Will the criticisms levelled at vertically integrated financial models in Australia by the country’s financial regulator be replicated over here by the FCA?
A recent review of financial advice by the Australian Securities and Investments Commission (ASIC) found that conflicts of interests needed to be managed better.
The investigation into the five biggest vertically integrated financial businesses, including banks ANZ, the Commonwealth Bank of Australia (CBA), National Australia Bank (NAB), and Westpac, and life insurer AMP, looked at products they recommended and the quality of the advice provided on in-house products.
It found that overall, 79 per cent of the financial products on the firms’ approved products lists were external products and 21 per cent were internal or ‘in-house’ products.
In-house bias
However, 68 per cent of clients’ funds were invested in in-house products.
The split between internal and external product sales varied across different licensees and across different types of financial products.
The situation was more pronounced for platforms compared with direct investments. And in most cases there was a clear weighting in the products recommended by advisers towards in-house products.
As the publication date of the FCA’s interim report into the platform market draws closer, is the UK’s regulator likely to draw any parallels with Australia?
In the strictest sense of the phrase, a vertically integrated model is where the manufacturer, wholesaler and retailer are the same person.
In Australia, the models have integrated everyday banking, mortgages, financial planning, wealth management and insurance within a single entity – pretty much the whole value chain.
The major banks will typically own one or two major platforms, a discount broker, an asset manager, at least one life insurance company, a mortgage business and two or three financial businesses.
Paul Resnik, co-founder and director of FinaMetrica, says: “The trigger event for the Australian review is that the regulator is saying, ‘We understand you are a vertically integrated business, but you are pretending not to be’.
“If everything [the regulator] is trying to do is to put confidence back into saving and investing, that [behaviour] is not conducive and it leaves people without trust.”
Key points
The Australian regulator has found that conflicts of interest in financial services need to be managed better
In Australia, companies are much more vertically integrated
The FCA in the Uk has been looking at vertical integration also
So concerned have some of the Australian banks been by ASIC’s scrutiny and the challenges of trying to make the model a financial success, they have started selling off parts of their businesses.
In the UK the picture is a little different.
In recent years, some retail life firms have acquired advice networks, while a number of wealth firms have invested in their fund management capabilities, built platforms and moved into financial planning.
Major players using this model include Standard Life and Old Mutual Wealth.
Even though the firms in the company might be owned by one parent, at the adviser end of the supply chain of these vertically integrated models, the advice is typically less restricted than their Australian counterparts.
Also, banks in the UK do not dominate the market in the same way they do in Australia, and one of the main problems the ASIC found with its firms was the lack of disclosure.
How the UK differs
Andrew Baker, partner at NMG Consulting, says: “The Australian model has been almost completely vertically integrated, whereas in the UK it is advancing from something of a low water mark.
“In the UK, we have seen plenty of examples where you have institutions that own platforms and asset management for example, but they may not have owned advice, whereas in Australia they have owned the administration, platform, asset manager and the advice.”
As a result of the expansion of the vertically integrated models in the UK, this has led to criticisms about how much value customers get from the products and whether they are benefiting from the economies of scale.
The FCA’s probe has been looking at the impact of vertical integration and commercial relationships between platforms, asset managers, discretionary investment managers and financial advisers.
At the launch of the review last July, Christopher Woolard, the FCA’s director of strategy and competition, said: “Those relationships have the potential to distort competition by encouraging platforms to compete in the interests of those with whom they have commercial relationships rather than in the interests of consumers.”
David Harris, director at Tor Financial Consulting, says the challenge for the FCA will be in understanding how all the vastly different platform models in the UK work.
Jason Butler, a former senior partner at Bloomsbury Wealth, says he expects contingency charging to feature in the paper.
He says: “The problem we have got with vertically integrated firms is on the one hand they say control, quality, due diligence, pricing, and economies of scale, and on the other end there is no tension to reduce costs.
“There is only so much great outcome you can have. If you are charging someone an all-in cost of 3 per cent, it doesn’t matter how great the outcome, there’s not much left for the clients to have.
“There is a paradox, in that scale, if it has all gone to the benefit of the shareholders running the business and it has not been shared equitably with the consumer.”
Echoing his views, Mr Harris says the FCA’s focus on treating customers fairly is likely to lead to the regulator pushing for clearer disclosure between the distributor, the platform and who owns the platform.
Amid the debate over how inherent conflicts of interest are managed, Mr Butler says vertical integration can still be a good thing where businesses share their benefits of scale by reducing prices.
In its own review, the ASIC did note that vertical integration can provide economies of scale and other benefits to both the customer and the financial institution.
It states: “Consumers might choose advice from large vertically integrated firms because they seek that firm’s products due to factors such as convenience and access, and recommendations of ‘in-house’ products may be appropriate.
“Nonetheless, conflicts of interest are inherent in vertically integrated firms, and these firms still need to properly manage conflicts of interest in their advisory arms and ensure good quality advice.”
Increasing transparency
The Australian regulator is now consulting with the financial advice industry and other relevant groups on a proposal to introduce more transparent public reporting on approved product lists.
Mr Resnik says: “I don’t think vertically integrated models are bad as long as everything is transparent and clearly communicated and, most importantly, you reach an informed consent with the client.
“So the client understands the nature of the business and is happy to deal with you in a vertically integrated way, as long as they are aware of the restrictions of that and they are happy with the costs and performance.
“Some clients want the path of least resistance, so everything has to be transparent.”
It remains to be seen what direction the FCA will go in and whether it will take anything from the ASIC’s own findings.
It is worth noting that both regulators have a close working relationship.
They run a joint programme to help fintech companies in Australia and the UK that wish to enter the other’s market.
They have also taken similar views on tightening the rules around contracts of difference products, while Australia’s Future of Financial Advice reforms is said to be equivalent to the Retail Distribution Review.
Ima Jackson-Obot is a features writer for Financial Adviser
