Examining the FSA's Retail Distribution Review: An update
Speech by Amanda Bowe, Head of Department, Retail Distribution
Financial Services Distribution Summit
4th September 2007
Introduction
I am very pleased to be here today. It is a fitting time to concentrate on our review of retail distribution. We've all had a couple of months - and no doubt some wonderful holidays – during which to read the Discussion Paper and digest the proposals. And it is just under a year since our Chairman, Callum McCarthy, drew significant attention to this review with his speech at the Gleneagles summit last September.
Callum's comments began a debate that has developed over the last 12 months from analysis of the root causes of problems, to identifying five common themes around which to consider solutions, and then to setting out some ideas and proposals which we did in our June paper. Events like this and all those scheduled for the next few months demonstrate the interest and welcomed level of engagement so far.
We have always been clear that our paper is not the end of the process. It is the beginning of the debate, the starting point for further discussion. But we can't have a good debate unless people are properly informed about what's on the table.
So, although I am not going to be defensive, I do feel that I should use today to focus the discussion and clarify a few things. This is particularly vital because of the importance of the proposals for firms' planning, strategy and in some cases future livelihood. We don't underestimate that and so today I want to reassure you of our real intentions – to set the record straight if you like - so we can move through the rest of the discussion period on common and accurate ground.
The DP
The proposals put forward in the DP are very much based on the ideas that came out of the groups of senior individuals from across the market – that is across the entire distribution sector including, importantly, small firms. We are very grateful to those who gave up so much of their time in the first half of this year. I am sure you are looking forward to hearing from the chairs of those groups later today.
I think – and at least hope - they still agree that the paper is a fair reflection of their group discussions. We see no value in saying we will listen to the industry and then giving a selective interpretation of the discussions, which is what some have suggested we have done. What we have tried to do is bring the groups' work together in a sensible, workable package setting out what the ideas – if taken forward - could mean for the future of retail distribution. That is how the proposals have been presented.
Much of our paper is consistent with the way the market is moving already, as you would expect. Furthermore, since the paper's publication a number of firms have indicated that they are already operating some of the proposals; others have indicated their desire to do so. Of course, this will mean we need a sensible transition for any regulatory change so that those firms that have set on a path of, for example, raising their professional standards for advisers, or changing their remuneration arrangements can continue down that path. Importantly, therefore, the paper sets out options and choices for firms in the way they might operate – a mixed economy as it has been described with little to stop other firms from adopting some of the proposals now if that's what they choose to do.
This perhaps leads me nicely to the subject I have been asked to cover today: that is the FSA's role in changing this market.
The FSA's role
I should first be clear about where the FSA stands when it comes to changing markets. We do not believe it is our role to create markets, destroy markets, or to define their structure. We have a statutory responsibility only to intervene in markets when the market itself is failing to function in a manner consistent with our objectives and where our intervention can deliver benefits that justify the costs – that is after all the role of regulation.
We do believe that markets that work effectively can offer, through competition and innovation, the choice, value and services that meet consumer needs – and we believe the ideas in the DP could do just that.
But the key word in that last sentence is effectively. We think, and many agree, the market is currently not working as effectively as it could. In some parts it is clearly failing consumers as we've seen from the results of our thematic work. And as our Chairman noted a year ago, it is not necessarily operating in the best interests of firms either. We are clear that these failings are not aimed at one particular part of the distribution sector – the problems we set out to resolve through this review, as clearly defined at the start of the discussion paper, materialise in different ways across the entire sector.
We freely acknowledge that we've had almost two decades of various forms of prescriptive regulation from the FSA and our predecessors. And that regulation has been subject to change which in itself brings costs to firms and, ultimately, consumers. But in spite of this regulation, we still see problems and at some point we have to question whether regulation is aimed at the right areas and is having its desired affect. That's why the paper sets out areas where we might need to change as well, for example in how we can help firms understand and manage their potential future liabilities. All this is consistent with our move to principles-based regulation and our reliance on firms' management to deliver the right outcomes for their business and their customers.
The RDR
Which is where the approach to the RDR comes in. This is is the first time we have engaged quite so comprehensively with the whole of the retail distribution market, working together to achieve better outcomes for consumers and for firms and seeking so specifically to find market solutions in the first instance.
We want to continue this engagement with you over the next few months as we get your responses to the DP. Most of our discussion papers contain only a handful of questions. This one has 70. And we normally only hold a discussion period for three months. This one has six months. This shows the importance we attach not only to the subject but also to listening to your views and getting the final outcomes right.
We have a genuinely open mind about how that final outcome might look (despite suggestions from some that we have already decided). We need to do a lot more work during this discussion period. In particular we need to understand the potential impact on consumers of the ideas put forward. And of course we must have your views. They are essential in helping us to refine the ideas and to determine how best they should be implemented – if at all. You may even have better ideas that you want to share with us. And we welcome challenge from you – provided it is constructive.
What are we hearing so far? We have had some good quality feedback already, and it is fair to say that the reaction so far has been mixed. This has come through in the 100 individual responses we have received. Some have embraced the paper, whilst others are understandably more cautious; some are rubbishing the whole paper in some cases apparently without having read anything other than a few headlines; others are providing really constructive comments on the pros and cons of the ideas put forward. What is not clear to me just yet, is whether there is a further group – large or small – of people who have not yet engaged at all. We will have a clearer picture of this over the course of this month as we start our significant programme of work to engage with individual firms and consumer groups - I'll come back to this later.
Some respondents have suggested there is no need for change – "..my business is successful…", "…I have no complaints from my customers…", "…I have x years' experience so don't need to sit more exams…" and so on. That may be so, for a particular firm. But there is still much to do to build confidence and trust across the industry and that is why the package of ideas in the paper needs to be considered as a whole.
Given the scope of the paper and the issues under discussion, we are not surprised at the variety of opinions being expressed. There are clearly some areas where opinion is more divided than others. This is also not surprising as some of the proposals could well require people to change both themselves and their businesses. A key message today is that we are very keen to hear your thoughts and get your response and we do want that to be based on the package of ideas put forward in the paper, not just on one or two specific points.
It is an open discussion, not an exercise to push through the ideas in the DP. So you can and should take this opportunity to influence the outcome of the review.
The detail
What is it that we suggest in the paper? We envisage a market which allows more consumers to have their needs and wants met and to be able to understand the products and services provided to them, bearing in mind the general lack of financial capability. We want standards of professionalism that inspire consumer confidence, and remuneration arrangements that allow competitive forces to work in favour of consumers. We want an industry where firms are sufficiently viable to deliver on their longer term commitments and where, in doing so, they treat their customers fairly. And we need a regulatory framework that can support these outcomes without inhibiting innovation.
To achieve these aims, and building on the ideas of the groups, the paper proposes two different types of adviser. For those consumers with more complex needs:
- first, professional financial planners; and
- second, general financial advisers.
And for those consumers with less complex needs:
- a potential primary advice service.
Just three labels – no more – and based on a future retail distribution market, not added to the existing structures and labels. We are not wedded to these working titles. We know that anyone operating in the financial services market should be professional, whether in a bank, IFA, life company, wealth manager or elsewhere. And we know that 'primary' can mean different things to different people. So again we are open to ideas and alternatives.
You'll be relieved to know that I am not planning to run through the detail of the DP – all 77 pages of it - now. I do, however, want to focus on a few areas where the ideas have been misunderstood.
First, qualifications and professionalism
We set out some different suggestions for debate on what "highly qualified" might mean – and these were deliberately different because we want your views on what standards should apply. The paper makes it clear that we are talking about higher professional standards here, not just higher qualifications. For example, we have focused on chartered or certified because they are the standards familiar to many in the market. It might be that the ISO 22222 could provide an alternative or even complementary standard. We want to see the right balance between the qualifications required to do the job, and the experience and knowledge gained whilst doing it. We are not just interested in examinations. We are interested in a range of things that constitute professionalism including ethics, competence, experience, and so on. Identifying how best to achieve this balance is one area where the industry could usefully take the lead.
Second, remuneration
We've suggested that remuneration for professional financial planners might be agreed only with their customers and not determined by the product provider – or customer agreed remuneration as we have termed it. We are not seeking to determine how every adviser in the marketplace is remunerated. We are not suggesting that customers have to write a cheque to pay an hourly fee. And, again contrary to some reports, we have not made any reference to the level of fees that might be chargeable for investment advice.
The proposals in the DP aim to shift the debate away from fees vs commission, recognising developing market practices such as the advent of wraps as well as appreciating how consumers behave. We want to remove the potential for bias from provider-based remuneration. That is what we are saying about customer agreed remuneration.
Furthermore, high professional standards must imply that remuneration is a matter for customer agreement without any external influence. This is what removes the potential for bias. And this is where there is a key role for providers to take the lead. Indeed, many intermediaries have told us that they are fed up with receiving 'marketing' emails from providers with 'special offers' on commission rates, thus fuelling the fire about product or provider bias. So the proposals here are not just aimed at the receivers of commission – they are also aimed at the givers of commission, to coin a phrase
Some say we've been too vague on how customer agreed remuneration might work. We've got over four pages on it in the paper, so I think we've been pretty clear, at least about our aims. Clearly there is much more to be done to understand the practicalities and implications and, as promised in the DP, we have this work underway now.
There are already firms operating along the customer agreed remuneration lines and it is pleasing to receive feedback from a number of advisory firms who say that the proposal to redefine 'fee-based' is consistent with how they are now operating. So there are some firms and consumers that find customer agreed remuneration a sensible, straightforward and convenient way to pay for investment products and advisory services. But we should be clear – this isn't just about changing the name. The outcome we want is for the advisor and customer to be the focal point for discussion about the cost of the services being provided.
Importantly, we and you want the customer to appreciate the value of good financial advice and accept that this comes at a cost. A major step here is for consumers that currently do not pay by fees to understand that advice is not something that they get for free, it is a valuable, professional service and worth paying for. The proposals in our paper seek to reinforce this point.
Finally, it is also worth clarifying that the outcome we are seeking from customer agreed remuneration is not limited to the classic provider/IFA model. We are also interested in how it applies to integrated businesses, such as bancassurers and those with tied sales forces and how we go about removing or reducing the conflicts that are inherent in internal remuneration structures. We are asking questions about that in the DP and we'd welcome feedback on whether the principles should apply regardless of the business model.
It is up to firms to decide whether they want to become professional financial planners. There is no obligation for any firm to move to this model – choice prevails - but there will be regulatory benefits if it chooses to do so, as you would expect in a risk-based and proportionate regulatory regime.
Independence
One of the benefits and levers might be the proposal that only these firms can call themselves 'independent'. Let's deal with this particularly contentious issue up front!
In the paper we propose that the 'independent' brand might be confined to those firms that are free from conflicts in terms of remuneration because their remuneration is agreed with the customer, not the provider. And to those firms that choose to operate with the highest standards of professionalism.
In suggesting this, we were keen to focus on independence in so far as it means free from outside control or influence; not depending on another for livelihood or subsistence (that is the Oxford Dictionary definition of independent by the way). Following this logic, we asked the question as to whether independence should also need to mean 'whole of market' as is currently the case.
But we know that, over time, independent has become a very strong and important brand for advice. So we think it is worth exploring, with your help, what independence really means and in particular to consumers. Isn't it our shared objective to ensure that the customer understands not just how they are paying for the service but who they are paying – and for what?
Some IFAs we have spoken to think that professionalism is a stronger brand and more important in gaining customers' trust than 'independence' which, some say, means a variety of things to consumers. But many have responded that independence means choice and therefore must be limited to those firms that offer products from the whole market, ie those that are not tied or multi-tied. This may well be where we end up. We will explore this and other questions further over the coming months. And we will, as with all the responses we receive, use the feedback we get – which is pretty consistent so far – and our own research in this area to inform the final outcome.
Now to prudential requirements
A few days after our review paper we issued a companion paper discussing the potential changes to the prudential rules for personal investment firms.
Some have misinterpreted – or misrepresented - the message behind that paper. Let me clarify again. We don't start from the premise that a firm's behaviour – for example the likelihood for it to mis-sell – is directly linked to the capital it holds. The paper does not say that. We are keen to improve standards of risk management in all regulated firms and ensure that they have sufficient funds to cover the risks in their business. That is the starting point for any risk-based prudential regime. And that may well be the key to providing personal investment firms with the right incentives to do so.
Financial resources are the means by which exceptional costs, such as those arising from mis-selling can be absorbed. This is consistent with our requirements for, say, product providers and banks, who are already required to hold sufficient capital to withstand the extreme situation of potential mis-selling claims and other operational risks.
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 through claims on the compensation scheme. That is the clear message you have sent to us – and the proposals in the RDR discussion paper around management of future liabilities are intended to help achieve just that.
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 of the RDR and they should not be viewed in isolation.
In summary then, for full advice we want to provide incentives for those firms that are well-run and choose to move to higher professional standards and remuneration structures that carry less risk for consumers and to firms. And we want firms with lower standards that pose higher risks to hold capital that reflects those risks, 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. This is about choice, incentives, and disincentives.
Primary advice
I'd now like to move on to primary advice. So far I've covered ways in which the RDR aims to give consumers that currently take financial advice a better outcome. But there are potentially millions of consumers that currently do not take advice, and yet who might benefit from doing so.
For many this is due to a lack of financial capability - the FSA is leading a national strategy on that - leading to a lack of awareness that they might need or could take financial advice. For others, it could be a matter of cost. We want to do what we can to reduce the regulatory costs – where appropriate – to ensure that those firms that want to provide consumers with affordable advice can do so, thus helping more people access advice and buy savings and protection products. And we want to ensure that if the natural market response to our proposals for full financial advice results in leaving some without access to financial advice, that our regime enables something that can fill that gap.
Meanwhile, and we cannot consider these ideas in isolation, Otto Thoresen's review for the Government is developing a national service for generic financial guidance. Helping people understand where to go and what to do when they need financial help is likely to result in more people being directed into the regulated advice market – whether to those offering full financial advice, or to those offering something simpler such as the proposed new primary advice service.
On this basis, there is nothing to threaten the market for full financial advice – in fact the combination of a national generic advice service and the development of primary advice may well increase the overall market for financial advice, bringing benefits to all.
Some are sceptical over the ability of the industry to attract new savers into the market. Some think that consumers won't save unless they are forced to do so. We share some of these concerns, which is why we emphasise in the paper the potential impact of the national generic advice service, and our leading role in improving consumer education.
To enable firms to offer something economically we would need to lower the costs resulting from regulatory requirements. But we are absolutely clear that this must be balanced against the need for appropriate levels of consumer protection. This doesn't mean lower standards as some have said, just appropriate standards – standards appropriate to the risks. And I want to be very clear here: whilst it might not result in the "most suitable" advice and product solutions, it must not result in "unsuitable" advice and product solutions.
One way to get this balance might be a 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 you would like us to go in terms of agreeing some type of criteria, or at least helping firms define those products. The intention here is not to constrain competition by product regulation, but to constrain as far as appropriate the risks to consumers from inappropriate product sales and to give firms as much certainty as possible about the potential liability from giving such advice.
And if you read our Discussion Paper, it is suggested that the minimum standard for primary advisers is the Certificate in Financial Planning – so no different to that required now for full financial advisers. So this is not 'dumbed down' advice as some have suggested and it is consistent with our overall commitment to raise professional standards across the piece.
We are asking whether there could be conditions in which primary advice firms could call themselves 'independent' – we have not given any suggestions on what these conditions might be in the paper – but our aim here was to enable those firms that choose to offer primary advice to do so alongside their full financial advice offering, providing they meet the other conditions to call themselves independent. And it is pleasing to hear some IFAs say this could provide a real opportunity - to service some of their customers who have more straightforward needs and don't need full financial advice and at the same time growing their less-experienced advisers.
Of course we expect banks and building societies to be interested in supplying these services, but this is not a proposal simply for them. As I say, forward thinking IFA firms could easily fit this into their advice offering, or even specialise in it. It is not far from what many are doing already. So this is not a meal ticket for the banks as some have tried to position it.
Some are also using past experience to say that simple advice has been tried before and has not worked. But that's no reason not to try again if we collectively seek to address the apparent problems with previous models.
For example, previous attempts have started with pre-conditions – such as the product charge caps which we are told are the major barrier to the provision of basic advice on stakeholder products. Our only stated pre-condition at this time is that consumers are treated fairly.
We know that these proposals are green and at an early stage of development. But the basic aim is to strike the right balance between reducing the costs of supply, providing a suitable solution for customers, and containing the risk of consumer detriment. So we have quite a challenge ahead for what we are calling, for now at least, primary advice. This has to be based on whether there is an appetite by firms to provide such a service – some are serious and it is with real examples that we will be able to flesh out the very green proposals in the paper and see what, if any, regulatory regime is needed to support that service.
We are ready to do what it takes to allow such a market to take off, provided always that consumers are adequately protected.
It might be a difficult balance to achieve, but hopefully not impossible, and one that we have the beginnings of in the paper. But only the beginnings. And there is no way we would let – as some have suggested – any form of primary advice that risks widespread consumer detriment take off. If we cannot get the right balance between an economically viable model and the fair treatment of customers or our own research suggests there is no demand, then primary advice will not go ahead.
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 throughout, and with full advice at one end, and simpler and less costly ways to deliver advice at the other. And a market where the potential liabilities for all firms can be better contained – or at least better managed - to the benefit of all firms and their customers.
Next steps
Finally, turning to our own work over the next few months? Our DP committed to carrying out research to understand more about the demand and supply issues and the potential impact on firms. This research is now well under way. Along with the responses to the DP, the results of this will contribute to the Feedback Statement we plan to publish in the second quarter of 2008. This will also set out the route-map for consulting on how we might implement the changes that we then propose. And it will pick up on related work including, importantly, any further consultation on the discussion paper on prudential requirements I mentioned earlier.
One of the talking points so far has been the timescale of the changes. Many have given their view on when the proposals would come into effect – many, that is, except us. We have never stated a particular length of time.
What we have said in the paper is that we welcome views on what would represent a sensible transition period. We know that some of the changes could require time for firms and individuals within them to adapt. It is clearly unreasonable to ask people to change overnight, so we would take a sensible approach - and advice from the industry – on the transition period.
Depending on the content of the feedback statement, there may be a consultation paper later in 2008, giving our definitive take on the proposals for change. This would of course include full cost-benefit analysis.
Listening
As we enter the discussion period for the review, we look forward to having a lively and constructive debate with you and the whole market. This is one of the things we set out originally to achieve. We'll continue to try and spread the debate and speak to as many firms, consumer groups and other interested parties as we can. We've got 25 different events, workshops and roadshows to attend this month alone.
We cannot respond individually to every response we receive but please rest assured that if you take the time to give us your views, we will take the time to listen, and we will take this into account alongside all the feedback we get between now and the end of December.
I am pleased to see that from the responses we've received so far, there are a number of firms thinking quite carefully about the RDR and how they act on it. We are not looking for excuses to intervene in this market. What we say is that many of the things that have been put forward in the paper – improving professionalism, building more sustainable businesses, giving customers a greater say in how advisers are paid – these are things that many would say the industry should be doing anyway. And these are things that firms can just get on and do now. They do not all need regulation to make them happen.
So we hope that you take the opportunity that this paper gives you. As Callum noted at our conference in June, retail distribution is the biggest challenge for the FSA. Whatever the shape of the eventual proposals, we are committed to seeing through reform in the market for the good of all its participants.
That is why it is so important that you engage with us during the next few months and work with us as we decide on how best to proceed. That engagement might extend beyond your written feedback to action by you now. And we hope that where you disagree with the ideas put forward, you might come up with other, perhaps better, ways to improve the professionalism, reputation and efficiency of the retail investment market.
Thank you for listening to me today.