Profiling the consequences of the UK RDR pitfalls

The benefit of South Africa’s late adoption of global regulation is that the local insurance industry can learn from the examples/lessons experienced in international markets.

In an effort to focus on the effects that RDR had on the investment industry in the UK; Hamilton van Breda, Head of Retail Sales at Prudential, addressed the On the Regulatory Front seminar in Johannesburg in an effort to see if these impacts could also affect the South African market.

The departure point

The departure point of RDR in South Africa is the same as the departure point in the UK. So the perception that the South African financial services industry is the only industry in the world that is teeming with unscrupulous characters/companies needs to be put to bed.

Van Breda points out that the purpose of RDR in the UK was that retail investors were subject to complex charging, they were unclear on what they were paying for advice and how their fees were structured, there was some mis-selling in the industry, and the industry had low training requirements.

But what did the RDR aim to achieve? Some of the important objectives included better professional advice standards through new examination requirements, improved consumer understanding of different types of advice and improved transparency by moving away from commission to adviser charging a fee.

The impact

It is important to note that RDR only applied to the investment sector in the UK and not to the life sector. RDR in South Africa will apply to all industry sectors.

“In the UK, advisers will need to set their own charges in agreement with the clients. However, product providers could offer facilities for the adviser charge to be deducted from the investment. Because of this deduction, firms were required to provide clear, concise disclosure documents. There was also a ban on taking commission from a discretionary manager when the manager was recommended,” said Van Breda.

This applied to all products sold before 1 January 2013, but what about legacy products? How did the rules apply in these instances? Van Breda pointed out that advisers would be able to continue receiving on-going trail commission on legacy business until 6 April 2016. Where personal recommendations were made on top-ups and increases, new adviser charges would apply. Cash rebates by product providers to platforms were banned from April 2014, and that included legacy business.

The result

The fallout from these impacts was staggering. Adviser numbers dropped by 25% over a two year period. In 2011 there were 40 000 advisers in the market which dropped to 31 000 in 2013.

“A major unintended consequence of this was that there was large scale neglect of advice to the mass market. What were the prevalent economic requirements in the industry? In order to run an effective practice, a company had to have a market capitalisation of £220 000 a year, which means that they collected an average premium of £1 500 a year from 150 clients. In addition, clients needed to have an average net worth of £150 000. It is worthwhile to point out that there are only 850 000 clients that fit this profile in the UK,” said Van Breda.

Changes to the servicing model

There has been some debate as to what would constitute a high net worth client in South Africa. A number that has often been suggested is that this group would be made up of those earning over R1 million a year. If this is the case, and advisers do abandon clients to focus on this target market, we could see a similar neglect of the mass market that was seen in the UK.

Van Breda pointed out that the UK market was split into the mass market, the middle market and the high net worth market. The mass market was serviced by agencies and banks which benefited from an inflow of some independent advisers which joined their market. The middle market received limited  servicing while high net worth clients received the lion’s share of advice from wealth manager who also benefited from some independent advisers which joined their market.

“If we have to translate this into the future of distribution in South Africa, the FSB want to split the market into tied, multi-tied and independent advisers. Agencies and banks will consist of tied advisers which will grow in numbers as some independents proliferate into that market. Multi-tied advisers will make up the bulk of the corporate market which will also grow in numbers because of independent advisers moving into this market. The result is that the truly independent advice sector will shrink dramatically,” concludes Van Breda.

Focus on profitability

This does not mean that it is all doom and gloom for the South African market. While RDR will have an impact, there is no reason that advisers cannot still be profitable.

There needs to be a focus on business profitability. Advisers need to segment their client base which will determine the level of service that clients will be offered which will influence profitability of each client.

Advisers also need to think about the client’s willingness or ability to pay fees as well as their knowledge or sophistication of products. This will determine how much work an adviser needs to put in with each client.

Editor’s Thoughts:
We won’t know the real effects of RDR until it is implemented in the market. Early adaptation of the lessons explained above may be beneficial as advisers will then be able to weather the RDR storm. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

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