Say the word “compliance” and many agents and advisors become furious about the government regulations they have to abide by, some of them seemingly useless, if not downright harmful to business. You probably count yourself among the angry and frustrated.
You’re in good company — globally speaking. For your counterparts in regions around the world are dealing with many of the same issues: mounting paperwork, beefed up requirements respecting disclosure, due diligence, and responsibilities owed the client regarding product and plan recommendations.
And in several countries — the U.K., Canada, South Africa and Australia — the really big issue is pay. As regulators raise practice standards for financial service professionals and endeavor to protect consumers from substandard advice, they’re also launching an assault on compensation arrangements they see as conflicting with their objectives. Upshot: commissions on product sales are being reduced or eliminated in favor of fee-based advice.
On January 1 2013, the U.K’s Financial Conduct Authority (FCA), implemented one of the largest shake-ups in financial services in the last 30 years: the Retail Distribution Review (RDR). The RDR increased professional qualifications for advisors, categorized them as “independent” or “restricted” (depending on their ability to offer a full range of financial service products) and mandated greater information-exchange and transparency in advisor-client engagements.
The most consequential change of the RDR rules impacted compensation: Agents and advisors could no longer receive commissions on new policy sales, only advisory fees. Clients who purchased life policies prior to 2013 could also discontinue renewal/trailing commissions if they believed they weren’t receiving adequate advice or service.
Advisors that were earning trailing commissions on bundled, pre-RDR investment products are also impacted by the new rules. Beginning April 6, 2016, a sunset clause kicks in requiring advisors to implement new fee-based arrangements on these products — or give away their services for free.
These changes, industry pundits feared in the run-up to 2013, would negatively impact producers’ income, as clients cashed cash out their policies and bought new ones so they can turn off the renewal commissions. The loss of commission income, combined with the new educational and transparency requirements, would also prompt producers to leave the business — or force other, non-RDR-compliant agents to operate under the radar. (These fears have, to a degree, been born out. See accompanying chart.)
For U.K. insurance and financial service professionals already operating on a fee basis, the RDR has entailed greater compliance, but been less disruptive. Katy Baxter, a principal of Baxter & Lindley Financial Services Ltd., says she now must submit to the FCA periodic reports detailing the firm’s business activities, including investments, planning arrangements and fee income.
One purpose of the exercise: to ensure that capital adequacy requirements are met. (Investment firms subject to the U.K.’s Capital Adequacy Directive, or CAD, must hold capital against operational risks arising from the giving of financial advice.)
How onerous have the new requirements been? Baxter says the additional workload has mainly saddled a firm co-director in charge of compliance. But the burden has, since last year, been lessened by the adoption of new data capture solutions that automate regulatory reporting; and by the outsourcing of certain compliance functions.
“I’m working on the assumption that if I’m taking over the running of the business, I don’t really want to have anything to do with compliance,” says Baxter. “I need to know that I have really good people who are doing the due diligence.”
In respect to wealth management, much of this due diligence is handled by Transact, a product of Integrated Financial Arrangements plc., which boasts an online administrative tool to help advisors manage their clients’ portfolios. The software holds investments in tax-advantaged savings vehicles and, says Baxter, offers “phenomenal” compliance reporting capabilities.
If international regulators were to reshape rules to be better attuned to advisors’ business practices, what changes might we see? To start with, more specifics from regulators as to what they want.
Baxter says that U.K. regulators have at times described as inadequate certain financial reporting of business activities or processes, but then failed to indicate how to comply with the rules. Result: Guesswork, as firms are left to their own devices to try to fill in the blanks.
“If [regulators] were really clear and said, ‘We want from you A, B, C and D,’ that would make the compliance process a lot easier,” says Baxter.
The U.K.’s Retail Distribution Review has had an impact far beyond the nation’s borders. In November 2014, South Africa’s Financial Services Board (FSB) proposed a similar regulatory regime (also called Retail Distribution Review) that promises big changes for advisors. To be implemented in phases between now and year-end 2017, the RDR entails changes to compensation and disclosure practices. Under the new rules, agents will no longer be able to charge commissions on policy replacements or exchanges’ only advisory fees will be allowed.
For new policies, producers will be permitted to take a 50 percent up-front commission on the sale. Thereafter, they can charge fees (in place of trailing commissions) for advice offered during policy reviews. And advisors will have carry out such reviews every six months to secure a written “mandate” (authorization) to continue charging fees.
Commissions (both upfront and trailing) on sales of most investment products are going away, too. Excepted from this provision are low-cost products or investment advice, provided that the advisor meets certain (as yet undefined) qualifications.
Criteria aside, the advisors will have to disclose during initial client meetings (1) their professional classification (i.e., “type advisor” (captive or career agent), multi-type advisor (multi-product/multi-carrier), independent financial advisor or (optionally) certified financial planner); and (2) how the regulatory classification may limit their product or planning recommendations.
These and other regulatory changes on the horizon — including new compensation disclosure rules and a requirement to treat customers fairly (TCF) under South Africa’s Personal Protection Act (PPA) — will entail an overhaul of business processes for the industry’s players.
“The big financial services providers will have to re-gear whole structures — how they remunerate their producers, organize their agencies and operate IT support systems,” says Kobus Kleyn, director and financial advisor, Kainos Financial Services Ltd. “Major changes will have to take place.”
“For commission-only advisors, the changes will be difficult to navigate,” he adds. “Our practice is more fortunate than many because we’ve already adapted to the fee-based regime. But fee-based advisors represent only about 1.5 percent of financial service professionals in South Africa.”
Much of the challenge, he notes, will be to reduce operational costs to compensate for the additional compliance work and reduced revenue that inevitably results when transitioning from a commission- to fee-based practice. Hence the need for technology that can, among other things, provide labor-saving efficiencies, reduce errors and, for the benefit of clients, enhance security of personal financial information
“The bottom line is, costing under RDR and other new regulations is going to be critical because upfront commissions are going away,” says Kleyn. “You’ll have to reduce overhead costs drastically. All the changes we’re making in our practice aim to help us run the business more cost-effectively and productively.”
Yet practice management changes can only accommodate so many edicts from the powers that be. Establishing a “macro-managed” environment in which regulations endeavor to balance consumer protections and business needs is fine. What Kleyn cannot accept is regulators interfering with his practice.
“Under a micromanaged system, the cost of running a practice would become too expensive,” says Kleyn. “Then agents and advisors will leave the business. And when they do, the loser will be the consumer. There’s no doubt about it — the U.K. is proof of that.”
The phrase “regulatory overkill” perhaps best sums up the situation in Canada. The nation now has 53 entities, both national and provincial, that oversee insurance and financial service professionals. For both newbies and veterans in the business, the dizzying array of agencies and authorities can seem intimating and overwhelming.
There’s the Mutual Fund Dealer’s Association or MFDA, which oversees distributors of mutual funds and exempt fixed income products. The Ontario Securities Commission administers and enforces securities legislation in Ontario, the largest of Canada’s provinces by population.
The Office of the Superintendent of Financial Institutions (OSFI), reporting to the Minister of Finance, is the primary regulator of insurance companies, trust companies, loan companies and pension plans in Canada. Not to be confused with OSFI is the Financial Services Commission of Ontario (FSCO), which also reports to the Minister of Finance and regulates many of the same entities.