In her speech concluding the Brexit negotiations, EU Commission president Ursula von der Leyen quoted TS Eliot: “What we call the beginning is often the end. And to make an end is to make a beginning.”
The new beginning for financial advisers could be a regulatory regime that is more attuned to specific needs of the sector. The latest FCA data shows nearly nine in 10 adviser firms have five or fewer staff. It is a matter of fact the small IFA makes up the backbone of the profession rather than the large network or national advice firm.
But charges disclosure regulations such as Mifid II hit the small firm disproportionally.
In the past, critics of Mifid II have described it as ‘well intentioned’ but yet to deliver positive outcomes for the end client. They also point out it causes a lot of extra work for advisers, paraplanners and administrators. In 2019, a CoreData survey of 1,000 advisers in the UK showed 31 per cent thought Mifid II was a greater worry than Brexit.
Now the UK has left the EU there is an opportunity for regulators and lawmakers to address these issues head on. There are also early signs the appetite to diverge from the EU on financial services regulation could be growing.
At the annual Mansion House speech delivered earlier this month to the City of London, Bank of England governor and former FCA boss Andrew Bailey said the UK could not be tied to EU rules and doing so would be “unrealistic, dangerous and inconsistent”.
Bailey added: “The EU has argued it must better understand how the UK intends to amend or alter the rules. This is a standard that the EU holds no other country to and would, I suspect, not agree to be held to itself.”
It was under his watch at the regulator that EU rules such as Mifid II were introduced and rolled out.
Bailey is not alone in his views on how life should be in a post-Brexit world. Other powerful organisations and influential figures have started to make public soundings on divergence too.
The FCA’s head of consumer distribution policy, Alex Roy, has said Brexit gives regulators the opportunity to “specifically look at the advice/guidance boundary”.
Speaking at a conference organised by membership group Tisa, Roy discussed how Brexit could remove barriers that prevented consumers from engaging with their finances.
At the same conference, Tisa revealed it had launched a project about the future of advice and said Brexit could enable more guidance to be given to consumers. It argued that the combined effect of the RDR and Mifid II was preventing a higher take-up of advice among consumers.
Tisa advocates a new regulatory system that ‘delivers better’, rather than delivers the best possible outcome for consumers.
The system it envisages would have less liability for advisers and encourage people to take the initiative on their finances. Tisa notes the watchdog has a greater focus on preventing consumer harm than on empowerment.
It also warns that advisers must be active and make strong contributions to two consultations under way.
The first is the Treasury’s consultation on the Future Regulatory Framework Review. This is currently in its second phase and considers how financial services need to adapt for their future outside the EU.
The second is the FCA’s call for input on consumer investments that will shape the watchdog’s strategy over the next three years. Tisa expects an update on both during the summer.
The stars could be aligning for a once-in-a-generation opportunity to set the future direction of advice. What are the chances of this happening?
A wide range of voices are united in the view that Brexit is a chance to make regulation more friendly towards small advice firms. But they warn that reform will not be easy and expectations must be managed. As the saying goes: the devil will be in the detail.
One of the best places to start working out these details is the Future of Advice report published by trade body Pimfa — the Personal Investment Management and Financial Advice Association — at the beginning of February.
It accepts that the definition of advice is derived from European legislation and it acknowledges the FCA’s limited ability to simplify the rules.
It wants “a review of the handbook” so a new regime can be made that is less costly, more proportionate and allows innovation. Specifically, Pimfa asks for better scrutiny of rules if they turn out to be poor ones and a flexible rulebook that permits the development of digital service offerings.
Pimfa also argues that Mifid II must be confronted because it defines advice for the UK and is the major obstacle to making advice more accessible. The trade body lists the detrimental and unintended consequences inflicted on advisers and consumers.
These are growing amounts of scarce and expensive resource devoted to tasks that increase work for firms and costs to consumers. They offer no additional benefit, says Pimfa, while creating more unread documents.
Product governance rules and the requirement for annual reviews are flagged up as well.
The report adds: “Now the UK has left the EU, there is a clear opportunity for the regulator to review the architecture of the handbook and provide a clearer distinction on the boundary between advice and guidance, and for it to be determined by objective criteria.”
The call for a strategic revamp is echoed by NextWealth managing director Heather Hopkins, who wants a specific break with EU rules.
“The big issue I had with the EU advice regime was that it was so product driven, and I hope for one thing: a split between product and advice.
“If that can happen, IFAs will be able to give one-off advice regularly,” she says.
Hopkins asks: “Could we have a situation where financial planning is product agnostic? The product recommendation is the regulated part of advice and so many big firms focus on products rather than on financial planning.
“One of the reasons IFAs say they are hamstrung is because they are liable for advice on an ongoing basis. It means they can offer advice only where there is an ongoing relationship because the firm has to take professional indemnity insurance into account.
“The big unlocking for me would be whether advisers could give advice on a more transactional, one-off basis.”
Stars are aligning for regulatory reform but it remains a medium-term prospect
We are calling for the FCA to allow more to be done under guidance rather than advice. The FCA can now move away from Mifid II to better meet the needs of advice in the UK. There is a Treasury consultation on the Future Regulatory Framework Review.
When we respond to that, we will be highlighting a real opportunity to come up with a better definition of advice that can help the profession deliver more support.
We want to see more people engage with their finances because we believe that consumers should be required to take more responsibility for their financial future.
We are calling on the government to use the ‘greater good’ principle and would like it to task the FCA to use powers to roll it out to help consumers engage with finances.
As the Treasury consultation develops, we might begin to see a direction of travel come through.
We need to move away from the current COBS manual and all the EU rules that interact with it. There is a big task ahead and we would not expect any radical changes in the short term.
We now have a chance to ask: what does a better regulatory regime look like in the future and how can UK citizens benefit from advice? I like to think that a healthy advice market could be part of our economic recovery. It is a potential win-win situation.
The question of Brexit divergence fits in with much current work on RDR, FAMR, the call for input into consumer investments and the Treasury consultation. Introducing the ‘greater good’ principle would be quite a big thing, akin to auto-enrolment.
Aegon pensions director Steven Cameron
Reducing business costs
Any reform of rules that govern the advice sector should look at reductions to the cost of doing business, according to Positive Solutions financial planner Chris Lee.
Lee has seen the amount of money and time he spends on compliance increase over the past decade.
He says: “I started my firm with nothing and built it up to a sizeable concern, but I now have hit a brick wall where I cannot grow further.
“You try and explain to a client that there is a fee of £3,000 to do this work but 25 to 30 per cent of it goes on regulatory overheads.
“Then explain that another 25 to 30 per cent disappears in running the business. I end up with less than £1,000 from the £3,000 fee and a lot of that is down to regulation.”
The emphasis on product regulations appears to show up in the relationship Lee has with compliance officers at his network, Quilter.
He says: “Here is an example. I get a visit from a field compliance officer from the network who cannot figure out where my money comes from. I say: ‘This is charged directly to the client.’ They see my fees but no product attached to the bill, and it confuses them.
“You can operate as a financial planner without being regulated and yet it is more important than the product. Should financial planning be regulated?”
Total pre-tax profits for financial adviser firms were £808m in 2019, down 7 per cent from £872m in 2018, according to data from the FCA. A breakdown of revenue by firm size can be seen in the graph below.
Bonfire of regulations?
Any regulatory reform is a combination of political will, scope and feasibility. There are two models that can be pursued: a bonfire of regulations or a more glacial approach. An inevitable tension arises between wanting to pass rules in a short time and ensuring they are well considered.
Currently, no one knows how the trade-off between speed and better-adjusted rules will play out. But lawyers do not expect immediate change and industry veterans warn against ripping up the rulebook.
Foot Anstey partner Alan Hughes says: “I am not aware of any proposed big policy changes in this area as it would be in the medium term and require a consultation. I also don’t think the profession would want massive deregulation and the problems that go with it.
“Many of the reforms post RDR have increased professionalism, yet a fair point is the more onerous technical requirements. These could be removed but that is a difficult thing to do. Disclosure of costs is tricky to comply with and you can get rid of it but what do you replace it with?”
Hughes anticipates an incremental approach rather than a ‘big bang’ that really would be a bonfire of regulations.
He uses the analogy of the RDR where the sector knew it was coming several years before it was implemented.
And he notes that the hope for technology to step in to solve the advice gap and drive down costs has not been fulfilled.
He also understands why Tisa is championing a new regulatory system that delivers better, rather than the best possible outcome for consumers.
Unfortunately, it is challenging to define ‘better’ compared with ‘best possible outcome’ for the consumer because the latter is more binary.
Hughes adds: “The other issue around [prospective reform] is that the regulator polices these rules.
“One of the big problems is the lack of trust in the FCA among advisers because they are suspicious that the watchdog is a retrospective legislator. So even if you alter some of the rules they are still being supervised by the current regulator.
“Many advisers don’t want to water down regulation but to make it more efficient. Yet the gold standard of advice is expensive. It is always the case that the higher the compliance burden the more you benefit from economies of scale.
“Many firms do not want to do one-off advice because it is risky. What everyone wants is the ongoing relationship and fees because that is what makes you profitable and adds capital value to your business.”
Impartial Financial Advisers Association director general Garry Heath urges the sector to grab the opportunity presented by Brexit with both hands. He sees it as a catalyst to prompt a much deeper, philosophical conversation about the sort of regulation from which advisers can benefit.
He reports that others he knows have begun this conversation and it bodes well for the future.
At the very least, it shows that European regulations were ill suited to the culture and needs of the UK’s advice profession.
Heath says: “While we were in the EU we were regulated as if we were German advisers. Take capital adequacy requirements, for instance. We have got that rule because the banks in Germany give advice.
“I point this out as one of the examples where financial services regulation did not work for the UK services model in any shape or form. We are also going to have to look at Mifid as one of the things going forward. Rather than have all these airy ideas, how many people actually read what we are handing out?
“Overall, we should look to make regulation more effective because it allows firms to grow. At the moment we have a high entry level for new starters.”
Nonetheless, Heath does not believe the process of reform will be easy because there will be many vested interests to overcome. He is thinking particularly of the large multinational banks and asset managers that have a greater say in how the rules are set compared to small IFAs. These small firms are less able to absorb compliance costs, while FCA figures show firms with six to 50 advisers have the highest average retail investment revenue per adviser, at £189,449 (see table).
Heath says the views of these large firms hold greater sway with regulators and politicians. Just because the UK has left the EU, it does not mean these forces have lost that clout with the regulator.
There is actually a link between Heath’s personal experience of lobbying and the chance of regulatory reform arising from Brexit.
He says: “What shocked me when I first went to Brussels many years ago was I saw all these lobbyists. I spoke to one of them who worked for Lloyds and he said he was lobbying for more regulation.
“Banks and insurers spend a lot of money on lobbying for a regime that suits them because they believe they benefit from it.”
Finding the right balance
The thorniest dilemma to resolve, according to Heath, is the trade-off between devising effective regulation, which takes time, and delivering new regulation as soon as possible. The longer the status quo continues, the less chance there is of genuine reform.
Yet he is also sceptical a bonfire of regulations conducted with zealous vigour will lead to good outcomes in the long run.
He says: “If we fail to reform relatively quickly, the status quo will remain the status quo. But if we do a bonfire of regulations we may end up with more than we started with.
“I am old enough to remember when the Conservatives changed all local councils in 1974. What happened? The cost of government went up.”
For Heath, the success of a reformed system would not lie in the theory codified on paper but in the experience of those supervised by it.
He applies the same argument to the culture of the regulator and the mindset of staff who work there.
Heath adds: “I want to try and get us away from the involvement of theory people. We have this battle between practice and theory where the watchdog is led by theoretical thinking. People are working in their silos and we need a more holistic approach.
“What cheers me up is that people are beginning to talk about the rules and are now realising there are other issues. There are several that need sorting out, from the Financial Services Compensation Scheme to professional indemnity insurance and the Financial Ombudsman Service.”
For Heath, an important step would be a fourth objective added to the three the FCA has now. This would encourage consumers to invest and protect themselves as soon as possible to improve their financial independence and personal responsibility.
He contends this would achieve “a balancing factor” that would counteract the overprotective nature of the existing list. According to the Financial Services and Markets Act 2012, the current FCA objectives are to protect consumers, safeguard financial markets and promote competition.
Such a regulatory system raises a question Heath included in an article he wrote before Christmas: “Why does it need 124 pages of regulatory-driven paper to invest in a £20,000 Isa, yet only a third of a page of A4 to borrow £20,000?”
Arlo International managing director Jonathan Hives would like the FCA to champion the cause of UK advisers in EU markets.
He says: “We have already received an email from a regulator in the EU that has asked us to try and continue a relationship to a degree. This is a sign that each country in the EU recognises that the UK will still be an attractive proposition.
“Now is a chance for the UK to almost do a Singapore — to tweak regulations and give IFAs the scope to broaden their potential client bank.
“Where the UK has an advantage is the FCA. All firms are supervised by a stringent regulator and that should give other planners in third countries cross-border comfort.”
The advice sector has talked longingly about an alternative regulatory regime that is less painful than the existing one. It would be a shame if it did not use the spur of Brexit to come up with some original ideas for improving the status quo.