Model behaviour

The advent of Consumer Duty has catalysed a lot of focus on fair value, or at least a lot of chat. Anecdotal evidence would appear to suggest that many firms may not have made any material changes to their charging structures.

However,  a recent survey by Schroders gave rise to a headline in the financial press this week, making this bold claim:

“Advisers reject 1% fee model as most charge less than 0.75% …”

It is hard to know where to start with a critique of this statement, but I’ll try …

The tag line to the article confirmed that “The majority of advisers are now charging 0.5-0.75% for ongoing advice, as advisers feel the FCA’s consumer duty is putting pressure on the ongoing charging model.” It is undoubtedly true that the FCA has ongoing adviser charges on its to do list. But the survey is stated to have been carried out with 254 advisers so extrapolating that small number of responses to a conclusion about advisers generally is a bit of a stretch.

Questions about statistical significance aside, there is a more fundamental problem with the headline in that it seems to convey a misconception of what a fee model actually is. There are basically three different fee models – time cost and fixed fee, neither of which are in widespread use, and percentage fees based on the value of the client’s portfolio, sometimes referred to as ‘ad valorem’ for no particular reason other than to show off a bit of Latin! Percentage basis is the model – the number before the percent sign is irrelevant, 0.5%, 0.75% or 1% are all incarnations of the same fee model. So, a move from 1% to a lower number is likely to be welcomed by clients for obvious reasons and by the FCA if it was driven by a proper review leading to the new lower fee more closely reflecting the cost of delivering the service being charged for. But it is not a rejection of the percentage fee model and leaves in place pretty much all the same issues that the FCA has raised, in particular, how can firms justify different clients being charged more (or less) for the same service.

The last major intervention around adviser remuneration was RDR and I did a lot of work with firms at that time in relation to charging models. For the most part firms merely turned pre-RDR ‘initial plus trail’ 3% plus 0.5% into adviser charging of, wait for it, 3% plus 0.5% but could be persuaded that at the very least, the model should include some element of tiering in an attempt to mitigate the obvious unfairness of a one size fits all percentage. Some firms were also persuaded to identify a minimum fee (fairer to the business) and a maximum fee (fairer to the client). But here we are, almost eleven years later, with the same issues around adviser charging firmly in place. It may be of interest to look at how the starting price of 0.5% crept up to an almost universal 1% over the years. In my many discussions with firms around RDR, it quickly became clear that the ongoing adviser charge was going to be increased from 0.5% to 0.75% or 1%. When asked, firms gave one of two reasons for increasing the rate. The first reason was along the lines of ‘I spoke to a few advisers at last week’s <Enter preferred name of provider> seminar on RDR and they said they were going to charge 0.75% – 1%’. Call me picky but this ‘me too’ approach does not seem to be a very robust basis for a firm’s charging model! A (slightly) more considered reason was that ‘0.5% is not enough to cover the cost of providing ongoing service for clients with smaller portfolios’. That would be fair comment but for two things. First, few of these firms really had any objective idea of how much it cost to deliver ongoing service to any client and second, it ignores the inescapable reality of arithmetic. Even 1% or 2% or 22% of a small enough portfolio may not cover the cost of ongoing service. Hence, the need to start any consideration of fee structure with a detailed examination of the cost of delivering the service and then to implement a minimum fee to ensure that service is only provided at an economic price.

Now, as part of the implementation of Consumer Duty, firms should have undertaken a review of their fee structure. No doubt some will have done this and applied a bit of the objective self-challenging, based on having some idea of the costs of delivery approach mentioned above. Some may not have bothered at all, and others may have simply paid lip service to a review, starting with a view that their fees are ‘fair value’ and ending up at the exact same place. The FCA commented in the recent Consumer Duty webinar that such reviews should be more than simply an exercise in ‘justifying the price firms already charge’.

Now, you may be starting to think that I would recommend avoiding any fee model with a percentage element but that would be wrong. The percentage model has very obvious issues including those indicated here but fixed price and time-cost based models are not free of problems either. To a point, the issues with each approach can be mitigated but probably not resolved completely, the fact is that there is no perfect fee model that someone could not pick holes in.

Value not price

Despite the thrust of the ‘fair value’ requirements in Consumer Duty, the FCA continues to claim that it is not a price regulator. That is true to the extent that the regulator does not seek, at least yet, to set prices or price caps – firms can charge what they like and how they like.

But firms need to be able to justify the amount they charge IN RELATION TO THE VALUE OF THE SERVICE PROVIDED. This is nothing new. Longstanding FCA COBS guidance states:

“In order to meet its responsibilities under the client’s best interests rule and Principle 6 (Customers’ interests), 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.”

Note that this encompasses ALL charges payable, not just the adviser charges. Firms need to determine the cost of all services provided, otherwise how can they analytically justify what they charge? We have seen very little evidence of this.

Another vital point to note, one that is often not recognised, is that the price cannot be assessed for value in isolation from the benefit that the client will obtain for that service. So, a ‘fair‘ charge for one client with a portfolio of £X will almost certainly be less, or not, fair value for a client with a smaller or a larger portfolio – the one size fits all problem.

And finally …

It has been said that the most expensive food is the food you throw away because it has gone out of date or whatever. Similarly, it can be argued that the most expensive thing people buy isn’t the thing that costs the most but the thing that serves no purpose or that they did not really need. The latter thought is one that firms need to bring to bear here. A firm’s ongoing service may well be fabulous and also thoughtfully priced to be economic for the firm and also fair to clients – but that can only apply for a service that a particular client actually needs. Make no mistake, the FCA will be looking for firms to not only justify the amount charged but also whether a client needed that service in the first place.

Ongoing service seems to have become a default offering across the market but COBS 9A.2.19 states:

“… firms shall have, and be able to demonstrate, adequate policies and procedures in place to ensure that they understand the nature, features, including costs and risks of investment services and financial instruments selected for their clients and that they assess, while taking into account cost and complexity, whether equivalent investment services or financial instruments can meet their client’s profile.”

Even in the world of clients with a drawdown arrangement where ‘accepted wisdom’ is that all such clients need ongoing advice, the FCA has stated:

“Our view is that many consumers would not benefit from ongoing advice as their circumstances are unlikely to change significantly from year to year.” (PS20-06) The FCA went on to suggest that ad hoc advice as and when required could be appropriate for many clients and, even where ongoing advice is needed and would add value for the consumer, firms should consider whether this should be paid by the client directly rather than ‘from a product’. The latter approach would remove the potential conflict of interest seen in many switch recommendations where there is no consideration of the firm providing ongoing service on a third-party product that is not within their preferred investment solution but should be retained rather than switched because that is the most suitable advice.

So, it seems reasonable to suggest that not all clients need contractual ongoing service – firms should have a suitable investment solution for such clients and be able to show that it is recommended when appropriate.

Important Note: ATEB news is intended to provide general information ONLY. The content, including any views expressed or guidance provided, does not replace the need to comply fully with FCA Rules and Guidance. Unless you have discussed news article content with ATEB, and specifically how it relates to your circumstances, then ATEB disclaims all liability and responsibility and actions arising from any reliance placed upon it. For the avoidance of doubt therefore, any reliance you place on such information without our consultation is at your own risk.

ATEB Compliance offers compliance and regulatory advice.

ATEB Suitability provides report writing software for the financial services market.

Our View

It seems likely that many firms will have to continue to refine their implementation of Consumer Duty in 2024. A good place to start is with another look at the firm’s ongoing advice service.

Action Required By You

Food for thought. Happy Christmas to all.
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About the Author

Technical Manager - Often referred to as the Oracle or the Sage, Alistair has a wealth of financial services experience. He is our go-to Technical Manager and enjoys nothing more than a complicated conundrum. Feel free to test his renowned knowledge by getting in touch.

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