As Canadian regulators continue to contemplate radical reforms to retail investment regulation, such as banning embedded commissions or imposing a fiduciary duty on financial advisors, policy-makers in the U.K. are looking for ways to address the fallout of their own recent reforms.
Despite the fact that the Canadian Securities Administrators (CSA) first issued a pair of consultation papers setting out their concerns with current conduct standards and mutual fund fee structures almost three years ago, the lack of concrete reform proposals doesn’t mean that the issues have gone away. Speaking at the Ontario Securities Commission’s (OSC) annual conference in mid- October, OSC chairman Howard Wetston stressed that the regulators are still “very engaged” in possible reforms, such as the introduction of a statutory “best interests” duty on advisors.
The CSA is expected to release the results of independent research that it commissioned from York University professor Douglas Cumming into the impact of mutual fund fee structures on fund sales soon. That paper, combined with research published earlier this year by the CSA and other consultations, is expected to help lead Canadian regulators to a policy decision early in 2016.
In the meantime, policy-makers in the U.K. have just launched their own review of the market for financial advice, a review that may well be instructive for both Canadian regulators and the financial services sector at large. On Oct. 12, HM Treasury and the U.K.’s Financial Conduct Authority (FCA) initiated a joint consultation on ways of improving consumer access to financial advice as part of the Financial Advice Markets Review (FAMR) that was announced earlier this year.
The consultation will examine what consumers of financial services need in terms of advice, the extent to which those needs are being met and possible ways to address the shortfall between the demand for financial advice and the supply. The FAMR consultation will run until late December; a final report is due before the U.K. government tables its next budget in 2016.
This latest consultation in the U.K. is particularly relevant to the policy debate in Canada, as reforms to strengthen investor protection in the U.K. – known as the Retail Distribution Review (RDR) reforms, which included banning embedded commissions and raising proficiency standards for financial advisors – are seen to be among the reasons that the availability of financial advice has been reduced in that market.
Martin Wheatley, formerly head of the FCA, admits that this reduced availability has been the primary challenge of the RDR reforms. Wheatley, speaking at the OSC’s annual conference, noted that the initiative has been successful in a couple of major ways: improving the industry’s professionalism and enhancing the product mix for clients.
In fact, Wheatley says, the U.K. saw a massive shift in the sorts of products being sold to investors once the RDR reforms came in – with high-margin products dropping to just 20% within three months of the implementation of the RDR from 60% of product sales immediately before, as advisors began making greater use of products that weren’t as remunerative under the previous industry structure. However, the primary challenge posed by the RDR, he says, was an initial reduction in the availability of advice for less affluent clients.
This challenge has been one of the central concerns in Canada, with the investment industry arguing that if regulators force the scrapping of trailer fees for mutual funds or require reps to provide only advice that meets a “best interests” standard, these requirements will have the effect of cutting the supply of advice, particularly to less affluent clients.
The FAMR paper confirms that there has been a reduction in the availability of financial advice in the U.K. since the RDR reforms took effect in 2012. According to the paper, the number of advisors in the market declined to 24,000 in 2014 from 26,000 in 2011.
According to the paper: “A number of major providers have cut back their professional advisory businesses or left the market. In addition, a number of those firms offering advice apparently are focusing more on wealthier customers than the mass market.”
At the same time, the paper notes, the FCA’s data on product sales indicates that the proportion of retail investment products that are being sold without advice has increased to approximately two-thirds in 2014-15 from about 40% in 2011-12.
Although both the availability and the use of financial advice appear to have declined in the U.K. since the introduction of the RDR reforms, those reforms are not the only factor. In fact, the FAMR paper indicates that the situation is more complex and nuanced than the tougher rules simply resulting in a reduction in the provision of advice.
For example, the paper notes that some consumers may be deciding that the value of the advice they are receiving is not worth the cost; trust in the industry has eroded; and investors may be more confident in going without advice, particularly as the availability of online tools and information to support financial decision-making have increased.
Given multiple possible causes for the decline in advice, the U.K. consultation will be looking at a range of possible solutions, including: ways to deliver advice, or at least financial education, in workplaces and through public institutions such as libraries and post offices; improving consumer trust in the industry by better aligning investor and industry interests; and supporting the development of more cost-effective online advice.
Indeed, competition is seen as a central solution to reducing the advice gap. Wheatley reports that the shift in the advice market has already created opportunities, which small firms and independent advisors are capitalizing on.
As a result, these smaller businesses have seen a “huge” increase in their business, he notes. And, he adds, “fintech” solutions are emerging to exploit the gap in advice. Although digital advice models are cropping up in the U.K. as they are in Canada and the U.S., the FAMR will aim to identify any regulatory or structural barriers that are preventing even greater innovation.
In addition, the review will look for ways to reduce regulatory risk and uncertainty, according to the FAMR paper: “One question we will consider is whether any ‘safe harbours’ may be appropriate for financial advice” – which would involve adopting provisions that reduce or eliminate potential liability in certain circumstances.
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