The Retail Distribution Review
The Retail Distribution Review (RDR) is one of the biggest changes ever to hit the financial advice industry. Trust and estate practitioners who work with financial advisory firms, or plan to in the future, need to know how the RDR has affected these firms and their services.
The RDR was implemented from 31 December 2012. It was the brainchild of what was until recently the industry regulator, the Financial Services Authority (FSA). The FSA came into being in 2006, and since then the financial advice industry has been in a continuing consultation on the implementation of the RDR and the future of the industry. Throughout the consultation, the overriding objectives of the FSA were to:
- improve the quality of investment and pension advice given to consumers; and
- improve consumers’ confidence and understanding of the advice they are given.
There are many facets to the RDR, but in simple terms it aims to ensure that consumers are offered a transparent and fair charging structure for the advice they receive, are clear about the services they are paying for and receive advice from highly qualified professionals.
Removal of commission
The biggest change for many financial advisory firms has been the removal of commission payments from providers for selling their products. In the past, advisors’ remuneration was frequently decided between the advisor and the product provider, with little or no input from the client. Some providers offered more commission to encourage advisors to recommend their products, often with great success. An advisor might earn an initial commission of 7 per cent of the investment amount for recommending an investment bond,3 per cent for recommending an open-ended investment company or unit trust, and 0 per cent for recommending that their client keep their money in a cash savings account or make no changes. Little wonder that conflicts of interest occurred between what was best for the client and what was best for the advisor.
Advisors are still able to take charges from products, although this is administered in a more transparent way. Alternatively, charges may come from cash accounts or the client simply writing a cheque or paying by direct debit.
Whatever the payment method, the difference is that charges need to be agreed between the client and their advisor, with no input or influence from product providers. The client also needs to sign a fee agreement to confirm that they agree to the charges.
There are some exceptions. For example, commission can still be taken when pure protection products are sold, and execution-only services or discount brokers can still receive new commission payments on non-advised sales.
As a result of the RDR, and particularly because of the removal of commission payments, many financial advisory firms have been forced to change their business models. Greater emphasis must now be placed on providing an ongoing service and justifying charges. Advisors have needed to reassess their service propositions to ensure that what they provide is valued by clients and is also profitable for them. This has affected the services many clients are now receiving.
A less affluent client isn’t going to be in a position to afford a highly bespoke service. Financial advisors, who want to be profitable, have therefore needed to determine whether these clients will be offered a less tailored and lower cost service or, in some cases, no service at all.
This dilemma has led most firms of advisors to segment their client banks, matching each client to the appropriate level of service and, as a result, charges they should pay. Ideally this will mean clients are only offered and pay for the services that they really need and value.
At the end of 2012, the qualification threshold to permit financial advisors to be authorised to give advice was raised significantly. Most advisors appear to have risen to this challenge and have improved their qualifications where needed. However, some had to stop giving advice at the end of 2012, or decided to retire rather than take additional exams.
It is difficult to argue that the higher qualification benchmark wasn’t necessary, particularly as the previous standard was so much lower than that of other professional advisors such as lawyers and accountants. Hopefully advisors will now work towards achieving chartered financial planner or certified financial planner status, if they haven’t already.
It is likely that more advisors will leave the industry even after reaching the higher qualification threshold. This is because the new world of financial advice will require an improved skillset some advisors will struggle to master. Advisors will need greater planning skills and expertise to justify their fees and show clients that they are adding value.
If they can’t do that, their clients will, quite rightly, go elsewhere.
The qualification threshold to permit financial advisors to be authorised to give advice has been raised significantly. Most advisors appear to have risen to this challenge
Of those firms that remain, fewer will be able to offer independent financial advice. In the past, many firms purported to be independent when clearly they weren’t. This may have been because they sold products chiefly from a limited range of providers or did little other than sell their own investment funds and products. The rules over what constitutes independent financial advice have been tightened so that many of these firms must now refer to themselves as ‘restricted’ rather than ‘independent’. This provides clients with greater clarity over the type of advisor they are working with and the type of advice they will receive.
Many firms have chosen not to be classified as independent. Instead, these firms have opted to provide restricted advice, primarily because they don’t wish to meet the more stringent independence criteria as, with additional support from product providers or by focusing on selling their own products, they can operate on higher margins.
Debate continues about whether other professional advisors should be able to refer clients to financial advisors who aren’t independent. It is well known that in the past some have passed clients to financial advisors who are not independent, and today restricted advisors still get many referrals.
The overriding concern for professional advisors must be to ensure their clients have access to the most appropriate advice and service. The RDR will help them achieve that goal if they are referring to, or working alongside, financial advisors. When considering using the services of a restricted advisor, it is imperative to find out why the advisor is classified as restricted, and what impact that may have on the advice provided.
Is everyone a winner?
On the whole, it seems that the RDR has had a positive impact on clients. It should ensure that they receive an agreed level of service, know what they are paying for and how they are paying it, work with better qualified advisors and have a real understanding of whether their advisor is independent and working solely in their best interests, or restricted.
However, not everybody is going to be a winner. Many financial advisors have already left the industry because they have been unable to comply with the RDR criteria, and many others will struggle to earn a livelihood as they now have to demonstrate real added value to clients. Not all clients will benefit from the RDR, either. Many will find it difficult to access good quality independent financial advice in the future. This is because there will be fewer independent advisors and those who remain will focus their activities on wealthier clients. This will mean that those clients with investment assets of less than, say, GBP100,000 could be forced to use restricted advisors, get help or assistance from their bank or use execution-only services.
The situation is similar for other professional advisors, such as lawyers and accountants. Those who have worked with financial advisors in the past, or plan to in the future, may find it more difficult to obtain access to the right independent financial advice for their clients.
The real winners are those financial advisors who offer advice and service that is valued by their clients and for which the clients are willing to pay. Other winners are affluent clients who can afford to pay for good-quality independent financial advice, who can now do so with confidence that their advisor is suitably qualified and acting in their best interests. The final group of winners are other firms of professional advisors who can refer this type of client to this type of advisor. They are safer in the knowledge that they are giving their clients access to the most appropriate financial advice and service.
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