Retail Distribution Review

Written evidence submitted by the Financial Services Authority

EXECUTIVE SUMMARY

1. We welcome this opportunity to submi t this memorandum to the Committee’s inquiry into the Retail Distribution Review (RDR) .

2. We launched the RDR in June 2006, to address the root causes of significant problems identified in the distribution of retail investment products and services . There was broad support from the market at that time for the need for reform which meant that our review was able to focus on solutions rather than analysing the past.

3. The RDR is a key part of our consumer protection strategy, and an example of intervention where we have decided that there is a need to address problems across a whole market because previous, more piecemeal approaches had not addressed the issues effectively. We aim to modernise the industry and establish a resilient, effective and attractive retail investment market in which consumers can have confidence and trust at a time when they need more help and advice than ever with their retirement and investment planning. The rule-making which has already taken place, and continues, will be supported by our intensive supervision of firms and complements the work of the Consumer Financial Education Body (CFEB) to improve consumers’ financial capability. We continue to work closely with CFEB as we move towards implementation of the new RDR regime.

4. A broad range of firms operate in this market, with diverging views on the best way to implement reform. We have taken these opinions into account in forming our proposals and making new rules. We recognise that the RDR involves significant change in the market so we would expect some of our proposals to be controversial. This is why we have consulted so extensively and over such a long period. We spent two and a half years (June 2006 – November 2008) encouraging ideas and views from industry practitioners, consumer representatives, investors and potential investors, trade associations, professional bodies and other stakeholders on the issues that needed to be addressed and to identify potential solutions that we could research before finalising our policy and rules.

5. We are grateful to all those who have contributed considerable energy to this review. They have helped us to identify and develop ideas, giving us feedback along the way to help us understand the likely impact of our proposals. This gave us a very clear view of where our regulatory interventions are most needed and the likely market impact. We believe that we have settled on the right combination of measures to reduce the cost to consumers of continued unsuitable advice and to deliver a clean and sustainable market for the future. We also fully recognise the need to monitor the impact of these policies on a continuing basis, both before and after, implementation of the new regime.

6. Our analysis shows that t he longstanding problems in the market have been created by an asymmetry of power and information between product providers, advisers and consumers, as well as other factors such us remuneration structures, levels of professionalism and a lack of clarity on the part of consumers about the service they are getting.

7. Our proposals aim to ensure that:

¡ consumers are offered a transparent and fair charging system for the advice they receive;

¡ consumers are clear about the service they receive;

¡ consumers receive advice from highly respected professionals; and

¡ advisory firms are more stable, than now, and better able to meet their liabilities.

8. Within the definition of retail investments w e include, products and services such as pensions, investment funds (unit and investment trusts), life products (endowments, with-pr ofits and unit-linked policies) and exchange-traded funds. Our new rules will apply to all advice given in relation to such products and services, regardless of the type of firm for whom any individual adviser works – so advisers within banks, asset managers, life insurers, sole traders, partnerships, stockbrokers, networks , IFAs or financial advice firms will be subject to the same regulatory environment. We have also considered the development of new distribution channels such as platforms.

9. In the following sections we cover:

A. Problems in the market;

B. Our extensive consultation programme;

C. Myths and misconceptions about the RDR;

D. Changes being introduced under the RDR;

E. Contentious issues; and

F. Costs and benefits.

A. PROBLEMS IN THE MARKET

10. The RDR was launched in response to both our, and market participants’ observation of significant problems in the UK market for retail investments. In deciding whether to invest, consumers are being asked to make decisions about markets which are, by their very nature, uncertain and which can be complex. When they decide to invest they are also being asked to take risks which can often be quite difficult to assess and they may not crystallise until a long time after the decision to invest was taken. This is one of the main reasons why consumers seek advice; it is also why consumers need advisers they can trust, why advisers need demonstrably to behave in a professional way and why the interests of advisers need to be clearly aligned with those of their clients. These are not characteristics of the retail investment market.

11. While risks of unfair treatment of retail customers have, in several respects, been accentuated by the financial crisis, the issues reflect longstanding problems created by asymmetry of power and information between providers, advisers and consumers, together with unsustainable business models. While we are putting measures in place to address issues that led to the banking crisis, we believe that addressing the root causes of problems in the retail investment market – which pre-date the crisis - is also required if consumers are to be better protected.

Market complexity and lack of consumer understanding

12. We note above the risks and complexities involved in investments and the information asymmetries. There are sophisticated investors who are confident in making investment decisions, but, in many cases consumers purchase retail investment products relatively infrequently (such as arranging a pension), so have little experience to draw on. Retail consumers also tend to find the effect of total charges on their investments hard to determine. They simply do not have the same information as the sellers of these products and receive poor quality advice [1] . As a consequence of this market failure, compounded by the low level of financial capability among many consumers and their overall lack of interest and engagement, consumers do not act as a strong pro-competitive force in this industry.

Incentives from adviser remuneration

13. The role of the intermediary is to provide advice to the consumer. However, advisers’ remuneration structures are such that the cost of advice (commission) is often built into the product charges. Our consumer research shows [2] that only around half of respondents understood how the long-term value of their product would be affected by commission. Consumers are left with the impression that advice is free [3] . The adviser’s interests are often aligned with the provider, not the customer. Competition between product providers tends to focus on encouraging the adviser to recommend a particular product. As a result, product features, including charges and commission, provide incentives to attract the adviser rather than focusing on product features which are attractive to the consumer (such as delivery of good performance and long term growth or income) [4] .

14. This leads to an inherent misalignment of interests between the intermediary and the consumer, which can lead to various forms of bias:

¡ Provider bias – advisers recommending a provider’s products on the basis of commission payments;

¡ Product bias – some products carrying higher commission payments than others, biasing advisers’ recommendations to those products paying higher commission; and

¡ Sales bias – generation of income is contingent on a sale being made due to the advisory firm’s business model being dependent on payments of commission. This can lead to an incentive to ‘churn’ the client’s investment in order to generate income.

15. Once products have been purchased, there is limited evidence of consumers switching if performance is not satisfactory. However, the potential conflict of interest created by commission, due to the risk of bias, or a perception of it, leads to low persistency, and undermines trust. This does not help the long term sustainability of the sector. For example, our thematic work on pensions revealed evidence [5] of consumers switching for other reasons, such as inappropriate advice from advisers motivated by income generation. The table below summarises three further examples of where we have found evidence of bias:

Detriment to consumers

16. The table above reveals approximately £223m of detriment arising only from those sales that were unsuitable. The data in this table is drawn from cases of unsuitable sales of a number of different types of retail investment products, where detailed research has been conducted on mis-selling. Research on mis-selling is not available for all products in the market, and therefore this figure of £223m is likely to underestimate total consumer detriment.

17. To provide an indicative estimate of total detriment, we have extrapolated the estimates of consumer detriment to all sales in the market, taking the following approach:

a) ABI and IMA data suggests that the total annual market for retail investment product new business is £109 bn;

b) Assuming 12-20% of all products sales are unsuitable (as set out in Table 4 of PS10/6); and

c) Using an estimate of the detriment to consumers published in CP 09/18 – 3% of the value of the amount invested.

18. This suggests that the annual detriment arising from the sale of an unsuitable product could be in the range of £0.4 bn - £0.6 bn:

Cost of poor quality advice

19. Poor quality advice or unsuitable advice often results in consumer detriment. However, as noted above, this may not be identified until years after the sale, if at all. There are limitations in the way that capital resources requirements and Professional Indemnity Insurance (PII) requirements for firms currently remedy this. Product providers also have responsibilities for treating customers fairly. Again, it may be many years before problems become apparent, for instance with the performance of a product relative to what the consumer was led to believe. The result of this can be uncertainty for consumers and can mean potential claims against those who supplied the product or gave advice many years after the original purchase. By the time these claims come to light, those that gave the advice may no longer be in business, leaving others in the industry to meet the costs of compensation.

Credibility of advisers

20. Currently 70% of consumers do not seek investment advice from an adviser. While levels of trust in advisers are higher among those who use one than among those who do not, 40% of those who have recently used an adviser say they do not trust financial advice [6]  . Our consumer research has found trust to be a more important factor than price [7] when selecting an adviser and that confidence can be established in advisers through the demonstration of knowledge and qualifications [8] . The consumer’s current perception of financial advice presents a disincentive to consumers seeking advice in the first place. We therefore believe that trust is key - the RDR will instil more trust and confidence in the retail investment market from consumers, leading to more engagement which should attract new people to seek advice and possibly invest.

21. Taking the problems we discuss above together, we believe that the market for retail investments has not worked and still does not work efficiently. It serves neither the interests of consumers or firms, whether providers or distributors of retail financial services.

B. EXTENSIVE CONSULTATION

22. From the start of the review there was encouraging consensus from market participants, as well as consumer groups, about the problems in the market and the need for change. There has also been consensus that the time was right for substantial change.

23. We have held an open debate about industry-led solutions, wherever possible, in what has been the FSA's most extensive and far-reaching consultation process to date. This involved some two and a half years of discussion and a further two years of formal consultation, during which we have received nearly 2,000 formal responses and proactively contacted around 2,500 firms, in addition to considerable additional correspondence and discussion.

24. We used industry working groups, as well as considering the views of individuals, consumer representatives, a wide range of firms, and their representatives, to develop our proposals. Often debate has arisen around detailed points of the proposals. We have listened to the arguments and evidence presented, amending several proposals in response to this debate, where appropriate. For instance, we have amended our professionalism proposals to allow alternative assessment methodologies to be used in light of concerns about written exam-only qualifications, and we have also allowed for an additional transitional year for our capital requirements proposals, to take account of difficult trading conditions. However, there are detailed areas where some decisions were more controversial; we explain the reasoning behind these decisions in more detail in section E.

25. This extensive consultation has enabled us to listen and respond to market participants concerns and so develop, with industry, a package of reforms that we believe is necessary to address the problems in the market, improve consumer outcomes and confidence, as well as support the long-term viability of the retail investment market.

C. MYTHS AND MISCONCEPTIONS

26. A number of misconceptions about our RDR proposals have arisen over the years. We take this opportunity to clarify our position on these

Consumers will have to pay for advice upfront; many will be unwilling to do that and will not take financial advice at all

27. We recognise that consumers may not wish, or may not be able to afford, to pay an upfront fee for advice. Our approach offers consumers some flexibility on methods of payment. They can make the payment for advice by an upfront deduction or by the charge being deducted from regular payments over time, through the product. The critical change is that payment for advice can continue to be facilitated by the provider through the product, but the amount cannot be decided by the provider; that is decided directly between the adviser and the client.

The absence of complaints is an indication of quality advice

28. Some IFAs argue that, because only 2% of complaints that go to the Financial Ombudsman Service are levelled against IFAs, it follows that the independent sector provides a better service than the banks. We do not accept this. The total figure for complaints referred to the Ombudsman Service, on which this 2% figure is based, includes complaints about services and products such as banking and credit which are not provided by IFAs, so the comparison is not a fair one. The more relevant data to use relates to products and services provided by both IFAs and banks, such as investments and pensions. 14% [9] of new cases referred to the Financial Ombudsman Service in 2009\10 relate to this area - 22,278 cases out of a total of 163,012 of which 50% were upheld. Of these 22,278 cases, IFAs accounted for 12% of investment-related complaints, compared with 29% for the banks. On pensions, IFAs accounted for 28% of complaints and the banks 10%. This demonstrates that there are problems which need addressing, irrespective of the advice service (independent or restricted) or firm type (small or large). These figures are broadly representative of the source of advice because the Baseline Survey of Financial Capability found that 30% of the adult population sought advice; of which 57% used an IFA and 36% a Bank.

29. While complaint volumes are one important indication of the quality of advice or services received, a complaint – by definition - relies on the consumer becoming aware that there is a problem with the product or service and raising that with the firm. The asymmetries of information mean that a consumer may never realise they have been advised to purchase an inappropriate product, the time lag between the advice being given and a problem crystallising, and often the firm no longer being in business when a problem is discovered (this leaves others in the industry to meet any costs of compensation) mean that while complaints received can provide one indication of poor quality advice, an absence of complaints is not a reliable indicator of good quality advice.

Access to advice

30. Some in the industry believe that the RDR will reduce access to advice for the less well off. We do not agree. We have said that changes from the RDR are significant and there will indeed be changes within the market; however, the impact on market capacity and structure is likely to be limited. For example, Oxera reported [10]   that around 14% of firms that currently provide independent advice indicated that they are likely to provide restricted advice post-RDR. This market impact will, in some cases, simply be a shift in the service description of the firm from independent to restricted advice because of the new definition of independence.

31. Another element of market impact comes from the number of advisory firms and individual advisers who will completely leave the sector. A number of studies have been carried out which produce estimates and these indicate a range of 10 – 20% of advisory firms may leave the sector. Our own research tells us that around 23% of advisory firms may exit the market because of the RDR proposals. Whereas the number of individual advisers who may leave could be in the region of 8 – 13%, excluding those who plan to retire anyway and based on surveys of firms’ expectations of their advisers, and advisers own intentions [11] . This range is consistent with NMG’s own estimates of the impact of the RDR on IFA numbers based on their IFA Census survey. We consistently used a forecast of 10% - 15% when considering the reduction in adviser numbers by December 2012, once planned retirement is excluded. Previous research by the FSA estimated the level of exit to be 11%. If 8% do exit the advice market, adviser numbers will fall by 3,802; at 13% this increases to 6,178. IFAs represent a disproportionate number of those most likely to leave with 11% of IFAs expressing an intention to leave the market completely compared to 8% for all advisers. A 10% fall in the number of IFAs would result in a decline of 2,635, i.e. they would account for 69% of all those exiting. Age is an important part in advisers’ decisions with the proportion intending to remain an adviser reducing from 84% (under 35 yrs) to 65% (35 – 54 yrs) and still further to 40% (55 yrs+). Firms with fewer advisers, and that earn lower revenues, indicate they are more likely to leave the industry; this is why the impact on the number of advisers is proportionately less than on the number of firms.

32. As a result of market exit, and if new firms do not enter or existing firms do not expand, around 11% of people currently receiving advice will not have access to the adviser they are using at the moment because their adviser will leave the market. They can, of course, consult another adviser, and other firms may seek them out as clients. We believe that the final figure is likely to be less than the 11% identified.

33. As we have said, we will be monitoring the changes in the market, including exits during and after the transition. Even if demand for advice outstrips supply, entry barriers are low. In the longer term, new entry or expansion by existing players is likely to fill the gap. Some customers may question whether they need advice when they understand how much it costs them (a cost which is currently opaque because of commission) but that is a personal decision based on how much individuals actually value the service they receive.

34. The majority of the UK’s population has little or no liquid savings (the median financial wealth for families in Britain was just over £1,000 in 2005 [12] ). Until savings have been established, investment products and services are unlikely to be suitable. For many people in this position, the proposals by CFEB for an annual Financial Health Check seem likely to be particularly valuable. There could also be potential benefits to this group from the Treasury’s proposals for simple products. Those consumers who have established savings, and for whom investment advice is the right way forward, have access to simple, low cost stakeholder products. The charge caps and simple terms of stakeholder products provide strong consumer protection and as a result we are not extending the RDR to the Basic Advice regime. This means, for example, that advisers on such products can continue to receive commission and give advice without holding a qualification.

35. However, we acknowledge the concern of mainly product providers that the market for stakeholder products is small and we believe this is primarily due to the lack of profit margin. At the same time, we are aware that there is a widespread belief that the RDR will result in a reduction in the take-up of advice and that some lower-cost option (along the lines of Basic Advice) should be available to those consumers whose needs are relatively simple and likely to be met by straightforward products. We have had extensive discussions with the industry on the concept of simplified advice to support the development of such a process and we know that a number of firms have developed pilot processes to test out the attractiveness and viability of such a service. Furthermore, to assist the firms who are developing such processes, we will produce some material on the concept of simplified advice this year.

D. CHANGES BEING INTRODUCED UNDER THE RDR

Consumers are offered a transparent and fair charging system

36. A key objective of the RDR is to address the potential for remuneration of advisory firms to distort consumer outcomes. Under our new rules, an adviser will be required to say how much their services cost and will agree with their customer how much they will pay. This means that advisers will have to talk to their customers about the cost and value of their service which could stimulate competition among advisory firms. This change realigns the adviser’s interests with those of their clients.

37. We acknowledge concerns from some IFAs that despite these changes there is still potential for certain reward structures for in-house sales staff in banks and other advisory firms to cause the types of bias we have described. We are scrutinising those reward structures for in-house sales staff across the advisory sector.

38. The new rules will also prevent advisers from receiving ongoing commission ("trail" commission) where they are not providing the customer with an ongoing service.

Consumers are clear about the service they receive

39. A further objective of the RDR is to improve the clarity with which firms describe their services to consumers. It is important for consumers to know if their adviser is able to recommend from all of the market or only from a limited range of products. At present, to describe themselves as independent, advisory firms must consider the whole of the market for packaged products (these are products such as pensions, endowments and collective investment schemes) and offer the option of paying by fee.

40. The new advice landscape will be made up of independent advice, restricted advice (including simplified advice services) and basic advice (about stakeholder products). Before any advice is provided, firms will need to make clear to the consumer which of these services they are offering. The new rules for independent advice means that consumers will receive recommendations that consider all relevant options, free from any restrictions or bias. Those advisory firms who do not meet those rules for independence will have to explain the nature and extent of the restriction, for example, whether they advise on a particular range of products or on products from a limited range of product providers.

41. These new rules have received significant support in our consultation and require firms that provide an independent advice service to have the knowledge to consider a wider range of products than now. For example, the new definition includes investment trusts and exchange traded funds.

Consumers receive advice from respected professionals

42. From the start of the RDR, concerns about the credibility of advisers were often at the heart of the debate, which concluded with an early consensus among stakeholders on the need for professional standards to be raised. We believe that to raise trust and instil confidence it is important that consumers receive advice from professional, respected advisers.

43. The RDR will establish standards of professionalism that, when delivered by advisers will inspire consumer confidence and build trust in the market so that financial advice is seen as more of a profession. We are doing this by instituting an overarching code of ethics, modernising qualifications and enhancing standards for continuing professional development (CPD). We will require advisers to hold a Statement of Professional Standing (SPS) confirming that they meet these standards. We developed and agreed these proposals with our Professional Standards Advisory Group (PSAG) [13]   which comprised trade associations, professional bodies and consumer representatives. We then measured the proposals against other professions [14] .

44. In developing our policy and rules, we consulted on a proposal from our industry groups that advisers wanting to provide a wholly independent service should have to achieve qualifications at graduate level [15] . While many advisers tell us that they want to become more professional, feedback was that this level was too high for the market at the moment. We therefore settled on the vocational equivalent to the first year of an academic degree [16] as this level requires more relevant skills than is required by the current standards [17] . In the light of feedback about the relevance of the content, we added more on investment risk and ethics as well as practical application of knowledge to the syllabus. We believe these changes are fundamental to equip the modern adviser to give good quality advice, and many advisers recognise that these skills have great relevance to their role.

45. The enhanced professionalism requirements will also mean that advisers, on the whole, will be more competent than at any time in the past. As the professionalism and reputation of the adviser community increases, new entrants will be attracted to the sector. We are seeing more learning opportunities for new entrants and some firms are creating graduate recruitment schemes to accommodate some of the demand.

Advisory firms are more stable and better able to meet their liabilities

46. We have put in place new rules requiring personal investment firms (which broadly derive the majority of their business from advising on and managing investments for retail customers) to have adequate capital resources in order to minimise the financial impact of unsuitable advice. We believe that it is important for firms to have a strong capital base so that they are able to deal with complaints arising from their advice. This would reduce the situations where the Financial Services Compensation Scheme (which is funded by firms who remain in business) has to pick up the cost. In developing our proposals we reviewed the extent to which such rules could mitigate the incidence, and the impact, of unsuitable advice by personal investment firms. We concluded that such rules could not mitigate the incidence of poor advice but could affect the impact on the sector as a whole. We are implementing an expenditure-based requirement (EBR) and will require firms to hold (at least) a level of capital resources equivalent to a specified number of months of their fixed expenditure. The new rules will come into effect on 31 December 2011 with two years for the transition. In response to feedback we agreed an additional transitional year because firms were experiencing difficult trading conditions.

47. We have confirmed that, in the light of the feedback we received, we will review how the new capital resources rules apply to firms with different business models to ensure that they deliver consistent regulatory outcomes. We will consult on this in July 2011.

E. CONTENTIOUS ISSUES

Absence of a Long-Stop

48. Some advisers express frustration at the absence of a long-stop time limit on the period within which complaints must be brought or the application of the statute of limitations because they want to limit their liabilities. This strength of feeling, particularly amongst IFAs, was made clear to us when we first consulted on long-stop in 2007. To justify the introduction of a long-stop we need to identify benefits to firms or consumers beyond the savings for firms in compensation payments. These benefits would need to exceed the consumer detriment from time-barred complaints [18] .

49. Responses to our consultation focused on ‘fairness’ arguments around the statute of limitations and concerns about handling ‘stale’ claims – particularly into retirement. We were unable to convert these arguments into a persuasive analysis that it would be reasonable to impose responsibility on consumers to identify any and all issues with advice within a given period.

50. Other respondents highlighted the consumer detriment and reputational damage that a long-stop could cause. Due to the strength of feeling on the issue we made a further call for evidence in 2008 but only three firms responded with further evidence. This prompted us to seek further evidence to see if we could build a persuasive argument. We could not and we had to conclude that we should not introduce a long-stop because we were unable to demonstrate that it would bring additional benefits to consumers and firms (for example from greater investment in the sector).

Experienced Advisers and Grandfathering

51. We considered grandfathering but the majority of respondents to our consultation [19] were not in favour (including AIFA, the main representative body for independent financial advisers). Any grandfathering provision would have to be made available to all advisers operating in the market, irrespective of who they work for. There was a broad consensus that grandfathering would not support the necessary efforts to restore confidence in the industry and would thwart efforts to implement demonstrably consistent minimum standards across the profession. This was the view of the majority of advisers and their representatives.

52. Our own recent experience in allowing grandfathering rights for mortgage brokers has been that it has seen a continuation of mis-selling, resulting in nearly 100 brokers being disqualified to-date for incompetent and unethical practices.

53. The majority of those in favour of grandfathering said that to be eligible, advisers would have to meet certain conditions, such as the absence of complaints against them. As noted earlier, we do not agree that this is an objective measure of competence. Other suggestions have been that advisers tell their customers they are not qualified. However, this approach requires the consumer to exercise a judgement that they are generally ill-equipped to make.

54. We also considered a working group recommendation in 2008 to permit existing advisers a grace period of two further years (to end-2014) under supervision to allow them longer to get qualified. However, we had serious concerns about the supervision of these advisers being effective. At its most unacceptable supervision carried out within firms is a form of remote file checking with no coaching, mentoring or training of the individual. Instead, we found an acceptable compromise and said that those who are on course to complete, or already hold, an appropriate qualification can continue with this. This meant that from November 2008, existing advisers could continue or begin their studies using existing higher level qualifications, without having to wait for the new qualifications to be made available. Overall, our view is that, by the end of 2012, established advisers will have had enough time to meet the new standards.

55. While we are sympathetic to the issues raised by some advisers with significant years of experience, experience alone does not necessarily equate to competence – and it is competence that the new minimum qualification standards aim to address. We are not satisfied that the existing standards are adequate to meet the demands of today’s challenging investment market or that advisers have been maintaining their knowledge in line with changes in the market. This is borne out in our platforms thematic review [20] , published in March 2010, where advisers were recommending a service they did not understand themselves. So the professional standards have been modernised to reflect the role actually performed by advisers.

56. In light of concerns from advisers about sitting traditional written exams, and having taken advice from PSAG and the Office of Qualification and Examinations Regulation (OfQual), we agreed to allow alternative forms of assessment. These assessments provide those advisers who do not wish to sit a written examination with a viable alternative to demonstrate that they meet the standards. These test the relevance of advisers’ knowledge as well as practical application. PSAG, however, rejected a form of FSA kite marking, where the proposal was that we assess individual advisers against the examination standards based on the content of client files - these are unlikely to cover all of the areas within the examination standards. In summary there are a number of different ways in which advisers may become qualified without taking a traditional written exam, notably:

a) There are two qualifications that do not involve any written examination instead they use what is called a 'competency day'. This involves reading a series of case studies and discussing these with an assessor.

b) We are currently consulting on including a work based assessment in our qualifications list.

c) There are also case study based written exams which involve the candidate being given a fact file prior to entering the examination hall and then being asked to write their recommendations on the file in exam conditions.

57. However it should be noted that the take up of these types of options is very low.

Market Impact of Professionalism

58. We do not believe that the RDR will result in the loss of the most experienced advisers, despite recent concerns, as we expect that those advisers who have actively sought to maintain competence by keeping up to date with market developments not to have to commit a significant amount of time to study. OfQual guidelines suggest the average new learner takes 370 hours to complete a diploma: this includes directed study, homework, assessment, and preparation time. This is the expected time that a new entrant would take: we would expect those advisers with considerable experience to find that the time they need to study will be significantly lower than that. The main qualification providers for this sector have indicated to us that it is taking between 6-24 months for most experienced and new advisers to complete their qualifications.

59. We have worked closely with qualification providers to ensure we recognise as many relevant qualifications as possible. In some cases qualification providers have altered their qualifications to meet the new standards e.g. including practical application of knowledge in university degrees and adding UK taxation into overseas qualifications. This approach differs radically from regulators in other countries, who provide no choice at all as they set their own qualifications. The list now includes over 60 appropriate qualifications. There is a wide range of support available to individual advisers to help them complete the qualifications, some of it free of charge.

60. Our experience is that advisers are now, on the whole, getting on with attaining qualifications. In March 2010, 49% of all advisers were already appropriately qualified [21] . A further 40% expected to have attained an appropriate qualification by end-2012. Of the remaining 11%: 6% did not know or did not answer the question, 4% will not qualify at all, and 1% will not qualify by end-2012. In fact, far from being put off by studying, many advisers are going further and taking more advanced level qualifications. We will continue to monitor market developments and the progress being made towards the deadline.

Removal of Factoring

61. In developing our proposals, and in response to feedback from our industry working groups and our consultations, we explored with the OFT whether a maximum commission agreement or a standard commission rate could be created for all investment products. However, the OFT expressed the same concerns about the competitive impact as they did when they banned the maximum commission agreement in 1989.

62. Under our new rules product providers will be allowed to offer consumers the choice to have adviser charges paid out of their investments. In particular, consumers who contribute to their investments on a regular basis will be able to spread the cost of initial advice fees, thus helping to maintain access to the market. However, unlike the current indemnity commission, providers will not be allowed to advance this money to advisers before it has been collected (a practice sometimes referred to as factoring).

63. Effectively this means that providers cannot use their own funds to advance this money to advisers before it has been collected from regular premium insurance products (such as endowments), as they currently can by using indemnity commission – where a future stream of commission payments is rolled up and paid in a (discounted) lump sum when the product is sold. It should be noted this is only a feature of the insurance market and does not feature in other product markets such as mutual funds. In a market without commission, but with adviser charges, it has been suggested that product providers should be allowed to achieve the same result by "factoring" the stream of adviser charges that would accrue over time in a regular premium product, discounted at a rate of interest chosen by the product provider, in order to encourage new saving and provide stability in the adviser sector of the market.

64. However, we see a number of reasons why this would be undesirable. First, there is no evidence that the current indemnity commission, which proposals for factoring by product providers would replace, has led to any substantial increase in new saving. In fact, there is some evidence that it has encouraged churn in the market, adding to its lack of sustainability. Second, the discount rate in factoring offered by product providers would have the potential to bias the recommendations of adviser firms, as different discount rates would generate different "factored" amounts for the adviser. Product providers could compete not on the price of the product to the consumer, but on the discount rate that generates income for the adviser. We have discussed a single factoring rate with OFT and their view is that this would be anti-competitive [22] . During pre-consultation and consultation, we asked the industry for reasons to allow product provider factoring but no compelling arguments were provided.

65. We recognise that some advisers have been dependent on upfront remuneration and that there may be transitional liquidity problems for some advisers. However, we believe that a limited proportion of income is earned via sales of regular contribution products and it is important to note that advisers may still be able to arrange third party factoring if this is something they would find valuable in running their business and improving stability.

F. COSTS AND BENEFITS

66. We published our cost-benefit analysis (CBA) for the RDR in June 2009 which we updated in March 2010 in light of responses to our consultation. We have published additional CBA as and when we consulted on other rule changes that also relate to the RDR, such as in June 2010 for the supervision and enforcement of professional standards. Some of the market impact costs of our CBA have drawn specific comment which we respond to below, but the RDR is a package of measures and to realise the benefits those changes must be delivered as a package.

67. We used data provided to us by firms to estimate that costs for the first five years of the RDR would range from £1.4bn to £1.7bn; an increase from our earlier estimate of £0.6bn (also based on estimates provided by firms). The difference arises because the draft rules we published gave firms a better understanding of the changes they will need to make and the costs they are likely to incur. Consequently, firms’ responses to our second CBA survey are materially different in some areas from the responses to our first survey on estimating compliance costs. The main changes in the cost estimates are increases in the costs of introducing the move away from commission to ‘fees’.

68. Clearly any additional compliance cost for firms, and ultimately consumers, is a matter of concern to the FSA. We believe these changes are necessary to increase consumer protection. The main benefits of the RDR changes would be an improvement in the quality of advice and a reduction in the incidence of mis-selling caused by product, provider and sales bias. In our March 2010 Policy Statement [23] we presented evidence of annual benefits in the region of £225mn which was from a sample for mis-selling cases. To give an indication of scale of potential detriment to consumers caused by mis-selling annually, we have extrapolated the levels of mis-selling in these studies to the whole market and used an estimate of detriment presented in our June 2009 Consultation Paper [24] to obtain an estimate of £0.4bn to £0.6bn.

69. An increase in the quality of advice should lead to increased persistency and a reduction in unnecessary transaction costs. In addition, Oxera concluded that providers are likely to compete on the cost of advice and by offering better services to advisers post RDR, and that this is likely to benefit consumers indirectly.

70. We based our decision to raise professional standards on recommendations from our initial industry working groups, which were refined and developed by PSAG, throughout which we carried out substantial consultation. This was supported by some focussed research on how higher professional standards might lead to better outcomes. The research we obtained indicated that both in the UK and non-UK markets advisers meeting higher professional standards give more suitable advice. We have summarised this research, and the main findings, in the following paragraphs:

a) Professional Standards and Consumer Trust [25] : This research found that in the longer term, measures to improve compliance with professional standards may result in improved consumer trust and engagement in markets.

b) Professional Standards Bodies: Standards, Levels of Compliance and Measuring Success [26] : This research demonstrated that professional bodies operating in markets with potentially similar consumer problems are taking a broadly similar approach to us in standard setting and establishing processes for monitoring and enforcement.

c) Linking Professional Standards to ‘Consumer’ and Other Outcomes in the Financial Sector [27] : The research presents two case studies showing positive links between standards and outcomes. The first was a review of financial planning advice by the Australian regulator and consumer agency. The evidence suggests that qualification at the level of higher education and engaging in Continuing Professional Development (CPD) contribute to increasing professionalism and improving the quality of financial advice. The second study aimed to identify whether qualifications of fund managers could be used to explain differences in the performance of their funds. The research concludes that clients with advisers holding professional membership and/or higher qualifications ought to improve outcomes.

d) Platforms thematic review [28] : Our data from early 2010 on platforms shows the advice of advisers meeting current qualification standards was deemed to be ‘suitable’ less often than that of advisers with a similar qualification to the new standard.

e) Major banking group - internal review: The review analysed quality of advice provided by level 4 and level 3 advisers. Analysis of fail rates (a measure of ‘poor’ quality) and risk scores (a blend of Key Performance Indicators including complaints) showed that indicators were better for higher qualified advisers.

71. In the longer term the RDR should remove some of the negative perceptions of the advisory process, which undermine confidence and often deter people from seeking advice. This could provide further opportunities for the advice sector.

CONCLUSION

72. The number of people currently seeking advice, as a proportion of the population, is small. If more people are to seek advice in the future, then they must both trust the advice and view the service as good value for money. Our proposals address both these issues by improving the likelihood of there being trust and confidence in the market and by making clear to consumers the cost of advice and the nature of the service they are going to receive.

73. The RDR is absolutely vital if we are to build consumer trust and confidence in the advice sector. We expect the package of changes we are making will result in a sustainable market that is a better place in which to do business in the long-term and advisers will be better equipped to give good quality advice. Any dilution of the proposals will result in an increase in the cost to consumers through continued unsuitable advice.

74. We will continue to support advisers towards the end-2012 deadline to ensure they fully understand the new requirements. We will be running further industry events this year, producing more material - particularly for smaller firms - and continuing our supervisory programme to assess firms’ readiness for the RDR.

January 2011