Supplementary Written evidence submitted
by the Association of Independent Financial Advisers
Following AIFA's oral evidence session to the
Treasury Committee on 12 October, I am pleased to enclose further
Written evidence addressing the issues raised by your members.
In addition, I believe it is appropriate to
cover two areas.
Firstly, the assertion that the AIFA comments
might be muted by "the long shadow of the FSA". In operating
as a core part of the consultation process employed by the FSA
to agree new regulation, AIFA has always adopted an approach of
trying to achieve consensus, work to develop win/win solutions
and be clear about the risk and outcome desired. In doing this
we have found that a consultative approach based on listening
,understanding and providing positive feedback and engagement
has worked best. When we have disengaged, become confrontational
and "shouted" we have rarely won the hearts and minds
of the FSA decision makers, as we have no "power".
It is this desire to work with and collaborate,
as we should have the common agenda of delivering better consumer
outcomes, that restricts our desire and ability to criticise.
As we work closely together with the FSA on a range of issues
it risks being "personal". Hopefully the direct answers
on both the RDR fiasco and grandfathering indicate that we are
not afraid to state our case, but careful in our language to avoid
offence. We work within the shadow as they have the ultimate decision
making ability, without the trade bodies having any right of appeal.
Indeed in the area of grand-fathering the ultimate
authority vests not even with the FSA, but with the awarding bodies.
These are entities such as CII or IfS who undertake the examinations
and agree the "Continuous Professional Development"
schemes and "gap-fill" rules. It is their failure to
have operated satisfactory CPD schemes for those with historic
qualifications that brings us to the world today. That we cannot
just apply new exam standards to new entrants and are able to
evidence that existing advisers are at the right standard. It
is these awarding bodies choice to enforce examinations and not
adopt a CPD in-fill approach.
Finally, it is important to note that we represent
a broad church, with many of our members believing that competence
should be assessed to level 6, and AIFA was successful in reducing
this to level 4. This was to avoid an even larger loss of available
consumer advice. On the other wing there are those who consider
that they should never be assessed by examination and that their
record as advisers speaks for itself. This is as damaging in our
view, as a base level of demonstrable competence has to be the
foundation of any trade or industry.
I hope you find that our Written evidence addresses
some of the Committee's concerns in more detail.
WRITTEN EVIDENCE
About AIFA
The Association of Independent Financial Advisers
(AIFA) is the representative body for the IFA profession. There
are approximately 16,000 adviser firms that employ 128,000 people,
and turnover is estimated at £6.5 billion (including £4.5
billion from life policies, £1 billion from fund management
and £1 billion from mortgages and general insurance). Around
20% of the UK population regularly use an IFA, with c45% consulting
one from time to time.
Membership is voluntary and on a corporate basis.
IFAs currently account for around 70% of all financial services
transactions in the UK (measured by value). As such, IFAs represent
a leading force in the maintenance of a competitive and dynamic
retail financial services market.
About IFAs
In every year for the last five, consumer trust
and confidence in the IFA profession has grown. Research by Nottingham
University shows that IFAs are the most trusted part of retail
financial services (by a considerable margin) and that, in the
midst of the banking crisis demand for independent advice increased—and
the level of confidence in IFAs increased.
IFAs are regularly cited as offering low-cost
barriers to entry into new markets, and the European Commission
last year commented positively on the role of intermediaries as
a force for driving competition (to the advantage of consumers)
in financial services.
The UK has experienced the worst banking crisis
in a century. The financial services industry has emerged with
a tarred reputation from this period: yet no IFA firm posed a
systemic risk, or contributed to the failures in this turmoil.
IFAs will be regulated by the CPMA under the
proposed structure. However, clearly the decisions made by the
FPC will impact IFAs, and a number of IFA firms in AIFA's membership
are part of a wider banking, insurance or mutual group and therefore
will form part of a group regulated by the PRA. In our response
we have focused predominantly on the CPMA, as this is the area
with most interaction with members and consumers, but we have
also addressed the necessary interaction between the three regulatory
bodies.
1. EXECUTIVE
SUMMARY
Regulatory intervention has become the hallmark
of the retail financial services market given the significant
importance it has to individuals. However while AIFA welcomes
the need for regulation as a means of making the market safer
for consumers, we are also adamant that it must improve its effectiveness,
and make absolutely clear its purpose. Constant regulatory flux
deters financial investment in firms and weakens consumer trust
in the sector. In some cases the implementation of the regulatory
system actually threatens to undermine the existence of the market
as a viable entity, restricting the ability of consumers to obtain
the products and services that they need.
For the future, we have therefore identified
six high-level principles that we believe should apply to the
governance of regulation.
First and foremost we believe regulation must
enable better outcomes for more consumers. This means regulation
must not only protect consumers from unscrupulous market participants,
but also facilitate more access to advice for consumers, particularly
at this stage in the economic cycle. But there is evidence to
suggest that in recent years, UK regulatory practice has failed
the consumer in a number of ways. The number of people saving
has fallen dramatically, the cost of advice has risen, consumer
confidence and trust have been damaged, and many of FSA's efforts
to promote public awareness through information and disclosure
overload have been ineffective.
The new regulator therefore needs to address
the wider public policy agenda in order to help consumers re-engage
with their long term financial well-being and making more, and
better, provision for themselves. This should involve closing
the savings and protection gap as a statutory objective of the
CPMA. We also need to see consumers take on increased responsibility
for their own financial future, as this will ultimately help yield
the optimum outcomes for them.
However there is little evidence that the majority
of consumers—even sophisticated consumers—wish to
be educated about the intricacies of financial products and services.
On the other hand there is a lot of anecdotal evidence that people
want help in dealing with their financial issues which is why
financial advice has emerged over the last few decades as an important
component of the market. The CPMA must therefore act in a way
which increases consumer access to real advice, rather than limit
the supply of it through excessive regulatory burdens.
Secondly, we believe it is essential that regulation
has the appropriate checks and balances in place to ensure accountability.
In the past the system of accountability for the regulator has
relied too heavily on internal self-assessment, with the result
that there were no effective checks and balances in places. Any
future regulator should therefore be held far more tightly accountable
to the delivery of their objectives in the most efficient and
cost-effective way. We believe that the necessary degree of rigour
can only be achieved by an independent body, external to the regulator.
This principle is derived from the single most
important lesson learned from the history of regulation. There
is no reason to believe that initial objectives, no matter how
well-intentioned and well-articulated, will be achieved when a
new system is established—unless there is a rigorous process
in place to keep it aligned to those objectives.
We therefore see a greater role for the National
Audit Office (NAO) and Public Accounts Committee in reviewing
the new regulatory structures, the continuation of the Regulatory
Decisions Committee (RDC), the continuation and strengthening
of the three "consultative panels" including new statutory
footing for the Small Business Practitioner Panel as well as a
wider role for the Treasury Select Committee.
Thirdly, we believe regulation must work in
a proportionate and risk based way, focusing on those aspects
of the financial services industry that pose the greatest risk.However
this has certainly not been the case under the FSA who, in order
to avoid criticism, have tended to pursue actions they viewed
as bomb-proof, and cascaded them to adjacent markets. The result
of this approach has been that IFA firms, who pose no systemic
risk to the economy, and are working in the best interests of
their clients, have been at the receiving end of FSA's intrusive
supervision to a far greater extent than large banking institutions
at the other end of the "risk" scale.
In fact it is our view that well-managed firms,
which treat their customers fairly, should be given regulatory
incentives for doing so, in order to incite positive behaviour.
It would be these good firms that would benefit from regulatory
change. Regulatory dividends, whether based on fees, capital requirements
or supervision, would provide a clear demonstration of a regulator
that wishes to work with the sector to bring about consumer benefit—and
this would be welcomed by all participants.
Fourthly, we believe regulation must change
less, with fewer "new ideas" and more consistency of
delivery. Although the history of regulation under FSA has been
relatively short, there have already been a considerable number
of waves of different requirements with the result that a degree
of regulatory fatigue has set in. The costs of coping with FSA
regulation keep rising, and the combined effect of this and fatigue
is to drive members of the market out—to the detriment of
consumers.
Our members also report that the messages they
receive from different parts of the regulator are inconsistent.
The Policy division is often seen as open, receptive and understanding
about the real issues of operating in the marketplace, while Supervisors
are left to stick to the rules in their own way. Enforcement,
while necessary, can become unnecessarily and excessively aggressive
in an environment where the regulator is investigator, judge and
jury.
At this stage a radical change of direction,
or complete rewrite of the rulebook, would be both unwelcome and
counterproductive. However we do believe that there is considerable
scope for improvement in how regulation is implemented.
Looking forward to the new regulatory structure
it is essential there is close and continuous co-operation between
the newly formed statutory bodies to ensure consistency of delivery.
Each of these bodies should formally benefit from each other's
objectives as specified secondary objectives, with the establishment
of a college of supervisors to ensure cross-body cooperation,
coordination and control.
There also needs be a higher standard of staff
across the system as well as far more joined up working from the
policy, supervision and enforcement teams. Remuneration also has
a role to play here, and we recommend any financial rewards for
staff should be based on long-term outcomes, just as has been
proposed for the financial services industry which they regulate.
Fifthly, it is essential that the regulator
use its resources in the most cost effective and economic way,
in order to deliver the best possible value for money for both
the industry and ultimately consumers. By definition, consumers
will not be able to obtain the products and services they need
if the provision of those services is eliminated or made expensive
by the actions of the regulators. Yet that is exactly what has
been happening under FSA.
IFA firms bear a disproportionate brunt of the
rising fees, especially considering they pose little or no systemic
risk to the economy, are the lowest causes of complaints to the
Financial Ombudsman service, and are consistently found to be
the most trusted part of the financial services sector. It is
also worth pointing out that the true cost of regulation to all
of these firms currently increases with experience—the lack
of a long stop for the industry means that businesses, especially
the smaller ones, have the burden of making provision within their
accounts for the increasing risk of complaints as well as the
proposed increases to Capital-adequacy provisions.
In order to ensure cost effectiveness there
must always be an identifiable market failure, and a cost/benefit
analysis undertaken, before regulatory action is considered. We
also believe CPMA's policy in setting fees should be risk-based,
and use the tools at their disposal to reward firms that invest
in their business and its people.
The sixth and final high-level principle is
that regulation must take fully into account the European dynamic
at play. Increasing amounts of financial regulation are now emanating
from Europe, and it is therefore crucial that the UK is best placed
to achieve positive engagement on the continent in the coming
years and ensure we remain a leading player, for the benefit of
consumers. We also feel there is potentially much to be lost at
a European level in the near future, as highlighted by Sharon
Bowles' recent letter to Vince Cable, further highlighting the
need for UK regulators to be fully cognisant of the European dynamic
at play in the market.
These six principles run the risk of looking
so obvious that they could easily be dismissed out of hand. But
the point is that no matter how the principles are espoused: in
practice, they have not been delivered—and that is what
needs to be fixed by the new regulatory structure. The success
or failure of regulation in the future needs to be capable of
being measured against these yardsticks.
2. INTRODUCTION
AIFA clearly recognises the important role that
regulation plays in making the retail financial services market
a safer place for consumers, and a place in which they can have
trust and confidence. We are therefore fully in favour of cost
effective, proportionate regulation which builds on that which
already works.
To achieve this, AIFA welcomes the current debate
on the purpose of regulation, and hopes that a revised regulatory
structure, and the supervision within that structure, will result
in better consumer outcomes.
We believe the opportunity to develop a regulatory
regime, which facilitates the provision of independent, impartial
advice to consumers, is vital. The need for access to advice is
currently magnified by the increased need for people to save for
a longer retirement, against a background of decline in company
pensions—and state benefits that are becoming less and less
affordable.
At a time where consumer responsibility and
the need for self-provision are so high on the political agenda,
AIFA therefore feels it is appropriate that the overriding purpose
of regulation is to encourage better access to more consumers,
thus leading to better outcomes.
With a new government which intends to reform
and improve financial regulation in the UK, this is a good opportunity
to step back and ask some key questions:
— How can regulation most effectively promote
and protect the interests of consumers?
— Knowing what we know now, how do we need
to adjust the way that regulation works so that it has the best
chance of meeting this objective?
In this paper we intend to propose the high
level principles that are essential for good regulation, how FSA
has failed in these principles in the past, and how they should
best work with the newly proposed structure.
3. HIGH LEVEL
PRINCIPLES OF
GOOD REGULATION
While AIFA welcomes the need for regulation,
we also strongly believe that it must improve its effectiveness,
and make absolutely clear its purpose. Constant regulatory flux
deters financial investment in firms and weakens consumer trust
in the sector. In some cases the implementation of the regulatory
system actually threatens to undermine the existence of the market
as a viable entity, restricting the ability of consumers to obtain
the products and services that they need.
For the future, we have therefore identified
six high-level principles that we believe should apply to the
governance of regulation.
(a) Enables better outcomes for more consumers.
(b) Has the appropriate checks and balances in
place to ensure accountability.
(c) Works in a proportionate and risk-based way.
(d) Changes less, with fewer "new ideas"
and more consistency of delivery.
(f) Takes into account the European dynamic at
play.
These principles run the risk of looking so
obvious that they could easily be dismissed out of hand.
But the point is that no matter how the principles
are espoused: in practice, they have not been delivered—and
that is what needs to be fixed by the new regulatory structure.
In the absence of a strong and independent sanity check, all organisations
tend towards self-preservation and self-justification, irrespective
of the motivations of their founders. Regulation as operated by
FSA is no different.
So the significance of these principles is that
they need to be delivered. The success or failure of regulation
in the future needs to be capable of being measured against these
yardsticks.
(a) Regulation must enable better outcomes
for more consumers
We believe in duality of regulation when it
comes to consumers—not only must it protect them from unscrupulous
market participants, but regulation must also facilitate more
access to advice for consumers, particularly at this stage in
the economic cycle.
But there is evidence to suggest that in recent
years, UK regulatory practice has failed the consumer in a number
of ways.
— It is has resulted in the number of people
saving and investing to improve their financial future falling
dramatically—complexity and rising regulatory costs under
FSA have increased barriers to the supply of savings products.
Meanwhile it has been far easier for consumers to obtain debt,
due to relatively lax legislation in this area. Regulation has
also increased the cost of advice, meaning large numbers of mid
and low earners are effectively excluded from financial advice,
since its provision has become uneconomic—without this advice
people are more prone to get into debt than they are to save for
their future.
— It has damaged consumer confidence in
the financial system—since inception FSA has seen its primary
role transform into "stopping bad things happening",
which has had unhelpful consequences for the market. When working
primarily from a definition of "bad", "good"
has tended not to get promoted. FSA's public pronouncements have
also tended to be about what's bad in the market: regulatory interventions,
fines, criminal prosecutions—and even speeches (the infamous
"be very afraid" speech by Hector Sants). By the time
a consumer actually engages in the financial services market,
all the procedures that have to be gone through, including large
amounts of mandatory documentation, communicates one clear and
consistent message: "this is a dangerous market". So
although the purpose is to protect the consumer, the overriding
focus on bad practice has given consumers a distorted impression
of the market and reduced their confidence.
— Many of its efforts to promote public
awareness have been ineffective—FSA's awareness objective
was somehow converted into an overall drive towards giving consumers
as much information as possible through lengthy disclosure documents.
However there is little evidence that the majority of consumers—even
sophisticated consumers—wish to be educated about the intricacies
of financial products and services. And the actual effect of information
overload is to produce less transparency and lower awareness because
the consumer simply doesn't read it. Indeed FSA's own research
into Financial Capability entitled "A Behavioural Economics
Perspective" confirms that attempts to improve knowledge
may not necessarily lead to better outcomes and "what people
choose to know and what they do with their knowledge may primarily
depend on their intrinsic psychological attributes". Consumers
can therefore be given all the financial information in the world
but if they do not trust the information or the person giving
it to them, then the information is ultimately pointless. Hence
whilst information is an important building block, "advice"
is the essential "ingredient X" that makes all the difference.
Because the information is delivered by a trusted source, the
IFA, people have confidence to act on it. That is why financial
advice has emerged over the last few decades as an important component
of the market and as a useful behavioural "nudge" to
push consumers in the right financial direction.
The new landscape
Given the current state of the UK market, the
new regulator needs to address the wider public policy agenda
in order to help consumers re-engage with their long term financial
well-being and making more, and better, provision for themselves.
We need to see the next decade become focused
on the "enfranchisement of savings" and a return to
thrift and prudence—but regulation has a role to play in
facilitating this journey. We also need to see consumers take
on increased responsibility for their own financial future, as
this will ultimately help yield the optimum outcomes for them.
We call for:
— CPMA to address the wider public policy
agenda in terms of helping consumers re-engage with their long
term financial well-being and making more, and better, provision
for themselves.
— an additional statutory objective for
the CPMA of restoring a savings culture to the UK.
— consumers to take on increased responsibility
for their own financial future, as this will ultimately help yield
the optimum outcomes for them.
— CPMA to increase access to financial
advice for consumers.
— the new regime to make absolutely clear
to consumers whether they are receiving truly independent advice
or merely being sold a product.
— the introduction of a 15 year long stop
to bring financial services into line with the Statute of Limitations.
(b) Regulation must have appropriate
checks and balances in place to ensure accountability
In the past the system of accountability for
the regulator has relied too heavily on internal self-assessment,
with the result that there were no effective checks and balances
in places.
Any future regulator should therefore be held
far more tightly accountable to the delivery of their objectives
in the most efficient and cost-effective way. We believe that
the necessary degree of rigour can only be achieved by an independent
body, external to the regulator.
This principle is derived from the single most
important lesson learned from the history of regulation. There
is no reason to believe that initial objectives, no matter how
well-intentioned and well-articulated, will be achieved when a
new system is established—unless there is a rigorous process
in place to keep it aligned to those objectives.
There must also be a relationship of "legitimate
expectation" between the regulator and regulated—this
is when the principles of fairness and reasonableness are applied
where a regulated firm has an expectation or interest in the regulator
retaining a long-standing practice or keeping a promise.
Payment Protection Insurance (PPI) is a case
in point. Whilst there is a clear an demonstrable issue from the
consumer perspective, the regulator has not performed well as
they have been retrospectively influenced by the actions of the
Competition Commission and the Financial Ombudsman Service. Whilst
issues surrounding PPI were well-known to everyone in the market,
including the FSA, we saw little direct action taken. For the
FSA to later turn around and attempt to retrospectively punish
firms for carrying out the regulated activity which the FSA had
itself permitted, reviewed and in some cases approved, is a breach
of this legitimate expectation.
Further, when it comes to Judicial Reviews,
we believe it should be the Treasury that bears the cost of action
rather than forcing the industry to effectively pay twice, when
they may well have a legitimate case against the regulator.
The new landscape
We call for:
— any future regulator to be held far more
tightly accountable to the delivery of their objectives in the
most efficient and cost-effective way;
— a greater role for the National Audit
Office (NAO) and Public Accounts Committee in reviewing the new
regulatory structures;
— a wider role for the Treasury Select
Committee to play in scrutinising the entire regulatory architecture;
— the continuation and strengthening of
the role and powers of the three "consultative panels"
including new statutory footing for the Small Business Practitioner
Panel. Also deeper engagement from the panels with the industry
to ensure they fully understand the effects of the regulator's
policies on the industry and in turn, consumers;
— a role for a "consumer champion",
that is separate from the CPMA. We believe there may be merit
in considering the DG SANCO approach, the consumer directorate
in the EU;
— the continuation of the Regulatory Decisions
Committee (RDC) in the new structure;
— the publication of Board minutes as a
means of deepening accountability and transparency;
— the further proposed mechanisms to be
set out in statute, notably:
— a requirement to produce an annual report
to be laid before Parliament by the Treasury;
— a requirement to hold annual public meetings;
— a duty to establish consultative panels;
— a duty to maintain a complaints mechanism
similar to that required of FSA; and
— decisions to be subject to appeals in
the Upper Tribunal, and where appropriate reviews and inquiries.
(c) Regulation must be proportionate
and risk-based
Regulation must be proportionate as well as
focused on those aspects of the financial services industry that
pose the greatest risk to the economy.
However this has certainly not been the case
under the FSA who, in order to avoid criticism, have tended to
pursue actions in recent years that appear to be "bomb-proof".
But this is a classic case of the "perfect" being the
enemy of the "good". In its pursuit of "perfect"
regulation over "good" regulation, it has actually had
the detrimental effect of limiting access to financial services
products when in fact the absence of them is much more likely
to generate hardship.
The result of FSA's approach has been that IFA
firms, who pose no systemic risk to the economy, and are working
in the best interests of their clients, have been at the receiving
end of FSA's intrusive supervision to a far greater extent than
large banking institutions at the other end of the "risk"
scale. To put this into context, one of our members, a medium-sized
provider of independent advice, which has never been fined or
sanctioned by the regulator in any way, was the recipient of three
intrusive and formal "ARROW" visits by the regulator
over a period of four years. During the same period, immediately
prior to its demise, Northern Rock had none.
This example reflects the way that regulation
is often administered in the market: organisations that are large
and complex require the existence of people within the regulators
who are capable of dealing with them. The majority of the people
who work within the regulator will naturally use their energy
dealing with issues within their comfort zone. While this is human
nature, an undue degree of attention on relatively small firms
is bad regulation and damages the market.
The new landscape
We call for:
— the new regulators to focus on those
aspects of the financial services industry that pose the greatest
risk—a continuation of the "follow the money"
approach being undertaken by FSA at present and not just "point
of sale" regulation, as per FSA's Retail Conduct Strategy;
— regulation to not be applied to adjacent
markets without due consideration being undertaken;
— well-managed firms, which treat their
customers fairly, to be given regulatory incentives for doing
so, and it should be these firms that benefit from regulatory
change; and
— The publication of a "regulatory
dashboard" so firms can be sure of accessing dividends in
their regulatory journey, and making any changes appropriate for
their business.
We propose three types of dividend are adopted
by the CPMA:
— Regulatory fees—the new fee system
should favour firms that have invested in compliance and management
ability and so pose lower regulatory risks to CPMA or their client
base. It is our contention that well run firms that take their
regulatory and corporate responsibilities seriously should attract
regulatory dividends through lower regulatory fees.
— Regulatory capital—we think there
is a prima facie case for the new regulator to tier its regulatory
capital requirements based on a firm's compliance record—and
other behavioural indicators. The information that is currently
collected through firm reporting and within FSA risk profile methodology
should be intelligently used to tier firms' capital requirement.
This would see a tangible reward for better run, lower risk, firms.
— Supervision—intelligent use of
the regulator's data should be deployed to recognise those firms
that pose lower risks than others. This would see low risk firms
subject to less intensive scrutiny.
These are only examples of how the new regulator
could seek to incite positive behaviour. They would provide a
clear demonstration of a regulator that wishes to work with the
sector to bring about consumer benefit—and this would be
welcomed by all participants. We would be happy to assist in developing
this proposal further.
(d) Regulation must change less, with
fewer "new ideas" and more consistency of delivery
For market regulation to be effective, it needs
to meet the following criteria:
— The participants of the market need to
know what is permitted and what is not, so that they can get on
with doing their jobs with confidence;
— Regulation needs to be applied consistently
across the market in order to avoid arbitrage;
— Regulation needs to be applied reasonably
consistently over time; and
— The different parts of the regulatory
structure need to act congruently.
However there is little evidence of such consistency
from the FSA. Although the history of regulation under FSA has
been relatively short, there have already been a considerable
number of waves of different requirements with the result that
a degree of regulatory fatigue has set in. The costs of coping
with FSA regulation keep rising, and the combined effect of this
and fatigue is to drive members of the market out—to the
detriment of consumers.
The full FSA rulebook is a large document written
in language that is difficult to comprehend: as a result there
is a new industry of expensive compliance experts who do their
best to interpret what they think the rules mean. At the same
time the regulators apply principles, most notably "Treating
Customers Fairly", that while sounding perfectly reasonable,
are vague and open-ended. The result is that those being regulated
do not know how to behave, and live in fear of unintentionally
putting a step wrong.
Over time, generations of management at the
FSA have taken different positions, meaning that practical agreements
about how the rules are to be implemented often change when the
management team changes. Our members also report that the messages
they receive from different parts of the regulator—whether
the policy team, supervision team or the enforcement teams—are
often highly inconsistent.
An example of regulatory inconsistency is FSA's
"Make a Real Difference" (MARD) initiative, a £50
million initiative which aimed to improve the effectiveness, skill
and attitude of FSA staff and support the shift to more principles
based regulation. However MARD was effectively abandoned, yet
the industry have been paying for it for at a cost of £5
million a year since 2007, and will continue to pay £5 million
a year for the next seven years, with little or no identifiable
benefit.
The new landscape
At this stage a radical change of direction,
or complete rewrite of the rulebook, would be both unwelcome and
counterproductive. However we do believe that there is considerable
scope for improvement in how regulation is implemented.
Below sets out how we believe the new regulatory
landscape can address the problems outlined above, while ensuring
consistency of delivery in the new regulatory structure.
We call for:
— close and continuous co-operation between
the newly formed statutory bodies and the FPC to ensure consistency
of delivery;
— clear objectives of the individual regulators
which fit logically together. History has shown us that failures
happen when there are gaps in regulatory oversight, when regulators
fail to co-operate or when they fail properly to fulfil their
obligations;
— each of the three regulatory bodies to
formally benefit from each other's objectives as specified secondary
objectives, rather than just as "have regards to";
— a college of supervisors as the best
method for cross-body cooperation, coordination and control;
— a higher standard of staff as well as
more joined up working from the policy, supervision and enforcement
teams; and
— financial rewards for staff based on
long-term outcomes and visible success measures of policy initiatives.
(e) Regulation must be cost effective
It is essential that the regulator use its resources
in the most cost effective and economic way, in order to deliver
the best possible value for money. This value for money must be
both in terms of the industry and ultimately consumers who are
the ones who will end up bearing the cost of increased regulation
through higher product and advice charges.
By definition, consumers will not be able to
obtain the products and services they need if the provision of
those services is eliminated or made expensive by the actions
of the regulators. Yet that is exactly what has been happening
under FSA.
As we have stated previously the complexity
and ever rising regulatory costs under FSA meant the cost of advice
was also forced to rise rapidly, meaning large numbers of mid
and low earners became effectively excluded from accessing independent
financial advice, since its provision became uneconomic.
IFA firms bear a disproportionate brunt of the
rising fees, especially considering they pose little or no systemic
risk to the economy, are the lowest causes of complaints to the
Financial Ombudsman service, and are consistently found to be
the most trusted part of the financial services sector, as evidenced
by the independent annual "trust index", carried out
by the University of Nottingham Business School.
Example of regulatory costs:
Below are just a handful of examples of the
cost burden of regulation faced by IFA firms under FSA's regulatory
regime.
Example one:
A large IFA network puts the cost of regulation
at the equivalent of 20-25% of their turnover.
Example two:
A mid-size IFA firm, made up of 27 advisers,
faced regulatory costs this year of approximately £430,000.
This was made up of the following:
| FSA fees | £ 83,000
|
| Compliance | £196,000 |
| Finance | £ 24,000 |
| MD | £ 17,000 |
| Professional indemnity insurance | £110,000
|
| TOTAL | £430,000 |
This means the average cost per adviser for the year was
almost £16,000.
This overall cost of regulation to the firm is five times
the direct cost of FSA fees—given FSA directly costs the
industry £450 million, it must therefore indirectly cost
the industry in the region of £2.25 billion.
Example 3:
During the financial year 2009-10 one of our sole trader
members spent £1,948.59 on FSA fees and levies, broken down
in the following way:
| Financial Services Authority Periodic Fee |
£ 925.00 |
| Financial Capability Periodic Fee | £ 10.00
|
| Financial Services Compensation Scheme Levy
| £ 978.59 |
| Financial Ombudsman Service Levy | £ 35.00
|
| TOTAL | £1,948.59 |
However he spent £8,772 in cash terms on regulation,
over 4.5 times the direct cost of FSA fees. This is another indication
of how regulatory costs go much wider than just fees.
Example 4:
A mortgage intermediary member put the cost of compliance
alone last year (including people, systems, PI insurance) at £150,000,
which was approximately 7% of their gross revenues. On a per case
basis they calculated this as a cost of about £50 per mortgage
transaction.
It is also worth pointing out that the true cost of regulation
to all of these firms currently increases with experience—the
lack of a long stop for the industry means that businesses, especially
the smaller ones, have the burden of making provision within their
accounts for the increasing risk of complaints as well as the
proposed increases to capital-adequacy provisions.
IFA firms would not be so exasperated about regulatory costs
if they felt FSA had been putting this money to good use, and
there were clear benefits to be gained from the money spent. However
many of FSA's Cost Benefit Analysis were seen as "highly
questionable". Post Implementation Reviews also do not provide
proof of value, or evidence of the policy being successfully delivered.
The RDR is a case in point with its estimated £1.7 billion
cost out of kilter with the benefits which will be judged with
hindsight. Latest figures from FSA suggest this initiative will
target just 48,000 advisers across the broad industry, equating
to the equivalent of over £35,000 per adviser in costs. This
is surely not cost effective regulation.
Another good example is FSA's initiative "Make a real
difference" (MARD) initiative, referred to earlier in this
paper. Again this was an initiative that was effectively abandoned
by FSA, but one which the industry are still paying for at a cost
of £5 million a year for 10 years, with little or no identifiable
benefit. Other examples of these ongoing costs include Treating
Customers Fairly (TCF), More Principles Based Regulation (MPBR),
the Enhanced Supervision Strategy, and the ARROW framework.
The regulation of the mortgage industry proves further evidence
of increased regulatory costs under FSA. In 2004, the Mortgage
Code Compliance Board (MCCB)—FSA's predecessor in terms
of mortgage regulation—covered 10,388 intermediary firms,
comprising 38,147 sales staff, in addition to having responsibility
for monitoring the activities of 156 lenders. The incurred cost
of this operation was £4 million.
Fast forward to 2010 when FSA is now responsible for the
mortgage regulation, and the costs have skyrocketed to £24
million, of which £14.4 million is paid directly by intermediaries,
despite the number of regulated firms dropping to just 5,477.
The new landscape
Going forward we therefore wish to see the following from
the new regulator:
— there must always be an identifiable market failure,
and a cost/benefit analysis undertaken, before regulatory action
is considered;
— any new regulatory interventions need to be subject
to the highest levels of public scrutiny—and their benefits
clearly articulated and measured; and
— CPMA's policy in setting fees should be risk-based.
We would also encourage CPMA to use the tools at its disposal
to reward firms that invest in their business and its people eg
through regulatory dividends.
It is also worth pointing out that we are very concerned
by the overall cost of the proposed new regulatory structures—£50
million as a transitional budget is potentially insufficient,
yet still a considerable further sum to the industry.
Whilst many other Government funded regulators are facing
substantial cost pressure, the industry funded FSA is not and
this needs to be considered carefully. IFA firms are already facing
a barrage of costs due to regulatory changes in 2012, and we therefore
call on Treasury to carefully consider all aspects of the costs
of any changes, as well appropriate weighting towards different
parts of the financial services sector; the cost of the RDR alone
is equivalent to over £35,000 per "adviser" in
the UK.
AIFA would also like to continue the debate relating to the
cost allocation model within the CPMA structure. AIFA has engaged
heavily with FSA over recent months on this issue, including substantial
work with external consultants. We feel that there are more appropriate
allocation methods for the cost of regulation, and would welcome
the opportunity to consider this further in light of the revised
regulatory structures when they are confirmed.
(f) Regulation must take into account the European
dynamic at play
Increasing amounts of financial regulation are now emanating
from Europe, and it is therefore crucial that the UK is best placed
to achieve positive engagement on the continent in the coming
years and ensure we remain a leading player, for the benefit of
consumers.We also feel there is potentially much to be lost at
a European level in the near future, as highlighted by Sharon
Bowles' recent letter to Vince Cable, further highlighting the
need for UK regulators to be fully cognisant of the European dynamic
at play in the market.
The new landscape
AIFA continues to believe that European regulatory powers
are not sufficiently addressed within the proposed new architecture,
and that lead regulators may not be most appropriate.
Of most concern is the split between PRA and CPMA of the
three new European Authorities. It is proposed that CPMA will
lead on European Securities and Markets Authority (ESMA) related
issues, whilst PRA will lead on European Banking Authority (EBA)
and European Insurance and Occupational Pensions Authority (EIOPA)
areas. The UK is therefore taking a vertical approach, in which
the division of regulatory responsibilities is based on the type
of institution.
However this does not tie in with the horizontal approach
at the European level, whereby regulation is based on the type
of product. Whilst work such as Basel III and Solvency II are
addressed by EBA and EIOPA respectively, and therefore appropriately
sit with the PRA, there are much wider streams of work which fit
less well. IMD and the associated work of the PRIPs initiative
is also part of EIOPA's work.
However, whilst PRIPs will impact the conduct of business
practices of all firms engaged in providing "investment"
advice in the UK to retail clients, the lead UK authority would
be the PRA, not the CPMA. To have the prudential regulator as
the lead authority on conduct of business related activity would
seem wholly inappropriate.
We therefore call for:
— further consideration given to the lead authorities
on prudential issues and conduct of business related activity;
and
— enhanced co-operation between regulators at a European
and international level. There has been some support for a more
formal context for this co-operation, particularly for prudential
matters, amongst our membership.
4. DELIVERY OF
REGULATION—THE
RETAIL DISTRIBUTION
REVIEW
The Retail Distribution Review (RDR) is a prime example of
how FSA has failed in its delivery of regulatory policy. While
AIFA supported the six original RDR objectives throughout the
three year discussion period, we are highly sceptical that the
final proposals will see these original outcomes ultimately delivered.
This would be a wasted, not to mention highly expensive, opportunity.
(a) Does the RDR enable better outcomes for more
consumers?
No. Indeed the RDR started from a point of aiming to achieve
better outcomes for consumers, through increasing their confidence
and trust in retail financial services, whilst also increasing
consumer access to advice. These were all laudable aims and ones
which the IFA profession were fully behind.
However over the three year consultation process FSA seem
to have forgotten their original aims, to the point where they
now seriously risk driving out good firms, increasing the costs
of advice and reducing access to the financial services market
for UK citizens. This will serve the regulator, industry and consumers
badly and a generation will be robbed of the security of improved
protection, savings and investments that professional, independent,
financial advice can bring.
The RDR threatens to bring about consumer detriment in a
number of different ways:
Access to advice
AIFA strongly supports the raising of professional standards,
as a key element of retaining and building consumer trust in financial
services. However, professional requirements do not necessarily
mean traditional examinations, and more pragmatic and adviser-orientated
solutions should be sort.
There is a danger that FSA's RDR qualification requirements,
and in particular the 2012 deadline imposed for achieving them,
may result in a significant number of advisers leaving the industry,
thus decreasing consumer access to advice.
Indeed if there is a rush to implement the RDR, there could
be a real danger of consumer detriment. Ernst & Young produced
research showing that 30% of advisers would leave the sector as
a result of a rushed implementation. If only 10% of advisers left,
our figures show that:
— A drop of £650 million in long term business
would result in just one year.
— £1.76 billion of net sales of OEICs and Unit
Trusts would be lost.
— For individual pensions there would be a drop of around
two million in policies with the result that pension benefits
paid out would reduce by £4.4 billion.
A longer transitional period may be the answer to this, as
may better vocational routes for advisers which are not currently
available today.
Remuneration
We recognise that commission had a negative image in the
past, which is why AIFA and our members have been completely behind
the move to adviser charging, supporting it throughout the whole
RDR process. In fact many of our members have been operating a
fee based system for a considerable time.
However FSA's decision to ban the practice of "factoring"
runs counter to the Government's desire to restore a regular savings
culture in the UK which can be delivered by encouraging people
to buy regular premium pensions. Factoring is the cost-effective
way that consumers can receive impartial advice at outset, with
the cost of advice split over a period. The removal of factoring
will significantly impact any consumer seeking advice on regular
premium accumulation products—such as pensions.
Consumer Trust
One of the main opportunities the RDR has to restore consumer
trust was to create a market which has the fewest possible divisions,
builds on consumer understanding of simple words like "advice"
and which throws open the doors to market improvement. This improvement
is essential, for, as the FS Consumer Panel stated:
"The current advice landscape is characterised by confusion
and negative emotions. The RDR proposals should reduce distrust
and confusion in the advice market and in theory may enhance the
propensity of consumers to seek advice."
Consumers therefore need to be absolutely clear as to whether
they are receiving "advice" or being "sold"
a product. AIFA believes that the benefits to the consumer in
offering absolute clarity of whether a firm is the "agent
of the client" or "agent of the provider" will
go a long way to restoring trust in the sector. Unclear motivations
have damaged trust in the past, and the RDR could have been the
opportunity to restore trust through the distinction afforded
by those working for the client without potential conflict of
interest. We believe this clarity is fundamental to the success
of the RDR.
However while FSA recognised this clear distinction between
advice and sales in its Interim Report, it has since shied away
from this stance following pressure from the banking community.
Instead there will now be a distinction between independent advice,
which is unbiased and unrestricted, and "advice" that
does not meet these requirements and is therefore restricted (more
appropriately labelled "sales").
Whilst those offering restricted "advice" will
have to make this clear in written and oral disclosure, it is
highly disappointing that FSA decided not to enforce a specific
set of words to ensure consistency across the market. As a result,
this does nothing to help consumers understand the motivations
of those purporting to give "advice". We believe this
is a missed opportunity to create real clarity in the market place
for consumers.
(b) Are there appropriate checks and balances in
place to ensure accountability?
No. While the three FSA Consultative Panels fed into the
RDR debate, and gave feedback to FSA on its proposals, these views
were often overlooked. The Financial Services Consumer Panel (FSCP)
in particular strongly recommended that FSA make a strong distinction
between sales and advice to make it easy for consumers to distinguish
services offered by IFAs and those from paid salesmen from financial
services providers. FSCP chairman at the time, Lord Lipsey, strongly
criticised the distinction proposed by the FSA as "devoid
of meaning" and "nonsense language". His successor
Adam Phillips also shared a similar view which he publicly expressed
to FSA. However this appeared to have little effect on FSA's thinking
in this area.
It is also only now, at this late stage in the process when
the final rules have been decided, that the proposals are being
scrutinised by MPs in Parliament, via the Treasury Select, the
recent Westminster Hall debate, and plans for a backbench debate
in the Commons. This parliamentary scrutiny should have happened
much earlier in the process in order to fully hold FSA to account
in this area.
While we welcome the commitment by FSA for a post implementation
review of the RDR, it will not necessarily provide proof of value,
or evidence of the policy being successfully delivered. We would
rather see increased access to independent advice as a metric
to measure the RDR's success—if access to advice decreases
it would bring consumer detriment. Latest figures from FSA suggest
this initiative will target just 48,000 advisers across the broad
industry. This equates to the equivalent of over £35,000
per adviser in costs.
(c) Does the RDR work in a proportionate and risk-based
way?
No. The wider economic situation has changed dramatically
since the RDR started which FSA failed to recognise accordingly
in its proposals. IFA firms were not the cause of the crisis and
have weathered the storm in good shape. However, firms do not
have the financial base that they had at the start of the RDR
and FSA should have recognised this in any new regulatory intervention.
Change is expensive and change on this scale, and during
these economic conditions, demands the co-operation of the regulatory
authorities with the industry. The RDR was a prime opportunity
for FSA to seek to incite positive behaviour through providing
"regulatory incentives and dividends" for firms who
invested in their business and people to deliver the RDR outcomes.
Indeed at the start of the RDR, FSA discussed ways of doing this
which included statements in DP07/01 such as "well-managed
firms, which treat their customers fairly, should be given regulatory
incentives for doing so, and it should be these firms that benefit
from regulatory change", and that "Firms with good market
practice would receive a regulatory dividend but those with riskier
market practice would need additional FSA supervision".
This was echoed by the RDR Sustainability Group who recommended
that "…there should be a regulatory dividend for having
robust management, systems and controls". There was a recognition
that firms would need to invest in their people, and may need
to change their business models, if the RDR's objectives were
to be seen through. AIFA welcomed this regulatory support and
proposed a "regulatory dashboard" which could be published
so firms could be sure of accessing dividends in their regulatory
journey, and making any changes appropriate for their business.
However the impact of the banking crisis saw the notion of
dividends removed, which we believe was an unfair response given
that IFA firms did not cause the crisis. The new regulator should
offer lower fees for firms that invest in developing their people,
compliance and management, which then lowers the risk factor.
Lower risk should bring less intensive regulatory burdens commensurate
with the lower risk posed.
Given the wider state of the economy, there was also a prima
facie case for FSA to tier its regulatory capital requirements
based on a firm's compliance record—and other behavioural
indicators. The information collected within FSA risk profile
methodology could have been used intelligently used to tier firms'
capital requirement. That would see a tangible reward for better
run, lower risk, firms.
(d) Has the RDR been consistently delivered?
No. Throughout the entire RDR process there have been numerous
U turns, and changes of heart by the regulator. The labelling
issue is a prime example. In the initial RDR paper, FSA proposed
three different labels for advice—"professional financial
planning", "general financial advice", and "primary
advice". By the time of the Interim Report this had changed
to a single tier professional advice sector in which advice offered
must be whole of market, independent advice. The sales regime
had to be strictly non-advised and labelled as such. A few months
later this had changed again, with FSA proposing a muddy landscape
of "independent advice", "sales advice" and
"guided sales". By the time of the Policy Statement
last year, these labels changed yet again, divided down by "Independent
advice", "restricted advice", "simplified
advice" and "basic advice". FSA's proposals for
remuneration structures, professionalism and qualifications have
also changed numerous times over the three year consultation period.
The number of personnel changes within the RDR team has undoubtedly
not helped this inconsistency. Whilst a degree of turn-over is
expected, and should be planned for, the wholesale changes within
the RDR team have contributed to mixed messages being communicated
to the industry and a number of policy misalignments and re-prioritisations.
The new regulator should learn from this experience and projects
should either be shorter—or teams and individuals should
be expected to stay the course (ie not moved internally). This
is not a comment on the competence or professionalism of the individuals
concerned but a statement about a better way of working.
(e) Is the RDR cost effective?
No. The intermediary market could be hit with costs of more
than £1.7 billion as a result of the RDR, which is out of
kilter with the benefits which will be judged with hindsight.
Indeed the publication of FSA's Cost/Benefit Analysis on the RDR
drew widespread criticism for its lack of depth and failure to
grasp the true costs of change for firms. The costs will have
a major impact on firms without delivering genuine consumer benefit
which was the original objective of the RDR. These additional
costs to firms also come at a time of difficult trading conditions,
with firms being required to hold more capital and pay higher
regulatory fees.
(f) Does the RDR take into account the European
dynamic at play?
Again the answer is no. IMD, PRIPS and MIFID are all due
to be published by the European Commission in the next three months,
and all will have huge ramifications for the market. However FSA
has failed to take account of the impact of these pieces of legislation
on the intermediary market, and how in turn the various streams
of the RDR will thus be affected.
3 November 2010
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