The UK Financial Conduct Authority (FCA) – the new, allegedly improved successor to the FSA – has published the long-awaited “platform paper” setting out new rules on rebates of fund charges from fund managers to investment platforms.
This follows the Retail Distribution Review rules that came into effect at the beginning of the year, which banned financial advisers from receiving ongoing payments made by fund managers (a practice known as trail commission). The FCA will now bring in something similar for investment platforms, which are the intermediaries where the investor or adviser can access funds from many different fund firms in a single place.
These rules will radically alter the way that UK platforms and fund supermarkets charge for their services, since most currently rely on these rebates as some or all of their charges. In future, they will need to charge investors directly for their services.
For more background on how rebates and charges currently work, see this earlier article on RDR and unbundled pricing. Below is a quick summary of the FCA’s new rules and what they may mean for investors.
A tangled mess
The outcome of the paper is largely what the industry expected:
- Cash rebates that go direct to the investor or to the platform are going to be banned.
- Unit rebates to the investor – where the rebate is paid in additional units of the fund – will still be permitted. This exemption was sought by some providers on the grounds that they could still use their purchasing power to negotiate discounts from the fund manager, thereby benefiting consumers.
- However, cash rebates from fund manager to platforms will be permitted if they are passed on in full to the investor in the form of additional units purchased with the cash.
- Cash rebates of up to £1 per fund per month to the investor will be permitted. This is supposed to be an easement to prevent the overhead of administering unit rebates on very small amounts.
- This rule will come into effect from 6th April 2014 (i.e. the next tax year).
- Rebates on existing investments will be able to continue until 5th April 2016.
If all this sounds bizarrely complicated, it is – and the complication arises mostly because of the unnecessary decision to permit unit rebates. An outright ban of all rebates would be the simplest and most transparent solution, so exactly why the FCA considers this tangled mess to be an improvement defies understanding.
The taxman strikes
To make things even more confusing, all this needs to be considered in conjunction with an announcement from HMRC last month that all fund rebates – cash and unit – will be taxed as income with effect from April 2013. Previously they were treated as a return of charges paid, which was not taxable.
Many in the industry think that this unfavourable new tax treatment will hasten the end of the rebate model in any case, despite the exemption for unit rebates in the platform paper. If an investor has to pay tax on the rebates, they will lose out compared to holding funds that don’t pay rebates and paying an equivalent fee to the platform.
In practice, that outcome is not absolutely certain. Rebates into an ISA or SIPP will continue to be tax-free, so there’s no theoretical reason why platforms couldn’t continue to operate a unit rebate model on these accounts.
In addition, the vast majority of investors are not aware of exactly how charges work at the moment and what they’re paying. It’s by no means clear that they will be aware enough or care enough about the tax position of unit rebates to understand that they are incurring unnecessary tax costs.
However, Skandia – which was the most vocal proponent of allowing unit rebates – is already being forced to adjust its plans in response to HMRC’s decision. This may be an indication that even if rebates survive in some form, they are unlikely to be widely used.
Apart from the uncertainty over whether rebates survive or not – a question which is more HMRC’s doing than the FCA’s – there are plenty of other questions surrounding the new rules:
Perhaps the most important is whether there each fund will end up having a proliferation of new share classes as each platform strikes a different deal with each fund manager for “clean” share classes (clean share classes being those that don’t pay a rebate and consequently have lower AMC). Multiple platform-specific share classes could make it harder to compare platforms and might interfere with plans to make it quicker for investments to be “reregistered” (ie transferred from one platform to another when the investor wants to change providers).
This was perhaps the strongest argument against a commission ban, since only a single share class for all platforms was needed when the platforms could negotiate individual cash rebates with each fund manager on the side. The problem with this was the lack of transparency, since many platforms did not disclose their total rebates. (HMRC’s new position on taxing rebate has also now made it less attractive.)
The FCA’s new rules specifically concern platforms – some execution-only brokers and SIPP operators technically fall outside the rules. In response to this, the FCA’s paper states that:
We feel there is a strong argument for the application of similar rules to adjacent markets. This is particularly the case in the execution-only and self-invested personal pension (SIPP) markets. We will consider these markets as part of our ongoing work and will aim to consult later on any rules, where necessary.
indicating that they want all similar providers to fall in line and will regulate to have them do so if not. Some firms such as Hargreaves Lansdown have already indicated that they will comply with this in areas such as SIPPs, but the question remains as to whether it would have been better for the FSA/FCA to draw up a universal no-rebates policy to cover IFAs, platforms, SIPP operators and everybody else from the start.
The platform paper continues to allow payments by fund managers to platforms in certain circumstances, specifically:
- payments for the work incurred correcting a pricing error by the product provider;
- payments for the work incurred in dealing with a corporate action by the product provider;
- payments for the work incurred in providing the product provider with management information regarding the consumers who are invested in the product; and
- payments in relation to advertising products on the platform.
The last point is open for abuse, since a platform could in theory refuse to include a fund manager’s fund unless they contribute regular “advertising expense”. While this might not directly impact the consumer, it would increase the fund manager’s costs and could therefore lead to them levying an higher AMC on their new clean share classes as they seek to recoup that.
This is not just a theoretical concern – it’s widely reported in the industry that payments to at least one large intermediary are a considerable help in getting your fund on its recommended list. The FCA indicates that it wants to prevent this:
However, we do not expect payments for advertising to be used to help a product provider gain access to a shortlist of funds, influence any ranking of products, or otherwise result in a channelling of business to that product provider.
but given that this has been happening for a while, it remains to be seen whether the FCA’s new approach will genuinely succeed in preventing this from happening.
All in all, the FCA has done little to clear up the confusion in the short term. In general, any move towards greater transparency seems desirable and there is a good chance that this ultimately settles down for the benefit of investors – but right now, any investor trying to choose a new fund supermarket needs to be aware that charges could change very dramatically in the next year.