Understanding the FSA's Retail Distribution Review

The financial services industry is undergoing significant change, and the changes brought about by the Retail Distribution Review (RDR) can be positive if investment managers embrace what the regulator is trying to accomplish. At the core of the review is the desire to rebuild trust in the financial services industry, whose reputation has been damaged by years of greed and scandal. ?For the legal profession, the important issue is to whom will you refer your clients?

RDR sets out to ensure investment firms provide clarity on what clients can expect. Since 1 January, all firms providing advice on retail investment products to retail investors must clearly describe their advice as either independent or restricted.

This status is set at the firm level. To be independent, a firm's advice must be unbiased and unrestricted, and based on a comprehensive and fair analysis of the relevant market. Otherwise, the firm will be classed as restricted. All firms are free to choose how they describe their advice, but it must be clear and not misleading. This advice will cover collective investment schemes, life policies, personal pensions, structured products and most other packaged products you can think of that give exposure to underlying financial assets.

The FSA worded the definition so that products developed in the future fall within the scope and, as such, the same standards are applied when selling to retail clients. Direct equities, direct bonds and derivatives are the only instruments currently outside the scope.

Unbiased and unrestricted

Under RDR, it is much more difficult to earn an independent badge. Advisers must be able to look at the whole of the market for all investments meeting a client's requirements and to do so with nothing clouding their judgement. That does not mean they have to explore every product from every provider for every client. A firm may produce a list of suitable products, for example, a panel or buy list, but it must be sufficiently broad to meet a wide range of client needs and it must be reviewed regularly. Independent firms' advisers must be able to go 'off panel' if it is in the client's best interest.

Investment managers that use model portfolios, or a fund or funds structure, must ensure the overall portfolio is suitable to meet the client's needs. To be independent, they must create the portfolios from an unbiased and unrestricted view of the relevant market.

Most banks have chosen to be restricted, either because they have their own funds or products, making it very difficult to be unbiased, or because they lack the expertise to search the whole market for products that meet a client's needs. There will be occasions when it makes sense to refer a client to a restricted firm. For example, you may have a client with specific ethical investment requirements, and a decision has already been made on the most suitable structure for the client.

It would seem logical, in this case, to recommend a firm that specialises in ethical investments. If this firm only has clients who want ethical investments, it would have no need to consider any other type. It is likely to market itself in a way that attracts only those clients for which it is able to offer suitable advice, for example those that know they want ethical investments. You could even argue that specialising in a small market could make their advice potentially better for a client with that specific need. The firm would, therefore, be restricted for a perfectly justified reason.

Client care

There will be other times when it makes more sense to refer a client to an independent firm. The choice, however, is not this simple. You may also need to consider the firm's expertise in areas such as wealth structuring, financial planning, tax and offshore matters. These considerations could make the difference between a suitable solution for a specific need and the best solution for the client's wider needs. The structuring of even the simplest investments can make a huge impact on after-tax returns for the client.

Irrespective of the RDR status, you will want the assurance that your client will be looked after with the same care and attention that you would give them. Take for example a divorcee who has no real investment expertise. Your legal representation has ensured a fair outcome in the settlement, and you now need someone who will look after their long-term financial well-being; a firm capable of advising across the full financial spectrum is most likely to be best placed to support you and your client.

If the FSA's intention is to improve the investment market to the point that consumers can really start to trust the advice they are given, surely we need to ?go beyond just providing adequate solutions for their needs. If RDR is successful in achieving its goals, members of the legal profession should be able to make a more educated assessment of what is best for their clients. That has to be a good outcome.