It is frustrating to see so much energy expended on trying to argue what should be, so clearly, an indefensible position: that commissions are such an essential part of the provision of professional financial advice that their removal would destroy the value, rational and delivery of advice itself.
Advocis’s Consumer Voice Survey 2015, “Investor Insights on the Financial Advice Industry” makes some bold statements about the risks to the provision of advice in the event of a ban on commissions and reports on what I believe to be a heavily biased survey of “consumer views” on the value of advice, conflicts of interest and the impact of commissions on financial advice. I will delve further into this report in a subsequent post.
Advocis represents individuals registered largely as product sellers but called “advisors” within an industry where remuneration is largely transaction related. Commissions and product distribution dominate advisory based retail financial services from the product providers, to the umbrella organisations that “employ” the registered representatives and other related dealing categories, to the “advisors” that sell and extends to its regulation.
The whole industry is tied together as one by transaction remuneration and still regulated to a great extent along product lines: Mutual funds, Insurance, brokers selling a wider range of goods etc. This assertion is oddly enough one in which Advocis are themselves in agreement with and I quote from one of their relevant communications below.
I believe that the archaic and inter dependent structure of distribution and its regulation is one major reason why Advocis, despite its arguments for the recognition of “advisors” as financial professionals, cannot distance itself from the most glaring of all conflicts of interest, that of transaction remuneration.
Under the Securities Act the only individuals registered as advisers per se are those that are held to a higher fiduciary standard while there is no such recognition of the term “advisor”. Advocis want to have their financial services representatives recognised as bona fide investment professionals while retaining a framework that remains dependent on transaction returns and excludes itself from a statutory best interest standards. Perversely the very changes it stands against are two of the biggest that would pave the way for the development of a fully professional advisory industry. Its arguments are no less painful to the intellect than nails dragged screeching across a blackboard!
Everyone in the commission chain operates within a heavily conflicted frame. Indeed it is the existence of a chain of relationships dependent on the transaction in Canada that makes the current framework for “advice” particularly troubling. It is frustrating to see so much energy expended on trying to argue what should be, so clearly, an indefensible position: that commissions are such an essential part of the provision of professional financial advice that their removal would destroy the value, rational and delivery of advice itself.
In its press release, Do Canadians Value Financial Advice, Advocis make the following statement about the loss of access to financial advice in the event of a commissions ban:
“Clearly, Canadians value their financial advisor and do not want that relationship disrupted. If a ban on commissions is successful, as some are calling for, we will see a sharp decline in access to professional advice because those who need it most won’t be able to afford it,” says Greg Pollock, president and CEO, Advocis, The Financial Advisors Association of Canada.
Do consumers value financial advice? Of course they do, but this has little to do with support of transaction remuneration.
And from its Consumer Voice Survey 2015 report:
One of the options is to ban third-party commissions paid to financial advisors by their dealers for the advice provided to consumers in assisting them with their mutual fund purchase decisions. Such a ban would be similar to what has taken place in other jurisdictions such as the United Kingdom and Australia. In both countries, early results indicate the banning of third-party commissions has resulted in an advice gap — where high-quality financial advice is increasingly unobtainable for those who need it most.
In the one statement they say we will see a “SHARP DECLINE” in access to professional advice, because those who need it most will not be able to afford it. In the other they say advice is merely assistance with mutual fund purchase decisions. They add that the banning of commissions, in other countries, has resulted in an advice gap where high quality financial advice is increasingly unobtainable.
I would counter that removing embedded commissions and introducing a statutory best interest standard would more likely lead to a sharp decline in unprofessional advice and an improvement in the quality and value of advice. I would also add that in their September “ADVOCIS SUBMISSION Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives” they made the following statements:
We identify and describe four major problems with Ontario’s existing regulatory framework at the level of retail financial services:
1. anyone can call him- or herself a financial advisor and offer financial advice, including planning;
2. existing regulation focuses on product sales, at the expense of proper regulatory oversight on the critical financial relationship between the advisor and the client;
3. there is no firm, clear, and universal requirement for advisors to stay up-to-date in their core areas of knowledge; and
4. there is no effective, industry-wide disciplinary process
Clearly they concur, not all advice is professional advice and the system is overly focussed on the product (a consequence of commission remuneration) leaving the critical relationship between client and advisor unattended (a fiduciary type relationship). Advocis are effectively arguing for change but their addiction to commissions seemingly prevents their full conversion. They go on to say:
“the various inadequacies of the current regulatory scheme result in unnecessary and avoidable consumer exposure to fraudsters and advisor incompetence;”
Advocis admit that the current system exposes consumers to fraudsters and advisor incompetence, something missing from its communications defending the commission based system and not worthy of mention in its most recent survey of Consumer opinions. I do find numerous contradictions between Advocis’ support of commission and its own analysis of major problems in Canada’s retail advisory segment of the financial services industry. That commissions cannot possibly be a vitiating factor is worrying, especially for such a large and important body representing so many “advisors” responsible for so many Canadians.
Personally I find the pro transaction return lobby group’s arguments extremely biased, overly narrowly framed and ignorant of the importance of innovation, technology transparency, professionalism and higher standards in the developing market for commission free best interest investment standards.
I will now refer to the Post RDR Implementation Review by Europe Economics which largely refutes the allegations of “sharp” declines in access to “high quality professional advice” and looks at the issue in much more objective empirical terms.
Evidence in the UK suggests that professionalism amongst advisers has increased:
The RDR has initiated a move towards increased professionalism among advisers. One indicator of this is the vast majority of advisers now being fully qualified to QCF Level 4 compared to Level 3 pre-RDR, with an increasing number attaining an even higher qualification level, i.e. chartered status. In addition, membership of professional bodies has increased. Another indicator is the increased focus by advisers on the provision of more holistic, ongoing advice services
Yes, the segmentation of the market has changed, but there is little evidence that this has led to a significant decline in the availability of advice:
Evidence presented in Section 5.3 of this report shows that ban on commission has led many firms to consider the fundamentals of their business models and make key changes, e.g. segmenting their customers, with some focusing on services to those with higher levels of investible assets and more complex (and profitable) investment advice needs. Despite these changes there is little evidence that the availability of advice has reduced significantly, with the majority of advisers still willing and able to take on more clients. At the same time consumers are increasingly buying products on a non-advised basis, such as D2C platforms, as described in Section 5.
In their research commissioned for this review, NMG Consulting concluded that the implementation of the RDR has not deterred a significant proportion of consumers from seeking advice. Of those who received advice prior to the RDR, 14 per cent had shifted to a non-advised channel post-RDR. When the reasons behind this were explored, 42 per cent stated that the reason for choosing to make their own decision was that the activity, product or investment value did not justify receiving advice. When the reasons for all consumers investing on a non-advised basis were explored (including those who invested on a non-advised basis pre-RDR) only seven per cent of these cited advice not being value for money as a reason. This means that, now consumers are in a position to judge the value of the advice received, this is not in itself significant in driving those consumers away from advisers.
The ban on commission has led the majority of firms to fundamentally consider their business model and, where necessary, make key changes. ….. Some firms have also moved to increase ongoing charges, in part coincidental with the provision of more extensive ongoing service offerings. Lastly firms are trying to become more operationally efficient, for example through their increased use of B2B platforms or of paraplanners. Notwithstanding these changes there is little evidence that the availability of advice has reduced significantly, with the majority of advisers still willing and able to take on more clients
And here is some much more detailed work on the subject:
There is also evidence of a move among some advisers towards higher net-worth customers. Although sources suggest minimum thresholds vary by firm, some firms have moved to minimum wealth levels of between £50,000 and £100,000. However much of this evidence relates to what firms were planning pre-RDR…..This contrasts with research from Schroders which shows that for the majority of firms the minimum levels are lower. In their survey 50 per cent of advisers reported that their cut-off level for investment, which was used to determine which clients were asked to leave, was below £25,000, and over 30 per cent saying it was below £50,000. Mintel contends that the availability of advice has declined post-RDR especially for customers with less than £20,000 to invest.
However the evidence also suggests — crucially — that the number of consumers affected is small. Research undertaken by Schroders found that less than 15 per cent of advisers have asked ‘smaller’ clients to leave. This is supported by NMG Consulting research which finds that although 38 per cent of advisers stopped servicing some existing clients because they might be unprofitable, on average this number was small –– 16 clients in the twelve months to Q3 2013 and nine clients in the twelve months to Q2 2014. On average advisers refused to take on only three clients for reasons of insufficient profitability. The survey shows further that on average adviser firms took on more clients over the period (an average net increase of 26 clients) which suggests that at least some of the unserved clients were absorbed by other firms. In addition, feedback from our interviews finds only one firm had significantly reduced its client base post-RDR, and as this was at a very high threshold in investable assets which implies a particular business model
The report also importantly delineates the market for advice and the gaps where they may exist:
In considering the ‘advice-gap’ attributable to the RDR (in Section 5.4), we distinguish between three groups of consumers who may have a need for investment advice but who may not be receiving it for different reasons: (a) those not engaged in the investment market; (b) those unwilling to pay for advice at true cost; and (c) those seeking advice but where firms are unable or unwilling to provide them advice.
The first group, though important, does not constitute an ‘advice gap’ in that the affected consumers are not actively looking for investment advice (they might, of course, benefit from unregulated, generic advice). The bank exit may have increased the size of this group as evidence suggests bank based advisers were effective in prompting a decision to invest from unengaged consumers. It is debatable whether this is an RDR effect, as bank exit appears driven by a combination of factors, including wider strategic considerations.
The second is driven by consumer choice about value for money and existed to a degree prior to the RDR. To the extent that this is a choice by consumers as to whether they are willing to pay for investment advice, whether this group is a ‘gap’ is arguable. By revealing the true cost of advice the RDR is likely to have increased the size of this group, although the evidence suggests the size of this increase has been limited by the move by the majority of firms to adopt contingent charging structure rather than up-front fees. This group includes consumers who we expect would pay for cheaper forms than the full advice model — the absence of these cheaper models therefore creates a forced choice for this group. There are signs that in time the market will adjust to address at least part of this gap by developing cheaper advice offerings that these consumers may consider value for money
The third group is firm-driven. This group of consumers is likely to have increased under the RDR as a result of firms moving to target higher wealth, higher margin consumers. Some firms are segmenting their client books and focusing on wealthier customers. Where this is the case, the evidence suggests the number of consumers affected is generally small and that these consumers are likely to have been picked up by other adviser firms. Advisers have capacity and have been taking on new clients. There is little evidence that consumers perceive themselves to have been abandoned by advisers. As this gap is likely to be small, to the extent there are firms willing to provide advice to lower wealth consumers, the market should be able to resolve this in time.
Gaps that have developed are small, firms have adapted their charging structures to accommodate different preferences, cheaper forms of advice may be developing as a result of market changes, advisors have capacity and there is little evidence that consumers perceive themselves as being abandoned.
Industry commentators suggest that ‘simplified advice solutions’ designed for the mass market might be profitable and there are encouraging signs of innovation in the market, particularly in relation to simplified or automated advice.
…we note that it does not appear that consumers perceive that they have been abandoned by advisers. NMG Consulting consumer research in 2014 finds that of unadvised investors, only one per cent gave as a reason for investing without advice ‘an adviser wouldn’t be interested in serving me’.
In Advocis’s Consumer Voice 2015 survey the implication was that consumers were happy with their existing relationships and that a change remuneration practices would have possible negative repercussions. The same UK Post RDR Implementation review suggests that this schism has not happened in the UK:
At present, trust in financial advisers amongst those who are currently advised remains high, and indeed our fieldwork and the FCA’s third cycle of the Thematic Review finds that financial advisers believe their clients place high levels of trust in them.36 This is derived from the personal and long-term nature of the adviser-client relationship. The Thematic Review found that the key benefit to consumers of receiving ongoing advice is the peace of mind that someone with expertise and awareness of the market is taking care of their investments –– trusted relationships underpin this.
There is even evidence, albeit limited to date, of a decline in complaints about bad advice:
there has been a drop in the proportion of complaints received by the FOS relating to financial advisers, from 1.5 per cent in 2010 to 0.5 per cent in 2014.38 This may suggest a potential reduction of unsuitable advice in the market after the introduction of RDR. However further investigation of the driving factors behind the decline in complaints would be needed before this could be attributed to RDR.39
How have investors reacted to the change in remuneration structures? Advocis would say that in Canada such a change would not be received positively: not so in the UK though!
Data from the RMAR show that post-RDR a notable number of clients began paying for ongoing advice (nearly one third of the total number of clients paying for ongoing advice services), and a negligible number stopped paying for advice over the same period. This transition from previously not explicitly paying for a service to now doing speaks to increased consumer engagement. Levels of savings and investment have also largely increased, suggesting a possible increase in the engagement in the market.
But the market for advice has been declining for some time anyway as lower cost platforms become available:
Nevertheless consumers’ demand for investment advice has been falling over recent years, a trend which began long before RDR implementation and is correlated with the growth of alternative methods of investing, such as D2C platforms. However there is little evidence that explicit adviser charging introduced by the RDR has led to significant numbers of consumers no longer being willing to pay for advice.
And cost does not seem as big a barrier to consumers. If cost of fees were indeed an issue we would likely see more change here.
When choosing an adviser consumers value quality indicators such as trust and reputation over cost. There is some evidence that consumers are driving firms to compete on quality of advice, with some firms increasingly using levels of professionalism as a source of competitive advantage. However, with relatively low levels of understanding amongst consumers in relation to adviser charging, there is little evidence consumers are driving firms to compete on the cost of advice.
The lack of an effect of adviser charging may appear surprising. For example, an experiment by Decision Technology found that a significant minority of people may be averse to paying an upfront fee for advice. Between 20 and 30 per cent of the online subjects displayed evidence of “narrow framing” and loss aversion making them excessively averse to paying for advice which is not contingent on investment.70 However, when one considers that the majority of advisory firms have been adopting charging structures with contingent fees as a percentage of investments rather than upfront lump-sum fees, as discussed below, it is less surprising that consumers could be less sensitive to the switch to explicit adviser charging
And we must not forget the role of technology, a key component in best interest standard service delivery in adapting to this changed remuneration environment:
The growth in technological solutions for advice and investment also provides some opportunities for advisers to adopt more cost efficient ways of working.
The clearest trend is a move towards platforms, which advisers use on behalf of their clients to search for and manage their investments. Reduced search costs and the ability to track investments for all clients in one place means that the use of platforms will increase the efficiency of firms and reduce costs. The growth in intermediated sales through platforms has been significant. For example, a report by Dunstan Thomas shows that in 2013 around 54 per cent of advisers planned to migrate in excess of 70 per cent of client’s assets onto wrap platforms. This strong trend is likely to be driven by a range of secular factors, most notably supply-side improvements in technology and a general business need to improve profitability, and has been at most enhanced by the RDR.
with an increasingly computer literate society, consumers, particularly in the mass market, use and transact on the internet more often than before and are more willing to by-pass advisers with self-directed investing via web-based services to save time and money.101 NMG Consulting consumer research found that a significant proportion of consumers, particularly when investing smaller amounts, were happy to direct their investments themselves.102 Earlier research conducted by Cass has revealed that a significant proportion of the UK’s population would be willing to use a ‘financial guidance service’ instead of using a financial adviser to help them make their savings and investment decisions.103 These services can be accessed via non-advised D2C platforms.
The fall in adviser numbers need not lead to a corresponding decrease in the capacity for advice. Existing advisers in the market have taken on more clients –– research by NMG Consulting shows on average advisers took on a net increase of 26 clients in Q2 2014.105 There is also evidence to suggest that advisers may have the capacity to take on even more clients. Tower Watson’s model estimates that the aggregate supply of full regulated advice outstrips demand…This model implies that increased efficiencies among advisers are possible. This is somewhat supported by evidence that advisers are making greater use of technology (e.g. adviser — i.e. B2B — platforms and social networking sites) and paraplanners to grow their businesses and increase efficiency