Dan Draper, global head of Lyxor ETFs, explains how the RDR is set to bring the UK intermediary market closer to the US investment advisory model.
It is abundantly clear that the UK's independent advisory sector is facing a major overhaul following the latest Retail Distribution Review (RDR) proposals.
The proposals outlined by the FSA in July are set to create a more polarised market, with independent advisers on the one hand and on the other those providing "restricted advice".
However, as a US citizen living in the UK, I am experiencing a case of déjà vu. Having started my career in the US, I can see that the RDR proposals will help move the UK intermediary market ever closer to the investment advisory model that dominates the US market.
Comprehensive and fair advice
The FSA's consultation paper sets out detailed final proposals to implement the wide-ranging reforms it outlined in November last year.
The aim is to improve outcomes for savers and investors by enhancing the quality of advice they receive and prepare both consumers and the industry for the future.
The FSA insists financial advisers should only be able to describe themselves as independent if their advice is based upon a "comprehensive and fair analysis" of the relevant market, which will require them to extend their knowledge of ETFs and other appropriate products. They will also have to provide advice on a fee basis.
So why does this mean the UK will emulate the US? The retail investment advisory market in the US is now dominated by regulated investment advisers (RIAs). But this was not always the case.
Back in the 1990s, financial planning was largely provided by lawyers, stockbrokers and accountants as add-on services. RIAs largely evolved from the stock-brokerage industry when clients started to ask for more holistic wealth management advice on asset allocation for investment portfolios as well as for pension, tax and estate planning.
There was a major rise in demand for asset allocation advice after the TMT bubble burst in 2000, which punished those investors who discovered post-hoc that their investment portfolios had relatively little diversification and minimal risk control.
A surge of stockbrokers left their employers to set up their own RIA firms as they realised the tremendous entrepreneurial opportunities that were arising. They provided high-level asset allocation services on a fee basis, thereby aligning their interests with those of their clients.
ETFs to take off in the UK
The emergence of RIAs also facilitated the rise of ETFs in the US retail space. ETFs are the tools of choice for RIAs. They use them for their low costs, convenience and liquidity, all of which make them ideal vehicles for use in portfolios defined by client risk profile preferences and future cash and income budgeting requirements to drive an overall asset allocation process.
The ETF market started in 1993 when the first one was launched to track the S&P 500. In the early stages, ETFs were largely institutional solutions. But since 2000 their use by retail investors has risen dramatically, with the RIA sector being a key driver.
At present, the UK ETF market is a long way from the US situation.
The UK market is polarised between the lower end of the market serviced by banks charging on a commission basis and the top end serviced by IFAs who are also still largely incentivised with high commission payments.
The vast majority of these IFAs are former insurance sales people with an average age somewhere in the 50s.
They have built up successful businesses based on close personal relationships. Understandably, many do not relish the prospect of moving to a full fee basis and having to meet the new professional standards that will be introduced in 2012.
As a result, many will look to leave the industry, possibly selling their businesses.
The IFAs that are left in 2012 and the new ones joining the industry are likely going to arrive, or quickly become, professionally qualified.
There will be a great demand for their services because for some time there will be a shortage of people who are able to operate in this new environment until such time that we see a new generation of advisers emerging from academic and vocational training courses.
And while investor confidence in the markets has taken a severe knock in the current financial crisis, the losses incurred will only serve in the long run to remind people that they need sophisticated, holistic financial advice from highly qualified, professional advisers, in the same way that the TMT bubble provided a catalyst for the RIA sector in the US.
The shortage of expertise means there will be plenty of entrepreneurial opportunities in this new advisory regime in the UK. Existing IFAs will either adapt or sell their businesses to big, well-organised firms that will acquire and then transition clients to a fee basis.
The opportunities available have not been lost on some US-based RIA firms, recognising they can bring the experience they already have to the UK by buying UK firms with good books of clients.
Just as in the US, the new regime will have to be supported by the university system in order to bring through successive generations of professional advisers.
The exams will be fairly stringent but the graduates will not be experts on everything, rather qualified generalists with knowledge of asset allocation, broad insurance, estate planning, pensions and tax.
And just as in the US, the asset allocation tools of choice for IFAs will increasingly become ETFs.
The funds available to UK investors have traditionally been loaded with high initial and trail commissions and have largely failed to beat the underlying benchmark indices.
The new generation of advisers will not be swayed by commission. They are going to focus on risk profiling the clients' personal goals and providing asset allocations to give the best probability of meeting future wealth goals.
Three years at Wells Fargo
Effective from 9 December 2019
One firm with permission suspensions left
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