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December 2, 2012 3:51 am
The Retail Distribution Review (RDR) in the UK and the Future of Financial Advice (FoFA) Act in Australia are examples of a new regulatory regime that embraces the fee-for-service business model in wealth management. They could well be the precursor of a new regulatory movement toward making the fee-based model much more important in the industry globally. Wendy Guo and Tom Robinson discuss the fee-for-service model particularly in the Asia-Pacific wealth management landscape.
What is behind the changing regulatory trends since the global financial crisis?
Before 2009, there were numerous cases of mis-selling of investment products by wealth management service providers working on commission. These included subprime mortgage products, collateralised debt obligations, mini-bonds, accumulators, and various other products that are questionable in their design or simply not suitable for the client. The Occupy Wall Street movement, which has spread around the world, is one manifestation of the public’s loss of trust in the industry and its professionals – a loss due to this type of behaviour. Regulatory authorities are now concentrating on eliminating the conflict of interest inherent in the compensation paid to wealth management service providers.
How prevalent is the fee-for-service model?
Following the RDR in the UK which is slated for implementation at the beginning of 2013, the FoFA Act was introduced in Australia in July 2012, and the government is currently consulting with industry on its implementation. The Act introduces a fee-based regime and a ban on “conflicted remuneration” (including any payments from products and platforms to advisers). It also bans certain insurance product commissions, “soft dollar benefits” to advisers, and asset-based fees where the client has borrowed to finance the product’s purchase.
While the fee-based mandate is a main feature of the private banking heritage in Europe, and the US has around 27,000 independent registered investment advisors, it may be a long time before the fee-for-service model becomes prevalent in Asia-Pacific. There are signs, however, that it is slowly increasing in acceptance. Apart from Australia, rapid growth in the number of independent financial advisers in India in recent years signals a gradual shift away from a product-centric model. Japan’s smaller private wealth management companies typically earn advisory fees rather than trading commissions. In Singapore, managers who follow a fee-based model formed the Association of Independent Asset Managers in 2011 to set their members apart from conventional asset managers.
How are the wealth owners in the Asia-Pacific region different from those in the west?
A high proportion of Asian wealth owners are first generation with an entrepreneurial background and aged under 50, particularly in the case of China. Unlike wealthy European families which have watched their wealth rise and fall over the generations, Asia’s new wealthy have shorter time frames for gauging returns. They tend to emphasise tactical opportunistic strategies and short-term performance. In many Asia-Pacific countries, capital gains are not taxable or subject only to a relatively low tax rate, so portfolio turnover is not a concern. These investors generally prefer paying transaction-based fees rather than asset-based fees.
Real estate has been a main source of wealth creation for Asia-Pacific wealth owners, who typically have 20 per cent or more of their net worth in real estate. The proportion of overall wealth requiring standard investment advice tends to be relatively low.
In developed Asian markets such as Hong Kong and Singapore, the second or even third generation is taking up leadership in some prominent family businesses. With some exceptions, a significant portion of them still like to have substantial input in wealth management decisions
Is the fee-for-service model the panacea?
Compared with a transaction-based commission-led brokerage model that tends to be more short-term and opportunistic, a fee-for-service model allows an adviser to take on a long-term view and provide differentiated and relevant value added service to investors. With fee-based service, the incentive design eliminates much of the conflict of interest. There is no guarantee that the service is always satisfactory under any model. A recent mystery shopping survey conducted by the Monetary Authority of Singapore found almost a third of the product recommendations were viewed as being unsuitable, as they were inconsistent with the client’s objectives or circumstances. Ultimately, quality of advice and professional ethics are the key to the long-term success of the industry.
Wendy Guo is head of education, Asia-Pacific and Tom Robinson is managing director, education at the CFA Institute
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