At the end of 2012, the market for retail financial advice underwent long-awaited reform in the shape of the
Retail Distribution Review (RDR). The RDR rewrote the rules that govern how individual investors pay for financial advice, the professional qualifications of those that advise them and the financial relationship between product providers and advisers, who had been subject to "commission bias".
Two years on, the changes - both positive and negative - that the RDR has brought to the market are starting to become clear.
Industry experts agree that one clear gain from the RDR is that the adviser community is now much more professional than it was before the minimum qualification standards came into force, and many are now seeking to go beyond the basic requirements and attain chartered status.
"It has been a momentous shift and very positive for consumers"
Malcolm Kerr, a senior adviser to EY on financial services, says: "My guess is that in the next few years, the majority of people giving financial advice will be chartered financial planners and that's when it really starts to look like a profession."
The CISI already awards a
Chartered Wealth Manager qualification that recognises senior members in the retail sector at the pinnacle of their profession.
Beneficial ban
There is also broad agreement that the banning of sales commission payments from product providers to advisers has been beneficial. Robin Keyte, who was named Financial Planner of the Year for 2014 by the
Financial Times' Money Management magazine, points out that poor-value products such as with-profits investment bonds that were regularly sold under the commission system are much less common now. The removal of commission bias among advisers has enabled them to focus much more on the interests of their clients, he believes.
20%
The percentage of net new business which passive funds now account for
31,220
The number of advisers in the market in early 2014, down from 40,566 in 2011
60,000
The number of people turned away by financial advisers in 2013 because they did not have enough to invest
EY's Kerr argues that this change helps to explain the growth of passive funds, which have lower overall costs of ownership and now account for 20% of net new business: a significant gain over the past two years. He also believes that the transparency that the RDR enforced on costs and service levels is a big benefit for retail clients, particularly in the area of ongoing service.
Before the RDR, advisers received a 0.5% annual trail commission from the fund providers that received the client's money, but the adviser was under no obligation to provide any ongoing service in return. Today, advisers must spell out what services they undertake to provide in order to be able to levy an ongoing service fee on existing customers.
Exactly what ongoing services advisers are offering has been a subject of keen interest for the Financial Conduct Authority (FCA) during its RDR implementation reviews. The latest of these,
published in mid-December, found that there were still problems with some firms failing to be sufficiently specific in this area, but the Authority believed that the situation was improving.
Cause for concern
Where the FCA found greater cause for concern was in the level of transparency on charges.
Most firms still levy both their initial and ongoing charges as a percentage of the client's investible assets, and one of the FCA's key aims has been to ensure that firms also spell out these changes in pounds and pence. Where initial charges are concerned, the FCA's latest implementation review found that 15% of firms still failed to do this - for example, by illustrating what someone with £100,000 to invest would pay - down from 24% in the previous review. Similarly, 9% failed to tell individual clients what they would pay in cash terms, down from 24% previously.
However, when it looked at ongoing charges, the FCA found that 35% of firms did not disclose the charges in cash terms "relevant to the individual client". The regulator said it was "disappointed" with the small improvement here from 41% in its previous review.
Keyte agrees that disclosure around charges is better than it was, but still has room for improvement, particularly in helping clients to understand what their total ongoing fees are likely to be at the beginning of the engagement. He hopes the situation will improve from April 2016, when European rules on
Packaged Retail and Insurance-Based Investment Products (PRIIPs) will come into force, covering both advice and product charges.
Rising charges
Keyte also says that the amount clients are paying for advice has gone up since the RDR. Before the changes, most advisers charged an initial 3% when the client was taken on and then received an annual 0.5% fee in trail commission. He notes that ongoing charges are now more commonly around 1%, while research in 2013 by Action Consulting suggested that initial charges on a £100,000 portfolio were about 2.4%, while ongoing charges averaged 0.82%.
Keyte also points out that fund charges have typically dropped from 1.5% to 0.75%, but that this gain has been more than offset by higher charges for advice. "The only way that will be dealt with is through competition as consumers become more aware," he says. EY's Kerr, meanwhile, notes that while initial charges in the UK remain around 3%, clients in the US expect to pay 1%.
Overall, though, industry experts believe the changes that the RDR has ushered in have been extremely welcome. "When you think about where the industry has come from pre-RDR, you have to say it has been a momentous shift and very positive for consumers," says Keyte. "I hope that this is only the beginning.
Mind the advice gapAccording to the most recent figures compiled by the Association of Professional Financial Advisers (APFA), the number of advisers dropped from 40,566 in 2011 to around 31,220 in early 2014.
Much of this decline is accounted for by the withdrawal of most banks and building societies from mass-market investment advice - they employed 8,658 advisers in 2011 and just 3,556 by early 2014. However, most of that drop happened in the lead-up to the RDR - by the end of 2012, the number of bank-based advisers had already fallen to 4,800.
Does the drop demonstrate that an 'advice gap' now exists, thanks to the RDR? Opinion is divided. Analysis carried out for the FCA by Towers Watson and published in mid-December suggested that demand in the UK for 'full' regulated financial advice could be met by around 25,000 advisers, compared with more than 30,000 currently working.
"These results therefore indicate excess capacity (or a negative advice gap) based on the productivity and time-allocation assumptions used, of around 17% of the adviser base, or about 5,000 advisers," Towers Watson concluded, although it conceded that this spare capacity could be absorbed if the new pension freedoms created additional demand for advice before and during retirement.
However, although there may be enough advisers in theory to meet demand, it is widely believed that many clients with smaller sums to invest are no longer able to access advice because it is not economic to serve them.
Chris Hannant, Director General of APFA, believes that reduced access for some groups is one of the major drawbacks of the RDR changes. He says that in 2013, AFPA conducted a "quick and dirty" survey of members, which suggested that 60,000 people were turned away that year by financial advisers because they did not have enough to invest to make them profitable clients for an adviser. "Because there is more focus on what it costs to deliver advice, more consumers are being turned away," he says.
Andrew Power, Partner in the financial services practice at Deloitte, suggests that the growth in customer numbers using Hargreaves Lansdown's Vantage platform between 2012 and today offers a good proxy for the scale of the advice gap, because many of those people would previously have been served by advisers, particularly in banks. Between 30 June 2012 and 30 June 2014, the number of Vantage clients jumped from 425,000 to 643,000: a rise of just over 50%.
However, it is possible that any advice gap may soon start to close. EY's Malcolm Kerr believes that some banks will soon re-enter the retail advice market with services based on a combination of internet, telephone and face-to-face consultations.