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Summary of the FCA Guidance Consultation on inducements and conflicts of interest

The FCA today published its report into the findings of the thematic review on inducements and conflicts of interest. The FCA will use the findings, which include examples of both good and poor practice by firms, to launch a consultation on how distribution agreements could avoid undermining the Retail Distribution Review (RDR).

FCA Guidance Consultation

Summary

The FCA reviewed 80 distribution agreements from 26 retail investment product providers and advisers. The regulator was unhappy with almost half of those agreements because it feared they could potentially breach FCA principles and inducements rules, undermining the objectives of the RDR. The paper clearly sets out that unregulated entities, such as external compliance and support service firms, are included in the guidance and the review as these ultimately provide services to advisory firms.

The review identified a significant increase in overall spending by life insurers for services offered by some advisory firms in the lead up to, and following, the implementation of the RDR. Some agreements potentially incentivised advisory firms to promote a particular provider’s products or services. This creates a risk that the advice given to customers would be biased towards commercial considerations rather than the suitability of the recommendation. Additionally, the report found inadequacies in the systems and controls that some advisory firms had put in place to manage potential conflicts of interest created by distribution or service agreements. Joint ventures in particular were singled out as having significant risk of breaching conflict of interest principles and inducement rules. Any firm considering a joint venture is advised to discuss plans with the FCA prior to launching the initiative. Although distributors have been involved in the review, the emphasis is firmly on life insurers.

Principles For Business

The FCA expects firms to carry out their business in line with Principles for Business, which includes the requirement for all firms to manage conflicts of interests fairly (Principle 8). There are also specific rules within the Systems and Controls Sourcebook (SYSC) in relation to the identification and management of conflicts on interests.

There are concerns with both actual and potential conflicts. If an advice firm has an arrangement where a benefit could become receivable, this is enough to compromise the impartiality of the firm. Both advice firms and providers need to ensure that the risk of conflicts through offering/accepting any benefits is effectively managed so that the payments do not cause a bias in the advice given to customers.

Inducement rules

The review identified that firms often took an overly broad interpretation of the non-monetary benefit guidance set out in COBS. The inducement rules also require any payment or benefit paid to a firm to be disclosed to customers, with some exceptions. The paper indicates that this was not happening in practice. 

The paper covers areas such as IT development and maintenance, training, conferences and seminars and management information.

Good practice

It was encouraging to see that the FCA included some examples of good practice in the paper. These include:

  • Advisory firms demonstrating payments made by provider for developing its IT systems covered the costs of integrating the respective new business systems only and resulted in the anticipated equivalent cost savings for the provider.
  • Advisory firms demonstrated that integrating IT systems was designed to enhance the quality of service to customers by streamlining and automating processes and reducing the possibility of errors in the application processes.
  • Providers who contribute to training events had benchmarked the training costs to determine the reasonableness of contributions requested from advice firms. In addition the provider contribution was designed to recover the costs incurred by the advice firm of arranging the provider’s active participation at the event.
  • A provider giving an advice firm training on the features and benefits of its products or services is unlikely to impair its compliance with conflicts of interest principles if the training is made available to all advice firms.
  • A provider contribution to a seminar organised by an advice firm where the provider’s participation is for genuine business purposes and the contribution is reasonable and proportionate.
  • Providers who purchase management information from advisers deriving a genuine business benefit from purchasing it. 
  • Agreements entered into by providers following a detailed analysis of the services offered by advice firms to ensure compliance with the relevant rules
  • Providers who had established and documented clear policies on distributor spending to provide an effective governance framework
  • Controls in place to ensure that benefits from providers did not affect personal recommendations

Poor practice

The FCA also included examples which demonstrated poor practice and could potentially cause conflicts of interest, including:

  • Payments from providers to develop advice firms general IT systems or infrastructure
  • Longer term multi-year agreements representing substantial revenue streams for the advice firm, and where the advice firm is reliant on this on-going revenue.
  • Clauses that allow the provider to reduce the level of payments for a reduced level of services in the event that the provider loses its place on the panel or where there is a reduction in sales of the provider’s products.
  • Agreements which generate a profit for the advice firm and are linked to the distribution of the provider’s products. While the rules do not prevent advice firms from making a reasonable profit, this needs to be managed by firms.
  • Instances where staff in advice firms are responsible for both providing information/guidance to advisers on the benefits of products and are also responsible for negotiation and provision of services to providers. 
  • Advice firms seeking/receiving contributions from providers towards the cost of organising a workshop for advisers where the contribution is disproportionately high.
  • Excessive payments from life insurers to an advice firm to take part in an annual conference where the payments did not reflect the time and sessions at the conference where the provider played an active role.
  • Advice firms seeking recovery of all costs incurred in running seminars rather than a contribution designed to recover the costs associated with the life insurer’s active participation.
  • Excessive hospitality events for advisers, including overseas locations and includes spouses/partners.

Conclusion

All firms should review their existing service or distribution agreements in light of the proposed guidance. Additionally, systems and controls in place for establishing/maintaining these agreements should also be reviewed. The FCA has acknowledged that many firms have already reviewed arrangements and made amendments or terminated where necessary. No timescales have been given for this although the regulator sets out their intention to include this in on-going supervisory work.

The FCA announcement has been widely reported in the trade press and national media.

Our verdict

The paper is helpful in providing guidance for providers and distributors, particularly on how the rules interact with the new RDR framework. It is encouraging to see that there is good practice in this area and that the FCA has acknowledged that many firms have already taken action to improve their practices and the systems and controls around inducements.

Today’s publication is a good start, but we do believe that more clarity regarding FCA expectations in this area would be helpful in some areas, particularly around initiatives such as joint ventures.

We will be responding to the FCA and will continue to work with them to develop their final guidance on inducements.

Read the full guidance document on the FCA website.


Last updated 01/07/2016