Hamilton van Breda, Head of Retail Sales at Prudential, examines international regulatory changes that will likely affect how we provide and pay for financial advice in SA.
The financial services industry has been undergoing intense scrutiny and extensive global regulatory changes are being legislated on how financial advisers are remunerated for their professional services. Part II of his article provides a snapshot of some of the latest proposals and how they could be impacting us in the not-too-distant future.
South Africa’s regulator, the Financial Services Board, will be influenced by changes in Australia, the UK and other countries
Local industry bodies that are looking at the trends in how consumers pay for financial advice have focused primarily on developments in Australia under the banner of “Future of Financial Advice” (FoFA) and in the UK under the auspices of “Retail Distribution Review” (RDR). Holland, India, Singapore and more recently the European Union are other areas looking to make changes. One thing all have in common is the aim of eliminating so-called “conflicted remuneration” in distributing retail financial products, to ensure fewer conflicts of interest for financial advisers and better outcomes for consumers. We believe that these broad- based financial services trends will be difficult for our own regulator to ignore.
Below is a brief summary of FoFA in Australia, the UK’s RDR and changes in Europe.
1. Australian Future of Financial Advice (FOFA)
The FOFA reforms focus on improving the quality of financial advice, particularly product recommendations, and expanding the availability of more affordable forms of advice. The reforms aim to improve investor protection and instil confidence in the financial advice industry.
The reforms ban “conflicted remuneration”, including commissions
This means that licensees and authorised representatives will not be allowed to give or receive payments or non-monetary benefits if the payment or benefit could reasonably be expected to influence financial product recommendations or financial product advice provided to retail clients. This reform means that more financial advisers’ fees will be paid directly by the client than indirectly through product commissions, making them more fair and transparent.
The FOFA legislation also sets out restrictions on employee performance benefits (or bonuses paid to advisers who sell the most investments). This does not mean that advisers can no longer receive volume-based performance benefits. The way those performance benefits are structured may have to change, however, to comply with the legislation.
FOFA will also introduce a broad ban on volume-based “shelf-space” fees. These fees are generally paid by fund managers whose products are made available through various investment platforms.
FOFA introduces a statutory fiduciary duty to act in the best interests of their clients
The best interests duty requires advisers providing personal financial advice to retail clients to act in the best interests of their clients. This means putting the client’s objectives and financial situation first when providing advice.
Advisers are required to make ‘reasonable inquiries’ to obtain accurate information from the client and conduct a ‘reasonable investigation’ into relevant financial products. This is designed to protect advisers from clients claiming that the adviser should have done something onerous or unreasonable in order to act in their best interests.
Increasing transparency and flexibility of payments for financial advice by introducing a two-yearly opt-in arrangement
Advisers will be required to request their retail clients to opt-in, or renew, their advice agreements every two years if clients are paying on-going fees. In addition, an annual statement outlining the fees charged and services provided in the previous 12 months must be provided to clients paying on-going fees. This means advisers will be in regular contact with their clients and will need to demonstrate the value of the services they are providing their clients.
Percentage-based fees (known as assets under management fees) will only be charged on ungeared products or investment amounts
These fees are also only payable if agreed to by the investor. FOFA also expands the availability of low-cost ‘simple advice’ to improve access to, and the affordability of, financial advice.
A one-year transition process
In order for the financial services industry to move to the new regime more smoothly, the reforms include a one-year transition period.
2. The UK Retail Distribution Review
The RDR aims to ensure consumers:
- Are offered a transparent and fair charging system for the advice they receive;
- Are clear about the service they receive; and
- Receive advice from highly respected professionals.
- Advisory firms to explicitly disclose fees and separately charge clients for their services;
- Advisory firms to describe their services clearly as either independent or restricted;
- Individual advisers to adhere to consistent professional standards, including a code of ethics.
To achieve this, the Financial Services Authority (the UK regulator) published new rules that will require:
There are many advisory firms in the UK that are passionate about their independence. Many advisers see RDR as prohibitively onerous, but they do believe that those firms that are innovative can deliver efficient and effective independent advice. One key element of the survival of independent advisers is the perception that IFAs must understand “everything” about every viable product in the market!
One of the most significant changes initiated by the RDR is that product providers will no longer be able to pay initial or on-going (trail) commission on new products.
Instead, advisers will need to set their own charges in agreement with their customers. These levels will not be restricted or monitored by the product provider. However, product providers must obtain and validate clients’ instructions on adviser charges deducted from products. Also, post RDR, advisers “can only charge on-going fees for an on-going service”. Product providers may offer facilities for the adviser charge to be deducted from the investment.
3. What about Europe?
There is an unprecedented wave of regulatory initiatives affecting the European asset management industry. In the wake of the financial crisis, there was a clear message from governments in Europe: Self-regulation is not working and better regulation is necessary to avoid a new crisis of the same proportion (or contain it). The aim is more efficient monitoring of systemic risks and better investor protection.
The European Commission proposes to address the regulatory playing field between various types of investment products, referred to as Packaged Retail Investment Products (PRIPs). The intention of PRIPs is to achieve consistent and effective standards for investor protection across a wide range of investments, and ensure there is a level playing field for distributors and providers of investment products. The proposals are now with the European Parliament and the Council of the European Union for discussion. Implementation of the new measures is not expected until at least 2015.
How will our South African regulator embrace the international trends?
From a South African point of view, it will be interesting to see how the FSB manages its review of the entire value-chain of retail financial services, and which lessons it draws on from Australia, the UK and elsewhere. The FSB’s overarching mandate is to protect consumers, making it vital for them to ensure that all clients are treated fairly and that the ‘Treating Customers Fairly’ (TCF) outcomes that are underway are at the center of any regulatory reform that seeks to change financial adviser remuneration models. With commissions out of favour and a fee-based approach gaining momentum, a discussion document is likely to be issued and more consultation will take place in the coming months. Based on international experience, legislative changes will be necessary and a transition period will be allowed.
Independent financial advisers in South Africa will undoubtedly come under pressure from a more onerous regulatory regime and the associated higher costs of doing business. Some may leave the industry. However, those with a clear business proposition and loyal client base should continue to do well, as others seek support from industry networks or sign exclusive agreements with product providers.
South African retail investors should be encouraged to know that they are likely to benefit from more transparent and understandable fee structures for financial advisers, as well as independent and professional advice, in the coming years.
While this article is really intended as an indication of current thinking, nothing is cast in stone.
There will still be extensive consultation. However, what is certain is that change is the only constant. At Prudential we are comfortable with this, and as a global group we have the benefit of shared lessons and a truly international perspective. We look to the future, firm in our commitment to the benefits of financial advice and the solid partnerships that we have built up over many years.
This article forms part 2/2 of this story which appeared in the Winter issue of Consider this. Click here to read the first article.