Financial Advice - What's in a phrase?
As you may be aware, the government’s response to HM Treasury’s September 2016 consultation on amending the definition of financial advice was recently published, in which it was noted that the majority of respondents agreed the proposed definition was simpler and broadly supported the change. Resultantly, the government has decided to proceed with the change to the definition of financial advice for regulated firms.
To recap, one of the recommendations of the Financial Advice Market Review’s (FAMR) final report was that the Government should consult on amending the definition of regulated advice to bring it in line with the EU definition set out in the Markets in Financial Instruments Directive (MiFID), which the review held was clearer for both firms and consumers, as well as significantly easier for firms to build into their compliance processes.
The FAMR found that there is a growing trend towards consumers making and executing their own financial decisions, and that for consumers with relatively straightforward needs or relatively small amounts to invest the cost of regulated advice may outweigh the benefits. The report also highlighted that one of the significant drivers of this trend is that firms are limiting the amount of guidance they are giving consumers for fear of inadvertently straying into the provision of regulated advice without meeting the relevant regulatory requirements. By stepping back from the regulated advice boundary, firms are providing less support to consumers and therefore increasing the risk that consumers make potentially poor investment decisions – over time this has created an ‘advice gap’.
The root cause of the uncertainty is that UK firms currently face two definitions of regulated financial advice. The first of these definitions is contained in the Regulated Activities Order, which defines regulated financial advice widely, capturing advice that:
relates to a relevant investment (which includes contracts of insurance and regulated credit agreements);
is given to a person in their capacity as an investor or a potential investor; and
relates to the merits of buying, selling, subscribing or underwriting the investment.
The Markets in Financial Instruments Directive (MiFID), however, contains a narrower definition of financial advice, with a key requirement that it must be a personal
recommendation. Further FCA obligations, for example around suitability, attach solely to personal recommendations and not the wider definition of regulated financial advice.
The role of new technology has also been cited as a major influence in the government’s decision to enact the change, FCA chairman John Griffith-Jones has himself called out in a recent speech:
“Rules that were designed for the paperwork era do not work necessarily for the online one. The distinction between advice and guidance, once reasonably clear, has become much greyer with the advent of platforms and the potential of robo-advice”.
As of 3 January 2018, requirements relating to advising on investments will be enacted via an amendment to Article 53 of the RAO. The change means that most regulated firms will be exempt from the need for FCA permission to advise on investments unless the firm is providing a personal recommendation for a specific product. The aim of the revision to RAO is to mitigate the risk of firms carrying on the regulated activity of financial advice without the required permission, which it is hoped will in turn give firms greater confidence to provide consumers with pertinent information to make their own financial decisions.
Interestingly, the government has only changed the definition of financial advice for regulated firms and will leave the wider RAO definition of advice as “advising on investments” in place for unregulated firms. The thinking behind this is that regulated firms will be free to provide more advanced guidance services, ones that would have previously been caught by the RAO definition of advice, without being subject to the more onerous regulatory obligations associated with regulated advice (such as the need for advisors to hold specific qualifications).
Unregulated firms, however, will not be able to provide these more detailed, tailored services, thereby reducing the risk of consumers being scammed or inappropriately guided by organisations sitting outside of the FCA’s oversight.
A real solution or a sticking plaster?
Perhaps unsurprisingly, industry opinion over the merit and likelihood of success of the change has been split. From reviewing the feedback to HM Treasury’s consultation the pervading attitude from those responding parties is that the change is generally a favourable one, closing the loop on an area of uncertainty and freeing up firms to provide much-needed guidance to customers looking for a general steer on their finances.
Advocates have also argued that, while firms will unavoidably need to implement systems and controls to ensure they do not provide personal recommendations and will have to retrain staff accordingly, these requirements will be substantially easier to introduce than trying to avoid the pitfalls of giving regulated advice under the existing, broad definition, without the required regulatory permission.
Dig a little deeper, however, and it becomes clear that there are many dissenting voices too. Common among the criticism is the concern that consumers will still not understand the difference between advice and guidance, even after the boundary is changed. On this point it should be noted that the government acknowledges that the terms can be confusing for consumers and has therefore tasked the Financial Advice Working Group with developing new consumer friendly terms to describe advice and guidance services.
This new consumer terms aside, the problem to some is that the notion of guidance must surely raise the question: guidance towards what? These individuals are of the view that the very term ‘guidance’ should be outlawed in favour of a straight and unequivocal choice between information (only) and advice. As many within financial services are only all too aware, guidance often sits both uncomfortably and confusingly in some muddy middle ground between the two, not helped by the patently misleading title of the MAS.
In particular, the following two areas of ongoing uncertainty have been commonly mooted:
Navigating the boundary between providing helpful guidance based on a customer’s circumstance (such as a financial ‘health check’ prompting customers to think about their financial needs and priorities) and straying into an implicit personal recommendation.
Navigating and managing the risks of the different regulatory requirements that apply depending on whether a firm is providing factual information on particular investments, or moving beyond that into advice on the merits and risks associated with buying or selling particular investments (i.e. non-personalised regulated advice).
As a result of these concerns, a number of stakeholders have stated they have designed their current guidance services to stop a ‘safe distance’ short of where they perceive the regulated advice boundary to be and, unless the FCA can satisfactorily advance its work on clarifying what regulated firms can offer under the ‘guidance’ banner, this situation is unlikely to change.
This brings us rather neatly to what many believe the true root cause of the advice gap to be, namely the Retail Distribution Review (RDR). The primary reason for the RDR was to combat potential poor sales practices and in 2012 financial advice experienced a watershed moment when the way regulated financial advisors were remunerated and how they could recommend investment products was substantively altered.
While the RDR is generally considered to have been successful in driving up the quality and professionalism of financial advice in the UK, it is also acknowledged that the cost of advice (and indeed the perceived cost of advice) had risen as a result. Cost is a factor in the advice gap as there is a segment of the market unwilling to pay the high costs of regulated advice to address what they consider as their relatively straightforward financial needs and, resultantly, significantly fewer retail customers are now seeking the services of a financial advisor.
While the RDR has long been contentious within the advice profession, some have now drawn the line at what is seen as yet another regulatory sea-change that is only being invoked in an attempt to address the inevitable shortcomings of a change that itself attempted to fix something that wasn’t broken in the first place.
The FCA has published a document that summarises the changes being made and the implications of the changes for both regulated and non-regulated firms. The FCA has stated that there is no need for firms to take any action now, nor will firms have to re-apply for existing permissions for advising on investments.
The FCA has also confirmed that it will make changes to its Handbook and Regulatory Guides and will consult on these changes later in the year, with a view to them coming into effect at the same time as the changes to the RAO are made in January 2018.