September 27, 2010 11:09 am

A new landscape for financial advisers

Consumers who need financial advice in 2013 will be faced with a very different landscape after regulatory changes come into effect.

The Financial Services Authority in the UK has said that the controversial practice of taking commission on sales of financial products will be banned in two years’ time. Financial advisers will instead have to charge an upfront fee for giving advice to consumers as part of what is known as the Retail Distribution Review.

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The charging of commission has been blamed for a number of mis-selling scandals over the years. These include mortgage endowment policies – many of which have failed to meet their investment targets, leaving homeowners struggling to repay their mortgage – and precipice bonds, which lost investors billions of pounds in the early years of the past decade.

Such products paid financial advisers generous commissions of up to 8 per cent of the sum invested. This practice, detractors argued, created a “commission bias”, encouraging advisers to sell the product that paid them the highest sum, rather than the one that was best for the consumer.

The commission structure has often been difficult for consumers to understand. Not all advisers make it clear how much of a client’s investment is being earmarked for commission. Headline commission rates are usually only the initial commission paid at the time the money is invested. But many products, including unit trusts, also have “trail” commission deducted annually, even if no further financial advice is given.

The FSA hopes that this confusion will disappear from 2013. Financial advisers will have to set out clearly the fee structure to the consumer before a product is bought. Consumers will also be offered what the authority expects to be a more professional service from advisers, who will have to sit new exams and be better qualified.

Furthermore, advisers will be split into two categories: independent and restricted. The first group will have to advise on every type of product, without a bias towards one provider. Restricted advisers may be restricted in one of two ways: either they will limit their advice to products from only a few providers, or they will advise on every type of product but in one specific area, such as pensions or investments.

Investors could also find themselves being offered a greater variety of products once commission is banned. At present, many financial advisers do not recommend exchange traded funds and investment trusts to clients, as these do not pay commission. But when advisers are forced to recommend products across the entire spectrum, providers of these listed funds hope that their sales will increase.

This would bring private investors in the UK closer to their US counterparts. Retail investors in the US represent roughly 50 per cent of the ownership of ETFs, whereas in Europe it is less than 10 per cent, according to Source, an ETF provider.

Consumers will also be able to use execution-only services, which allow them to buy products directly from providers without taking advice. These services are already present with simple forms of investment such as individual savings accounts. To meet growing demand, product providers and financial adviser firms are expected to ramp up their offerings in this area too.

For some people, the ban on commission will lead to lower fees. Patrick Connolly, head of communications at AWD Chase de Vere, the financial adviser, says: “Fees will come down at the top level. A person with £1m will ask, ‘What value am I getting for £10,000 in fees?’ They will thrash it out with the adviser.”

But, while the ban on commission is generally applauded, there are fears it will raise the cost of advice for many people.

The commission system, it is argued, created a cross-subsidy whereby those with more to invest paid higher sums, making it cheaper for people with less money to invest. If advisers start charging a realistic fee that represents the use of their time to each customer, it is likely that these fees will be higher than the commission had been for customers at the lower end of the scale.

“The further down the wealth ladder, the bigger the cost in proportion to the benefit,” says Russell Warwick, distribution strategy director at Prudential.

“For wealthy consumers, many are willing to pay for advice – the challenge will be for the mass affluent and the mass-market consumers who could be facing relatively large advice costs.”

There are concerns that some consumers could stop taking financial advice altogether. “Will people be alienated by the advice process by the increasing cost? We fear so,” says Steve Folkard, head of savings and pension policy at Axa.

However, the consultation process has not yet been completed. Life companies and financial advisers are putting pressure on the regulator to fill this perceived advice “gap” by making other forms of advice available.

“At the moment, it’s not clear how consumers who cannot afford a straightforward service will be served,” says Mr Folkard.

The Financial Services Authority in the UK has said that the controversial practice of taking commission on sales of financial products will be banned in two years’ time. Financial advisers will instead have to charge an upfront fee for giving advice to consumers as part of what is known as the Retail Distribution Review.

The charging of commission has been blamed for a number of mis-selling scandals over the years. These include mortgage endowment policies – many of which have failed to meet their investment targets, leaving homeowners struggling to repay their mortgage – and precipice bonds, which lost investors billions of pounds in the early years of the past decade.

Such products paid financial advisers generous commissions of up to 8 per cent of the sum invested. This practice, detractors argued, created a “commission bias”, encouraging advisers to sell the product that paid them the highest sum, rather than the one that was best for the consumer.

The commission structure has often been difficult for consumers to understand. Not all advisers make it clear how much of a client’s investment is being earmarked for commission. Headline commission rates are usually only the initial commission paid at the time the money is invested. But many products, including unit trusts, also have “trail” commission taken out of them yearly, even if no further financial advice is given.

The FSA hopes that this confusion will disappear from 2013. Financial advisers will have to set out clearly the fee structure to the consumer before a product is bought. Consumers will also be offered what the authority expects to be a more professional service from advisers, who will have to sit new exams and be better qualified.

Furthermore, advisers will be split into two categories: independent and restricted. The first group will have to advise on every type of product, without a bias towards one provider. Restricted advisers may be restricted in one of two ways: either they will limit their advice to products from only a few providers, or they will advise on every type of product but in one specific area, such as pensions or investments.

Investors could also find themselves being offered a greater variety of products once commission is banned. At present, many financial advisers do not recommend exchange traded funds and investment trusts to clients, as these do not pay commission. But when advisers are forced to recommend products across the entire spectrum, providers of these listed funds hope that their sales will increase.

This would bring private investors in the UK closer to their US counterparts. Retail investors in the US represent roughly 50 per cent of the ownership of ETFs, whereas in Europe it is less than 10 per cent, according to Source, an ETF provider.

Consumers will also be able to use execution-only services, which allow them to buy products directly from providers without taking advice. These services are already present with simple forms of investment such as individual savings accounts. To meet growing demand, product providers and financial adviser firms are expected to ramp up their offerings in this area too.

For some people, the ban on commission will lead to lower fees. Patrick Connolly, head of communications at AWD Chase de Vere, the financial adviser, says: “Fees will come down at the top level. A person with £1m will ask, ‘What value am I getting for £10,000 in fees?’ They will thrash it out with the adviser.”

But, while the ban on commission is generally applauded, there are fears it will raise the cost of advice for many people.

The commission system, it is argued, created a cross-subsidy whereby those with more to invest paid higher sums, making it cheaper for people with less money to invest. If advisers start charging a realistic fee that represents the use of their time to each customer, it is likely that these fees will be higher than the commission had been for customers at the lower end of the scale.

“The further down the wealth ladder, the bigger the cost in proportion to the benefit,” says Russell Warwick, distribution strategy director at Prudential.

“For wealthy consumers, many are willing to pay for advice – the challenge will be for the mass affluent and the mass-market consumers who could be facing relatively large advice costs.”

There are concerns that some consumers could stop taking financial advice altogether. “Will people be alienated by the advice process by the increasing cost? We fear so,” says Steve Folkard, head of savings and pension policy at Axa.

However, the consultation process has not yet been completed. Life companies and financial advisers are putting pressure on the regulator to fill this perceived advice “gap” by making other forms of advice available.

“At the moment, it’s not clear how consumers who cannot afford a straightforward service will be served,” says Mr Folkard.

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