24th January 2013
No one can absolutely guarantee success but I’m still firmly of the view that overall the Retail Distribution Review (RDR) reforms, as part of a wider package of reforms and initiatives including the setting up of the Money Advice Service, should make a major contribution to making the investment market and any related financial advice, work better for consumers and society at large. But the reforms won’t just work as if by magic. Consumer representatives and independent advisers have a critical role to play in making markets work better.
This raises two more questions:
· how will we know if markets are working better for consumers; and
· what can consumer representatives and advisers do to help promote the best outcomes for the public and behaviour from the market that we want to see?
These questions are especially important now that we have seen many of the major financial institutions including high street banks, building societies, and the bancassurers roll out their charges for restricted advice.
Restricted advice is the new category of financial advice which allows a business to recommend a limited number of products rather than search the whole market as independent financial advisers must.
There are some worries that they could still be disguising high charges for advice and for fund management.
How will we know if markets are working better?
Commentators will have their own particular measures for judging what a successful market looks like. At the Financial Inclusion Centre we use a system that measures consumer and market outcomes, derived from long established consumer principles.
These principles concern access, choice, safety and security, fairness and integrity, value for money, social utility, information and advice, redress, confidence and trust which we think have stood the test of time as measures of whether consumers are getting a good deal with all the associated protections required, when they are investing money,
Helpfully, these outcomes also map very well onto the new financial watchdog the Financial Conduct Authority’s statutory objectives set out in the new Financial Services Act.
We judge whether the retail market is working well for consumers if they:
· have access to a choice of safe, value for money, fit-for-purpose, socially useful products and services that perform well and meet their needs and wants;
· are treated fairly by financial institutions and firms that deserve their confidence and trust;
· have access to the right information, financial capability and, where necessary,appropriate, good quality financial advice from well trained and competent advisers to help them make the right financial decisions and choices;and
· receive adequate redress when things go wrong that are not their fault, and that wrongdoers are held to account.
As the market continues to respond to the RDR measures, we will monitor and analyse the impact on those outcomes.
Making markets work
Creating well-functioning markets requires the ‘holy trinity’ of:
1. Effective regulation: regulation that tackles the root causes, not the symptoms, of consumer detriment and market failure, aligns the interests of consumers and the market, and promotes market efficiency;
2. High standards
of corporate governance and business ethics: markets and financial institutions that operate with integrity, and conform to high standards of corporate governance and ethical behaviours; and
3. Productive market forces: markets must be efficient and truly innovative, sustainable and resilient, and competition must work in interest of consumers and the wider economy.
The Retail Distribution Review measures are intended to reduce the risk of a repeat of major misselling scandals by tackling the conflicts of interest caused by commission bias and other aggressive incentive strategies which were the root cause of so much consumer detriment.
The measures also aim to help consumers make much clearer choices, find better quality advice and improve confidence and trust by improving levels of training and competence and professionalism.
However, the reforms shouldn’t just be judged on those outcomes – critical as they are. It is important to remember that the primary function of the investment services market is financial intermediation – in this case, allowing consumers to invest for the future by providing capital to the real economy.
We need an efficient and competitive investment services market which provides real long term value for consumers – especially now in this new economic reality defined by squeezed household incomes, greater risk aversion and low levels of confidence and trust, low financial returns, low economic growth – and benefits the real economy.
At first glance, the investment services market ticks all the boxes in terms of the right conditions for a competitive market. There are hundreds of providers, thousands of products, with seemingly continuous innovation and new product development, and barriers to entry into the market are fairly low. There is certainly the illusion of innovation competitive activity.
However, the reality is different. We think that the consumer sometimes fails to get value and indeed can see it destroyed because of inefficiencies in the investment ‘supply chain’ which far outweigh the costs associated with misselling. These can include:
i) high charges on core products sold through the market compared to better value ‘substitute’ products. For example, we think tracker funds often do a better job on average than active funds and at a lower cost.
ii) Unnecessarily high search and ‘advice’ costs caused by overcomplexity, product proliferation, spurious innovation, and too many layers of intermediary and providers, for example, fund of funds.
iii) perhaps most importantly, consistently poor investment underperformance and risk management – generating good returns and managing risk is supposedly the core function of the investment management industry which it fails to do well.
In other words, before the RDR, market dynamics tolerated and indeed, it could be argued, actually favoured the manufacturing, distribution and sales of high cost, poor performing products and providers. A truly competitive market would not sustain this situation.
What can independent advisers and consumer groups do to make markets work?
The RDR reforms alone will not create the type of competitive, efficient market consumers need. However, the reforms do provide a real opportunity for advisers and consumer groups to drive down distribution costs, reward good value and sustained good performance and, of course, penalise poor value and performance. That is what real competition is all about.
In the post RDR world, independent advisers have a great opportunity to leverage their role as trusted intermediaries and agents of consumers to hugely influence market behaviour, drive down costs and compel powerful financial institutions to produce good value, simple, transparent products and services.
Now that the big beasts such as the banks have entered the fray, independent advisers have a great opportunity to demonstrate real value to consumers and prevent the big guns exploiting their influential market positions and distribution advantage.
But consumer groups can also help. The way the institutions have structured and presented their charges is confusing. Many consumers are likely to find it difficult to compare what’s on offer (in terms of how much they will pay and what they will get for the money) and make informed decisions. We would like to see consumer groups publish comparison tools which standardise the approaches adopted by the different institutions and allows consumers to see clearly how much they would be charged for advice on specified amounts of assets, and over different periods.