While debate in Canada continues about how far regulators should go with new rules to improve investor protection, other countries have forged ahead. Initiatives undertaken elsewhere have focused on embedded fees and conflicts of interest in particular. But whether reforms in other countries have achieved their goals or, indeed, if less affluent investors now are worse off remains unclear.
In the U.K., for example, where commission-based compensation has been banned, some investors have benefited from greater levels of transparency and choice since the regulatory reforms were introduced. Other investors, however, have been left with few good options.
“Not everyone had access to financial advice prior to [the regulatory reforms], that’s true,” says Chris Hannant, director general of the Association of Professional Financial Advisors in London. “But I think it’s even harder now to find an advisor willing to take you on unless you have a fairly substantial sum of investible assets.”
Who gets what – and how much – of the advisory pie also is affected by the drive globally to reform compensation in the investment industry. While some firms are merging or disappearing altogether as a result of the growing compliance burden and increased competition from automated advice, firms nimble or large enough to weather the storm are taking advantage of the new investor protection rules to grab more of the wealth-management business.
“[The reforms] don’t change the profitability of the industry. It continues to be profitable and growing,” says Michael Spellacy, senior partner, asset management, and leader of global wealth management with Pricewaterhouse Coopers LLP in Stamford, Conn. “What these reforms change is the dynamics of who gathers the lion’s share of the profits.”
In Canada, regulators have taken a cautious path relative to other countries. Instead of an outright ban on commission-based compensation, for example, Canada has chosen to use disclosure as its main regulatory tool, arguing that if investors are told in plain terms how much they pay each year for advice, they can make an informed decision regarding the products and services they want.
But now Canada’s regulators are beginning to believe that disclosure by itself is insufficient and are considering the introduction of a fiduciary-like standard and a ban on embedded commissions. If the regulators choose to move closer to the more aggressive approach taken in other places, what is likely to happen?
Here’s how regulatory reform has been playing out in the U.K., Australia and the U.S.:
Starting in January 2013, after a six-year development period, the U.K.’s Financial Services Authority – the predecessor organization of the current Financial Conduct Authority (FCA) – ushered in the Retail Distribution Review (RDR). The RDR is a series of regulatory changes governing the financial advisory industry and meant to improve transparency, raise advisor qualifications and better align compensation with client interests.
The key element of the RDR was banning embedded commissions paid to advisors by product manufacturers. Advisors in the U.K. subsequently were limited to charging clients a one-time fixed fee for advice, an hourly fee or a fee based on invested assets.
In addition, the FSA created two categories of advisor: independent financial advisors (IFAs), who can offer clients all types of investment products, as well as the complete range of products from investment firms; and restricted financial advisors (RFAs), who can sell either the products of one manufacturer or those from a wide range of providers, but remain limited to offering only one type of product. Both IFAs and RFAs have to make clear to clients which type of advisor they are. Finally, the RDR raised proficiency requirements for all advisors.
Studies undertaken since the implementation of the RDR suggest that the changes have had mixed results.
On the positive side, the standard of advice has improved as advisors work to meet the higher qualification requirements. In addition, investors’ access to a broader array of suitable investment products increased. During the period immediately prior to implementing the RDR to three months after its implementation, the percentage of high-commission products sold through the advisor channel dropped to 20% from 60%.
However, since the implementation of the RDR, there has been an exodus of advisors from the industry. In the period 2011-14, the number of advisors practising in the U.K. dropped to 30,000 from about 40,000 – a drop of a 25% – according to the FCA. The drop in advisor numbers is attributed more to the higher qualifications requirements under the RDR rather than to the ban on commissions, Hannant says: “Many advisors nearing the end of their career, or who were working part-time, took the view that [going back to school] wasn’t necessarily worth the aggravation.”
A related issue raised in the aftermath of the introduction of the RDR was the apparent widening of the “advice gap” – a decrease in accessibility to financial advice for investors with modest assets. A study released by the FCA in March 2016 found that the percentage of firms requiring clients who are seeking advice to have a minimum of £100,000 in investible assets increased to 32% in 2015, from 13% in 2011.
At the same time, some clients who may have been unaware of how advisors were compensated under the old commissions model balked when faced with the prospect of paying up front for advice. “Those with lower levels of wealth found themselves facing fees that were somewhat disproportionate to the amount of investible assets they had,” Hannant says.
The FCA states it’s interested in looking for ways to narrow the advice gap, including encouraging the development of firms offering clients access to streamlined, affordable, automated advice.
“You’re seeing a migration toward the robo- or automated advice offering, so that clients aren’t paying the higher fee for advice if cost is an issue for them,” says Deborah Fuhr, a managing partner and co-founder of exchange-traded fund industry consulting firm ETFGI LLP in London. Sales of these funds have grown in the U.K. following the RDR reforms, she adds.
Starting on July 1, 2013, a raft of regulatory changes affecting advisors in Australia became mandatory as part of the Future of Financial Advice (FOFA) legislation after a one-year voluntary period. FOFA was launched by the Australian government in 2009 and was passed into law in 2012.
In introducing the reforms, the Australian government’s intention was to protect clients. That included improving both access to and the quality of financial advice.
The FOFA legislation bans “conflicted remuneration structures,” including commission-based compensation, volume-based compensation and “soft dollar” benefits. Advisors are limited to charging a fee for service that has been disclosed and agreed to by the client.
The FOFA reforms include a qualified best-interest standard for advisors with “safe harbour” provisions, whereby an advisor can be considered to be in compliance with the duty if he or she takes certain steps, including meeting “know your client” and proficiency requirements.
While the legislation became effective only recently, “there is little doubt that the FOFA reforms have had a significant impact on the financial advice business,” says Anthony James, asset- and wealth-management leader with Pricewaterhouse Coopers (Australia) LLP in Sydney.
Faced with a ban on commissions and additional requirements when fulfilling the best-interest duty, bank-owned platforms have begun offering streamlined, low-cost advice services via advisors who are predominantly salaried employees, James says. Indeed, firms that previously relied heavily on revenue from product or platform providers are seeing margins shrink.
However, independent advisors, as well as those working on certain platforms, have benefited by placing greater focus on high net-worth clients. And less affluent investors are being guided to lower-service advice models. “Clients who don’t have the appetite to pay for advice directly are being pushed to digital and other low-cost, self-service channels,” James says.
Notably, a key feature of Australia’s retirement savings structure is the existence of the “superannuation fund” program, which is a mandatory, defined-contribution type of pension plan for employees. Contribution rates for these plans can range up to 15% of salary, with the money managed by private firms.
The contribution rates are so significant, the program “almost stifles the need for Australians to save independently for retirement,” says Chuck Grace, a lecturer at the University of Western Ontario’s Richard Ivey School of Business and a financial services sector consultant with Bigger Picture Solutions Inc., both based in London, Ont.
The U.S. Department of Labor introduced a fiduciary standard for advisors, known as the DOL fiduciary rule, in 2015 and published a final set of regulations in April 2016; the DOL fiduciary rule takes effect in April 2017. Under the rule, advisors must provide clients with advice that is in their best interest as it pertains to their retirement accounts, including 401(k) plans and individual retirement accounts.
“The essence of the rule is to ensure consumer protection,” Spellacy says, “and that there is both direct transparency and elimination of conflicts of interest around retirement assets.”
The DOL rule will prevent advisors from charging embedded commissions. However, there is an exception, welcomed by the industry, that allows for commission-based compensation if the advisor has the client sign a “best interest contract exemption” (BICE). With a BICE, the advisor must commit to putting his or her client’s interest first and must disclose information about fees and any apparent conflict of interest to the client.
However, clients who have signed a BICE have full recourse to legal action if they think that their advisor has not met his or her commitment to put the client’s interest first. “It’s such a litigious society that the actual implementation of [the DOL rule], the lobbying [against it] – a lot of it has been driven by how the U.S. operates,” says Victoria Loutsiv, partner, enterprise risk, and governance and regulatory leader with Deloitte LLP in Toronto. That threat of liability is expected to accelerate the trend of American advisors moving to fee-based compensation models.
And the DOL rule is not the only regulatory change on the horizon. The U.S. Securities and Exchange Commission (SEC) is considering introducing its own uniform statutory fiduciary standard, although that regulator hasn’t signalled how or when it will proceed.
Even without any move by the SEC, the implementation of the DOL rule will reshape the U.S. advisory industry, Spellacy says. Firms that had relied primarily on commission-based business models will see profits reduced dramatically, he adds. As a result, many small and mid-sized firms will either exit the business or be bought by larger institutions.
“We expect significant industry consolidation and restructuring as a result [of the DOL rule],” Spellacy says. “There are many broker-dealers, wirehouses and independents in the U.S. that won’t be able to tolerate the [increased] cost of compliance.”
But for clients with higher levels of assets, the transformation of the advisory industry is likely to be positive, Spellacy adds: “There will be an extraordinary level of choice, autonomy and independence over who clients select [as an advisor], what products they select and how they select them.”
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