What are you saying?
6 December 2004
On 31 October 2004, there was a change in the rules regarding the regulation of financial advisers. It meant that more than 30,000 firms (ie businesses that are regulated or will require regulation) and individual advisers required regulation for the first time because they offer mortgage products. From 14 January 2005, general insurance and term insurance advisers will also have to be authorised.
A statutory requirement is being imposed under the regime designed for savings and investment products (such as life insurance, pensions, unit trusts and shares), doing away with the culture of self-regulation that had existed previously.
That meant, and still means, a whole lot of work for the Financial Services Authority (FSA). It also means the entire sector is undergoing an upheaval the likes of which has never been seen before.
The backdrop to these changes is one of change around the globe. In the US, New York Attorney General Eliot Spitzer has made recent attacks on the insurance brokers sector, accusing it of charging large secret commissions in areas such as reinsurance and corporate insurance.
This is making a lot of UK brokers nervous. Following the Enron scandal, investment analysts in the UK had to change the way in which they worked or else there was a threat of being tarred with the same brush as their US counterparts. The same now holds true for insurance brokers, which are concerned that some of their business practices might receive a lot of focus from the FSA.
This is not to suggest that they are doing anything illegal. However, it is never comfortable when longstanding industry practices come under external scrutiny. For example, there is little doubt that in the retail protection insurance market, the ratio of commission to premium could seem quite high to an outsider – and that to date there has been no strong disclosure regime.
The latest changes mean that those firms that will now be regulated are going to have to get used to a new way of working. The process for dealing with clients has changed, in that the FSA has specified what information firms have to provide and how they will be in breach if that information is incorrect or they provide it in the wrong order. This means that many of them are going to have to be a lot more careful.
An intermediary offering retail financial services products will now have to declare who they are, who they work for and what they are selling. This declaration will come in a single, unified model, no matter what product is being offered.
They will then have to record what the customer wants and provide a recommendation. The unified model means that all advisers will have to use an FSA-approved format of brochure describing the terms of the contract and explaining why they are recommending one particular product over another.
Those advisers which were already regulated before the new regime came into effect, in the savings and investment industry, are also facing a significant upheaval in the way they operate in the form of depolarisation.
Previously, there was a clear division between independent advisers and advisers who represented only a single group and thus sold only that group’s products. Under changes to be introduced in the first half of 2005, advisers will be free to negotiate their own agencies and restrictions.
The concern is that this will affect transparency and thus consumer protection. Whereas before, customers knew if they were getting independent advice or a recommendation from a set group of products, financial advisers can now tie in with particular providers and their initial statement to the customer will not have to go into specifics about the arrangements the adviser has made.
The outcome of all this upheaval will be, most likely, an increasing convergence as advisers become aware of the need to belong to a large organisation or to band together into larger groups. One reason for this is that the common framework of regulation makes it easier for an adviser in one sector (such as mortgages) to also offer products from other sectors (such as insurance and investments).
However, with regulation comes an increasing administrative cost in order to ensure compliance. Advisers will need to be able to take advantage of economies of scale, which will drive them to join together.
In the savings and investment sector, many small intermediaries are already being driven out of business by a pair of linked contributory factors. The first is the demands made by the industry’s scheme for compensating clients of small firms that have failed; the second is the lingering impact of the market crash that occurred between 1999 and 2002. The latter has taken a while to feed through to some intermediaries, but they are definitely now feeling the pinch.
In addition, as mentioned above, these new regulatory changes make it more difficult to get by as a smaller player anyway.
The impact on providers, the manufacturers of the financial services industry, has been equally dramatic. Some, such as Royal & SunAlliance and Sun Life Financial of Canada, have left the savings and investment market altogether, while others such as Prudential and Standard Life are taking steps to bolster their financial positions.
This consolidation is resulting in a smaller number of larger, more powerful providers, which does at least offer customers more security. However, it is still unclear as to exactly what impact the depolarisation of financial advice will have on customer choice. The period of change and upheaval is set to carry on and the FSA will continue to have its work cut out for it.
Michael Wainwright is a partner in the financial services sector group at Eversheds
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