It has, after all, been over five years in the making, having started with a speech by the then chairman of the FSA, Sir Callum McCarthy, in September 2006. Since then there have been numerous consultation papers and one could be forgiven for not completely understanding what the final rules are.
Although this is a UK-focused initiative, financial advisers worldwide are likely to feel the ramifications, as many other regulators are watching the changes carefully and contemplating their own version. Clients with a UK connection will almost certainly be directly impacted in some way, whether through existing products or a change in their understanding and expectations of financial products and advice.
The RDR is a key part of the FSA’s consumer protection strategy. It aims to establish a resilient, effective and attractive retail investment market that consumers can trust, at a time when they need help and advice more than ever, with their retirement and investment planning.
The RDR aims to ensure consumers;
- are offered a transparent and fair charging system for the advice they receive
- are clear about the service they receive
- receive advice from highly respected professionals.
To achieve this, the FSA has published new rules that will require;
- advisory firms to explicitly disclose and separately charge clients for their services
- advisory firms to describe their services clearly as either independent or restricted
- individual advisers to adhere to consistent professional standards, including a code of ethics.
It should be noted however, that the European Commission is looking at the regulation of Packaged Retail Investment Products (PRIPs), with a view to harmonising disclosure and sales practices across the EU and this may yet have an impact on the proposed RDR rules.
The changes will come into effect on 31 December 2012 and will apply to all advisers in the retail investment market, regardless of the type of firm they work for (banks, product providers, independent financial advisers, wealth managers or stockbrokers).
‘Retail investment product’ is defined as;
(a) a life policy; or
(b) a unit; or
(c) a stakeholder pension scheme; or
(d) a personal pension scheme; or
(e) an interest in an investment trust savings scheme; or
(f ) a security in an investment trust; or
(g) 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 a financial asset;
(h) a structured capital-at-risk product.
The definition of ‘retail investment product’ is intentionally broad, to ensure that all comparable investment products sold to retail clients on an advised basis, including those developed in the future, are subject to the same relevant selling standards.
Pure protection products do not currently lie within the scope of the RDR.
Higher professional standards
The minimum qualification requirement for advisers will be QCA level 4. Grandfathering rights will not be allowed – a grandfather clause would have allowed people who are already authorised to continue providing advice without meeting the new requirements.
In the future advisers may well need to hold even higher qualifications, and the FSA has acknowledged it will be looking at how the minimum standard can be increased to QCA level 6 – the equivalent of a degree.
According to the RDR’s current rules, advisers will need to hold;
- a Statement of Professional Standing (SPS) issued by a body accredited by the FSA and
- an appropriate qualification and complete gap-fill where required.
The FSA and the body that issues their SPS will regularly hold advisers to account for these new requirements.
This has led to many commentators predicting a large reduction in the number of advisers practising in the UK, as a result of retiring early, not meeting the required criteria or moving to countries where regulations are not so onerous.
The FSA now proposes a new advice landscape:
- Independent advice
- Restricted advice, allowing both
– Single / multi-tied advice and/or
– A simplified advice process
- Basic advice
- Non-advised services (including execution only).
Independent advice is defined as “a personal recommendation to a retail client in relation to a retail investment product where the personal recommendation provided” is;
(a) based on a comprehensive and fair analysis of the relevant market and
(b) unbiased and unrestricted.
Firms that specialise in a narrow and distinct field, such as ethical investing, may still provide independent advice, provided the whole of that market is considered. Independent firms may continue to use panels but these should be broad and regularly and comprehensively reviewed, to ensure that customers are not materially disadvantaged.
Restricted advice includes all forms of advice which does not meet the ‘independence test’. Restricted advice must meet the same suitability, adviser charging and professional standards as independent advice. The key difference is the requirement to disclose the nature of the restriction.
Simplified advice, a form of restricted advice, is not defined but describes a streamlined advice process, typically automated, which aims to address the straightforward needs of customers.
Basic advice covers a narrow product range of stakeholder-style investment and savings. The qualification requirements are lower, as are remuneration restrictions.
One of the most significant changes initiated by the RDR is that product providers will no longer be able to pay initial or trail commission on new products. Instead, advisers will need to set their own charges in agreement with their customers; these levels will not be restricted or monitored by the product provider. However, product providers must obtain and validate clients’ instructions on adviser charges deducted from products. Also, post RDR, advisers "can only charge ongoing fees for an ongoing service”.
Product providers may offer facilities for the adviser charge to be deducted from the investment. However, the deductions must be matched by corresponding payments to the adviser firm and providers will not be able to advance finance to advisers out of their own funds (known as ‘factoring’). This applies to both single and regular premiums and effectively ends indemnified initial commission options.
Firms will be required to provide clear, concise disclosure documents that help customers to understand the services being provided and to recognise the cost and value of advice. Customers must receive information that outlines the cost of advice separately from the cost of the product (sometimes referred to as ‘factory gate pricing’).
The principles of adviser charging also extend to instances where an adviser recommends that a customer uses the services of a discretionary manager, in which case the adviser is banned from taking commission from the discretionary manager. Similarly, advisers should not receive any other income from other sources, including distributor influenced funds.
Adviser charging will not apply to advice relating to business sold before 1 January 2013, so product providers will be able to continue paying ongoing trail commission on ‘legacy business’. However, personal recommendations made after 2012 must be paid for by adviser charges, so advised top-ups and increases, post RDR will no longer be able to generate initial commission or additional trail commission.
Trail commission can continue unchanged on legacy business where no advice is sought or where advice results in;
- no change to the product
- a reduction in the investment amount or regular payments
- a change between income and accumulation units
- a switch within a life policy.
There is a ban on negative charges for post-RDR products, effectively capping allocation rates to 100% before deduction of adviser charges.
For UK-based product providers, adviser charging deductions will not be an allowable expense, as is currently the case with commission.
This is one area where everyone is still awaiting final rules. The topic has largely revolved around the FSA’s desire for transparency on platform charges, with its preference being for any fund rebates to be re-credited to the client’s policy as additional fund units in the same funds – not as cash payments. However, the FSA has not reached a conclusion and it may yet transpire that, either as a result of market pressure or regulatory requirements, product providers have to treat fund rebates the same way platforms treat them.
Some fund managers have already taken action in advance of this clarification and started to launch rebate-free share classes so that, whatever the outcome, they already have a solution.
Despite the stated aims of RDR, there is growing concern in the UK that it may push clients away from taking professional advice – either because there are fewer advisers offering it, or because they do not value advice enough to pay an upfront fee for it.
This is a high-level overview of RDR and more detail can be found on the FSA’s website at www.fsa.gov.uk/rdr
Phil Oxenham is marketing manager at Skandia International