The Production Intervention and Product Governance (PROD) regulations brought in under Mifid II have now been in place for two years. The Financial Conduct Authority has said it is concerned about how some aspects of the regulations are being implemented and in January it raised the issue in a letter to financial advisers, saying advisers need to “ensure the advice you provide is suitable, costs and charges are disclosed clearly, and you act in the best interests of your clients. Conflicts of interest must be identified and where they cannot be prevented, disclosed and managed."
A review of the implementation of PROD in the distribution of investment services was expected in the first half of 2020. The outbreak of the coronavirus has caused the FCA to make some changes to the timing of its programme of regulatory reviews. For example, the Assessing Suitability Review 2 has been pushed back to 2021, and the FCA’s planned evaluation of both the Retail Distribution Review and the Financial Advice Market Review have been pushed back to the second half of 2020 at the earliest.
But just because the timetable has slipped does not mean that issues are being overlooked by the regulator. So far this year, the FCA has raised concerns about the quality of equity release advice, permanently banned the sale of retail mini-bonds and announced a ban on contingent charging for defined benefit pension transfers. This month it started a review of how fund managers are meeting their requirements under the PROD rules.
In short, the FCA has flagged up its intention to review how advisers are meeting the requirements of the PROD rules and whether it is this year or next, it will get around to putting adviser practises under the regulatory microscope."
In terms of advising on investments, this means advisers’ processes will be scrutinised in several different areas. Taken together, the PROD rules and communications from the FCA identify several areas that will be under review; segmentation of clients, suitability of investments and services, and value for money.
To recap, here is what the PROD regulations say about the distribution of investment services.
A distributor must:
- understand the financial instruments it distributes to clients;
- assess the compatibility of the financial instruments with the needs of the clients to whom it distributes investment services, taking into account the manufacturer’s identified target market of end clients; and
- ensure that financial instruments are distributed only when this is in the best interests of the client.
FE Fundinfo’s recent Adviser Report into adviser business practices (Surfing the wave) shows advisers use a number of different ways to segment their client base. This can include client sophistication, life stage and attitude to risk. But our research also found 32% of the advisers do not segment their clients at all. Separately, research from consultancy The Lang Cat shows that by the end of 2019, just under 20% of financial advice firms do not operate a centralised investment proposition.
Added to this, the FCA’s guidance for ensuring the suitability of each investment product used is that the target market needs to be “identified at a sufficiently granular level”. Understanding the background and aspirations of clients is a central feature of the PROD rules and it raises an important question for advisers using single multi-asset funds, rather than outsourcing their investment service. Can single multi-asset funds continue to offer a suitable investment solution for a range of clients with the same attitude to risk but different investment timeframes, or to clients with similar capacity for loss, attitude to risk and who are investing over the same time horizon but who are at different stages of their lives?
It is possible to meet the regulator’s requirements by giving bespoke advice to each client, but the costs involved often means this remains an option only for high net worth clients. For other clients, not using a CIP leaves many advisers potentially at risk of falling foul of the regulator. It also risks placing clients into investments that may not be appropriate or value for money.
This is potentially where the real risk lies for many advisers. The debate over whether bespoke discretionary fund management is worth the cost is not a new one. But even where higher-net-worth clients are considered a more natural fit for a bespoke service, they may not be appropriate on a value for money basis. Value for money will, of course, vary considerably depending on the client and their aims. However, paying the full cost of a bespoke DFM if the client could be adequately served by a cheaper alternative is unlikely to meet the FCA definition of PROD compliance.
As the FCA says, advisers need to consider “the nature of the financial instruments to be offered or recommended and how they fit with end clients’ needs and risk appetite” and “the impact of charges on end clients”, as well as the financial strength of the product manufacturer, their processes and service standards. This applies to existing clients as well as to clients who have gone through the advice process in the last two years.
Advisers are also becoming increasingly conscious of costs. The latest State of the Adviser Nation from The Lang Cat shows that 90% of advisers have taken steps to reduce the overall costs to clients, with 36% of advisers taking steps to reduce the cost of investment management.
How FE Investments can help
The FE Investments Mosaic managed portfolio range was launched in response to these competing demands from advisers. By offering five risk profiles over a choice of three different time horizons, the range provides sufficient choice to meet the needs of a wide variety of client profiles, while detailed reporting and a well-diversified range of portfolio holdings means the assets of wealthier investors are not concentrated in a small number of funds. Blending active and passively run funds keeps costs well below those of bespoke discretionary management.
Further developments in platform functionality are also helping to bridge the gap between discretionary managed portfolios and full bespoke discretionary fund management. The introduction of the Individually Managed Accounts (IMAs) service on the Standard Life Wrap brings the option of automating CGT harvesting and automatic use of annual ISA allowances to managed portfolio services. It also gives advisers the option to exclude specific funds from the portfolios to meet individual client objections or preferences, all without the cost of full bespoke management.
The business of financial advice will continue to evolve and providing a better and more flexible investment service at a lower cost will ensure advisers continue to meet the demands of clients and the regulator.
Click on the link to learn more about the Mosaic Portfolios and the Individually Managed Accounts.
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1 - FCA letter to financial advisers 21 January 2020. https://www.fca.org.uk/publication/correspondence/portfolio-strategy-letter-for-financial-advisers.pdf
2 - FCA Handbook, chapter 3 – PROD Product Intervention and Product Governance Sourcebook.
3 - FE fundinfo 5th annual financial adviser survey “Surfing the wave”. May 2020
4 - Better. Faster. Stronger. How do we rebuild a better centralised investment proposition from here? July 2020
5 - State of the Adviser Nation. The Lang Cat. February 2020