Retail Distribution Review

Written evidence submitted by Peter Falls, Financial Adviser

Synopsis

This report covers the following:

I) Introduction. A general description of my business and how I try to serve a regional middle market

2) Mortgages. These are seen as an introduction to the financial services industry for most people in my client bank. Looks at why mortgages, as the largest expenditure in a vast number of households, if properly managed throughout the term of the mortgage, is of significant important to the clients.

3) Investments and Pensions. In particular stakeholder pensions and NESTS, and why I believe stakeholder pensions have not worked and NESTS will not work either.

4) The Advice Process. This looks at why I think the current advice process is fundamentally flawed and why it needs reformed so that the general public will have confidence in the financial services industry.

5) Conflict of Interest. I strongly believe that the sale of financial services within 2 industries, banks and estate agencies, are in reality conflicts of interest, and this should be looked at in detail by the Financial Services Authority.

6) Examinations and Grandfathering. With some reservations, can understand the need for further qualifications, for older advisers like myself.

7) Other Issues. Debt management and Buy and Rent back. Two areas of interest close to my heart where I think the regulator needs to do more in one case, and has got it wrong in another.

Introduction

This report is a description of my business, how it operates, some of my prejudices and some of things that I feel should be done, to help the general public get a proper service from the Financial Services industry.

My business is office based in Cookstown, Northern Ireland. I have 2 employees, I full time, and I part time and also outsource my reports to a Para planner who works on a subcontracted basis.

For some years now I have operated as a port of call for what would be considered a middle market in the financial services industry. Primarily clients in the socio/economic groups B/C1/C2.

Much of my client bank tends to be the type of client that many IFA's shun, considering them too low value.

In order to service such a client bank two things are needed volume and efficient processing.

For that reason all interviews are held in office, I have long since given up home visits, I work on a principle that my door and my phone is always open to my clients no matter what their concern is.

For obvious reasons most of my work is dealing with mortgages, life insurance, some pension work and some investment work and crucially debt management. Central to my business is that all clients shouId, without having to pay for the facility, be in a position to speak to me regarding any of these aspects of their financial planning.

A cornerstone of my business is that all clients have the right:-

1. Once they come to near the end of their mortgage product, to have their mortgage reviewed free of charge.

2. That those who have investments and pensions have the right to come in as and when they feel like it, but are normally phoned once a year for review to allow them to discuss their investments.

This model sounds simple but needs to be efficient. All report writing and other secretarial work is pushed back to my staff, leaving me free for the advice process.

One of the major downsides of such a business model is that while I may have a turnover of £110,000 to £120,000 per year, costs are high between staff costs, compliance costs and office costs, £80,000 to £90,000 will to be spent on these overheads.

[ believe the model can work, with the proper level of support, for turnovers of up to £200,000 per adviser.

Ultimately if such a business model is to work, it has to be based on integrity and good service. If integrity and good service are adhered to, then profitability will accrue naturally as the need for new products by existing clients becomes apparent.

Such a model, if widespread throughout the UK, would alleviate the need for a simplified advice process to service the mass market, as currently advocated by the British Banker's Association. (See Money Marketing Dec 22010 P21).

The current government has emphasised a fair society and the FSA has spend literally, millions of pounds on a campaign for treating customers fairly. In my view putting in place a simplified service for the so called mass market, is flying in the face of these 2 regimes.

If the bankassurers feel that such customers are not profitable, why do they not refer them out to IFA's like myself, who would be only too glad to take on the business.

Mortgages

Within my business model mortgages are a major door opener. For most people within the socioeconomic groups in which I normally work, the biggest expenditure they are likely to make in their lifetime is their mortgage. The proper management of this loan is a key requirement for their financial wellbeing over the period of the loan. Both in terms of mortgage products and the ancillary insurance products that go with it.

If! place a mortgage I do not charge a fee other than the lenders procuration fee, plus the commission which I receive for the various insurance products. If, by chance, the customer doesn't want to take an insurance product, or I refer the client directly to the lending institution and do not receive a procuration fee, then a fee may be charged. I try to avoid charging upfront fees as this practice, I believe, drives clients to go directly to the lenders, limiting their choice, and pressurising them to take additional services, e.g. a current account to service the mortgage. A current account to service a mortgage should be the free choice of the client, not a prerequisite of the lender.

The service I offer entitles the client to the placing of the mortgage and processing throughout underwriting to the point of offer. Beyond that clients have the right before the end of their mortgage product, be it a fixed, discounted or tracker product, to a full mortgage review. Their ongoing mortgage needs are discussed in detail, whether to stay with the same company and renegotiate a new product or remortgage to another company. Also discussed will be, further borrowing, repaying extra off the loan or changing the mortgage term.

If such a process is carried out over the lifetime of a mortgage, the customer can save thousands of pounds on their mortgage on the one hand, avoid unnecessary hardship in difficult times on the other.

Normally I find that up to 80% of my clients stay with their existing lender and take a renegotiation product.

I will say that the attitude of lenders to advisers like myself varies enormously. On the one hand Progressive Building Society here in Northern Ireland look upon the client as jointly the responsibility of myself and the Society, and will interact with me. They will let me know what the mortgage balance is and exactly when the product is coming to an end. They will allow me to discuss the renegotiation product with the client on a one to one basis and put in place an appropriate product for them. As well as that they pay me a fee for carrying out this work.

On the other hand the major lenders like Halifax, Santander and Nationwide BS tend to have a system where I can only get information on my client's mortgages, by the use of a Letter of Authority, and even then the Letter of Authority has a limited time span. In some cases they will even ask for a fee to disclose the information, which I find absolutely ridiculous.

In such cases, I find it easier to call the client in, phone the lender on an open line in the office, and allow the company to go through security with the client, thus getting the necessary information to discuss the available products with the clients. This way the client gets a proper advised service.

When the customer tries to phone their own lender, they are offered what is called a "non-advised service". Often this leads to an inappropriate product being taken by the client. Many clients do not understand that a fixed rate may offer security; it can come with quite a hefty price tag in terms of either, or both, an arrangement fee or a rate that is substantially higher than a tracker or discount product. Notification of this price variation should be part of the "non-advised service" but as far as I am aware, never is.

The classic example is Mr & Mrs M whose originally mortgage was set up with Halifax, through another broker. When they phoned Halifax in July 2008 they negotiated what was called a staged fixed rate of 5.45% to the end of August 2009,5.95% to the end of August 2010 and 6.55% to the of August 2011. At this point in time they are spending £628 per month on an outstanding balance of £83,000.Foliowing the dramatic fall in interest rates in late 2008, this couple, with proper advice, could have saved thousands of pounds on their mortgage over the last two and a half years.

When I phoned Halifax on their behalf, Halifax view was that if the client paid the redemption penalty of £1,780 approximately upfront, then they would renegotiate down to a tracker rate which would save them approximately £250 per month. As a young couple, with a young family, they simply do not have this sort of money to pay this upfront fee and are forced to pay their existing mortgage through to July 2011, hardly treating customers fairly. Because the house is almost certainly in negative equity they are, in effect, mortgage prisoners and will have to stay with Halifax.

As this product was taken through a non advised service with Halifax, Halifax will not accept responsibility for Mr & Mrs M taking the product.

Such experiences are all too common within the financial services industry and lead to client disillusion with the industry. Mr & Mrs M's experience highlights the need for good quality independent financial advice, not only for the high net worth market but also for the mass market.

How was I paid for my service? Simple... the couple's life insurance products were too expensive, both clients were in good health, I rebrokered their life, critical illness and accident and sickness cover, to other providers with a saving of approximately £25.00 per month and I have earmarked them for a mortgage review in June 2011. A simple straight forward process that works and is proven to work.

I heard a statistic which I cannot verify, that when interest rates fell sharply in the 2008 crash, almost 50% of all mortgages in Britain were on a fixed rate. As a mortgage adviser of nearly 20 years I find that a damning indictment of the industry as a whole, and should not have happened. I believe that fixed rates should only be taken where there is a real danger of unaffordability if interest rates should rise sharply. For most mortgage holders, particularly those whose mortgages have been out for a few years, tracker and discount rates are almost certainly a better option.

Investments / Pensions

Stakeholder pensions by any standard have been an unmitigated disaster and unfortunately the thinking behind these pensions, can be seen from the article which I read in Money Marketing (2 December 2010) where Miss Angela Eagle MP was interviewed, clearly shows why they are a disaster.

Quotation,

"Miss Eagle acknowledges concern over an advice gap left by the RDR but says 'less advertising and more information' on products should reduce the need for advice in the mass market. She says 'if you are operating in a system where greater access to information is being achieved, the requirement for advice on every product would hopefully lessen because people could see clearly what they were being offered and the price of it. I think it was particularly invidious when commission charges and hidden charges were influencing advice or at least colouring it".

Five things stand out clearly from this quotation:-

1) The advice baby is being thrown out with the problematic commission bathwater.

2) Pensions are, by and large, not bought, they are sold. The mass market as opposed to those who are financially astute, simply do not understand pensions, and regardless of how clear the information given on websites and brochures, it is simply not being read by the mass market.

Much of what is written about pensions and investments, as well as decision trees simply goes over the head of those that it is targeted at. In my view, and you will find in the view of most IFA's, decision trees are a total and utter waste of time and government money.

3) If you have to sell pensions then someone has to be paid for selling them. The thinking that by making pensions cheap to the mass market they will be automatically bought is simply wrong, and the lesson of stakeholder pensions verifies this.

For those committing long term to a private pension, their commitment is on a par, in monetary terms with their mortgage. No one would advise a first time house buyer not to take financial advice. Why then, should first time pension buyers be denied advice?

If advisers are needed to sell pensions, and they are, the advisers will have to be paid for selling pensions. Unfortunately the idea of the public writing out a cheque for anything from £500 upwards, to an adviser to set up a pension, simply isn't going to happen except in the high net worth market. The result is that pensions are simply not taken up.

I will go so far as to say that unless NESTS are made compulsory, a very large proportion of the population will simply opt out, whether through the encouragement of their employers or simply through lack of understanding of why the need to buy such products.

An example is Mrs T, who is an employee in Boots and currently has a stakeholder pension with Legal & General, to which she contributes £100 per month. Although educated to third level, she does not understand the policy but felt uneasy that she wasn't saving something towards her retirement and as such agreed to put the minimum into the pension. Even though affordable she can see no reason to increase payments to the policy. This is hardly an example of a decision tree working properly.

4) This brings us to the commission's element of Miss Eagle's statement. The fact remains that most people who come through my door are neither naive nor stupid. They realise that I have to be paid for both my time and my expertise.

If commission, fees and/or client remuneration, regardless of what term you use for such payments, are explained clearly to clients and the level of this remuneration is also explained, clients will understand how I am paid and they accept these charges are necessary for the work that I do.

It may come as a surprise to many within the regulatory framework that the general public do realise that financial advisers are not a charitable institution and need to be paid for their work.

The general public wants as wide a variety of remuneration options as possible as a means of paying for their pensions and investments.

The British taxpayer pays hundreds of millions of pounds to fund the FSA surly it is not beyond this organisation to put in place a regulatory framework to counter commission bias? Or is it?

5) Pensions, as well as mortgages, should be one the largest investments most people make during their lifetimes. The fact that they are not is probably an indictment of the whole financial services industry. For this reason pensions have to be serviced as well as sold.

If we are going to have good pension planning for the mass of the UK public, we have got to have a framework in place that can support them through the long years of saving towards a retirement. The vast majority of the people who come to my door seeking investment/pension advice simply have not got the wherewithal, to put in place a strategy for themselves nor how to manage that strategy going forward.

This is particularly important in times of market stress.

When fund values fall, many clients walk away from their investment strategy through sheer disillusionment. It is very difficult for those who do not have an innate understanding of the markets, to continue funding a pension or regular savings ISA, if the fund value has actually fallen over the previous 12 months, although they have continued to contribute towards it. This is what has happened with personal and stakeholder pensions down through the years, and to maybe a lesser extent with ISA's.

The result is that we have tens of thousands, possibly millions, of small paid up pension pots, lying dormant and grossly underperforming. This is hard earned money belonging to people who have become, simply disillusioned by the pension system.

During times of stock market stress my phone will continuously ring with clients worried about their funds. They need a hand holding exercise where they are told "look, don't panic, you do not need your money now and leave it were it is, it will recover through time". This can never be achieved through the sort of system that Miss Eagle contemplates.

Consider this scenario.

For a high network client assume £60,000+ per annum income, the idea of putting £6,000 gross per annum into a pension then receive a tax deduction of 40%, £2,400, the net loss to their income of £3,600 is unlikely to seriously affect their lifestyle. They are still going to be able to change their car, have an annual holiday etc.

Now consider the same situation for someone on a £20,000 per annum, trying to put away £2,000 per annum. Their position is very different. Firstly they are only receiving a 20% tax deduction i.e. they will invest £1,600 of their £2,000 out of their hard earned salary. That £1,600 can be the difference, if they continue to fund their pension, of having to defer changing the car or defer taking a holiday each year. The saving of 10% out of gross pay, into their pension represents a real struggle, particularly with all other living costs.

Such customers certainly need to know that their contributions will return a long term gain for themselves. In the current pension market that is simply not happening. This government has decided, in its wisdom, that it is going to work towards a flat rate pension of £140 per week, for every individual pensioner. I can only say that it cannot come too soon. The system of guaranteed minimum income has been one of the major disincentives for people in the middle income bracket, saving towards their retirement. Their attitude being, why should I pay towards a pension to simply subsidise what the government is going to give me anyway. All the decision trees in the world won't explain this to those on lower or middle incomes. These people need to know that their money is well spent, and if well invested, will materially benefit them in retirement.

Ultimately for pensions and investments, the advice has to be paid for. In my model I have a set fee which can be paid through commission or by writing out a cheque, the choice is the clients. I also charge a 0.5% trail commission which at this time, allows me then to continue to service the client. When one of my clients phones me I am able to offer them advice and help if needed as well as regular reviews. The model is relatively simple and though time consuming once set up, can be very profitable.

The Advice Process

The major cause of disenchantment with the financial services, by the general public, is in my view, the way regulation has been set up.

It is my belief that the current system of fact finding and report writing, is all about protecting the adviser and the advisory firms, and not about protecting the customers. Put simply, the advice process covers the back of the adviser, which was never its primary aim. Two examples come to mind:

1. Where a client has possibly £100,000 to invest, should that be going into collectives, units trusts, OEIC's or into a bond. If the bond pays more commission then there is always the risk that the adviser will go down the bond route. For an experienced adviser like myself, justifying that bond against collectives is not that difficult, in almost all circumstances. That has simply got to be wrong. It should be possible to outlaw commission bias, without killing product based remuneration.

2. I have seen some work carried out by Alliance & Leicester where the client has been asked to sign a document referred to as: - Personal Financial Review-Important Information followed by the name and address of the client.

This document serves no other purpose than to cover the financial advisers back and has little value in confirming the needs of the client, and for those who may not be reasonably well educated, a difficult document to understand.

There is no doubt that there is a culture whereby clients are asked to sign reports and personal financial reviews. In some instances the information in these documents has been proven to be inaccurate at a later time. This has worked against any complaint the client may have had. Unfortunately it is not that difficult for unscrupulous advisers to have documents signed first and then amended later, this mitigates against the best interests of the clients.

At the heart of financial advice is "Know your client" and this has to be true. The practice of meeting a client for the first time, filling out, fully, a personal financial review and having this signed, and then going off and working out solutions for the client's problems is great in theory but totally absurd in practice. When a client first comes to an adviser they rarely have all the information to hand that is needed. With that in mind at a second interview, new information may come to light, which will change the advice. For that reason personal financial review should be moving documents and the client should not be asked to sign it at any point in time, pre advice is just ridiculous. While the document should be available for the client to view and amend if necessary, it certainly should not have to be signed, as is the request by many compliance departments.

Suitability reports need to be simplified with a basic outline of the client's needs, of the advice given and why it was given. Disclaimers of why other advice wasn't given and technical jargon should be kept to a minimum. As much of this information is usually cut and pasted into reports, making the document so complex, largely nullifying the point of the report in the first place. Risk warnings are usually available on Key Features documents so there is no point repeating them in reports and much of the research should be held on file but shouldn't necessary need to be included on the report as well. It should be available to the client if they want it.

A simple report covering a mortgage and associated insurances can run up to 20 pages which will almost certainly never be read. Complete madness.

Conflict of lnterest

One of the worries I have is conflict of interest. For this reason I do not have a formal agreement with an estate agent, as I always worry that my advice will be in contradiction to what the client is hearing from the estate agent etc.

Some accountants and solicitors would refer cases to me on an ad hoc basis but I do not have a formal agreement and as such I do not pay them any commission or fees.

Three examples clearly come to mind:-

1) A client puts a bid on a house and is accepted. I arrange a mortgage and when the survey is carried out the value is less than that which the client offered. If the client has not been sent to me by an estate agent I simply say to the client, please go back to the agent and renegotiate the price.

If the estate agent has referred the case to me, where do my loyalties lie? With the estate agent, who is trying to get the best price for his client, or with my client the purchaser?

2) A more serious issue arises when the client concerned cannot meet mortgage criteria in terms of income, affordability etc. Pressure inevitably comes on the adviser, by the estate agent, to try to make the client fit the criteria so that a sale can be progressed. This situation should not be allowed to happen.

3) A client has come to me in the recent past and she confirmed that she was asked by a developer, through the estate agent for a non refundable £1,000 deposit. She was then referred on to the in house financial adviser, who discovered, due to a poor credit rating that he was unable to place the mortgage. When she failed to get a mortgage, the estate agent failed to return the £1,000 to her. Because the builder, estate agent and crucially mortgage adviser were all working in tandem, she was not made aware of her rights with regard to her deposit. I felt this was wrong and if the financial adviser had been acting only for the client, she would have been advised to go to the Consumer Council or her solicitor before handing over any money.

Banks

By the same token I feel that this is a problem within the banks.

What banks do best is offer retail banking products, mortgage, loans, credit cards savings/current accounts etc. A conflict can arise when they try to sell other financial services. The problem arises, particularly with investments, when the client needs a truly independent portfolio which should include bank products. How can the included bank products be best advice, if the bank will almost certainly insist on offering fixed term bonds, cash ISA's etc, from its own portfolio?

When the Financial Services regulation was put in place in 1988, financial services were taken out of solicitors and accountants offices. It is my view that the same should have happened with the banks. The banks should be forced to set up independent financial advisory services independent of the bank itself, to which they can refer their own customers and know that that customer will receive independent advice.

Throughout this report I will refer to the Progressive BS, a local mortgage lender here in Northern Ireland, who by some distance I regard as the best lender, in terms of probity and customer service. In their case, while the do not offer an independent advisory service, they refer all their financial services out to a tied Legal & General rep. I have questioned the fact that this isn't actually independent but rather they refer out to a tied agent but I believe that the simple principle is correct. Having spoken to the local Progressive BS manager, Progressive BS has no input into the advice that will be given by the Legal & General rep.

It is up to the banks in this position to make the system profitable.

Examinations and Grandfathering

Someone like me at age 59 is going to find it difficult, but will have to eventually sit the exams as necessary. I can completely understand that there is a perception that financial advisers are poorly trained and poorly educated. It is important that we are not only seen to have a level of expertise through what we do in our everyday life but also in terms of the qualifications of which we hold.

For this reason I am of the opinion that we are better to stay with the present requirement that we move towards Q4 level for all financial advisers. I will suggest that possibly a longer time frame was put in place, possibly one if not two years extra, to allow for the uncertainty that has occurred in the previous 2 years over RDR.

RDR is by and large a good idea; it did need to take place. I do feel that much of the thinking behind it has been put in place through centralised government thinking and with little input from people like myself, and those out on the coal face where we are meeting individual clients on a daily basis. We probably have a much better understanding of what the man or woman in the street needs from a good quality financial services industry.

Other Issues

Debt Management

I see debt management as a crucial part of any advisory service but at the moment it is not regulated.

The problem as I see it is the thinking is that anyone who gets into trouble with debt through banks, private loan companies etc, should go to their Citizens Advice Bureau who will offer them what is considered a free service. I think this is simply wrong.

Those responsible to a greater or lesser extent for an unmanageable debt, on the one hand are the lenders and on the other hand the debtor. As such they should have to pay for clearing up the mess, not in these stricken times, the hard pressed tax payer. Surely it is not beyond the remit of the FSA to regulate debt management companies, whereby their charges are made transparent and those of us in the financial services industry can refer cases that come across our desks to them, in the knowledge that everyone is singing off the same hymn sheet.

Buy and Rent Back Schemes

Such schemes have been taken under the wing of the FSA. I have got say that where this simply was a problem and needed regulation, the standard of regulation seems to be so onerous that no one is now prepared to offer this product.

There is no doubt that a well constructed Buy and Rent Back contract has a lot of advantages for both the landlord and the tenant. There are quite a few cases whereby this type of arrangement could stop repossession if properly carried out. Unfortunately here in Northern Ireland the regulations are so onerous that no company at this time has been able to register.

When I speak to the companies who were initially considering setting up, their attitude was that the regulation was so onerous, that they have simply walked away from it.

Surely a case of over regulation killing off what was probably a good idea.

January 2011