Out-Law Guide 8 min. read
11 Oct 2011, 12:01 pm
This guide is subject to UK law and was last updated in October 2011.
The Financial Services Authority (FSA) has published draft guidance on how simplified advice will fit into the new financial advice regime when the Retail Distribution Review (RDR) rules come into effect at the end of 2012.
The question remains, however, whether there will be sufficient demand from low to middle income earners for simplified advice to be a commercially viable option for firms.
Bruno Geiringer, a retail financial services partner at Pinsent Masons, the law firm behind Out-Law.com, said the FSA's paper was a welcome development.
"The industry seems to have identified a consumer need for simplified advice and so it has become hugely important to have clear and reliable guidance," he said.
"There have for some time been concerns within the sector that one possible consequence of RDR might be that full advice becomes less available and more expensive.
"Now, taking into account the advance of technology and consumers' increasing readiness to transact online and understand the limitations of such a service, there should be a place for simplified advice, which will help fulfil the RDR objective of creating a market that allows more consumers to have their needs and wants addressed.
"But," Geiringer warned, "it is important that firms developing their own simplified advice process take this opportunity to comment on the proposed guidance by the 15th November closing date."
Simplified advice is where a financial adviser provides a personal recommendation to assist consumers in making straightforward investment choices.
As with "full" advice, simplified advice involves regulated advice and so the adviser must comply with requirements in the FSA’s Conduct of Business Sourcebook (COBS) to take reasonable steps to ensure that a personal recommendation is suitable for the consumer.
Whilst recognising the benefits of a low-cost, straightforward advice service, the FSA believes simplified advice is only really likely to be suitable for people who do not have unsecured debts and, in addition to the money they have to invest, have built up other emergency savings and already have insurance cover in place for their core protection needs.
But since (according to data from National Savings and Investments) only 49% of the UK population have enough savings put aside to cope with a financial emergency, the regulator considers the potential market for simplified advice for investment products (as opposed to savings products) may be not as large as many in the industry have suggested.
Additionally, given that simplified advice is aimed at consumers who cannot or will not pay for full advice, it is not clear how much appetite there will be to pay for the service.
Nevertheless, the FSA wants to make sure that, if simplified advice does take off, there is sufficient guidance in place for firms wanting to enter this market.
"Our aim is to ensure that we have a regulatory regime for retail investment advice which provides for an appropriate level of consumer protection, and within which firms can offer simplified advice processes if they think this is an attractive proposition for them and their clients," the FSA's consultation paper states.
"Given the target markets described to us, which are typically consumers with low investable assets who have little or no investment experience, we would expect the products being recommended through simplified advice to be easy-to-understand, low-cost, flexible, and not high risk, with simple charging structures and straightforward outcomes.
"If the suite contains products which do not meet this description, we would expect firms to show that this is appropriate for the target market, and to demonstrate what systems and controls are in place to limit the recommendation of these products to only those for whom they are truly suitable."
If it is to be economically viable, firms developing a simplified advice service need it to be as streamlined as possible. Typically, it will be highly automated, whether provided online, face-to-face or over the telephone. These systems are not being designed to provide advice on a consumer’s existing financial investments.
But in order to satisfy the suitability rules, COBS requires the adviser to obtain sufficient information from the client to have a reasonable basis for believing that the advice meets the client's investment objectives, is such that they can financially bear any related investment risk consistent with their investment objectives and that they have the necessary experience and knowledge to understand the risks involved.
Suitability in the context of simplified advice should also include an initial assessment whether a simplified advice service is appropriate for that particular client at all.
The draft guidance advises that firms should try to find out about a client's level of debt and how much they have in savings. It should not recommend a retail investment product if the client would be better advised to repay the debt or if they do not have enough savings to cope with an emergency.
"Firms should not rely solely on a client’s judgment as to whether they are able to cope with their existing level of debt or the adequacy of their savings," the consultation paper continues. "If a client has debt that they should repay or insufficient emergency savings, they should exit from the process and be referred on as appropriate."
How should firms satisfy these requirements without the process becoming cumbersome and uneconomic to run? Firms responding to the proposed guidance might also question the FSA on how they can judge a client’s ability to handle debt if the client’s word is not sufficiently reliable.
The FSA points out that the suitability standard is flexible, relating to the type of service, the product and the client. It will judge advice in the specific context in which it was given.
But it wants to see numerous "drop-out points" built in to the system so that the consumer is taken out of the process if he answers a question in such a way that suggests the product is not suitable, for example, because of his level of debt or lack of savings.
"We would expect to see many instances where no recommendation is made because the product suite does not include a product that meets the consumer’s needs," the paper states.
The paper summarises existing high-level standards and guidance that firms should take into account when designing and implementing simplified advice and choosing an appropriate product suite. Firms building their simplified advice process should note that the FSA will want to see all of the data from it.
The FSA acknowledges that simplified advice may be appropriate for consumers who choose to use a streamlined service, as long as they are made aware of and understand its limitations.
"A client agreeing to go through a simplified advice service does not absolve a firm from its obligation to make sure that personal recommendations on designated investments are suitable," the draft guidance warns. "However, certain circumstances may reduce the degree of detail that a firm needs to obtain in relation to a client’s existing investments in order to be able to recommend they purchase a new investment product."
An automated process may, for instance, ask the client whether they want their existing investments to be considered for suitability or taken into account in assessing the suitability of a new product.
The draft guidance suggests that, if the client answers "no" to both, and the firm "has reason for believing that the client understands the implications of this decision", the amount of information the firm needs to obtain may be reduced. But if the client answers "yes" to either, or is unclear about the implications, they should be taken out of the simplified advice process.
"Client understanding of the limitations of the service could be achieved through mechanisms such as timely alerts, by playing back answers to the client for confirmation (both during the process, and at the point that the recommendation is given), and filters throughout the process," the draft guidance suggests.
"For automated advice services, confirmation processes will need to be designed in a way that reflects how individuals typically interact with such screen-based systems, and should not allow, for example, clients to simply ‘click through’ important information."
Since simplified advice involves providing the consumer with a personal recommendation, it will be subject to the same RDR rules as other advice models.
Those rules require advice on retail investment products to be clearly described as either "independent" or "restricted" (see: The RDR: advice services).
The FSA's draft guidance confirms that simplified advice would be a form of restricted advice because it does not consider all retail investment products that might be suitable for the client.
Simplified advice would also be subject to RDR rules on adviser charging, which means that, instead of earning commission set by the product provider, the adviser would be paid a fee agreed with the client in advance for the advice on retail investment products and related services (see: The RDR: adviser charging).
The draft guidance suggests that firms offering a simplified advice service should disclose their charging structure at the start of the advice process – after the initial assessment to find out whether or not the client is likely to be suitable for the process. But the adviser charge can be contingent on the client going through with the recommendation.
Charges should be able to be easily understood by the firm's target market. The overall cost should be taken into account when assessing the suitability of the product for that particular client. In some cases, it may be in the client's best interest not to receive advice at all (COBS 6.1A.16G).
Another RDR-related issue is that of professional qualification. The FSA has not been convinced that there should be a lower qualification requirement for an adviser providing simplified advice than for any other form of regulated advice.
In a fully automated system, however, the client may not actually have any contact with an adviser. In which case, the FSA would expect a fully qualified retail investment adviser to be involved in the design process from the start and be able to confirm that the system is fit for purpose.
If an automated system refers the client to an adviser for advice, then that adviser must be fully qualified. But if the individual only provides support and information and not regulated advice, that individual might not have to be qualified.
As the paper suggests, however, it is sometimes difficult to draw a line between support and advice. Firms would have to have appropriate control systems in place to prevent support from straying into regulated advice and ensure that any individual providing the support avoids making any judgment on the suitability of the products recommended.
The paper also confirms that adviser charging and the new professional qualification standards do not apply to "basic advice", where an adviser only advises on stakeholder products, as the safeguards are in the products themselves.
The draft guidance confirms that the FSA's complaints sourcebook (DISP) and the jurisdiction of the Financial Ombudsman Service (FOS) will apply to complaints arising from a simplified advice process.
The FOS confirms on its website that simplified advice processes must comply with the same regulatory requirements as those involving full advice:
"In any complaints we might receive, we would judge the advice in the specific context in which it was given. So we would not expect a 'full fact-finding' exercise. But we would look at the questions asked and the options open to the particular consumer concerned," the FOS states.
"Where the simplified advice involves an automated process, we would look – as part of our consideration of any complaint – at whether there was a good record of the information the consumer gave and the choices they made."
Consumers receiving advice through a simplified advice process may also have recourse to compensation under the Financial Services Compensation Scheme when a firm is unable, or likely to be unable, to pay claims against it.
The consultation on the draft guidance closes on 15th November 2011.
Contact: Bruno Geiringer ([email protected] / 020 7418 7306)