With the proposed Retail Distribution Review (RDR) fast on its way, the local financial services industry is working proactively to transform its commission structures to eliminate conflicts of interest, and increase transparency to the benefit of clients. Carl Roothman, Chief Executive of Sanlam Investments Retail, shares his views on RDR and how the investment industry needs to change to make sure it always acts in the interest of investors, while continuing to attract motivated and professional advisers.
Q: With the gradual professionalization of the financial planning industry, and the move towards treating customers fairly, RDR for South Africa comes as no surprise. Which aspects of the current local planner remuneration system are causing the biggest conflicts of interest?
A: Currently, policy lapses and reinvestment is often in the adviser’s, and not the client’s, interest. Advisers are incentivised to advise clients to switch from one product to another, while more often than not, it would be better for the client to remain invested in the same product. RDR should remove the incentive to switch out of funds. Section 14 transfers can also give rise to conflicts of interest.
Even though the ongoing financial adviser fees after such a transfer are strictly regulated by the Pension Funds Act, the advice around the choice of a new product provider is not necessarily sound. A third source of conflict of interest is the proliferation of broker funds.
Some, not all, of these funds add not only additional layers of fees, but also add complexity in an industry where the number of unit trust funds already exceed the number of shares on the local stock exchange. Part of a well regulated distribution function is a simplified product offering, which means an urgent need for fewer, but transparent and appropriate products.
Q: Which set of principles do you follow in your thoughts on how to best reform remuneration in the industry?
A: Firstly, always act in the best interests of the client. Secondly, sound advice should be affordable.
Q: Who would be the best person to determine the quantum of remuneration for investment advice: the regulator, the product provider, or the client?
A: Advice fees should always be agreed between the client and the adviser, and facilitated by the product provider. All fees need to be transparent with a clear break down of what fee is payable for what service, such as administration, asset management or advice. The fee structure should be simple and usable on a one-to-many basis across clients.
Q: According to Rick Elling, Head of Investment Solutions at Sanlam UK, more than 20% of the UK Financial Advisers have left their profession since the implementation of the UK RDR. If South Africa follows suit, prohibitive RDR legislation could mean that thousands of South Africans no longer have access to much needed financial advice. In your opinion, what is needed to sustain the financial planning profession?
A: Yes, that figure sounds right. When I was still a private banker at a UK owned bank, we saw fall-outs in UK banks after guaranteed products with a hidden 3% upfront commission structure were replaced.
More recently, at one specific UK investment platform that we were looking at, there were more than 200 000 so-called orphan clients, predominantly clients that were not able to or not willing to pay the advice fees after RDR was implemented. While it is important that the industry attracts more financial planning professionals that are sufficiently compensated for their expertise, we would not want to see the rise of a client segment without access to affordable upfront and ongoing advice. We believe that advice adds value. Entry level investors would therefore need access to simplified advice.
Currently, an advice culture exists where clients are led to believe that they can constantly chase the highest possible return for their particular risk profile, leading to high-volume fund switching.
We need to change to simplified advice that entails:
a) choosing a targeted return investment that is right for you;
b) a cost-effective solution;
c) ongoing advice that monitors when your needs change and only then facilitate a switch, and not facilitate switching to chase last year’s top fund managers.
Q: From a client’s perspective, which remuneration structure, in your opinion, is fair for each of the three main services offered by a financial planner: a) the drawing up of a financial plan; b) the implementation of the recommendations in the financial plan; c) on-going advice on an annual basis?
A: The design of a financial plan is a professional service and the planner should either charge per hour or a fixed amount per plan. For implementation, the client needs to negotiate either only an initial financial adviser fee or a combination of an initial and ongoing adviser fee to increase the net investable amount after initial fees are deducted. For ongoing advice, the ongoing adviser fee model makes sense. The important thing is that the fee agreement clearly differentiates between these services.
Q: If you were the regulator, would you differentiate between remuneration legislation for tied agents and independent advisers, and how?
A: No, all advisers should be treated the same by legislation, with the exception that independent advisers need to prove that they have compared solutions across product providers before recommending a product to a client. I would not abolish sales targets for tied agents, as competition leads to innovation and more efficiency.
The overriding principle for a product house managing tied agents remains: are we acting in the best interests of the client?
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