Retail Distribution Review

Written evidence submitted by the Smaller Businesses Practitioner Panel

INTRODUCTION

1. The Smaller Businesses Practitioner Panel was set up by the Financial Services Authority in recognition of the need to have a specific Panel to represent the interests of smaller firms to work alongside the Practitioner Panel and Consumer Panel. More details of our role and membership are at Appendix 1.

2. We have supported the principles of the RDR overall, but soon after the RDR was launched, in November 2006, the FSA set out five themes for the RDR [1] as follows:

· the sustainability of the distribution sector;

· the impact of incentives;

· professionalism and reputation;

· consumer access to financial products and services; and

· regulatory barriers and enablers.

3. We are increasingly concerned that Hector Sants narrowed these objectives down to three in his previous evidence to the Treasury Committee. This effectively excludes the objectives of sustainability of the sector and consumer access to products and services. We believe that all these objectives must be taken into account. The detail of how the RDR is implemented is vital for the small firms sector – around 6,100 small firms hold permission to conduct RDR related activities within the retail sector (approximately 42 % of the small firms population); around 4,900 of these are Financial Advisers. (These figures are indicative only, and are used to illustrate the significance of the RDR to small firms within the industry.)

4. There is much evidence to show that people tend to be reluctant to save significantly for the future, so the majority of investment products need to be sold rather than bought. This means that if access to financial advice is reduced, many people will have even less provision for their own financial affairs going forward than they currently have.

5. The key is for the RDR to be used as an opportunity to improve the system of providing advice in a way which is sustainable for the industry. We believe that this means providing greater clarity, transparency and accessibility for consumers, whilst ensuring that firms have clear regulatory boundaries to provide different levels of financial advice. However, the RDR, whilst addressing some flaws in the current system of financial advice is also likely to introduce real consumer detriment with some sections of society. We have asked for the FSA to articulate their vision of consumer access to financial advice in the UK. To date the FSA has not provided this. Neither have they quantified the specific success measures from the current position. If this is not possible, the FSA should at least undertake a cost benefit analysis of the impact of the proposals as a whole to see the overall impact, not just on the financial services system, but on the wider community and people’s access to advice and decisions to save.

6. We have set out our views from the perspective of smaller firms on the two missing additional objectives, plus the objectives as listed by Hector Sants and required by the Committee below.

CONSUMER ACCESS TO PRODUCTS AND SERVICES

7. We believe that the RDR in its current form is in danger of reducing access to financial advice for the majority of consumers.

For middle and higher income consumers

8. Independent financial advice is currently focused on middle and high income consumers. The proposals under the RDR to charge fees without commission payments means that full independent advice will increasingly focus on high income consumers rather than middle income consumers. These middle income consumers ,will not have high enough levels of investments to justify full independent advice on a fee basis, even through adviser charging. This could disenfranchise a significant proportion of consumers.

9. As a result of a combination of the move to fee based models, the higher qualifications, and the increased capital requirements, the FSA has acknowledged that this will lead to a reduction in the number of advisers in business. Hector Sants said a loss of 20% of the current 25,000 advisers would be, ‘acceptable’. However, if each adviser serves an average of 200 clients, the result is one million people potentially left without an adviser.

10. It has been suggested that the loss of 5,000 advisers would not be a problem as their customers will immediately be taken on by the remaining advisers. There is reason to challenge this assumption. The advisers who are left are likely to serve a smaller number of customers with the increased customer expectations when moving to a fee-based model. The greater time commitment per customer significantly reduces the number of customers that can be served by each adviser. This is supported by the FSA’s own research (conducted by Deloitte) which shows that fee-based advisers are only able to serve a third of the customers a commission-based adviser. (80v230). This, in numerical terms is potentially another 3m of customers who would be left without an adviser.

11. The RDR seems therefore to be only addressing part of the market: there must be a means of encouraging the provision of financial investment advice to middle and low income consumers as well as high income consumers.

For low income consumers

12. Research [2] shows that low income families - due to a variety of issues, including low financial capability, mistrust of the financial services industry and the view that mainstream providers "are not for them" - do not purchase financial products in the same way as the more affluent sections of the population. Those on low incomes will also not engage in the low cost web based distribution systems that are attractive to more affluent sections of society.

13. Examples of this can be seen in the low take up of the Child Trust Fund in the less affluent areas of the UK, which illustrates the point that even "free money" is shunned by those on low incomes unless they are given advice on the product and encouraged to participate. Regulatory measures can have a severe impact on this sector - the regulatory and competence requirements introduced by the PIA in the 1990s effectively destroyed a whole sector as the Home Service companies left this market. This meant that low income families were no longer able to purchase protection and savings products from a competitive market which had many providers. It is no coincidence that since that time the discussion on financial exclusion has escalated.

14. By significantly increasing the cost burden, the RDR is in danger of destroying the current network of mutuals that gives financial services’ access to a whole sector of society. Other providers will not fill the void for low income saving because the profit from small premium business is too low for their business model. In the absence of any alternative, those on low incomes will be permanently excluded from purchasing affordable financial products.

SUSTAINABILITY OF THE SECTOR

15. We believe that the RDR must consider the sustainability of the sector in developing its detailed proposals. This objective must not be dropped, as threats to the sector directly threaten consumer access. It is not only higher income consumers who will suffer if advice is restricted through the RDR – the market has developed to enable mutuals to provide lower income consumers with advice on saving or managing their money through commission, and this sector will be unsustainable under the current proposals.

Impact of fee-charging

16. Many independent advisers will not be able to survive a switch to fee based advice, simply because the business model will become more complex and expensive.

17. So advisers will find that their businesses are unsustainable, and leave the industry. In addition, the smaller number of advisers that may be left could suffer significant additional financial pressures that may well lead to a second tranche of advisers leaving the industry at a later stage. The RDR is also likely to impact on the diversity of the industry, as it becomes more and more difficult for small firms to survive, leading to conglomeration and a dominance of larger firms, to the detriment of consumer choice and flexibility.

18. As the numbers of advisers decrease, there will be more pressure on those that are left in supporting levies for the regulatory system, particularly the FSCS, so causing more firms to come under financial pressure and increasing the general cost and yet further restricting consumer access.

19. In addition, according to HMRC [3] , 50% of the population own less than £37,283, including their homes (50% of the population have Net Capital of £37,283 or more). In addition, Ernst & Young’s paper ‘2012 – Going for gold?’ said that "mass market research has found an individual earning around £22,500 per annum (the average national wage) has net monthly income of about £1,400 per month and outgoings of £1,388." These people might be less incentivised to seek advice if they know the adviser will charge a fee, even if it can be paid through adviser charging.

Impact of increases in capital requirements

20. The proposed increases in the levels of capital requirements for firms at the same time as the RDR will cause significant additional pressure on the sustainability of firms in future. The plans are for the minimum level to be increased to £20,000, or the amount needed to cover three months’ running costs – whichever is the larger. These costs will increase for the advisers who are changing their business models from commission to fees, as the fixed cost salaries are likely to increase significantly. So the very advisers who are adhering best to the RDR are likely to be hit hardest by the increases in capital requirements.

21. Although the FSA seems to be expecting new and better qualified advisers to come into the market to fill the gap left by those departing, these increases in capital requirements will make it difficult for new entrants. Unlike in other areas of business, the FSA’s rules forbid firms from borrowing or factoring to cover requirements for reserves. So, start up firms will have to find at least £20,000 of capital, in addition to all working capital, before they can be authorised. We believe the planned increase in capital requirements will be a significant barrier to entry for new firms.

22. The changes to capital requirements seem to be an example of the FSA’s tendency towards a "one size fits all" approach to regulation. We have yet to see a justification for why the FSA needs to see the capital levels to be able to cover the orderly run off of an advisory business as opposed to a deposit taking business. The FSA should only be concerned about consumers and their ability to claim for compensation if necessary, and this is already covered by the FSCS. Instead it seems the FSA is applying a response to the financial crisis which was necessary in other sectors to a sector that was not responsible for the problems in the crisis. The main result of this will be to increase the scope of consumer exclusion as many firms struggle to maintain the higher capital requirements.

TRANSPARENT AND FAIRER CHARGING SYSTEM

23. We fully support the original aim of the RDR to provide transparency and fairness in the charging system. However, we are concerned that plans to introduce adviser charging do not provide a fairer solution for consumers who may not have the cash flow to pay fees up front. We think that fairness and transparency can be achieved just as well by consumers being fully informed of the cost of their advice, and the fact that this charge will be covered through commission. Consumers can then see how much the advice is costing, and how much the product provider is paying to enable their product to be sold.

24. We also continue to be concerned that the UK is moving ahead of the rest of Europe and may be going in a different direction, at a time when European legislation is increasingly tending towards maximum harmonisation in the implementation of directives. There is a very different model in Europe, with distribution dominated by larger banks and insurance companies and no significant equivalent of the smaller firms and diversity which is prevalent in the UK. It is therefore conceivable that those larger firms will dominate decision making in Europe, and future European requirements may cause the UK to dismantle the RDR’s changes, with significant costs to the UK financial services industry.

A BETTER QUALIFICATION SYSTEM FOR ADVISERS

25. We support the ambition of increasing the professionalism of financial advice. However, we believe that qualification requirements should be appropriate and proportionate to the advice being given.

26. Essentially the RDR qualification requirements - set to cover complex investment vehicles - will significantly increase the training costs and salaries of the new ‘league of advisers’ such that product providers in this market sector will not be able to distribute and advise on these small premium products because the regulatory overhead will be too high, unless they are stakeholder products through basic advice. We believe that the qualification requirements of the RDR will add no value at all to those on low incomes. The current diploma syllabuses contain many requirements which are irrelevant to the needs of those on low incomes. It is difficult to understand how the attainment of the full diploma for advisors operating in this market sector would either help the advisor do a better job, or the low income consumer get better advice.

27. It is also the case that many on middle incomes may require advice on a specific aspect of their income or investments, and may want to restrict the advice that they pay for to just that area. We believe that if the FSA had clear rules on the liabilities for restricted advice, many advisers could specialise in particular product areas. These advisers may have only a basic knowledge across the market, but then specialise in a particular sector and provide full independent advice in that one sector such as pensions.

28. We believe that the FSA must retain a more flexible system of qualification of advisers under the RDR – just as all consumers are not the same, so not all advisers should be the same in having to offer a full and expensive service. There is an urgent need for the RDR to recognise the variations needed in developing its detailed proposals.

GREATER CLARITY AROUND THE TYPE OF ADVICE BEING OFFERED

29. All people, at whatever level of income and investment, should have easy access to fair and not misleading financial advice. The FSA needs to ensure that the RDR achieves a level of distribution at a price point which gives good value for the customer.

30. Many of the concepts being developed in the RDR are already incorporated in other aspects of FSA regulation. In recent years, the FSA and the industry have spent significant resources and money in embedding the regulatory principle of "treating customers fairly" (TCF) into their organisations. The results of this regulatory work have yet to be fully assessed and yet we are embarking on another significant regulatory change trying to achieve similar objectives.

CONCLUSION

31. The future of financial advice is important to consumers and to the industry. The RDR is being developed in a disproportionate manner. It deals with some of the current issues in the retail financial sector, but does nothing to create an improved regulatory environment to meet the needs of consumers; indeed consumers will be disadvantaged as a consequence of these changes. There must be a parallel development of a system of simplified advice and products to provide financial advice which is simpler and cheaper to deliver and more targeted to customer needs.

32. The RDR is being implemented at a time when the objectives of the regulation of retail conduct are to be changed with the creation of the CPMA. We believe it would be much better if the new CPMA objectives could be set and checked with the RDR before the requirements of the RDR are finalised.

33. We believe that the current proposals are a "one-size fits all" to both qualification requirements and provision of services that will lead to the further exclusion of the majority of the population and lead to a large number of experienced and competent advisers losing their livelihood, at the expense of consumer access and at the very real risk of yet further exclusion when we as a society need more people to save, not less. The fact that the FSA has recently announced consultation [4] on excluding certain product types suggests an acknowledgment that ‘one size does not fit all’ and we would ask that this be reflected in a much wider reconsideration of the RDR, rather than just excluding a small number of products.

34. Our headline suggestions for amendments to the RDR are as follows:

· The FSA should take the lead in setting out a clear regulatory environment to enable the creation of simplified products and the provision of simplified advice for those products within the same timescale as the rest of the RDR.

· There should be a delay in the RDR to allow the simple products regime to be developed, a broader cost benefit analysis of the whole of the RDR to be carried out, and for the CPMA objectives to be set and checked against the expectations of the RDR.

· Professional qualifications should be set at different levels to reflect varying consumer needs and that enable simpler products to be bought without significant regulatory overlay.

· There should be a further delay in the deadlines for any higher capital adequacy requirements linked to the RDR. The FSA needs to provide a better justification for the increased level of requirements to ensure that it is relevant to advisory firms. At the same time, businesses need to embed their new business models (which are likely to provoke cash-flow uncertainty) before having to adhere to more rigorous capital requirements, if justification is forthcoming to keep these requirements applicable.

January 2011

APPENDIX 1

ROLE AND REMIT OF THE SMALLER BUSINESSES PRACTITIONER PANEL

1. The Smaller Businesses Practitioner Panel (SBPP) was set up by the Financial Services Authority (FSA) to represent the views and interests of smaller regulated firms and to provide advice to the FSA on its policies and strategic development of financial services regulation. 

2. Our members are drawn from smaller firms operating across the main sectors of regulated business.

3. We consider several factors when deciding on the definition of "smaller" businesses and take a flexible approach to the application of criteria.  A firm may have – in relative terms – a minor market share or small number of employees in the context of its industry sector.  In addition, the firm’s financial position and whether the firm is owner-managed may be relevant.

4. We work to ensure that the interests of smaller financial services firms are taken into account and their importance to a healthy, successful and vibrant marketplace are properly reflected in the policies of the FSA.

5. The names of the members of the SBPP as at 17 January 2011 are as follows.

Panel Member Position

Guy Matthews Chairman Chief Executive, Sarasin Investment Funds

Clinton Askew Director, Citywide Financial Partners

Ian Dickinson Director, The Brunsdon Group

Paul Etheridge Chairman, The Prestwood Group

Peter Evans Chief Executive, Police Credit Union

Sally Laker Managing Director, Mortgage Intelligence

Fiona McBain Chief Executive, Scottish Friendly Assurance

Andy Smith Special Projects Advisor, TD Waterhouse UK

Ian Templeton Managing Director, UIA (Insurance) Ltd

Andrew Turberville Smith Chief Operating Officer and Finance Director, Weatherbys Bank Ltd