Key regulatory challenges for platforms
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Speech by Dan Waters, FSA Director of Retail Policy and Themes & Asset Management Sector Leader
Cicero Forum, London
29 February 2008
Thank you for inviting me to talk to you today. I welcome the opportunity to update you on our views of some key regulatory issues facing platforms. I have settled on six – which may be too many! These are: (1) principles based regulation; (2) the packaged product regime; (3) disclosure, especially of charges; (4) reregistration; (5) use of platforms by intermediaries; and (6) duties of platforms in the provider/distributor chain. This is quite a wide canvass. I hope to leave a little time for questions at the end.
By way of background, we consider that in this young and dynamic market it is very important for all participants to engage with emerging regulatory issues. It is therefore encouraging to see conferences of this quality. As you know, platforms play an increasingly important role in the retail market landscape - even becoming the dominant form of distribution in some areas – you have seen a range of statistics yesterday on the size of this market. We see this change and intend to give the market, its issues and risks the level of attention they merit.
Today, I would like to bring you up to date with developments since we published the Discussion Paper (DP) last June and the additional chapter on provider/distributor responsibilities in September. As you may know, we will publish our Feedback Statement on the DP next month.
We were pleased with the level and quality of responses we received to the DP. We received 80 responses, spread across all sectors of the market, from large platform providers and trade bodies to individual IFAs. The responses were balanced, informed and constructive. The DP covered a range of issues for both platform providers and intermediaries, and our approach to regulating this market. Without wishing to front-run the Feedback Statement, I will have something to say about the responses and our emerging thinking on key issues.
More principles-based regulation
First, more principles-based regulation. Platforms are a comparatively new area for firms, whether providers or intermediaries. As a result, firms are in a different place when considering how regulation applies. Unlike other markets or activities, platforms do not have a long history of regulation. There is no framework of detailed rules-based regulation and processes to use as a base for developing a more principles-based approach. While of course there are rules relevant to products and services offered on platforms, you have been presented with a relatively clean sheet of paper in terms of how you go about managing risks and ensuring customers are treated fairly in this medium.
This relatively ‘clean sheet’ means that firms must determine the best way forward in a risk-based manner and in a way that is treating customers fairly given their own individual business models. It is clear that this poses challenges. There are few old rules or processes to use as 'props' and firms have to focus on the outcomes that matter for consumers.
In the DP we put forward our view that principles-based regulation was the right approach for this market. We were pleased that respondents agreed with us. In a fast evolving, new market like this, detailed rules run the risk of stifling innovation and are likely to become out of date quickly. Our preference therefore is to continue with more principles-based regulation and we don't propose bringing in any new rules at this stage. However, we have not discounted the possibility of new rules in some areas in the future where this would be necessary to ensure that consumers are protected. This should not materialize if the industry succeeds in the objectives of managing risks and treating customers fairly in the current principles-based environment.
Although we do not plan any new rules at this stage, many respondents sought guidance on some issues. We will therefore be looking to bring out guidance where we feel this is necessary and particularly helpful. In doing so, we will adopt a collaborative approach with the industry and other stakeholders.
The packaged product regime
The second area I want to discuss is the packaged product regime. In the DP we asked whether the Handbook posed problems for firms in this market, including in particular the packaged product regime. Some respondents felt the packaged product regime was unhelpful and not aligned with new services and business models. Many other respondents, however, felt that the Handbook did not pose problems and that DP had usefully clarified some issues; for example, maintaining independence whilst using one or a small number of platforms.
In general we believe the concerns over the packaged product regime are overstated. The regime fulfils an important role by levelling out the differing requirements of MiFID and other EU directives. The core element of the regime is compatible pre-sale product information for packaged products and this remains an important protection for consumers. The risks which led to the regime, such as the payment of commission and the complexity of products, are still with us. Nevertheless the regime has evolved. It is far more principles-based; we have removed many of the rules or turned rules into guidance. New products have emerged and we brought SIPPS into the regime last year, but only after establishing evidence of market failure and checking that the benefits outweighed the costs.
It is also said by some that our Handbook is very product focused and does not take into account the more service-based - or advice-led - way that firms are increasingly adopting. We need to bear in mind that MiFID - and hence much of COBS – does address individual product advice, but both have a wider recognition of the context of the service in which that advice is being provided. I think it is wrong to say that this framework constrains the development of service-based propositions. Indeed we are seeing that development every day. There may be challenges, but the more principles-based way we are operating increasingly gives firms the scope and flexibility to innovate and adopt practices that suit their firm and their customers.
In addition, we are increasingly applying more common standards for retail investment products across the board rather than for just packaged products. You may recall that in the old Conduct of Business Sourcebook (COBS) there was a different standard for suitability when recommending a packaged product. With the introduction of COBS we levelled the playing field and we now have a single standard of suitability for all designated investments
Disclosure of products and services
The third area I would like to cover is disclosure of products and services, particularly charges. In the DP we asked how disclosure could best be achieved. There was widespread support for the need for clear and transparent disclosure but little agreement on the best way this could be achieved. For example, some respondents suggested a single overall cost for platforms and the products held on them, similar in concept to a total expense ratio or reduction in yield. Others suggested quoting the costs for the platform, the products or funds, and the advice, separately. The divergence of views is perhaps not surprising given the range of platform business models – where some have the platform costs bundled in with the product costs and others differentiate between the two.
We remain concerned about the disclosure of the costs of products and services in general. In September last year we published a report on Good and Poor Practices in Key Features Documents and this showed significant incidence of poor standards in these documents. We have seen examples showing similar problems in the platforms industry. While some platform providers do better, the industry as a whole is not yet demonstrating good practice across the board. It is essential that this improves.
We need to move this debate forward to ensure that disclosure is clear and intermediaries and consumers can make good decisions about whether to use a platform and, if so, which platform to use. There is a clear challenge here. The range of business models in the platform market means that it is unlikely that a prescriptive 'one size fits all' approach would be the best solution. Equally, we don't want to do this in a way that favours one business model over another.
We need to move forward to ensure that platform disclosures are not only clear but can provide a basis for more readily comparing cost and service offerings. We also want to ensure that – as far as the consumer goes - costs are not lost in the complexity of the overall proposition. Consumers need to be able to understand the overall effect of the costs and the level of services they get for these. MiFID, moreover, requires all fees, commissions and non-monetary benefits to be disclosed. This includes, for example, fund rebates to platforms operating what we refer to in the DP as ‘supermarket-style’ pricing.
It is clear that disclosure is an area that needs further work and the industry needs to achieve greater transparency in its language and presentation. Inadequate disclosure will not meet one of the key outcomes of Treating Customers Fairly – namely, that consumers are provided with clear information. You are aware of the timetable we have put in place for treating customers fairly so firms should already be working on this. Following the publication of the platforms Feedback Statement next month we will engage with the industry in order to take this forward.
Re-registration
The next topic I want to discuss is re-registration, particularly in relation to PEP/ISA holdings. In the DP we asked whether platforms should allow customers to re-register assets away from a platform. There was almost universal agreement that re-registration should be allowed. A small number of respondents, however, raised the practical problems - and hence cost – involved in achieving this.
Many of these problems arise from the lack of automation in collective investment scheme trading and hence the need for laborious manual processes. In addition, we hear that there are often problems and delays between platform providers and fund managers in completing this paperwork. It is also clear that this is a wider issue than just platforms. We are of course working with the Treasury, as part of the better regulation agenda, to remove some of the legal and regulatory barriers to the electronic transmission of buy and sell orders in units of collective investment schemes. We expect that the removal of this barrier will be followed up with tangible efforts by all the relevant firms to adopt the technical messaging standards and, more importantly, to put in place the technology infrastructure that moves us towards the ultimate goal of straight through processing in mutual fund dealing. In the 21st century, current market practices in this area can best be described as Byzantine.
Against this background of current widespread bureaucracy and the pervasive lack of standardisation in dealing, it is unsurprising that the current means of carrying out transactions, for instance to move ownership from one nominee account holder to another, or from one nominee account holder to direct ownership, in respect of authorised schemes is, by necessity, a manual and typically drawn-out process.
We have heard from a number of firms that they are well able to deal with the resulting onerous procedural and operational issues this situation presents. We are at the same time aware however that other firms, particularly those with a potentially much higher volume of transactions to process, may not have modelled or, in any case, may not be easily be able to bear the expense of facilitating, in particular, in specie transfer out.
We cannot but support the widespread agreement that reregistration in specie should be allowed. Given the implications of this for certain firms that have not modelled for this eventuality, or for those that have a practical problem in facilitating transfers out, we would consider that the application of a reasonable charge to cover the cost of facilitating the transfer would be a pragmatic solution. It is, of course, always open to customers not to pay this charge and encash their holdings. But this seems an expensive option.
Use of platforms by intermediaries
The next subject is around the use of platforms by intermediaries. We asked a number of questions about:
- the role of platforms in the move away from up-front commission;
- the reasons for adopting a particular platform;
- advising customers and providing ongoing services; and
- management of conflicts of interest.
We are aware that many intermediary firms have adopted platforms as part of a wider business model change and - when undertaken well - this has resulted in benefits to customers as well as the firm. We are also aware of the influences and pressures that may apply to intermediary firms – their financial position, marketing approaches by platform providers and potential conflicts of interest. In the press and at conferences and seminars, there has been a lot of useful discussion about best practice. We would urge all intermediaries to engage with this debate, within the context of the wider RDR, and ensure they adopt good practices that work well for them and for their customers.
In the Discussion Paper we set out the issues that intermediaries should be considering. In addition, we published a factsheet that can be found in the small firms section of the website. This discusses how intermediaries should adopt and use platforms, covering a wide range of issues.
Including conferences such as this one, there is plenty of help for intermediaries when considering how to achieve good practice and treat their customers fairly. I would like to reiterate that this is an area we remain concerned about and will be looking at further.
We are also aware of the increasing use of what might be called 'distributor-influenced funds'. These are funds that individual intermediary firms have set up in conjunction with product or fund providers for the intermediary's exclusive use. There are different variants. In some cases, intermediary firms specify a broad asset allocation and the provider firm manages the investments to this brief. In other cases, intermediary firms are making the individual fund decisions within a fund of funds arrangement.
There are some serious issues that firms should consider before going down this route and it is not a decision that should be taken lightly. First, there are training and competence issues – are the advisers adequately trained with appropriate expertise and experience to be offering services at this level? We expect firms to be able to demonstrate that advisers have the capabilities to provide the service they are giving. Second, there are potential conflicts of interest here which can be very significant. Firms need to think very carefully about how they can manage these conflicts effectively. In this analysis they may find that they are unable to manage these conflicts effectively, in which case they should not go down this road. Third, there is a potential for disclosure of costs to become more complex. Firms need to think about this carefully and ensure that this already difficult area is addressed effectively.
Some of these developments raise concerns similar to those we had in the past regarding broker funds. As we move to a more principles-based environment, firms should be clear that this does not mean a lessening of the standards they need to meet. Firms need to adhere to the conflicts of interest rules that MiFID introduced, including the duty to act in the best interests of their client. They must meet the Principle 8 requirement that they manage conflicts of interest fairly. Firms must also meet high level and specific requirements for product disclosure, including the need to disclose total costs to the customer. Furthermore, our requirements on suitability are outcome-focused and hence firms need to take into account the fund characteristics, the risk profile and the charges. We will take a very dim view of any firm that is returning to the bad old days of broker funds.
Duties of platforms in the provider/distributor chain
Finally, I would like to cover the subject of the additional chapter to our Platforms paper which concerned the responsibilities of providers, distributors and platform providers for the fair treatment of customers. We were interested to read the responses to this additional chapter, which caused some controversy. Many of these concerns have been assuaged by the publication of a set of good practice illustrations for the managers of UK authorised collective investment schemes. These illustrations were the output of two separate working group meetings held at the FSA in December, attended by representatives from 17 different firms including fund management firms and platform providers and two trade bodies.
The illustrations addressed many of the points discussed in the additional chapter, in particular providing clarity about our intentions on target market and expected management information to demonstrate treating customers fairly in this context. Time does not permit me to go into this here but I commend that work to you.
To be absolutely clear then, and this will be of interest to this audience, in general we would not expect CIS operators to obtain the personal details of investors in their funds, unless that was relevant to the nature of the product (e.g. for a CIS which is designed specifically for and marketed to 65 year olds).
Our additional DP chapter focused on the provider/distributor debate in the context the use of platforms. We have made frequent reference during the course of this speech, as well as in our various policy publications, to the nascent nature of the platforms sector and we are well aware of the diverse offerings in the platforms market.
Platforms variously describe themselves as portals or as administrators or as custodians or as intermediaries. We recognise this diversity and reiterate our desire not to disrupt the sensible development of the market. However, regardless of the nature of the business, it is clear that in the provision of services to an end customer, a platform provider creates its own responsibilities to that customer, even where that customer also uses the services of an adviser. One of these responsibilities we suggest will be to ensure that these very product providers upon whom the good practice illustrations are focused are able to carry out all the distributor identification and analysis of sales volumes that they need to be able to do to ensure that retail customers who end up with their products are being treated fairly. We believe then that you, as platform providers, should be able to provide them with the wherewithal to meet their responsibilities. This will not, as we suggested in the additional chapter, require platform providers to opt down to retail customer status under COBS 3.7.1 R.
In addition, as entities with your own relationship with retail customers, you bear the responsibility of particular duties, some of which we have articulated in the additional chapter. These include ensuring that customers receive full and timely information on any changes to a product held in a nominee account – including on unit-holder voting or changes to an investment strategy. In relation to this responsibility, we believe that it ought to be standard practice for platform providers to set retail customers’ expectations, through relevant disclosures, which highlight this aspect of the way that assets are held once a customer or its adviser starts using a platform.
In this additional chapter, we also state that going forward some platform providers might assume the roles typically undertaken by product providers. Of course, as a general principle, any such assumption would be prefaced by the relevant platform provider taking on the relevant regulatory activity, which may in turn affect the range of regulatory provisions that apply to it as a regulated firm.
In conclusion, although we have seen good progress and a generally positive response to our DP, we feel the risks in this market remain and will become more significant as the market expands rapidly.
I reiterate the challenges and opportunities that result from the more principles-based regulation of this market. Firms must embrace these challenges and consider carefully how they manage risks and ensure that customers are treated fairly. Everyone in the chain - from product providers to platforms providers to intermediaries – all have a role to play in this.
We are also keen to continue the debate and play our role in helping the industry achieve these objectives. In the Feedback Statement we will announce our plans for moving the debate forward in ensuring that platforms play a beneficial role in the retail market.
Thank you