UK: Banking and Capital Markets Insight - March 2011

Last Updated: 22 March 2011
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

Welcome to the March 2011 edition of Banking and Capital Markets Insight, which focuses on technical issues currently coming out of the banking, capital markets, securities and fund management arenas. This issue again is a wide ranging one, covering significant issues in respect of hedge accounting, current issues around deferred remuneration, the Financial Services Authority's (FSA) Retail Distribution Review (RDR), and European regulation.

Our articles cover the following diverse areas:

  • As the FSA Retail Distribution Review starts to take greater shape, Fiona Mackeaggan provides an update on the current issues emerging from the RDR, which will require firms to react now, particularly as a number of the changes require careful re-thinking of current procedures and systems processing;
  • As the new European System of Financial Supervision starts to take shape, Clifford Smout considers the extent to which the new structure will make immediate and obvious changes to the current UK regulatory oversight;
  • Hedge accounting is the latest area in which the International Accounting Standards Board (IASB) is looking to make changes to IAS 39. Kush Patel considers the Exposure Draft on hedge accounting issued in December 2010, and the potentially significant relaxations in areas like hedge effectiveness and net position hedging; and
  • The combination of the FSA Remuneration Code and the new UK tax legislation on "Disguised Remuneration" provide some significant challenges to remuneration planning. Bill Cohen, Neville Bramwell, Olivia Biggs, and Robin Moscoso review the current position and potential approaches ahead of the UK tax legislation's Royal Assent later in the second half of the year.

We look forward to your comments on the current edition and your suggestions for future articles.

Mike Williams


The FSA aims, through the RDR, to deliver significant change to the way consumers receive financial advice and are sold investment products, as well as to improve consumer trust and confidence in an industry rocked by a number of misselling scandals. The FSA estimates that the average annual detriment arising from the sale of unsuitable products to retail investors to be between £0.4 and £0.6bn.1

The RDR forms a core part of the FSA's consumer protection strategy and builds on the Treating Customers Fairly programme. The RDR will apply to all firms involved in the retail investment market, from banks, building societies, wealth managers, stockbrokers to Independent Financial Advisers (IFAs), as well as product providers and platforms.

The FSA has conducted almost four years of market analysis, engaged with a range of market participants, consumer representatives and other key stakeholders, and has published a variety of discussion papers (DP) consultation papers (CP) and policy statements (PS).

In March 2010, the final rules2 on the "description and disclosure of advice services" and on "adviser charging" were published. CPs on two other key strands of the RDR, Professionalism (CP10/14), and Platforms (CP10/29) were published in June and November 2010 respectively, with the final rules on Professionalism (PS11/01) published in January 2011.

The publication of the final rules in PS10/6 and PS11/01 brought some clarity around the description and disclosure of advice services and the requirements around adviser charging and professionalism. With less than two years to go to implementation, we consider the impact of some of the changes and some of the key questions facing firms.

Describing and disclosing advice services
(Independent or Restricted)

From 1 January 2013, firms providing advice services to consumers will be required to describe their service as either "independent" or "restricted":

  • Independent: Unbiased, unrestricted, based on a comprehensive and fair analysis of the relevant market.
  • Restricted: Any advice that is not independent, as defined above.

The FSA defines the "relevant market" as all retail investment products (RIPs) that are capable of meeting the investment needs and objectives of a retail client.

The new rules apply to the distribution of RIPs, a newly defined term, broader than the existing "packaged products" definition3, and cover:

  • a life policy;
  • a unit;
  • a stakeholder pension scheme;
  • a personal pension scheme;
  • an interest in an investment trust saving scheme;
  • a security in an investment trust;
  • a structured capital-at-risk product; or
  • any other designated investment which offers exposure to underlying financial assets, in a packaged form which modifies that exposure when compared with a direct holding in the financial asset.

These changes are likely to impact sectors of the market differently, depending on the services offered.

  • Any firm currently providing independent advice must consider whether it can meet the new requirements based on the revised definition of independence and the broader range of products.
  • Wealth managers are likely to be required to define their service as "restricted" unless they provide advice across the full range of RIPs, including for example, pensions. If the "independent" label is vital to the firm, it faces a choice of training and developing its staff to have the requisite product knowledge, or recruiting advisers with the necessary product knowledge and experience.
  • Similarly, IFAs are likely to face a challenge to develop sufficient product knowledge to advise on complex investment products, such as unregulated collective investment schemes, which they are not currently required to advise on in order to call themselves independent.
  • Firms that use panels may still be able to hold themselves out as "independent," providing that the panel is sufficiently broad, reviewed regularly, and the use of the panel does not materially disadvantage any retail client.
  • Banks and other product providers with a distribution capability are likely to be "restricted" either based on the range of products on which they can advise, or because they only recommend their own products or products from their Group. This is not a significant change to the current position.

Under the RDR, basic advice4 will be considered to be a form of restricted advice, and as such, firms offering this service will need to comply with the description and disclosure requirements. However, basic advice will not be subject to adviser charging and advisers may continue to earn commission on individual sales using a basic advice approach.

Non-advised or execution-only transactions are out of scope of the new rules, and therefore are not subject to the rules on adviser charging. The FSA will be monitoring the use of non-advised and execution-only transactions to ensure they are not being used to circumvent the RDR rules.

"Simplified Advice" was discussed through the consultation process, although the FSA has not provided a framework or rules, primarily due to the lack of consensus across the industry, and expects industry to lead the design of the process. Although various models have been discussed, primarily led by the industry bodies, there has not been an agreed approach at the time of writing.

Adviser charging

"Today's new rules are designed to boost confidence and trust in the retail investment market by removing commission bias, actual or perceived, and exploding the myth that investment advice is free. It is vital that consumers know not only the cost of financial advice, but also its value. There is a need to reconnect the adviser and client, where one pays for the services of another, and without the distraction of commission. Only then can consumers have real confidence and trust in the advice they are receiving."5

From 1 January 2013, financial advice on RIPs will be subject to adviser charging rules with charges based on the service provided and not the product (or product provider) recommended. Charges must be disclosed to the client as early as practicable and be shown in cash terms.

Currently, product providers are able to legitimately pay commission (initial and trail) to advisers for recommending their products. Under the new rules, commission payments will be banned on new business written after 31 December 2012, meaning product providers will not be permitted to pay commission and advisers cannot be remunerated by commission received from product providers. Instead, the adviser firm must be paid by their client via a charge disclosed and agreed in advance.

Trail commission will no longer be permitted on new business, and adviser firms will only be permitted to receive an ongoing payment (from the client) for the provision of an ongoing service. Firms offering an ongoing service must ensure that they have systems and controls in place to ensure that clients receive the ongoing service that they are paying for. Firms may continue to receive trail commission on "legacy business" (pre-31 December 2012) providing the business remains "essentially unchanged".

A key challenge facing firms is that people are not used to paying for financial advice, and may be unwilling to pay for it in the future. The FSA recognises this, but believes that the benefits brought through advisers being remunerated by the client for providing advice, rather than by the product provider for selling a product, outweigh the risks of consumers being unwilling to pay for advice.

Clients will not be obliged to pay upfront for advice; they may choose to do so or to have the charges deducted from the investment. If the client prefers the latter option, the product provider must obtain and validate the client's instruction to the adviser before making any deductions.

The increased transparency brought by the adviser charging rules has been broadly welcomed by the industry and should enable consumers to clearly see the cost of the product as well as the cost of advice. However, concern remains that adviser charging rules will make financial advice less accessible for a significant proportion of the population, in particular those not currently saving for retirement.

The deadline to comply with the new rules is just under two years away. For firms which do not already have a charging structure in place, it is important to start preparing for adviser charging as early as possible.

Firms should consider:

  • how much it will actually cost to provide advice;
  • whether the charge should be a percentage of the amount invested or based on the amount of time spent, a fixed fee or a combination of these options;
  • what to charge if the client is given advice but chooses not to proceed with the recommendation, or the recommendation is that the client should not invest;
  • how to transition from a commission structure to a fee-based model; and
  • how to position the cost of advice with a client base which may not be used to paying a fee for financial advice.

Adviser charging will also apply equally to firms categorised as "vertically integrated"6. Product costs must be clearly separated from advice charges; they must be representative of the cost of the service being provided and expenses must be allocated fairly. The cost incurred from providing advice must not be hidden within any costs of manufacturing the product and cross-subsidisation must not be significant in the longer term.

Providers will have to examine their current distribution models as they will no longer be able to control product distribution through commission payments. They will be permitted to facilitate the collection of adviser charges, providing they offer sufficient flexibility in the levels of charges they facilitate and do not unduly influence or restrict the charging structure that the adviser firm can use. This may lead to increased technology costs as providers may see this as a way to differentiate themselves from their competitors. Providers will have to develop factory gate pricing7 and high product charges cannot be hidden within a bundled charge. Performance will be a key differentiator and may lead to products with less impressive performance records being squeezed out of the market.

The wide range of charging structures which are likely to be adopted by adviser firms, as well as changes to product offerings, mean that product providers may face some significant costs to prepare for the RDR.


The changes proposed in the CPs on Professionalism have provoked significant discussion and push-back, mainly from the IFA sector, culminating in a House of Commons debate in November 2010. Although the PS was originally expected in December 2010, publication was delayed until January 2011, following the Treasury Select Committee's request to the FSA for written evidence on whether the RDR will achieve its objectives.

In PS11/01, the FSA sets out its expectations of both firms and advisers. To raise standards, the FSA requires all advisers to adhere to a common professional standard, with minimum levels of qualifications and ongoing Continuing Professional Development (CPD) requirements. Advisers must be qualified as a minimum, at QCF8 Level 4 standard, which is broadly equivalent to the first year of a Bachelors degree.

The FSA expects all advisers to meet the new qualification requirements. Reliance on industry experience and/or lower level qualifications from previous regimes will not be permitted, although the FSA will allow qualification "gap filling." This will allow advisers already holding an appropriate qualification to update their knowledge before 31 December 2012 (if they were deemed competent as at 30 June 2009).

The FSA has published the list of RDR compliant qualifications, including topics such as investment risk and ethics, and qualifications which require a practical application of knowledge. By raising the minimum levels of qualifications, the FSA aims to improve the profile of the industry, increase consumer trust in advice, and mitigate the risk of poor or unsuitable advice being provided to retail investors.

The FSA will require advisers to undertake relevant CPD of 35 hours per year, with at least 21 hours being "structured learning"9. If an adviser carries out more than one regulated activity, such as giving advice on investments and managing investments, any CPD carried out for the latter activity would not count towards the required 35 hours. Research conducted on behalf of the FSA showed that 20% of advisers will have to increase the number of hours of structured CPD currently undertaken, to meet these new requirements.

To complement the FSA's more intensive supervisory approach, the RDR will lead to a greater focus on individuals. Under the rules in PS11/01, advisers will be required to submit a Statement of Professional Standing on an annual basis to declare that they have complied with APER10 and have met the CPD requirements under the Training and Competence sourcebook.

Firms will be required to ensure that their advisers have met the FSA's requirements around qualifications, CPD and ethical behaviour. Firms will have to submit individual retail adviser professional standards data to the FSA on a quarterly basis. The FSA intends to use this data, along with the results of outcomes testing, to identify issues at an adviser level and to build up, over time, a profile of individual advisers.

To meet the challenges around Professionalism, firms will need to consider:

  • current level of qualifications held by their advisers and whether there are significant gaps to be filled;
  • the cost (financial and time) of helping advisers prepare for the new qualification requirements;
  • contingency plans in the event that key advisers do not meet the new qualification requirements;
  • the potential impact on adviser remuneration and retention, following successful completion of RDR compliant qualifications; and
  • the changes to the FSA reporting requirements post-2012.


In its March 2010 DP, the FSA sought views on the options for changes to how platforms are regulated to achieve the RDR's objectives. To date, regulation of platforms has been largely principles-based, but this is set to change if the proposed rules in CP10/29 are implemented as they stand.

The FSA proposes to define a platform service as a service that "involves arranging and safeguarding and administering assets" and "is provided in relation to retail investment products which are offered to retail clients by more than one product provider." To ensure wealth managers and advisers are not inappropriately subject to these rules, the definition excludes services solely paid for by adviser charges and services which are ancillary to managing investments for a retail client.

Despite expressing a preference for banning product provider payments in the DP, the FSA has decided to allow fund managers and other product providers to make payments to platforms for administration services, subject to improved disclosure to consumers and impartiality in product presentation. They concluded that the main purpose of platforms is to provide an administrative service and therefore, it was reasonable to permit them to charge for the service.

Cash rebates, where the product provider includes commission in the product charge which is automatically rebated to the consumer in cash, have been banned, due to the potential for confusion and for product bias to continue. However, the proposal only prevents cash rebates, so fund managers may rebate part of the charges through additional units.

Platforms will be subject to the same rules on adviser charging as product providers, namely that they must obtain and validate instructions from the client to pay the adviser charge through a deduction from their cash account held on the platform.

The FSA noted in its DP that some platforms do not allow customers to re-register holdings if they change platforms, requiring assets to be encashed, causing "inconvenience, delay and potential tax consequences". As a result, the FSA proposes to make it compulsory to allow assets to be re-registered.

In its DP, the FSA clarified that platforms are required to demonstrate through their Internal Capital Adequacy Assessment (ICAAP) that they have sufficient capital resources to wind down their regulated activities in an orderly manner. The FSA commented that it does not believe that the Fixed Overhead Requirement under Pillar 1 is sufficient to enable platform firms to effect in-specie transfers of assets. No changes to the Handbook are proposed although the FSA intends to carry out supervisory reviews of all platform operator ICAAPs to ensure they consistently apply the guidelines.

The CP proposes that investors who invest via a platform should be provided the same information on voting rights and other fund information that they would receive if they held the funds directly. The FSA notes that it has been aware that this information is not necessarily forwarded to the investor. As this issue is not unique to platform providers, the FSA proposes to introduce a new definition of "intermediate unitholder" to include nominee firms, such as ISA and SIPP providers and stockbrokers who hold authorised funds in nominee accounts.

The deadline for responding to the CP closed on 17 February, with a policy statement to follow "as soon as possible".

Some key issues for platforms to consider are:

  • Revenue and profitability – can the platform be profitable if revenue is restricted to service fees?
  • Challenges for platforms which do not currently offer re-registration.
  • Will additional capital be required?
  • What impact will the ban on cash rebates have?

Countdown to implementation

With less than two years to go before the implementation of the RDR, firms and advisers who have not already begun their preparations to meet RDR requirements need to act quickly to consider how they will meet the challenges and take advantage of the opportunities afforded by the RDR, be it through reviewing the strategic direction of the firm, reassessing their current and target client base and product range, or by enhancing their own product knowledge and taking appropriate examinations to ensure that they stand out from the crowd in the new, commission-free world.

Fiona Mackeaggan

To read this Report in full, please click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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