23rd December 2010

IFA letter of the week

I aim to start 2011 as I did 2010 and that is by being an RDR bore, so here goes.

I find it revealing that when the FSA seeks to use research date in support of its proposals it conveniently ignores the alternative interpretations that are frequently placed on the same data by the researchers.

One example is the lack of trust in the industry that Callum McCarthy and others have frequently alluded to. In 2008 the FSA with BMRB produced Consumer Research 65a. This confirmed that accountants, solicitors and bank managers were the most trustworthy occupations with financial advisers not being far behind.

Consumer Research 76, also from 2008, established that between 67% and 92% of consumers considered advisers as worthy of high or medium trust. Then, in September 2010, the FSA published its annual research on consumer confidence. This disclosed that 98% of those questioned believed their adviser had treated them fairly, banks scored 83%.

FSA Occasional Paper series 32, in April 2009, confirmed "Charles River Associates (2004) finds limited evidence of commission bias in the market for UK retail investment products." This is not new but it's nice to see the FSA confirming it.

The 65a research was particularly pertinent as it actually asked consumers what they considered important when purchasing a product. The three areas highlighted were product information, whether the adviser is independent or not and whether the adviser meets regulatory requirements. The least important? How fees or commission is calculated.

Charles River Associates carried out further FSA research in January 2009 and this included the following statement. "It is often argued that providers offering higher commission will 'buy' market share. We did not find evidence to support this."

Hector Sants recently suggested that annual consumer detriment due to mis-selling is running at between £250m/£500m, a guess that has since been uplifted to £400,/£600m in his letter to the TSC. In reply to a recent FOIA request the FSA advised, "The figure given to the Treasury Select Committee was 'around £250m'. The precise figure is £223m". Notwithstanding that the figure provided to the Treasury Select Committee was overstated by 12.1%, or 124.2% if we look at the £500m suggestion, one wonders how impressed the TDC will be at receiving misleading information?

Within PS10/6 suggested consumer detriment is broken down into four sections. To my knowledge these assumptions have never been scrutinised yet they veer towards the absurd and must be challenged.

One of the accusations levelled by Charles River Associates is that advisers place investors into unit trusts instead of equity ISA's and suggested £70m as the resulting detriment due to losing tax efficiency. A true equity ISA only benefits from CGT relief over and above the basic unit trust and most investors do not exceed their annual CGT allowance so the detriment figure appears implausible. Notwithstanding this I question why any adviser would fail to make use of the full ISA allowance before using an OEIC or unit trust. Does this sound a likely scenario? There is no commission differential so the only reasons would be stupidity or laziness.

Another area related to advisers recommending distribution or with profit bonds instead of equity ISA's. The Charles Rivers research in 2002 allocated £49.5m p.a. of consumer detriment to this on the basis that each sale lost the consumer up to 0.50% p.a. In June 2009 Oxera calculated that the commission on bonds has been reducing year on year, falling from 5.25% in 2005 to 4.32% in 2007. Additionally, back in 2002, the total sales of such bonds was 433,000 a figure which fell to 71,439 for the year ending September 2010. IFAs were only responsible for 45.6% of these sales.

All other things being equal the detriment figure should be zero if we also take into account Charles Rivers observation that the RIY on bonds is sufficiently lower than ISA's that after 10 years the detriment disappears.

I wonder how many of the other FSA assumptions are built on hills of sand?

Alan Lakey

FSA/FCA, Adviser Letter of the Week, RDR