Does broker system need fixing?

As the UK seeks to rebuild consumer trust by banning the payment of financial advisers for selling investment products, should Ireland follow suit, asks CAROLINE MADDEN

THE DEATH knell has been sounded for commission-based financial advisers in the UK and a new era of fee-based advice is being ushered in. In light of the recent mis-selling scandals on our own shores, should we follow the example being set by our neighbour?

The UK’s Financial Services Authority (FSA) has proposed sweeping reforms of the retail investment market in a bid to rebuild consumer trust. The new rules, which are due to be introduced by the end of 2012, will ban the payment of commissions to financial advisers for selling investment products.

The thinking is that this will drive “commission bias” out of the system. If the proposals are adopted, consumers will be given the choice between paying an upfront fee for financial advice, or else having the cost of the advice deducted from their investment. The FSA’s proposals are a response to the commission-driven mis-selling scandals that have arisen in the UK over the last two decades.

Last week, when publishing the details of a number of disturbing case studies relating to the sale of inappropriate financial products in Ireland, the Financial Services Ombudsman Joe Meade said that he believed staff members in financial institutions were paid commission to secure inappropriate deals. Surely the Irish financial advisory market is also sorely in need an overhaul? Not surprisingly, the Irish Brokers’ Association (IBA) argues that the need to tighten the remuneration structure for brokers is much stronger in the UK than in Ireland.

“Unlike Ireland, where the maximum single premium commission is 3.5 per cent of the initial investment, in the UK it was possible for brokers to obtain up to 8 per cent of the investment lump sum for new monies if an offshore product was used,” says Ciarán Phelan, chief executive of the IBA.

And as one might expect, Phelan doesn’t feel that abolishing the commission system would solve any mis-selling problems that may exist in the market. “The problem doesn’t seem to be with brokers or with individual sales staff in organisations,” he says.

“It is with the culture of the organisation. Changing the method of remuneration of those at the bottom doesn’t resolve the policy decisions made at the top.”

The Financial Regulator declined to comment as to whether or not it would consider banning commissions paid by providers to advisers who recommend their products. However, last December the regulator issued a report on the intermediary market which included a number of recommendations on how the current system could be improved.

For example, it advised that non-life insurance brokers who receive remuneration from a product provider should have to disclose this to the customer. It also recommended that intermediaries should only be allowed to call themselves “independent” if they give their clients the option to pay for their services in full by means of a fee.

Even if one accepted that these recommendations go far enough, they will only be implemented once a review of the Consumer Protection Code is completed, which could run into next year.

In the meantime, according to the regulator, financial advisers are not obliged under the Consumer Protection Code to disclose commissions to their clients (although sales remuneration must be disclosed in relation to certain life assurance products under the Life Assurance (Provision of Information) Regulations 2001).

This lack of transparency can leave consumers with the impression that advice from commission-based advisers is free, which is not the case. The commission paid to the broker is usually factored into the overall cost of the financial product purchased.

Advisers can earn several types of commission, from an initial commission, which is a percentage of the customer’s initial lump sum investment when they first buy the product, to a fund-based commission, which is an annual percentage of the overall value of the client’s investment or pension fund.

The problem with this system is that an adviser may get a higher commission from one financial services firm than another, which creates a potential conflict of interest.

The risk is that the adviser could be swayed by higher commissions.

Consumers must keep in mind that purely commission-based advisers are under constant pressure to sell. If they don’t sell, they don’t earn anything, whereas fee-based advisers who charge an hourly rate or an upfront flat fee for their financial expertise will still make a living regardless of whether their client buys a product or not.

The good news is that individuals don’t need the regulator to outlaw commission-based advice in order to ensure that they receive independent, unbiased advice. They simply need to eschew commission-driven salespeople in favour of impartial, fee-based “authorised advisers” who agree to pass on any commissions they receive.

Only authorised advisers can conduct a full survey of the market. Therefore they can provide the widest choice of products and the broadest advice. The two other categories of financial advisers operating in Ireland – “tied agents” and “multi-agency intermediaries” – are restricted in the range of products they can offer.

The bad news is that Irish people have a strong aversion to paying for advice that they believe they get for free elsewhere. The IBA says that it is in favour of consumers being able to decide between fee-based and commission-based payment structures, and that some of its members already work wholly or partially on a direct fee basis, but their experience is that Irish consumers favour the commission approach rather than having to pay an additional fee.

And even if individuals do decide to pay upfront for independent financial advice, actually tracking down a fee-based adviser is easier said than done. A list of authorised advisers is available on http://registers.financialregulator.ie/, but it isn’t particularly helpful as it doesn’t identify which advisers are fee-based. Consumers must contact advisers individually to find out whether they operate on a fee or commission basis.

It may take a little more effort and a change of mindset, but unless individuals embrace the concept of independent fee-based financial advice, chances are Mr Meade will be kept busy for the foreseeable future.