Ian Middleton, MD of Masthead.
The first phase of the Retail Distribution Review (RDR) will be implemented later this year, bringing South Africa a step closer to making direct payment for financial advice a greater reality. The implications of this change will be significant not only for consumers, but also financial advisors, and both need to prepare for the new advice scenario of RDR, says Masthead.
Billed as the biggest change in regulation in the advice world since the introduction of FAIS, RDR will, among other things, put an end to commission earned by financial advisors on lump sum investments. RDR forms part of the Financial Services Board’s (FSB) framework that seeks to ensure fair outcomes to customers and tries to minimise potential conflicts between the interests of customers, product providers and advisors.
“It is important that consumers are made aware that advisors will be charging fees in lieu of commission falling away,” said Ian Middleton, MD of Masthead. “This will require a mindset change, considering that most consumers don’t generally think of commission as payment for advice. There is a perception that advice is given for free. Consumers need to realise that fees are just a different way of paying for what the advisor does for them.”
In an RDR environment, consumers are likely to face various ways of charging by advisors. They could be billed an hourly rate for the cost of advice, just as they are billed when they consult a medical professional. Or they could be charged per use, which is effectively a transactional cost for services. Alternatively, in relation to investments, they could be billed a fee that is linked as a percentage to the size of the investment.
“Whichever method of charging is applied, the customer will be responsible to pay. But, they won’t necessarily have to dig into their pockets to fund the fee,” said Middleton. “The RDR proposals cater for a system whereby product providers can collect and pay fees to advisors on behalf of customers in much the same way that commission is currently paid from the product provider to the advisor on the sale of an investment product.”
Besides consumers, financial advisors also need to prepare for an RDR environment. “The single biggest challenge they face is how to articulate their value proposition to customers and then link this to the right level of fee to charge,” said Middleton. “If customers recognise the value advisors offer, and see them adding value on an ongoing basis, they will accept that they need to pay a fee and feel comfortable paying it, as they would for other services.” If they don’t experience value, they will not want to pay.”
According to Masthead research among independent financial advisors to determine their RDR readiness, less than one in three advisors currently charges fees. Where they do, it’s more likely to be in relation to advice on lump sum investments and short-term insurance.
“Of those who don’t have a fee structure, a mere 8% say they would be very comfortable to implement a fee charging model,” said Middleton. “Some 44% say they have some work to do before they can do so, while 42% say they are ‘concerned’. This latter group raises a concern in that if these advisors choose not to implement fees and fall out of the market, the advice pool will notably shrink. This will impact consumers.”
He added that another challenge for advisors is knowing where to pitch their fees. Advisors who have a sliding scale for fees on investments typically charge upfront fees of up to 1,5% and ongoing fees of up to 1% of the value of the assets. He said more than half of the advisors feel that fees, whether hourly rates or otherwise, should not be regulated by the FSB, mostly because their practices are too different. Others said the complexity of their customers’ needs should determine fees. Some 16% believe that although the FSB should not regulate fees, it should provide guideline charges.
Middleton said further feedback from advisors revealed that 53% of advisors think consumers would pay for advice on risk products, as value is added through the advice given. “Advisors say that customers pay for time, trust and a relationship with their advisor. Those who believe customers would not pay for advice say their clients cannot afford fees and may resort to buying online or using direct marketers because they think they will get a cheaper premium.
He also noted an RDR fee-based world with less upfront commission will pose a short-term cash crunch for advisory practices as they switch from commission to fee-based billing. For this reason, the sooner advisors gear their business to switch to fee based billing, the better. Currently 57% of advisors earn more than half their income from new business. For 55% of advisors, more than half their new business income is based on upfront commission.
“South Africa is a highly under-insured, under-saved nation. It is imperative to have the right environment that ensures ease of access to financial advice at an affordable price. It is also important that a balance is achieved to ensure financial advisory practices remain viable businesses and the industry does not appear unattractive to new and younger entrants. In a market of ageing advisors, where the majority are over age 40, it is vital to attract younger candidates to participate in a succession plan.
“If we get the balance right, a win-win situation can be achieved for consumers and advisors, as well as the broader community,” he said.
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