ABOUT APFA
The Association of Professional Financial Advisers (APFA) is the representative body for the financial adviser profession. There are approximately 14,000 adviser firms employing 81,000 people. 40% of investment and protection products are sold through financial advisers, with annual revenue estimated at £3.8 billion (£2.2 billion from investment business, £1.2 billion from general insurance and £400 million from mortgages). Over 50% of the population rank financial advisers as one of their top three most trusted sources of advice about money matters. As such, financial advisers represent a leading force in the maintenance of a competitive and dynamic retail financial services market.
Summary
This paper is submitted as APFA’s preliminary response to HMT and FCA’s Financial Advice
Market Review (FAMR) Call for input. It represents our initial thoughts on the cost of providing advice and does not purport to respond to the questions set out in the Call for input. We believe that the cost associated with providing advice is a significant aspect of the
‘advice gap’ that this Review is seeking to address and therefore were eager to set out our views on these issues at an early stage. We are encouraged that the Review’s initial focus is also on these areas and we will endeavour to address the questions raised in a full and comprehensive response in due course.
APFA welcome the Financial Advice Market Review (FAMR) looking at how financial advice could work better for consumers. We understand the review’s principle objective is to address the question: why there is no provision of financial advice for the mass market?
APFA welcome the recognition that the challenges in reaching a mass audience include regulatory barriers imposed on the financial advice sector especially the interplay between the regulatory framework for advice and the role of the Financial Ombudsman Service (FOS) and the Financial Services Compensation Scheme (FSCS) in redress.
The terminology used is important. The debate on financial advice often gets confused over the use of the ter m “financial advice”. Sometimes it is used to denote general financial planning and sometimes regulated investment advice. With wealthier clients there is a significant overlap, but they are not the same thing.
In terms of provision, advice tends to be given on a product basis reflecting the regulatory framework. The availability of advice for different product types for the mass market varies, but is readily accessible for general insurance, mortgages and protection. A broad based advice service is available to wealthy clients and tends to have a focus on investment advice. In our view, the gap principally relates to holistic financial planning and investment advice for those with lower asset levels.
What do people need? For many mass market clients, the issues they face will be how to get a good deal on insurance, protection and mortgages; to save more and reduce their debts.
Their need for investment advice will be limited, but with auto enrolment it is to be hoped increasingly they will have some pension savings. If they are saving in pensions, the defaults

of the scheme should mean that even without active engagement their “choice”, while maybe not optimal, will not be bad. On average, they should save more in their pension. Obviously, with pension freedom, they face far greater choice at retirement now. Some of these are covered by the Money Advice Service remit, although in our view what the MAS provide is more information than advice.
So the challenge in our view is around financial planning and investment advice at retirement for those with lower asset levels.
Financial advisers have tended to increasingly focus on higher net worth individuals over the past 10 years. This has been a trend before the Retail Distribution Review (RDR), but has been exacerbated by it. In the run up to the RDR, the number of advisers fell by around 15%
(numbers have since recovered a bit) reducing supply. The initial economic assessment, undertaken by Europe Economics (December 2014) for the FCA, tentatively concluded that the price of advice has risen since RDR was introduced.
Just as significantly, RDR has led advice firms to focus more on the costs of serving different clients. An NMG (2015) survey, conducted for APFA, shows that increasingly advisers have had to turn away potential clients as the cost of providing the advice would not make it economic for the client. In the 12 months to January 2015, over 60% of advisers turned away potential clients, either because it was uneconomical to the client based on their needs
(42%) or it was unprofitable to the firm (29%). There are firms that are building new lower cost services to provide financial advice to the wider market, though still face the liability and cost challenges of those focusing on higher net worth individuals.
The key challenge to winning a new client is demonstrating value for the client – obviously the higher the cost of delivery and the price of advice, the greater the challenge. There is a minimum cost threshold in delivering advice whatever the level of the sums involved, yet the value equation is different for those with higher levels of assets.
One of the primary cost drivers for financial firms is the liabilities associated with getting it wrong. A barrier to a thriving and accessible advice sector comes from the potential significant liabilities and uncertainty that attach to investment advice: the lack of a ‘longstop’, which means that possible claims can hang over advisers indefinitely; the uncertainty and systemic problems relating to the Financial Ombudsman Service (FOS); the ever-increasing
Financial Service Compensation Scheme (FSCS) levies. These issues together with the incremental cost of regulation have added to the cost of providing advice and so led to a focus on wealthier sections of the population.
APFA will respond to the review consultation in due course and is considering with members broader questions about the regulatory framework and issues that hinder the development of a broad based market for advice. But, in our view, a driving factor for the current focus on ever higher net worth individuals has been the rising cost of being in the advice business, so part of the solution must be to reduce the cost of giving advice. This has a two-fold scope:
1. address the problem of liabilities faced by financial advice firms and the costs this involves;
2. reduce the costs of regulation.
Liabilities and compensation
In order to establish a framework for the development of a mass market solution, it is necessary to address the issue of liabilities that attach to advice. One of the principal considerations for a firm in taking on a client is the potential liability that comes with advising

them and the balance of risk and reward. For investment advice in particular, given the sums involved, the cost of getting it wrong are significant. The growth of a compensation culture has had a considerable impact on advice firms from the cumulative effect of FOS compensation, FSCS levies and Professional Indemnity insurance. This has prevented firms from investing in greater capacity, expanding and innovating.
Ultimately, the costs are all borne by clients. There is a question to be considered about the balance of what is compensable. For example, should those taking very high risks have the comfort of being bailed out by those making very low risk investments? The consumer benefits are skewed as the loss and subsequent compensation for the few is highly visible; whereas the cost borne by the many is spread over a larger number. But as compensation pushes the price of advice up, fewer consumers are able to access it. We believe there needs to be a reform of the compensation system available to consumers. A balanced and comprehensive safety net needs to be designed involving the introduction of a longstop and reform of the FOS and FSCS. For a start, these bodies should be governed by the same set of common law rules and legal principles.
In addition we believe there should be a fundamental change in the scope of compensation within both FOS and FSCS. At the moment, consumers are compensated for non-regulated products because the advice is regulated.
We believe that an unregulated activity should not be part of any regulatory body’s remit. There should be no compensation for people taking extreme risks. Such people should not be afforded the same protection if they are actively choosing higher risk investments.
Longstop
In the current system, there is no time limit as to when a claim relating to financial advice can be brought before the Ombudsman. When firms are making decisions about the services they will provide, the clients they will take on and their charging structures, they are significantly influenced by the potential liabilities they might incur and the “risk premium” they need to build into their charging structure. Much of the cost of advice is driven by the need to manage future liabilities and having an open-ended liability significantly increases the uncertainty and the ability of firms to model and manage that risk. This has the following implications:
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innovation is inhibited as firms are unwilling to develop low cost simplified advice models, as the liability that attaches, and therefore the cost, will make them uneconomic to deliver;
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firms are unwilling to take on smaller clients, as the potential risks outweigh the benefits, making it uneconomic to service such clients;
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non-advised services will increase as such services have minimal liability for firms. This however provides less protection for consumers and less transparency around costs.
In addition, part of the costs, arising out of the possibility of ongoing liability, are storage costs and firms’ time and resources in dealing with FOS complaints over 15 years old. Firms feel they need to retain records indefinitely as they can never be sure a complaint won’t be made against them. In addition, firms’ Professional Indemnity Insurance (PII) is affected.
Many insurance firms are not willing to provide cover for financial advisers; those that do, are able to charge inflated prices and high self-insured excesses. It has been estimated that the
PII cost of unlimited liability represents about 5% of PII costs.
However, it is the uncertainties around liabilities which act as a major barrier to investment.
Firms have told us that legacy liabilities can affect the value of a company by up to 50% and that it is extremely difficult to secure investment in any advice business, especially those

over six years old. The consequence of lack of investment is that firms remain small and fragmented and therefore are unable to become more efficient and cost-effective by, for example, introducing more stream-lined services and economies of scale. Without investment and innovation in the advice market, a large number of consumers will remain unable to access affordable advice. There needs to be a compromise between consumer protection and unlimited liability for firms in order to ensure consumers can still access advice.
The Limitation Act 1980, as amended by the Latent Damage Act 1986, provides every UK citizen with an end date after which no legal action can be brought in negligence. Parliament decided that 15 years was the right balance between consumer protection and the duties of firms. This should also apply to a dispute resolution service that is providing a free alternative to consumers.
APFA have been campaigning for a 15 year longstop for the advice profession. Further to recent discussions between APFA and the FCA, the FCA plan to publish an opinion on the longstop this autumn, which will be followed by a consultation. This will act as evidence gathering alongside the FAMR consultation and hopefully this will be an opportunity to resolve this issue and create a fair time limit on when claims can be made to the
Ombudsman, just as exists in UK civil law.
For a full and detailed argument for a 15 year longstop, please see APFA’s Position
Statement, dated February 2015 {hyperlink}.
Financial Ombudsman Service (FOS)
The advice sector has concerns about the way FOS handles complaints. These relate principally to a lack of clarity as to processes and procedures, inconsistency of decisions, lack of training and guidance provided for adjudicators and a bias towards complainants.
Whilst we recognise the need for a dispute resolution service for consumers, the advice sector needs to have greater confidence in the way complaints are handled. The systemic problems in the FOS decision-making process have a significant impact on advice firms and consequently on their ability to provide a service for the mass market.
First of all, the problems regarding the liabilities advisers face and compensation costs have an impact on professional indemnity insurance premiums. This pushes the cost of advice up, making it less accessible and viable.
APFA are currently involved in an ongoing discussion with FOS on these issues and believe these matters should be addressed in this review. An example is the lack of equal access to the adjudicators or Ombudsman. We understand it is FOS policy that, when a claim is made, both sides are given equal access to an adjudicator as their aim is to resolve the dispute bringing both sides to a mutually acceptable solution if possible. This obviously requires both viewpoints. However a recurring complaint by many of our members is that whilst the claimant has full access to the adjudicator, the adviser does not, despite making numerous requests for a conversation by telephone.
Other concerns are that, in a large number of cases, FOS has widened the scope of the original complaint in an attempt to identify any mistakes and will find redress for the consumer even without establishing a causal link between the mistaken advice and the consumer’s loss.
Secondly, the uncertainty surrounding liabilities means that advisers are driven to using lengthy disclosure documents with an eye to future risk mitigation. The sheer volume of

different disclosure requirements together with the fear of falling foul of the rules inhibits investment and innovation in the market. It means firms structure their business in order to manage liabilities rather than being open to more innovative ways of providing advice.
Simplified or focused advice models would clearly cater for a wider market, but the development of such services is inhibited by concerns around how FOS would treat them in the case of consumer complaints. Even if the guidance were crystal clear, there is uncertainty on how FOS would interpret it. There is a belief that FOS would treat such simplified models as ‘full’ advice. FOS does not follow the law, only makes decisions with regard to it. It has scope to find against advice given that was fully compliant with FCA rules.
There has to be acceptance and clarity about the boundaries between advice types and between guidance and advice, and assurance that these will be applied by FOS. It is these uncertainties that deter investment and consequently expansion, thus limiting the capacity of firms to provide advice to a broader market.
In recent years there has also been a growth in claims brought by Case Management
Companies (CMC). A large number of these cases are frivolous and unfounded but still cause a significant cost to advice firms in investigating and defending them. We believe that there should be a fee charged to CMCs for bringing cases before FOS as this would encourage such companies to only bring claims with a reasonable prospect of success.
We believe FOS should be a fair process and follow legal principles. It should be impartial and fair at every stage of the decision process, including having an independent appeal procedure. At the moment, the Ombudsman has the power to review the decisions reached by the adjudicators. However as Ombudsmen and adjudicators have a close working relationship there clearly is a lack of independence between them. There should be a completely separate and independent appeal panel or the right to appeal to the civil courts to ensure a fair and transparent process, in which the advice sector can have faith in.
Only once the advice sector has confidence in the system, will it be able to provide a full advice service accessible to a wider number of consumers.
Financial Services Compensation Scheme (FSCS)
FSCS levies have increased significantly this year, with fees jumping by over 100%. The combined levies for investment and pensions and life intermediation were higher (£216m) than the retained profit in the sector last year
(£171m). Whilst we accept the need for the
FSCS and also understand its benefit for consumers, the soaring levies are detrimental to consumers themselves as they bear the costs and the unpredictability of the levy and the need to find funds in such a shor t time frame, puts severe pressure on firms’ finances. This has the knock on effect of reducing the public’s ability to source financial advice.
We believe the solution is for a product and service levy that would fund the FSCS by setting a small surcharge for different product categories (including advice), with a levy attached to the income from the transaction and sale of a product, added to its price and paid for by the client. These could be uniform for simplicity or higher levies could be charged to unregulated or higher risk products. This would be neutral for a firm’s finances in the same way IPT or
VAT flows through. We believe that being transparent about the cost of FSCS protection to consumers would raise the profile of FSCS levies with the public and make them much more aware of the risks that they were taking.
We also believe that the scope of compensation should be limited to certain products. At the moment, consumers are compensated for non-regulated products because the advice is regulated. The FCA should direct that FSCS compensation is only available for advice on

investments in products suitable for retail customers, or a ‘whitelist’ of appropriate products.
We believe that it is fairer that consumers do not bear the cost of compensation for what happens with respect to unregulated products, be it the wrapper or the underlying investment. Such unregulated products (such as UCIS) could still be sold subject to suitable recommendations and risk warnings, including that no FSCS cover applies. We believe that any product the FCA says is not suitable for retail customers should not be eligible for claims under the FSCS.
We believe consumers should take on greater responsibility for their decisions. Under the current system, the FSCS potentially pays out 100% up to £50k. A consumer should bear some responsibility for taking prudent decisions and so we believe that compensation should not be total, for example a maximum of 75% of the amount invested. These changes would not only reduce the FSCS bill but would also create more engaged and prudent consumers.
The FCA has indicated that it will review the funding arrangements for the FSCS in 2016 and
APFA are currently working on a paper presenting suitable alternatives. We believe the
Financial Advice Market Review is an opportunity to reform FSCS funding as part of a comprehensive solution in improving access to financial advice for all consumers.
Regulatory Costs
APFA’s ‘Cost of Regulation (2014)’ survey showed that advisers’ costs for the FCA, FOS,
FSCS, Money Advice Service and Pension Wise, together with associated indirect costs amounted to £460 million in 2013. The FCA’s annual levy was raised by 10% for 2015/16.
The regulator said this increase was down to an 8.5% rise in FCA staff and IT costs and an extra £4.7 million levy to pay for Pension Wise.
APFA have recently conducted a ‘Cost of Regulation’ survey in order to have up-to-date data on this matter. This shows that the direct and indirect cost of regulation makes up 12% of a firm’s costs and by inference 12% of the price of advice.
There are various other needless requirements that incrementally add up and increase the cost of providing advice. For example, there is a £300 fee for consumer credit permission for giving debt advice. Advisers continue to pay consumer credit fees even though their activity in the consumer credit market is negligible. Advisers do not offer credit or provide debt counselling as a service, so we therefore believe that the FCA should re-examine the boundaries for needing a consumer credit permission and clarify the requirements on those genuinely undertaking the activity.
Further costs are likely to arise with the obligation to keep telephone recordings for five years under the rules of MIFID II. Advice firms also expend a considerable amount of time and resources fulfilling reporting requirements. With regard to RMAR, it is felt by many firms that information is just asked for ‘for the sake of it’ and that it is difficult to see what use it has.
The increasing level of fees that adviser firms have to pay, are inevitably passed on to consumers. There is the need for ‘better regulation’. This could be achieved by cutting regulatory costs for firms. There are a number of other measures that would help reduce costs:
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Reducing reporting requirements, which take up a considerable amount of a firm’s time and resources;
 Freezing the regulatory bodies’ budgets in nominal terms for three years;
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Simplifying the FCA handbook, by reducing its length by a third over three years.

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Bringing back the regulatory fines (removed in April 2013) to reduce the cost of regulation.
Conclusion
We believe that investment advice can be extended to the mass market, provided there are reasonable and measured changes to the regulatory framework. In this paper, we have set out our preliminary views relating to the more obvious ways of addressing the cost of regulation. A more far reaching reform of the regulatory framework, relating to suitability requirements and provision of simplified ad vice, how a ‘safe harbour’ for certain types of advice might work, governed by a set of simpler guidelines, may be necessary in order to develop cheaper models of advice for the mass market. APFA will provide a full and considered response on these matters after discussion and consultation with our members.
October 2015
APFA