UK: Developments in Relation to Distribution

Last Updated: 19 May 2003

The Financial Services Authority (the FSA) has published a number of consultation papers for a proposed overhaul of the current methods of distribution in the financial services and insurance sectors. In addition, there are other proposals which the Treasury plans to implement in 2004/2005 concerning the distribution of general insurance and mortgage products to implement the Insurance Mediation Directive. These two areas are inter-related and this article explores some of the consequences which may result from these changes.

Distribution, for more than the last decade, has been on the basis of "polarisation". This has meant that advisers fall into one of two categories – they are either:

  • Independent, authorised in their own right by the FSA, providing services in relation to the entire range of products available in the market place; or
  • Tied Agents, appointed by a single product provider to act as sales agents in respect of the products of that provider. This category would include direct sales forces and appointed representatives. With the use of marketing groups, these tied agents have been able to sell the products of more than one product provider, for example from all the product providers within the same group.

The consultation papers which address product distribution include CP159, entitled "Appointed Representatives – Extending the Current Regime" and CP160, "Insurance Selling and Administration: The FSA’s High-Level Approach to Regulation", both of which were published in December 2002; CP166, "Reforming Polarisation: Removing the Barriers to Choice" published in January 2003; CP 170, "Informing Consumers: Product Disclosure at the Point of Sale", published in February 2003; and, most recently, in March of this year, CP174 "Prudential and Other Requirements for Mortgage Firms and Insurance Intermediaries".

Summary of proposals

The overall effect of these proposals will be to alter the existing arrangements for distribution. The FSA’s proposals address the distribution of products which it currently regulates, as well as those whose distribution will soon fall within the FSA’s regulatory net, such as mortgages and general insurance products. Introducing these new areas of regulation will lead to changes to the current position. To accommodate this, the FSA proposes to create a harmonised approach to distribution for all of the products which are subject to its regulation. Much of what is proposed will still, however, be familiar (albeit extended to cover the new areas). There will be a transitional period in which to implement the changes which relate to appointed representatives.

Marketing groups

Currently, many packaged product providers are allied with other firms, often those in the same group, to form marketing groups. A marketing group is set up for the purpose of marketing the products provided by its members. Life policies, units in regulated collective investment schemes, interests in investment trust savings schemes and stakeholder pension schemes are all packaged products.

The FSA has indicated in its consultations that it would like to do away with the current concept of the marketing group, in favour of an alternative approach.

The first of the alternatives to a formal marketing group involves using the current marketing group associate – an authorised firm which is not itself a provider of packaged products but which, instead, distributes the products of other members of the marketing group.

Where a current marketing group already contains a marketing group associate, this entity could continue to be the focus for distribution. A review of its regulatory permission will be necessary and this may require extending, for example, to cover the FSA’s additional areas of regulation. The impact of these additional areas of regulation will require any group which offers mortgages, general insurance or pure protection products to consider carefully whether the relevant entities are appropriately authorised for distribution. For those who already distribute their products using a marketing group associate, the implications of the abolition of marketing groups should not be too onerous and the changes are likely to be of detail rather than substance.

A second alternative to formal marketing groups proposed by the FSA is that an authorised firm could instead "adopt" the products of another firm. This would permit the "adopter" to sell both its own products and those which it has adopted. Any appointed representative would be able to sell the products which its principal may sell, either the principal’s own or those it has adopted. This would, however, be subject to certain limits. Life offices and the managers of authorised unit trust schemes would not be able to adopt freely the products of third parties as these entities are subject to restrictions under the relevant EU Directives.

The FSA has also put forward a third alternative, which is to maintain some form of grouping arrangement. This would probably be tighter than a marketing group as it exists at the moment, being more likely to be composed of only affiliated companies. This would make it easier to identify the principal. The FSA would prefer not to use this route, but raised it as a consultation query.

While the routes preferred by the FSA (the first and second alternatives above) may help with distribution, both also have disadvantages. The use of an existing marketing group associate may be relatively easy for those with such a company already, but establishing such a company will be time-consuming and costly for those who do not. Product adoption, on the other hand, can carry with it the reputational risk of being associated with products over which you have no control.

Distribution channels

It is intended that much of the terminology of distribution will remain the same. There will still be appointed representatives and independent financial advisers. However, the FSA proposes to change some of the specific requirements relating to these.

Direct marketing

Authorised firms will, of course, still be able to market and distribute their own products in much the same way as now. There will be certain changes, particularly for general insurance and mortgages once their distribution becomes directly regulated by the FSA but there are already requirements which apply to their distribution (and often these products are sold alongside other, more heavily regulated, ones).

In addition to their own products, product providers will (as mentioned above) also be able to "adopt" the products of other providers and distribute them.

Independent Financial Advisers ("IFAs") These will be firms which are authorised, in much the same way as now. In order to use the term "independent" (or any similar term) the FSA proposes that a firm must advise across the whole of the market and offer customers the opportunity to pay for the advice they receive by means of fees rather than relying solely on commission. The use of the "independent" branding must satisfy the "clear, fair and not misleading" requirement in that these firms should have no interests or procedures which compromise their "independence". This is a response to the criticism that advisers’ interests are not aligned with those of their customers, due to the payment of commission.

In reality, as is the case now, searching the "whole of the market" will require that the IFA uses a panel constituted from a sufficiently large number of packaged product providers. For providers who are reliant on distribution via IFAs, being included on the panels of the large IFA chains may be critical.

The FSA proposes to abolish the "better than best" rule which prevents an IFA from advising a customer to purchase a product provided by a significant shareholder in that IFA unless it is better than the best alternative product on the market. There will, however, be alternative safeguards, including disclosures and reporting requirements, designed to protect against any conflicts of interest with customers. While the obvious drawback of the better than best rule of where a product provider has a significant stake in an IFA is likely to be withdrawn, the FSA’s safeguards are intended to prevent a wholly-owned IFA from simply providing a feeder route to its product providing parent.

These changes may lead to product providers acquiring chains of IFAs more than has been the case before. Acquisitions might, to a degree, help with distribution problems created by the abolition of marketing groups.

Appointed representatives

As now, an appointed representative must have an authorised principal who makes the appointment. This will often be the product provider or one of its marketing group associates. The FSA proposes that there will continue to be two categories of appointed representative. The first category is those who merely introduce a customer to their principal, from whom the customer will receive any advice. The second category is those who advise on products and arrange for their customers to buy them.

Introducer Appointed Representatives – these will be free to have links with a number of principals rather than be confined to a single one. This is on the understanding that the principal to whom the customer is introduced will provide sufficient information and advice to the customer to enable him to decide whether the product is suitable. This represents a significant liberalisation of the current position under which introducers may only introduce customers to their one principal. While this will allow introducers to become more significant in the market, this approach is only likely to benefit directly those product providers who are capable of providing advice.

Other Appointed Representatives – the intention is that these will be able to advise on a wider range of products than is currently the case. This may be achieved because principals will be able to sell not only their own products, but also be able to adopt (and so sell) the products of another provider. Where a principal adopts (and so can sell) the products of another provider, so can any appointed representatives of that principal. This is likely to be of particular benefit to specialist distribution firms who can enter into appointed representative arrangements for the distribution of some products without having to remain abreast of the entire market place. As they can at the moment, a principal will be able to impose limits on any of its appointed representatives being appointed by other principals. As will be seen below, however, the FSA proposes that an appointed representative will only be able to have one principal per category of business.

Out of range recommendations – the FSA is proposing to allow a principal to permit its appointed representatives to make "out of range" recommendations (ie, to recommend a product which is not one within the scope of the appointment because, for example, it is offered by a different product provider) where such recommendations are in the interests of the customer. The principal for that category of business will, however, retain responsibility for any such recommendation. The FSA anticipates that this could be of benefit in areas where there is a limited number of providers, such as in relation to annuities.

In the terms of appointment, principals will need to consider whether they want to permit their appointed representatives to do this and, if so, how it will be policed.

Substitutable product categories – the FSA proposes that an appointed representative will only have one principal per category of business. The purpose of this is to make it clear where responsibility lies in respect of that business.

CP159 proposes to divide products for appointed representatives into thirteen categories of "substitutable products". The rationale for this is that products within a particular category should only be capable of substitution by other products from within that category. For products which are not substitutable in this way, such as mortgages and car insurance, an appointed representative can have different principals. The various categories of substitutable products are set out in the table below.

Accordingly, an appointed representative will have one principal for all designated investment business (as this is a single substitutable category) and so could only sell the pensions and unit trusts of one particular principal (or those adopted by that principal).


Substitutable product categories

Designated Investment Business:

Designated Investments - this includes packaged products (such as life policies, pensions and unit trusts) and non-packaged products (eg, shares and derivatives)

Regulated Mortgage Activities:

Regulated mortgage contracts
Lifetime mortgages

General Insurance and Pure Protection Business:

Term and critical illness
Medical and Dental
Income Protection
Long-Term Care
Domestic Buildings and Contents
Personal Motor
Legal Expenses
Extended Warranty

However, that appointed representative could have entirely different principals for its mortgages and general insurance businesses (and even different principals for the different categories of mortgage and general insurance).

One of the most significant changes for existing activities which this will introduce will be to restrict the activities of appointed representatives on the non-packaged products which they currently sell. Under the FSA’s proposals, they will only be able to sell the non-packaged products of one principal per category of product, a significant tightening of the regime from its current position. This may lead to some appointed representatives considering becoming authorised.

In contrast to the position of an appointed representative, in respect of the categories listed in the right hand section of the table above, an IFA will be expected to be able to advise on all such products (or at least all of those offered by the panel of providers selected by that IFA).

For those who are appointed rather than independent, it will be possible to be an introducer for some categories of product and an advice-giving appointed representative for others.

Between the two?

The FSA’s proposals may allow a "third way", which effectively permits a "multi-tie" distribution channel. An authorised firm which is a distributor (rather than a provider) could adopt the products of a restricted number of providers. These products could then be distributed, provided that sufficient disclosures were made to the customer so that customers are not confused into thinking that the distributor is an IFA.

Care must be taken with the branding of any such operation, so as not to infringe the use of "independent" but more choice would be provided than that offered by a typical tied agent. It could then be possible to have a network of appointed representatives which would distribute the selected range. This could provide a means to circumvent the requirements for IFAs, including the safeguards, while claiming to offer more than a single provider tied distribution channel.

Expected developments

The FSA has announced its intention to bring in a "menu" based system for the distribution of products, requiring up-front disclosure of the services and available options for a customer. The FSA is expected to consult in more detail on this later in the year.

The FSA is also proposing to reform the sales documentation for products. The current "Key Features Document" and "illustration" will be replaced by a "Key Facts Document" and "examples" respectively. These documents will be heavily prescribed and branded in such a way as to make it clearer that they are regulatory requirements rather than part of the firm’s sales literature, for example by including the FSA’s logo and an explanation of the relevant regulatory requirements. The FSA has recently published the findings from research it has commissioned in this area in Consumer Research 18: "The development of more effective product disclosure". The FSA has estimated that the cost to the life industry alone in implementing this change is expected to be Ł100 million.

There will also be changes to the marketing documentation to be used for authorised collective investment schemes following the latest in the round of UCITS Directives. The documentation under this will be prescribed at EU level and so leaves little discretion to the FSA.

What to do now?

The firms which already operate in this area are likely to be in one of a number of positions and will need to consider how these proposals will impact on them:

  1. Product providers who rely on IFA distribution will want to ensure that they form part of the panel from which the IFAs will make their recommendations and may want to consider whether any other distribution route is desirable.
  2. Marketing groups will need to consider distribution arrangements going forward, especially if the group uses appointed representatives. Where there is a marketing group associate acting as principal, then this is one solution. The FSA has specifically requested responses to the consultation from those who would like to see marketing group arrangements continue.
  3. Another distribution method may be the adoption of products of third party providers (or those of other group members) or to have one’s products adopted by third parties. This may be attractive to distribution firms as a form of "multi-tie" arrangement.
  4. General insurance and mortgage intermediaries should consider the impact of authorisation on them and prepare for this or seek to become appointed representatives of suitable principals.
  5. Firms already authorised will need to consider whether their regulatory permission is wide enough to allow them to carry on their current activities.

Article by Dicken Watson

© Herbert Smith 2003.

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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