The Retail Distribution Review (RDR) in the U.K. and the Future of Financial Advice (FoFA) Act in Australia are examples of a new regulatory regime that embraces the fee-for-service business model in wealth management. They could well be the precursor of a new regulatory movement toward making the fee-based model much more important in the industry globally. Wendy Guo, Tom Robinson from CFA Institute and Raghu Mandagolathur from CFA Society Kuwait discuss the fee-for-service model in the wealth management landscape.
What is behind the changing regulatory trends since the Global Financial Crisis?
Prior to 2009, there were numerous cases of mis-selling of investment products by commission-incentivized wealth management service-providers involving subprime mortgage products, collateralized debt obligations, mini-bonds, accumulators, and various other products that are questionable in their design or simply not suitable for the client’s objectives and circumstances. The “Occupy Wall Street” movement, which spread around the world, is one manifestation of the public’s loss of trust in the industry and its professionals that has arisen as a result of this type of behaviour. Regulatory authorities are finding that eliminating the conflict of interest inherent in the compensation paid to wealth management service providers and requiring greater transparency are becoming front and center elements of their regulatory agenda.
How prevalent is the fee-for-service model?
Following the RDR which has been in progress in the U.K. for several years and slated for implementation at the beginning of 2013, the FoFA Act was introduced in Australia in July 2012, and the government is currently consulting with industry on its implementation. The Act introduces a fee-based regime and a ban on “conflicted remuneration” (including any payments from products and platforms to advisers). It also bans certain insurance product commissions, “soft dollar benefits” to advisers, and asset-based fees where the client has borrowed to finance the product’s purchase.
The fee-based mandate is a main feature of the private banking heritage in Europe. The U.S. has around 27,000 independent registered investment advisors and it is slowly increasing in acceptance in Asia Pacific. Apart from Australia, rapid growth in the number of independent financial advisors in India in recent years signals a gradual shift away from a product-centric model. Japan’s smaller private wealth management firms typically earn advisory fees rather than trading commissions. In Singapore, the Association of Independent Asset Managers was formed in 2011 to set their members, who follow a fee-based model, apart from the conventional asset managers.
In the GCC statistics on managed accounts are relatively sparse compared to co-mingled funds or mutual funds. Fee-based service models have generally made a slow start with most money managers based in banks focusing on a transaction based fee model.
How are the wealth-owners in the GCC different from those in other part of the world?
The wealth created in the GCC region by private investors is primarily through inheritance and income thanks to consistently high oil revenues over generations. This may explain the high levels of risk taking appetite which may go down progressively as the second and third generation wealth owners may change the structure more from inheritance to investment performance.
The wealth management business model for GCC will take some global and some domestic characteristics. This is based on their deployment of their wealth which is estimated to be biased more in favor of global investments due to lack of local absorptive capacity. While for the global segment, they tend to follow the traditional fee based outsourced model, for the domestic they tend to prefer commission based self-directed investment decision making process. GCC high-net worth clients enjoy a high development index when it comes to their global investments. They get the privilege of full product suite including mainstream and alternative products. Hence, GCC high net worth individuals are acutely familiar with asset based fee concept as well as transaction based fees for their global investments.However, the same cannot be said about their regional investments where fee based service model is prevalent in the managed accounts segment of the fund management business, which can either be discretionary or non-discretionary. Also, fee based business is practiced for custody accounts which is quite popular service.
Is the fee-for-service model the panacea?
Compared with a transaction-based commission-led brokerage model that tends to be more short-term and opportunistic, a fee-for-service model allows an advisor to take on a long term view and provide differentiated and relevant value-added service to investors. With fee-based service, the incentive design eliminates much of the conflict of interest. There is no guarantee that the service is always satisfactory under any model. A recent mystery shopping survey conducted by the Monetary Authority of Singapore found almost one-third of the product recommendations were viewed as being unsuitable, as they were inconsistent with the client’s objectives or circumstances. Ultimately quality of advice and professional ethics are the key to the long term success of the industry.