Five barriers stopping simplified advice and how they can be overcome

The Retail Distribution Review (RDR) of 2012 fundamentally changed how retail investment advice was given. It banned commission and now advisers make an explicit charge which customers have to pay for advice. The FCA has published a consultation paper that says it is aimed at "clarifying the boundaries and exploring the barriers to market development" of retail investment advice (56-page / 705KB PDF).

Uncertainty over the boundary between sales models that provide personal recommendations on retail investments, like simplified advice models, and those that do not are vital.

The FCA has said that "there are options … that sit between execution-only and full advice, that we believe that there are no regulatory barriers to providing these alternatives”. This is encouraging stuff from the new regulator, but why aren’t we seeing more opportunities for people to go somewhere and obtain simplified advice rather than having to pay a sizeable fee for a full financial advice service they may not need, or resorting to execution-only platforms?

Following a thematic review, the FCA itself has identified five barriers to this happening.

Uncertainty risk

Firms are uncertain about the breadth of the suitability standard for providing personal recommendations online, especially when for a focused scope. Where does the fault for this uncertainty lie? Is there a mismatch of interpretation between the industry and regulator? Would more examples and case studies help?

The clue to answering this concern is the reference to a “focused scope”. It will always be easy when investigating a complaint to say 'so-and-so should have taken this and that into account' but that must be wrong if the limits of focused scope are clear and understood.

Systemic misselling risk

Automated advice processes could result in systemic misselling and the potentially much-repeated liability makes these processes less viable. It may be a nice problem to have such a volume of users to raise such a concern but buying indemnity insurance can lay off some of the risk.

Nothing beats having a compliant process to start with and that is the basic requirement. But there is fear that the regulator might order a systemic past business review either against one firm or the whole industry. However, the regulator has a role to play here to ensure this risk is mitigated by its own involvement in providing appropriate guidance and supervision. This needs to be recognised. And the Financial Ombudsman Service (FOS) has a role too. Its stating that it would “recognise the nature of the service” is a good development. This would seem, on reflection, to be a lesser barrier now than in the past.

Causation risk

Firms believe they have to price into their models the risk that they may have some liability for the online simplified advice even if the customer decides later to transact elsewhere. This can be solved by ensuring the user is given a simple and clear statement at the start of the process that if the customer does not buy the product through the adviser, the adviser can limit his liability. And the law could help here by having a clean break in the chain of causation or establishing the loss as too remote from the advice given.

Causation is when there is a direct link between negligence and loss caused by a breach in the duty of care. Although only a court can decide if there has been a break in the chain of causation it would still be relevant to consider the FCA’s conduct of business rules and guidance.

The FCA however will need to move away from considering that the duty of care in the case of focused or simplified advice in relation to retail investment products includes having to deal with wider considerations, such as the absence or insufficiency of protection insurance. This is important if the concept of simplified advice is going to be developed by some of the bigger and more conservative players, such as banks and life insurance companies, who need to spend millions to develop systems to cater for potentially very high volumes of customers.

FOS risk

A barrier to developing a commercially viable online simplified advice system is the way FOS would handle complaints and the growth of complaint management companies. However, as we have seen recently, the number of claims management companies operating in the UK has fallen by nearly 600 since stricter rules came into force in April 2013 so, maybe, this is also becoming less of a concern.

Compliance risk

Simplified advice systems need increased levels of compliance oversight, which defeats the objective of a streamlined process. Compliance is always going to be required whatever distribution model is used and an online automated system should have an inherent advantage that, once designed and built properly, it should comply with the regulations, otherwise it should not be launched. The problem is keeping it up to date with regulatory changes and, more importantly, regulator’s and customers’ expectations. But that is mainly an IT concern  and not a compliance concern.

The FCA also said that it had concerns with the inability of firms to filter out customers for whom the simplified advice process was inappropriate. This seems odd since the FCA found that most firms had identified the types of customer that a non-advised service was appropriate for, including the range of investments to make available, the type of and content of information non-advised customers needed and the systems necessary to ensure good outcomes.

So, why can’t the same be said about simplified advice models? The answer for firms looking at this part of the distribution market might lie in developing more robustness in the design and ongoing governance of the simplified advice model and focusing on the needs of customers more to deliver good outcomes.

The FCA’s thematic report devoted nearly nine pages to describing the key elements of a non-advised service delivering good customer outcomes but said nothing about what would be the key characteristics of a simplified advice model, presumably because this has been covered by the existing guidance. The challenge is there: can a simplified advice model operate viably and result in good outcomes for customers, taking into account the need for a certain volume, keen pricing and a trusted brand?

Current guidance

Like its predecessor the FSA, the FCA says that it encourages the development of well-designed, low-cost methods of meeting customers’ straightforward needs. But does it?

The current regulatory guidance on simplified advice was published by the FSA in March 2010. The guidance set out the requirements for firms developing a simplified, automated, advice model for customers with straightforward investment advice needs. Yes, suitability standards are required to be met; yes, training and competency requirements are needed for a “simple needs adviser” or the designer of the automated system; yes, the post-RDR charging rules should apply to the simplified advice service; and yes, it is restricted advice.

But these are the same elements required for giving full advice. Why would someone launch a simplified advice model rather than a full advice one after complying with all that? Within these elements, there needs to be a degree of tolerance that distinguishes the simplified advice service from the full advice service, otherwise, what is the point? Unfortunately the FCA seems to disagree.

It says in its consultation paper: “We do not believe that the relaxation of the requirements for individuals who give simplified advice is in the best interests of the customer”. It seems we therefore have an impasse – the regulator does not want to compromise its objective of customer protection yet it also wants to have a regulatory regime that encourages the development of well-designed, low-cost methods of meeting customers’ straightforward needs such as simplified advice. Something has to give if the two objectives are to be met.

The existing 2010 guidance on simplified advice must surely now be discredited. In it, the FSA said it was “not convinced, as some commentators appear to be, that the RDR will mean many customers who want and need advice will not be able to access it”. If that seems to be very wrong then so, too, is the FSA’s reliance placed on the Money Advice Service. The long-awaited RDR post-implementation review is expected at year end and is awaited with interest.

How to respond

So what should be submitted to the FCA in response to the guidance consultation on simplified advice?

Firstly, we believe the FCA has already demonstrated a significant shift from the previous, somewhat rigid, thinking of the FSA and has demonstrated that it is open to a different approach to simplified advice.

It has recently said that “the suitability requirement is flexible”; “the information a firm must obtain will vary from case to case”, and “the firm would need to explain to the customer their other financial needs will not be addressed”.

But this approach needs to be developed into everyday supervisory practice and incorporated into the FCA rule book. So, when the FCA says in its consultation paper that collecting information to meet the needs of suitability must be what is necessary to achieve the outcome, this must translate into a different standard of fact-finding for a simplified advice service.

This line of thought would seem to be backed up by MiFID, mentioned in paragraph 3.26 of the consultation paper. It’s time for the FCA to be straight about this and say so.

Secondly, the thematic review and consultation paper “talk” about “simplified advice” and so it is time for this term to be defined and included in the glossary of the FCA handbook so that there is clarity about what exactly it means. We would welcome the inclusion in the FCA rulebook of a great deal of the existing guidance on simplified advice, but as amended of course after the consultation exercise to enable it to become a more viable service.

Thirdly, it should also be clear that the service provided under a simplified advice model does not include advice on existing products held by the customer. The customer has to know the limit of the simplified advice service and that this is not included, else it’s full advice for them or they make their own minds up with no liability on the simplified advice service provider.

Fourthly, the current guidance on a simplified advice process says it is not suitable for people who do not have their priority needs met or who have need to reduce existing debt. If this service can ignore existing products, it should also not be concerned with whether a priority need has been met or whether the customer is in debt.

People are commonly both borrowers and savers today and to exclude people with debts from using a simplified advice model would reduce the size of potential customers likely to be in this segment of the market and potentially increase the inaccessibility of people with simple needs and means to advice, which is known as the 'advice gap'.

And besides, what is meant by 'priority needs'? This is likely to mean different things to different people. If it is an important boundary line for when simplified advice can be accessed, then the term 'priority needs' should be defined in the rules. If someone has a specific investment need despite having a debt or existing products, some help of some sort, hence advice, should still be available to them and it would be much more beneficial than no advice at all and would still achieve good outcomes in most cases. Of course this is always to be judged only within the scope of that advice parameter.

Conclusions

We think the FCA should be much clearer about simplified advice and marry its guidance on the subject with the handbook. It should distinguish simplified advice much more fully from both full advice and execution-only. This is particularly the case in relation to those execution-only businesses that, in an effort to avoid liability, state that they are not giving advice when they are as close to doing so as they can be, or are actually giving advice.

It is also important to consider disclaimers. We agree with the FCA that a disclaimer attempting to say a service is non-advised when in fact a recommendation is being presented will be ineffective in negating liability for that recommendation. However, we do believe that a well drafted, bold disclaimer describing clearly the limited extent of the simplified advice service will be effective to ensure customers understand their rights and remedies if they use that service.

Bruno Geiringer is a life insurance and wealth management expert at Pinsent Masons, the law firm behind Out-Law.com. 

This article first appeared in a white paper by Pinsent Masons addressing different aspects of the FCA's consultation. You can also see our analyses of retail investment advice; 'Project Innovate';  digital technology; social media and financial advice; FCA guidance on the regulation of advice; FOS as a barrier to innovation, and local authority duties to advise on social care funding.