I once described commission as the cancer at the heart of the financial services industry. In fact more than once. Many, many times. It took years before the regulator took any notice. Not so much of me, but of the growing evidence that commission caused bias in investment recommendations to the detriment of consumers.
From 31 December 2012 commission was banned on all new sales of investment and pension products. So I was shocked this week to read new figures from the Financial Conduct Authority which showed that in 2016 retail investment advice firms still earned £843m a year from commission. A lot of this money is from ‘trail commission’ which was earned on sales before the 2012 ban. Trail commission was typically 0.5% of the money that had been invested and was paid to the adviser for as long as the investment was kept. Nominally it was paid by the investment firm. But of course ultimately it came from the customer’s investments.
More than half of all investment advice firms now like to impose a percentage charge on their clients directly – I call it a tax, they call it an ongoing fee for services provided – typically of 0.5% or 1% of the wealth of their clients. Altogether 57% of advice firms use this wealth tax as their sole way of charging and another 10% use it as part of their charges. Only 16% charge an hourly rate and another 16% charge a fixed fee.
More than eight out of ten advisers hide the payments from their clients by using what are called ‘facilitated payments’. That means the adviser does not send a specific bill which the customer pays. Instead the fee is taken from the investment. In other words it is ‘facilitated’ by the firm where the investments are kept.
Although the client has to be told what the fee is there is no direct connection between the charge and its payment which disappears from the investment and is passed direct to the adviser. No wonder advisers tell me that customers do not care about the price. If they saw a bill and had to pay it directly they might care a bit more.
Firms are successfully replacing the income they used to get from commission. Total revenues of the 4970 firms which give investment advice have grown strongly since it was banned on new sales. But commission still represents a quarter of their income. Some of it is commission on products the client buys without advice and there is some evidence in the figures that firms are earning more from these non-regulated activities but the data is inconclusive.
Commission was not banned in mortgage or insurance sales. The new FCA data reveals that around 80% of the income of from mortgage and insurance sales comes from commission. Insurance – often sold on a restricted basis even by independent financial advisers – is the big money-spinner. In 2016 firms made a total of £15.1bn from selling insurance compared with £3.7bn from investment advice. Mortgage sales came in a poor third at £1bn.
The figures the FCA published this week were based on returns made by all the firms which sell us regulated financial products – investments (including pensions), mortgages, and insurance. download the Data Bulletin and the tables that underpin its graphs.
This piece was first published in the Money Box Newsletter
26 May 2017.