Does your firm understand the potential implications of RDR and is enough thought and preparation underway to ensure it adapts and is sustainable post 2012?
What is the RDR?
The RDR has been central to the FSA's retail agenda since June 2006. Its aim was to address persistent problems the regulator had observed in 20 years regulating the retail investment market. These 'problems' have contributed to a general lack of consumer trust and confidence in the products and services created and supplied by the industry.
The FSA's objective has remained constant throughout: to tackle the root causes of the problems in the market, by implementing meaningful and lasting change, to rebuild consumer confidence and trust. The FSA has boiled down the causes to:
- generally low professional standards amongst advisers;
- potential conflicts of interest and lack of transparency of advisers pay; and
- unclear disclosure of the services and products offered by firms.
The FSA wants both regulatory and industry driven change in place by the 2012 deadline.
The changes planned to disclosure, remuneration and professionalism are likely to have a wide reaching impact depending on a firm's business model. In certain areas, the ramifications are not yet entirely clear. As a minimum, firms operating in the retail investment market should conduct an impact analysis to help assess and identify the potential effect on their business. The following are some key areas for consideration:
- Capital: the implementation of the RDR will require a review of the business strategy, not only in the distribution model but also in the type, pricing and design of products and even the markets in which a firm operates. Arriving on the same timeline of 2012, Solvency II may have a similar strategic impact on markets and products, directly impacting the firm's capital requirements. For example, the debate within Solvency II on the treatment of annuity business needs to be considered in conjunction with the impact the RDR could have on the sale and distribution of such products. There could be many other links in Insurers' business models.
1. What impact will strategic changes in products and markets have on your regulatory capital requirements under Solvency II?
2. Have you considered the crossover between RDR and other regulatory initiatives?
3. Does your RDR strategy align with current thinking on future business models and structures?
- Advice and Distribution: the removal of traditional commission mechanisms will make it more difficult for providers to retain or grow market share via intermediaries. Self selection may well be increasingly popular; as a result brand perception will become a key differentiator in the consumers' selection process. In addition, some predictions are that the impact of the RDR will lead to a significant fall in the number of individual intermediary advisers post 2012. Alternative routes to market will be needed, and could include:
Vertical integration: buying up distribution capacity, either direct or IFA.
- Collaboration with banks to distribute via their branch network.
- Online distribution.
- Direct and execution only services.
However these options all have their own hurdles. Buying a distribution business carries additional costs of capital and increased regulatory risks. Many banks and product providers already have exclusive deals in place. In addition, with many banks in part-public ownership, it could be more difficult for providers to strike deals.
1. What alternatives are there to intermediary distribution?
2. What are the options for partnerships/affinities with distributors?
3. Does the firm have resources to invest in new distribution?
4. What is your strategy for online distribution?
- Business Model: the consumer can no longer be under the illusion that advice is free. All advisory firms will need to have 'advice' at the core of their proposition and be able to accurately price and clearly substantiate the added value.
It should be straightforward for existing IFAs to modify their tariffs as current rules mandate a fee option must be disclosed. The challenge is to translate the price on paper into a clear description of why their advice alone is adding value. The firms who have business models skewed to one-off transactions rather than building lasting customer relationships may struggle. For larger firms and networks the potential lack of transparency of income flows will mean that operating models will need to be reviewed.
The challenges for restricted advice manufacturer firms ('tied') are different but equally challenging. They will need to split the cost of the product from the costs of their advice. Clearly identifying and explaining the cost of advice is problematic because a tied advisers pay and reward is not a separately identifiable element in the total costs to the consumer. These firms may need to find some form of proxy or 'commission equivalence' to create tariffs for advice, particularly as their customer base is more likely to perceive the advice as previously being 'free'. It is unclear how tied firms can effectively break the link between having to sell a product to generate its income.
1. How will firms describe and demonstrate the value of their advice?
2. How will tied firms unwrap the cost of their advice from the existing charges disclosed?
3. Will the cost of advice rise to levels that deter current and new users?
4. Will consumers not seek advice if they are required to pay a fee?
- Professionalism and Qualifications: the professional and ethical standards of all advisers will increase through raising the minimum benchmark qualification for entering or continuing to work in the industry. The proposals also seek to tighten existing ethical and CPD standards by having an independent body to set, monitor, and enforce against breaches of those standards.
1. What is the strategy for attracting and training new recruits to the industry?
2. What percentage of existing advisers will not make the grade?
- Technology: the RDR proposals will affect a number of systems including those that underpin product design, pricing, marketing material, training and competence, administration software for intermediaries and consumer facing platforms.
1. How do firms plan to change their affected systems?
2. What budget exists over and above ongoing IT spends?
3. How many legacy systems does the firm need to adapt?
4. Does the firm have the right level of in-house resource and expertise?
- Product Design: the drive from the Government and regulators for simpler and transparent products is implicit in the RDR proposals. The financial services industry faces a challenge in designing products that will appeal to both consumers and advisers due to historical reliance on arguably more complex and opaque products. Consumers' and intermediaries' perception of a firm's brand will become a key differentiator in their selection process.
1. What products will providers offer post 2012?
2. How can products be made transparent and simpler for customers?
3. What is your planned response to the HMT July paper on improving access to simpler, transparent products?
4. What is your firm's view of more product regulation and its potential impact?
Ignoring the RDR proposals is not an option as Jon Pain (FSA Managing Director, Supervision) stated in his Gleneagles speech on 19th September:
'. to be clear the RDR applies across the market place not just distribution - IFAs, Fund Managers, Banks, Private Banks, Insurers and many others, who all need to be thinking about what impact the RDR will have on their products.'
Firms operating in the retail distribution market have just over 2 years to prepare their business for the changes outlined in CP09/18. While the intended aim of the changes is clear, the effect on business strategy, distribution, product design, systems and the bottom line are less so. Firms need to assess the costs and any opportunities now by working through the challenges.
Product providers need to design products that fit the increasing challenge of simplicity and transparency, and work out how they will distribute them post 2012. Advisory businesses will have to become genuinely relationship based, with advice no longer a 'free' commodity. Firms' income can no longer be solely reliant on selling a product and they must adapt to higher qualification, training and capital burdens.
All firms need to put time, energy, creative thought, and resources into their post 2012 business strategy and planning.