Brave New World

IN HIS now infamous speech to the Gleneagles Savings & Pensions Industry Leaders’ Summit in Scotland in September 2006, former UK Financial Services Authority (FSA) chairman Sir Callum McCarthy argued that the business model of the UK retail financial advice market was broken.

The status quo was not working in the best interests of consumers, manufacturers or intermediaries, Mr McCarthy said.

In presenting his case, the former Barclays Bank CEO drew on a historical analogy with which all Australians will be familiar. “In the 18th century, we exported our criminals to Australia and paid on the basis of every convict shipped aboard at the quayside at Bristol or London,” he reminded the audience of British financial services luminaries.

“On average, 12 per cent of those who were shipped aboard in Britain died en route; on some voyages more than one in three of those shipped died before reaching Australia.

“In 1792, the system was changed: shippers were paid for every convict delivered alive in Australia, rather than shipped aboard in Britain.

“In 1793, three convict ships sailed to Australia transporting 422 convicts, of whom 421 were delivered alive – a mortality rate about 1/50th of what had previously occurred. The new reward structure produced immediate and dramatic change.”

His point was that government intervention through legislation, coupled with a sound incentive structure, was a combination that produced results.

And so Australia’s foundational story featured in the speech that would serve as the foundation for the overhaul of the British financial advice industry, culminating in the Retail Distribution Review (RDR) reforms which came into effect in January 2013.

But the links to Australia do not end there. The UK regulations closely mirror, in both wording and intent, the Future of Financial Advice (FOFA) reforms that have just come into effect here. Six months on, the RDR has left an indelible mark on the UK financial advice industry.

This report looks at the similarities and differences between the two pieces of legislation, and the two markets on opposite sides of the world, to investigate whether Australia can expect a similar outcome.

Common law cousins

In the development of its legislative culture, Australia has often taken cues from its former colonial master.

Financial services regulation is no exception. At their core, both the RDR and FOFA seek to regulate the remuneration and distribution structures of the respective retail financial advice markets in a way that policymakers deem conducive to enhanced consumer protection. According to The Guardian newspaper, the objective of the RDR was to “raise professional standards in the industry, introduce greater clarity between the different types of service available and make the cost of advice very clear”.

Like FOFA, the practical corollary of this objective has been to do away with product commissions. The move to a fee-for-service remuneration model – which the British refer to more quaintly as a “customer-agreed-to” model – is the central implication of both reform agendas. Both are clear in their intention to ban conflicted remuneration and to make any product commissions earned from new advice clients unlawful.

On this key objective, the two are virtually indistinguishable.

Both reform packages also addressed the issue of an adviser’s fiduciary duty and disclosure requirements, though this is where the UK and Australian incarnations – at least from a purely theoretical perspective – start to differ.

While both stipulate a type of best interests duty requirement – whereby the best interests of the client must, by law, be the driving force behind product decisions and advice given – the RDR arguably goes a little further.

On top of the requirement to disclose fees and act in clients’ best interests, British advisers also have to fit into one of two new explicit categories of advice: ‘independent’ or ‘restricted’. These labels signal to a consumer the types of products and advice – and relationship to product manufacturers – they can expect from an individual adviser or planning firm.

In addition, the RDR raised the educational requirements for compliant advisers, introducing an enhanced compulsory diploma course. While the Australian Financial Planning Association has stipulated a university degree minimum standard for its members and Australians holding certified financial planner (CFP) accreditation from July, the FOFA reforms themselves contained no such provisions. So there are some core similarities and differences between the two reforms on a legal/theoretical level that will necessarily inform the ultimate practical implications for industry.

Pricing advice

According to Vanguard Investments UK’s head of retail, Nick Blake, British advisers have not, as a whole, warmly embraced the new regime. While making clear his summation is not based on any empirical data, Mr Blake suggests that “probably only 10 per cent of the [UK] market are ‘new model advisers’ [i.e. those already operating on a fee-for-service basis pre-RDR]; 40 per cent are probably transitioning from the old to the new; and the remaining 50 per cent are still in denial”.

One of the indicators that UK advisers have not jumped into the new era with both feet is the types of compliant remuneration models becoming popular. According to Scott Dawkins of Griffin Financial Services – an Australian-born financial adviser who worked in the UK for several years in the lead-up to the RDR – most have implemented models that are only just in line with the new requirements.

“Advisers in the UK have, as far as I can tell, by and large opted for asset-based fee arrangements post-RDR with some ongoing fees,” he explains. “Significantly few have embraced flat fees.”
This assessment is confirmed by Vanguard’s Mr Blake, who anticipates that in the post-RDR market, “asset-based fees will become the norm”.

Gillian Cardy, managing director of the recently-established UK trade association for independent advisers, IFA Centre, worries that this preference for asset-based remuneration is counter to the objectives of the reform agenda.

“My concern is that when an adviser works with a client over a number of years, assisting them in the accumulation phase, then in essence [an asset-based fee] punishes them for reaching their goals. That is, as their portfolio grows their fee increases, which seems counter productive,” she tells ifa.

“To have a charging model that is not in the clients’ best interests concerns me – it places the value on the money and not on the advice,” she adds, echoing arguments against asset-based fees often voiced in the Australian context.

By contrast, the number of Australian advisers looking to implement asset-based fee models following introduction of the FOFA reforms is seemingly much smaller. Only 10.2 per cent of respondents to a recent ifa online straw poll indicated they think an asset-based fee model is “best practice”, while 25.6 per cent opted for a “flat fee monthly/annual retainer” and a substantial 45.3 per cent indicated preference for a “hybrid” model.

More broadly, Australia may be better positioned to embrace change simply by virtue of the fact that – despite FOFA implementation being six months behind the RDR – we have had more time to get used to fee-for-service, aided by the early emergence of platforms.

“Australia started to see a move to fee-for-service models around five years ago and it has picked up momentum since,” says Robin Bowerman of Vanguard Investments in Australia.

“What the FOFA regulations have done is convince the more old-mindset advisers they needed to migrate to the new model.”
Mr Blake, who was last in Australia in 2004, agrees with Mr Bowerman that Australia was a few years ahead of the UK on its thinking around remuneration models and is in an advantageous position as a result.

Back to school

Of course, the British advisers that are implementing asset-based remuneration models have embraced the reforms to a much greater extent than those who have exited the industry altogether – of which there are no shortage. The latest FSA figures estimate that as many as 9,400 advisers left the industry between December 2011 and December 2012 in anticipation of the legislative changes, representing a 23 per cent decrease.

At the time of writing, the FSA had not released the updated numbers since RDR implementation, but sources suggest additional “thousands” may have left the industry. However, while few UK advisers may be embracing fee-for-service, it is the increased educational standards that have arguably caused most of these exits.

“The real, practical impact [of the RDR] has been the requirement to increase qualifications,” says Ms Cardy. “For many advisers, this was a major hurdle.”

Ms Cardy, who was actively involved in the RDR consultation process with the FSA and other relevant authorities, estimates that around three quarters of the entire advice industry were forced to upskill as a result of the new educational requirement. “It was certainly an enforced leap and not just a regularising of the norm,” she says. “It is correct to say that many left the market due to this requirement.”

Mr Dawkins agrees with the widespread impact of the educational requirements. “This had an impact on pretty much the entire financial planning industry,” he says. “In fact, there was a transition period when almost every practitioner was required to upskill.”

Given that FOFA does not mandate higher educational standards, Australia may well avoid this mass exodus from the industry.

However, with the concerted push by the Financial Planning Association and others to raise the bar, and support for higher educational standards often heard by ifa from readers, this trajectory may in time come to play a part Down Under as well.

Don’t bank on it

The FSA’s alarming estimates of the number of UK advisers fleeing the game is not only due to voluntary early retirement. A significant percentage can be attributed to the slashing of the retail advice departments of some of the UK’s major banks. The rapidity and force with which the banks have taken an axe to their retail advice offerings has been one of the more shocking impacts of the RDR.

Jon Dear, a marketing executive at the Sesame Bankhall Group, one of the UK’s largest dealer groups, tells ifa the industry was not prepared for the carnage.

“The RDR was expected to have an impact, but not on the scale we have seen so far,” he says. In late 2012, in anticipation of the RDR implementation date, Lloyds TSB cut 600 adviser jobs. In March, Spanish bank Santander announced it was packing up its UK investment advice service, resulting in 724 job losses. One month later, HSBC announced 3,166 job cuts in a major restructure of its advice department.

The National Australia Bank – which has substantial holdings in the UK banking and finance sector – also jumped on the bandwagon, closing the retail advice units of Yorkshire and Clydesdale Banks and ending an advice service relationship with AXA UK, resulting in a total 580 job cuts.

An editorial in the The Scotsman newspaper reflected the fear such large-scale slashing has engendered. “Do-it-yourself investing is booming, as consumers rejected by banks and financial advisers take matters into their own hands – and the risks that come with doing so,” it read.

However, Ms Cardy is not concerned about the loss of bank advisers. Understandably for an advocate of independent advice, she says the banks never had the best interests of consumers at heart in the first place. “There has been significant research that bemoans the quality of the advice given by bank advisers, so to complain that this poor quality advice is no longer in existence is illogical,” she says. “The banks have become synonymous with quick, over-the-counter transactional advice, and that model is difficult to place in the current environment.”

The mass closure of bank advice units will only serve to strengthen demand for IFAs, Ms Cardy says, aided by new clarity brought by the terms ‘restricted’ and ‘independent’.

Mr Dear also expects that IFAs may fare well in the absence of bank advisers – if they can survive the initial hurdles. “We will see many advisers re-engineer their businesses and they will achieve greater long-term profitability,” he says. “But the success and timescales for this depends on their starting point, as there is likely to be a significant short-term impact on cash flows.”

Vanguard’s Mr Blake agrees the UK banks have suffered a quality issue in the past and, as a result, the closure of the bank advice units cannot be blamed solely on regulatory change. “The banks have struggled over the years to maintain valuable, compliant advice models and have sometimes pushed out bad products or had bad advice exist in their channels,” he says. “I think the RDR was the final nail in the coffin for what was a difficult transition to the ‘new model’.”

For Australians watching the RDR unfold overseas, the slashing of bank advice jobs is certainly one of the more dramatic developments. However, the writing is not necessarily on the wall for Australian salaried bank advisers.

“The banks here have taken a very different strategic path,” says Mr Bowerman. “Instead of abandoning advice, they have bought up the major platforms and distribution channels and consolidated them.”

The Australian banks and larger financial institutions may well benefit from FOFA in the same way UK banks have suffered. Because the Australian banks (along with AMP-AXA) are so dominant in the space, they are seemingly leading the charge to

FOFA-compliance rather than packing up shop.

Indeed, at a press conference in March, NAB chief executive Cameron Clyne told ifa that advisers on NAB’s Australian dealer channels should not expect the same outcome as those at the Yorkshire and Clydesdale Banks. “That decision [to cut the advice offerings of NAB-owned UK banks] is specific to the UK and related to some legacy issues there,” he said. “It’s not reflective of our strategy for our wealth franchise in Australia.”

‘Preserve of the rich’

In May, the UK Independence Party called for the RDR to be scrapped, arguing the reforms were pricing the average Briton out of professional advice. The Eurosceptic minor party, which holds 11 seats in the European parliament and has three members in the UK House of Lords, says the RDR is anti-libertarian.

“We believe you should be able to make any arrangement with your financial adviser that suits you both,” said UKIP MEP Godfrey Bloom, a former independent financial adviser, in a statement. “It is no part of government to directly interfere in liberty of contract. The lower and middle classes will not have access to financial advice and it will be a preserve of the rich.”

While six months after implementation the call perhaps came a little late, UKIP’s supposition goes to the very core of the value proposition of the British advice market. Ms Cardy says the MEP has a point, but that it goes deeper than the RDR. “The perception that advice could become the preserve of the rich is true, but that’s not the fault of the RDR,” she says.

“That has long been the trajectory of the industry because, quite simply, most UK advisers focus on wealthy clients. You can change the rules all you like but the simple fact is that in this market very few are working with people who are making their first investment or looking to put away a hundred quid a month, and I think blaming the RDR is a scapegoat for a trend that was happening anyway.”

The evident preference of UK advisers for asset-based remuneration in the post-RDR environment indicates this positioning of the advice sector towards higher net-worth clients is unlikely to abate.

Another development that is important to note in the UK market is the rapid growth of free, online advice offerings such as

MoneySupermarket.com, which offer consumers general advice on savings and debt management. “In the UK, the biggest competitor to professional advisers is free online advice,” says Mr Dawkins. “Because the tax and super systems in Australia are so complex, online is not a competitor. In fact, it may actually be cheaper in Australia to buy insurance through an adviser than online.”

According to Mr Dawkins, this is an advantage that Australian advisers have in the new world order – being more willing and more able to shape their advice services to a broader cross-section of consumers. Ms Cardy says the unique Australian compulsory superannuation system adds to this fundamental difference between the value propositions of the two markets, “creating a climate of saving and investing, and a requirement for advice which simply does not exist in the UK”.

More broadly, Mr Dawkins suggests Australian advisers are the beneficiaries of a more generous consumer culture. “Things are generally very expensive in Australia and we are therefore more prepared to pay upfront for things and to pay quite a lot,” he says. “UK consumers are very price sensitive; the UK is a very different consumer society.” A fee-for-service system – as championed under FOFA – may therefore be better suited to Australia than to the UK, where consumers are less willing to pay and, given the rise of free services, are in a position in which they do not have to.

Around the world

Opponents of FOFA often chastise the reform package as an ideological plaything of the Australian Labor Party. The notion that at its core, FOFA is all about stacking power in favour of the industry superannuation funds at the expense of private sector financial services providers is often heard in the comments section of ifa online and from a range of commentators within the space.

One such commentator is Mr Dawkins. “In Australia, the reforms seem to be spearheaded by particular individuals within parliament who have strong connections to the unions and industry funds,” he says, echoing a valid and oft-heard criticism.

However, a close look at the RDR puts things in perspective. While there are key differences between the two reform packages, there are far more similarities. The RDR was championed not by the British Labour Party but by the former chief of one of the world’s biggest banks, and implemented by Prime Minister David Cameron’s Conservative-Liberal Democrat coalition government – hardly agents of a pro-union, anti-business agenda.

According to Mr Bowerman, the move to more regulated financial advice markets has little to do with domestic politics. “The key driver of both [the RDR and FOFA] is that investors simply got a bad deal and post-global financial crisis, something had to give,” he says.

Mr Bowerman points to the example of the United States where, partly off the back of rising demand for exchange traded funds, the industry has been moving to a fee-for-service arrangement even in the absence of government legislation.

Mr Blake keeps his finger firmly on the global regulatory pulse and suggests that other countries are now looking at the RDR and FOFA as blueprints for their own domestic reform agendas. He believes the regulatory authorities of Hong Kong, Singapore, the Netherlands and Switzerland have all demonstrated strong interest in the Anglo-Australian example, as well as the International Organization of Securities Commissions, the “global regulators’ club”.

Viewed through this prism, Australia is not an outpost where government is experimenting with its financial advice industry but rather, a leader in the global post-GFC thrust towards enhanced consumer protection. Furthermore, Australian advisers may well be in a better position than their foreign counterparts to thrive in the ‘brave new world’.

For Ms Cardy, the reasons for the changes are now of secondary importance. She offers some sage advice for Australian advisers about to embark on the process her members have just been through:

“What is absolutely obvious from everything that has happened here is that a lot of advisers simply didn’t leave enough time,” she says. “If you need to develop a new value proposition, that could take a year or more, so don’t leave it to the last minute.”
Or, in more Australian parlance: get a bloody wriggle on. «