The FCA’s proposed Consumer Duty is getting a lot of airplay in the trade media. First mooted in the FCA’s business plan a while back, it has been the subject of a couple of consultation papers, namely CP21/13 (May 2021) and CP 21/36 (December 2021).

We have already written briefly about the Consumer Duty proposals in overview – see here as well as a couple of follow up articles around specific aspects. Overall, we do not see much that is fundamentally new. At the moment, it looks more like a refresh and relaunch of TCF principles and some existing rules. Nonetheless, we are maintaining a careful watch on developments and anticipate creating a definitive view and summary when the FCA finalises its thoughts and publishes new rules. The consultation phase ended on 15 February. The FCA expects to publish the policy statement summarising responses and to make any new rules by 31 July 2022.

The four outcomes

The proposals are aimed at achieving four outcomes, namely:

1. Communications equip consumers to make effective, timely and properly informed decisions about financial products and services.
2. Products and Services are specifically designed to meet the needs of consumers, and sold to those whose needs they meet.
3. Customer Service meets the needs of consumers, enabling them to realise the benefits of products and services and act in their interests without undue hindrance.
4. The price of products and services represents fair value for consumers.

As indicated above, much of what is in the proposals appears to be a rehash of existing principles and rules. In particular, the first three outcomes are arguably well covered already. Some feedback to the first Consultation Paper argued that there is no need for yet more rules. Yet the FCA is adamant that new rules are required.

“We do not agree that we can meet our objective without new rules. … we intend to set higher standards in new rules, informed by our experience intervening in markets and firms and what we know about consumers. We will back up these rules with assertive supervisory and enforcement action.”

That debate will no doubt rumble on but outcome 4 above does appear to open up some never seen before regulatory activity around fees charged by advisers. As we stated in our article on 15 March 2022:

“The FCA and its predecessors have long stated that they are not a price setting regulator. However, it is undoubtedly true to say that there has been a constant and increasing focus on what the FCA likes to refer to as ‘fair value’.”

This is not a totally new concept as some rules already apply to fund managers in the form of annual assessments of value and this has had real world impact with funds closing or being merged with others where ‘fair value’ in all its guises was assessed not to be present. It seems that outcome 4 is merely a continuation of the process from fund managers down through the distribution chain and all the way to advisers. That conclusion is rather confirmed by this extract from CP 21/36.

“Where different firms are involved in the distribution chain for an investment product, they all have responsibility to consider fair value as part of avoiding foreseeable harm and helping support customers in pursuing their financial objectives. 

 The fund manager:
The firm must set fund charges to avoid poor value for customers. As a manufacturer, the firm is also responsible for ensuring that firms in the distribution chain have the necessary information to carry out their own assessment of value. 

The platform provider:
The firm must set fair value charges for using the platform. In some cases, the platform provider will be the final firm in the distribution chain. As such, it should consider the overall proposition, including fund charges, to consider if it provides fair value. 

The financial adviser:
The firm must consider if its advice charges provide fair value. In addition, it should consider the overall cost to the customer, including all product and distribution charges in the distribution chain.”

What might this look like for adviser firms?

Only time will tell. But despite ‘not being a price setting regulator’, it seems likely that advisers’ charging structures and the perceived fairness or otherwise of those charging structures will, in future, be an agenda item for any FCA visit or thematic review. A hint of where the FCA’s thought process currently sits is indicated by this extract from CP 21/13, which we also commented on in the 15 March article:

“Firms offering the same charging structure to all consumers may also not provide fair value. Whilst it may often be fair to do this, it may not always be fair where, for example, servicing fees are charged as a percentage of the value of a product (this might be in relation to the size of a loan, investments or savings). Some consumers may pay substantially larger fees in this way even though the costs of providing the service and the benefits consumers receive may be very similar. In such circumstances, firms should consider whether the relationship of the price such consumers would pay is reasonable relative to the benefits they receive.”

Experience suggests that most firms still charge on a percentage of AUM basis and that the model and rates often relate back to the pre-RDR commission profile and/or are similar to ‘what other firms charge’. Unsurprisingly, this has resulted in very similar charging structures across adviser firms. This could mean that price competition has driven charges down to a similar ball park range but could equally mean there is little competitive influence at play! So which is it? The FCA reckons it is the latter, i.e. lack of competitive pressure.

Evidence of this conclusion can be found in the FCA’s Evaluation of the impact of the Retail Distribution Review and the Financial Advice Market Review published in December 2021 …

Clustering reflects a lack of competitive influence on pricing

… the FCA paper included feedback on its analysis of adviser charges. In summary, the findings were as follows.

“… there is significant clustering around a few service types. Advice firms appear to face little competitive pressure to innovate and offer new, more affordable services, or to try to attract less wealthy consumers. Competition does not appear to be operating effectively in the interests of consumers. 

In a well-functioning market, we would normally expect there to be a broad distribution of charges, reflecting factors like different service levels, underlying costs to advice firms, and incentives for firms to compete on price. However, our analysis found significant clustering of adviser charges. 

More than 80% of ongoing advice services had ongoing adviser charges set at only three price points – 0.5%, 0.75% or 1%. One-off advice was slightly less concentrated, with 50% set at just 3 price points, including 38% of one-off services charging 3% of the portfolio value. 

Price clustering can reflect a healthy market where competition drives advice services to specific price/quality points. However, our analysis indicates that ongoing services with a 1.0% annual adviser charge did not have noticeably different features to those charging 0.5% annually. This was also the case for one-off advice, where those services charging 3% did not have noticeably different features to those charging 2% or less. Nor were the charges explained by economies of scale, with little indication that firms with more clients, or more affluent clients, had lower adviser charges.”

Demonstrating ‘fair value’

We would imagine that every firm believes that its services and related charges are fair value. But, given the FCA’s analysis of the market suggests little operation of price competition and its stated intention, under Consumer Duty, to scrutinise firms’ charging models, it would seem prudent to ensure you can answer the question “How do you know your charges offer fair value to consumers?” before the Regulator asks it.

This question faces two ways – to the firm and to the client.

Looking at the firm side of things first, it seems obvious to say that, as in any business, the price of services and product should reflect the cost of delivering those services/products. However, given the clustering of charging models around percentages and similar rates, it is perhaps reasonable to suggest that many firms did not undertake any work at the time RDR came into effect to actually identify the cost of their initial and ongoing services. And many seem not to have done so since RDR either. If that were not the case, then we would expect every charging model to incorporate a minimum fee and for there to be far less clustering as different firms factor in different costs of operation. Firms with office space in expensive areas might be expected to have higher charges and firms that have efficient processes and good use of technology could be expected to have lower charges. Of course, there are other costs, PI, compliance etc. that arguably should be similar across firms but that is not the case in practice as firms can have different risk histories that could be reflected in lower or higher PI/compliance costs.

So, the starting point for building a ‘fair value’ charging model is to understand how much it costs to deliver the service. And firms should not forget to build in a decent profit margin on top of costs of business. Having this information standing behind the charging model should go a long way to answering the question we posed above.

The remaining part of the answer is rather more difficult to pin down. How can the value of the service to the client be measured? There is already a requirement to do so. Since RDR kicked in on 21 December 2012, COBS 6.1A has included the following:

“… a firm should consider whether the personal recommendation or any other related service is likely to be of value to the retail client when the total charges the retail client is likely to be required to pay are taken into account …”

The first thing to recognise is that value is not about how much is charged – that is price – value is about the benefit(s) gained by the client in return for paying the price! With these thoughts in mind, fair value might be assessed with consideration of the following aspects.

1. The price charged truly reflects the cost of delivering the service
   As described earlier, having a firm grasp of how much each service costs to deliver has to be the first step in setting the level of charges. That means breaking the service down into its constituent parts, making a reasonable estimate of how long each takes ‘on average’, identifying who is involved in delivering that part and how much those concerned cost to employ for that period of time and adding in an appropriate proportion of ancillary and often less obvious costs including, compliance, PI, office rent, etc. That should provide a reasonable indication of the cost of delivery. Add an appropriate profit margin. Finally, identify a fair way to allocate charge between different clients – they need not all pay the same but they should all pay only what is fair in relation to the service(s) they actually take.
2. Compare notes
   The process in 1 above should mean that the firm’s charging model is not simply a replica of every other similar firm’s charges. However, if the charges appear to be either significantly higher or lower than other similar firms, you may need to review your price setting process again. Have you missed any costs, leading to an inappropriately low charge? Are you applying an unrealistic profit margin, leading to an outlier high charge?
   Of course, this presumes that other firms’ charges are visible. At the present time, many are not as firms tend not to publicise their charging structure on their websites. Given that the FCA’s analysis shows price clustering where firms all charge the same, or similar, amounts, this can’t be because the charging structure is based on some magic formula that must remain a commercial secret!
   While we are not suggesting that adviser firms should compete on price alone, we do believe it would be good for consumers if more firms were to publicise their charges up front. After all, the assessment of value is ultimately in the client’s mind and it is impossible to compare the potential value of a firm’s services without knowing the price of the services.
3. The charge is proportionate
   This is not about the quality of the service. Advice to invest £5,000 in an ISA might well be top notch but if the firm’s minimum fee is £1,000 then it is arguably disproportionate to any benefit the client obtains from the advice.
4. Services are designed primarily for the benefit of the client not the firm
   In Market Study MS 17.1.3, ,the FCA stated: “Adviser platforms are chosen by advisers but are paid for by consumers.”
   In other places, the FCA has commented on the value of platforms as follows:
   “Using platforms could improve your administration and, thereby, the services you can offer your clients. But you need to make sure that this does not simply increase complexity and costs that are passed on to your clients, without giving them new services they value in return.”
   … and …
   “(we found) service level was an over-riding factor when selecting platforms. In some cases firms placed the level of service they received as a key factor ahead of the level of service received by their client … a firm’s desire to save on administrative costs should not lead to it recommending clients to use a platform when it is not in their interests”
   Firms can avoid these criticisms by ensuring that the benefits to clients of the service provided and how it is provided, for example by use of a platform, are not only clearly identified but also obvious to each client. And benefit can often be defined by identifying disadvantages that might apply if the service were not designed and delivered as it is. For example, without the platform the cost of delivering valuation statements could well be higher, or providing 24/7 client access to view their investments not possible.
5. The service and charges are clearly defined
   Having gone to the trouble of carefully crafting services and a fair charging structure, it would be remiss of firms not to ensure that clients are fully clear about the service they are signing up to and, more importantly, understand the benefits the service brings. It should also be clear what is NOT included in the service, for example, when might a client paying ongoing adviser charge have to pay in addition to that ongoing charge.
6. The elements of the service are truly of value
   Remember that client benefits can be tangible, tax savings for example or intangible, such as peace of mind. Advisers often focus on the former, and give too little, or even no, weight to the intangibles which are arguably more important to the client.

Finally, make sure your service does not suggest the service includes things that:

• the firm has to do anyway: like keep client data up to date
• the client would reasonably consider should be a given: like access to an adviser
• cannot realistically be delivered: like telephone calls returned within two hours (for ‘gold’ clients) or by next business day (for other clients)
• are of debatable value: quarterly newsletters?