The Department of Labor's fiduciary rule has become a highly contentious issue in the US, with some suggesting that it will ultimately improve the quality of advice for consumers, and others suggesting it will lead to a damaging mass exodus from the industry. But the reality is that debates about lifting the standards for financial advice is not unique to the US; in fact, countries ranging from Australia to India, and from the Netherlands to the UK, have all enacted even more stringent reforms than the DoL's fiduciary rule, in most cases resulting in an outright and total ban on all investment commissions. Which provides us an interesting glimpse into how the financial services industry really is impacted as fiduciary standards are raised and commissions are reduced.
In this guest post, industry commentator Bob Veres shares his recent interview with Keith Richards, regarding the ban of commissions in the UK that was implemented in 2013 after their Retail Distribution Review (RDR), and how it has impacted demand for financial advice. Richards is the CEO of the U.K.'s equivalent of FINRA, and a former executive at UK equivalents of a major life insurance company, and before that a major broker-dealer.
Given his background, Richards was not surprisingly a major skeptic of the commission ban before it was enacted. But the "surprise", he reveals, is that the ban on commissions has actually created an environment which is better for both the industry and advisors. Richards believes that transparency and separation of fees from products has resulted in advisors better understanding the needs of their clients and articulating the value they provide, which has resulted in clients who are perfectly willing to pay for an advisor's expertise. In fact, demand for financial advisors is on the rise since commissions were banned, and financial intermediaries that feared a massive decline in revenue are actually seeing an increase, instead!
However, there are some reasons to believe that a ban on commissions in the US might not play out the same way it did in the UK. The key distinction is that nearly 20 years ago, the UK began to lift the educational standards for financial advisors, which meant that by the time commissions were banned and advisors had to get paid for advice, they were actually reasonably well trained to deliver that advice. By contrast, in the US, a wide swath of "financial advisors" have nothing more than basic Series 7 or Series 65 licenses, and consequently might not have enough training and education to get paid for their advice alone, if they were actually required to do so! Which means ultimately, lifting the standards for financial advice in the US needs to consider both the fiduciary duty of loyalty, and educational competency standards as well!
Nonetheless, for those advisors - or executives at financial services companies - who fear that a fiduciary standard and limitations on commissions would be destructive to the financial advisor business model, hopefully this perspective on how an even more stringent fiduciary standard and commission ban in the UK actually increased demand for financial advice, and the success of financial services companies, will be helpful food for thought!
Does Fee-Only Really Lead To Prosperity?
Synopsis: The CEO of the U.K.’s equivalent of FINRA thinks that a fee-only advice environment is actually quite good for business.
Takeaways: People in a commission environment don’t recognize the conflicts and consumer issues that arise from conflicts of interest—until they’re forced to eliminate them.
Here’s something to think about: What would happen if U.S. regulators moved beyond the current debates about a fiduciary standard, and banned the commission revenue model for advisors—and brokers who pose as advisors—altogether? This is admittedly a hypothetical question at this point, with the incoming Republican Congressional leadership vowing to repeal the DoL rule and most of Dodd-Frank, plus the likelihood of a Republican-appointed SEC chair stepping smoothly into office from the C-Suite of one of America’s larger wirehouse firms.
The very idea of banning commissions would have industry lobbyists conjuring visions of an apocalyptic landscape where tens of thousands of brokers would have to scurry out of business, unable to live on the value of their counsel instead of their accustomed role facilitating transactions while being paid commissions to support giving their customers “free” advice. The lobbyists would tell us that hundreds and perhaps thousands of financial product companies would be extinguished due to their inability to pay for customer investment inflows. And (the old tired trope that is always trotted out) they would argue that middle-income investors would be left in the cold when it comes to financial advice.
But is it possible that the lobbyists are exaggerating a bit? Might our financial system actually thrive in a commissionless environment?
How A Commission-Based Executive Converted To Fee-Based Advice
I recently had a very interesting conversation with Keith Richards about the abolishment of commissions for advisors in the U.K., and the impact it had on the industry and the advisors who recommend investment products.
Richards is the CEO of the 37,000-member Personal Finance Society in London, England—which appears to be the United Kingdom’s equivalent of our FINRA, with its own code of ethics and standards, assigned by the Crown to govern its members and protect the public. The PFS issues a certificate called a Statement of Professional Standing, which empowers individuals in the U.K. to provide financial advice, and requires its members to demonstrate a minimum of 35 hours of continuing professional development (what we call CE credits) each year.
One could hardly describe Richards as a fee-only fanatic. Before his current position, he was a senior executive at one of the U.K.’s larger mutual life companies, overseeing sales of the UK equivalent of variable life and annuity products; that is, blended insurance and investment vehicles where, it was determined in various inquests post-2008, consumers were deeply confused about what they were paying in return for the sales recommendations they received.
Richards has also served as Group Distribution and Development Director for Tenet Group, described as an “intermediary group” in the U.K. business landscape, comparable to a large independent broker-dealer in the U.S. At Tenet, he oversaw the commission-driven sales activities of thousands of financial advisors all over the British isles—a role that most dually-registered U.S. advisors would immediately recognize. “You have to realize that here in the U.K., up until 2012, everyone was effectively remunerated through commission,” Richards told me.
In fact, Richards conceded that initially, as the U.K. began exploring the idea of total fee disclosure and a system of fee-compensated advice, he was alarmed. “When you’re living in that [commission] environment, firms, industries, and insurance companies will naturally resist any reform in the belief that they’re doing a great job,” he said. “Clients weren’t complaining, so what was the problem?”
Now here’s the punchline: Richards now believes that both the industry and advisors have benefited from the banishment of commissions. “Transparency, and separating fees from products, has actually worked in favor of the profession and the industry,” he says.
You heard that right. Instead of a nuclear winter where only a handful of advisors and a few large index funds remain, the banning of commissions has been accompanied by an uptick of prosperity across the U.K. financial system.
How A UK Ban On Commissions Reformed The Delivery Of Financial Advice
“When advisors were forced into fee agreements with clients, it forced them to, first of all, understand the clients’ needs and to explain the value that they can provide, and the relevance of that,” Richards explained. “This led to a very pleasant discovery: when advisors started explaining their fee structures, they found that their established clients were quite satisfied with that. In many cases, the fee values have increased rather than going down. Many [financial intermediaries] expected to see quite a significant reduction in their revenue streams, but actually the opposite has occurred.”
And the industry? “Life products in the U.K. have dramatically changed,” said Richards. “Life in the U.K. is now purely protection, like term insurance, with level loads. Most advisors are recommending purely investment solutions, and the only thing that a life company might provide is an appropriate tax wrapper.”
The solutions include investments many American advisors would recognize: mutual funds, private accounts, stocks and bonds. “Most of them are open architecture,” Richards said. “You can simply select from platforms with two thousand or three thousand fund choices.”
For a fee.
The legislative initiative that banned commissions in the U.K. is called the Financial Services Act of 2012, which took effect on April 1, 2013. This was the U.K.’s equivalent of America’s Dodd-Frank Act, in that it mostly sought to stabilize the country’s financial system, address some of the risks that larger institutions were taking, and strengthen consumer protections in the wake of horrifying losses and a very public realization that most investors had no idea what they were paying for the financial products they were purchasing.
The Act created the Financial Conduct Authority, an independent regulatory body that prevents unauthorized persons from engaging in regulated activities (including financial advice) and ensures the protection of consumers when receiving advice from professional advisors. Among those protections, outlined in the Retail Distribution Review, or "RDR" (which actually went into effect on January 1, 2013) was the requirement that advisors charge fees, and that they adopt what is never quite called a fiduciary standard, but certainly sounds like one: “to put the well-being of their customers at the heart of how they run their businesses and to promote behaviour, attitudes and motivations about good conduct above anything else.”
“The U.K. is essentially about fee-only advice these days, so advisors are now fee-only,” Richards added. “There is no commission allowable for investment advice in the U.K.”
When Richards describes the difference between the old environment and the new, he sounds a bit like those fee-only planners you run into from time to time who used to work in a commission-driven environment, and now will tell anyone who will listen that they didn’t realize how much those commissions were influencing the advice they provided.
“We, as an industry, were really missing the point about conflicts of interest and how cultural behaviors could be driven by our own interests rather than the needs of our clients,” said Richards. “But it becomes evident when you’re forced into a different regulatory regime. The big problem was how much our charging structures were very opaque, and therefore consumers didn’t really understand how much they were being charged,” he continued. “You could argue that the reason people didn’t complain is that their costs were not transparent to them, so they couldn’t know what they should be challenging.”
“That doesn’t necessarily mean cheapest is best,” Richards added quickly. “What it means is that you need to be very clear about the value that clients are getting for the amount you’re charging them. We have seen a complete transformation, where fees are totally transparent now, and the risk of bias has been reduced significantly.”
Raising Educational Standards For Financial Advisors (First)?
Interestingly, Richards is not saying that a country can just ban commissions overnight and everybody benefits. The progression in the U.K. was quite a bit more complex than that. And the actual fee structure that British advisors operate under is not exactly what it is for a "fee-only" NAPFA planner here in the U.S.
Long before the transition away from commissions, the U.K. regulators did something that is probably long overdue here in the U.S.: they imposed minimum knowledge and continuing education standards on everyone who provided advice. That addressed what would be a powerful objection here in the U.S.: that many brokers and sales agents really aren’t equipped to provide (much less live on) real financial planning advice that materially benefits the consumer.
“In 1997, minimum standards and qualifications were introduced in the U.K., which were raised further in 2012,” said Richards. “What we’ve seen is a continuous drive up to higher levels of technical and professional qualifications in the U.K. There is no question that the technical competence has increased significantly over the years, which in itself does lead to different behaviors and a different level of service.”
In other words, before advisors were forced to live on the value of their advice, there had been a decades-long effort to make sure everyone who called him/herself an advisor possessed a certain level of training and expertise in the investment markets, insurance, taxes, risk profiling and inflation. “If you didn’t qualify in 1997 to the required level, then you had to stop trading,” said Richards. “And exactly the same occurred again in 2012.”
As a consequence of these higher standards, the attrition that would hit U.S. brokers who are mostly sales-trained actually happened in the U.K. not long after 1997, meaning that by the time the new compensation structure hit those who sold products on the other side of the Atlantic, they were better prepared to gulp and tell their clients that they were going to have to pay for expertise.
Interestingly, the same higher-standards initiative for commission-compensated U.K. advisors caused the nation’s product manufacturers and industry to go through their own necessary attrition, consolidation, and hardening of their value proposition prior to entering a fee-only world. “At one time, there were somewhere on the order of 250,000 advisors in one form or another in the U.K.,” said Richards. “Today we have around 32,500 regulated advisors.”
“Having higher-qualified professional advisors who are totally transparent about their fee structures, in itself, forced companies to focus on what consumers really value and need,” Richards explained. “Twenty or 30 years ago, the market here was dominated by big life insurance companies that manufactured and distributed their own products, often through big sales forces that worked under their roof.
“What insurance companies offer on the investment side now are investment platforms, sometimes with tax wrappers,” Richards continued. “And the distribution has almost entirely moved into the intermediated market”—i.e. independent advisors making their own decisions about the quality of the products and their suitability for clients.
And how, exactly, are advisors compensated under the new fee-only regime? If you’re hoping that all U.K. advisors would qualify for NAPFA membership, prepare yourself to be a bit disappointed. “The typical fee here is a percentage of the assets being invested or under management,” Richards explained. “It could be anywhere from 0.5% to 2.0% for the initial advice, as a front-end charge, for the interview, the fact-finding, coming back with recommendations and a financial planning report. The ongoing fee could be anywhere from 0.25% to 1.0% per annum,” he added. “Alternatively, it is not uncommon for advice firms to offer a fixed fee if they come across a consumer with relatively straightforward needs.”
How would that not qualify for NAPFA membership? “The primary model is declared fees that utilize any commissions available in the products,” Richards explained. “Any commission surplus would be rebated back to the client’s investment account.”
In other words, the primary "fee-only" model in the U.K., at least for the initial planning work, is what we in America would call “fee-offset,” with the investment company paying the advisor after the advisor has recommended its investments. After the initial financial advice engagement, the revenue structure appears to resemble our AUM.
My takeaway from this is that there would be no zombie apocalypse if America were to go beyond mere fiduciary requirements to a strictly fee-only compensation model. But I now also think that the U.S. has not done nearly what the U.K. did, decades ago, to prepare the industry for such a shift. It would be reasonable to follow a tiered approach: strengthen the Series 7 or Series 65 to something more closely resembling the CFP or PFS designations—to at least require everybody who sells insurance and investment products to have the knowledge to benefit clients with their advice. Then eventually, we could start requiring everybody to live by the value of their advice, too.
Richards assured me that he, as a former skeptic, was made a believer when he saw fee-only in action. “This is a very buoyant market for professional advice,” he said. “I can tell you that demand has been increasing year on year for the last three years. Transparency, separating fees from products, has actually worked in favor of the profession now, and the industry.”
So what do you think? Would a ban on commissions in the US lead to rising demand for financial advice as transparency increases? Or does the US need to lift its financial advisor educational standards first? Please share your thoughts in the comments below!