Retail Distribution Review

Written evidence submitted by the Association of Independent Financial Advisers

EXECUTIVE SUMMARY

1. AIFA is fully supportive of the original RDR objectives and the main elements of the reforms. However, the RDR is far from perfect, and there are several improvements which we believe FSA needs to make in order to ensure the successful delivery of the original objectives. Unless these improvements are made there is a real danger that substantial numbers of advisers will leave the market prematurely, meaning that there will be fewer places for consumers to go for independent financial advice in the future.

2. Qualifications

The raising of professional standards is a key element of retaining and building consumer trust in financial services, and demonstration of competence at Level 4 is entirely appropriate in the modern world. We cannot support ‘grandfathering’ on the grounds that thousands of non-independent advisers (young and old, to avoid age discrimination) would by an administrative device be brought up to the level that most AIFA members are achieving through a great deal of hard work. However we are concerned that a fixed deadline for all advisers will cause unnecessary hardship for some advisers and their clients when greater flexibility would not undermine the effect of the reform.

We call on FSA to:

· take a more flexible and pragmatic approach for those advisers who are demonstrating commitment in attaining Level 4 as the deadline approaches.

· make it clear the basis on which they would entertain dispensation requests from advisers for an extension of the timescale to complete their qualifications.

3. Remuneration

AIFA believes that an effective market requires customers to be clear about the services they are receiving and what they are paying for them. However we have two main areas of concern regarding the remuneration changes: if FSA is not highly vigilant about attempts to cross-subsidise advice costs from product manufacturing, banks and other vertically-integrated firms may disguise the advice costs and so undermine the foundations of the RDR; secondly, we are extremely concerned by FSA’s decision to ban the practice of ‘provider factoring’, which we believe is critical for preserving and encouraging a much-needed regular savings culture. In particular we are concerned about the impact on the Group Personal Pension (GPP) market which could cause many employers, who are unwilling to pay a fee for advice, to turn away from offering or developing their staff pension proposition.

We call on FSA to:

· be absolutely clear and public about how it will police its commitment to ensure a level playing field between IFAs and vertically integrated firms on Adviser Charging.

· review its ban on provider factoring and work with the OFT to facilitate a standardised approach.

4. Consumer Access

Whilst consumer access to financial advice is arguably more important than ever before, the RDR has not proposed reforms which will achieve this. It is all very well to make improvements to the quality and professionalism of the advice proposition for those who receive it, but the broader objective should be to achieve the greatest good for the greatest number.

We call on FSA to:

· revisit its original consumer access objective.

· take a much more energetic role in developing a regime which will allow greater numbers of customers to receive cost-effective professional advice.

5. Advice Categories and Labelling

AIFA is concerned that despite considerable endeavours, the division of advice categories and the labelling of those services will confuse customers as to the nature of the service they are receiving. It is also crucial that consumers have a good understanding of what sort of adviser they are engaging with, whether ‘independent’ , ‘restricted’ or ‘basic’.

We call on FSA to:

· provide clarity as to how the new labelling regime will work in practice, particularly the policing and enforcement of the use of the ‘independent’ , ‘restricted’ and ‘basic’ labels

· review its projections for the proportions of ‘independent’ versus ‘restricted’ advisers, with a view to mitigating the risk that the eventual distribution of advisers will be incongruent with the intentions of the labelling distinctions.

6. Regulatory Dividends

The RDR was a prime opportunity for FSA to seek to encourage positive behaviour through providing "regulatory incentives and dividends" for firms who invested in their business and people to deliver the RDR outcomes. Regulatory dividends would provide a clear demonstration of a regulator that wishes to work with the sector to bring about consumer benefit – and this would engender a far more constructive response from the wider adviser community on the RDR as a whole. However the impact of the banking crisis saw the notion of dividends removed, which we believe was an unreasonable response given that IFA firms did not cause the crisis.

We call on FSA to:

· revisit the notion of regulatory dividends which we propose could take the following form:

- A regulatory fee system which favours firms that have invested in compliance and management ability and so pose lower regulatory risks

- Regulatory capital requirements based on a firm’s compliance record and other behavioural indicators. This would see a tangible reward for better run, lower risk, firms.

- Supervisory approach based on intelligent use of the regulator’s data to recognise those firms that pose lower risks than others. This would see low risk firms subject to less intensive scrutiny.

7. Statute of Limitations

The lack of a liability long stop for the industry means that businesses have the burden of making provision within their accounts for the increasing risk of complaints, the cost of maintaining records over a long period, as well as the proposed increases to capital-adequacy provisions.

We call on the Government to:

· consider again the question of a liability long-stop for advisory firms and bring Financial Services in line with the Statute of Limitations.

8. Timescales and Implementation

The RDR is an extremely important and far-reaching reform programme and it must be implemented properly. However FSA has delayed the publication of many of its proposals, including information on the use of platforms, its final professionalism proposals and qualification gap-filling requirements. As a result the final post-RDR ‘landscape’ is still not clear, posing several issues from a firm management perspective. Furthermore FSA has not published an implementation plan nor provided confidence that it has sufficient control over the inherent risks to allow the RDR to proceed on schedule.

We call on FSA to:

· provide clarity for firms on outstanding issues and establish a moving deadline whereby RDR will be put in force only after a reasonable period has elapsed after publication of the final outstanding elements of the rules. Unless FSA proactively demonstrates it has the confidence it can implement the RDR successfully, then we believe FSA should delay it until it has.

· publish an implementation plan which outlines the success criteria, assesses the risks, and sets out the mitigating actions the regulator will take to ensure that the RDR delivers its desired outcomes, while clarifying who will be accountable in the new regime for the RDR decisions that have been taken and the outcomes that will be created as a result.

ABOUT AIFA

9. The Association of Independent Financial Advisers (AIFA) is pleased to have this opportunity to contribute to the Treasury Committee inquiry into the Retail Distribution Review (RDR).

10. AIFA is the representative body for the IFA profession. IFAs account for over 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. AIFA’s role is to work with industry stakeholders and policy makers to bring about a more positive regulatory and business environment for members. It is AIFA’s objective to play a critical but constructive role within the regulation. AIFA is a non-commercial, not-for-profit trade body.

INTRODUCTION

11. AIFA is fully supportive of the original RDR objectives and the main elements of the reforms. When customers see a financial adviser it is entirely appropriate that they should be told very clearly the costs involved and the services they can expect in return, and it is also appropriate that advisers should be competent at a level that commands public trust.

12. However it is fair to say that AIFA’s membership is best described as a ‘broad church’; some IFAs are firmly opposed to the RDR, whilst others believe it should have happened long ago. We have therefore consulted our membership extensively on the RDR over the four year period to ensure we have taken into account our members’ views appropriately and are representing the interests of the profession and the customers it serves. We have conducted research, held working parties and discussion forums, and of course we have considered the complexities of RDR issues regularly in our Council, whose membership is elected from IFA firms of all shapes and sizes.

13. It is this consultation with our membership which has led us to the RDR viewpoint we hold today. This is also supported by independent research which found the substantial majority of IFAs are either ‘enthusiastic’ or ‘willing’ adopters of the RDR requirements, and are actively preparing for the new trading environment [1] . Nevertheless we recognise there are some IFAs who passionately object to the RDR and wherever possible we have incorporated their concerns into our consensus position.

14. The current shape of the RDR is actually considerably better than was originally proposed due in part to the participation of AIFA and other organisations in the consultation process. Early in the RDR consultation it was proposed that payment for advice should be by up-front fee alone, and that the qualification standard for a Professional Financial Adviser should be Level 6. As we know, the final rules allow advisers to be remunerated through the product, and to be qualified at no more than Level 4.

15. However, the RDR is far from perfect, and there are several improvements which we believe FSA needs to make in order to ensure the successful delivery of the original objectives. Unless these improvements are made there is a real danger that a large number of advisers will leave the market prematurely, meaning that there will be fewer places for consumers to go for independent financial advice in the future. This will not deliver FSA’s originally intended RDR outcome of increased consumer access and will also further contribute to the erosion of the savings culture in the UK. The proposed improvements are set out in more detail below.

Qualifications

16. The raising of professional standards is a key element of retaining and building consumer trust in financial services, and demonstration of competence at Level 4 is entirely appropriate in the modern world – an increasing majority of IFAs are either there already or are well on their way. This has been aided by the availability of qualifications based on case studies, such as the DipIP which AIFA has developed with the Chartered Institute of Bankers in Scotland (CIOBS), and which are more suited to the experienced adviser. Work is also continuing to develop qualifications based on practical assessment, but we would encourage the bodies involved to redouble their efforts to reach a conclusion that is both economic and practical.

17. On the issue of ‘grandfathering’, which was debated at length during the consultation period of 2007-9, it is worth noting that the term means different things to different people. However FSA’s definition of grandfathering is to deem someone of a lower qualification level to be at a higher level without any further demonstration of competence. On that basis it would mean that thousands of non-independent advisers (young and old to avoid age discrimination) would by an administrative device be brought up to the level that most AIFA members are achieving through a great deal of hard work. We therefore cannot support grandfathering as we believe it would be unfair to the majority of our members. At a time when we are seeking to improve consumer confidence in our market, it would be difficult to explain to the public how an adviser could be elevated to a higher level of qualification without any further assessment of capability.

18. However we are concerned that a fixed deadline for all advisers will cause unnecessary hardship for some advisers and their clients when greater flexibility would not undermine the effect of the reform. We therefore call on FSA to take a more flexible and pragmatic approach with regard to the deadline for those advisers who are demonstrating commitment in attaining Level 4 as the deadline approaches. The objective must be to ensure that the maximum number of advisers are able to trade at the higher level of competence and this is not best served by simplistic lines in the sand. We believe that FSA should make it clear the basis on which they would entertain dispensation requests from firms for an extension of the timescale to complete their qualifications.

19. There are a wide range of predictions as to the number of IFAs who will exit the industry post-2012 as a result of the RDR, but AIFA categorically believes that FSA is wrong to say that a 20% drop is acceptable. It is incompatible with the original RDR objective of improved consumer access to accept a significant reduction in the number of places that consumers can go for independent financial advice.

Remuneration

20. AIFA believes that an effective market requires customers to understand clearly the services they are receiving and what they are paying for them. This is the foundation of public trust in the advice profession. What Adviser Charging does is put advisers in the position of determining their own remuneration and explaining it clearly to customers. It means they will have to show their customers that the service they are offering represents value for money.

21. However we have two main areas of concern regarding the remuneration changes. Firstly we call on FSA to be absolutely clear and public about how it will police its commitment to ensure a level playing field between IFAs and vertically-integrated firms on Adviser Charging. If they are not highly vigilant about attempts to cross-subsidise advice costs from product manufacturing, vertically-integrated firms may disguise the advice costs and so undermine the foundations of the RDR.

22. Secondly, we are extremely concerned by FSA’s decision to ban the practice of ‘provider factoring’, which we believe is critical for preserving and encouraging a much-needed regular savings culture. Whilst some would have us believe regular savings are inconsequential, ABI figures suggest otherwise. In Q3 2010, new regular premium investment savings and individual pensions together amounted to 14% of the entire amount invested in investment savings and individual pensions.

23. Factoring is the cost-effective way that consumers can receive advice at outset, with the cost spread over a period. It is not practical for an IFA to charge hundreds of pounds up front when the savings plan may be only tens per month, and if the adviser can only recover the cost of his advice over a long period the focus is likely to shift away from serving customers who are seeking regular savings.

24. The Group Personal Pension (GPP) market will be the largest regular premium market impacted by the RDR factoring ban. The impact of banning factoring on GPPs could cause many employers who are unwilling to pay a fee for advice to turn away from offering or developing their staff pension proposition.

25. AIFA feels that there are important parallels to draw from, and precedents set by, NEST. Banning factoring in the GPP market, will mean that the cost of establishing a scheme will need to be paid up front, either by fee or through market solutions such as nil-allocation periods. However, the initial cost of NEST is not being paid upfront by members, instead being paid for by the factoring of the 1.8% on-going charges being taken from all contributions. This is both evidence that schemes prefer to pay for the initial cost of establishment by monthly deductions, and also raises competitive issues between NEST and the wider commercial GPP market.

26. We therefore call on FSA to review its ban on provider factoring, and work with the OFT to facilitate a standardised approach.

Consumer Access

27. The objective of increased consumer access, was fundamental to Sir Callum McCarthy’s vision for a reformed market. It appeared as a key objective in the original FSA discussion document in 2007 and was also the subject of one of FSA’s cross-industry RDR working groups. However it has been dropped from subsequent papers without explanation and no longer features as a key RDR outcome.

28. Given the worrying savings and protection gap in the UK, we believe encouraging people to re-engage with their long term financial well-being should be paramount. Research commissioned for the ABI, and conducted by Oliver Wyman and Co, identified in 2001 a £27 billion p.a. savings gap between what we are currently saving and what we need to save for an adequate income in retirement. A more recent study by Aviva put the figure much higher at £300 billion.

29. Whilst access to financial advice is arguably more important than ever before, the RDR has not proposed reforms which will achieve this. It is all very well to make improvements to the quality and professionalism of the advice proposition for those who receive it, but the broader objective should be to achieve the greatest good for the greatest number.

30. We are also concerned that Hector Sants’ letter of 13th December to the TSC only appears to reference the detriment caused to those who buy unsuitable products, rather than the detriment of products not being bought at all, which we believe should be of equal if not greater concern.

31. FSA’s solution for increased consumer access was Simplified Advice, but it has never got beyond the concept stage and appears to have been side-lined. The cost of developing economical advice solutions in an intensely demanding regulatory environment precludes market innovation and it is essential that FSA should recognise that it has a responsibility to be more proactive in engaging industry stakeholders in the development of an approved model.

32. We therefore wish to see FSA revisit its original consumer access objective – and take a much more energetic role in developing a regime which will allow greater numbers of customers to receive cost-effective professional advice.

Advice Categories and Labelling

33. AIFA is concerned that despite considerable endeavours, the division of advice categories and the labelling of those services will confuse customers as to the nature of the service they are receiving. It is crucial that consumers have a good understanding of who they are engaging with, whether ‘independent‘ , ’restricted’ or ‘basic’. It is worth noting here that in the mortgage market the same labels are due to be applied but with different definitions, potentially adding further consumer confusion.

34. We also need much more clarity from FSA as to how the new labelling regime will work in practice, particularly the policing and enforcement of the use of the ‘restricted’, ‘independent’ and ‘basic’ labels.

35. Additionally, given the changes to the definition of independence, we call on FSA to review its projections for the proportion of ‘independent’ versus ‘restricted’ advisers post-2012, with a view to mitigating the risk that the eventual distribution of advisers will be incongruent with the intentions of the labelling distinctions.

Regulatory Dividends

36. 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 encourage 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".

37. 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.

38. However the impact of the banking crisis saw the notion of dividends removed, which we believe was an unreasonable response given that IFA firms did not cause the crisis. AIFA therefore calls on the regulator to revisit the notion of regulatory dividends which we propose could take the following form:

· Regulatory fees - the new fee system should favour firms that have invested in compliance and management ability and so pose lower regulatory risks to the regulator or their client base.

· Regulatory capital - there is a strong case for the regulator to develop its regulatory capital requirements based on a firm’s compliance record and other behavioural indicators. 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.

39. These are only examples of how FSA could seek to encourage 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 believe progress on this issue of dividends would engender a far more constructive response from the wider adviser community on the RDR as a whole.

Statute of Limitations

40. If RDR is about making the industry work better, and enabling better outcomes for consumers, then the introduction of a 15 year long stop is an issue that needs to be addressed. The lack of a long stop means that businesses have the burden of making provision within their accounts for the increasing risk of complaints, the cost of maintaining records over a long period, as well as the proposed increases to capital-adequacy provisions. Furthermore, the uncertainty generated by open-ended liabilities makes it difficult for firms to be sold and also hinders their ability to attract new sources of capital.

41. Introducing a 15 year long stop would address these issues while bringing financial services into line with the Statute of Limitations. Indeed research we carried out with YouGov showed that the majority of consumers were actually in favour of a time limit for responsibility, with 75% of clients questioning agreeing there should be some time limit for IFAs to be legally responsible for advice given.

42. We believe the introduction of a long stop would be a very positive move for the future evolution of the advice market if it were achieved.

European Agenda

43. 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.

44. However revisions to IMD and MiFID, and the PRIPS initiative are all expected over the coming year, potentially with ramifications for the market. However FSA has failed to articulate how it will account for 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.

Timescales and Implementation

45. The RDR deadline was set early on in the process and it is fair to say a great deal has happened in the intervening period – the financial crisis and the resulting economic fallout, a raft of European legislation, not to mention the election of a new Government, and its proposals to reform the entire regulatory structure.

46. During the four year consultation process FSA has also delayed the publication of many of its proposals. Indeed we are still waiting for further information on the use of platforms, FSA’s final professionalism proposals, and qualification gap-filling requirements. As a result the final post-RDR ‘landscape’ is still not clear. This obviously poses several issues from a firm management perspective, as firms need sufficient time for operational and business planning – which they are unable to do with confidence until they have clarity from FSA.

47. Furthermore FSA has not published an implementation plan and has not provided confidence that it has sufficient control over the inherent risks to allow the RDR to proceed on schedule. The RDR is an extremely important and far-reaching reform programme and it must be implemented properly. The planning, and risk management must be of a very high standard and the industry needs confidence that FSA is proceeding with due control and governance.

48. We therefore call on FSA provide clarity for firms on outstanding issues and establish a moving deadline whereby RDR will be put in force only after a reasonable period has elapsed after publication of the final outstanding elements of the rules. Unless FSA demonstrates it has the confidence it can implement the RDR successfully, then we believe FSA should delay it until it has.

49. Further, we call on FSA to publish an implementation plan which outlines the success criteria, assesses the risks, and sets out the mitigating actions the regulator will take to ensure that the RDR delivers its desired outcomes, in much the same way in which FSA expects the firms it regulates to operate. There should also be greater accountability so that it is clear who is responsible for the decisions being taken and the outcomes that will be created as a result. Bearing in mind the creation of the CPMA from 2013, and the current operation of a shadow regime, it is essential that the industry should also be told who will carry the post-implementation accountability for the decisions that are being made today.

CONCLUSION

50. In summary, AIFA fully supports the original objectives of the RDR and the intended outcomes. However we want to see several improvements to allow these original objectives to be ultimately delivered, namely:

· FSA to take a more flexible and pragmatic approach with regard to the deadline for those advisers who are demonstrating commitment in attaining Level 4 as the deadline approaches. FSA should make it clear the basis on which they would entertain dispensation requests from firms for an extension of the timescale to complete their qualifications.

· FSA to be clear and public about how it will police its commitment to ensure a level playing field between IFAs and vertically-integrated firms on Adviser Charging.

· FSA to re-think the question of provider factoring on regular premiums, including the ban on factoring in the Group Personal Pension (GPP) market, and work with the OFT to facilitate a standardised approach.

· FSA to revisit its original consumer access objective – and take a much more energetic role in developing a regime which will allow greater numbers of customers to receive professional advice at low cost.

· FSA to provide further clarity as to how the new labelling regime will work in practice, particularly the policing and enforcement of the use of the ‘independent’ and ‘restricted’ labels.

· FSA to review its projections for the proportion of ‘independent’ versus ‘restricted’ advisers post-2012, with a view to mitigating the risk that the eventual distribution of advisers will be incongruent with the intentions of the labelling distinctions.

· FSA to make good on its concept of ‘regulatory dividends’ where well-run advisory firms have invested in their business and people to deliver RDR outcomes.

· The Government to again consider the question of a liability long-stop for advisory firms and bring Financial Services in line with the Statute of Limitations.

· FSA to provide clarity for firms on outstanding issues and establish a moving deadline whereby RDR will be put in force only after a reasonable period has elapsed after publication of the final outstanding elements of the rules.

· FSA to publish an implementation plan which outlines the success criteria, assesses the risks, and sets out the mitigating actions the regulator will take to ensure that the RDR delivers its desired outcomes, while clarifying who will be accountable in the new regime for the RDR decisions and outcomes that will be created as a result.

51. There is a great deal more work to do to deliver the RDR vision, but if the above points are addressed there is every reason to believe that Sir Callum McCarthy’s vision could be realised. There is much more consensus on core issues than recent publicity suggests, but that consensus is still looking in the direction of Canary Wharf for further action.

January 2011