FSA review seeks end to pensions and investment mis-selling

Will the Financial Services Authority's long-running review of pensions and investment retailing prevent future mis-selling scandals? The commons treasury committee has its doubts. We look at the review's proposals for replacing commission-based selling with upfront charges, and examine what they mean for employers setting up group pension schemes.

On this page:
Charging replaces commission
Consultancy charging for GPPs
"Independent" or "restricted" advice
Making advisers more professional
FSA evidence is "weak"
Less advice will be sought.

Key points

  • A Financial Services Authority (FSA) review of pensions and investment retailing is set to revolutionise how financial products, such as personal pensions, group personal pensions (GPPs) and stakeholder pensions, are sold.
  • A new system of adviser, or consultancy, charging will replace commission-based selling from January 2013, and it will be unlawful for pension providers to pay financial advisers to "push" their products.
  • Employers and advisers will instead agree charges for advice, which can be deducted from individual employees' GPP accounts. Advisers and firms must disclose charges to customers upfront, in the form of a price list or tariff, in a move designed to increase employers' engagement with the issue of adviser remuneration.
  • A recent report from the Commons Treasury Select Committee raises serious questions about the impact of the review on the financial services sector - the FSA itself predicts that 25% of advisers will consider leaving the industry - and calls for it to be delayed by a year.

The Financial Services Authority (FSA) launched its review of retail distribution in June 2006 to tackle several features of the retail investment market that it saw as barriers to transparency and consumer confidence. These include the complex charging structures of many retail investment products and consumers' low level of financial capability, which, the FSA argues, results in an over-reliance on advisers.

The providers of financial products, such as group personal pensions (GPPs) and stakeholder pensions, often pay advisers to push their products, leading, the FSA suggests, to a "misalignment" of advisers' interests with those of consumers. Crucially, it can take many years before poor-quality advice becomes apparent, by which point it is often too late for the consumer to remedy.

The proposals set out in the FSA's Retail Distribution Review (RDR) are due to come into force on 1 January 2013, but a recent report from the Treasury Select Committee (on the Parliament website) calls for their implementation to be put back by one year. The committee argues that the delay will give advisers and advisory firms more time to comply, particularly with proposals on adviser qualifications, and also to start what is expected to be a long process of cultural change in the industry.

Research carried out for the FSA during its long review (external website) predicts an exodus of advisers if the proposals in their current form are introduced in early 2013. The picture is also complicated by the fact that the FSA itself is due to be replaced by a new Financial Conduct Authority, which may have different priorities.

Charging replaces commission

The RDR has implications for employers sponsoring GPPs and stakeholder pensions in particular. One of the key changes due to come into effect in January 2013 is the replacement of commission by adviser charging. The FSA argues that this will lead to greater transparency in adviser remuneration, as clients will know what they are paying for, and that the advice is not biased by the payment of commission from the provider of the financial product.

The mechanism replacing commission will be an agreement on fees between the adviser and the customer, christened "adviser charging", which will replace the current system where the product provider largely determines the remuneration of advisers. The new system will ban advisers from receiving commission from product providers in return for recommending their products.

All firms giving retail investment advice will have to set their own charging structure, based on the level of service they provide. They will also have to disclose charges to customers upfront, using a price list or tariff - for example, according to hourly rates, a percentage of the premium, or fixed fees. Advisers and firms will also be required to deliver an ongoing service to customers when an ongoing fee is levied, unless the product encompasses a regular payment.

Consultancy charging for GPPs

The main effect of the RDR on corporate pensions relates to the new system of adviser charging. In the case of GPPs, group stakeholder pensions and group self-invested personal pensions, this switch to adviser charging will be called "consultancy charging". Instead of receiving commission payments from the pension providers, advisers will negotiate their remuneration with the employer buying the group scheme. The employer will be able to pay the adviser this charge as a fee, as currently, or agree to the fee being taken in "charges for services" from employees' pension accounts.

Advisers' chargeable services can include helping the employer to choose a group pension scheme, promoting the scheme to employees and assisting in ongoing scheme administration. Employees will have to be given full details of the charges before they join the employer's group pension scheme.

The FSA believes that this switch to more open, transparent charging will prompt employers to be more engaged with the level of the adviser's remuneration and the quality of advice they receive. The FSA has issued rules to:

  • ban commission on all new GPP products and sales, whether sold with advice or otherwise, including schemes switching to new providers after January 2013;
  • allow ongoing commission to continue on GPPs established before the ban is operative;
  • extend the ban on commission to investment products linked to occupational pension schemes that are sold as GPP alternatives, under the new system of consultancy charging;
  • allow consultancy charging from GPP contributions and member accounts on a £-for-£ basis; and
  • require advisers to disclose their full remuneration to clients.

"Independent" or "restricted" advice

From January 2013, financial advice will either be "independent" or "restricted" and firms claiming to be independent will need to consider a broad range of products beyond basic packaged ones. This wide range of retail investment products should include structured investment products, all investment trusts, unregulated collective investment schemes and any other investments that offer exposure to underlying financial assets in a packaged form. Independent advisers operating under the new definition will also have to provide unbiased advice based on a fair analysis of the relevant market, and advisers will need to inform clients in advance that any advice they give will be independent.

If a firm or adviser only gives advice on products from a limited number of providers, or only considers certain types of products, they will have to describe themselves as "restricted". Firms will need to inform clients in writing and orally, before giving advice, that the advice provided is restricted, and the nature of the restriction.

Some in the industry argue that this split between "independent" and "restricted" advice will create a two-tier industry - larger firms and advisers will operate at the top end of professional financial planning as independent advisers, while others will offer a lower level of primary advice, based on less sophisticated financial services, as restricted advisers.

The proposals as a whole are likely to lead to a contraction in the number of financial advisers, but within this, there is also likely to be a drift towards top-end financial planning work. The fixed costs of doing business will rise as a result of the RDR, pushing larger firms to recoup them from more wealthy clients paying for more complex advice. Bog standard, mass-market mortgages will become less attractive areas of business to what will become a more highly qualified group of advisers working in a smaller number of larger firms.

Making advisers more professional

The third set of changes proposed by the RDR covers the professional qualifications of advisers. In future, advisers will be required to hold qualifications equivalent to a certificate in higher education in order to practise, together with a statement of professional standing from a new accredited body.

Advisers will also need to follow a code of ethics and to carry out at least 35 hours of continuous professional development (CPD) a year; conducting research on products and services for clients will not count as structured CPD. The new accredited bodies to be set up as part of the review will be expected to assess the CPD activities of a random sample of 10% of their members each year to ensure compliance with this provision.

FSA evidence is "weak"

The Commons Select Committee report calls some of the FSA's evidence to the committee "weak", adding that the authority itself concedes that the review's proposals will cause large numbers of, particularly smaller, advisers to leave the industry, reducing competition and choice for consumers, especially smaller savers. Delaying the review's implementation by 12 months would reduce this risk, the committee argues, giving financial advisers more time to comply.

The current implementation date of January 2013 represents a "cliff edge", as there is no phasing of the requirements on training and standards, the committee maintains. However, others in the industry argue that many larger firms are already well on the way to complying with the proposals, and giving more time to attain qualifications would not send the right message to those already taking steps to meet the requirements in advance.

The select committee report notes that the introduction of the new rules banning commission could prompt advisers to hold a kind of "fire sale" as they approach January 2013, resulting in a burst of GPP selling activity. The committee will, therefore, monitor the GPP market until this point to check advisers are not taking advantage of the decision to allow commission-based selling in the run-up to 2013.

Less advice will be sought

Consumers currently view financial advice as "free", the committee argues, and moving to a new system of adviser and consultancy charging will make the price of advice transparent. The setting of a market price for advice is a "healthy development", it adds, particularly if it leads to better consumer scrutiny of the quality of the advice.

Adviser remuneration has been something of a running sore in financial services for many years. The accusation is that commission-based selling means consumers are sold products on the basis of how remunerative they are for the advisers.

However, banning commission and replacing it with charges represents a significant culture change for the industry, and setting a market price on advice will lead to a reduction in the consumption of such advice, the select committee warns. Many commentators agree that fewer consumers will walk through advisers' doors once they realise that this sets a fee clock ticking. The FSA, in its proposals, is attempting to balance the need to regulate against a wish to encourage saving - will the cost of this regulation be so high that consumers cannot afford to pay for the advice they need?

The new Financial Conduct Authority that is set to replace the FSA will have different objectives to its predecessor. Meanwhile, the costs of complying with the RDR proposals have soared over the five-year lifetime of the review, from an original £0.6 billion to £1.4-£1.7 billion. The select committee says that the Treasury needs to make clear that the current RDR proposals are consistent with the new authority's objectives.