On 18 September 2013, the Financial Conduct Authority (FCA) published a report (together with some draft guidance) on its findings of evidence of advisory firms undermining the Retail Distribution Review (RDR). In particular, the FCA found evidence of firms accepting inducements from product providers, which did not look like traditional commission payments, but were intended to achieve the same outcome, i.e. to secure distribution of the relevant provider's products. These inducements included certain payments by product providers to develop and/or maintain advisory firms' IT systems.

The FCA indicated in its report that it would be carrying out follow-up supervisory work and clamping down on any firms who continue to receive or provide these types of inducements.

Introduction

One of the central objectives of the RDR rules and guidance (which came into force on 31 December 2012) was to remove the potential for remuneration or inducements received by advisers from product providers to inappropriately influence the advice such advisers gave to their customers. The FCA wanted to check that firms were not undermining these objectives and therefore asked 26 life insurers and advisory firms to provide information about their main service and distribution agreements, which the FCA reviewed to assess:

  • whether advisory firms were soliciting payments from product providers that could lead them to channel business to a particular provider; and
  • whether product providers were making these payments to secure distribution of their products.

The FCA noted in its report that over half the firms it had sampled had agreements that the FCA considered could breach Principle 8 (Conflicts of Interest) and the inducement rules in the Conduct of Business Sourcebook (COBS). These agreements included certain contracts for IT development and maintenance, which the FCA felt had the potential to create conflicts of interest and cause advisors not to act in the best interest of their customers.

Findings relating to IT development and maintenance

COBS 2.3.15G provides that a product provider may pay cash amounts or give other assistance to a firm not in the same immediate group for the development of software or other computer facilities "necessary to operate software supplied by the [product provider], but only to the extent that by doing so it will generate equivalent cost savings to itself or clients".

The FCA considered this provision and noted that payments from product providers to advisory firms for IT development and maintenance that are restricted only to those costs that are necessary to integrate and feed information into a product provider's IT systems are likely to be acceptable if:

  • the provision or receipt of such payments does not impair the firm's duty to act in its customers' best interests;
  • the payments can reasonably be expected to result in equivalent cost savings to the provider or its customers; and
  • the quality of service received by the customer can reasonably be expected to be enhanced by the payment.

Indeed, the FCA cited an example of a payment made by a product provider for such limited purposes (which resulted in the cost savings and increased customer service mentioned above) as an example of good practice.

However, the FCA noted that "payments from providers towards the wider development of an advisory firm's IT system or infrastructure, where such development is needed before the advisory firm's system can be integrated with the provider's", are likely to be of such a scale and nature that they cause conflicts of interest that are not in the customers' best interests. It noted the following as examples of poor practice in this area:

  • payments from providers to develop advisory firms' general IT systems or infrastructure; and
  • sizeable annual payments from providers for general IT maintenance.

The FCA felt that these scenarios had the clear potential to create conflicts and cause an advisory firm to put its commercial interests ahead of its customers' best interests.

Based on this guidance, it seems that the FCA will look carefully at exactly what services are being provided under any IT development and maintenance arrangements between providers and advisory firms. It will expect the services being provided under these agreements to be fairly limited in scope and for firms to demonstrate the relevant cost savings and enhanced customer service mentioned above.

Comment

The FCA notes in its report that it expects firms to review its guidance and, if necessary, revise their existing agreements. It goes on to note that it will take further action against firms that continue to infringe the RDR and the FCA's final guidance (which will be published following consultation on the guidance in the recent report), suggesting that there is a real risk of enforcement action in this area. Indeed, two firms have already been referred to enforcement for potential rule breaches as a result of the FCA's findings in this review.

Both advisory firms and product providers will therefore need to carefully consider their existing and proposed IT development and maintenance agreements and ensure that what is being provided under those contracts:

  • is sufficiently limited in scope; and
  • generates cost savings to the product provider and/or the customer and ideally customer service benefits.

Where firms have entered into agreements that are not limited in scope and cover the development and maintenance of the advisory firm's general IT systems, the parties to these agreements should consider changing the scope of the arrangements or risk future enforcement action by the FCA.

For more information, please click here