Managing your money – the hidden cost of taking advice

How financial advisers should get paid for their services is a debate that has raged for some years now. And it's one that's happening all over the world. Australia banned commissions last July, although there are indications that it may water down its original ban, while European regulations, in the form of MIFID II, are set to be implemented next year.

The Central Bank is also looking at the role of financial advisers, although this is more focused on reclassifying authorised advisers as part of its review of prudential requirements for the sector.

One of the major proponents of banning financial services firms from paying commission to advisers to sell their products is the UK, which, in January 2013, introduced its retail distribution review (RDR) regime. But is it working as planned?

Last week, the British financial regulator published the second in a series of three reviews of RDR regime. One of the main aims of the retail distribution review is to increase transparency by improving the clarity of the information firms provide to their clients through their disclosure documents, and to introduce remuneration arrangements that allow competitive forces to work in favour of consumers, by making it easier for them to shop around.

However, the latest review from the new regulator, the Financial Conduct Authority (FCA), shows it is not quite working out as envisioned. Although financial advisers may no longer be able to earn commission from product providers on investments they sell on to their clients, the FCA still has serious concerns about how financial advice is being dispensed.

'Widespread' failings
Pointing to "widespread" failings, the FCA found that financial advisers were not being clear with consumers on just how much advice cost, with 73 per cent of of the 113 firms reviewed failing to provide the required information. Almost 60 per cent of firms failed to give clients "clear upfront generic information" on how much their advice might cost, and a similar proportion failed to give additional information on charges, such as not highlighting that ongoing charges may fluctuate.

Another issue highlighted in the review was that almost a third of firms who offered a “restricted service”, in that they were not in a position to advise on a full range of financial products and providers, did not clearly disclose this restriction to clients.

The survey also found that wealth managers and private banks performed poorer than other firms in nearly all aspects.

As the FCA noted, “some consumers could be unaware of, or even misled, in relation to the cost of advice (both initial and ongoing), the type of service offered by a firm (ie whether it’s independent or restricted), the nature of a firm’s restriction (if applicable), or the service they can expect to receive in return for the on-going fee”.

Clive Adamson, director of supervision at the FCA, described the results as being "a wake-up call" and he called on the industry to respond.

The FCA will again review the situation in the third quarter of 2014, and if it’s found that firms are still not complying, “it will consider further regulatory action, including referrals to enforcement”.

But how does the situation compare in Ireland? If there are still problems in how UK financial advisers disclose fees and charges – even though commission is banned – how do Irish firms stack up?

While there has been much discussion on whether or not Ireland should go down a similar route to the UK in banning commissions on financial advice, the approach thus far has been to maintain the status quo.

Some would argue that this is a shame, given the challenges associated with commission-based financial advice. These include a trading bias, whereby an adviser has a propensity to recommend the client buys an insurance or investment product – whether they need it or not – as this is how they earn commission; the potential for abuse by product pushers looking to boost commissions by effectively flogging financial products; and a preference for products which pay commission – even if a lower cost structure, which doesn’t pay commission, such as an exchange-traded fund, might suit the client better.

Consumer demand
However, for Brendan Costello, managing director of Talk Financial in Galway, while many financial advisers now "openly and willingly embrace the fee-based model", large numbers of consumers have yet to do so.

“People will embrace the concept of fee-based advice – but will they embrace it at a level that’s economically viable?”

He questions whether or not the general market is yet positioned to “broadly accept and engage in a fee-only financial market”, and fears that if the Central Bank was to force an RDR-type regime in Ireland, it would lead to financial advisers closing, and consumers being obliged to seek out advice in banks. Given that banks typically operate as tied agents, whereby they can only sell products from certain providers, this would reduce the availability of independent advice for consumers.

Indeed, while his company has always operated a fee-advisory platform, he notes that in terms of overall revenues, about 20 per cent comes from the fees clients pay; about 10 per cent from fees on funds invested in by clients; and the balance is commission of one form or another.

“If you pull that plug how can they physically trade – if they wean off the traditional commission model and wean customers on to a fee-based model it would require a massive change in attitude from the consumer,” he argues of a move to fee-only advice.

Mixed model
Joe McGuinness of Framework Financial in Dublin, which also offers a fee-based service, agrees. "Aspirationally, I'd like to have that scenario [fee-only], but it's not possible at this point in time. Fee-only would remove too many people out of the advice net."

A practical solution for Costello is a mixture of fee and commission. “It’s the right way to go,” he says.

But do consumers have enough information to make sense of just how much they’re being charged, and how much is being charged upfront and how much is coming from commissions?

In the commission-free UK, advisers are required to give an approximate pounds figure where a firm charges a percentage, or an estimate of the number of hours of work involved where charges are given hourly. At present in Ireland, financial advisers are obliged by the Central Bank to disclose the commission that advisers earn on products they sell.

“Most products have a disclosure requirement, which is a document which highlights the commission that’s paid on it. But often that’s found on page 10 and it may not be entirely obvious,” notes McGuinness. “Commission is not necessarily wrong – but there’s not enough clarity around what the advice could be,” he says.

Clients are also entitled to a quotation, which is an illustration that will show them what commission is being paid and how it impacts on the return of their investment.

But do consumers fully understand this?

“I don’t think they’re fully aware. Until we separate out the advice piece, it will always be difficult to get a handle on what it’s costing them,” says McGuinness.

In addition, not all products must disclose these payments. There is no requirement for example for commissions to be disclosed on company pension arrangements, just personal pensions and PRSAs.

And not knowing what you’re buying can harm your investment.

Take the example of a client who wants to put €500 into a pension over 35 years. With commission of 3 per cent available over the life of the product, this could put upwards of €6,000 into the hands of the adviser.

Paying a fee for the pension advice instead, and benefiting from a lower annual management fee on a no-commission fund, could be a better outcome for a client. Zurich and Friends First for example, offer low-cost pension contracts, with no commission and 0.4 per cent annual management fees.

The UK also operates the concept of “customer-agreed remuneration”, which puts the issue of fees and charges central to the discussion, and means that clients have to sign off on the level of fees being paid. McGuinness says that this is something that could be considered in an Irish context.

“A situation where they had to sign off on a fee within the process could offer much more clarity for the consumer,” he argues.

For now, much is unlikely to change in the short-term in Ireland, although the UK’s RDR experience is likely to be watched closely. In the medium-term, MIFID II is on the horizon. With an implementation date of 2016, this European regulation will ban commission for advisers who want to call themselves “independent”.