The Retail Distribution Review (the “RDR”) was a project undertaken by the Financial Services Authority (the “FSA”), the relevant regulatory authority in the UK, to assess and amend the rules pertaining to the sale and promotion of financial products, including funds, to the retail public in the UK. It has resulted in new and updated rules which will become effective from 31 December 2012. It can be noted that over 30% of the 5,000 Irish funds currently authorized by the Central Bank have UK promoters, which indicates the importance of this market for the Irish industry and this article explores some of the implications of this new regime in the UK for Irish funds distributed in that market, while also noting the relevant requirements of the Central Bank of Ireland (the “Central Bank”).
Overview of Changes contained in the RDR
Under the new regime adopted pursuant to the RDR, product providers will be banned from offering commission to secure sales from adviser firms and, in turn, adviser firms will be largely prohibited from recommending retail investment products that pay commission1. In addition fund manager rebates may not be passed on to financial advisers.
Consumers must agree the fee for the relevant advice in advance. The consumer will still be able to have their adviser’s charges deducted from their investments, if they wish, but these charges will no longer be determined by the product providers the financial advisers are recommending. Disclosure of product and advice charges will be required.
Firms providing advice on retail investment products to retail clients will need to describe these services as either ‘independent’ or ‘restricted’. The standards expected of independent advisers will be amended from those currently applicable so that firms holding themselves out as independent must only make personal recommendations based on a comprehensive and fair analysis of the relevant market that is unbiased and unrestricted. All other advisers will be deemed “restricted advisers”.
Structural Changes in the UK Distribution Market
Financial advisers will henceforth be paid by retail clients rather than the investment managers of the funds their clients select. However, the use of panels, platforms and model portfolios by advisers in selecting products is possible by financial advisors and this is one of a range of issues upon which guidance has been issued by the FSA.
Panels- an advisory firm can use research to distil the product market into a panel and then select individual products from the panel when giving independent advice to its clients. Advisors would need to ensure that any panel is sufficiently broad and if the advisor provides independent advice it would need to be able to advise off-panel if that would be in the best interests of a particular client.
Platforms: An advisor firm may use platforms in providing independent advice, but similarly it needs to remain aware of the limitations of its chosen platform and advise ‘off-platform’, or through another platform, where this is best for a client in a specific case.
Model portfolios: this refers to pre-constructed collections of designated investments, including some retail investment products that meet a specific risk profile, possibly offered with a periodic rebalancing of investments to maintain a consistent asset allocation. Model portfolios allow a firm to pre-determine what will generally be its advised asset allocation for certain investment objectives or attitudes to risk, and to distil its product research in line with these asset allocations.
The FSA has also issued specific guidance in relation to distributor-influenced funds, being funds created for the clients of a particular distributor, typically an adviser firm or network. They could be designed on a bespoke basis for the distributor or they could be set up using an existing fund that is tailored for the distributor. Although fund management is outsourced to other entities for such funds, the distributor may have a degree of influence over the fund (short of day-to-day asset selection). It may be, for example that the distributor is able to create accountability of the investment adviser by attending investment committees or have representation on its board.
Facilitation of the Payment of Adviser or Consultancy Charges
The RDR rules on Adviser Charging (which apply to individual advice for retail clients with respect to retail investment products), allow a client to pay adviser charges direct to an adviser or to agree that the provider should pay them from the investment on the client’s behalf. The adviser charge can be deducted from the investment as a lump sum or, if an ongoing service is provided or the product is a regular payment one, as a series of regular payments.
Facilitation takes place where the consumer, instead of paying the adviser charge direct to the adviser, pays a single amount to the product provider, who then pays the adviser charge to the adviser on behalf of the customer. The rules for firms willing to facilitate payment of adviser charges are set out in the FSA’s conduct of business rules .The guidance confirms that both of the following two methods can be used by product providers to facilitate payment of adviser or consultancy charges under the RDR rules on facilitation:
- paying the full amount received from the customer into the product and then deducting the amount (or amounts) of the charge from it; or
- deducting the initial charge from the amount received from the customer and then paying the remainder into the investment product.
Practical Implications for Irish Funds
The RDR relates to retail distribution in the UK so, although it is not directly applicable to Irish authorized funds, it is relevant in determining distribution strategy for such funds in that market. Given that over 30% of Irish funds have been established by UK promoters (although many of these are non-retail products) this is a significant portion of the market. In addition, certain other markets have similar provisions, or proposals for similar rules at varying stages, so it would be appropriate for Irish funds seeking international distribution to adopt a general strategy for dealing with markets which have a prohibition on commissions to distributors. The following points should be considered:
- Fee structure:
Where distributors are generally being paid a fraction of the management charge it may be useful to create new share classes or even sub-funds with a different fee structure which reflects the requirements of the RDR that no such payments be paid to the distributors. Creating a separate class with a different fee structure and what may appear to be lower charges may be problematic for existing funds and it can be noted that it is generally not permitted by the Central Bank for a separate prospectus to be issued in respect of a single share class alone. The general requirement is that where a supplement is issued specific to a share class it may only contain information specific to that class. Consideration should be given therefore as to how best to cater for “RDR” investors without antagonizing existing investors.
The traditional distribution arrangements, with the distributor receiving a fee from out of the management fee based on sales, will generally require revision. Promoters and investment managers may, however, consider continuing to use distributors on a similar basis to gain access to panels or platforms operated by separate independent retail advisers as contemplated by the FSA’s guidance. Amendment to the existing contractual arrangements will probably be required however.
- Operational issues:
Following from the above, it may be appropriate to build in the potential to facilitate payments to third party advisers, as provided for in the FSA’s guidance. This may require adaptions to the fund’s existing administration agreement as well as subscription forms. The custodian will also need to be satisfied with the basis upon which subscription proceeds are repaid from the fund to an independent adviser where facilitation occurs and the funds pass through the fund’s accounts.
The Central Bank views the “promoter” of an Irish authorized fund as the driving force behind the decision to establish it. Although the Central Bank does now permit distributors to act as promoters, to date the vast majority of promoters to Irish investment funds have been investment managers. Given the specific guidance from the FSA regarding distributor-influenced funds it seems likely that these entities will comprise a greater proportion of the promoters of funds in general, including Irish funds, going forward. New investment managers coming to the market may therefore seek to do so in collaboration with existing distributors seeking to provide specific types of products, rather than establishing their own standalone products and then seeking distribution outlets for them.
Although the RDR is a UK initiative which does not directly affect Irish funds, in practice Irish funds which are distributed at a retail level in the UK would be advised to consider whether they will need to take steps in response to this to ensure that their UK distribution will not be adversely affected. Such amendments should be considered in advance of the commencement of the new regime in the new year and may incorporate changes both at an operational level and also with regard to the distribution channel. As this new model becomes more prevalent throughout Europe Irish funds aimed at the retail market may need to determine and adopt a revised distribution strategy on a general basis.