If you need a friend, get a dog

 

It was the great Gordon Gekko who said, Moral hazard is when they take your money and then are not responsible for what they do with it.”

With these words of wisdom, I felt it might be time to reflect upon the fact that nearly 26 years ago, on 27 October 1986, the closeted clubby world of the City was subject to a positive tsunami of changes that today, for those of us old enough to remember it, was called the “Big Bang”.

I was working in the City at the time and the financial services world as we knew it changed forever from that date. The late starts, long lunches, early finishes were no longer fashionable, everybody started dressing like Gordon Gekko, mobile phones were hand borne not hand held, the colourful LIFFE boys would strut around the Royal Exchange between trades and generally life seemed to have a very particular and agreeable buzz.

Over the past 26 years what was once a rather staid gentleman’s club of friends and relatives had morphed into a US-stylisation of business practices. With it came the skyscrapers of Canary Wharf and the City all linked with the considerable diversity introduced by foreign banks as plus points, but, the downside was that it came with a certain killer instinct that would mean even your friends and colleagues were not guaranteed a particular benefit without a cost attaching.

‘Bolly’ for me please?

But in the post big bang world, as Gekko would say, “if you need a friend, get a dog”.

Regulation and financial services have not always been easy bedfellows yet upon reflection the world did seem a nicer, gentler place in many ways in the years building up to that 1986 Big Bang.

But what led to Big Bang was that the London Stock Exchange was coming close to, if not actually being found out. It was really a cartel, fixing commissions and linking this with admission complexities that would do the Royal & Ancient some credit.

It was a posh, gentlemen’s club version of the markets, like Smithfield or Billingsgate but with manners. We saw a closed shop for the benefit of brokers and stock-jobbers all safely contained in their pin striped, bowler hatted bunker which in the coming brave new world of class and professional barrier deconstruction would not be seen as acceptable any more.

Margaret Thatcher had been in power for some 7 years and the Thatcher vision of wealth creation for all was heading down the “pike”. We saw the de-nationalisation of utilities, we “Told Sid” and the nation rode a gravy train of expectation with flotations of once staid mutual institutions like the Halifax and Abbey National building societies- yes, remember them?

The merchant banks were in gorge mode on these flotations. SG Warburg, Schroders, NM Rothschild, Samuel Montagu, Hill Samuel and Morgan Grenfell were there doing it “large”.

US investment banks like Goldman Sachs and Salomon Brothers (remember them too?) were also keen on some action but leading up to Big Bang it was not too easy for them to get into the club.

But change was on its way, the days of fixed commissions and closed shops were being replaced by the need to be competitive. The City was no longer a place for “Gentlemen and Players.” It was becoming a world of young and thrusting market traders who had switched venue, or who had been recruited from, the perceived ‘low rent’ market environs of Petticoat Lane, Billingsgate and Covent Garden. And those guys brought their trading skills and “Loadsamoney” culture to the previously hallowed ground of the City and the Stock Exchange. But instead worked in trading ‘Pits” or sat staring at banks of screens waiting for that big deal, bonus moment.

The big success story of Big Bang was Warburg’s swallowing up of Ackroyd and Smithers, Rowe & Pitman and Mullens & Co who in turn were swallowed whole by UBS, then UBS/Phillips & Drew/Swiss Bank empire.

In the feeding frenzy Barclays paid very big money indeed for Wedd, Durlacher and de Zoete and Bevan, Deutsche Bank ate up Morgan Grenfell, Midland Bank (who are they) bought W Greenwell and this got digested by HSBC, Kleinwort Benson bought Grieveson Grant, and NM Rothschild, Smith Brothers.

And what of the “Gentlemen and Players”? Well they all retired to their stockbroker belt houses having “trousered” some very serious money.

With this sea change we saw the disappearance of those traditional and cautious values, my word is my bond, trust, nods, winks and tips were all to be replaced by what is now seen in many quarters as a reckless abandon, using somebody else’s money to trade on your own account for the benefit of the Banks who employed you. If it all went wrong, the bank carried the losses until, as we saw with the spectacular banking collapse, the taxpayer did.

So when the indigestion disappeared from this bout of Mr Creosote like fiscal gluttony, was Big Bang a success, was big beautiful?

Gekko I think has proved to be the master philosopher as the banks post big bang did take our money and were not responsible for what they did with it.

The recent Barclays LIBOR affair has shown only too clearly that

“there is a very big difference between rehabilitation and repentance” and as far as casino banking and regulation is concerned, there is some way to go on both counts.

Longstop and enforcing the law

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Do you remember the story of Deborah Hunt? She is the (now former) financial adviser who last July drove the wrong way up the M5 without insurance but with twice the legal maximum level of alcohol in her blood.

She ended up behind bars for her little soiree.  Imagine what would have happened, though, if she had told the court that the Financial Services and Markets Act does not specify which side of the motorway she had to drive on. Nor does it impose a limit on how much alcohol she could have and still drive – and she only had to have professional indemnity cover, not third party motor insurance.

Clearly, if Parliament had intended financial advisers to only drive on the left hand side of a motorway, to do so whilst sober and to be properly insured whilst driving, it would have made it quite clear in FSMA.

But the reasoning is obviously ludicrous.  FSMA, and any other new law for that matter does not reassert all other legislation currently in force. Instead, all existing legislation remains in place unaltered unless the new Act specifically amends it.

FSMA takes this approach. It repeals part or all of no less than 13 Acts. Alas for Ms Hunt, none of them relates to her offences but my point is that even in her intoxicated state, I suspect she was sufficiently compus mentis to appreciate that such a defence relied on the logic of an idiot.

Enter the Financial Services Authority and the Financial Ombudsman Service. They say that because the 15 year Long Stop described in Section 14B of the Limitation Act 1980 is not referred to in FSMA, it obviously does not apply to firms over whom they have jurisdiction, arguing that if Parliament had wanted it to apply then it would have discussed the matter and thus rely on the perverse logic that Ms Hunt was not foolish enough to attempt to use.

But despite being a silly argument, it turns out that Parliament DID consider the issue of the Long Stop and the regulation of financial services at the same time. The Queen’s speech in 1986 refers to two particular Acts.

Of the first she says it “will protect the interest of investors”. This is the original Financial Services Act.

Referring to the second, she says “Legislation has been passed for England and Wales to set fair time limits for cases involving latent damage”. This is the Latent Damage Act, which inserted Section 14B into the Limitation Act 1980.

So it turns out that the assertions of FOS and the FSA are unclear, unfair and misleading. They know, or should know, that Parliament had already considered the matter but apparently chose to ignore its decision, and the words of Her Majesty, that were inconvenient to their agenda.

This reminds me of the Witch in the prequel to the Lion The Witch and the Wardrobe when she claimed to be too important to bound by the Law of “mere mortals”.

Remember Walter Merricks’ boast that FOS was “unashamedly making law”? It is not there to make law. It is there to fairly administer justice – and the Law says that justice cannot be fairly administered in respect of a negligent act that may, or may not, have occurred more than fifteen years ago.

The FSA can, of course make rules which have the force of Law.  So can your local council or water company – but a bylaw cannot override national law.  If the national government imposes a limit then no bylaw  can increase it. Your local Highways Authority can impose a lower speed limit on a road but it cannot make it higher than 70 mph for a dual carriageway or 60 mph for a single one because those are the national limits.

So it should be with the FSA or any other regulator. It must operate under the Law not above it.

If it had concentrated on enforcing the Law as it stands rather than trying to make Law on the hoof perhaps it would have spotted that LIBOR was being fraudulently rigged and that the cost of fraudulent complaints about events that occurred twenty years ago will ultimately be borne by the consumers it says it seeks to protect.

Peter Turner

Dispusolve and The Compliance Cooperative

FSA RDR finalised guidance Is that all clear to you? FSA RDR finalised guidance now out.

 

So at last the FSA guidance has been issued, all 16 pages of it. The purpose is to create clarity, at least I have assumed that to be the case. But as with all FSA communications the devil is in the detail and in this case some very non “Plain English”.

Whilst this is no doubt a move in the right direction, why can they not make these communications easy to understand, definitive and unambiguous? Even a simple flow chart or decision tree could help for many in gaining a better understanding.

But with better understanding comes confusion as it makes it easy to expose the faults

The first major area for concern is found in section 2.15 regarding excluding product types from consideration, it states:

“If a firm cannot or will not advise on a particular type of retail investment product, and that product could potentially meet the investment needs and objectives of its new and existing clients, then its advice will not meet the standard for independent advice.

In other words, the justification for a firm excluding types of retail investment products from its range needs to be centred on the client. As an example, the fact that a firm’s professional indemnity insurance policy specifically excludes certain products would not be a valid reason for never advising on such products”.

As one IFA observed. “Well that’s clear then – just because your PI doesn’t cover the risky product does not mean you shouldn’t advise a client to have it? I presume that the FSA are then going to state that we no longer need to have PI cover to trade then? The rest of it clears up some of the mess however”.

The regulator said a firm’s independent status would not be affected if it referred clients for pension transfer or long-term care products.

It said: “Such firms can also make internal or external referrals for advice on non-retail investment products. If a firm does not provide any personal recommendations on retail investment products to a client, and refers them to another firm instead (including to a firm providing restricted advice), this will not affect its independent status.”

So, an “independent” firm can refer clients to a “restricted” firm for advice in an area it does not wish to or is unable to advise upon and still keep independent status.

So a solicitor refers a client to an independent firm that then refers on to a restricted firm? This is madness and will lead to ever worsening confusion at best.

On European regulations, it said: “MiFID II is currently being negotiated in the European Council and parliament and it is not yet clear whether the revised directive will include a definition of independent advice”.

How can a document carrying the title “Finalised Guidance” contain such a wording as “is not yet clear”?

I think there should be an industry prize to the first person who is able to decode this into an easy to understand, plain English document for the very many small IFA firms who do not have the time or resource to do so?

Post RDR advice costs. “What’s it all about Alfie”?

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I read a comment earlier in the week in relation to this headline “Aifa and Deloitte disagree on independent advice cost. Independent advice is likely to cost more than restricted recommendations, Deloitte warns, while Aifa says charging will be unaffected”.

It said I would have thought that it makes no difference what sort of advice is provided because it will all cost the same in time and of course the cost of regulation just keeps increasing while the failures increase in size. What’s it all about Alfie?? 
Strangulation by regulation because supervision has failed?

And I guess the question must be what the unintended impact of regulation has done and it will do to the cost of advice and the relationship impact upon the Consumer?

Deloitte’s say that IFA firm compliance costs will no doubt increase due to the need to ensure that advice meets the now less than “clear English” FSA definition of independent status.

These are of course all part of the costs that are borne by firms in doing business, but let there be no doubt, these will be paid for by the consumer.

Or more accurately, it is expected the consumer will pay, but will they want to?

Do they see value? Well that is the challenge for firms, finding a way to demonstrate value in their proposition.

Do they see the purpose and benefits of independent advice or will consumers care??

Will restricted advice offer lower costs to consumers?

AIFA see that firms charging will not be affected by the model a firm adopts, I am not sure I see this is possible.

It is understood that certain platforms may offer different remuneration packages depending on the status of the adviser they are dealing with. Does this mean a restricted firm will have more or less attractive options than the independent firm?

What of P.I. costs in all this expense?

These are rising and will rise more. Why? Well a contraction in the market does not help and although P.I. is mandatory for firms it is a fact that P.I insurers are hit hard too due to the oft-denied application of retro regulation on IFAs.

Having read the FSA RDR guidance on Independent and Restricted advice one wonders what the point of P.I is any more.

Section 2.15 of the guidance states:

“If a firm cannot or will not advise on a particular type of retail investment product, and that product could potentially meet the investment needs and objectives of its new and existing clients, then its advice will not meet the standard for independent advice.

In other words, the justification for a firm excluding types of retail investment products from its range needs to be centered on the client. As an example, the fact that a firm’s professional indemnity insurance policy specifically excludes certain products would not be a valid reason for never advising on such products”.

P.I is really redundant TODAY as a suitable insurance cover for many adviser firms because the excesses are so high and often matched with many restrictions. It is now a one shot stop gap disaster cover for smaller firms. Link this to the possibility of multiple claims and a firm will be see no alternative but to shut up shop as it simply cannot afford the claims, an attractive option for limited liability firms.

And where do the claims go- the FSCS of course.

Maybe time for a re-think, P.I. could be abolished and the premiums go to create an industry self-insured pool within the FSCS along with a Consumer levy?

The Consumer always pays in the end but at least this thought would demonstrate greater consumer transparency and move it away from the cost of advice and place it firmly into the cost of protection where it really should be.

As the song goes What’s it all about, Alfie?
Is it just for the moment we live?

Valuing bespoke over personally tailored. Counting the cost of Independence

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If you pop into Gieves & Hawkes at 1 Saville Row and head for the made-to-measure department, you will have two choices, bespoke, made from outset specifically for you, or the so-called ‘personally tailored’ suit. Unlike bespoke, £3,000 plus, the personally tailored suit is produced to order from an adjusted block pattern and costs from about £1,000. There is also the ‘off-the-peg’ option at around £500.

The difference in cost shows that it is labour that defines cost not material. In a fee-based world, the cost of labour is going to count like never before.  Clients want to see their money invested, not squandered on costs.  Yet the FSA is becoming increasingly prescriptive, valuing bespoke over personally tailored.

This approach is both misguided and expensive. Some say “You can’t do too much for your client.’ Sorry, when you are charging them, you certainly can.

Others don’t share the FSA’s view. Carol Sargeant’s Treasury team working on simplified products has adopted a ‘better off with than without’ mantra.  Whilst the Financial Services Consumer Council have a totally different view on advice to the FSA. If they had their way, simplified advice would be a reality and so it should be.

Some 60% of advisers now believe that asset allocation and fund selection should be outsourced to experts; in the case of network and national bosses, that figure grows to 100% (King’s New Clothes, CWC Research, 2012).  This might be in the form of model portfolios, multi-manager or discretionary management.  Model portfolios were dealt with on GC 12-06, a helpful paper that made sense bar the section 4.9 which was, apparently misinterpreted and will be clarified.

The latest paper published this month, Retail Distribution Review: Independent and restricted advice”, is intended to help with the advisers’ crucial decision on this issue. UCIS, at least, are now out of the game – some common sense there.

That apart, little has really changed in terms of regulatory risk or operational cost. They have defaulted to “rarely if ever’ on the use of a single platform. If I have read this right, a single platform plus ‘off-platform, is never likely to be enough. Oh dear. This takes no account of operational costs that will have to be passed on to the customer.

I should add before going further that financial planning should be utterly bespoke. It should be perfectly cut to fit the client. However, when it comes to investment, the only issues for the vast majority are attitude to risk/capacity for risk and term of investment.

The exceptions are rare. Please note that I am referring to retail investment products – not the contents. Thus a socially responsible investor will have different stock in the fund/product/wrapper. The regulator has always quoted the ethical investor as an example of where the range can be restricted. This is not the case. The independent adviser will still be required to research all products, including those from abroad, on a comprehensive and fair basis. There is then a secondary stage where the products have to be screened for content i.e. the actual securities held – quite a challenge. A restricted ethical adviser could focus on purely ethical funds. The issue is whether or not the comprehensive analysis at individual client level justifies the cost. My answer is ‘no’.

Typically default propositions are managed funds of one form or another, and rightly so. The designers of NEST understand the impact of cost. No provider of group retirement benefits, being compelled to offer good value, would consider a bespoke approach – yet for many, their pension is their biggest asset.

Model portfolios are personally tailored rather than off the peg. Sadly the regulator is looking for more. The latest paper says:

If a firm is constructing its own model portfolios, which include one or more retail investment products, for use in providing independent advice, it should ensure that it bases its selection of retail investment products on a comprehensive and fair analysis of relevant product markets.

There is little wrong with this piece, except that the expression ‘comprehensive and fair analysis of relevant product markets’ is beyond the scope of most adviser firms (this is based on our own research). It is setting the hurdle very high – and the cost. It gets tougher:

If any aspect of the model portfolio is not suitable or consistent with the client’s investment needs and objectives, then either: 1) the model portfolio should not be recommended; or 2) the model portfolio should be tailored so that it is suitable (which would make it a ‘bespoke portfolio’).

This piece is much trickier and shows the regulator’s penchant for ‘bespoke’. I just cannot understand the view that some aspects of models may be unsuitable. We are not that complex on the investment piece – it is only about risk and timeframes.

Once you introduce bespoke advice, it is not just the initial cost that is higher, but the ongoing cost. Reports, analysis, reviews and rebalancing are now individual pieces of work as opposed to automated processes that the platform does for nothing. This will add hours of expert work, equal to thousands of pounds. For what?

The next issue that I tussle with is discretionary investment management (DIM).  The use of DIM is a perfectly legitimate way of outsourcing investment advice. In most cases, it means that professionals are running the money rather than keen amateurs. Yet, the regulator has singled out DIM for special treatment. Can someone please explain to me why, other than legal structure, a fund of funds is any different to a DFM? Or indeed, a balanced fund, a manager of manager fund or indeed any fund where the manager can buy and sell whatever he or she likes as long as it is within the mandate.

A ‘recommendation’ in this context is used to mean a situation where an adviser has considered a client’s personal circumstances and decided that a discretionary investment service is the right solution for them.

I do not understand what personal circumstances would dictate a fund of funds over a DFM, or managed etc, etc. I do accept that an adviser with a client proposition focusing on those with investable assets >£250,000 is right more likely to consider a DIM solution than one whose clients have smaller sums. Indeed, a firm may have two propositions for two client segments, a DIM solution for one and manager of manager for the other. They might run on different platforms!

The important issue is that they are not bespoke with associated costs. The concern is that the regulator is becoming too prescriptive in an area where prescription is dangerous.

The Eurozone crisis demonstrates that people of the highest intelligence express totally divers views on the problem. If at such a basic level of economics there is no consensus, how is it possible to be prescriptive about investment outcomes?

There are those who favour long-term strategic asset allocation and passive funds. Others favour tactical asset allocation and active funds. Both can be wrong; both can be right. The buyer must be made aware, as much as is feasible, of methodology and cost. After that a degree of caveat emptor must apply.

Advisers considering whether to opt for restricted or IFA should study the facts but weigh expert opinions carefully. Some have businesses that depend on large numbers of IFAs surviving; others will make their fortunes from restricted propositions. I am in neither camp, but if I were an IFA today, I would opt for a whole market restricted proposition and my clients would benefit from a total lack of provider bias together with an operational set-up that drives costs to a minimum whilst delivering outstanding service.

Clive Waller, Managing Director, CWC Research

This article first appeared in FT Business 20 June 2012