This article appears in the December 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Investors with small nest eggs often find advice in short supply. The U.K.’s Financial Conduct Authority (FCA) is trying to address this challenge with proposals for a cheaper “basic advice” model that may provide lessons for the Canadian market.
In a consultation paper, the FCA detailed reforms designed to make supplying advice to an underserved portion of the market easier. In the U.K., this market includes an estimated 4.2 million investors with at least £10,000 in cash — potential clients with the means to invest but not necessarily the opportunity, as financial firms typically target wealthier investors.
A shortage of advice for lower-net-worth investors has been documented in Canada too, including among investors working with a financial advisor. In a 2019 study, the Ontario Securities Commission’s Investor Advisory Panel (IAP) reported that many investors aren’t receiving basic advice regarding financial planning, budgeting and estate planning despite implicitly paying for it through embedded compensation structures such as investment fund trailer fees.
The shortage was particularly acute for investors with less than $50,000 and “mass market” investors with $50,000 to $100,000, the panel noted.
The IAP’s research sought to challenge the assertion that eliminating embedded compensation would create an “advice gap” by making serving smaller clients uneconomical. The report argued that since the gap already exists, regulators should tackle the conflicts of interest and other regulatory concerns arising from embedded compensation.
Ultimately, the Canadian Securities Administrators (CSA) eliminated trailer fees only for dealers that are prohibited from providing advice (i.e., discount brokers), leaving the advice gap for another day.
One possible answer is robo-advisors. However, the FCA’s paper stated that while automated advice can work for some investors, robo-advisors have met with limited success in the market: “Our research shows that customers tend to prefer human interaction and benefit from a personal recommendation.”
Now, the FCA wants to make providing human advice to smaller clients more economical. The proposed “basic advice” regime would impose less stringent regulatory requirements while preserving investor protection.
The proposed regime would allow advisors to recommend a limited set of “mainstream” investments under a streamlined suitability process that reflects the lower risk of dealing in straightforward products. Lower proficiency standards would reflect the reduced complexity of the required advice. On the compensation side, investors would be able to pay for transactional advice in instalments.
“We are proposing this change because we want consumers who would otherwise be interested in advice but put off by the initial fees to be more able to access core investment advice,” the FCA’s paper stated.
The proposals are out for comment and the regulator intends to finalize the new regime in the spring of 2023, with implementation by April 2024.
In Canada, investor advocates welcome the idea of a basic advice regime but question whether regulation is what’s preventing it.
Jean-Paul Bureaud, executive director of FAIR Canada, said improving access to advice for lower-net-worth investors may encourage them to save more and build wealth more effectively: “The idea of expanding access to good financial advice in Canada is certainly worth considering and investigating more deeply.”
However, Bureaud is skeptical of the FCA’s proposed streamlining of regulatory requirements. “It’s not clear to me that regulatory standards are the main barrier,” he said. “There could be many other reasons, including that potential investors do not want to pay the fees, that they may not trust the industry or that they may not know who to approach or where to start.”
If other reasons exist, “lowering investor protection standards may not lead to any meaningful change in this phenomena,” Bureaud said.
Neil Gross, former chairman of the OSC’s IAP and now a member of the CSA’s new IAP, also supports the idea of improving access to basic advice. “Many consumers’ investment needs are pretty straightforward, so an affordable basic advice package is a great idea,” he said.
However, Gross cautioned that firms must buy in and fill this gap in the market.
“Making it work will take more than just finding service delivery efficiencies and combining them with an accommodating regulatory design. It will also depend on the emergence of industry players who see a strong business case for tapping the mass market instead of just chasing high-net-worth clients,” he said. “So, before regulators start proposing this, perhaps they should ensure there are firms convinced that a ‘no frills’ brand of advice will be lucrative.”
Assessing industry appetite should be easier in Canada due to self-regulatory organizations, which the U.K. eliminated long ago. But while one of the long-term goals of Canada’s SRO reform is to enable greater industry innovation, the new SRO won’t be able to nurture new business models for some time.
“The key isn’t a single SRO,” Gross said. “It’s an SRO with a single rule book — one in which like activities are regulated alike, and business just has to comply with one set of rules. As soon as the new SRO gets that in place, things will be much better.”
Harmonizing the industry’s rule books is likely to take a couple of years. By then, the results of the FCA’s basic advice experiment should be available for Canada’s market players to assess.