The Retail Distribution Review - Triumph of form over substance

After the Wall Street crash Congress introduced a major piece of legislation to control the banking industry. The Glass Steagall Act was 33 pages long and for the next 60 years it worked really well.  Everyone understood it, the courts interpreted it and almost every first year economics student could have told you what it said. Indeed some of them had probably read it. Short, to the point and effective it controlled the entire US Banking Industry and its relationship with its customers by dividing Investment Banking from Retail Banking.

Contrast this with the hundreds of pages of rules, and the thousands of pages of interpretation, which appear to be necessary to regulate the sale of a life policy to an ordinary UK resident and you may begin to get some perspective on the extraordinary detail which, completely unnecessarily, has become the norm for 21^st Century regulation in the UK. This is not because of Europe, not because there are huge problems (although there are some) and not in any way because the consumer of Financial Services will benefit (they definitely will not) but because lawyers have taken over the regulation of the activity of major areas of the economy including dominating the drafting of laws within parliament and regulatory bodies established by legislation In this particular case the FSA has evolved from the simple early legislation (The Prevention of Fraud Acts) originally written at the same time as Glass Steagall to the point where regulations today are written by lawyers for other lawyers to interpret. The whole process of regulation has become a game of lawyer versus lawyer and it is inconceivable today that any major financial institution will not have a legal department with qualified lawyers interpreting the laws and regulations laid down by parliament and
regulators. Yet strangely enough the miss-selling (Payment Protection Plan, 100% mortgages, Pensions etc) is greater than before we had the FSA and financial stability (banking crisis generally, Northern Rock, Icelandic Banks et al) worse. Why?  Because lawyers writing rules that only lawyers can understand is a recipe for disaster.  And disaster we have assuredly had.

The latest example, RDR, on the face of it is admirable in its intention. The road to hell is paved with good intentions. So is the road from Canary Wharf where our financial regulators sit. They want to do good.  They mean to do good. They just do not have a clue as to the damage they do, and would really be sad if they knew the results of their current endeavours. Institutionally they believe that problems are solved by ever more detailed rules which proscribe the behaviour of which they disapprove. Curiously this tendency has been recognised by the FSA and its Chief Executive and an official return to principles based regulation was briefly espoused. The actual results of their endeavours have been to make a rule book so fiendishly complicated that even those who devise it forget what they intended and the actual results are so far divorced from the original problems that the net effect is almost without exception just another layer of
expense and the removal of access to any financial advice for a growing part of the population.

RDR and the Financial Adviser

The Financial Services Authority, almost as its dying act, (it splits into two new regulators this year) has under the innocuous title RDR (Retail Distribution Review) introduced a series of changes to the financial services industry which will profoundly affect every Financial Adviser and their clients. The changes enter into full effect on 1^st January 2013, but everyone must be fully prepared for them well ahead of this date. The changes will drive many Financial Advisers out of business.

The most obvious changes which affect every adviser are that the rules forbid commissions from insurance companies to advisers and that every adviser needs to achieve a particular level of professionalism. These two most prominent reforms will have no effect on most relationships (most revenue has been fee based for some time and many front line employees already hold level 4 or above qualifications) but there is a more fundamental change which is perhaps harder to explain. It is that the FSA wants a firm to be able to justify “Independence” in a much more robust and broad fashion than ever before. It necessitates two changes in the way in which advisers relate to clients.

The first affects many organisations. For instance NW Brown Group today comprises four regulated companies, each specialising in individual areas. Insurance broking has been regulated differently from Investment Management, which in turn has been historically very separate to Financial Advice. With the RDR requirements that a firm offering independent financial advice must be able to advise on everything from Pensions to Investment Trusts to Life Policies within one firm we need to change our structure. The route we have chosen is to amalgamate the company providing advice on packaged products today (NW Brown Financial Services Ltd) with that which does most of our Pensions business, the SIPP and ISA business plus all direct investments (Investment Trusts, Ordinary Shares etc.), NW Brown and Company Ltd.

The second is that we have to be very clear as to which client is buying what service from us and therefore we will look afresh at all our relationships client by client to ensure that we are offering clients the service they wish for. Because, under the new organisation, we can offer the whole breadth of services, we will take the opportunity of giving Financial Planning clients whose main relationship with us concerns investments to enter into an “Investment Management Agreement” whereby they give us limited discretion to manage their investments within an agreed remit. We will also, within the new structure, be able to settle and control transactions in any market more effectively for all of these clients as the combined firm will have ‘client money’ permissions only given to firms which meet higher capital requirements. The note below describes the various ways in which advisers might act for you in general terms and describes how “Advising” differs from “Managing”.

Note on Possible Relationships

There are four categories into which financial services performed in the UK by those authorised under the Financial Services and Markets Act may fall:

1)    Advising

Where it is appropriate for you to receive advice the  adviser will attempt to find out from you all the relevant information you are prepared to provide and requires before considering, in the light of your financial and family/ work etc. circumstances, whether they are able to give you advice which will potentially improve your future circumstances. This advice might cover a very wide set of possible outcomes, including potentially introducing you to specialist accounting, tax, trust or other professionals. In many of these cases the  adviser will be able to advise that the services of another person (either within or outside the same group) may be suitable. If within the same group they will refer you to them without any recommendation or suggestion that they are the best provider. So, for instance, if within NW Brown we decided your assets were under-insured we would introduce you to a relevant NW Brown Insurance Broker who could talk to you about your problem but we would not recommend NW Brown Insurance Brokers Ltd as it is part of the same group. Any decisions to use them would have to be yours alone, and if you wanted we would provide names of other insurance brokers you could talk to. The regulatory burden surrounding advice is much greater and the  adviser must show he tried to get all relevant information,  and that his advice was appropriate given the circumstances. He will record why he decided to make the recommendations he made and why he expected you to be better off as a result. He will always charge a fee for advice, and he will, at the point he decides it is appropriate for him to act for you on an advisory basis, agree with you the terms on which he will act. Given the detail required the fee for a full examination of your financial circumstances is unlikely to be less than £1,000; before RDR many advisers would provide an initial session free in the expectation that the commission they would collect on sales to those who bought a product from them would pay for those who did not proceed. 

2)    Managing

Where it is appropriate you may wish to ask a firm to manage your investments for you. In this case the manager will take the decisions to buy and sell which he  believes will reflect your desires and circumstances. He will regularly report to you and consult you on any major changes, and ask you to tell him if your circumstances change, but broadly speaking you will have delegated all day to day decisions to him. The regulatory burden here is similar to that in 1) Advising above as far as you are concerned but as far as the regulator is concerned the manager must have systems and controls internally to ensure that he is doing what he ought to under your agreement, that he is buying and selling and holding investments properly and for good reason and that his accounting and settlements systems are effective and regularly checked. This is a much more stringent control system for the simple reason that he is making day to day decisions on your investments and carrying them out on your behalf.

3)   Execution Only

Here the adviser carries out business on your instruction. The regulatory burden here is that he acted in a professional way and chose an efficient way to execute your instruction. He can and should inform you of any relevant technical information and if he disagrees with your instruction he should give you his opinion as to the course you are proposing but he must be clear he is not advising. He will record this. This may seem like the easy and cheap way for most people to get what they want, and for those not prepared or able to pay for advice it is really all that is left. Ironically it is those who have the most financial knowledge who are probably most able and willing to pay for such services so the effect of the regulator making access to financial advice so much more difficult and expensive is likely to be that anyone with median income or below no longer gets any advice at all.

4)    Other Non Regulated Services

Normally in association with providing 1) to 3) above, firms will offer Custody/Collection/Trustee or other associated services. Generally these lie outside direct regulation by the FSA. If you solely use these services they will be subject to individual agreement with you on agreed terms. There are some services we at NW Brown offer in regard to Mortgages and Child Care Vouchers which lie outside the scope of the FSA and there are also certain larger clients to whom the RDR does not apply because they are not defined as “Retail”.

Conclusion

The FSA pays lip service to cost benefit studies but has yet to come close to estimating either costs or benefits realistically. Most supposed cost benefit studies in fact have few if any numbers in them for the benefits, usually because it is fairly obvious that there are none. The idea of evidence based policy making has not penetrated Canary Wharf, and indeed the regulatory industry as a whole cannot afford to consider the consequences of their actions in any rigorous manner as it is patently the case that not only are there are no proportionate gains in consumer protection from the millions of words and billions of pounds spent, there is much evidence that consumers are paying through the nose for on average worse returns on their money than usual in the decades before the Financial Services Act was introduced in 1986.