The need for a coherent approach to product transparency and distribution requirements for substitute retail investment products?

Transcription

1 The need for a coherent approach to product transparency and distribution requirements for substitute retail investment products? Response of the Association of British Insurers The Association of British Insurers (ABI) represents nearly 400 member companies, which between them provide 94% of domestic insurance in the United Kingdom (UK). The ABI works on behalf of the UK insurance industry to keep standards high and to make its voice heard. 1. Executive Summary 1.1 In the UK, the market for retail investment products functions well, as the Financial Services Authority has applied similar regulatory treatment to products serving similar consumer needs, and adopted principles based regulation. This has facilitated product innovation whilst ensuring that consumers are adequately protected and has been achieved over many years with many changes and at great cost to the regulated industry. We therefore see no problem in the UK market for retail investment products. Our experience demonstrates that it is possible for a national regulator to run a horizontal regime. Retail savings markets in the EU are local in nature, and likely to remain so for the foreseeable future. Further evidence is therefore needed before a view can be taken on whether a horizontal regime is desirable at EU level, how it could be done, at what cost and for whose benefit. 1.2 The European Union has, through MiFID, demonstrated that principles based regulation can work across Member States. We believe that the Commission needs to allow sufficient time for MiFID to be implemented across Member States before any conclusions can be reached on the state of the pan-european retail financial market. Once MiFID is fully implemented and the market has operated in the new MiFID environment for some time, it may be appropriate to review the EU retail financial market to ensure it is working effectively. Meanwhile, this Call for Evidence is a useful opportunity for early reflections on the issues. 1.3 Additional regulation should only be considered if this review identifies consumer detriment, and only if it stands up to rigorous cost-benefit analysis. Such regulation should be principles based. Any intervention should also encourage competition and innovation between products and minimise the compliance costs on product providers. We encourage the Commission to carry out some fundamental research into consumers needs, and not to start with the existing regulatory regime as a given. 1.4 The majority of our comments relate to UCITS and unit-linked life insurance products given that the FSA applies a similar regulatory treatment to products that

2 serve similar consumer needs. To a greater or lesser extent, all of the retail financial products discussed by the Commission in its Call for Evidence serve similar purposes, though it is arguable whether they are strictly substitutable with one another. The exception is annuities, which, in our view, have distinctly different characteristics to the other forms of retail investment products and should not be considered substitutable with other wealth accumulation products. Introduction 2.1 The ABI and the UK insurance industry are taking a close interest in the European Commission s work in relation to substitute investment products and we look forward to working with the Commission as its work on this issue progresses. Given the wide-ranging nature of the issues raised in the Commission s Call for Evidence and the limited time available in which to prepare a response, it has not been possible for the ABI to complete the necessary research, analysis and consultation necessary to fully answer all of the Commission s questions. If the Commission would find it useful, we would be willing to elaborate on the answers provided below. 2.2 The ABI recommends that the Commission use the opportunity that this Call for Evidence provides to carefully consider the outcomes any regulatory regime covering the transparency and distribution requirements for financial products should seek to achieve, rather than simply viewing the existing regulatory regime as the starting point. We encourage the Commission to carry out some fundamental research into this before reaching any conclusions about what is desirable. It will be important for such analysis to be informed by the needs of consumers purchasing retail investment products. Regulatory intervention, if any, should aim to meet these needs. In our view, the Commission should carefully consider and publicly set out the objectives that it wishes to achieve in the further development of the retail market for investment products across Member States. The ABI is of the view that the Commission should seek to create a regulatory environment in which: consumers have confidence in both the market and the individuals and firms operating within it. To achieve this, the market needs to be underpinned by a regulatory regime that requires appropriate levels of disclosure. Consumers should be able to make informed decisions about whether to use a financial adviser and whether to accept their advice. In addition, consumers need to have confidence in the experience and expertise of the financial advisers so that the investment vehicle chosen by the consumer is appropriate for the particular consumers circumstances, investment objectives and risk profile; increasing the level of savings across Member States is facilitated. Governments in a number of Member States are increasingly facing the challenges associated with an aging population. Many governments are seeking to encourage consumers to increase their use of insurance products to provide effectively for a range of social services, but especially health care and retirement; competition between products is encouraged. As will be seen from our responses below, the ABI is of the view that an important aspect of any 2

3 regulatory regime is for it to allow the market to develop in response to the needs of consumers. Over many years the insurance industry has developed a range of new and innovative products and markets resulting in increased choice and, with the wide range of providers, a reduction in prices for consumers; and competition between firms is encouraged. One factor influencing a company s decision to enter a market will be the compliance costs associated with the regulatory regime governing that market. If the regulatory regime is complicated, this may act as a disincentive for firms to enter the market resulting in reduced competition between firms ultimately leading to higher costs for consumers. 2.3 In the United Kingdom, the Financial Services Authority (FSA) has moved to adopt principles and risk-based regulation to govern financial markets a move supported by the ABI. Principles based regulation focuses on the high-level outcomes the FSA is seeking to achieve allowing firms to determine, in the most appropriate way for their operations and their customer base, how to achieve those outcomes. Although we recognise that this regulatory philosophy has posed challenges, it has allowed for the development of competitive and innovative financial markets in the UK as firms focus on their consumers and products rather than regulatory compliance with prescriptive rules. 2.4 Principles based regulation also allows the industry to complement high-level statements of principle by the regulator with its own statements of good practice. This helps to ensure a proportionate regime which provides flexibility as to how firms achieve regulatory outcomes. An example of this is the ABI s Guide of Good practice for Unit-Linked Funds 1, which is designed to help firms comply with the FSA s principle for business of treating customers fairly. 2.5 The use of principles based regulation has also been successful in the European context as has been demonstrated by the Markets in Financial Instruments Directive (MiFID), which incorporated and expanded on the high-level outcomes that the Investment Services Directive had previously set out for the financial services market. As yet it is too early to tell whether there are sufficient grounds to justify further regulatory intervention at EU level in this field. We are encouraged that the Commission has stated its commitment to moving towards a more principles-based approach than that demonstrated in MiFID to any regulatory intervention that is required. 2.6 Given the wide variety of products on the market, combined with the range of cultural preferences across Member States for the provision of financial products and services, it will be important for the Commission and other stakeholders to understand any differences in terminology that exist for the variety of products. If the Commission is interested, the ABI is prepared to provide a paper providing a description of the products being considered in this Call for Evidence and how these products are regulated in the United Kingdom. 1 Linked%20Guide%20of%20Good%20Practice.pdf 3

4 2.7 As will be seen from our comments below, for some time in the UK the FSA has applied similar regulatory treatment to products that serve similar consumer needs. For this reason, we do not see that a problem of the kind identified by the Commission in the Call for Evidence exists in the UK market. The Commission s Call for Evidence is a welcome first step in ascertaining the extent of any differences that exist both within and between the regulatory regimes operating across Member States and whether any differences give rise to any problems. Following the Commission s consideration of the responses it receives to this Call for Evidence, it will be important for the Commission to provide clear evidence that a real problem exists, the extent of any issue and provide a robust cost benefit analysis before embarking on further work in this area. 2.8 We are therefore somewhat surprised by the consultation paper on the medium term work programme of the three Level 3 Committees published on 22 November This identifies competing products as one of six key areas in which the Committees are committed to delivering maximum consistency across sectors in the period to end of We believe it is important that the Level 3 Committees await the outcome of the Commission s Call for Evidence. If there is no clear evidence that a real problem exists, it would be inappropriate for the Committees to conduct any work in this area. Consistency of regulatory regimes should not be pursued for its own sake. Question 1 Do you see that different regulatory treatment of substitute products gives rise to significant problems? 3.1 For some time, the FSA has taken the view that similar products should be regulated in a similar way. UCITS and unit-linked life products, for example, are subject to very similar conduct of business regimes in the UK. Both life companies and UCITS managers are subject to the FSA s 11 High-level Principles for Business 2. In addition, insurers are subject to prudential requirements to monitor and safeguard their solvency. UCITS are subject to a detailed rulebook that prescribes how the fund should be run, based on the UCITS Directives. Although the conduct of business rules for unit linked life products and UCITS are broadly similar, some minor differences do exist. The ABI is of the view that these differences do not, however, give rise to consumer detriment in the UK market although we support the comments of the Investment Management Association in relation to guaranteed equity bonds outlined in their submission to the Call for Evidence. 3.2 The ABI is concerned that the results of the Call for Evidence will be influenced by the views of submitters in some Member States that have not implemented all of the relevant Directives governing financial markets, notably MiFID. It will be important to assess whether a problem, in terms of consumer detriment, exists in relation to the retail financial market when all Member States have regulatory regimes based on 2 Please see: 4

5 EU-wide legislation and when that legislation has had sufficient opportunity to operate in the market. Similarly, sufficient time is required for the regimes of national regulators to be allowed to operate. In other words, this Call for Evidence comes at a very early stage in the Commission s thinking in this area. 3.3 It is important to note that the ABI s answer to this question has been prepared from the perspective of the UK market. Some UK insurance companies operate in other Member States and therefore may have differing views in relation to the regulatory regimes operating in those markets. Question 2 Do you regard the perceived concerns relating to different levels of product transparency and intermediary regulation as a significant threat to the further development of EU markets for retail investment products? 4.1 As indicated above, the conduct of business rules for unit linked life products and UCITS in the UK are broadly similar, although some minor differences do exist. The ABI is not aware of any research or reports indicating consumers, or any other party; have specific concerns relating to the functioning of the market as a result of these minor differences. 4.2 Much depends on what is meant by further development of EU markets for retail investment products. Market integration is one policy goal, but should not be the primary goal. The ABI is of the view that the needs of consumers should drive the development of the market for retail investment products. As a result of language differences, the proximity of the consumer to the product provider, distribution channels and cultural preferences, we believe that the market for retail investment products is primarily a local market, with limited cross-border activity. This is analysed in the Commission s recent European Financial Integration Report In addition to these factors, an even more important consideration is the tax treatment of retail investment products. Especially significant for consumers is the differing tax treatment of different products across Member States which acts as a key driver of the demand for particular investment products. For all these reasons the market for retail financial services in Europe is likely to remain local for the foreseeable future, although there will probably be some modest increase in crossborder trade as providers take opportunities in niche markets. The differing regulatory regimes governing the range of retail investment products across Member States are a relatively minor factor in the fragmentation of the EU market. 4.4 The cumulative effect of all of these factors means that the further development of EU markets for retail investment products will be a long-term project. The Commission should not use regulation to drive the development of a cross-border market where there is little demand from consumers to see such a market emerge. Question 3 5

6 Is it appropriate to regard different retail investment products as substitutable regardless of the legal form in which they are placed on the market? 5.1 The substitutability of one product for another is a function of the financial circumstances, risk profile and personal views 3 of the individual investor. In the United Kingdom, unit-linked life products and UCITS are broadly similar as they serve the same basic purpose of collective investment in equities. They could therefore be considered as broadly substitutable. However, given that there are a number of regulatory differences between them, notably their tax treatment, they could not be regarded as perfect substitutes in an economic sense. As a result of the different tax treatment of products and their personal needs, consumers often use unit-linked life products and UCITS for different purposes. 5.2 Unit-linked life funds are primarily used for regular premium pension saving. They are also used for medium-term saving by individuals who are investing a lump sum, such as an inheritance or the proceeds from the sale of a business. The principal attraction of unit-linked life funds is that they provide a flexible contract that permits a wide range of investments at low cost. Investment management charges and the costs of switching are competitive and the range of available assets is broad (and includes UCITS funds). This means that an investor using a life fund can invest in UCITS, without incurring the costs of buying and selling as a private investor. 5.3 UCITS are often sold through the Individual Savings Account 4 (ISA) tax-wrapper. The typical purchaser of an ISA is a retail investor wanting to make a regular contribution to a medium-long term investment. UCITS are also widely used as part of the investment portfolio of pension funds. The principal attraction of UCITS from an investment perspective is that the investor, through the fund manager, is able to maintain a diversified portfolio reducing their investment risk. 5.4 We note that the Call for Evidence includes some annuities in the list of substitute products. In the UK, an annuity is an insurance product solely associated with the de-cumulation of a consumer s previous saving, i.e. the consumer provides the annuity provider with a lump sum which is used to pay annual retirement income for the remainder of the consumer s life. Given that the other products discussed in the Call for Evidence are concerned with capital accumulation, it is not clear why annuities have been included in the Commission s Call for Evidence. Furthermore, in the UK, if a consumer has accumulated a pension fund over the course of their lifetime, it is compulsory to purchase an annuity at the age of 75. No other product discussed in the Call for Evidence has any form of compulsion associated with it 3 For example, one investor may object, for whatever reason, to investing in a fund that invests in US equities preferring that their investment be made in a fund investing in European equities. From the perspective of the fund manager, both funds are substitutable in that it is anticipated both will make a return on investment. However, because of the consumer s personal preferences, one fund is not a substitute for the other. 4 Please see H M Treasury s Factsheet: Individuals can save up to 7,000 a year in an ISA without incurring tax on the income received. 6

7 meaning that it is not possible that these products are able to compete with annuities for pension de-cumulation. 5.5 As a result, the ABI is strongly of the view that annuities should not be viewed as substitutable with the other forms of retail investment products discussed in the Call for Evidence. In our view, given that annuities have distinctly different characteristics, the Call for Evidence should focus solely on the retail market for wealth accumulation products. Which of the products listed below should be considered as substitute investment products? 6.1 As indicated above, the substitutability of one product for another is a function of a range of factors and to a greater or lesser extent all the products mentioned, with the exception of annuities (UCITS funds, nationally regulated retail funds, exchange traded or listed funds, unit-linked life insurance, retail tranches of structured notes, some bank term deposits) could be considered substitutable. As outlined earlier, the ABI is of the view that annuities are designed to de-cumulate wealth whereas all the other products listed are designed to accumulate wealth. Therefore annuities should not be considered substitutable with the other products listed nor should they be considered as an investment product. What are the features / functionalities (holding period, exposure to financial / other risk, capital protection, diversification) that lead you to regard them as interchangeable? 6.2 The ABI is of the view that it is not helpful to set out a list of factors to determine whether one product is substitutable for another given that as soon as any list has been developed, the potential exists for an innovative new product to enter the market that does not meet the relevant test but could be regarded as substitutable. As indicated earlier, the ability of the insurance industry to develop new and innovative products has substantial benefits for consumers and it is important that product innovation should not be stifled by overly prescriptive regulation. 6.3 Any determination in relation to substitutability should be based on the particular needs of the consumer in any given investment situation taking into account the relevant market. Differences in language, cultural preferences, tax treatment and distribution channels mean that the UK consumer may regard one product as substitutable for another whereas a consumer in another Member State may come to completely the opposite conclusion. 6.4 Flexibility in the design of UCITS and unit linked products, for example in terms of holding periods, investment in different asset classes or risk profile, mean that these products can be tailored to meet the needs of a variety of different consumers. For the average consumer, however, the type of product and its regulatory treatment are irrelevant considerations compared to the importance of the charges the customer will incur and the product s tax treatment. Have you encountered any legal or other definition which would encompass the range of substitute investment products? 7

8 6.5 No. It may be useful for the Commission to examine whether the SSNIP test used in competition law may assist in determining whether one retail investment product is substitutable for another 5. As previously indicated, in the United Kingdom similar products have similar regulatory treatment. Question 4 Which factors in your opinion drive the promotion and sales of particular investment products? 7.1 The factors that drive the promotion or sale of one investment product over another are specific to the insurance company involved and their consumers. As a result, most of the factors listed in the table are, to a greater or lesser extent important considerations influencing the sale or promotion of particular products. For this reason, we do not consider that it would be useful to rank these factors in terms of their importance in driving the sale or promotion of particular products as outlined in the table on page 14 of the Commission s Call for Evidence. 7.2 It is important to recall that the primary reason consumers purchase retail investment products is a desire to see a return on their investment. In a competitive marketplace, financial service providers develop innovative products designed to achieve this objective taking all relevant factors into account. Critical factors for providers to consider in developing, marketing and selling particular retail investment products are the cultural preferences of consumers and the taxation treatment associated with various products. 7.3 There are a number of additional factors acting as important considerations in driving the sale of specific investment products. In the UK, although the state provides a pension, it is widely accepted that this is insufficient to sustain an acceptable lifestyle in retirement. This has increasingly led to consumers wanting to make private provision for their retirement, which, in turn, has led to the development, and marketing of formal, tax efficient investment vehicles to meet this demand. In addition, the net worth of an individual consumer acts as an important driver for particular investment products. Clearly, a high net-worth individual is likely to require more complex financial advice and investment products to meet their more complex financial needs. Noting the importance of these factors, in the ABI s view, the regulatory treatment of a particular investment product has little, if any, effect on consumer demand for one investment product over another and consequently, little effect on providers promoting and selling one product over another. Question 5 Do pre-contractual product disclosures provide enough information to help investors understand the cost and possible outcomes of the proposed investment? 5 The Small but Significant Non-Transitory Increase in Price (SSNIP) test is used in competition law defines relevant markets where products are considered substitutes. 8

9 8.1 Whether pre-contractual disclosures provide enough information is best answered by the FSA. In the UK, both unit-linked life products and UCITS are subject to extensive disclosure requirements and investors are provided with a significant level of information about each type of product. A Key Features Document (KFD) and illustration must be provided for unit-linked life products at the point-of-sale, the content and format of which is prescribed in regulation. For advised sales, a notice of cancellation rights is required both for unit-linked life products and for UCITS. However, the requirements are more detailed for unit-linked life products, for example, an illustration is required containing a projection of future returns. 8.2 In the UK, the FSA has recently undertaken a review of a range of KFDs available in the market. The FSA identified a number of issues and has indicated that over the course of 2008 they will be requiring firms to make improvements to their KFDs. The FSA s Retail Distribution Review also examined whether the disclosure regime for consumers of financial products is adequate. 8.3 The ABI welcomes the work of the FSA in this area, as it is in the interests of financial service providers that their consumers are informed and satisfied with the financial products that they purchase. It is important to recall, however, that changes to the KFD requirements impose significant compliance costs on firms as documents need to be re-written and re-printed and staff re-trained to ensure that they provide consumers with the information required. 8.4 It is important that the benefits of any amendments to the requirements for KFDs outweigh these significant costs. An important factor influencing this will be the actual benefit consumers receive from the information that they are provided. Recent research by the ABI and the National Consumer Council in the UK has suggested that investors make very limited use of the significant amounts of precontractual information that are currently provided 6. Furthermore, it is highly unlikely that the average consumer compares the pre-contractual product disclosure of one product with another to assist them to make a decision on which product to purchase. 8.5 A key factor influencing whether consumers are adequately informed is their level of financial education given the need to understand often complex, legal and financial information. The Commission has recently published a Communication on this issue, the purpose of which is to assist stakeholders to develop financial education schemes in response to the rapid evolution, innovation and globalisation occurring across the financial services industry 7. Levels of financial education differ both within and between Member States and when this is combined with differing languages, cultural preferences and distribution channels, it is important that precontractual product disclosure to consumers is appropriate rather than enough. In addition, these factors may indicate that pan-european standardisation is not in the interests of consumers. 6 See: 7 See : 9

10 Question 6 Do differences in conduct of business regulation result in tangible differences in the level of care that different types of intermediary (bank, insurance broker, investment advisor / firm) offer to their clients? 9.1 As indicated earlier, there is little substantive difference between the conduct of business rules applying to UCITS and unit-linked life products in the UK. 9.2 A key component of the regulatory framework in the UK is the suitability rules that apply to sales of investment products, including UCITS and unit-linked life products. These rules require that the adviser should only recommend a product if they assess that it is suitable for the customer. A letter must be provided to the customers, explaining why any recommendation is suitable. In the UK, the FSA has chosen to exempt UCITS managers and most independent financial advisers from the MiFID although MiFID s suitability rules apply to all advised sales of UCITS. For which conduct of business rules (know-your-customer, suitability, information / risk warnings) are differences the most pronounced and most likely to result in investor detriment? 9.3 As indicated earlier, there is little substantive difference between the conduct of business rules applying to UCITS and unit-linked life products. Question 7 Are there effective rules in place to ensure effective management / disclosure of conflicts of interest (and / or compensation arrangements) by the different categories of product originators and / or intermediaries for the different types of investment product? 10.1 As outlined earlier, the regulatory regimes governing UCITS and unit linked life products are broadly similar and require disclosure of any commission the intermediary may receive for the product provider and conflicts of interest are managed by a regime shaped by MiFID. To ensure that these rules are appropriate, the FSA s RDR is examining these issues In our response to the Retail Distribution Review (a copy of the ABI s submission to the FSA s RDR is attached to this paper) the ABI is calling for: clearer intermediary services that consumers can understand (sales and advice); a new regulated sales process Assisted Purchase helping people get affordable access to basic products; help for future generations to access financial services through improved Financial Capability and Generic Advice; all advisers to be able to demonstrate their professionalism with higher minimum standards and compulsory membership of a professional body; 10

11 changes to the setting of remuneration to ensure that it is transparent, set at fair levels and linked to clearly defined and understood services; and improved regulatory supervision of intermediaries including risk based capital requirements. For which type of product do you see a regulatory gap in terms of the coverage of conflict of interest rules? 11.1 In the UK, one of the FSA s 11 High-level Principles for Business relates to conflicts of interest and provides a firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client. This represents a fundamental obligation of a financial services provider under the UK s regulatory regime regardless of the type of product they are involved in selling. As a result, the ABI is of the view that there are no regulatory gaps between products in relation to conflict of interest rules Before any conclusion can be drawn on whether a regulatory gap in relation to conflict of interest rules exists across the European Union, it will be important for all Member States to implement the relevant Directives governing financial markets and provide sufficient time for those to be operationalised and reviewed by national regulators. Furthermore, it will be important for national regulators to consider whether improvements in enforcement might yield greater benefits than implementing new rules. Question 8 Is the risk of unfair marketing / misleading advertising more pronounced for some product types than for others? If so, why? 12.1 ABI submits that the risks associated with unfair marketing or misleading advertising are generic across all financial products. In the United Kingdom, the FSA adopts a risk-based approach and the regulatory regime applies very similar rules in relation to financial promotion of both UCITS and unit linked life products. These are built around the core requirement that promotion of financial products should be clear, fair and not mislead the consumer. Can you point to concrete examples of the mis-selling of the different types of investment product resulting from unfair marketing / misleading advertising? 12.2 Under previous regulatory regimes there has undoubtedly been unfair marketing and mis-selling of investment products. It is also likely that this has occurred under the current regime, however, with principles based regulation firms have a much clearer indication of the outcomes the FSA wants them to achieve. Where noncompliance with the relevant rules has been detected, the FSA has taken appropriate action and where the FSA has found that the regulatory regime needs to be improved to prevent these activities, it has similarly taken appropriate action. The FSA s recent move to more principles-based regulation has provided firms with a 11

12 range of ways to ensure that they comply with the relevant regime, and facilitated product innovation. Question 9 Is a horizontal approach to product disclosures and / or to regulation of sale and distribution appropriate and proportionate to address the problems that you have identified? 13.1 Before a horizontal approach is considered, it is vital that all Member States meet the existing EU regulatory requirements. Once that has been achieved, the next stage will be to determine whether consumer detriment exists, and how best to address it. Our experience in the UK demonstrates that it is possible for a national regulator to set in place a regulatory regime based on a horizontal approach. Further evidence is needed, based on market conditions and consumer preference in all Member States, before a view can be taken on whether this can work at EU level. It would be essential, however, that a horizontal approach at EU level is both principles and risk-based, rather than adopting a prescriptive approach to conduct of business regulation. Any intervention should also encourage competition and innovation between products and minimise the compliance costs on product providers If, in due course, the Commission looks in close detail at the case for horizontal legislation at EU level, we would recommend close study of the lessons that can be learnt from prudential legislation. Retail regulation is inevitably more local in nature, and any regime is likely to be host-state based. However, some of the tools developed in the context of prudential regulation may bear examination in a retail context for example the use of mediation and peer review at Level 3 to examine different approaches by national regulators. Another read-across might be the use of a standard model for conduct of business requirements, but also allowing firms to have alternative models approved by the regulator, so that firms can, for example, tailor their disclosure document for different customer segments. Can you specify how this objective of coherence between different frameworks would address the problems? What are the potential drawbacks of such an approach? 13.3 As will have been seen from the answers provided above, the ABI is of the view that no problem exists in the UK retail investment market because of any differences in regulatory treatment. There is currently an extensive regulatory framework in Europe (Life Assurance Directive, Insurance Mediation Directive and the Distance Marketing Directive) which adequately addresses the concerns about the retail investment market that have been raised in the Commission s Call for Evidence. We would be particularly interested whether the responses to the Commission s Call for Evidence demonstrate that a problem exists across Member States. If such a problem is found to exist, we strongly encourage the Commission to prepare a robust cost 12

13 benefit analysis to demonstrate that EU-wide action will address the identified problems, and that the additional costs of any proposal do not outweigh the benefits. Question 10 Can market forces solve the problems that you identified (fully / partially)? Are there examples of successful self-regulatory initiatives in respect of investment disclosure or point of sale regulations? 14.1 As indicated above, the ABI does not believe that a problem exists in the UK that needs to be solved. We do not have sufficient evidence to tell whether there is a problem at EU level Were the Commission to decide that regulatory action is required, they should give consideration to the possibility of self-regulation in the first instance. The Code of Conduct on Clearing and Settlement is an excellent example of this. In the UK, industry initiatives play a useful role alongside the FSA s regulatory regime, for example the ABI s Customer Impact scheme in life insurance. Are there any constraints to their effectiveness and / or enforceability? Are you aware of effective national approaches to tackle the issues identified in this call for evidence? 14.3 It is too early to address this issue. Should it be left to national authorities to determine the best approach to tackling this problem in their jurisdiction? 14.4 It is too early to address this issue. Is there a case for EU level involvement? 14.5 It is too early to address this issue. Association of British Insurers 18 January

14 THE ABI S RESPONSE TO DP 07/1: A REVIEW OF RETAIL DISTRIBUTION Executive Summary 2. The ABI and its member companies recognise the importance of reform of the distribution of retail investment products. We believe that reform should seek to create a virtuous circle started by raising financial skills and increasing trust in the market. Importance of reform of the distribution of retail investment products Increased trust and confidence Raise financial capability Better appreciation of the value of saving Less pressure to sell, lower costs, fewer mistakes Source: ABI 3. To address the challenges we face in the market, we must focus on the needs of consumers, but recognise the value added by advisers and other service providers and provide incentives for this work to take place. In our response we outline the steps we believe are necessary to ensure the market is trusted by consumers and profitable for providers and intermediaries. 4. Proposals must avoid developing unnecessary complexity in the market and will need to be properly tested with consumers, intermediaries and providers before they are introduced. We should also avoid stifling competitive developments within the market where competition can deliver for consumers. Proposals must seek to build 14

15 on areas where the market currently works well and on areas where the market is already starting to innovate. 5. We are convinced that reform is necessary and timely. To ensure success the FSA must focus its efforts at the next stage on a small number of key issues where it can deliver real change. These should build on the FSA s existing financial capability strategy and the emerging proposals on generic advice. 15

16 6. The priority for the industry must be to meet consumer needs, thereby raising demand for the products that the industry offers by: Giving customers clear services that they can understand (sales and advice): A single regulated category of advice, with qualifications and specialisms allowing advisers to differentiate themselves rather than regulatory titles. A new regulated sales process Assisted Purchase helping people get affordable access to basic products. Developing simple products that consumers can understand. Helping future generations access the market through improved Financial Capability and Generic Advice. 7. If we can raise demand we must then ensure that the market can deliver a service to match expectations. To do this we believe that it is necessary for: All advisers to be able to demonstrate their professionalism: A new minimum qualification of Diploma for advisers; Compulsory membership of a professional body; A new Professional Standards Board; Improved consumer information on qualifications, charges and services. Remuneration to be transparent, set at fair levels and linked to clearly defined and understood services: Customer Agreed Remuneration for all firms offering products from a range of providers; Where intermediaries are not offering a choice of providers they should be able to demonstrate how they have addressed the potential for bias and clearly disclose the services they are providing. Effective supervision of all firms: A balanced scorecard approach taking into account a range of factors such as qualifications and remuneration to be used to target firms for enhanced regulatory supervision; The level of capital held by the firm to be included within such an assessment. 8. We believe that the objective must be a market that treats customers fairly as well as being sustainable and profitable for intermediaries and providers. But, if additional costs, through for example increasing minimum qualifications, are the accepted price for a market with better outcomes for consumers, there must be a regulatory dividend for firms in the market. Regulatory support is required, in particular to develop a new Assisted Purchase route to market, supporting the takeup of CAR across the advice market and improving the supervision of intermediaries. 9. We believe that our proposals would make a significant difference to the market. They cannot be delivered overnight and more work is required to determine feasibility, practicalities, transition issues and therefore an appropriate timetable. But, they can be delivered by the industry within an overall framework of principles enforced by the FSA. The industry faces many similar challenges in the protection 16

17 market and we propose that in 2008 we test which solutions for the investment market should also apply to the protection market. 17

18 Introduction 10. The ABI accepts that the distribution of life and savings products can be improved for the benefit of consumers, distributors and manufacturers. 11. Working together with the FSA, the industry can develop reforms that help consumers understand their needs, and get the right products and services. We believe that more people could get savings and investment products while new business models are developed by the industry. Regulation should encourage new distribution channels to develop, and expand consumers access to, and understanding of, financial products. 12. Reform should increase consumers confidence and raise professionalism but we must be realistic about the degree to which customers can or, in the future, could understand the market. We therefore recognise that there is a need to improve regulation to protect consumers and ensure the development of a more efficient market. We believe that this vision can be delivered by the industry within the FSA s desired principles based approach. 13. In facilitating the required changes the FSA should seek to coordinate their retail strategy, ensuring that the priority themes are aligned and complementary, allowing the industry time and resource to implement any changes. Scope of response 14. Our response is limited to comments on the retail market for investment products. We outline the destination for market reform and also the potential steps on this route. Our ambitious set of reforms will take time to implement and at this stage we have insufficient evidence to develop a definitive timetable. That said, it is certain that reform is essential. 15. We will use the time between the end of this consultation and the publication of the FSA s consultation paper in 2008 to consider further the likely challenges we face. 16. Our response is split into five sections: Section 1: Creating better outcomes Section 2: Key perspectives on the challenge Section 3: Increasing demand Section 4: Increasing consumer confidence Section 5: Delivering reform 17. While this response is limited in scope to the retail investment market, we acknowledge that the industry faces many similar challenges in the protection market. Many intermediaries selling investment products also sell protection products. Can the solutions we are proposing be applied only on one part of an intermediaries business? 18

19 18. As in the investment market, consumers should expect transparent products and services that meet their needs. Is the protection market delivering this? Persistency of protection sales and therefore their profitability is also a concern. 19. We are proposing a new sales process Assisted Purchase which would match consumers with products that meet their basic needs. Simple protection products must be included in such a process. 20. Protection is outside the scope of this review. But in 2008 we must test which solutions that we propose for the investment market are equally appropriate for the challenges we face in the protection market. 21. Responses to the individual questions raised in the Retail Distribution Review are attached separately. 19

20 Section 1: Creating Better Outcomes 22. We believe that reform should seek to create a virtuous circle started by increasing trust and confidence in the market. By focusing on the needs of consumers, we can address the challenges we face. Importance of reform of the distribution of retail investment products Increased trust and confidence Raise financial capability Better appreciation of the value of saving Less pressure to sell, lower costs, fewer mistakes Source: ABI 23. At present regulations governing disclosure of relationships, the sales process and qualifications seek to give consumers confidence in the market. The Retail Distribution Review recognises that the current mix has failed to deliver satisfactory outcomes for consumers, intermediaries or providers. Regulation needs to be rebalanced towards better qualifications and professionalism and away from regulatory interventions that add cost without promoting the choices that consumers need or securing their trust. 24. We must ensure that the market is simple for consumers to access, giving them the choices they need in a form that they understand. A new route for consumers to access the market is needed we call this Assisted Purchase providing an option between execution only sales and fully regulated advice. Consumers in future would access financial products through any number of these channels at different times to meet different needs, just as they use a number of different channels when buying other products or services. 25. Coming pensions reforms, including auto enrolment and Personal Accounts to be introduced from 2012, provide additional impetus for the need to improve financial 20

21 capability. As consumers seek to engage with financial services the market will need to develop the products and services that meet their needs. 26. Discussions around Generic Advice envisage a service focused largely on the needs of people with lower than average incomes. Many who do use Generic Advice will not need investment or savings products. Many consumers of investment or savings products will not need Generic Advice. 27. As we develop channels that are better understood by consumers, we also need to ensure that we deliver the professional services they expect. Where they want assistance, it must be backed up with systems and processes that ensure that they are given clear information, from professional staff with simple products and providers demonstrate a commitment to Treating Customers Fairly. Where they want advice, it must be backed up by a clear demonstration of the professionalism of service. 28. The market is already making rapid progress towards greater professionalism research from IFA Promotions (IFAP) demonstrates the rise in the number of advisers attaining additional qualifications 8. We argue in this paper that all advisers should demonstrate their professionalism (both through qualifications and ongoing demonstration of competence), not just those who currently choose to take additional qualifications. 29. Where advice is being provided we do not believe that the current minimum level of qualification provides the minimum level of skills (or examined competence) that a consumer should be able to expect. The Diploma represents a more appropriate minimum. To achieve this, the industry must find ways to support advisers who choose to demonstrate their skills, either through financial support for exams or providing access to training. New routes to qualification are required, not just the traditional exam based. 30. Professionalism means more than simply having the right qualification. Consumers accessing the market in future also have a right to expect advisers behaviour to match their qualifications and professional standing. Membership of a professional body with a strong professional code of ethics provides reassurance in other professional services. Such ethical standards should equally apply in this sector. 31. As consumers become more engaged we will need to work harder to demonstrate the value added by advice. Greater transparency of the services they are receiving and its cost are essential. Consumers should be confident that the advice is free from bias, with a transparent cost of advice set by the adviser and not by the product provider. 32. Regulation will remain as the back-stop for consumers. Those firms who demonstrate their professionalism should expect to see the burden of regulation fall. Higher standards and greater consumer engagement will lead to a larger market for 8 State of the IFA Nation, IFA Promotions, growth rates Sept 05-Sept06 21

22 financial services and higher demand for our products and services. As demand increases, understanding will continue to increase, reinforcing the virtuous circle. 22

23 Section 2: Key Perspectives on the Challenge The Consumer 33. The financial services market provides products and services that meet a wide range of consumer needs. Many consumers are well served. Yet many consumers have little understanding of the products we provide. For instance, around a quarter of consumers who hold stocks and shares state that they don t want any risk in their savings 9. Lack of understanding, and at times the behaviour of those in the market, has led to mistrust Low trust has been re-enforced by consumer confusion about the way the market operates. Incentive structures within the industry are seen as boosting sales rather than enforcing independence and impartiality. 35. Consumers expectations are changing; they want products that are more flexible. As a result, the length of time savings and investment products are commonly held has fallen significantly 11. Consumers now regularly switch many products they hold, and savings products are not excluded from this trend. Many consumers are benefiting from this greater flexibility. The Intermediary 36. Intermediaries have thrived despite constant change and pressure on their business model, both from regulators and external commentators. Despite this, commission remains the main way consumers choose to pay for advice. Remuneration by commission can bring benefits to both intermediaries and their clients. Clients can choose to pay for advice only if they make a purchase; and they can spread the cost over time, increasing affordability and access. While up-front and indemnity commission allows intermediaries to be paid when they do the work. 37. Many firms within the market do operate on a fee basis (around 11% charging fees without commission offset 12 ). But it is most common in relatively niche markets e.g. group pensions and high net worth individuals. 38. The interaction between means testing, Personal Accounts, debt and other forms of saving (such as housing equity) together with new tools allowing intermediaries greater flexibility in financial planning is making financial advice more complex to deliver. These changes, together with high regulatory burdens are impacting on the availability of advice, particularly with lower income consumers. IFAs are reacting to the need for higher skills by gaining more qualifications but this is tending to push them further up market and away from the mass market. 9 Levels of Financial Capability in the UK: Results of a baseline survey. FSA CR47 10 Survey of consumer attitudes to financial services and their experience in buying them. Financial Services Consumer Panel, March Understanding Switching ABI Insurance Market Study no.2 12 CRA International Intermediary survey 23