FCA “Customer Duty” Initiative
The first thing that annoyed me when reading the FCA “Customer Duty” paper was that the regulator doesn’t understand that there is a fundamental difference between customers and clients. The dictionary definition of a customer is: “A person or an organisation that buys something from a shop, store, or business”. So, ‘customer’ is a word that we mostly refer to in regard to casual purchases. But a client is a person or organisation that has a long term and quite intimate relationship with organisations such as accountants, lawyers or financial advisers. An entirely different business model.
The second thing that annoyed me is the term “Fair Value” It looks to me that this is all about metrics and pricing, not value. Forgive me if I use asparagus as an example. For the last month or so I have been cutting about twenty spears every other day. I planted twenty “crowns” about ten years ago and I expect they will continue for another twenty years. So my asparagus is free. Actually you can buy enough asparagus for a couple of people for about £2.00 but I enjoy seeing my shoots grow. Bear with me!
At Pont De la Tour restaurant near Tower Bridge, a starter of “English asparagus with “creme fraiche” is £17.00 – about £40 for two people including service. But the diners consider it “Fair Value” as or they wouldn’t be there. The River Cafe in Hammersmith is the asparagus equivalent of St James’ Place. Getting a table there can be quite difficult. It has been around a long time and the customers love it. At the moment their current starter of “English asparagus (five spears like the others) comes with anchovy butter and parmesan and is priced at £27.00; say £60.00 for two people with the service charge. £60.00 for something that can be purchased for £2.00! Of course the diners know that, but they are happy to pay. The believe it is fair value. And why not?
As we know, “Fair Value” in retail financial services is more complicated. But from what I hear, financial advisers have something in common with the restaurants mentioned above. Demand exceeds supply. So, why on earth would one want to reduce fees? What’s the problem? Well, I think Customer Duty might require some changes to the financial advice business model. This might reduce some revenue streams; in particular the standard “on-going advice fees” which might be anywhere from 40bps to 100bps.The FCA have been concerned about these fees for years. They have observed that almost every client seems to need two annual reviews and they have been wondering how valuable these are to the clients. Is there conflict of interest? Do advisers and businesses suggest that such reviews and fees are essential? Is it possible that because some consolidators use on-going fees as a metric to calculate the value of the business there is pressure to lock these in?
Also, “fair value” needs to include the costs of underlying products. For example, in drawdown these might include: SIPP fees, DFM fees, underlying OEIC fees, platform fees, as well as the adviser fees. These could add up to about 2% pa. And if we took a £500,000 portfolio we could be looking at around £10,000 PA. That adds up to perhaps £100,000 over ten years and maybe £25,000 of that would have gone to the financial adviser – enough to enjoy asparagus in some very smart restaurants!
When one is building a portfolio 2% isn’t an issue for most people. But in drawdown it’s about 50% of most clients’ income and that doesn’t look like fair value to me. I’ve recently changed my adviser to one who will operate on a fee for service model. Maybe advisers might feel it appropriate to mitigate any potential conflict of interest by presenting a fee for service arrangement and an on-going fee model and let the client decide.