In Part 1 and Part 2 of our RDR series we looked at the consultation paper on Advisor Categorisation. In Part 3 we turned to the second consultation paper on Investment-related matters published at the end of 2019, and focused on how investment management will be defined and categorised from a licencing perspective, the impact that this may have on the fit and proper standards for investment managers and also considered how the Product Supplier Agent (PSA) and Registered Financial Advisor (RFA) categorisation will work in the investment sector.
RDR Proposals on Investment Related Matters
In Part 4: Investment-related matters, the last part of our RDR series, we look at the implications for remuneration and charging structures in the investments sector.
Cost Disclosure
In the initial RDR proposals (published in 2014) the regulator expressed concern about remuneration and charging structures in the investment space as these “all have a direct impact on the ability of products to meet reasonable customer benefit expectations.” To address this concern there needs to be clear and understandable disclosure of the fees, costs and charges in the investment value chain. The FSCA proposed in the 2018 Investment Paper that the ASISA Effective Annual Cost (EAC) disclosure mechanism currently used for collective investment schemes, be enhanced and used as a basis to ensure that customers are placed in a position to understand the quantum and impact of the layers of costs in the investment value chain. Industry is largely in favour of this approach but warned that there is a need for simplicity and flexibility as some commentators warned that the EAC is complex and can be difficult to understand. The thinking is that the requirement for disclosures be made in a format similar to the CIS Minimum Disclosure Document and be extended to model portfolios and other non-CIS solutions.
It is our view that there should be disclosure regarding the relationships in the value chain that clearly sets out who does what, who can do what, and who gets paid for what, as we think that this would be consistent with the activity-based approach that underpins many of the RDR proposals. If the relationship and status, together with money flow, are clearly and simply disclosed, then this will assist investors to understand and compare costs associated with every entity in the value chain. To that end, we are in support of everyone disclosing the same information so that things are comparable.
In the investments consultation paper the FSCA also reminded industry of the changes to the General Code of Conduct. In a show of consistency, these changes have subsequently been published on 26 June 2020, requiring written customer consent to the amount, frequency, payment method and receipt of any fees (excluding regulated commission and certain other regulated fees) including consent to the details of the services that will be provided in exchange for those fees.
Mitigating the risk of duplication of charges
One of the principles for intermediary remuneration identified in the initial RDR proposals is that an intermediary may not be remunerated for the same or similar service twice. The regulator has concerns about inappropriate duplication of fees particularly where fees are charged by an investment manager in respect of portfolios where the CIS Manco or other asset manager is also charging fees on one or more of those portfolios, e.g. third-party co-branded models where there are fees charged by the CIS Manco and by the third party investment manager.
Although the FSCA agrees that enhanced disclosure is a significant mitigating factor to reduce inappropriate cost duplication, they re-confirmed their view that this on its own is not enough, and there needs to be additional regulatory interventions to address this risk. However, they have not proposed a solution yet, but have indicated that there will be further consultation on potential measures to deal with these risks.
Again, looking to consistency in regulatory thinking and approach, FSPs also need to consider the general remuneration principles introduced through amendments to the General Code of Conduct which confirm that an FSP may only earn financial interests where these are reasonably commensurate with the service rendered, it does not result in being paid more than once for a similar service, that any actual or potential conflict must be effectively managed and delivery of fair customer outcomes is not impeded.
Mitigating the risk of conflicted advice in vertically integrated models
Where an investment manager and an advisor form part of the same group and advice is given to customers on their own or the group’s investment portfolios then there is a real risk that the advice is conflicted and the FSCA requested input on how these risks of conflict could be adequately mitigated. The regulator agrees that branding is a useful tool to highlight intra-group relationships between advisors, investment managers and product suppliers and they are open to co-branding rather than prescribing that a single brand be used as was initially proposed, provided that each brand is sufficiently prominent to highlight the relationships concerned.
Investment advisor categorisation is also a mechanism to address these conflict concerns, which we dealt with in detail in Part 3 of this series.
It was initially proposed that, where there is advice and investment management performed by the same entity, the entity would be disallowed from charging both advice and investment management fees. Our response to this proposal, along with other commentators, was that it was not in line with the RDR activity-based approach, where fees should be paid for the activity performed. The FSCA has agreed with input from industry and will not proceed with the initial proposal. In other words, where advice and investment management is performed by the same entity, that entity will be able to charge for each activity.
Facilitating and monitoring advice and other fees
In the 2018 Investment Paper, it was proposed that entities such as LISPs, CIS Mancos, Insurers and even investment managers themselves, would be required:
- to facilitate the deduction and payment of advice fees to an adviser,
- to offer certain fee structures,
- to monitor the advice fees charged by advisors, and
- to report on these fees to the regulator.
The FSCA received very divergent views on the various proposals and confirmed that these are still being considered. The regulator is also contemplating an information gathering exercise to assist in finalising their position.
Remuneration for automated advice
With the introduction of a definition for automated advice in the Fit and Proper requirements, the regulator asked for input on how to deal with advice fees in an automated advice model. The FSCA agreed with industry input that there is no separate remuneration dispensation required for automated advice and that equivalent standards and principles should apply to all advice models.
Mitigating the risk of conflicted exercise of discretionary mandates
The regulator has concerns about situations where an investment manager provides discretionary investment services to customers and as part of that service, selects portfolios which it also manages, or which are managed by an associate, as this presents conflict of interest risks. The FSCA called for input on how to mitigate these risks in the 2018 Investment Paper and confirmed in the second consultation paper on Investment-related matters that it will take the comments from industry into account when developing regulation to deal with these risks. Although there was no further indication from the FSCA regarding its updated position, we remain of the view that the best way to mitigate the risk of conflicts of interest in these types of cases is through clear and sensible disclosure by all parties, which should include disclosure about (1) status (RFA or PSA), (2) relationship with the investment product supplier, (3) activities performed by each party, and (4) any money flows. In line with the principle that the same FSP can charge for different activities performed (i.e. both for advice and for investment management services), our view is that these potential conflicts can be adequately managed through clear disclosure.
Conclusion
The jury is still out on many of the proposals relating to remuneration and charging structures in the investment sector and, based on the FSCA’s comments that final proposals on several of these matters are to an extent dependent on the outcomes of consultation in the other investment related proposals, we expect to see further updates from the FSCA in this regard. FSPs should, however, consider their own remuneration and fee arrangements in light of the conflict of interest risks identified by the FSCA so that they can anticipate any impact that these could have on their business models.