IFA firms could get caught in a "spiral of decline" with falling revenues, increasing costs of conducting business, competition from banks and a lack of investment in low-growth firms, according to the Financial Services Authority (FSA).
In its Financial Risk Outlook 2006 the FSA admits some firms have struggled to remain profitable because of a variety of factors including a lack of consumer confidence, the impact of depressed stock markets in previous years and operating costs.
In particular: “concern remains about underlying business models for many firms, which are characterised by lack of capital, low growth and lack of innovation”.
In light of this, the FSA says firms need to identify cost-cutting measures and increase productivity to remain viable.
Although it predicts an increase in the adoption of new technologies, such as wrap platforms and fund supermarkets, it says a lack of capital is a major barrier preventing many firms from taking up the potential opportunities offered by technology, and there is a continuing reliance on investment from the major providers.
As a result, the FSA says the retail intermediary sector could decline, leading to a “significant structural change in the sector over the next three to five years”.
But Tracey Mullins, director of public affairs at the Association of Independent Financial Advisers (Aifa), says while Aifa supports greater use of technology “telling small struggling firms to spend more money sounds quite patronising”, particularly when many firms wish to remain independent rather than join networks, which would support their technology needs.
Mullins argues the greatest costs IFAs face come from regulation, the Financial Services Compensation Scheme and the Financial Ombudsman Service, all of which are having a big impact on the sector.
Another problem the FSA identifies in its Risk Outlook is “fragile” consumer confidence in long-term investment products and increasing levels of indebtedness, which could mean some consumers may begin to adopt a debt-repayment financial strategy rather than seeking to save and invest thus affecting profitability for IFAs.
But the FSA says advisers can play a role in boosting consumer confidence by helping them make decisions about appropriate products, making product descriptions clear and ensuring they fully understand the risks and benefits offered by the different products available.
For example, the FSA says advisers must carefully explain the implications of equity-release products, some of which may make it difficult for the consumer to move properties, and must do more to inform their customers about the implications of closed with-profits funds.
Similarly, while tax simplification brought by A-Day will bring consumer benefits, the FSA warns it presents some complexities in the short to medium-term during the implementation of the new regulations.
It adds: “Consumers will need to be made aware of the risks and opportunities that the changes present to their pension arrangements. Also, financial advisers will need to understand fully the implications of the new tax regime for their customers as well as the transitional issues that may arise.”
IFAs are also facing the pressure of trying to manage their legal and operational risks carefully in order to keep up with financial innovation and regulatory change.
The FSA says one such change has been the full implementation of depolarisation in June 2005. It says it is “committed” to carrying out a full post-implementation review which assesses the effect of the changes against its objectives.
“We plan a rolling programme of work over the next few years including an assessment of consumers’ understanding of the new information about the status of their adviser and the cost of advice, as well as how they respond to it,” the FSA states.
While it is too early for the FSA to evaluate the effectiveness of depolarisation, it says: “Firms will need to be mindful of the potential impact of greater transparency about their remuneration arrangements, among other things.”
Mullins says a survey of Aifa’s members found consumers are still confused after depolarisation but by using greater transparency IFAs can help to re-build consumer confidence.
In particular, she points out IFAs tend to add a lot more information into the original documents Aifa proposed they use to explain depolarisation, thus making them more complex.
Mullins adds: “Complex information can make consumers suspicious. IFAs need to be clearer and smarter about what they are putting out. But they often put more information in because they are worried about the regulator.”
Advisers were once again warned they need to ensure they are applying the FSA’s Treating Customers Fairly principle, as the FSA states: “Many retail intermediary firms are small but this does not mean that this principle does not apply to them. Firms’ failure to apply this principle could lead to misleading financial promotions, remuneration models that serve the interest of the adviser above the needs of the consumer, and/or poor quality advice leading to customers being sold inappropriate products.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Emily Perryman on 020 7968 4554 or email [email protected].IFAonline
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