Retail Distribution Review

Written evidence submitted by the Financial Services Practitioner Panel

Introduction

1. This evidence is from the Practitioner Panel, a body set up under FSMA 2000 as an independent Panel to represent the interests of practitioners to the FSA. Details of the role and remit of the Practitioner Panel are at Appendix 1.

2. The Committee has asked for evidence on the basis of whether the RDR will achieve the stated outcomes from Hector Sants on 23 November, and whether the outcomes could be achieved in other, potentially better, ways.

3. Soon after Callum McCarthy initiated the RDR, the FSA announced five priorities for the RDR in November 2006, as follows:

· The sustainability of the sector

· The impact of incentives

· Professionalism and reputation

· Consumer access to products and services

· Regulatory barriers and enablers

We are concerned that Hector Sants dropped the principles of sustainability of the sector and consumer access to products and services when he stated the priorities to the Treasury Committee. These two priorities should be seen as crucial elements in the mix if the aim is to achieve an advice system that works for consumers and firms in the future.

4. The Practitioner Panel has been supportive of the original aims of the RDR, and has worked with the FSA and the other independent Panels to try to shape the RDR in a way which will be achieve all of the original priorities – including the first original objective to maintain the sustainability of the sector.

5. We wholeheartedly support aims in the RDR to achieve a better qualifications framework, transparent and fairer charging, and the raising the quality of advice. An increase in the savings culture, with better access for more consumers, will be to the benefit of consumers and firms alike.

6. However, we have expressed increasing concern at the way that the original aims of the RDR are being implemented. We believe that, although there was much debate in the early stages of the RDR, there needs to be further consideration of the wider impact of these changes now that the detailed proposals have been developed. Just as the FSA has now agreed to undertake a wider cost benefit analysis (CBA) on the Mortgage Market Review (MMR), we believe a similar CBA should be undertaken for the RDR to look at the wider impact of the RDR. Such a CBA should investigate the cost of a fundamental gap emerging for lower income consumers who cannot afford to pay for advice. Our view is that unless a clear system for simplified products and advice is developed, the RDR could end up leaving a large proportion of people worse off, with less access to advice and so saving less and ultimately costing the government and society more to support as they reach retirement.

7. We are pleased the Government is committed to seeing " a thriving and trusted financial services marketplace, where consumers can buy the products they need with confidence." [1] However, the RDR may well undermine that ambition by destroying large parts of the current advice network.

8. Our evidence will focus on the three key questions which we believe the Treasury Committee need to ask the FSA in relation to the plans for implementation of the RDR.

Question 1 – will there be significant consumer detriment?

9. The reduction in access to advice with the FSA’s "one size fits all" approach is something which the FSA seems to have dismissed as a necessary and affordable cost. However, we believe that the wider economic and social implications are significant: Hector Sants talked of a loss of 20% of the 25,000 advisers. If each adviser serves an average of 200 clients, that is one million people who will potentially lose their existing adviser. There are also indications from the experience of other countries, that there could be a second wave of losses of advisers, as a proportion of advisers make the necessary changes and then find a year or so down the line, that their business is not able to survive.

10. If you add to this that the FSA’s Deloitte [2] research showed that those advisers which are left will serve fewer clients on a fee basis than commission basis (on a ratio of 80:230) there is a potential for massive diminution in the savings culture in the UK. The following quote from the Deloitte report emphasises this point: "The business model for the fee-based firms tends to involve fewer, more lucrative customer relationships than commission-based firms. The business model for the commission-based firms involves a larger number of customers, typically with lower incomes than the customers of fee-based firms."

11. It is particularly the case that middle and lower income consumers will lose out, and this is likely to be for a wider basis of products than just investments. Financial services firms such as banks and building societies may currently offer access to commission based advisers for their customers. The RDR, in stopping access to commission based advice on investments, may well make it not viable to provide such advisers for customers, as the business model becomes too complicated for low premium investment products. This may also have a knock on effect to advice on life cover or critical illness cover which is currently offered through the same advisers, but may not be economically viable without the investment sales at the same time. The FSA’s Deloitte report highlights the cross-subsidy role: "Commission-based firms appear to be more willing to cross-subsidise within the business. In particular, they are more likely to take on and maintain relationships with clients they consider to be unprofitable, partly in the hope that they will become profitable in the future. Compared with a typical fee-based firm, a typical commission-based model appears to build a larger number of relatively low-value relationships on a speculative basis, in the expectation that some will go on to become profitable in the future."

12. We believe that there must be a stronger lead from the FSA, and ultimately the CPMA, in setting the regulatory context for simplified advice. Simplified advice is the means by which consumers may be able to access financial advice at a basic and cheaper level – which may well be more suited to the consumer’s interest and ability to pay than the full level of independent financial advice. The Government has recognised the need for simple financial products in its recent consultation. It also acknowledges that "marketing and branding will be critical in ensuring sufficient demand from consumers for simple products." [3]

13. The FSA and Government have said that the industry should develop its own means of providing simplified products and advice, but there is a need for a regulatory lead for a number of significant reasons:

· It is not appropriate for the industry to develop its own solutions in the present regulatory environment – the current rules are too onerous and complicated to be able to deliver low cost simplified advice. It would be a waste of time, and a huge drain on FSA resources, to cope with hundreds of individual firms coming to it with their own ideas of simplified advice, and asking for regulatory discussions. We need leadership from the FSA, or a possible delay until the CPMA can provide that leadership;

· It is the regulator that needs to set out the track along which firms developing simple products or giving simplified advice must travel. Product providers need to have some outline guidelines before being able to develop simple products. In particular, there needs to be regulatory certainty that if products are developed within agreed criteria, there will be no retrospective regulation to take previously "simple" products out of that range. For advisers, there needs to be an agreed outline of questions within a decision tree that would allow a simplified advice facilitator to advise on the purchase of a product, or to direct the customer to a more qualified adviser if it turned out to be a more complex case.

· Urgent parallel action is required for the development of simplified advice to minimise the consumer advice gap and to cut off a route for some advisers to specialise in one area of simplified advice rather than take the more complex whole of market option under the RDR. We remain in constructive dialogue with the FSA on simplified advice. We are optimistic in the light of recent feedback from the FSA, and will continue to encourage them to undertake further work in this area.

14. The FSA needs to develop a clear regulatory regime to allow simplified advice to be given within agreed criteria, which if followed, will not risk a future change in the regulator’s interpretation of the rules leading to a systemic review. Simplified advice should enable many more people to access financial advice, and many more advisors to remain in business – specialising in certain aspects of the market.

Question 2 – will the RDR cause a disproportionate increase in cost and bureaucracy?

15. At the moment, it seems that the RDR is in danger of increasing the cost and bureaucracy of giving financial advice without any commensurate benefits.

16. Firstly, in the area of professional standards we have particular concerns:

· The strict cut off timescale will cause many advisers to have to leave the market. However, those advisers who do not want to qualify to Level 4 might be able to stay in the industry if the FSA was willing to develop simplified rules for simplified advice, which should require a lower level of qualification. This would enable a simplified advice "facilitator" with a lower minimum qualification level to provide simplified advice in certain restricted areas at a lower cost;

· The proposed CPD (continuing professional development) requirements are inflexible and inflict overly burdensome requirements on larger firms which have a strong internal training culture. The FSA seems to be applying new requirements across the industry with no flexibility to reflect the range of different firms covered by the requirements. We would like the FSA to consider granting permission for relationship managed firms at least, to oversee their advisers’ individual CPD as part of an accredited scheme, as is the case in legal and accountancy professions. The current proposals refer to accredited bodies checking the CPD of 10% of advisers, but in firms which have a strong internal training culture and have built their reputation on quality of service, they will already be monitoring 100% of CPD. This re-checking of firms which can prove their training and CPD is at the required standards should not be necessary if firms can be monitored through the ARROW process.

17. We are also increasingly of the view that the rises in capital requirements are unnecessary at this time of change and could make advisory firms more unsustainable as they have to keep larger amounts of capital in reserves. We do not believe that anyone has made the case adequately for why the capital requirements need to be increased for advisory firms, who are not in the same position as deposit takers who hold systemically significant levels of client money. We have not seen a convincing cost benefit analysis for this change. Whilst the Panel is supportive of ensuring firms have robust capital positions, we believe that , in the light of the proposed changes to business models and working capital arrangements under the RDR, as well as current economic conditions, these changes in capital requirements may be too much pressure on advisory firms at this time.

18. The biggest regulatory cost for industry is regulatory change. It is only recently that the FSA’s initiative on Treating Customers Fairly has become fully embedded in the industry, at huge cost to firms. Many of the concerns that the FSA is seeking to address in the RDR, in terms of fairness of charging and clarity of advice, could well be tackled with full application of TCF.

Question 3 – how will success be measured?

19. The FSA has assured us that criteria have been set for a post-implementation review of the RDR after 2 years. However we have challenged the FSA that there does not seem to be a clear definition of success baseline from which success will be measured, nor any analysis of the risks involved. The FSA has said [4] that the costs to the industry could be up to £1.7bn over 5 years, and we have said that there need to be more quantifiable success measures from the FSA. We have said that success measures such as "less unsuitable sales" are unclear and could well be misleading.

20. It seems also, that the FSA is adopting an "all or nothing" approach to the RDR. Current estimates range from a loss of 8% to 40% of advisers, and yet the FSA does not have a formal means of monitoring the level of departures caused by the RDR as it is implemented. In addition, the FSA does not seem to have developed any contingency plans for changes to the RDR, should the highest level of destruction start to take place.

21. We have also expressed concern about whether the means of implementing the RDR is being measured against the criteria of the CPMA as well as the FSA. This is necessary to ensure that accountability will be maintained in the new regulatory body, and it will not be subject to significant changes once the CPMA is in charge – with the industry expected, yet again to bear the cost.

Conclusion

22. We believe that the overall aims of the RDR are to be applauded, and we have supported the development of this programme. However, it is the detail and the timing of implementation which is problematic.

23. In the RDR, the FSA is continuing to propose significant structural change in the retail market when the CPMA will shortly take over control. It would seem more cost effective for all to wait at least until the chief executive of the CPMA is appointed and the objectives of the CPMA are clarified by the Government. This is particularly as there are also changes currently being implemented in the European regulatory structure, and there is a background of an uncertain economic environment.

24. We recommend that sustainability of the sector be given greater priority in the further development of the RDR, and that a system for the regulation of simplified advice be developed as an integral part of the RDR. A wider cost benefit analysis (CBA) of the whole of the RDR at this stage – similar to the CBA being undertaken for the FSA’s Mortgage Market Review – would highlight the need for these aspects to be taken into account.

25. We recommend that there are issues which should be urgently addressed before the implementation of the RDR. A delay in implementation would also allow the RDR to be aligned with the new UK regulatory structure, the European changes to be fully implemented, and firms to have more time to plan for the changes required to the shape of their business and the qualifications required.

January 2011

APPENDIX 1

ROLE AND REMIT OF THE PRACTITIONER PANEL

1. The role of the Practitioner Panel is to advise the Financial Services Authority on its policies and practices from the point of view of the regulated community. It has statutory status under the Financial Services and Markets Act 2000 (FSMA). As such, the Practitioner Panel is given access to the FSA’s plans for new regulatory policies, and so is able to provide an important sounding board for the FSA before the ideas have been made public.

2. Members of the Practitioner Panel are drawn from the most senior levels of the industry, with the appointment of the Chairman being formally approved by the Treasury, to ensure independence from the FSA. The members are chosen to represent the main sectors of the financial services industry as regulated by the FSA. The Panel currently has senior practitioners from the retail and investment banks, building societies, insurance companies, investment managers, financial services markets, custodians and administrators.

3. The Chairman of the FSA’s Smaller Businesses Practitioner Panel (SBPP) sits ex officio on the Practitioner Panel to ensure co-ordination, but debate on issues specifically affecting smaller firms are covered by that Panel. The SBPP is submitting separate evidence to this Inquiry.

4. The names of the members of the Practitioner Panel as at 10th January 2011 are as follows.

Panel Member Position

Iain Cornish (Chairman) Chief Executive, Yorkshire Building Society

Richard Berliand Head of Global Cash Equities & Prime Services, JP Morgan Securities Ltd

Russell Collins Head of Deloitte UK Financial Services Practice

Mark Hodges Chief Executive, Aviva UK

Simon Hogan Managing director, Institutional Equity Division, Morgan Stanley

Garry Jones Group Executive Vice President & Head of Global Derivatives, NYSE Euronext

Roger Liddell Chief Executive, LCH.Clearnet Group Limited

Guy Matthews Chief Executive, Sarasin Investment Funds

Helena Morrissey Chief Executive Officer, Newton Investment Management

Andrew Ross Chief Executive, Cazenove Capital Management Limited

Malcolm Streatfield Chief Executive, Lighthouse Group plc

Paul Swann President and Chief Operating Officer, ICE Clear Europe

Doug Webb Chief Financial Officer, London Stock Exchange Group

Helen Weir Group Executive Director Retail, Lloyds Banking Group plc