Tuesday 9th June 2009

The Destruction Of Independent Advice

THE DESTRUCTION OF INDEPENDENT ADVICE

 A message to the consumer In October 2004, mortgage advice became formally regulated by the FSA (Financial Services Authority), because the Treasury, headed by Gordon Brown as Chancellor of the Exchequer, believed that this area of financial services needed government intervention to ensure an orderly market. Pure protection (life assurance etc) and General Insurance (insuring homes, vehicles and so on) came under the same regulatory control a few months later. Pure protection had been deregulated in the 1990s in order to make it more straightforward for the public to obtain advice and cover.

Nobody likes red tape, but there seemed to be a genuine will, on the part of all players in the industry, to support regulation in order to curb excessive practises that were seen as detrimental to the consumer, such as unaffordable borrowing and the sale of unsuitable protection products. I had concerns at the time because FSA pensions regulation had led to a serious shortfall in pension provision. Regulation of investment products had become so onerous that it was beginning to have an effect on the public investing in equity-based ISAs, unit trusts and other Stock Market-linked investments.

 This meant less money being saved in these vehicles and a reduction in funds being invested into British industry by the public. I was also afraid that any regulation of protection advice might result in a protection gap, which, in turn, could lead to over-dependence on state support for individuals faced with poor health, loss of income through illness or redundancy or loss of a breadwinner due to untimely death. I have never been a fan of big government, so I was nervous about government intervention and, almost five years on from the start of mortgage and insurance regulation, I am saddened to see that the Pensions Gap, the Savings Gap and the Investment Gap have been joined by the Protection Gap and now the Lending Gap.

This has led me to the conclusion that state interference in all of these markets has resulted in reduced public access to independent advice and reduced take-up and availability of product choice in these areas. Independent advice means that an expert in the field compares the products available for protection, insurance, investments, pensions, mortgages etc to find the product best suited to the needs and aspirations stated by the consumer. There are of course, many ways to obtain these products, such as approaching one or more providers, through asking friends and family for advice or by using one of a number of comparison website (who claim to enable you to do it yourself).

The internet is a brilliant tool, enabling public access to information once the preserve of academics and librarians, and it enables direct purchase of products without the need to use a middle-man or a shop. I question, however, its safety as a place to buy complex financial products. I work as a mortgage and insurance broker, a middle-man if you like, who provides advice to the public and, in return, I get paid by the mortgage lender or the insurer for marketing their products, for assisting in the application process and for carrying the financial risks in terms of future complaints inherent in today’s litigation culture. The natural reaction to the above is to see me as a salesman, selling the products of the highest bidder in terms of the commission that they pay.

This has never been the case and the wide spread of products and providers that I have used (both pre-regulation and post-regulation) is testament to my integrity in this matter. The providers paying higher commissions tend to have poorer value products and have largely departed the market following the banking crisis and mortgage and protection commission is effectively standardised across the market. I am a qualified expert in my field, with over twenty-five years experience but, in the last two years, I have seen the seeds of destruction sprouting in the industry that I love. I believe that this destruction will have serious repercussions for the public as consumers of these products. Furthermore, I believe that the very regulators charged with protecting the consumer are guilty of complicity in this destruction. The Financial Services Authority are putting the final touches to a study called the Financial Services Review.

Ostensibly a consultation process, it has largely been an artifice created by ex-bankers and ex-insurers for the benefit of banks and insurance companies. The three main thrusts of this Review, soon to be codified into law, are as follows: Firstly, the removal of commissions from investment products in order to prevent “Commission bias”, the danger that an adviser will recommend one product over another because the commission is higher. This means that, in order to obtain independent advice, you will have to pay the adviser a fee rather than have the cost of advice contained within the product itself. This rather equates to having to pay a supermarket cashier for ringing up the goods rather than the supermarket having a profit margin on their goods that includes paying the cashier.

Banks and insurers will still be able to employ and pay advisers, for selling their own products, but there is a naïve assumption that the public can decide which bank or insurer to approach in the first place. Perhaps they have decided that this decision can be assisted by their advertising departments. There is a view that, rather than banning commissions, these should be standardised across the industry, meaning that a pension or investment product contains the adviser’s remuneration, but would stand or fall based on its merits. This suggestion has been discounted by the FSA and the banks. Secondly, the requirement that all Independent Financial Advisers (IFAs) must pass much higher-level qualifications on the basis that this would improve public confidence and encourage the consumer to pay hefty fees for independent advice, even though the banks and insurers will continue to pay their own staff to provide “Free” (but not independent) advice. The adviser would have to fund this self-education and exam process.

One would naturally assume that the employees of banks and insurers would also be required to pass these exams, but this is not the case as they will be labelled “Sales” staff, not advisers. Thirdly, the by then unpaid IFA will need to increase the amount of financial reserves they hold in liquid form, in the middle of a credit crunch, in order to ensure that they have sufficient funds to pay compensation in the event of future complaints. In a recent decision, the FSA decided that any adviser would be financially responsible for past advice for the whole of his or her life, rather than for the fifteen years requested by the adviser community and their representatives. Why would anyone want to remain in an industry that imposes these rules on independent advisers and expects them to negotiate their pay with every customer?

The answer is that few do and those that choose to do so may not last very long. The consumer will still be able to buy pensions and investments direct from an insurer, but they will have to pay high fees for any advice because of the high level of regulation and potential liability imposed on any remaining advisers. The really bad news for the consumer is that this type of review is just beginning in the world of mortgages and protection. The even worse news is that some mortgage lenders have already decided to exclude mortgage brokers from some of their most attractive products because they see it as a way to prevent external expert scrutiny of their mortgage deals, as well as a way of managing funds in a mortgage famine largely brought about by their own actions. Despite receiving public funds on the publicly-announced condition that they utilise these funds to energise lending in both the business and mortgage lending market, Banks have instead restricted lending on their most competitive deals to direct applicants only and will not release these deals onto the general market for use by brokers and their clients. Furthermore, the cost of mortgages for those without large deposits, typically 25% of the property value, are up to a third more than those who have been fortunate enough to buy at the right time, at a time when the Bank of England Base Rate is at its lowest level since records began in 1694.

Mortgage regulation demands that advice on mortgages cannot be provided unless a formal illustration is first provided to the consumer and these have to be very accurate. Since access to the details of direct products is controlled by the lenders, it is impossible for mortgage brokers to advise their clients on these deals and, worse still, some banks are trying to encourage brokers to promote much more expensive deals where they are granting access. There are, of course, consumers who are rich enough and financially sophisticated enough to find a decent direct deal, but the Financial Services Authority have stood aside while the mortgage market has descended into chaos.

All of this might be deemed reasonable in tough lending conditions following a global financial crisis, but there is a further problem, which should be flashing up danger signals throughout the country. Mortgages form part of a regulated industry and one of the FSA’s four statutory objectives of financial regulation is: “Consumer protection: securing the appropriate degree of protection for consumers”. This means that the FSA have to do their utmost to protect consumers; it is the law. When the FSA designed the framework for mortgage regulation, they decided that there would be two ways to obtain mortgages. The intended route was “Advised” where an adviser discussed the needs and aspirations of a potential borrower and then recommended a suitable product from the range of products available to that adviser, either a single lender, a panel of lenders or whole of market, the latter being enough choice to be representative of the mortgage deals available across the whole market.

This meant that the consumer received advice and that this advice could be questioned at a later date with the possibility of compensation if the advice proved to be flawed. The second route, designed for those who were sufficiently knowledgeable to make their own choice was named “Non-advised” and was designed to be used with a standard script of questions so that a less experienced or less-qualified person could assist with a mortgage decision and application in these circumstances. Unfortunately, this second route has now become the norm for many mortgage lenders and it has, despite regulation, evolved into what is known as an “Execution-only” transaction.

This was originally intended for the pensions and investment market, where a seasoned investor who knew exactly which product he or she required, could purchase it with no advice at all. As a mortgage broker, I have never done an execution-only mortgage as I have never met anyone who knew which specific mortgage product they required. In fact, I have found the more the consumer states what they want (e.g. “The cheapest mortgage”), the more advice they tend to need and the more reliant they are on advice and recommendation. Yet these are the very consumers that are being targetted by what I would characterise as unscrupulous lenders. By using cheap headline rates and no easy option to obtain advice, lenders are channelling the most vulnerable consumers along an “Execution-only” route, which is the most exposed route possible.

Instead of discussion and advice, they may find themselves speaking to telephone based salepeople paid by the lender to obtain as much ancillary business as possible, such as insurance and other financial services. Instead of creating a human relationship with an adviser who carries responsibility for the advice provided, they find themselves alone in the dehumanised environment of a provider website, where the only information available is that which the lender wants to give. Instead of being guided through the increasingly confusing maze of mortgage products by an experienced adviser, they may find themselves sat in front of an employed salesperson, paid by the lender to provide as many of that lender’s products as possible, regardless of suitability. Mortgages are the main danger area, because the lender has the right to accept or reject an application and the consumer feels at their mercy without the protection of an intermediary acting on behalf of the applicant. Lack of an advocate leaves these situations ripe for abuse by the mortgage provider.

The mortgage market has become a dangerous place to be, where the best deals can only be accessed direct and by signing away consumer right through accepting a non-advised process, which can easily become a consumer-bullying procedure. The credit crunch and the Retail Distribution Review have dealt deadly blows to consumer rights because they have been used to encourage the consumer, often poorly educated in a financial sense and vulnerable to pressure and persuasion, to be delivered on a plate direct to the lender, without appropriate protection and external advice. The two strands, are part of the same process: the destruction of independent advice. One would naturally assume that the FSA, legally required to ensure the “Appropriate degree of protection for the consumer” would have something to say about this descent into non-advised and execution only caveat emptor chaos. Not at all.

The FSA have supported insurers’ and lenders’ actions and transgressions. They have stood aside whilst lenders and insurers have built distribution models that contain no provision for advice and therefore minimal provision for consumer protection. Attempts to hold them to account have been dismissed and rebuffed. The average consumer does not realise that this is happening but they will do so when they next attempt to obtain a mortgage. The consumer is being deliberately disempowered by the banks and institutions largely responsible for our current national financial malaise. The regulator is actively complicit in this disempowerment in direct contradiction of their own legal obligations.

The government, the architects of the regulatory regime that is being so perversely distorted, is standing aside and failing to supervise their own regulators who have, incidentally recently awarded themselves significantly increased bonuses. The only statutory objective in which the FSA has succeeded is in the reduction of financial crime, but they seem to have achieved this at a major cost to their other statutory objectives. So, in summary, one must ask the question as to whether the existing raft of regulation has delivered an orderly market with fair outcomes for more financially-aware consumers. Everyone knows that it has not, but it may already be too late to save the provision of independent financial advice unless drastic action is taken by what is now a lame duck government.

There is something rotten in the state of the nation.

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