The risks in retail financial services
This week saw the publication of the first Retail Conduct Risk Outlook report from the Financial Services Authority (FSA).
In the space of 96 pages, the regulator set out what they consider to be the biggest threats to consumers of retail financial products and services.
The report is a fascinating read.
Within the report, the FSA does a great job of highlighting the risks to consumers in three categories – current issues, emerging risks and potential concerns.
The risks listed as current issues are unlikely to come as much of a surprise. They have identified issues such as unfair terms in mortgage contracts and the way in which complaints are handled by the banks.
With the latest complaints data from the Financial Ombudsman Service (FOS) also published this week, nobody should be surprised that the handling of complaints by high street banks continues to be a risk to consumers and something the FSA wants to deal with urgently.
It is the emerging risks and potential issues that might contain a few surprises and this is where I think that everyone, consumers and advisers alike, could benefit from reading the report and understanding what is worrying the regulator.
The most relevant future consumer risks seem to centre on the commercial behaviour of financial advisers in the run up to the Retail Distribution Review (RDR) at the end of next year, possible weaknesses in the network IFA business model and the growing complexity of exchange traded funds (ETFs).
Looking at each of these in turn, there are clear warnings in the Retail Conduct Risk Outlook report for consumers.
The introduction of the Retail Distribution Review at the end of next year means that all financial advisers will need to be better qualified and operate on a transparent remuneration basis, known as Adviser Charging.
What the FSA appears to be worried about (and we would share their concern) is that some financial advisers will view the time between now and 31st December 2012 as a golden opportunity to exploit their ability to take large commissions by selling inappropriate or unnecessary financial products.
If you are the client of an IFA, you would be well advised to look carefully at their readiness for the new regulations at the end of next year and their motivations for any recommendations they make between now and then, paying particular attention to their commission disclosure and where this commission comes from.
Many individual IFAs are members of ‘networks’, which are larger organisations providing compliance and business support. The FSA appears to be concerned that some of these networks are unable to pay sufficient attention to the quality of advice being delivered by their members or have the financial strength to remain commercially viable in the long-term.
Certainly not all IFA networks fall into these traps and there are a few examples that demonstrate both robust compliance processes and healthy financial strength.
The risk relating to the use of Exchange Traded Funds (ETFs) is interesting.
These are still a relatively new investment vehicle for UK investors but they are becoming increasingly popular due to their low cost and ability to access specific investment markets. At face value they look very simple, but the more you dig below the surface, the more you realise that they are often incredibly complex tools.
Some of the main risks to consider with ETFs is how they deliver their returns, through the use of full physical replication or some form of synthetic replication. With the latter, there are counterparty risks that need to be properly understood before an investment is made.
We are pleased to see that the FSA is thinking ahead, not simply considering the risks to consumers that exist today but those that are likely to emerge in the future.
By identifying these, the FSA (and its replacement body, the Financial Conduct Authority – FCA) should be in a very strong position to focus resources on the areas of greatest potential consumer detriment and take early action to prevent this from occurring.
Photo credit: Flickr/Lucy_Hill