The FSCA has released a discussion document on investment related matters in the context of the Retail Distribution Review (RDR) initially published in November 2014. Subsequent status updates were published in December 2016 and more recently in June 2018.
One of the main objectives of the RDR is to address the risk of conflicts of interest between intermediaries and product or service providers on the one hand and customers on the other, i.e. conflicted advice. The discussion document focuses on the impact of a selection of the initial RDR proposals on the investments sector, and provides the FSCA’s updated thinking based on input received, specifically in relation to the initial Proposal Z (Figure 1) which deals with restricted outsourcing to financial advisors.
The FSCA received feedback from a wide range of entities and, having considered the various comments, have updated their observations, which include:
- They remain concerned about the conflicts of interest and customer confusion given the complexity of current investment product distribution models, particularly in vertically integrated business models.
- There is conflict of interest risk in third party co-branding arrangements (often called ‘white label’ arrangements) where CIS management companies outsource investment management to intermediaries who are also financial advisors. The good news is that the FSCA is no longer looking to prohibit all these arrangements but will look for other ways to address the risks.
- The focus on mitigating conflicted investment advice will include considering the roles of other types of discretionary mandate holders such as ‘model portfolios’ or ‘wrap fund’ providers.
- There is concern that the definition of “discretionary FSP” in FAIS is too broad and the type of services provided by Category II FSPs varies significantly. Because of this broad definition, the FSCA is of the view that remuneration is not always commensurate with the nature, extent and quality of actual services provided and may not always be paid for by the user of the service.
- There are inconsistent and sometimes inaccurate terms used to describe investment offerings and relationships between industry participants, for example, discretionary fund manager (DFM), asset manager, discretionary investment manager (DIM) are often used interchangeably.
3 main areas identified as Matters for Consultation
The FSCA identified 3 main areas where they have asked for feedback. In this article we do not go into detail in dissecting each of these areas but provide an overview of what the Conduct Authority is considering. These matters are complex and will, at the least, impact Category II FSPs as well as any FSPs that provide advice on investment offerings managed within a group that offers outsourced investment management services.
The 3 areas are:
- Defining and understanding different activities performed under a discretionary investment mandate.
As mentioned above, the FSCA holds the view that the definition of “discretionary FSP” is very broad and does not always distinguish between the different forms or types of services offered by these FSPs. They have, therefore, placed the different types of Category II FSP activities into the following 4 broad categories:
i. “Traditional”investment management involving portfolio construction through analysing and selecting underlying instruments;
ii. Third party co-branded investment management (often referred to as ‘white label’ arrangements);
iii. “Model portfolio” management which entails selecting and designing customised or “model” portfolio solutions, most often made up of a selection of CIS portfolios; and
iv. Mandates held mainly for convenience where no or very little actual portfolio construction, design or selection is performed.
In respect of each of these broad categories, the FSCA is looking to include various regulatory measures to, for instance, define the activities of each of these categories, set appropriate fit and proper standards for each and potentially create different licence categories.
- Categorising investment advisors within an RDR framework.
One of the FSCA’s observations is that there needs to be a clear understanding of the actual contractual and business relationships between the various links in the investment product value chain, for example, between the CIS management company, the Category II FSP, a LISP, etc. A question that also needs to be answered is how financial advisors who provide advice on investment products should be categorised, to reflect the nature and status of the advice they provide and their relationship with other components of the investment value chain.
Although not finalised, the proposed RDR advisor categorisation distinguishes between a Product Supplier Agent (PSA) who operates on the licence of a product supplier and may provide advice on the products of that product supplier only (or in its group) and Registered Financial Advisors (RFAs) who will be separately licensed to provide advice on the products their licence permits. The Conduct Authority has considered whether an investment advisor (in some cases) should be regarded as a PSA (effectively a tied agent) of an investment manager or Category II FSP and/or of a CIS management company and/or of a LISP (Category III FSP).
The FSCA goes into a lot of detail in this discussion document regarding various options and views in relation to PSAs and RFAs in the context of the investment sector. There are several regulatory challenges and the FSCA has asked for responses to various questions. They have also put forward a few measures, some of which seek to provide for clear requirements relating to due diligence, the governance and oversight responsibilities of, for example, a CIS management company, etc. As this is complex, we will unpack these in a subsequent article. However, these considerations will impact on Category I FSPs who are associated with or are part of a group which includes a Category II FSP or other investment providers.
- Implications for remuneration and charging structures.
There are several existing RDR proposals which deal with remuneration in the investment product space and in respect of which the FSCA intends to proceed with setting standards. Consideration will also have to be given to any additional remuneration and charging structures arising from proposals in the discussion document. A number of measures have been proposed and the FSCA has requested input on each of these which include engaging with ASISA on how to use the ASISA Effective Annual Cost (EAC) disclosure mechanism to understand the ‘layers’ of charges relating to investment products, how to address any duplication of fees, how to deal with conflicts where the investment advisor is part of the same group as the investment manager and clarifying the responsibilities of different entities in relation to the facilitation and monitoring of advice fees and other charges.
The FSCA has invited comment and input to the proposals and measures put forward in the discussion document and to submit these to the Conduct Authority by 17 August 2018. As always, Masthead will carefully consider the impact of these proposals on its members and welcomes your comments and views which will be consolidated into the feedback to the Conduct Authority.
Click here to read the full Discussion Document.