Rechtsanwalt, Partner, Head of Employment & Reward, Germany
Out-Law Guide | 05 May 2010 | 10:31 am | 16 min. read
The Financial Services Authority (FSA) wants to prevent platforms from receiving payments from product providers, but it promises that no changes will be made until after 31st December 2012, when the Retail Distribution Review (RDR) rules come into effect.
It has also decided to postpone its ban on product providers providing cash "rebates" for platforms to pay into clients' cash accounts until it has decided its course of action on product provider payments.
The announcements were made in the FSA's policy statement and final rules on platforms, published on 1st August 2011. The regulator hopes the delay will give firms time to adapt their systems. Other measures set out in the paper will come into force with the RDR rules on 31st December 2012.
Commenting on the policy statement, Bruno Geiringer, a partner in the Financial Services and Insurance group at Pinsent Masons, the law firm behind OUT-LAW, said it was sad that, after four years, the FSA was still not firmly regulating the sector. "The regulator's concern about upsetting firms' business models is surprising as this never stopped it before."
"It is time the platform industry created a new representative body to present its views coherently to the new regulators in future."
This guide looks specifically at platforms. The final RDR rules on independent and restricted advice, adviser charging and the impact on sales of pure protection products are considered in separate notes.
Platforms allow financial advisers to view and manage their client's investments online. They can also provide investment planning tools and other services for adviser firms. For product providers, platforms provide administrative services and a means of distributing their products. (see: What is a platform?).
In recent years, there has been a significant increase in business transacted through platforms and this is expected to continue.
Until now, the regulation of platforms has been principles-based, with very few provisions applying specifically to platforms or those that use them. The FSA, however, believes there needs to be a definition of "platform service" that is capable of covering the wide range of platform models, both now and in the future.
The rules, therefore, define a platform service as one which
A "platform service provider" is simply defined as a firm providing a platform service.
Administrative services provided by private client investment managers and advisers fall outside the scope of the definition. As do product providers, such as life companies, self-invested personal pension (SIPP) operators, authorised fund managers and firms that undertake custodian activities.
But execution-only brokers providing a custody service for the assets purchased are included. The FSA recognises such firms are not commonly referred to as platforms but considers they provide a similar service to execution-only wraps and fund supermarkets.
Some ISA managers may also be caught. An ISA is not itself a retail investment product, and so ISA managers are providing a service, not a product. ISA managers that distribute funds of more than one product provider will need to consider carefully whether they fall within the definition.
Platform remuneration and charges
One of the main aims of the RDR is to remove any influence product providers have over the personal recommendations financial advisers make to their clients about retail investment products. The RDR remedy is to ban commission-based sales and introduce adviser charging, so that advisers will be paid an agreed sum for their advice by the client.
Both wrap platforms and fund supermarkets currently receive payments from product providers. Most wrap platforms operate an "unbundled" charging structure, which means that the customer is charged a separate fee for their services.
Fund supermarkets, however, often follow a ″bundled″ charging model and do not usually make an explicit charge to the customer. In such cases, the fund supermarket receives payment from product providers for its services, usually in the form of a rebate of the fund manager's charges. Products providers may also be charged additional sums by the fund supermarket, for example for having their products on the platform. These are known as shelf space fees.
Other fund supermarkets, however, are developing unbundled charging models, charging the client a separate fee.
The FSA has for some time been concerned that the payments platforms receive from product providers may affect what products are offered by the platform and so undermine the fundamental RDR principle of ending provider bias. In addition, the bundled charging model might give the customer the impression that the fund supermarket is free when, in reality, the customer is paying indirectly via product charges.
Under the Markets in Financial Instruments Directive (MiFID), platforms are currently obliged to give advisers and customers an indication of the income level the platform will obtain from product providers for carrying out transactions and to disclose the actual amount on request.
The FSA's thematic review work in March 2010, however, showed that this information is rarely prominent and that many customers remain unaware of their right to ask for it.
In its March 2010 discussion paper, the FSA's preferred solution was to ban product provider payments altogether - effectively "unbundling" product charges and platform charges. Clearly, this would have had a profoundly adverse effect on fund supermarkets operating a bundled charging model.
In November 2010, the FSA announced it had decided not to pursue this option. Such payments would be able to continue, subject to improved disclosure and unbiased presentation of products.
But in its August 2011 policy statement, the regulator returned to its original approach and has made it clear that, in principle, it would like to ban such payments. "However, we cannot simply move to introduce such a prohibition now," the paper states.
"Before consulting on introducing a ban, we need to consider how such a move would impact on platforms' existing business models, and how long they might need to adapt to this change. Importantly, we will also need to consider how such changes would affect consumers, including looking at the different ways in which they interact with platforms when making both advised and non-advised purchases.
"We also need to consider the legal and practical issues. This would include considering how we might amend our rules, taking account of current EU Directives in this area, and how these might change in future."
Bruno Geiringer is not surprised the FSA has reverted to its previous stance. "Bundled charging has to go. The fund supermarkets who are the proponents of it are also the ones more likely to be able to adapt to an unbundled model," he said.
"The fact is that that fund supermarkets are bigger than most wrap platforms and so will be better able to afford the system changes. This may possibly have been one reason why the FSA has chosen the unbundled route after all."
How long the FSA's future research into the platforms market will take is not yet clear. All the FSA is able to say at this stage is that no rule changes in this area will come into force before 31st December 2012, when the RDR rules come into effect. It will also be considering whether transitional arrangements would be appropriate.
Another controversial issue during consultation was the FSA's proposal to ban cash "rebates", where the product provider credits the customer's cash account on the platform with a portion of the product costs.
The final RDR rules already contain a provision preventing product providers from structuring charges that could mislead or conceal the distinction between product charges and adviser charges (COBS 6.1B7R).
The proposed rule would have prevented firms from discounting or rebating retail investment product charges in order to offset adviser charges. The FSA's aim was to prevent cash rebates from influencing adviser behaviour – thereby undermining the whole purpose behind the RDR and the introduction of adviser charging.
About three-quarters of respondents to the consultation opposed the ban. Despite this, the FSA still considers prohibition is the right way to proceed – just not yet:
"We have decided that we would ultimately like to move to a position where cash rebates are banned," the policy paper states. "But we do not propose to make such a rule now. We consider that it would be best to hold off on introducing the ban on cash rebates to clients until we are ready to announce our detailed plans on payments by providers to platforms."
The FSA has also confirmed that it will look into the different treatment of rebates for advised and non-advised sales.
Again the timetable is unclear, but no changes will be made until after 31st December 2012.
The proposed ban would only affect cash payments. It would not stop a fund manager from, say, rebating part of its charges in the form of additional units or shares, thereby providing a route for fund managers to vary their charges and for platforms to pass on any discount negotiated with the fund manager.
Under the new rules, a platform service provider must disclose to the client any "fee or commissions" it will receive from fund managers or other product providers in relation to a retail investment product. This information must be provided in good time before concluding the business, or if that is not possible, as soon as practicable thereafter.
The guidance reminds a platform service provider accepting a fee or commission that it must pay due regard to its duty to act in the client's best interest and to communicate with the client in a way that is clear, fair and not misleading "and ensure that it presents retail investment business to professional clients and retail investment clients in an unbiased manner".
Similarly, an adviser using a platform service to arrange or advise on investments "must ensure that it uses a platform which presents its retail investment products in an unbiased manner". When selecting and using a platform service, it must pay due regard to its client's best interests.
Bruno Geiringer believes the new rules will increase transparency and that, as a result, customers will know more about charges. "But whether using a platform will actually become cheaper is not yet clear," he said.
"I would hope that, if they are no longer paying a rebate, fund managers will no longer charge 1.5% AMC but we will just have to wait and see if that happens across the market."
Paying the adviser charge
The FSA sees platforms as an increasingly convenient and transparent way for customers to pay adviser charges under the RDR. In many cases, the charge can simply be deducted from the customer's cash account held on the platform. But it wants platform operators to be subject to the same rules as product providers when they facilitate payment in this way.
Under the new rules, therefore, a platform service provider must obtain and validate instructions from the client to pay the adviser charge.
Some respondents to the discussion paper raised concerns that paying charges by unit redemption could have tax implications for the client. In some circumstances, the client might be better off paying in a different way.
In the November 2010 consultation paper, the FSA said it was not proposing to prescribe the method of payment. "We would expect the adviser to take account of individual client circumstances when agreeing with the client how their adviser charge should be funded."
"If a method such as unit cancellation is not in the client’s best interests (due, for example, to CGT issues) then we would expect this method to be used as a matter of course, unless the client is fully aware of the implications of this and wishes to proceed."
Platform service providers are already subject to the same rules on inducements in relation to designated investment business as product providers. Any benefit provided by the platform service provider to an adviser firm must be designed to enhance the quality of service to the client and must not impair the firm's duty to act in the best interests of the client (COBS 2.3).
Generally, the sort of benefits platform service providers provide are non-monetary, taking the form of training, consultancy services, investment planning tools or assistance with IT systems integration.
In its March 2010 discussion paper, the FSA warned platform service providers that, where they provide services to adviser firms, they must provide a clear, fair and not misleading description of those services and manage any conflicts of interest appropriately, particularly where the platform is owned or partly owned by product providers.
Adviser firms, too, were reminded that they need to be aware of potential conflicts of interest that might arise when a platform operator offers training or other benefits.
Most respondents to the March 2010 paper agreed with the FSA's analysis. There were, however, significant concerns about the conflict of interest that might arise if an adviser firm has a financial interest in a platform.
The November consultation paper confirmed that the FSA’s approach remains unchanged. The relationship should be disclosed and the conflict of interest managed to ensure the adviser firm acts in the client's best interests. But it recognises that there are valid concerns about ownership and says it will monitor the situation closely.
A recurring debate is whether an adviser firm can properly call itself independent if it uses a single platform to advise on packaged products, or (after 31st December 2012) on retail investment products.
Under current rules, an adviser providing independent advice to a retail client on packaged products must base that advice on the whole market or the whole of a named sector of the market (COBS 6.2).
When the RDR rules come into effect at the end of 2012, a firm advising a retail client on retail investment products will only be able to hold itself out as independent if it bases its advice on "a comprehensive and fair analysis of the relevant market" and the advice is unbiased and unrestricted (COBS 6.2A.3R).
The FSA maintains the view that, assuming that use of a platform is in line with the client’s best interests and leads to advice that is suitable, an independent firm may, in theory, be able to use a single platform for the majority of its clients. But it warns that, in such cases, it would be concerned if the firm made extensive use of a single platform, without thinking through the implications of this approach.
The new rule, therefore, requires a firm holding itself out as independent and relying on a single platform to take reasonable steps to ensure the platform service provider's selection of products is based on "an unbiased analysis of the relevant market", taking into account any fees, commission or other benefits the platform service provider receives in relation to those products.
If an adviser firm is going to use services such as guided architecture or model portfolio tools, the FSA would also expect the adviser firm to take steps to ensure that these tools are unbiased.
"In practice, and in the current platform market, which is changing on a frequent basis, we feel an adviser with a wide range of clients should not take the view that a single platform will be the right solution for the majority of its clients," the policy paper comments. "So it is for the adviser to judge which, and how many, platforms it needs to use to ensure that its clients’ needs are met.
This remains a difficult area, however. To try to clarify the independence rule further, the FSA has included further analysis and examples of good and poor practice in Annex 3 to the policy paper.
The August 2011 policy statement also deals with the non-RDR issue of re-registration - the transferring of customer assets from one platform to another without the customer having to sell and re-purchase their investment. This is sometimes referred to as "in specie" re-registration.
If a platform does not allow re-registration, the customer might incur a tax liability and other additional costs on the sale and purchase transaction. The customer may also lose out by being out of the market for a period of time during the transfer process.
For platforms that do allow re-registration, however, the process of manually re-registering investments from one platform to another is complicated and time consuming. Although the FSA has confirmed platforms can charge a reasonable amount for manual re-registration, this has not resulted in any significant changes to market practice.
The new rules will make it compulsory to allow re-registration from the end of 2012. This will not only affect platforms but also other firms holding customer assets through nominee arrangements, such as private client investment managers and SIPP operators.
Until then, whether or not a platform allows re-registration is one of the factors the FSA expects advisers to take into account when selecting a platform. Platform service providers are expected to make clear their position on re-registration and any charges to customers.
Under the new rules, such transfers should be carried out within a reasonable time, without prescribing a set timescale.
The policy paper warns: "If our post-implementation review work suggests that fund managers or other parties are causing unnecessary delays, or that timeliness is being achieved at the price of accuracy, we will consider further rules at that stage. We may also consider widening the scope of the requirement to cover other investments in the future."
Recent legal changes have made it possible to carry out paperless transfers of units or shares in collective investment schemes and progress is being made by industry working groups and trade bodies in developing a more automated process, although the FSA recognises that there are many practical and legal issues still to be overcome.
The FSA is supporting the initiative by TISA to set service level agreements and to automate the process. Pinsent Masons, the law firm behind OUT-LAW is providing legal advice to the TISA membership on the necessary contractual relationships between platforms, fund managers and product providers.
Meanwhile, the regulator expects firms to make appropriate arrangements to enable bulk transfers to be completed within a reasonable period of time, although it acknowledges that such transfers may take longer than single client transfers.
Another issue raised in the March 2010 discussion paper is whether platform service providers are holding enough capital.
The FSA expects platform operators to be able to demonstrate that they have sufficient capital to be able to wind down their regulated activities in an orderly manner, should the need arise.
Winding down would involve either returning assets (or the value of those assets) to customers, or transferring (re-registering) the assets to a purchaser of the platform business without significant loss or inconvenience to platform users. The amount of capital needed to do this is known as the Fixed Overhead Requirement (FOR).
But winding down a platform is costly and time consuming. Assets held on the platform are unlikely to be easily or quickly transferable – many of them will be held indirectly within nominee accounts and tax wrappers. In the discussion paper, the FSA doubted whether the FOR is enough to enable platform operators to effect a transfer of assets.
Draft guidance published earlier in 2010 suggested platforms' winding-down assessments should consider the likely time a wind-down would take, the costs that might be incurred, realistic cash in-flows and out-flows and any additional losses that might crystallise during the wind-down period.
The March discussion paper set out key areas platform operators should take into account, including adapting proposals for assets which are wrapped and unwrapped and for different types of wrappers. Platforms should also realistically assess the amount of communication they would need to have with customers, product providers and advisers as well as the number of staff they would have to retain and any additional costs (such as legal fees) that might be involved.
The November 2010 consultation paper confirmed this approach, but no changes to the Handbook are proposed. The FSA will be carrying out supervisory reviews of all platform operators’ internal capital adequacy assessments (ICAAPs) to ensure its guidelines are being consistently applied.
Passing on information and voting rights
Another issue is the information customers receive if they invest in collective investment funds via a platform as opposed to investing directly.
Under the FSA's Collective Investment Scheme Sourcebook, product providers are required to give information about annual and half-yearly reports and accounts and voting rights to the person named as the unitholder.
But where the customer invests through a platform, the holding is registered in a nominee account in the name of the platform operator. The product provider discharges his responsibility if he provides the information to the platform operator. There is no regulatory obligation on the platform operator to pass this on to the customer.
In the absence of any such obligation, practices vary from one platform to another. In some cases, customers have to request information about their voting rights in writing and may be charged for it. In others, the platform operator does not pass on any information at all. In either case, the outcome for the customer is a negative one.
The FSA wants to see investors who gain access to authorised funds through a platform service provider being given the same information as if they were holding the funds directly.
Under the new rules, an "intermediate unitholder" is required to pass on information to the end investors in a timely manner. Firms will not be able to make a direct charge for this service, although the FSA acknowledges administration charges may rise slightly as a result.
The information issue is not unique to platforms, however, so the new definition of ″intermediate unitholder″ is broad enough to include other nominee firms that are named on the unitholder register but are not the beneficial owners, such as ISA and SIPP providers and stockbrokers that hold authorised funds in nominee accounts on behalf of retail investors.
The FSA anticipates the new information requirements will take up the bulk of the cost of complying with the new rules. It has, therefore, included some measures intended to keep costs down, such as allowing firms to provide information by email with hyperlinks to relevant secure webpages. However, if a firm cannot electronically notify investors, it must make a postal notification. Notification of short-form fund reports will be allowed on a quarterly basis.
There were also plans to require intermediate unitholders to set up systems to enable the beneficial owner to exercise voting rights, or instruct the intermediate unitholder to do so on its behalf. Respondents were, however, concerned about the difficulty of processing voting mailings in the relatively short timeframe before an extraordinary general meeting. So, rather than impose a new burden, the policy paper allows firms to continue with their current approach, with a few amendments.
When the intermediate unitholder receives notification of a forthcoming EGM, it must inform all end investors in the fund of the proposal, explaining that voting rights are not available to the end investor and how it, the intermediate unitholder, proposes to exercise its vote.
Contact: Bruno Geiringer ([email protected] / 020 7418 7306)
Rechtsanwalt, Partner, Head of Employment & Reward, Germany