Background

Investment advice in the UK has been formally regulated since the 1986 Financial Services Act. Since this time, individuals engaged in the business of giving investment advice have been required to identify themselves as being either "independent" or "tied." Tied advisors, as the name suggests, were only be authorized to sell the products of one company - independent advisors had access to the products of the whole marketplace.

This statutory "polarisation" (so-called) of advisors was designed with investor-protection in mind. Consumers would gain, it was thought, by being able to identify those advisors only able to offer access to a restricted product range and those companies seeking to distribute products through tied sales forces would, in turn, be pressured to improve their product terms if they were to have any chance of competing with the independent sector, which could recommend the most competitive products the market could offer.

1986 to 2002 in practice

Polarisation in the 16 years to date, accompanied by ever more prescriptive regulation, it must be said, has not delivered unqualified consumer advantages. It did not prevent the Barlow Clowes scandal of the late 1980's from taking place, nor did it prevent the recent pension mis-selling debacle from happening. It did not prevent the overselling of endowment policies neither did it prevent the overselling of freestanding AVC plans. Furthermore, it did not prevent the collapse of Equitable Life and the widespread mistrust of with profits funds this engendered.

The financial services industry, encompassing mortgage providers, life assurance and pension providers and assorted investment-management firms, remains beset by criticism, rightly or wrongly, that it is fundamentally commission-driven and that this in turn skews advice, often to the detriment of the consumer. This criticism has been levelled at independent and tied advisors alike.

Financial Services Authority (FSA) Consultation Paper 121 (CP121)

With this criticism in mind, the future of polarisation has been the subject of much regulatory debate of late, culminating in the above consultation paper issued by the FSA in January 2002. Essentially, the paper proposes abandoning the current polarisation structure and allowing in future a variety of advisors to coexist. These will range from the tied advisor (as before), to the multi-tied (permitted to advise on a restricted range of products from a small range of providers), to the "authorized" (advising on the products of the whole marketplace but allowed to operate, as many IFAs do currently, purely on a commission basis) to the new-breed "independent" (see below). Essentially, there will be a free for all in the proposed new marketplace and any clarity of status that the current system might offer consumers will be lost or, at best, blurred beyond the consumer's understanding. It is hard to see any concrete consumer benefit emerging from the new proposals although there is plenty of potential consumer detriment to be found.

The new definition of independence

A key proposal in CP121 relates to a change in the obligations of Independent Financial Advisors. If the proposals contained in CP121 are enacted (and we are sure they will be in one form or another), an IFA will only be permitted to hold himself out as "independent" provided he enters into a "defined payment system" (DPS) (i.e. a remuneration agreement) with his client. As is ever the case with consultation papers, the devil will be in the detail of the DPS, yet to emerge.

In principle, we are entirely in favour of a DPS which requires advisors to set out clearly up-front and in writing, how they are to be remunerated. It must be right that clients are aware in advance of the likely costs, and also how it is envisaged that these costs should be met. What is not acceptable, in our view, is the widespread practice in the IFA marketplace to remain totally silent of the subject of product charges/commission receipts, believing it acceptable to rely on the information contained in an impenetrable "Key features" document or "cooling-off" notice. This is clearly one practice the DPS will not allow to continue in the new independent sector.

The DPS we, and many other professional IFAs currently operate is based on a mixture of defined fees and commission (depending on the work undertaken) set out for the client's attention prior to any advice or transactions taking place. For a number of reasons, commission can be a perfectly desirable way for a client to meet advisory costs in many circumstances. Importantly, whether or not commission is involved in a transaction, particularly an investment transaction, it is also necessary for a client to be made explicitly aware of the charges applying to the underlying investment. This should also be dealt with, in our view, in the main text of the advisor's letter.

What we do not know as yet is how prescriptive the FSA DPS model is going to be and whether in practice, it is one which IFAs en masse will be able to work with. If it is unduly prescriptive and seeks to prevent IFAs from entering into certain types of remuneration agreements with their clients, then IFAs may decide that it is no longer in their or their clients best interests to remain "independent" in the new regime.

The likely future for IFAs in general and Independent Advisory Services in particular

Speculating on the shape of the advisory marketplace to come, we are of the view that any form of "Defined Payment System" will reduce IFA numbers as many current IFAs will prefer to ply their trade under the banner of "authorized advisor," dropping the adjective "independent." Thus they will continue much as before but will not be able to hold themselves out as being independent (although how the regulators will police the normal use of the English language is impossible to see!).

The % of current IFAs who decide to drop their independent status will depend on the final shape of the DPS. Either the final shape of the DPS will be regarded by IFAs as practical and simply encouraging good practice (promoting their professionalism) or, which is the fear, it will be an unwieldy, overly prescriptive series of hoops which IFAs must pass through, rendering it commercially unviable as a business model.

Independent Advisory Services already operates an explicit remuneration policy with its clients. We very much hope to be able to continue under the new independent regime as before and to retain our independent brand. However, experience of having dealt with regulators has taught us that common sense does not always prevail where policy-making is concerned and we cannot at this stage know for sure whether the final shape of the DPS is one that will be practical for us or our clients to work within. If it turns out to be unworkable in our view, and assuming it cannot be challenged in the courts (we believe it could be open to legal challenge), we will then be left with no option but to revert to "authorized advisor" status, and continue to conduct our business relationships as we currently do.

Our view is that if we as experienced practitioners at IAS end up feeling unreasonably constrained by the final shape of the DPS requirements, then we do not see the "independent" brand surviving. If this happens and the majority of IFAs simply change status from that of independent advisor to that of authorized advisor, continuing to deal with clients in exactly the same way as before, one might be forgiven for asking precisely what the regulators think they will have achieved.

Neil Weston and Michael Sturgess/Independent Advisory Services
February 2002