What does it mean for advisers?
A new consumer principle will require regulated firms to deliver good outcomes for consumers by acting in good faith, avoiding cause of foreseeable harm, and enabling and supporting retail customers to pursue their financial objectives.
The new rules build on the FCA's treating customers fairly and product governance requirements, raising the bar in terms of their research, understanding and due diligence on financial products they recommend to their clients.
While the changes to rules are extensive, we focus in on what the upcoming rule change might mean for the investment landscape.
What does it mean for investment products and solutions?
We do not see the new consumer duty rules as fundamentally changing the landscape for the majority of investment solutions recommended by reputable advisers, such as model portfolios and funds, so long as firms are already delivering on their existing product governance obligations.
We do, however, see it as creating a higher hurdle to be able to target, document and evidence good outcomes.
Discerning between price and value can be a challenge.Where we do see pressure coming is on more complex and more speculative products where investment payoffs are complex, and/or for services where charging structures are opaque.
Below, we look at how investment solutions could be impacted with respect to: the design and manufacture of financial products; fee structures; and product switching.
Examples that would not meet the new consumer duty requirements, in our view, would include design and manufacture of financial products.
The new consumer duty rules will require firms to consider client interests in the design and manufacture of financial products.
Unreasonably priced products that offer poor value for money will come under scrutiny. Discerning between price and value can be a challenge, but we see the new consumer duty rules as forcing those involved in the design, manufacture or distribution of amber risk products to move up a notch to red risk.
Examples could include:
1) High-cost, plain vanilla index funds
Some providers, including Virgin Money, rightly attracted criticism for offering bog-standard FTSE 100 tracker funds with an OCF of 1.00 per cent, despite holding substantial assets within the fund.
The cost has been gradually reduced and the OCF is now 0.60 per cent. However, this still seems high when compared to an analogous fund tracking the same index from iShares, which costs only 0.07 per cent.
We see the bar being raised on manufacturers and distributors of structured products.The burden will now be on the providers charging high fees for vanilla index funds to evidence how the product is designed to act in customer’s interests.
Their defence will be that their fund costs need to cover the cost of client service as well as the underlying product, but even adjusting for this, the fund provides questionable value for money relative to its peers.
2) So-called 'closet-tracker' funds
Closet-tracker funds are funds that are described as active, charge as active, but deliver security selection decisions (and therefore returns) that are very close to or hugging the index.
In this way they are not purpose-built tracker funds, but funds claiming to be active while investing in a near-passive model. These offer poor value for money, and a study by ESMA suggested that a large number of active funds are in fact closet trackers.
The FCA was one of the first regulators to fine a firm for managing a closet tracker. The most important aspect is whether the fund is managed in a way that is consistent with how a client would expect, based on its description.
3) Structured products
Structured products have inherently complex pay-offs that are harder for investors, or advisers, to understand than for manufacturers to engineer. There is an information asymmetry between the manufacturer and end investor as to how to model and price risk, pay-offs and probabilities.
Structured products cannot magic away risk or magic in return, they just alter the pay-off profile of a traditional investment, and have the ability to recycle capital as income.
Platform providers will have materially increased responsibilities with the consumer duty.There is also sometimes a conflict of interest between advisers who recommend structured products and the clients who allocate to them.
We are unsurprised that larger well-established firms have exited the structured product market. While they have their adherents in the adviser market, we see the bar being raised on manufacturers and distributors of structured products to evidence that their products are in customers’ interests.
4) Products delivering poor client outcomes
Any product where there is clear risk to client outcomes:
- risk of loss of entire capital;
- unregulated investments, UCIS funds, retail mini-bonds;
- certain poor value or poorly designed structured products;
- poorly structured or poorly governed VCT or EIS portfolios;
- products with excessively high initial and/or termination fees;
- products with unreasonable lock-ins or cancellation terms; or
- products that by design or by expected client inertia disincentives a client review and switch discussion.
Ironically, this is an area where the regulator could do more in terms of policing and enforcement. While reputable advisers avoid these kind of products, they proliferate on the internet with seemingly little or no sanction from the regulator.
What does it mean for the adviser ecosystem?
Fund providers are already delivering against product governance (manufacturer) obligations as well as assessment of value reporting. We see their new obligations as being important, but incremental.
Portfolio managers offering MPS services likewise will have increased responsibilities with respect to potential end-users in their target market, despite having no direct relationships with clients.
The focus for advisers is to ensure their own house is in order and review their business operating model.Portfolio managers offering bespoke client-specific services will have materially increased responsibilities with respect to the consumer duty.
Platform providers will have materially increased responsibilities with the consumer duty, particularly with respect to obstacles that directly or indirectly discourage clients from changing platforms.
We would celebrate the day that platform accounts, like current accounts, have a seven-day guaranteed switch obligation. That would be a tremendous achievement by the regulator and industry alike, but I am not holding my breath.
Getting ready for the changes
In summary, the focus for advisers is to ensure their own house is in order and review their business operating model, terms and communications – as well as investment proposition to see how they stack up against the new requirements.
For advisers aiming to meet or exceed regulatory expectations by July 2023, having a robust centralised investment and retirement proposition, product governance policy and, in the future, a consumer duty statement of principles would be seen as best practice, in our view.
Advisers who need to revisit their investment proposition and operating model should now do so.
Henry Cobbe is head of research at Elston Consulting
