Friday, January 27, 2012

Financial Advice As a Profession in the United Kingdom

Financial advice and financial planning are two individually distinguishable practices, the former focusing on specific transactions, such as selection of a unit trust, and the latter focusing widely across a client's financial, and indeed life, objectives from a more holistic perspective. Financial advice could be described as sales oriented and target driven, whilst financial planning is more frequently positioned as a continuous and tailored service. However, despite this seemingly more favourable description of the practice of financial planning, it's important to point out that there are good financial advisers, bad financial planners, and vice versa. Financial advice can also be viewed as a subset within financial planning, but for the purposes of this text both disciplines will be considered as one and collectively termed as financial advice.

A profession can be described very simply as "a paid occupation, especially one involving training and a formal qualification" (Oxford, 2008), and in this respect a significant number of trades fall under the umbrella. Historically, however, only a limited number of occupations were termed professions, most notably law and medicine, and a vast array of measures have been developed to define the classification. One good description includes characteristics of "professional autonomy; a clearly defined, highly developed, specialized, and theoretical knowledge base; control of training, certification, and licensing of new entrants; self-governing and self-policing authority, especially with regard to professional ethics; and a commitment to public service" (Burbules & Densmore, 1991).

It could be argued that the provision of financial advice is a professional service based upon the depictions outlined above, but it's important to point out that this portrayal is tenuous in some respects. For instance, whilst advisers are required to demonstrate a level of autonomy and personal responsibility on a regular basis, the financial services sector lost its self-regulatory capacity some time ago and is now supervised stringently. In addition, whilst codes and qualifications have been developed by national and international trade bodies, the occupation is still comparatively young and therefore continues to grow - many of its facets having being serviced traditionally by accountants and solicitors in simpler times.

Financial advice delivered in the UK is generally funded indirectly through a commission built into products, or directly through a fee levied separately. Advisers currently gain their income from either one of these channels or from a combination of the two. Commission based advice can be preferable for a client because it's not immediately obvious that they are paying anything, whilst fee based advice can be less favourable given a client's intrinsic awareness that they are being charged.

Many industry spectators have, for a number of reasons, contended that the practice of commission based advice is wrong. It is argued that advisers are presented with an inherent conflict of interest where there is an incentive for them to suggest one product over another, because they could ultimately earn a greater income from commission. This idea of moral hazard could induce an unscrupulous adviser, for instance, to choose an investment that does not align with a client's risk appetite - purely to realise a more significant profit than had they selected a better suited product. Clients can be unaware of the level of commission they are paying, whereas fee based advice promotes greater clarity.

The debate surrounding commission based advice is particularly important due to the perceptions that consumers have about advisers. The financial services sector is seen as being very sales motivated whereas law and medicine, which are classically fee based for example, are not. This can be harmful because consumers consequently lack trust in practitioners such as advisers, who might in a consultation be felt to have an ulterior agenda of earning as much money through a client as possible - an unlikely sentiment with a doctor or solicitor on the other hand. Any efforts to modify consumer attitudes have hardly been aided by the gradual post-mortem of the recent financial crisis, where advisers have been labelled with a great deal of blame given their relaxed approaches in many cases and, in some cases, outright fraud. This is in addition to other scandals that the sector has suffered throughout the years such as mis-selling; and the fact that many advisers are employed or tied, and therefore limited in the products that they can suggest, introduces another element that could be manipulated.

In response to concerns relating to the practice of financial advice in the UK, the Financial Services Authority set out its intention as industry regulator to introduce change in consultation with relevant stakeholders, under the auspices of the Retail Distribution Review. Initial objectives of the RDR included enhancing factors such as product clarity, consumer needs, remuneration arrangements, professional standards, fair treatment, and effective regulation. Further to review, the FSA set out three proposals in its 2009 report.

The first proposal is that firms should be compelled to class their advice as either independent or as restricted. The implication here is that some advisers are currently employed or tied and therefore cannot make decisions for clients based upon the whole universe of potentially suitable products that exist, rather that they are limited to those instruments offered by their own or their preferred firms. This proposal is sensible because it is important that clients are made aware where their adviser is unable to offer completely impartial advice based upon the whole market of potential opportunities.

The second proposal is that commission based advice should be outlawed in favour of fee based remuneration. The existence of commission based advice can exacerbate occurrences of bad practice, where advisers could be encouraged to choose from a set of investment alternatives purely because a particular provider offers a higher rate of commission. Instead, advisers will be expected to set out fixed fees in advance so as to manage client expectations and encourage transparency.

The third proposal is that professional standards should be raised for advisers across the sector. This would involve the introduction of suitable qualifications and codes, to be overseen by a new professional standards board. Whilst the spirit of this proposal should be applauded, the planned actions are questionable however, in that such standards do already exist to a certain extent. A number of professional organisations are active including the Association of Independent Financial Advisers and the Institute of Financial Planning, each with their own ethical or professional codes. A broad range of industry qualifications are available from such bodies, and also from the Chartered Insurance Institute for example. The FSA should be cautious not to replicate any existing framework, primarily because such resources could in fact be taken advantage of, and also so as not to alienate important stakeholders.

Despite the positive nature of the RDR's proposals, there has been somewhat of an industry backlash, one body commenting that "we do not need second tier regulation" (AIFA, 2009). Some advisers believe that implementation of the RDR would strain their business interests and limit their ability to operate - "almost half of IFAs believe they will lose up to 80 per cent of their clients when the retail distribution review comes into force" (Welling & Carvill, 2009).

Whilst the practice of financial advice might align with definitions of professional occupations, it's clear that the sector still has some way to go in terms of turning around negative stereotypes about its practitioners, before it can truly be classed amongst the more established professions. Financial advice is an essential service offering for many consumers, and the FSA's RDR proposals should ensure that clients know where they stand, that they get a fair deal, and encourage an environment in which advisers are well qualified and uphold the highest standards of integrity. However, it's essential that the FSA establish a constructive working relationship with all relevant industry stakeholders including employers and trade bodies, so as to ensure that any implementation takes into account the concerns of those on the front line.

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