Andrew Fisher: Why commission had to be banned

On Thursday, the Financial Services Authority (FSA) published its most detailed document yet on the future framework for the delivery of financial advice – and it is now clear how the changes will affect UK investors. So you should start paying attention!

The background is a need for people to be able to access professional and independent advice, especially against the backdrop of the closure of company (defined benefit) pension schemes and an independent financial advice industry that is held in low regard. The FSA set out over three years ago to improve the consumer experience when seeking financial advice. Having been on the receiving end of much flak over the last few months, the FSA should be applauded for its solution.

Central to the distrust of so-called ‘independent financial advisers’ is commission. Commission is at the heart of all that is wrong in the financial advice industry. For many years, advisers have sold inappropriate products to unsuspecting consumers because it has suited them – rather than being in the best interests of clients.

Thankfully, the FSA has not danced around this: it has banned the payment of commission. The result is that consumers will be able to seek financial advice in the knowledge that the cost will be agreed at the outset and that the advice will be geared towards the investor’s interests and not the adviser’s commission account.

This is in contrast to the current position. Advisers in commission-based firms only get paid if they sell a product, and the amount they get paid will vary depending on the product and the provider. The temptation is for the adviser to ‘advise’ to buy the highest commission-paying product from the highest commission-paying provider.

This incentive explains the continued sales of investment bonds to consumers. These products are of no benefit to most individuals but they continue to sell in millions.

This inherent ‘product bias’ and ‘product manufacturer’ bias will not exist in the new world. The new rules will explode the myth that advice is free. Financial advice is not free – it never has been and never will be. The ‘old world’ pretence of “this advice is free for you because the product manufacturer will pay” is over. In the future, advisers will be forced to show consumers how much their advice costs and the consumer will have the opportunity to determine whether they consider this to be value for money.

For example, in today’s world, if commission-based financial advisers want to sell a £200,000 investment bond to clients, they will typically take an initial commission of 7 per cent, and some providers have offered up to 9 per cent. That is £14,000. This is a cost to the client but dressed up as a payment from the insurance company.

In the new world, commissions are banned. How many clients are going to opt to pay £14,000 for an hour’s advice to buy an investment bond? Top lawyers don’t earn £14,000 an hour – poorly qualified advisers do today, but not for much longer.

This increased transparency is important. Although commissions must currently be disclosed to clients, it is easy for the costs of commission to be concealed. In this example, the client invests £200,000 in the investment bond today, and the adviser takes 7 per cent commission – but, on day one, the bond is still worth £200,000. So it is not clear to the client where the commission charges are coming from.

The answer, of course, is that the client pays one way or another. If it’s not in the form of initial charges, then it is in ongoing charges or exit penalties. The FSA is banning this and in future will not allow adviser charges to be disguised in this way.

Some in the industry argue that the end of commission will mean that less wealthy clients will no longer be able to get financial advice, because they can’t afford to pay fees. But I think this view is insulting to them. Everybody pays fees from a car service to a visit to the dentist. Clear and transparent charges will always be better than opaque, high commissions.

The only people who will suffer from these proposals are commission-based salespeople and the companies that pay large commissions to encourage them to sell their products.

But a word of warning. Financial advisers do not have to implement these changes until 31 December 2012. Until then, consumers need to be aware that the risk of them receiving inappropriate advice remains. Therefore, they should seek out advisers who will provide them with truly independent fee-based advice.

Andrew Fisher is chief executive officer of Towry Law, the independent wealth management and financial planning group