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Out-Law Guide | 09 Jul 2012 | 10:40 am | 11 min. read
2013 will see a new retail investment advice landscape made up of "independent" and "restricted" advice, a ban on commission-based sales of retail investment products and the introduction of "adviser charging", where the adviser's fee is agreed in advance with the client.
The changes, which come into force on 31st December 2012, are the result of the Retail Distribution Review (RDR), launched in June 2006 by the Financial Services Authority (FSA) to tackle persistent problems and low levels of consumer trust in the retail investment market.
The regulator’s RDR policy statement, final rules and guidance were published in March 2010 (166-page/1MB PDF), followed in June 2012 by further guidance (16-page 219 KB PDF) on the categorisation of independent and restricted advice, based on common points raised by firms and practitioners.
The rules, which appear as amendments and additions to the Conduct of Business Sourcebook (COBS), affect all regulated firms involved in producing or distributing retail investment products and services including banks, building societies, life insurers, wealth managers and financial advisers.
This guide looks at the provisions for independent and restricted advice. The final rules on adviser charging and the impact on sales of pure protection products and on platforms are considered in separate notes.
The new rules on adviser services apply to firms advising retail clients in the UK on retail investment products (COBS 6.2A.2R).
A retail client is defined in the FSA Handbook as someone who is not a professional client or an eligible counterparty (broadly, any financial institution or undertaking). This is not quite the same as a consumer (defined as someone acting for purposes outside his trade, business or profession), although the vast majority of those affected by the new regime will be consumers.
The new definition of retail investment products is deliberately broad in range. It includes what elsewhere in the Handbook are termed packaged products: life policies, a unit in a collective investment scheme, exchange traded funds, stakeholder and personal pension schemes and an interest in an investment trust savings scheme.
It also includes a security in an investment trust, and a structured capital-at-risk product, as well as a "catch all" provision: "any other designated investment which offers exposure to underlying financial assets, in a packaged form which modifies that exposure when compared with a direct holding in the financial asset".
The FSA says in its policy statement: "Our new rules are intended to ensure that all products that might achieve similar outcomes for, and be offered to, retail investors are caught by our requirements, and we have included a 'catch all' in our definition of retail investment product to help ensure this is the case. If firms are in doubt, they should assume that products are caught."
The June 2012 guidance confirms, however, that the new regime will not apply to: advice on shares in an individual company whose primary business is not investing in two or more financial assets, or to an individual fixed interest security or an individual derivative where the exposure to the relevant asset is not modified in any way.
Firms advising on retail investment products must clearly describe their services as either "independent" or "restricted".
Firms providing independent advice must disclose this in writing to the client in good time before providing the service (COBS 6.2A.5R). This will not apply to advice on group personal pension schemes, which are subject to separate disclosure rules.
To qualify as independent, a firm must base any personal recommendation it makes to a retail client on a comprehensive and fair analysis of the relevant market and the advice must be unbiased and unrestricted (COBS 6.2A.3R).
The COBS guidance states that the relevant market should comprise all retail investment products capable of meeting the client's investment needs and objectives (COBS 6.2A.11G). For some independent financial advisers (IFAs) offering a non-specialised service, this will mean considering a much wider range of products than they do currently as the relevant market will generally include all retail investment products (COBS 6.2A.13G).
Advisers specialising in a relatively narrow field, such as ethical and socially responsible investments, may have a more limited relevant market to consider. If so, the firm must explain the nature of this relevant market as part of its written disclosure to the client and should not hold itself out as acting independently in a broader sense (COBS 6.2A.4G; 6.2A.6R).
In its June 2012 guidance, the FSA explains that a firm choosing to operate in a limited market might be able to provide independent advice within that field but that it "would need to be able to market itself in a way that attracted only the intended type of clients, and only take on the intended type of clients. This would mean that both the firm and consumers would need to be able to easily identify whether the consumers’ relevant market matched the firm’s specialism, for the firm to provide independent advice."
The regulator expects such circumstance to be limited but provides three examples: a firm that only advises on Islamic financial investments, a firm that specialises in advising trusts and charities and never advises on pensions, or a firm whose clients want to take an income from their pension and provides advice only on annuities and drawdown products.
The COBS guidance adds that a firm specialising in a relevant market should have systems in place to ensure it does not make a personal recommendation if there is a suitable product outside that relevant market (COBS 6.2A.22G). In this situation, the FSA would expect the firm to refer the client to another adviser that could consider all the products that would meet the client's needs.
Guidance is also provided on what constitutes unbiased and unrestricted advice (COBS 6.2A.14-17G). Where appropriate, this might include considering financial products outside the definition of retail investment products, such as National Savings products (e.g. premium bonds) or cash ISAs, if they are capable of meeting the client's needs and objectives.
Independent firms should also ensure they do not enter into any agreements with product providers that limit or restrict the advice they give (COBS 6.2A.15G).
In its June 2012 guidance, the FSA responds to queries about how certain product providers’ business models or distribution strategies might have an impact on a firm’s ability to provide independent advice.
"If an independent advisory firm cannot access products from a particular provider, for reasons linked to the provider’s business model, its advice may still meet the standard for independent advice," the guidance states. "For example, it may be that the advisory firm has access to a comprehensive range of comparable products, or that it provides advice on products that it cannot access, but does not execute the recommendations itself."
The FSA's consultation on the RDR rules gave rise to mixed views about whether a firm owned or financed by a product provider could properly call itself independent. The guidance says this will not contravene the requirement for unbiased or unrestricted advice - provided the advice remains unbiased and unrestricted (COBS 6.2A.16G).
"We recognise there are a number of valid concerns with ownership issues of IFAs especially where an IFA firm is recommending its own product or a product of a parent company. But we do not believe they are sufficient strong to automatically prevent an adviser owned by a provider from describing itself as independent," the FSA concludes in its policy statement.
"We would expect such firms to monitor the outcome that recommending their own product or the product of a parent company produced for the client and compliance with our rules more generally."
The FSA says it will also be keeping an eye on such firms via the data it collects.
Firms that use panels can still hold themselves out as providing independent advice, provided the panel is sufficiently broad in composition, is regularly reviewed and using it will not materially disadvantage the client (COBS 6.2A.18G).
The June 2012 guidance adds: "However, a firm that provides independent advice needs to be able to advise off-panel if that would be in the best interests of a particular client. To do this, its advisers should maintain an awareness of what is and is not included in the panel, so they can identify clients for whom an off-panel solution would be suitable. For example, if a client wants ethical investments and a firm does not have a product on its panel that is consistent with this preference, we would expect the firm to review the market for a suitable ethical product".
Where the analysis of the relevant market is carried out by a third party, the firm remains responsible for ensuring the criteria used are sufficient to ensure it is fair and comprehensive. Selecting products on the basis of a fee, or because a product provider facilitates adviser charging, would clearly not meet this requirement (COBS 6.2A.20G).
As is currently the case, a firm constructing a panel can decide what products are suitable for its client base. If it decides to exclude certain types of product, the FSA will expect the firm to be able to demonstrate clearly why this is consistent with its clients' best interests (COBS 6.2A.19G).
Other investment tools
The June 2012 guidance also looks at how firms might use platforms, model portfolios and discretionary investment services and yet still meet the standard for independent advice.
Platforms, which allow financial advisers to view and manage their client's investments online, often provide investment planning tools and other services for adviser firms.
The FSA applies a similar rationale to the use of platforms as for panels. "A firm can use platforms in providing independent advice, but needs to remain aware of the limitations of its chosen platform and advise ‘off-platform’, or through another platform, where this is best for a client," the June 2012 guidance states.
"The current market is changing on a frequent basis and – generally – platforms do not offer products from the whole of the retail investment product market. So, in the current market, we expect it to be very rare, if possible at all, that a firm could use a single platform for all of the investment business of all of its clients and meet the standard for independent advice."
A model portfolio is a pre-constructed collection of designated investments intended to meet a specific risk profile. A firm putting together its own model portfolios to include retail investment products must base its selection on a comprehensive and fair analysis of relevant product markets. If it uses portfolios constructed by a third party, it needs to ensure that the third party uses the same criteria when selecting retail investment products.
Before recommending a model portfolio, a firm should consider each product within it in light of the client’s individual circumstances. If any aspect is inconsistent with the client’s investment needs and objectives, then either the portfolio should not be recommended at all, or it should be tailored to fit. As with platforms, the firm should be able to advise on and recommend retail investment products not held in the model portfolio, if these could better meet the investment needs and objectives of the client.
A similar approach applies to a firm recommending a discretionary investment service. Such advice would not normally be considered a "personal recommendation" within the RDR rules since it does not relate to a specific retail investment product.
But in order to meet its obligations under the Principles for Business, the firm must objectively consider a wide range of investment solutions before recommending the client use a discretionary investment service and undertake sufficient due diligence on a discretionary investment manager (DIM) before recommending it to a client.
Where the recommendation effectively amounts to a personal recommendation (for instance, because the adviser explicitly or implicitly recommends particular funds offered by a certain DIM) the rules on personal recommendations apply.
If advice is not independent, then it must be described as restricted. This label covers firms that advise on their own products or on a limited range of products, such as bank advisers and other single-tied and multi-tied adviser firms. It also includes basic advice - streamlined advice on charge-capped stakeholder savings and investment products, often provided by supermarkets and other retailers.
Firms providing restricted advice (including basic advice) must disclose this in writing to the client in good time before providing the service (COBS 6.2A.5R).
The FSA has decided not to impose a mandatory form of words for this disclosure, but the firm must explain whether the advice is limited to products from a single provider, a single group of providers or a limited number of providers. If a firm provides both independent and restricted services, the disclosure must clearly explain the difference between them (COBS 6.2A.6R).
If restricted advice is to be given orally, this disclosure must be given orally as well as in writing (COBS 6.2A.9R). The guidance gives some examples of oral statements that would comply with this requirement.
Firms are also reminded of their obligation to set up and maintain appropriate systems and controls when providing restricted advice. COBS rules on suitability still apply. If nothing within the firm's range of products meets the client's needs, no personal recommendation should be made (COBS 6.2A.22G).
The FSA says it will be closely monitoring firms' training materials and will be carrying out mystery shopping exercises to check the extent to which these rules are being complied with.
Simplified advice processes
Simplified advice is where the adviser provides a personal recommendation to assist consumers in making straightforward investment choices.
As it involves a personal recommendation, it follows that simplified advice should be subject to the same rules on adviser charging and professional standards. In March 2012, the FSA published guidance (23-page / 278KB PDF) on how those rules should apply to simplified advice (see: The RDR: simplified advice).
The FSA Handbook defines basic advice as advice on stakeholder products using a process that involves putting pre-scripted questions to the client.
Under the new regime, basic advice will be a form of restricted advice and so firms offering this service will need to comply with the same disclosure requirements. They will not, however, be subject to adviser charging and so will still be able to earn commission on individual sales. Nor will they be subject to the same qualification requirements as independent or restricted advisers.
Some respondents to the consultation thought these proposals would only perpetuate consumer confusion about different levels of service. But the FSA has decided it is necessary to retain basic advice to support the wider stakeholder regime, although it says it will be keeping the position under review.
Non–advised services, or execution-only sales, where no advice or recommendation is given will not be affected by the new rules for the present, but this will be kept under review. Existing COBS rules for non-advised sales will continue to apply to the narrower definition of packaged products and firms will continue to be able to earn commission on sales.
The FSA will, however, be looking for any evidence that firms are exploiting the distinction between advised and non-advised services by, for instance, providing advice but then referring the client to a related company to complete a "non-advised" sale, or simply by mis-labelling services as non-advised.
In January 2011, the FSA published its final rules for minimum professional standards and qualification requirements (126-page, 2.2 MB PDF). The rules impose the same standards on advisers whether they provide independent or restricted advice. The only confirmed exception to this is basic advice.
The June 2012 guidance confirms that personal recommendations on retail investment products are subject to the same standards, regardless of the adviser who provides them.
The paper, however, provides some clarification on how differences between the qualifications and skills of advisers may have an impact on the ability of advice to meet the standard for independent advice, specifically in relation to advising on pension transfers and pension opt-outs and advising on long-term care insurance contracts.
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