conference two weeks ago.
And I am very pleased, as always, to follow Chris Cummings, who has again today provided the challenge and the debate we welcome as part of this review.
I would like to first of all say thank you to the ABI for the constructive way its staff and members have contributed so far. Your engagement is appreciated and vital for us to get the results to make the market work better for consumers – which, of course, you recognise means making the market work better for your firms, because the two can and should go hand in hand.
The ABI's agenda for this conference contains a quote against each speaker's subject for debate. These are from the great and good - and others; I say "others" as one of them is a quote from me. But there is no quote given in the conference agenda for my subject for debate. So I have come up with one of my own, taken from an even more elevated source than any of those chosen by the ABI. Shakespeare probably did not have the Retail Distribution Review in mind when he wrote the following, but its relevance to the RDR will I hope be apparent. "There is a tide in the affairs of men which, taken at the flood, leads on to fortune. On such a full sea are we now afloat. And we must take the current when it serves, or lose our ventures."
By now I hope you have all had time to digest, at least in part, our discussion paper. The proposals we announced on Wednesday 27th June represent ideas from your peers, meeting our desire for market-led solutions to tackle the biggest challenges facing retail distribution. Whatever the eventual shape of the proposals that are adopted at the end of the feedback and consultation periods, it is clear that there is a near-universal consensus that the time is right for a step-change in the retail distribution market which could benefit both the industry and millions of consumers. While it is important to get the details right - and this may also affect the broad proposals floated in the discussion paper - it is also important not to take our eyes off the wider picture; the Review is a big opportunity to improve the workings of the market for consumers and firms. We must together take that opportunity. This tide must be taken at the flood.
In many ways the paper is a landmark for us at the FSA. It is the first time we have engaged so heavily with the market at an early stage to work together on better outcomes for consumers. It is much more than just the latest set of proposals for change in the distribution market. It seeks an enormous amount of commitment from you in the market. You may feel overwhelmed by the 70 – yes 70 – questions we ask in it, but this reflects the importance we attach to getting your views and the breadth of issues it covers. This is an important subject to get right.
As an organisation, FSA is genuinely neutral on many of the issues in the paper, not least because we have a statutory responsibility only to intervene in markets when we have demonstrated that the benefits outweigh the costs. And to do this we need to understand the possible implications of the changes put forward in the paper, in particular the impact on consumers. So your views are essential in helping us to refine the ideas and to determine how best they should be implemented, if indeed we implement some of them at all.
The FSA's chairman has said that if we achieve the paper's aims it may be the most important thing the FSA has ever done. I am inclined to agree. And I agree with what Stephen Hadrill said when we published the paper – this is a massive opportunity for both consumers and the industry. This tide must be taken at the flood.
But, as always, there are some who think the proposals go too far. Equally, there are some that think they don't go far enough. As regulators we know from experience that we cannot please all of the people all of the time. Our job is to think about the arguments in the context of our overall objective – to make the market work better for consumers.
In the main, the response has been a cautious welcome to most of what is proposed, although there are clearly some areas where opinion is more divided. We have heard some examples this morning in the views of the two trade associations who have spoken already today – Stephen on behalf of our hosts, the ABI, and Chris for AIFA.
Both can see the potential benefits, but both also have specific questions that they feel need addressing.
There is in fact a lot of common ground. Both the ABI and AIFA want to strengthen consumer confidence in saving. Both welcome higher professional standards for advisory firms. Both agree the consumer should have a greater role in deciding how the adviser should be paid.
Our proposals thus build on broad consensus. This is no accident as the ideas represent views from a wide cross-section of market participants, including, importantly, consumer group representatives.
Indeed I think it is hard to disagree with the overall aims of the review. There are changes that need to happen. But we have to be cautious about whether these are the best proposals for achieving those aims. And rightly so. We have to maintain the debate with the industry, and most importantly, we have to understand what consumers really want and need from the industry, so we are clear where we could end up if these proposals, or indeed, any alternative proposals, are taken forward.
And we're being asked some tough questions. Chris challenges us about whether consumers will get a better deal out of the proposals. We believe they could. But the Discussion Paper puts many of these issues now in the hands of you, the industry, to develop the thinking and to make or disprove the case.
I think we have demonstrated through our willingness to listen to everyone's concerns in the period leading up to this paper that we will listen to what you say to us during the discussion period. You can and should take this opportunity to influence the outcome of the review. And that is what we will encourage in the next six months following our publication of this paper. We have a genuinely open mind on where this may take us.
The key messages in the Discussion Paper
I said I hoped you'd all had a chance to look at the paper, but let me briefly recap what the proposals are. As an overview, the proposals from the market demonstrate a strong appetite for:
- high standards of services and products to give consumers the confidence and trust to buy them; and
- enabling all consumers who would benefit from accessing the industry's products and services, and who can afford to do so, to do so cost-effectively.
In other words, to improve quality and to improve access to advice and to products.
You will know by now that to achieve the first action – the high standards – we may have to raise minimum requirements for those firms and advisers supplying both full range and specialist financial advice on investment products.
This may mean that for those with more complex needs there may be scope for two different types of adviser:
- first, professional financial planners; and
- second, general financial advisers.
The proposals for professional financial planners are that they operate to high minimum standards and are highly qualified – which of course some already are. We set out some suggestions for debate on what "highly qualified" might mean. Remuneration for these advisers would be agreed with their customers and not determined by a product provider. Let's be clear on this, because some comments have been made about the FSA seeking to determine how an adviser is remunerated. This is precisely what we are not doing – high professional standards must imply that remuneration is a matter for customer agreement without any external influence. This would remove the potential for provider bias, and in our view, should also be the main condition for these firms to call themselves 'independent'. The paper's proposal is that this is a free choice for a firm; there is no obligation for any firm to move to this model, but there is a regulatory dividend if it chooses to do so.
We have asked the question in the paper whether such independent advisers need to be whole of market and even two weeks into the consultation period we are pretty clear on the majority view! We asked this question not because we are at this stage minded to make this change but more to provoke a debate on the meaning of 'independence' in the context of the proposed new market for advice. It has clearly provoked, but I wonder whether many have really thought deeply enough about the question.
The other type of full adviser proposed – a general financial adviser – would continue to provide similar services to now, but may not have the same range of in-depth knowledge or be as highly qualified as professional financial planners. But the proposal is that they still should have higher professional standards than today.
They could be paid however they choose but we would want to reflect the potential risks to consumers of the chosen method of payment, and indeed reflect all the material risks inherent in a firm's business model, when we set prudential requirements and establish the level of our supervisory oversight. We would intend to apply a risk-based approach to regulating all firms and a likely outcome of this is more supervisory scrutiny and on average higher prudential requirements for general financial adviser firms than professional financial planners.
We published a Discussion Paper last week on prudential requirements for personal investment firms, to run alongside our paper on retail distribution. I should be clear that, like many of the proposals in the RDR, there are links between elements of the package. Higher prudential requirements may mitigate the risk of mis-selling by firms because of the greater level of commitment to the on-going business that they involve. They thus offer the prospect of providing incentives to firms to control conflicts of interest, particularly where remuneration structures continue to create such conflicts. Without them, there would be less of a case for allowing general financial advisers to continue as a regulatory category of firms without a sunset clause of some type. They are also the means by which exceptional costs, such as those arising from mis-selling can be absorbed. It is very much in the interests of the market as a whole that firms can meet these costs from their own resources so that other firms are not required to pick up the tab. So, although potentially higher minimum prudential requirements are never going to be popular among those affected by them, we see them as an essential part of the package which should not be viewed in isolation.
One last point that is also proving controversial is that general financial advisers could not call themselves independent. We see independence as an incentive for those firms that operate in a way that will deliver fairer treatment of consumers; in particular, operating a way which reduces the conflicts of interest. And we think fair treatment of consumers demands that advisers subscribe to the highest standards of practice when offering a full advice service, which means that any remaining conflicts of interest are likely to be well-controlled. So we think we should reserve the independent label for professional financial planners only.
In summary, for full advice we want ways to reward well-run firms that move to higher professional standards and to remuneration structures that carry less risk for consumers. And we want firms with lower standards and posing higher risks to hold more capital, not least to reduce the likelihood of other firms – maybe even some of yours – having to meet compensation payments if a firm goes into default.
I said earlier the Review was not only about improving the quality of advice, but also access to it. There is a risk that raising professional standards in the full advice sections of the market may increase its costs, and thus the quantity of it in practice available to consumers. This is not necessarily the case; one very professional IFA I know took umbrage at the thought that she might use the Review to raise her fees. But, whether or not the supply of advice would be affected by the proposals in the review, there are millions of consumers who currently do not take advice, and yet who might benefit from doing so. For many of them, that will be largely a matter of financial capability; and of course the FSA is leading a national strategy on that. For many others, it will be a matter of cost; that aspect of the problem is within the Review. We want to drive down the cost of distribution so that consumers on middle to low incomes can afford to take advice and buy savings products.
Let's be clear what we mean by 'afford'. We know that some firms have guidelines to determine who they will take on as a client. These guidelines might relate to earnings or some measure of wealth. We also know that product providers will typically set minimum levels for the size of regular or lump sum investments. So affordability is about the willingness of firms to offer products and services to certain consumers, as well as the willingness of consumers to pay for certain products and services. This means that some consumers may not be taking the actions that could make a large difference to their financial situation.
So there are proposals in the Discussion Paper for a more affordable service for consumers who need to save and have the means to do so, but who for various reasons may not be doing so or may not be doing so cost effectively. Typically, these consumers may have less complex needs and therefore may not require an expensive full financial advice service.
We know that these proposals are amongst the 'greenest' of the 'green' proposals in the paper. We want to strike a balance between reducing the costs of supply, providing a suitable, albeit not necessarily most suitable, solution for customers, but also containing the risk of consumer detriment. And there has to be sufficient profit potential to encourage supply.
Meanwhile, Otto Thoresen's review for the government is looking at developing a national service for generic financial advice, or (as he has recently called it) 'guidance'. This service might raise more consumers' awareness of their financial needs, and would best be complemented by the industry supplying a range of regulated advice services that would offer appropriate follow-up services for as wide a range of consumer needs as possible.
So the Discussion Paper proposes that we should encourage and facilitate the development of alternative, less complex advice – what we call primary advice – to improve access to financial advice for those with more straightforward needs and for whom, put simply, fuller advice services may not currently be on offer.
Primary advice could be a new type of regulated advice service addressing a broad range of a consumer's needs. It might point the consumer towards a limited range of savings, investments and possibly protection products.
The potential benefit of this is a much reduced (and less costly) advice process than a full advisory process. A less complex and less costly approach offers firms more opportunities to price these services more attractively for consumers, some of whom might not otherwise be served at all.
To enable firms to offer something economically we need to lower costs but also contain the risks for consumers. One way to do this might be some limitation on the type and make-up of products that are sold. And although product regulation is not our preference, we are asking how far we would like to go in terms of agreeing some type of criteria, or at least helping firms define those products. We are ready to do what it takes to allow such a market to take off, provided always that consumers are adequately protected.
Large numbers of people – the mid-market in particular – could benefit from primary advice. And if you read our Discussion Paper, it is suggested that the minimum standard for primary advisers is the Certificate in Financial Planning – no different to full financial advisers today. So this is not 'dumbed down' advice. Primary advice would be advice given to the same minimum standards of professionalism as are in operation today in the full advice market. And there would be safeguards on the product range and sales process which are not currently imposed on the full advice market, so as to reduce the remaining risk of any mis-selling. So the net minimum requirements would be higher than those faced currently by IFAs.
We expect a wide variety of firms might be interested in offering this service - you as insurers could do this. We also think that some of Chris's members might find that offering this type of service might be a more profitable approach for their firm. And we are asking whether there could be conditions for primary advice firms to be called 'independent' – we have not tabled any suggestions on what these conditions might be in the paper so the floor is yours! Of course we expect banks and building societies to be interested in supplying these services. But this is not, as some have said, handing the market to them on a plate.
Some may say that simple advice has been tried before and has not worked. But here is your challenge. Previous attempts have started with pre-conditions, for instance charge-capped products. So here's a blank sheet of paper – can you help to design this? Can you design an approach that is economically attractive to you as potential suppliers, that generates sufficient demand from consumers, and delivers an adequate level of consumer protection? We know that designing a service that strikes this delicate balance will be difficult. And let's be quite clear, if we cannot achieve this the proposals will not go ahead – we will not, as some have already concluded, risk widespread consumer detriment. And if major institutions are leading suppliers of this type of service, then given the potential vulnerability of the type of consumer it's aimed to attract, rest assured that the priority we attach to our Treating Customers Fairly agenda will ensure that the delivery of primary advice by these firms will be subject to close scrutiny from us. And we would not expect to see any firm wishing to do so unless it had first got its front-line culture into good shape, ie embedded Treating Customers Fairly.
So this is how it might look if the proposals or something like them were adopted – a market with different levels of advice to meet different consumer needs. A market with higher standards of professionalism at one end, and simpler and less costly ways to deliver advice at the other.
The discussion paper is all about airing, for discussion, the proposals that have come up from those to whom we have talked in the last six months, and getting your views. We don't think we've got all the answers and if there are better ways out there then we want to hear about them. And as we say in the paper, we also want to hear from consumers, and we will be undertaking research to understand better what they really want and need from our industry.
Revolutionary or evolutionary change
I was asked by the ABI for our views on whether this is a revolutionary or evolutionary change. Well, the proposals could certainly be called revolutionary. They are designed to change things. The Financial Times even calls them 'radical'.
But I suppose a revolution implies an immediate change. This is not what the retail distribution review is about. We're not under any illusions that these challenging and complex issues can be solved overnight. There's nothing we propose changing right now. And what we eventually introduce will be the regulatory incentives to help firms change and to deliver good outcomes to their customers. It's not about forcing anyone to change or dictating market structures – it is offering choice rather than a one-size fits all regime. Those of you that know us well know we are both obliged and wish to consult, to produce cost benefit analysis, basically to think carefully and weigh up the implications before we introduce important changes like this.
There are also firms operating along some of the lines proposed in the paper already – and nothing to stop others that want to from also doing so. As I said earlier – much of our paper is going with the grain of the market already.
So what we have now is the start of an evolutionary process. The paper is in your hands for the next six months. This is longer than our normal period, because we want to give you enough time to weigh up the proposals. We also want to have enough time to meet and talk to as many firms as we can.
And we want time to have a detailed look at the potential implications of the proposals. Time to begin the thorough cost-benefit analysis and consumer research that would form part of any eventual Consultation Papers arising from the review..
Market or regulator-driven
Another question I was asked to cover today was whether this is market or regulator-driven. It is a combination of both.
Market participants and consumer representatives have told us this is what they want. These are the problems they want addressed and these proposals reflect the views of those in the market that contributed to our review.
We are acting as a catalyst. We want to do everything we can to make this happen. In some cases that means changing what we do, because some of the things stopping the market work more efficiently come from us. Our regulation could be a barrier to innovation and progress, and we're looking at that during the next six months.
The timetable
As we enter the discussion period for the review, we look forward to having a lively and constructive debate with the whole market. We hope that where people disagree with the ideas put forward, they will suggest other ways to improve the professionalism, reputation and efficiency of the retail investment market. And please read the paper. I read one recent criticism in a trade publication that started with the line "I haven't had a chance to read it all yet, but..". We need constructive, rational debate to solve the industry's problems, and not emotional reactions to sensationalised headlines.
In the second quarter of next year we will follow up the responses with a feedback statement. This will set out the route-map for consulting on further changes. And it will pick up on related workstreams, including importantly, consultation on our Discussion Paper on prudential requirements for personal investment firms.
In the meantime, we want you to seize these opportunities to improve the quality and accessibility of retail investment financial products and services; to design better products that consumers need and would value and would want to hold to maturity; to enable consumers to make better informed decisions when buying these products and services; and to give consumers a real say in how they want these products and services delivered to them.
As insurance providers, there are clear benefits to you from doing so:
- You can benefit from the expanded market that this may bring.
- You can benefit from being able to compete more on the basis of the quality and price of your products, rather than on how much commission they pay. Giving consumers the real benefits that this type of competition can bring.
- And you may find that you get better quality, more persistent, business from the more professional distributor firms this review will help foster.
I welcome the strong engagement and commitment you've shown in the last six months. We all agree that tackling the root causes of the problems within the retail investment market is worth it – it could make a difference to, literally, millions of consumers' lives and create a strong, innovative, competive industry of which we can all be proud. It is an opportunity that together we must seize.
"There is a tide in the affairs of men, which, taken at the flood, leads on to fortune. On such a full sea are we now afloat. And we must take the current when it serves, or lose our ventures."