Amid fevered preparations for the March Brexit deadline, somewhere within the corridors of the regulator’s Olympic Park headquarters plans are being quietly drawn up to assess the most significant reforms to retail finance of the past decade: the retail distribution review (RDR).
The Financial Conduct Authority (FCA) has pledged to review the RDR in 2019. The evidence, from practitioners and official data, puts it beyond doubt that the RDR lifted the entire advice market to a more professional footing. It gave advisers greater power over providers while aligning advisers’ interests more closely with their own clients.
But six years on, the FCA must now tackle the same criticism that dogged the RDR when it was launched in 2006 and which has persisted ever since: that it created an advice gap, which has left the less well-off least able to access valuable advice services.
Clients who have enough assets to seek financial advice, however, are receiving a much better service.
‘Ending reliance on initial commissions has meant advisers are in a much more powerful position than in the old world of being product pushers and relying on providers,’ said Bill Vasilieff, chief executive of platform Novia.
This power shift, said Vasilieff (pictured below), has been ‘extremely positive in every respect’ as it has coincided with a ‘sea change’ in advice professionalism.
Despite what many feared at the time, advisers who have embraced the reforms have also been big winners as a result.
Providers and asset managers no longer call the shots in the post-RDR world. And this rising power is also driving up valuations of advice firms, with many developing their own investment arms to capture more margin.
According to a recent Pimfa report, using FCA data, retained profits (after tax and dividends) at advice firms was £230 million in 2017 – a dramatic rise from £100 million in 2012.
Meanwhile revenues are also on the up, with the Pimfa report noting a ‘surprisingly large’ jump in revenues of 22% in 2017.
On the same side
Along with this rising profit and revenue, IFAs are doing much more for their clients than the pre-RDR days of door-knocking salesmen, particularly in light of the pension freedoms.
Heather Hopkins, managing director of platform research company NextWealth, said it used to be the case advisers would sit opposite clients. Now they are sitting on the same side as them and helping them decipher which fund managers and platforms to use.
‘[Advisers] are now not acting in an administrative capacity, fulfilling orders,’ she said. ‘They are now the ones thinking about what is the right mixture of products for the customer based on their needs. They are now in the customer’s corner and I think that is a really positive thing.’
However, Hopkins (pictured above) added the percentage-based charging model is likely to face more scrutiny, because it still looks like a throwback to the commission days.
‘The scepticism I hear is the charging structure looks similar to commission,’ she said. ‘So the asset-based fee has a lot more transparency to the customer but it still does look like commission, because it is based on assets.
‘I think we will continue to see a shift away from asset-based charging towards fee-based charging. Particularly next year I think we will see more people challenge that model because Mifid II reporting will bring increased transparency.’
Closing the gap
The FCA’s 2019 review of RDR will also include an assessment of its financial advice market review (FAMR).
The FAMR was launched under previous FCA interim chief Tracey McDermott. It set out to improve access to advice for the less wealthy, and came hot on the heels of the pension freedoms and the subsequent increase in demand those reforms created.
Published in March 2016, the final FAMR report made a raft of recommendations, 28 in total, on how to overhaul the advice market. One of its headline reforms was to change the definition of ‘advice’ to be based on giving a personal recommendation, hoping more firms would provide the lesser but cheaper option of guidance. It also established a special ’advice unit’ within the FCA to help firms set up robo-advice propositions.
Respondents to the FAMR consultation told the FCA ‘the move from paying for advice via commission to paying adviser fees had contributed to many people not being able to get the advice they want and need at a price they can afford’. The FCA itself stated ‘advice is expensive and is not always cost-effective for consumers, particularly those seeking help in relation to smaller amounts of money or with simpler needs’.
Among the FAMR’s conclusions was that ‘new technologies can play a major role in driving down costs’ and it recommended building ‘a clear framework to give firms confidence to deliver streamlined advice on simple consumer needs in a proportionate way’.
Speaking with New Model Adviser® in October, FCA director of policy, David Geale (pictured above), confirmed the review will include a look at how much consumers are paying for advice since the RDR.
‘We will be looking at the advice market as a whole [in the RDR review]. We will be looking at what has happened since the FAMR and one of the aspects we will be looking at is the cost of advice,’ Geale said.
Pre-RDR advice charges were said to be around 50 basis points (bps) but they have since risen to an average of around 80-90 bps. According to a survey by wrap platform Nucleus, advisers’ average ongoing charges were 80 bps in 2017 – down slightly from the previous two years. A Citywire survey last year found the average charge was 87 bps. Both are clearly above the 50 bps of the pre-RDR days.
If the FCA’s RDR review concludes charges have gone up, how will the regulator react and will it impose any changes?
Abraham Okusanya, director of research consultancy FinalytiQ, said although IFAs have much more control since the RDR, they have not used this to drive down total costs for clients.
‘Advisers have much more power now and are more profitable than they have ever been,’ he said. ‘But the trouble is I don’t think firms are using that power to drive customer outcomes. We are still in a world where the total cost of advice is more than 2% per year and advisers haven’t used that power to drive costs down for investors.’
However, Okusanya (pictured above) does not think the regulator will intervene to force advisers to change their charging structure as it does not have the appetite to force major changes. He added market forces are more likely to result in total advice charges coming down, particularly with the rise of passive investments.
Stephen Girling, managing director of East Anglia-based SG Wealth Management, said although the RDR has dramatically increased advisers’ professionalism, it is now a more expensive product that is not meeting the needs of the whole public.
‘It took the RDR to change a lot of the previous practices, which didn’t have many companies aligned to customer’s best interests,’ he said.
‘The biggest negative has been the reduction in access to financial advice across many parts of the population. I think that was an unintended consequence. Financial advice has now become an expensive commodity and the FCA has not been good at meeting the in-between stage of full-blown advice and guidance. There doesn’t seem to be anything in the middle.’
At the time the RDR was introduced, fears of an adviser exodus, which would exacerbate the advice gap, abounded.
The then Financial Services Authority (FSA) had always sought to pour cold water on claims the RDR would create a significant advice gap. In 2010, FSA chief Hector Sants told MPs on the Treasury Committee: ‘Our estimates indicate it would be more like a 10% to 20% reduction in capacity and we have deemed that to be acceptable, otherwise we would not be doing it.’
But when the FSA handed over to the FCA, the regulator’s new chief executive, Martin Wheatley, revealed to the same committee he was ‘concerned’ that customers with ‘below £50,000 or £100,000’ were not getting an advice service. This was largely, he said, the result of banks pulling out of advice in the run up to the RDR.
However, although adviser numbers have fallen, in recent years there has been a recovery.
According to the Pimfa report, adviser numbers dropped from 26,339 in 2011 to 22,168 in 2013 (15%). However, since then they have risen back up to 26,311 in 2017.
Supply and demand
Although this recent rise is positive news, the problem for the FCA is the public’s demand has risen dramatically in the past few years, particularly because of the pension freedoms, meaning many are not getting the advice they need.
This shortage of advice supply to meet demand became acute as defined benefit (DB) transfer requests soared over the past two years and advisers struggled to keep up with public demand.
In 2017 Mercer estimated £50 billion had been paid to 100,000 members of DB schemes in the two years since the pension freedoms came into force. By the summer of that year, according to a poll by The Lang Cat, one in five advisers said more than a quarter of their business came from transfers.
The supply of advice will also be a key focus for the RDR review.
Anthony Morrow (pictured above), chief executive of digital advice firm OpenMoney, said the advice market ‘doesn’t function’ at the moment for people who don’t have big wealth built up.
To address this advice gap, Morrow said the FCA should use its RDR review to make advice mandatory at certain life stages.
‘If you made it mandatory, that people have to find advice, you would start to see a lot of work going on in the industry,’ he said. ‘If everyone who comes through a provider has to receive advice before they can draw benefits, you will definitely find those providers getting stuck in and creating advice options.
‘There is no incentive for providers to develop any new [advice] services because they are quite happy to keep the 30% of those customers who will do as they are told on a non-advised basis.’
Mandatory advice may seem a radical suggestion. But in the FCA’s pivotal RDR review, radical suggestions will be needed to address the public’s need for advice.