From investment management, to pensions advice and insurance policies - here are seven key takeaways from the FCA's 86-page Sector Views 2020 report, which highlights areas of potential detriment to consumers and how the City watchdog intends to continue to regulate these sectors of the financial services industry.
1) Investment products
The FCA report said harm in the investment management sector mainly comes from six areas. The regulator has stated it is "most concerned" about two: the pricing and quality of investment management products, and operational resilience.
The remaining four are: disorderly markets; market abuse; and pricing and quality of firstly, institutional intermediary services and secondly, custody and investment administration services.
According to the FCA, "there are many drivers that result in investors investing in poor value products, where they are either overpaying or holding investments that diverge from their stated objectives. Drivers of this harm range from consumers struggling to assess and compare fees and products to poor governance practices at asset managers."
Also, while its work on Mifid II and the Priips regulation has gone some way to mitigate this by improving transparency, the FCA acknowledges problems persist.
Therefore advisers who can help clients unpick the various costs and charges, and help to recommend both the best product for their clients' current and ongoing needs and demonstrate value for money, will be operating in line with the FCA's work on improving investment outcomes for consumers.
Moreover, the regulator has pledged to continue looking into concerns that "asset managers, particularly small ones, could be overpaying for bundled custody and investment administration services because of poor practices in some areas of service provision, such as FX transactions".
With environmental, social and governance issues coming increasingly to the fore, the FCA has stated it will be more closely involved in monitoring governance and the potential impact of ESG on investment sustainability.
2) High risk retail investments
Advisers should also take note of the FCA's focus on high-risk investment products.
On page 60 of the report, it commented: "The most significant consumer harm has come directly from growing consumer exposure to investment risk. Some consumers have ended up in products that exposed them to more risk than they expected or can afford."
While the focus has been on the products themselves, with debates focusing on whether to ban or restrict them, the regulator is increasingly turning its gaze upon financial advisers and intermediaries who distribute or recommend these products.
The report said: "The process through which these products are distributed, and the support network around it, has not always worked well enough to enable consumers to make good decisions."
Work the FCA has been doing to force asset management firms to disclose their value assessments has already led to some companies reducing their fees. Earlier this week, Aviva announced it was reducing its fees following the publication of its value assessment.
But the FCA's ongoing work on fees and charges in the fund management industry might also lead to a growing trend for retail investors to consider passive funds.
The Sector View 2020 stated: "A desire for lower-cost solutions and continued strong stock market performance have contributed to a steady increase in passively managed assets. Passively-managed assets now account for 26 per cent of total assets under management compared to only 17 per cent in 2008.
"Growth of passively managed assets has been steady since 2013, though 2018 saw a very small decrease. Institutional investors account for most of the passively managed AUM, with 27.9 per cent of total AUM managed for institutions being passively managed. On the retail side, only 16 per cent of funds are passively managed."
It is worth keeping an eye on this debate to see whether the retail market follows suit, driven by the regulatory scrutiny over charges.
3) Pensions savings and retirement income advice
The FCA has also been extending its reach over the pensions market, working more closely with The Pensions Regulator and the Department for Work and Pensions to optimise people's retirement outcomes and minimise consumer harm.
We have concerns that advisers may be recommending products with an ongoing advice requirement, potentially instead of more suitable options that do not have ongoing fees. -- FCA reportHowever, since pension freedoms came into force in 2015, the FCA has been increasingly worried about the potential for detriment caused by early access to pension money, the ease with which some people have been able to transfer their guaranteed defined benefit pensions and, particularly, the advice process around this.
It stated: "Unsuitable defined benefit (DB) to defined contribution (DC) transfers and retirement income advice see consumers give up valuable guarantees and take on significant risks."
The FCA also highlighted its work around pension scams to prevent people being lured into transferring or cashing out valuable pensions, only to lose not only their benefits but a significant chunk of their money to HM Revenue & Customs and the firm who recommended this course of action.
The FCA has claimed people are generally disengaged from their non-workplace pensions, which intimates that advice is desperately needed for pensions, but the regulatory noose on financial advice for retirement is tightening.
While it acknowledged "consumer complaint levels are comparatively low in pensions, at around 2.9 complaints per 1,000 accounts", it said there was an upward trend in complaints about self-invested personal pensions and income drawdown.
It said: "There has been an 86 per cent increase in open Financial Ombudsman Service complaints about Sipps in H2 2018 compared to H2 2017. Overall, Sipp complaints have a comparatively high uphold rate of 61 per cen. Income drawdown products also show a 36 per cent year-on-year increase and have a 52 per cent uphold rate, albeit from a much lower starting volume."
As a result, advisers can also expect more scrutiny even if they do not advise on DB transfers. The report said: "There is a clear trend for advised consumers to choose drawdown more often than annuities, compared to non-advised consumers.
The complexity of protection products, compared to other insurance products, increases the threat from poor value products as it is difficult for those with lower financial literacy to understand what they are purchasing. -- FCA"We have concerns that advisers may be recommending products with an ongoing advice requirement, potentially instead of more suitable options that do not have ongoing fees. This may be exacerbated by the consolidation of adviser firms, which has been a trend in the past few years.
"Consolidator valuations of advice firms are based on recurring revenue streams, which incentivises IFAs to recommend ongoing advice if they are planning to sell their business in the near future."
4) Insurance policies and premiums
While most advisers will not bother with general insurance, it is worth noting that the first step towards regulating the whole part of an industry is to take over parts of the edges of regulation; in this case, the home and car insurance markets.
The FCA's study has revealed ongoing concerns over much of the identified harm in general insurance, which are poor culture and low consumer engagement. This leads to several negative customer outcomes, not only the persistently high pricing of insurance premiums.
But while the FCA does not regulate wider protection, its sector view made an interesting comment: "The complexity of protection products, compared to other insurance products, increases the threat from poor value products as it is difficult for those with lower financial literacy to understand what they are purchasing."
Advisers who focus on income protection, critical illness and life insurance may not be currently regulated by the FCA but if the FCA believes protection is "complex", and cites a "threat from poor value products", the warning signs may be written on the wall.
5) Wholesale financial markets
The FCA has highlighted ongoing concerns over moving away from Libor - the rates at which banks lend to each other - as well as the potential for market abuse and white-collar crimes that affect the movements of stock markets and lead to wider shareholder and economic detriment.
The Sector Views stated: "Transition from Libor to alternative risk-free rates should, in the long-run, increase market integrity. But we are still concerned that the potential for a disorderly transition could lead to harm. Firms will also need to manage any conduct risks arising from transition.
"Large numbers of contracts and systems need updating before the end of 2021, after which Libor is expected to cease. Some markets have made good progress, but Libor is still used heavily, including in new contracts in some markets. We continue to work closely with market participants and other authorities."
6) Retail banking and retail lending
The FCA has already made much headway in reducing overdraft charges at banks and improving consumer's ability to switch accounts. This is not likely to make much difference to financial advisers, unless there are some clients who persist in wanting to hold significant amounts of money in cash accounts.
However it has cited ongoing issues over mortgage lending, citing ever-high levels of indebtedness and a lack of understanding of how this can affect future mortgage payments.
The FCA stated there are 7.4m UK adults in a state of indebtedness. "These consumers are more likely to face financial difficulties and some firms are not identifying this early enough", the FCA said.
Advisers approached to help clients get onto the housing ladder will need to demonstrate they have done proper, detailed cost and affordability assessments for their clients.
Moreover, because of rising competition in the market, the FCA claimed some providers have "stretched their affordability assessments to lend to potentially higher-risk customers", which the regulator has intimated is a problem waiting to happen.
The FCA also identified issues with the products that are on the market. Although most mortgage rates are at record lows, especially since we have been in a long period of persistently low interest rates, the FCA said there were problems with poor-value products, especially where firms target them at vulnerable consumers.
"Some mortgage customers are unable to switch to a better value product so we have introduced new rules to help them do so", the FCA said, adding that its work around vulnerable clients would continue.
Moreover, the FCA also pointed to the trends towards more homes being bought using the government's Help to Buy schemes, as well as more providers offering later-life mortgages.
Aside from questions over vulnerability, the FCA also warned of negative equity facing HTB property owners: "There is potential for these consumers to be more exposed to any change in economic conditions. A stagnant housing market, combined with the ‘new build premium’, could see a reduced number of re-mortgage options relative to a non-HTB property. They are also more likely to face negative equity if property prices begin to fall."
The same can be said for older customers who could find themselves in a negative equity position later on in life - factors advisers will need to consider when helping clients in these situations.
7) Macroeconomic trends and headwinds
In its 86-page report, the regulator warned that Brexit, demographic trends, technological advances and the shift to a low carbon economy are all significant transitional shifts that will change Britain, and therefore the way in which the FCA regulates Britain's financial services.
While highlighting individual areas of concern in the financial markets it regulates, such as high-risk investments, home and car insurance pricing and rising levels of indebtedness among consumers, the FCA also said it was aware of external socio-economic pressures taking the UK into new territory.
As a result, the FCA stated: "The macroeconomic environment has an impact on both the firms we regulate and the consumers we aim to protect. We aim to understand these impacts, how they drive change and how this may cause harm."
According to the City watchdog, the UK economy faces "both challenges and opportunities from Brexit, as well as global headwinds". These headwinds include the ongoing US-China trade tensions, as well as the possible impact of the new strain of coronavirus.
However, on a more national level, the FCA cited demographic and societal changes. It said: "Increased longevity and higher levels of student debt are leading to major transitions in the UK economy. Significant challenges face each age group. Older people are grappling with how to ensure they have adequate retirement funding, while younger age groups find it difficult to build up savings to meet unexpected expenses as well as to buy a home."
But it also acknowledged the rise of sustainability and a shift to a low-carbon economy, which it said "will make environmental considerations more important in some consumers’ financial decisions while others may be left behind".
Advisers would also be well advised to help clients make better sense of ESG within their portfolios, as well as improve communications to clients at times of macro-economic uncertainty to help clients make more informed, long-term decisions over their investment strategies.
simoney.kyriakou@ft.com
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