I ‘wanna’ tell you a story, as Max Bygraves used to say, of how the world of easy mass-market access to advice, now in intensive care, will see the life support machine finally turned off.
The potential for complete catastrophe cannot and should not be underestimated if our on-site snapshot poll of some 1,100 advisers is to be a guide.
I am very aware that from the FCA’s perspective, and that of the TSC, the regulatory focus is always, rightly, going to be on consumer detriment. But, if FOS figures are a guide, adviser-caused consumer detriment is very low indeed and something that the regulators are well aware of.
However, with the focus seemingly being solely on the consumer, some foreseen warnings, while they are clearly being flagged, will continue to be ignored and as a result matters will only get worse.
The adviser community and their clients are seeing a system that has worked quite well indeed for the mass market, and for very many years, being swept away.
Trail removal will ultimately destroy many possibilities of aftercare and ongoing service to many adviser firms’ customers (low end savers as Mark Garnier MP refers to them). And by that, I also mean the resulting further reductions in adviser numbers as the quest for the perfect zero risk financial services consumer world will be met by the perfect regulatory storm.
Trail removal is part of that ‘storm seeding’ possibility and the initial removal date of April 2016 is approaching fast although some provider firms have jumped ship already.
I am not sure that politicians, regulators or even in some cases financial advisers are aware of the potential consumer detriment and commercial devastation that will, without doubt, follow if the problem is not addressed now.
Here are some points to consider regarding trail, it’s origin and importance to both advisers and their customers/ clients:
- Trail or renewal commission formed part of adviser remuneration in most pre RDR contracts. Trail is a contractually binding adviser expectation.
- It is managed and administered mostly by provider legacy computer systems that have not got an ability to ‘menu-ize’ in retrospect without huge cost and that is not seen as a viable or worthwhile spend
- Trail is small in individual monetary amounts, paid subject to contracts remaining in force to an end date, maturity or claim event
Not all advisers took ‘initial commission’ preferring to build up value and income streams from an increasing number of small but regular monthly payments, again paid subject to the contract remaining in force to an end date, maturity or claim event.
- The accumulated value of trail, regular and/or renewal commissions, accrued over many years through many individual client policies, provides a recurring and stable income stream to the firm, in addition it creates the embedded value/ worth in an adviser business.
- Trail was/ is a substantial part of adviser retirement or exit plans too as any advisory business owner would look to sell this income stream along with the goodwill of their business.
- Up to and beyond RDR, firms were buying or selling businesses based mostly on the assumption that this income source will continue for many years to come.
- The advantage to acquiring firms is that it provides an immediate revenue stream, increases their client bank, and the recurring trail income they have acquired can often be their primary means to fully fund the buyout.
- Disadvantages to sellers are that the purchase money is not paid up front, often being paid over a number of years, typically 3 and has little security for the unpaid value.
- If the acquiring firm collapses in that time (looking forward) due to the discontinuance of trail, the total seller’s consideration may not ever be seen in full.
- More disadvantages lay ahead for the buyer if that trail revenue ceases, the value the firm thought they had paid for in their acquisition is reduced or disappears.
- But they still have a contractual obligation to buy a business, over a 3-year term for example, that they can no longer afford.
Now we must consider the potential ‘knock on’ problems relating to the removal of trail commission, this I believe has not been understood as fully as it should.
Removal of the accumulated value of trail, regular and/or renewal commissions (that were the embedded revenue streams and value in an adviser business) by design, default or regulatory intent destroys the value of that firm to the extent that it no longer has any worth and so nobody will want to buy it.
What happens to their clients if the firm simply closes down?
Removal of trail commissions could mean that the acquiring firm is unable to pay the full consideration or in some cases none of the consideration.
The loser in this scenario is the seller, their resulting loss could be huge.
The outcome could be that the seller then sues for the unpaid monies due to them, but, the buying business may be so unsustainable, for lack of this trail, that it closes as it cannot meet it’s liabilities as they fall due any longer. What happens to the clients?
Acquiring firms may have paid the seller in full for the businesses they have acquired, but no longer get the monthly income trail- a big cash flow hit. This could mean it can no longer meet the regulatory fees and other costs involved in running the business and they close down.
What happens to their clients?
The consumer is a very big loser too in all this. They may prefer that trail pays for ongoing servicing and advice. Removal would mean they would then have to pay a fee that they may not wish to or be able to afford to do.
What happens to them?
The possible outcome, the perfect storm.
The loss of trail, a regular income flow, could make many adviser businesses unsustainable; in fact the effect would be catastrophic if our poll of nearly 1,100 advisers is a good indicator.
Many advisory businesses, both in the IFA and banking sector have closed in the run up to RDR leaving many orphan clients, most of those the RDR survivor firms will not/ would not service as they would not/ could not pay fees that trail commissions have often, historically subsidised.
Politicians on the TSC are focused on this problem to the extent that they may look at the adviser gap effect in mid to late 2014 but it will get a lot worse before it gets better.
Fewer adviser firms mean higher regulatory costs for those that are left.
It also means that the liabilities of those firms, such as they may be, that have closed down will pass to the FSCS for any miss selling issues.
Those firms remaining in business will ultimately pay for any claims against these firms by higher FSCS levies and their PI costs will hike, if they can actually get it.
Many of those surviving firms may find, due to increasing regulatory costs that they can no longer pay those levies and close down. What happens to their clients?
The result, more burden on the FSCS and higher costs for the firms left is the outcome And fewer firms to fund the FCA and FOS regulatory costs.
But the biggest losers of all could be network clients.
Networks are also under pressure from the outcome of the recent FCA paper on inducements.They are coming under big financial pressures as the impact of FCA inducement removal could run to millions a year from their cash flow.
To see their trail removed will mean the lack of cash seeing increased budget balancing cost falling on their members, who may not wish to pay, or cannot afford to pay, preferring instead to leave and start their own firm or move to another advisory firm- if they can, or leave the industry.
Network collapses have a detrimental ‘tsunami like’ financial effect on those firms that are left and particularly in that brave new post RDR world.
Disenfranchised ‘consumers’ (clients) are left with nobody to turn to for advice, if they do not wish to or are unable to pay fees and in fact even if they do wish to pay fees.
The tsunami is coming, but are the regulators ready to deal with it, and will the consumer understand as it washes over them that what was being done in their name by regulation is the very thing that has made the disaster happen.
This requires urgent attention and a regulatory stop placed on the removal of contractually agreed trail to provide stability in a sector already under much transitional and evolutionary financial pressure.
Or will the tsunami, when it has passed, result in no need for regulation as there is nothing left to regulate.
Max Bygraves died in 2012, if our poll is even a half accurate guide, many advisory firms will die and many consumers will be very badly served as a result in 2016 unless something is done.
Now that would be a story!