Who's afraid of the RDR?

The UK continues to reshape market regulation in the aftermath of the global financial crisis against a backdrop of wider European reform. Following the government commissioned Vickers Report, an overarching banking sector review is expected, with efforts to ringfence basic operations including deposit facilities and business lending from investment banking functions with a perceived higher risk.

But while Vickers has dominated UK financial headlines in recent months, other areas are also set for major change, including domestic retail investment and fund distribution. The Retail Distribution Review (RDR) was launched by UK industry regulator, the Financial Services Authority (FSA) in 2006 – two years before the financial crisis struck – largely in response to perceived problems with the distribution of investment products to retail investors. With its full implementation deadline of December 31, 2012 now fast-approaching, the RDR is rapidly becoming a key priority. 

Independent financial advisers (IFAs) and platforms play a key role in the distribution of funds within the UK retail investment industry and have historically relied heavily on commission from fund sales. After various misselling scandals and doubts over the impartiality, standards and efficiency of advisers, the RDR measures are targeted chiefly at this area. Key proposals of the review include measures to improve clarity for consumers on advice services, address the potential for remuneration bias and increase the professional standards of advisers.

Spotlight on commission

Under the new regime, a commission-based system will be replaced with adviser charging, a system which allows advisers to set their own charges and no longer permits them to receive commission set by product providers. The transition to the new system is expected to be costly for many companies. In a major research paper on the RDR*, global consulting firm Ernst & Young predicted a significant fall in the number of IFAs after the introduction of the Review requirements, thanks to consolidation borne from cost pressures in complying with the new rules.

Advocates of the Review believe it will deliver more clarity on products and services to investors, increase transparency and consumer confidence, whilst raising standards of professionalism within the UK funds sector.

However, not everyone is convinced of the benefits of the RDR. A number of concerns have been raised by industry stakeholders, including IFAs, investment managers and insurers. Some fear product providers will opt for “vertically integrated” models rather than a variety of distribution platforms and that this could prompt the death of “open architecture” where clients can access a wide range of rival financial products through their own selected promoter and proprietary funds can be distributed via a wide range of alternative promoters. Others fear the new measures could increase the cost of funds to end investors and blur the picture on financial advice.

The new remuneration scheme is applicable to open-ended investment companies (OEICs) as well as offshore funds distributing in the UK and only applies to new assets invested post-RDR. At this stage in the review’s development some questions do remain over whether non-adviser (execution only) services should still give rise to commission.

While the RDR is predominately aimed at financial advisers, and is expected to have the biggest impact upon this group, the review is also likely to have a significant impact on end investors, back office systems and their service providers and financial promoters and platforms.

New complexity for offshore funds

From a technical perspective, the new regime gives asset managers the option to create new share classes for distribution in the UK to address the replacement of the commission-based system with adviser charging. This will require that new assets be invested in a new account post RDR under a new share class with reduced expenses as opposed to those existing ones still paying commission and therefore charging higher expenses.

This change presents a new degree of complexity for transfer agents (TAs). With this approach, TAs will have to be able to manage trailer fee calculations on both accounts (pre and post-RDR) with different rates. TAs will also have to know on which account to redeem (either accounts in the share class with reduced expenses or the share class with current expenses), based on order information from the investor/IFA order.

Under the current system it is common for investors simply to name their fund instead of their account number which, post-RDR regulations, could make it hard to identify which accounts/share classes investors wish to redeem. In the future, the process of clarification of orders will take longer and therefore need to improve. If basic/non-advised trades are still subject to commission TAs will also have to remain in close contact with relevant IFAs to determine on which accounts they must book trades.

After the introduction of the RDR, asset managers may also decide that they do not want to create new share classes. If this option is favoured, new assets will be recorded on the same account/share class for investment post and pre RDR and TAs will have to:

*Calculate commission (trailer fees) based on share lot (pre and post RDR) with potentially different conditions

*Redeem shares on certain share lots based on investor/IFA instructions

*Place trades on specific share lots if basic/non advised trades are still subject to commission. In these cases IFAs will need to provide information on the order

For now, the RDR remains an interesting UK test case for the reforms it promotes. Yet some fund promoters believe that similar measures may be applied to the funds and financial advice communities of Continental Europe under forthcoming Markets in Financial Instruments Directive (MiFID II) measures due for implementation in 2014. How such measures would align with the RDR remains open to debate.

Whatever influence the RDR exerts on wider European legislation, there is no doubt it will have a significant impact on investors, financial advisers, asset managers, platforms and their service providers. At RBC Dexia we are watching developments in this space closely. The companies that take action now are most likely to yield the most benefit and suffer the least disruption from the regulatory and implementation process ahead.

Olivier Portenseigne
Director, Product Management Shareholder Services and Distribution Support

Minesh Joshi
Director, Relationship Management, Sales & Distribution

*RaDar Life and Pensions Outlook for 2011: Ernst & Young

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