Fidelity's Shaughnessy on wraps

The FSA’s current proposals on banning rebates could be detrimental to clients, writes Gary Shaughnessy, UK managing director at Fidelity International

To date, the FSA has taken a hard line on the issue of fund management groups paying platforms for the administration they perform. It favours the creation of separate fund management charges and platform charges with no rebates allowed.

Its final verdict on the issue is due in the summer, but while the goal of transparency behind the changes is sound, the current proposals could have a number of unintended consequences. Most significantly, the proposals could have a direct impact on cost and availability of funds for IFA clients.

The FSA’s primary concern in its work on rebates has been the lack of transparency and potential for hidden conflicts of interest.

If a product provider pays a fee of, for example, 0.25% to the platform, the FSA is worried that it blurs the line between the platform as simply a technical solution and it being a distributor.

Equally, if rebates are paid directly into a client account as cash, the FSA believes this may influence the funds chosen.

Ultimately the FSA wants to ensure there is no hidden bias in fund selection, that customers can make an accurate comparison between different funds and that they receive good value for money. The FSA is concerned that without a ban on rebates there would be no change to the status quo – a rebate equivalent to the current trail commission could be paid to the client, leaving the total charge for the product as it is today and leaving the potential that the advice is presented as being offset against the rebate and therefore being “free”. This could undermine many of the goals of the RDR.

A vital agenda

The FSA’s transparency and clarity agenda is vital and its goals are ones the majority of the industry share. However, its solution so far has been to propose platforms are prevented from receiving rebates from fund management groups and costs for consumers are fully unbundled. But this may not produce the result the FSA seeks.

The first issue to consider is one of cost to the client.  The evidence to date is that fully unbundled platform solutions can charge the client significantly more than their bundled counterparts.

Debate rages over whether this additional cost reflects the different products and services available to investors and other countries (such as the US) have dealt with this by developing platforms where both models sit side by side – meaning the adviser can determine both the right investments for their client and make sure they are provided in a cost effective manner.

There is also the problem that the same rules are not extended to life companies. This could lead to a distortion of product selection within different tax wrappers in a way that clearly is not the intent of the rules being developed. Most platforms offer both life wrapped and other tax wrappers – but may need to present them in a very different way.

The same restrictions have also not been applied to execution-only brokers. This could mean it is more expensive to buy funds through an adviser than to go direct. Again, this cannot be the FSA’s intended outcome. The creation of a level playing field for financial products remains elusive.

What’s more , it is likely confusion will reign if the only solution is to inject a purely unbundled solution into a post 2012 environment, with clients and advisers grappling with legacy pricing on funds, legacy pricing on platforms, new business pricing for the same and potentially different pricing again for execution only and life wrapped business.

Detrimental effects on clients

There are other ways in which the FSA’s current proposals on banning rebates could be detrimental to clients. For example, advisers would no longer be able to use their buying power to negotiate better terms on mutual funds for their clients. Surely introducing our equivalent of the “net book agreement” is not the way forward!

One potential solution to this would be to create additional share classes to enable discounting. This clearly adds complexity for the consumer who could be faced with a proliferation of share classes but it would also add cost (an additional share class can add up to £20,000 to the cost of the fund) – and this is likely to be passed straight on to the consumer.

This cost would also be disproportionately high in smaller funds and may raise the TER by 20-30bps on these funds, acting as a drag on performance. It may discourage smaller groups from coming into the market and will reduce the likelihood of non-UK fund managers launching funds in the UK. Far from improving consumer choice, it could reduce the number of funds available for investors.

Part of the FSA’s concern about rebates has been they discriminate against smaller fund groups. In taking these steps, it may be doing exactly what it seeks to prevent. Again, far from levelling the playing field, the move could be anti-competitive.

Is there a clear solution? We suggest the following three simple measures:

1. Discounts to be allowed but only where the whole discount is passed to the investor.

2. A common approach to disclosure (both to the adviser and the investor) of the cost of platforms, any difference between charges earned from different funds or from different fund groups and any potential conflicts of interest including ownership.

3. Oversight and action by the FSA in respect of platforms or advisers who do not act clearly and transparently.

This is not a debate about whether bundling or unbundling is right as both models can readily sit side by side. It is a debate about the best way to improve transparency, choice, flexibility, value for money and availability of products and services for advisers and investors.

The choice being made over the next few months could lead to platforms being part of the solution or part of the next problem.