Regulators around the world have been focusing on how financial companies deliver advice to their clients. The standards that apply to that advice – especially how it is paid for – have been the subject of recent regulatory initiatives in Australia, the U.S. and Europe.
The official goals of these initiatives are to eliminate conflicts of interest that might harm investors, and to help them cope with the increasing complexity of financial markets. Less officially, these initiatives aim to push investors into lower-cost funds – something that fee disclosure at a product level has failed to do sufficiently, at least in regulators’ eyes.
While the scope of the initiatives varies, all incorporate at least one of the following elements: a ban on inducements, and higher standards for advisers.
Virtually all of the proposals call for such a ban – whether it is called a retrocession, rebate, sales load or commission. Whatever the name, they all involve payments from the sponsor of an investment product to the financial adviser who recommends it. Bans are already in place for at least some products in Australia, the Netherlands and the UK.
The bans eliminate incentives for advisers to choose products with high payouts to advisers, even when a lower-fee option might be better for their clients.
Instead, investors will pay financial advisers for their services directly, whether at an hourly rate, as a percentage of assets or as a fixed amount. But whatever the schedule, investors must agree to the fees in advance. Australia’s “Future of Financial Advice” reform requires that investors opt in at least once every two years.
Several of the proposals from regulators also impose higher standards on financial advisers than previously. For example, two of the proposals being discussed in the US would impose a “fiduciary standard” on advisers, requiring them to always put client interests ahead of their own. By contrast, many advisers working for brokerages are currently only required to make recommendations that are “suitable,” but not necessarily best, for their clients.
The UK Retail Distribution Review takes a different route to higher standards, by imposing an educational mandate. Before beginning to practice, advisers must obtain a qualification, which can involve extensive study and multiple exams. They must also stay up to date, with 35 hours of continuing education each year.
Many of the initiatives additionally encourage financial houses to provide broad-based advice to their clients. For example, the UK regulations specify that only advisers who consider a range of retail investment products can call themselves “independent.”
The initiatives further aim to close loopholes that subjected some products to lighter regulation than others. The fiduciary-standard proposal from the U.S. Department of Labor falls into this category. It would apply the same oversight standards to individual retirement accounts that are in effect for other tax-advantaged retirement accounts.
All of these initiatives have been controversial. In fact, the first to be implemented, the UK’s Retail Distribution Review, was discussed for more than six years before it took effect in 2013.
Given the dramatic changes in longstanding systems necessitated by many of these initiatives, the controversy is not surprising. The cost can be substantial. For example, Dutch fund sponsors have had to offer new “clean” fund share classes stripped of any inducements.
Other critics have suggested the initiatives may make financial advice both less accessible and more expensive. They argue that investors who need advice only occasionally may have been best served by the inducement approach.
The extended debate is a good thing. First, prolonged discussion allows more time for market forces to operate while bringing attention to the underlying concerns. Indeed, the trend in fees has been steadily downward in the US as advisers and investors have been encouraged to take a closer look at costs.
Second, it provides more opportunity to see the results of the programmes that have already been put in place. The UK programme appears to have had one of the intended effects, which is to increase use of lower-cost index funds. But it may also have caused a 10 per cent decrease in the number of financial advisers.
While most of the discussion of these trends to date has been at the local level, investors worldwide would benefit from comparisons that identified common experiences. We urge both the industry and regulators to look across borders for relevant models.