Financial services sector braced for sweeping reform

In less than three months’ time, the Financial Services Authority (FSA) will introduce some of the most radical changes that the industry has ever seen: the Retail Distribution Review (RDR) is set to revolutionise the delivery of financial advice.

First set out by the City regulator in June 2006, the RDR has one goal – building a more transparent financial services industry in which consumers can trust.

Will the new reforms achieve the desired results? And how will they affect you? Here we answer your key questions:

WHAT ARE THE KEY REFORMS?

There are two main hurdles that advisers have to overcome that form the backbone of the RDR.

The first is an attempt to increase the quality and consistency of financial advice by setting new professional minimum qualifications for advisers.

Many have gone back to school over the past 18 months to sit a string of new industry exams, knowing that if they don’t gain the new recognised level-four qualification and statement of professional standing they will not be able to practice in the financial advice sector come 1 January, 2013.

This is part of the FSA’s continual drive to increase the professional standing of advisers and put them on a similar standing to accountancy and legal professionals.

The second key change, and, perhaps the most significant, is the partial abolishment of commission payments from product providers to advisers.

Ongoing commission, commonly known as “trail” or “renewal”, can continue to be paid to advisers for certain contracts, but the RDR will ban the payment of commission from the sale of new investment products.

Instead of receiving commission from product providers, financial advisers will now have to charge their clients fees for their advice.

DOES THIS MEAN ADVICE WILL NO LONGER BE FREE?

The simple fact is that financial advice has never been free: any commission paid to your adviser will have been deducted from your investment in some shape or form.

Many advisers have managed to avoid having a direct conversation with their clients about the cost of advice because initial commission has been carefully disguised within product charges.

Advisers have had to disclose the level of commission they receive, but opaque charging structures mean that consumers have still suffered a lack of understanding on exactly how much the adviser is being paid by the product provider and where this has actually come from.

The RDR aims to address this issue. From the outset, you will know exactly what you are paying; costs will no longer be hidden within investment charges.

HOW MUCH WILL I PAY?

The new rules make it very simple and straightforward: consumers either pay the adviser directly for the advice or it is taken as a single charge straight out of their investment.

These fees can take the form of an agreed percentage based on the value of your initial investment (3 per cent, for example), a fixed hourly rate or a combination of both.

Depending on their level of expertise, advisers typically charge between £75 and £250 per hour, according to unbiased.co.uk, the website that promotes independent financial advice.

WILL I SEE CHANGES BEFORE 2013?

Some advisers have yet to embrace the RDR and are still doing most of their business on a commission basis. With initial commission of more than 6 per cent still being paid on some pension and investment contracts, certain advisers are viewing the next three months as the last opportunity the fund their business through initial commissions.

Firms serious about the RDR have already changed the way they work to a fully functional fee-based financial planning model.

Meanwhile, fund managers are launching RDR-ready share classes ahead of the full implementation of the new regulations. Investment funds generally carry an initial charge of up to 5.5 per cent and an ongoing annual management charge of typically 1.5 per cent per year (usually lower on investment trusts and trackers).

Within the typical initial charge is provision for a commission payment to the adviser of 3 per cent and within the annual management charge is provision for 0.5 per cent trail commission. However, investors are now able to invest in “factory gate” priced funds. In simple terms this means that there is no provision for any commissions or fund rebates. Initial charges for most funds will move down to 0 per cent, with ongoing annual management charges reduced to around 0.75 per cent.

CAN I SWITCH TO THE CHEAPER FUNDS?

Those who remain invested in funds bought before the launch of RDR share classes will continue to pay the higher level of management charges. The adviser will continue to receive ongoing trail commission regardless of whether or not they provide any ongoing advice or service. This creates a huge dilemma for advisers: will they review the investment funds and recommend the cheaper factor gate versions and charge the investor an ongoing advice fee? Or will they choose not to review the existing investments and retain the right to the trail commission without having to justify it to their clients? This is something that will only be seen over time, but this is something the FSA is likely to be keeping a close eye on.

WILL I GET A BETTER SERVICE?

With the abolishment of initial commissions, which many firms have relied upon, there is no doubt that the industry will quickly move towards building long-term client relationships: providing an ongoing service and charge ongoing advice fees will become commonplace.

The RDR should see investors and advisers working more closely together with a greater focusing on financial planning.

• Jason Hemmings is a partner at Edinburgh-based Cornerstone Asset Management