Contrary to what many appear to think, the Retail Distribution Review is not about abolishing commission and forcing brokers to negotiate fees directly with clients. It is in fact a far wider process aimed at simplifying compliance, and the regulation thereof.
The matter of remuneration is only one of three main thrusts to be reviewed and revised:
- The types of services provided by intermediaries
- The relationship between product suppliers and intermediaries and
- Intermediary remuneration
Services performed by Intermediaries
Proposal A: Definitions of “financial planning”, “up-front product advice” and “ongoing product advice” will be included in the regulatory framework. The definitions will be used to set conduct standards regarding the provision of each of these forms of advice, including the circumstances under which these terms may be used to describe services provided, and the way in which these services must be disclosed and explained to customers. Specific fit and proper standards will also be set for entities or individuals providing each of these forms of advice.
A clear understanding of what constitutes financial advice and intermediary services, respectively, through a consistent set of definitions in the regulatory framework, will facilitate compliance and support a level-playing field for competing service and product offerings. Customers will also be in a better position to assess and select the types of services available to them, and the cost and value of those services.
To clarify which services are provided to which party, and what capacity an adviser or intermediary acts in when performing these activities, it is proposed that an activity-based approach be followed in defining advice, intermediary services and other services provided by advisers and intermediaries.
Specific fit and proper standards will also be set for entities or individuals providing each of these forms of advice, with related conduct standards.
Earlier in the document, it is pointed out that there is no legislative definition of “financial planning”, and the use of the term is not prescribed or limited by law. The current FAIS regulatory framework does not recognise financial planning as an activity distinct from the provision of advice or rendering of intermediary services in relation to a financial product.
Particular emphasis has however been placed on reforming the regulatory framework for the provision of financial advice. It is in this area that the regulatory framework itself entrenches inherent conflicts of interest and inhibits the ability of customers to assess the value of the advice they receive. The current framework also hampers the ability of financial advisers to be fairly rewarded for good quality advice. This is particularly so in relation to the current regulated commission model in the insurance sector. Accordingly, although the RDR is not confined to the regulation of advice and remuneration for advice, it is in these areas that the most far-reaching regulatory reforms are put forward.
Under the heading “Risks to Intermediary Sustainability”, the paper expands as follows:
In the current framework, various inconsistencies and / or overlaps between the FAIS Act and provisions in sector-specific items of legislation have created a degree of confusion and regulatory arbitrage. These include inconsistencies between descriptions of intermediary services in the FAIS Act and insurance laws, as well as overlapping provisions in the FAIS Act, Collective Investment Schemes Control Act and Financial Markets Act.
In terms of the FAIS Act, advice is defined separately from other intermediary services. In terms of the insurance laws, advice is not separately mentioned, but can be seen as forming part and parcel of “any act directed towards entering into” a policy (in the case of upfront advice) or “maintaining or servicing” a policy (in the case of ongoing advice), both of which are key elements of the definition of services as an intermediary.
The definitions of services as intermediary in the insurance laws are broad and encompass all services rendered by an intermediary during the life cycle of a policy (advice, intermediation and administration). The remuneration payable in respect of these services is limited to regulated commission. There is no distinction between the remuneration payable when advice is provided or not (although the FAIS Act contains certain requirements with respect to advice). There is also no separation between the remuneration payable for the initial sale versus payment for ongoing service. As a result, in a completely up-front commission environment (such as that currently applicable to many long-term insurance risk products) there is a reduced incentive for the intermediary to provide such ongoing service.
The proposal to define the various services, and set conduct standards for each, will go a long way to distinguish between the practical demands of, for instance, a client in the low income market versus those in the higher income brackets. Regulation at the lower end of the market will be via very specific product regulation, while the higher end will be allowed more flexibility in terms of product choice.
Towards a Fee-Based Practice
Product providers will be obliged to facilitate payment of the advice fee on instruction from the client, very much like the current system. This will address the major concern of many advisors about having to negotiate fees directly between themselves and their clients. Greater awareness of the value of the service amongst clients may just, over time, make the transition to a fee-based practice a lot easier.