That the biggest IFA network, Sesame Bankhall Group, has announced that it will become 100 per cent restricted next year is hardly surprising. Under the retail distribution review, the regulatory hurdle was raised to a level that makes independence a risky and expensive option, especially when your sales team is a big bunch of very independent minded, self-employed businessmen and women who take pride in not being told what to do. As the saying goes: “It’s like keeping frogs in a wheelbarrow”.
Towry and St James’s Place are in no way damaged by their restricted status. RDR 2 may further increase the cost of independence by increasing the cost of funds to IFAs, creating competitive disadvantage.
A recent meeting of the Investment Network, a Chatham House rule group of senior people across retail investment, proved to be the most heated in its six-year history. The subject? Fund discounts to replace rebates, which are banned under RDR 2. It is a struggle to understand how people get so excited about such a boring subject, but they do. To be fair, so do I, as it could be the most important development in recent retail investment history. How on earth did we get here?
In the beginning, there were fund supermarkets and wraps. FSMs advertised that they were free, much to the annoyance of the wrap platforms. Their argument had certain merit. The price to the investor of the average fund was 1.5 per cent typically, whether one purchased funds direct, through an adviser or through a fund supermarket.
When pushed, they argued that the charges had been redistributed so that the fund manager received 75bps, the adviser 50bps and the platform 25bps. For some time it was received wisdom that this was the total story. That is what the regulator thought. It was not. The FSMs received additional rebates, typically 6bps to 8bps. This was said to cover administration. In reality, the rebates represented a discount for scale. These discounts were negotiated between the FSMs and the fund groups based on volume.
There is nothing wrong with rewarding economies of scale. It is a shame that it was all so covert. However, we have a shabby history of covert charging in this industry.
To be fair, the wrap platforms played an open and honest game. They persuaded asset managers to give them the 75bps covering distribution and they paid it straight to the customer.
When the regulator looked at platforms in an RDR context, it was unaware of the rebates outside of the annual management charge. Hence the nonsense of three platform papers with no conclusion. The FSMs did not come out of it with huge credit, desperate to defend their bundled model.
So we are about to enter the brave new world free of rebates. Or are we? No, of course not. It is not that simple. FSMs will not receive payments from asset managers; wrap platforms will not be able to give cash back to their customers. So how will FSMs recreate their business model?
In short, they want to continue to benefit from scale. They are the big aggregators that take thousands of small investments from adviser firms, small and large, and lump them together, so the FSM receives inflows in large amounts.
Three alternative methods of achieving this have been proposed:
• Extra share classes with a lower AMC, for example, 65bps, the so-called super-clean share classes
• Unit rebates
• Zero per cent share classes (where, in effect, the asset manager runs a mandate and bills all expenses to the distributor, but there are tax issues)
Old Mutual and some asset managers favour the unit rebate. It has the advantage of not creating the need for additional share classes, meaning all investors enjoy the same ‘currency’ which they can exchange anywhere, but it is not an elegant solution.
It really seems odd that the FCA is banning a rebate of cash to the investor, but allowing cash in the hands of the asset manager, who turns it to units to be handed over to the platform. The platform then converts the units to cash to give back to the customer.
Can you imagine how a bright journalist will report that one? Only it gets worse. Nobody spoke to the boys and girls at HMRC. When they heard about this they said: “We can tax that”, and they will. That is unless it is small; or, unless it is in a tax wrapper, which some 80 per cent is.
So far, we are guaranteed to confuse advisers, customers and data providers. There is one further little problem.
The rebates received by FSMs contributed to their margins. They need every penny they can get as the profit on platform businesses across the UK are trivial when looked at as one industry.
Discounts in any form go to the customer, or, arguably, to the adviser if fees are being increased from the original 50bps commission. So what is the benefit to the platform? It can only come from gaining greater market share from the wrap users, so the FSMs protect their margin by increasing volumes. One or two of you might have views about that, but there is a bigger point.
Why should asset managers give discounts to platforms that cannot promise volume? They see them as aggregators, not distributors. By their very raison d’etre, IFAs cannot promise volume. They cannot decide in advance where their clients’ money will go.
On the contrary, Hargreaves Lansdown has no such concern. The reason why its wealth 150 is being cut to 30, is the huge volume it can promise, the chosen few who make the successful bids. It has been reported that Hargreaves Lansdown is getting discounts of 25bps. We will see how many are at this level and on which funds. Architas is discounting by 20bps to Elevate. This is an interesting example, because Architas, thereby, in effect, provides Elevate with distribution power. Standard Life and Skandia will also both attempt to leverage their wealth management propositions.
Earlier, I mentioned SBG and its forthcoming restricted status. Also in the news was Henderson Global Investors’ increased new business. Henderson has two investment products with SBG. Under the new model, SBG will gain by having a state of the art investment proposition that can populate a centralised investment proposition without regulatory risk; Henderson will enjoy the flows that can come from a restricted arrangement.
I have no knowledge of the details of this arrangement, but such vertically integrated models enable the ‘product’ margin to be shared. Scale provides discount which increases competitiveness.
When asked about their criteria for discounts, a recent study found that asset managers answered, unsurprisingly, 100 per cent in favour of ‘volume’ (see Chart 1).
We then asked what volume would justify a 10bps cut in AMC. The answers varied from £20m to over £200m (see Chart 2). Only restricted propositions can promise such fund flows.
There is little doubt that asset managers will seek more restricted or vertically integrated arrangements. Discounts will not stop at Skandia, Standard Life and Hargreaves Lansdown. Life company-owned platforms will leverage these relationships; platforms with global influence will leverage that influence. You just cannot get the genie back into the bottle.
The concern for the IFA, typically a small business, is that they look very much like David in the battle against Goliath, with no scale, no clout and puny weapons.
But, do not forget who won that battle.
Clive Waller is managing director of CWC Research
Key Points
Under the RDR, the regulatory hurdle was raised to a level that makes independence a risky and expensive option
The financial services sector could be about to enter the brave new world free of rebates
Asset managers see platforms as aggregators not distributors.
