The menu of fees and commissions
45. Commission arrangements vary from product to
product and with the scale of the investment an individual is
making, but IFAs currently have three main sources of commission
income. One is "initial commission", which the Investment
Management Association told us had settled at an "industry
de facto standard"[127]
of 3%. The second element is "renewal commission", which
is a commission paid on regular premiums; the AIFA told us this
was typically in the range of 1.5% to 2.5%.[128]
The third element is "trail commission", which is paid
on the total fund value and, the AIFA told us, was typically in
the range of 0.5% to 1.5% per year.[129]
Over time these charges can amount to a considerable percentage
of the saver's original capital investment. Recent press articles[130]
have highlighted that the mixture of initial commission and trail
or renewal commission can result in clients paying many of thousands
of pounds in commission over the life time of a long-term savings
product, payments which can represent as much as 18% of the client's
total contributions over 20 years. The chief executives of the
major companies were unable to confirm these figures for us when
we asked them[131]
although the Investment Management Association did confirm that
over 10 years a client could see at least 8% of contributions
accounted for by commission payments on some products.[132]
Mr Cazalet of Cazalet Consulting told us that the result is that
the total cost to the industry each year of "procuring new
business, commission and other expenses, was about £7 billion,
which is roughly about £330 per household."[133]
46. In view of the potential scale of the commission
charges, it is important that clients are made fully aware of
them and any alternatives. The main alternative is the payment
of a direct fee by the saver to the IFA for the advice received.
Several industry witnesses, like Mr Bloomer of Prudential, pointed
out that survey evidence suggested that consumers had "a
concern about paying fees"[134]
and therefore if presented with an option would typically prefer
to pay commission. To make an informed choice, however, consumers
must have a clear idea of how much they might pay in fees relative
to how much they might pay on the same product in commission.
The FSA already has major reforms in train here as part of its
reforms aimed at depolarising the investment advice market. The
introduction of regulation in 1988 saw a 'polar' regime initiated
for financial advisers. They had to be either independent and
without contractual tie to any provider; or tied and advising
solely on the products of one provider. The FSA, in response to
an OFT finding that this was anti-competitive, is now abandoning
polarisation and as part of the proposed depolarisation reforms[135]
IFAs will be required to make much fuller disclosure of their
commissions, via a so-called "menu", and give the client
the option of paying a fee. The Chief Executive of the FSA told
us "The whole idea of our new menu system is to make it much
clearer to the customer the options they have and how they pay
for the service they are acquiring."[136]
47. The Committee heard evidence, nevertheless,
of continuing doubts about how effective the menu approach will
be in making savers fully aware of the full costs in terms of
initial and trail commission that they may end up paying for a
long-term savings product. Mr Prosser of Legal & General thought
the menu looked "quite a complicated document" and the
draft menu document provided by the ABI and examined by the Committee
used industry jargon in identifying various products (such as
"whole of life assurance" and "income drawdown
plan"). Ms Farnish, Chief Executive of the National Association
of Pension Funds pointed out "even the talk of 'units' is
mystifying to many consumers."[137]
The FSA appear to accept that the menu document is not necessarily
readily understandable to the average saver. Mr Tiner told us
"the menu goes with advice, so the adviser will need to talk
to that customer about what 'whole of life insurance' means."[138]
This seems to fall some way short of the goal of allowing fully
informed consumers to choose for themselves between paying fees
and commission. In addition, the Committee notes that the FSA's
own research into the proposed menu noted various factors in the
presentation of the various options that "combined to make
the fee option less attractive when the document was read without
the support of an adviser."[139]
In spite of this, Mr Tiner told us he thought "over time
the menu may act as an encouragement to more people to pay a fee
for truly independent advice."[140]
48. The Association of Private Client Investment
Managers and Stockbrokers (APCIMS) wrote in their submission to
our inquiry that "hiding the cost of advice in commission
distorts the market and leads to commercial drivers and business
structures that have led to some adverse consequences for savers.
Our preference is for advice to be charged openly."[141]
We note that the current FSA proposals on depolarisation and the
menu of commissions and charges represent what the AIFA described
on their website as a "U-turn"[142]
relative to the FSA's original proposal which would have constituted
much more radical reform. Full and open disclosure of fees
and commissions in a manner that is readily comprehensible to
savers and gives them a balanced view of the various options is
a vital part of delivering an efficient market in financial advice
and long-term savings products. The current proposals from the
FSA fall short of this goal in several key respects. There should
be no suspicion that an adviser might be able to steer a client
towards paying commission that might add substantially to the
client's advice bill, to the detriment not only of the client
but also the more efficient and fairer operators in the advice
market. It should be a basic requirement that each client should
be given an explicit comparison of the total cost, in cash terms,
of buying a product on a fee basis and the total cost on a commission
basis over the likely life of the product.
49. The Committee asked the FSA what would happen
to the trail commission payable on many products if the client
opted to pay a fee under the new menu proposals. We were told
that this was subject to negotiation between the IFA and the client[143],
but that the trail commission was intended to pay for on-going
advice to the client regarding the product. In the course of our
inquiry into endowment mortgages, however, it became clear that
there are many savers who over time sever their relationship with
an IFA and there are equally many IFAs that go out of business
over time. It would clearly be inequitable for the client to continue
to have to bear the cost of trail commission in such circumstances.
The Financial Secretary told us that she could not "justify
that for a minute"[144]
and the FSA agreed that savers would find it "a little strange"[145]
that they were still being charged trail commission if they no
longer had any relationship with the IFA receiving the commission.
50. For IFAs to receive trail commission whether
or not they are providing any real on-going advice to the client
is unacceptable. The persistence of this practice is a clear sign
that the market for financial advice is not working in the best
interests of consumers. The Committee urges the major product
providers, IFAs and the regulator to limit urgently the basis
on which trail commissions are paid in the financial services
industry and to ensure that such payments only occur when the
client is actually receiving the annual advice that such commissions
are supposed to fund. Clients opting to pay for financial
advice via fees should be given the explicit option of paying
an annual fee for any on-going advice they receive rather than
having trail commission paid from their investment.
51. Several witnesses told us that the role of IFAs
and their commitment to providing dispassionate advice to the
client, the saver, would become more transparent if they were
paid on a fee basis rather than by commission paid, in the first
instance, by the product providers. Mr Sandler told us that he
had recommended that "the use of the terms 'independent'
and 'adviser' be limited to those who established with the consumer
at the outset that the consumer would be paying fees."[146]
The Chief Executive of Prudential told us that while he would
rather see advisers paid on a fee basis, any major shift in this
direction "would leave a big cash-flow problem for [IFAs]".[147]
The product providers have already taken some action to offset
the cash-flow impact on IFAs of reforms in the commission system.
The Chief Executive of Aviva told us that the product providers
were increasingly offering level charge products, which charged
the customer no initial commission. Instead this was paid to the
IFA by the product provider who then recovered the cost by charging
the saver slightly more over a period of years. He pointed out
that this gave product providers "a very strong and obvious
and direct interest in the quality and the persistency" of
any new business.[148]
Even so, Mr McCarthy, Chairman of the FSA, indicated that reforming
the current IFA-led, commission-dominated distribution system
within the long-term savings industry was an area in which the
FSA found it "difficult to make changes very quickly."[149]
The Financial Secretary similarly commented that a "big bang"
approach to reform was unlikely because "IFAs have low capitalisations
generally, [meaning] it is difficult for the IFA market to adjust
quickly to change."[150]
The AIFA's submission acknowledged that the "most frequently
heard criticism about commission is that it is an opaque means
of remuneration", before going on to argue that the proposed
menu "removes that opacity."[151]
52. The Committee acknowledges the need for a
measured approach towards reform of the financial advice market.
Even so, given the potential failings we have identified in the
proposed menu approach to reform, we ask the FSA and the industry
to collect and publish regular data on the relative cost of buying
major products on a fee and commission basis and the percentage
of savers opting to pay via fees or commission.
Self-regulation of IFAs and others
in the industry
53. We noted earlier that consumer groups had given
us reassuring evidence about the quality of the service generally
provided by IFAs and that this was underpinned by statistical
evidence suggesting that IFAs have a better than average persistency
rate for the products they sell. Even so, given the generally
poor level of consumer trust there is little room for complacency
and a minority of IFAs has engaged in practices which risk tarnishing
the public reputation of the majority. We were surprised to hear
that the AIFA, an organisation that represents 70% of IFAs,[152]
currently has no code of ethics for its members,[153]
an omission which surprised the chief executives of several of
the major product providers too.[154]
The AIFA told us this reflected the fact that "we are in
a regulated market where, in effect, the FSA imposes various standards."[155]
Subsequent to our evidence session, the AIFA wrote to the Committee
informing us that the Association's Council had considered the
question of whether the AIFA should have a code of ethics but
still believed "that it would not be appropriate for the
Association to introduce any formal code as part of its membership
requirements."[156]
We asked the major product producers the extent to which they
enforced standards within the IFAs selling their products. Mr
Harvey of Aviva told us "80% of that job is done through
the [regulatory] process" and the FSA.[157]
54. The British Bankers' Association (BBA) have a
voluntary code, the Banking Code, which they described to the
Committee as their "flagship product".[158]
It is reviewed every two years by an independent reviewer after
consultation with consumer groups, government and the industry
and the BBA told us the it allowed the industry to react "quickly
and flexibly to difficulties in a way that Government regulation
rarely can."[159]
They us told us that in a Treasury sponsored review of the code
its chairman, Ms DeAnne Julius (at that time a member of the Monetary
Policy Committee), had described this as "an exemplar of
self regulation".[160]
The ABI has more recently also introduced a voluntary code entitled
"Raising Standards" and they told us "among the
key benefits of voluntary regulation are the ability to enhance
value for money for the customer and a proven ability to adapt
quickly and flexibly to potential problems. This in turn leads
to better relationships with customers, through enhanced consumer
protection, accessible providers and clear information."[161]
55. The Committee deplores the fact that a major
trade body such as the AIFA has no code of ethics, particularly
given the key role IFAs play in terms of the experience most consumers
have of the long-term savings industry. Across the industry there
is a danger that companies and trade bodies are abrogating their
responsibilities in relying so heavily on the FSA to police and
deliver good standards of behaviour. External regulation
by a body such as the FSA should not be seen as a substitute for
effective self-regulation within the industry via codes which
react quickly and flexibly to problems as they arise. All the
major trade bodies in the long-term savings industry should have
clear codes of practice which take the standards of behaviour
laid down by the FSA as a minimum but aim to improve on the FSA's
requirements in those areas where the industry feels that better
standards will do most to help its customer base. We call on the
Association of Independent Financial Advisers to establish a code
of ethics for its members, to monitor compliance with it and to
establish a means of enforcement for members who do not comply
.
116 Q 1572 Back
117
Q 1668 Back
118
ibid. Back
119
Q 1233 Back
120
Q 1467 Back
121
Q 2116 Back
122
HC 275, Ev 142 para 8.1 Back
123
Q 1325 Back
124
Q 2130 Back
125
Q 1587 Back
126
Q 1695 Back
127
Q 1053 Back
128
HC 71-II, Ev 294 Back
129
HC 71-II, Ev 294 Back
130
Financial Times, 7 February 2004, page 28 ; Sunday Telegraph
7 March 2004, page 19 Back
131
Qq 1677 and 1678 Back
132
Q 1072 Back
133
Q 62 Back
134
Q 1572 Back
135
Published by the FSA in CP 04/3, Reforming Polarisation: A
Menu For Being Open with Consumers, 26 February 2004. Back
136
Q 2001 Back
137
Q 1138 Back
138
Q 2019 Back
139
Polarisation-menu testing research, FSA Consumer Research
Paper 24, February 2004, page 12, para 1.22 Back
140
Q 2016 Back
141
HC 71-II, Ev 297 para 3 Back
142
www.aifa.net/about/default.htm Back
143
Q 2023 Back
144
Q 2123 Back
145
Q 2027 Back
146
Q 288 Back
147
Q 1572 Back
148
Q 1575 Back
149
Q 2000 Back
150
Q 2116 Back
151
HC 275, Ev 51 Back
152
www.aifa.net/about/default.htm Back
153
Q 1274 Back
154
Q 1651 Back
155
Q 1275 Back
156
HC 71-II, Ev 399 Back
157
Q 1585 Back
158
See list of Memoranda placed in the Library of the House and in
the parliamentary Record Office p. 78 (Memorandum by British Bankers'
Association) Back
159
ibid. Back
160
ibid. Back
161
HC 275, Ev 25 para 4.1 Back
