From the end of 2012, a firm making a personal recommendation to a retail client in the UK to invest in a retail investment product will no longer earn commission set by the product provider. Instead, the firm will be paid an adviser charge agreed with the client in advance.
The ban on commission and the introduction of the adviser charge is the cornerstone of the Financial Services Authority's Retail Distribution Review (RDR).
Product providers, however, will be able to "facilitate" payment of the adviser charge by deducting it from the investment, but only after obtaining and validating instructions directly from the client.
The final rules and guidance on adviser charging were published by the FSA in March 2010 (166-page/1MB PDF), followed by some minor clarifications in the regulator's October 2010 quarterly consultation paper (213-page /1.16 MB PDF), and the final rules on trail commission in November 2011.
In response to industry questions and concerns, however, two further consultation papers were published in November 2011, clarifying the position (1) when a product provider has facilitated payment of the adviser charge but the client cancels the product and (2) the treatment of "legacy assets" - retail investment products held by the client that were bought before the RDR rules come into effect.
In addition, early in 2012, HM Revenue and Customs is due to provide guidance on the VAT treatment of the adviser charge (see: the RDR and VAT). .
The RDR rules and guidance appear in the Conduct of Business Sourcebook (COBS) and will apply to business conducted after 31st December 2012.
This guide looks specifically at the provisions on adviser charging. The final rules on independent and restricted advice and the impact on sales of pure protection products and on platforms are considered in separate notes.
Adviser charging will apply to firms advising retail clients in the UK on retail investment products (COBS 6.1A.1R; 6.1A.3R).
It will apply equally to independent and restricted advice, but not to basic advice (advice on stakeholder products using pre-scripted questions), where advisers will still be able to earn commission on sales (COBS 6.1A.2R).
Non–advised services, or execution-only sales, where no advice or recommendation is given, will also fall outside the adviser charging regime.
A retail client is defined in the FSA Handbook as someone who is not a professional client or an eligible counterparty (broadly, any financial institution or undertaking). This is not quite the same as a consumer (defined as someone acting for purposes outside his trade, business or profession), although the vast majority of those affected by the new regime will be consumers
The new definition of retail investment products is deliberately broad. It includes what elsewhere in the Handbook are termed packaged products: life policies, a unit in a collective investment scheme, exchange traded funds, stakeholder and personal pension schemes and an interest in an investment trust savings scheme.
It also includes a security in an investment trust and a structured capital-at-risk product, as well as a "catch all" provision: "any other designated investment which offers exposure to underlying financial assets, in a packaged form which modifies that exposure when compared with a direct holding in the financial asset".
Advice on stocks and shares or on structured deposits, however, will not be covered by the new regime.
In a separate policy statement published on 30th September 2010, the FSA confirmed there will be a carve-out for firms that elect to sell pure protection products (term life insurance, critical illness and income protection cover) under COBS rules rather than under the Insurance Conduct of Business Sourcebook (ICOBS).
This means that firms selling pure protection under COBS will not have to apply adviser charging and so will still be able to earn commission on sales, although there will be some additional disclosure requirements (see: The RDR and pure protection products).
Under the new regime, a firm providing personal recommendations on retail investment products and any related services can only be paid by adviser charges and must not solicit or accept any other commission, remuneration or benefit of any kind, regardless of whether it intends to pass it on to the client (COBS 6.1A.4R).
Related services include arranging the recommended transaction or carrying out administrative tasks associated with it, or managing the relationship between the client and a discretionary investment manager (COBS 6.1A.6G).
Equally, product providers are prohibited from offering or paying commission, remuneration or benefits of any kind to a firm in connection with advice given or any related services (COBS 6.1B.5R).
This will not prevent product providers from offering to facilitate the payment of adviser charges from the client's investment (see below) or from paying administration or other charges to third parties, such as fund supermarkets (COBS 6.1B.6G).
The prohibition on firms and product providers does not apply to basic advice on stakeholder products. Advisers may continue to earn, and product providers to pay, commission on such sales (COBS 6.1A.2R; 6.1B.2R).
The new system will require firms to work out an appropriate charging structure for calculating the adviser charge (COBS 6.1A.11R). This can be in a standard form, rather than tailor-made for each client (COBS 6.1A.12G).
Whether the charging structure is based on a fixed fee, an hourly rate or a percentage of funds invested will be up to the firm, provided it always bears in mind its duty to act in the client's best interests. But the client should only pay ongoing charges if the firm is providing an ongoing, value-added service and this is properly disclosed to the client (COBS 6.1A .22R; 6.1A.26G).
Varying adviser charges "inappropriately" according to provider or product, or allowing charges to be influenced by what payment facilitation services are on offer would suggest the firm is not complying with the client's best interests rule (COBS 6.1A.13G).
This means that firms will not be able to charge more for recommending one product (such as a distributor influenced fund) instead of another "substitutable" product (such as a third party collective investment scheme).
This addresses a longstanding FSA concern about distributor influenced funds (DIFs), where adviser firms have a degree of influence over a bespoke or existing fund and, in return, may be paid a share of the fund charges. The new guidance will prevent firms from adopting higher adviser charges for recommending DIFs over other competing products.
And in requiring firms be paid only through adviser charges, the FSA warns: "we expect adviser firms to appreciate that they will not be able to continue to receive additional income from other sources in relation to DIFs". This would rule out remuneration paid to an adviser firm for its role on the governance committee of a DIF.
"We want firms to have charging structures that are product neutral, with firms focusing on the level of service they provide and the outcomes for the consumer," the March 2010 policy statement says.
"Firms should seek to base their charges on the services they provide, rather than on the type of products they sell. We think it is important for firms to take responsibility for the charging structures that they adopt, in accordance with this basic principle."
Firms should also consider whether their advice is likely to be of value to the client once the total charges the client is likely to pay are taken into account (COBS 6.1A.16G). In some cases, it may be in the client's best interest not to receive advice at all.
The firm's charging structure must be disclosed to the client in writing "in good time" before any advice or related services are given (COBS 6.1A.17R) and in "clear and plain language" (ICOBS 6.1A 19G). The information can be set out in the services and costs disclosure document or a combined initial disclosure document (COBS 6.1A.21G) and can take the form of a list of services and indicative charges (COBS 6.1A.18G).
If the actual charge payable differs materially from the charging structure, this must be disclosed to the client "as early as practicable"(COBS 6.1A.26R).
The total adviser charge
The total adviser charge payable to the firm or any of its associates must be agreed with and disclosed to the client "as early as practicable" in a durable medium or via a website. The cost must be shown in cash terms (or converted into illustrative cash equivalents).
Where payments are to be made over time, the client must be told how much is to be paid and when and the consequences of cancellation (COBS 6.1A.24R).
The guidance reminds firms of their duty to provide information that is fair, clear and not misleading. In particular, the client should be told to which services the adviser charge applies and if the total charge varies materially from the amount indicated in the firm's charging structure (COBS 6.1A.26G).
Firms are required to keep records of their charging structure, the total adviser charge payable by each client and, where this differs materially from the charging structure, the reasons for the difference (COBS 6.1A.27R).
Adviser charging also applies to product providers advising clients directly on their own products. The product provider must ensure that the level of its adviser charge is "at least reasonably representative" of the adviser services provided (COBS 6.1A.9R).
To be reasonably representative, the adviser charge should not include costs associated with manufacturing and administering the product. The allocation of costs and profit between the adviser charge and product cost should be such that any cross-subsidisation is insignificant in the long term (COBS 6.1A.10G).
More broadly, the amount charged should be at a level that would be "appropriate" if the advice and related services were being offered by an unconnected firm (COBS 6.1A.10G).
The rules also provide that product providers must take reasonable steps to ensure product costs are not so structured that they mislead or conceal the distinction between product costs and adviser charges. In particular, the FSA wants to end the practice of product providers offering to allocate over 100% of the client's investment, usually without making it clear that higher charges will apply.
Product marketing must not include statements about how much firms should charge for their advice services (COBS 6.1B7R).
Discussions are, however, continuing between the FSA and product providers on the separation and allocation of adviser and product costs, particularly as they apply to banks and building societies. Further guidance may emerge on these issues in due course.
Clients can choose to pay the adviser charge up front or have it deducted from their investment.
Payment can be made in instalments, but only if the adviser charge is in respect of an ongoing service provided by the firm which has been properly disclosed, or if the retail investment product is one to which the client makes regular contributions (COBS 6.1A.22R). The FSA believes any transitional liquidity problems this may cause advisers can be overcome.
If payment is to be taken from the investment, the product provider must obtain clear instructions from the client about the amount to be deducted. The payment facility it offers must also be sufficiently flexible so as not to constrain advisers in the charges they can make (COBS 6.1B.9R).
Despite some opposition from the industry, factoring (where a product provider pays the charge at a discounted rate and recovers it over time via the product) will be banned. But this will not prevent a firm acting on behalf of the client from making use of any facility for payment offered by another firm or by third parties (COBS 6.1A.7G), provided they comply with the rules.
In the case of platforms, this enables the adviser charge to be deducted from the customer's cash account held on the platform. Platform operators will be subject to the same rules as product providers when they facilitate payment in this way.
Product providers may also offer credit facilities to help clients pay the adviser charge, but only if this is in the client's best interests (COBS 6.1B.11G). Product providers entering into agreements with adviser firms to offer credit must abide by guidance and evidential provisions intended to prevent such arrangements from channelling business from the firm or influencing the advice it gives to clients (COBS 2.3.12E).
In November 2011, the FSA published draft guidance for consultation on facilitating charges (45-page / 473 KB PDF) and, in particular, the position on refunds where the client cancels a product and payment of the adviser charge is being facilitated by the product provider.
Under COBS 15, a client has the right to cancel a product within 14 or 30 days of concluding the contract or receiving the contractual terms and conditions, whichever is later. The rules also set out the effects of cancellation, including the sums to be refunded.
The proposed guidance states that, where a product provider has agreed to facilitate payment and the client then cancels, the provider can choose whether to pay the refund net or gross of the adviser charge, provided this is made clear to the client in advance as part of the information on the effect of cancellation (COBS 15.2.5R) and subject to any HM Revenue and Customs rules.
In the case of refunds of the consultancy fee payable for advice given in connection with a group personal pension (see below), cancellation rights are subject to Department of Work and Pensions rules which require refunds to be paid gross. This means the provider would need to seek a refund of the charges from the adviser. The adviser would then have to contact the employer or, if advice to a member of a group personal pension has been provided, the individual regarding payment of any outstanding adviser change.
The adviser charging regime is backed up by amendments to current rules and guidance on inducements and non-monetary benefits aimed at preventing firms receiving incentives (or "soft commissions") from product providers. The changes extend existing requirements under the Markets in Financial Instruments Directive (MiFID) to retail investment products.
Consequently, any non-monetary benefit received by a firm in relation to a retail investment product must be designed to enhance the quality of service to the client and must not impair the firm's duty to act in the best interests of the client (COBS 2.3.1R; 2.3.14G).
A list of reasonable non-monetary benefits, including hospitality, seminars and training, is provided (COBS 2.3.15G), although firms are reminded that it will be a question of fact in each case whether or not the benefit in question enhances the quality of service and satisfies the client's best interest rule (COBS 2.3.14G).
This list does not apply to non-monetary benefits given by a product provider to its own representatives or to a firm in the same immediate group in relation to packaged products. Somewhat confusingly, these will continue to be covered by the rules on disclosing commission (and commission equivalent) at COBS 6.4.3R (COBS 2.3.14G).
In an amendment to the guidance, retail investment product providers are specifically warned that making a benefit available to one firm and not another is "more likely to impair compliance" with the client's best interest rule, and that benefits of substantial value (such as adviser training programmes or significant software) should be made available equally to all firms (COBS 2.3.16G).
Adviser firms, too, are advised to be cautious about accepting benefits on which they will have to rely for a period of time, such as access to another firm's IT systems or client data software (COBS 2.3.16AG).
The adviser charging rules will only apply to business conducted after the end of 2012. Additional rules published by the FSA in November 2011 confirm that, in cases where a client bought a retail investment product before the RDR implementation date, the adviser concerned can continue to receive ongoing "trail" commission in relation to his pre-RDR advice until the product matures or is terminated.
If the client chooses to move to a different adviser, the trail commission can be re-registered to the new adviser, but only if the new adviser provides an ongoing service in return for the commission. The new adviser must disclose the actual amount of commission to the client "as soon as reasonably practicable" after the adviser has told the client of its intention to seek re-registration.
Trail commission may also be re-registered to a new firm if the original adviser retires or sells his business. In these circumstances, an ongoing service to the client does not need to be provided.
The rules on trail commission will come into force with the rest of the RDR rules at the end of 2012.
A legacy asset is a retail investment product purchased by the client before the RDR rules come into effect and which the client is still holding when the rules are in force.
Before the RDR regime comes into effect, legacy (i.e. additional) commission on advised and non-advised sales might become payable on legacy assets where there has been a change to the product, such as the client topping up a life policy or buying new units in a unit trust.
The RDR rules, however, will prohibit legacy commission on advised sales, but not on non-advised sales (COBS 6.1A.4R and 6.1B.5R). The FSA has confirmed that it has no intention of relaxing or amending this ban.
"Allowing legacy commission to continue could perpetuate bias in the market, with advisers having a vested interest in recommending that customers continue to hold legacy products or to increase payments into them," the paper states. "This would potentially create a systematic bias towards top-ups into existing products. It could also lead to advisers being paid twice for the same work, once through adviser charges and again through commission."
In a consultation paper published in November 2011, however, the regulator acknowledges that its previous statements on trail and legacy commission have led to some confusion in the industry.
The draft guidance (which will appear in the Perimeter Guidance manual or PERG) is intended to help firms understand when the legacy commission ban does and does not apply.
Firms should ask themselves whether a personal recommendation on a retail investment product was made to the client before or after the RDR rules came into effect. If pre-RDR, the advice will not be caught by the ban on commission. If post-RDR, no additional commission can be paid, although trail commission on the original advice may still be received. If there has not been a personal recommendation, then the adviser charging rules do not apply.
If new advice is given however, adviser charging will apply to that advice. The guidance gives examples of typical situations that amount to advising on existing investments.
One anomaly is that the FSA's RDR rules for platforms will, for the time being at least, still allow product providers to pay cash "rebates" via platforms for changes in legacy business. The regulator has made it clear that it wants to ban such rebates in the future, but not before 31st December 2012.
The consultation on the draft guidance closes on 16th January 2012 and the FSA will publish its policy statement in the first quarter of 2012.
Group personal pensions
The FSA's policy statement of June 2010 set out its final rules and guidance on how adviser charging principles will apply to advice given in connection with group personal pensions (including group stakeholder pensions and group self-invested personal pensions).
Under COBS 6.1C, firms assisting employers with the setting up and administration of group personal pensions after the end of 2012 will agree a "consultancy charge" with the employer, rather than being paid commission set by the pension provider. This will apply whether or not individual employees received advice.
For individual sales of personal pensions, the adviser charging rules will apply, unless the sale was non-advised or the advice given was basic advice given in connection with a stakeholder pension. In those circumstances, the adviser will continue to be able to earn commission.
The rules also allow trail commission and re-registration of commission for group personal pensions, if permitted by the contract between the provider and the original adviser (COBS 6.1C.8AR). The requirement for the new adviser to provide an ongoing service only applies where the employer has chosen to move to a new adviser and not to bulk transfers of business by the original adviser.
As in the retail investment market, the new adviser must disclose that he is applying for re-registration and the amount of commission being transferred. In the case of group personal pensions, however, the information and any ongoing service will be provided to the employer who set up the scheme.
Access and cost
In March 2010, the FSA revised its calculation of the likely cost to the industry of implementing the RDR as a whole. One-off costs are now estimated at between £605 million and £750 million (up from £403 million) and ongoing costs at between £170 million and £205 million per year (up from £40 million).
But, in response to concerns that the new regime would force many IFAs out of business and, as a result, reduce the availability of advice, the FSA points to recent research carried out by Oxera which concludes the impact might be more limited. Even with 25% of intermediary firms considering leaving the market, Oxera predicts that, in the longer term, the gap will be filled by new entrants and existing players.
As for whether consumers will be willing or able to pay for investment advice, the FSA appears to take the view that this is something consumers will simply have to get used to.
“Today’s new rules are designed to boost confidence and trust in the retail investment market by removing commission bias, actual or perceived, and exploding the myth that investment advice is free," FSA director Sheila Nicoll said on 26th March 2010.
"It is vital that consumers know not only the cost of financial advice, but also its value. There is a need to reconnect the adviser and client, where one pays for the services of another, and without the distraction of commission. Only then can consumers have real confidence and trust in the advice they are receiving.”
Contact: Bruno Geiringer (email@example.com / 020 7418 7306)