On 25 June, the FSA published a consultation paper on its Retail Distribution Review (CP09/18) that seeks to improve the manner in which investments are distributed to retail consumers in the UK. The paper sets out the FSA's proposals to implement reforms aimed at enhancing the quality of advice that savers and investors receive, and will effect all regulated firms involved in the production or distribution of retail investment products and services.

The key consultations relate to implementing rules to ensure that independent advice is truly independent, and that people can clearly understand the services being offered to them. The FSA is also keen to ensure that commission-bias is removed from the system and that investors know up-front how much advice is going to cost. Importantly, it has been proposed that the professional standards of advisers should increase by requiring them to obtain a qualification regarded as equivalent to that of a first-year university degree.

New independence standard

A new independence standard will apply to a wider definition of 'retail investment products,' which will include so-called 'packaged products' (i.e., regulated collective investment schemes, investment trust savings schemes, life assurance policies with an investment component, and certain types of insurance product) and annuities, as well as unregulated collective investment schemes, investments in investment trusts and structured investment products.

This will raise significant challenges for those who wish to offer independent advice as they will be required to have sufficient knowledge of all types of products that would be suitable for their clients.

It will still be possible to provide independent advice in a narrow and distinct field, provided the whole of that specialised market is considered and that this is made clear to clients.

Describing advice

It is proposed that investment firms will be required to disclose in writing to each client, before providing their service, whether their advice is 'independent' or 'restricted,' the former relating to only those recommendations that are based on comprehensive and fair analysis, providing unbiased and unrestricted advice. Those offering restricted advice will be required to disclose the name of the firm they work for and the range of products they advise on.

Basic Advice

The FSA has proposed to retain the Basic Advice regime. This is a streamlined sales and advice process by which consumers are asked pre-scripted questions about their income, savings and other circumstances to identify their financial priorities and suitability for a stakeholder product, without conducting a full assessment of their needs or offering advice on whether a non-stakeholder product may be more suitable. Those who only offer Basic Advice will not be subject to the proposed professionalism qualification requirements.

Adviser Charging

The FSA would like to see an end to the current commission-based system of adviser remuneration by banning advisers from recommending products that automatically pay commission, and banning product providers from paying commission to secure sales.

The new requirement for product and adviser charges to be kept distinct may lead to a ban on products offering negative charges, such as those that offer initial allocation rates greater than 100 percent.

Under the FSA's proposals, a set fee will be agreed between adviser firms and their customers in advance, and new standards will help determine appropriate fee levels. Consumers may have their adviser charges deducted from their investments, provided it is still the consumer and adviser that determine the adviser charges to be paid.

Ongoing charges should only be imposed where a client is paying for an ongoing service. The one exception to this rule would be for where a client is buying an investment to which it will contribute over time.

The FSA has proposed that adviser firms provide their clients with their charging structure ahead of providing advice, such as on a price list or tariff, and for product providers to separate the cost of product charges from the cost of adviser charges where these are paid from the product.

The FSA has also asked for suggestions as to the best way of ensuring that the intentions behind Adviser Charging are applied where group personal pensions are sold without advice.

Increasing professional adviser standards

New and existing investment advisers will be required to obtain a higher level of qualification, set at Qualifications Credit Framework Level 4 or equivalent. This is generally judged to equate to the first year of a bachelor's degree. All existing advisers should reach this level by the end of 2012, and new entrants will be expected to study toward a new benchmark qualification once finalised in 2010.

The FSA plans to implement an overarching Code of Ethics and to enhance the standards for continuing professional development. Such standards will be maintained and enforced through a new Professional Standards Board. The FSA will consult separately on the Board in the fourth quarter of 2009.

Implications for supervision

To ensure that its proposals deliver a reduction in the potential for product and provider bias, the FSA intends to monitor Product Sales Data and will challenge adviser firms to explain any increases in switching that appear inappropriate by using 'conduct risk toolkits.' The FSA will supervise the way adviser firms set up and operate their own Adviser Charging tariffs, and ensure that provider firms do not continue to influence adviser remuneration.

The consultation period closes 30 October 2009, though the FSA is requesting responses on the issues raised in relation to corporate pensions business by 31 July 2009. The FSA is seeking to publish a Policy Statement in light of the responses received in the first quarter of 2010, and to implement its proposals at the end of 2012.

The key RDR developments are:

  1. Advisers will not be able to be paid a commission for advice from product providers or to sell products that are commission-based
  2. Advisers will be paid a fee from their clients
  3. With packaged products, e.g., unit trust and ISAs, advisers will either be (i) independent – giving advice across the whole of the market, or (ii) restricted – giving advice across a limited number of products
  4. Advisers will be able to give "basic advice" – streamlined advice on simple products, e.g., stakeholder products, and will not need a professional qualification for this
  5. Advisers will need to obtain a professional qualification equivalent to the first-year of a degree to give any advice other than basic advice

The implications are as follows:

  1. The IFA industry is likely to contract. They will not receive the same remuneration levels and they will need to obtain a professional qualification.
  2. Product providers who distribute solely through IFAs will need to rethink their distribution. Many rely on paying high commissions to the IFAs, in addition to providing education on their products, to encourage IFAs to sell their products.
  3. Mis-selling may become an issue of the past as the incentive to mis-sell is commission-driven.
  4. Poorer individuals may not seek advice if they feel they need to pay for it. There is a misconception that advice is free at the moment even though they currently pay for the advice indirectly through commission sales. There will need to be a high degree of education to the market regarding payment for advice, and emphasis will need to be put on the fact that the payment can be made at the time the investment is made.