Changes to the Retail Investment Market – Confusion ahead?

With the publication in March this year of three new papers (consultation paper, discussion paper and policy statement), the FSA’s Retail Distribution Review (RDR) is moving full steam ahead and appears to be on course to be fully implemented by the end of 2012.

The RDR is one of the core strands of the FSA’s retail market strategy. It was launched in June 2006 to address perceived “persistent problems” in the retail market, such as insufficient consumer trust and confidence. It is intended to address the root causes of these problems, thereby increasing the numbers of retail customers who feel confident enough to purchase retail investment products.

The RDR applies to the distribution (in particular the advised distribution) of “retail investment products”. These include life policies, units in a collective investment scheme, pension schemes, investment trust savings schemes, securities in an investment trust and some other types of investments which offer exposure to underlying financial assets. The definition has been purposefully drafted widely so as to capture the full range of products being recommended to retail clients. It has also been modified to bring the RDR more closely into line with the European Commission’s work on PRIPS (see below).

The stated aims of the RDR are threefold. Firstly, disclosure – the RDR aims to improve the clarity with which firms describe their services to consumers. Secondly, remuneration - the RDR aims to address the potential for adviser remuneration to distort consumer outcomes. Finally, professionalism - the RDR aims to increase the professional standards of investment advisers.

The RDR is an FSA initiative and does not stem from any European-level imperative. The intended reforms will mean that the standards applied to participants in the UK retail investment market will be higher than the standards that apply to the markets of many other EU member states.

This raises several important issues, some of which can be considered now thanks to the recent publication of the final rules in relation to remuneration and disclosure, and some of which will need to be considered further once the final rules in relation to professionalism have also been provided.

The changes to the FSA’s rules which are to be introduced as a result of the RDR, will inevitably mean that in the UK market the requirements of several of the European Single Market Directives will be exceeded. Although some of the single market directives (such as the Insurance Mediation Directive) allow Member States to ‘gold-plate’ their requirements, the Market in Financial Instruments Directive (MiFID) is a ‘maximum harmonisation directive’. This means that FSA does not generally have the discretion to impose requirements additional to those specified in the directive itself. However, in certain exceptional cases the Commission allows member states to create or retain national requirements that go beyond MiFID, provided these requirements are notified and justified to the Commission.

In 2007, when MiFID was first implemented in the UK, the FSA made such a notification to the Commission. As a result of the RDR, the FSA has drafted an amendment to the 2007 notification, to be submitted for the Commission’s review. In addition, the FSA has been at pains to point out that it has been ‘working closely’ with the European Commission over the course of the development of the RDR proposals, and indeed the RDR proposals themselves had been changed as a result of Commission input. For example, in the earlier stages of the RDR consultation process (in its RDR ‘Interim Report’), the FSA had proposed a clear distinction between sales and advice, to the effect that only independent advisers would be able to give advice. Firms offering tied or multi-tied services would therefore have to either adapt their business models or stop offering advisory services altogether. The FSA discussed these proposals with the Commission, who formed the opinion that these proposals may be inconsistent with MiFID. On this basis, the FSA modified its stance, so that instead the RDR rules now call for a clear distinction between independent advice and non-independent advice, with clarity for consumers on the nature and distinction of the different services offered. However, the relationship between the RDR and applicable European requirements may be subject to change once the position re PRIPS is known (see below).

In April 2009, the European Commission published a Communication on ‘Packaged Retail Investment Products’ (PRIPs) in which it outlined a need at European level for better protection measures for retail investors who buy packaged investment products. Although existing directives (such as MiFID, the IMD and the UCITS Directive) regulate product sales and disclosure practices, there are inconsistent rules in relation to disclosure, selling and investor protection, which the Commission considers may lead to a risk of regulatory arbitrage and investor detriment. Therefore, the Commission has committed to standardising investor protection standards, which it considers will require legislative change.

In December 2009, the Commission Services published an update which provided further guidance as to the products which should be classified as a ‘PRIP’ (i.e. those which have an element of packaging; are capable of meeting an investor need for capital accumulation; and create exposure to investment risk). Direct investments in “plain” assets (such as ‘pure’ shares, bonds, commodities, property) are excluded. It also set out further information as to the application of the disclosure framework and provided further information in relation to the potential rules on selling practices.

The FSA’s RDR work and the Commission’s PRIPs work cover much of the same ground and have the same aim (increased investor protection). However, whilst the FSA is seemingly on track to meet the December 2012 deadline for RDR implementation, the Commission is still in the initial consultation stage re PRIPS, and there is currently no timetable for completion.

The FSA has been engaged in discussions with the Commission in relation to the RDR and the PRIPS work, and it has stated several times that it considers the RDR and the Commission’s PRIPs work to be compatible. However, given the Commission has not yet finalised its PRIPS proposals and is still in the consultation stage, the full impact of the PRIPS work on the RDR cannot be properly ascertained at this point. The FSA has acknowledged that amendments to the RDR rules may be required once the PRIPS work has been finalised. Therefore, there is the potential that the UK retail investment industry will have to devote the resources and incur the costs required to adapt in advance of the 2012 RDR deadline, but
may then have to devote further resources to adapt further once the PRIPS requirements are known, potentially leading to regulatory fatigue, additional costs and consumer confusion.

Much of the final rules in relation to disclosure and remuneration are to be made by way of additions and amendments to the Conduct of Business Sourcebook (COBS) in the FSA Handbook. These RDR rules in COBS will not apply where the retail customer is not in the UK, nor will they generally apply to the activities of UK firms in other member states. This is intended to prevent UK firms being at a competitive disadvantage outside the UK. It however remains to be seen whether the fact that firms from other member states can provide investment advice to UK customers on a cross-border basis without being subject to the new RDR rules will put UK firms at a disadvantage.