A bank vault: mis-selling by Britain's major banks has so far cost them £15bn © Chuck Savage/Corbis
Of all the scandals that have tried the patience of savers and investors in the five or so years since the financial crisis began, one stands above them all—the mis-selling of insurance policies linked to bank loans. The true scale of this debacle is still unclear but it has touched millions. Even the squeaky clean Co-operative Bank has found itself embroiled.
The major lenders have so far set aside around £14bn to cover compensation payments, but some believe the figure will eventually reach £15bn or more. The unprecedented size of the scandal over payment protection insurance (PPI) has rightly caught the public’s attention, but its repercussions are making themselves felt in other parts of the financial world, and particularly in the way that British consumers invest their savings.
Few will have seen much about it in the press, but over the past two years virtually all the major banks and building societies have decided to stop offering investment advice to everyone except their wealthiest customers. Barclays was the first to jump, in early 2011, while the most recent was Santander, which said in March that it would close down its advice arm, putting nearly 900 jobs at risk. In doing so, the banks are seeking to head off what might otherwise have become their next major public relations disaster: widespread provision of poor quality and biased investment advice.
The thread that connects the PPI scandal with the banks’ quiet withdrawal from offering mass-market investment advice is not difficult to spot: it’s all about incentives. In the run-up to the financial crisis, large numbers of people were taking out loans and banks knew they could make significant additional profit by selling them PPI policies. So incentive schemes were put in place to encourage frontline staff to sell their socks off, which they duly did with disastrous results. Much the same applies to bank staff who provide investment advice. A significant portion of their rewards over the years has depended on meeting targets, otherwise known as “shifting product.”
If the potential (and actual) problems with this situation are so obvious, the mystery is why it took a scandal the size of the PPI disaster to bring it into the open. At last, however, there are signs that things are changing and grounds, therefore, for some hope that one of the major potential causes of harm to retail investors may eventually be addressed.
In a speech last September, Martin Wheatley, head of the new Financial Conduct Authority, made clear that financial firms’ incentive schemes were going to have to change. “It has been too easy, for too long, for those selling or giving advice to be motivated solely by the rewards on offer to them, rather than how to enrich their customer,” he said. “It’s clear that people no longer believe that they will be treated fairly.”
Wheatley said that regulators had recently examined sales practices at “22 firms of all sizes, including high street banks, building societies, insurance companies and investment firms. And what we found is not pretty. Most of the incentive schemes we looked at were likely to drive people to mis-sell to meet targets and receive a bonus.”
So the FCA will look hard at how firms run their incentive schemes in future to head off the danger of people earning bonuses by pushing unsuitable products at consumers who lack the knowledge and confidence to know when they are being misdirected. But the major victory might already have been won: if banks are no longer going to provide investment advice to the broad mass of retail customers, one of the biggest potential sources of mis-sold investment products has arguably been removed. However, as always, this victory comes at a price. Which?, the consumer group, says that now banks and building societies have largely shut up shop, a large group of smaller investors have been left with no obvious place to go for investment advice. Unless and until new alternatives emerge, most will have to fend for themselves.
Another victory, and one that has received far greater publicity, is the arrival at the end of last year (after a mere six years’ preparation) of the Retail Distribution Review (RDR). This banned the universal practice of fund managers paying commission to financial advisers for channelling clients’ money into their funds, a system that gave unwitting consumers the impression that financial advice was somehow free. Nowadays, clients have to pay for advice separately, which makes the whole system a lot more transparent. In addition, the RDR made advisers gain proper professional qualifications and state whether they are independent (in which case they have to assess the whole market in making recommendations), or whether they offer “restricted advice,” covering products from a limited range of providers. It is the need for proper professional training that some observers believe prompted the banks to quit the market, since the cost of bringing large teams of advisers up to scratch would have been too great for them.
So in view of all this, are retail investors better served now than a few years ago, before the crisis began? Much depends on what sort of investor you’re talking about, says Robin Keyte, an independent financial adviser based in the West Country.
“High net worth investors who are savvy enough to negotiate on the fees, and in particular those prepared to take the time to find a service that doesn’t charge on a percentage basis, are better served than they ever have been,” he says. “The concern is for those investors who aren’t quite so savvy. I think they’re worse off because although RDR has made transparent the layers of cost—the fund management cost, the platform cost and the advisory cost—what we’re seeing is those layers of cost coming up to a total that’s more expensive than before in most cases.”
So transparency on its own is not enough, and in some cases it could even be making it harder for small investors with relatively modest portfolios (say £50,000 or less) to receive advice—either because no one will want to take them on, since the cost of providing advice will be out of proportion to the sums they are able to invest, or because they will balk at paying a separate bill for advice. As leading financial planner Amanda Davidson, of Baigrie Davies, points out, for all its failings the old system at least enabled people with relatively little money to gain access to an adviser because they benefited from an effective cross subsidy thanks to the larger commission advisers could make from their wealthier clients. The price of a properly transparent market has been the removal of that cross subsidy.
And those who applaud the demise of sales targets and opaque commission systems need to recognise that there’s more than one way to mis-sell an investment. You can do as much damage by failing to ensure your customers know their rights as you can by offering your sales people bonuses for meeting targets, or paying commissions to ostensibly independent advisers. Take the annuity market, where most people simply convert their pension pot into an annuity from the same provider that holds their savings. The majority are unaware that since 1975 they have had the right to shop around for the best deal on an annuity (which can be up to 30 per cent better, according to the Pensions Advisory Service) under the so-called Open Market Option. They are unaware or perhaps can’t be bothered and, not surprisingly, for many years pension providers were content to keep it that way.
Now, thanks to the extraordinary economic measures made necessary by the financial crisis, the incomes available from annuities have sunk to extreme lows. As a consequence, consumers can do themselves considerable damage by failing to shop around before they buy a financial product that must last for the rest of their life and that, once purchased, cannot be traded in or amended. In previous years this problem was—apparently—small enough to ignore. Now that approach will no longer wash and the industry is making belated efforts to make sure people realise they have a choice. But again, why has it taken a financial disaster to make clear the need to do something as basic as this?
If we are only now fixing things that, when set down in black and white, are so obviously unsatisfactory, then we can be no more than a few steps along the road towards a market that works in the interests of the people who pay the wages. That is not to decry the steps that are being taken, and the strong indications that more will follow as the FCA’s approach to protecting consumers evolves, but it’s important to recognise that the changes we have seen so far are a work, as yet, barely in progress.
Investors today who are relatively confident and knowledgeable have a far better range of tools, data and commentary available to help them navigate the market than was the case a few years ago. The sums we can protect each year in an Isa are far higher now than they were a few years ago (although the rules on pensions are much stingier). Services such as Stockopedia are a godsend to those with the time and inclination to do their own investment research (and the money to make the exercise worthwhile). There are even signs that new providers are emerging that will offer high quality, mass-market investment services at competitive prices: Nutmeg is one eye-catching example; others will surely follow.
But we are less than halfway there, and the basic reason is this: in Britain we like to think we have a large and sophisticated financial services industry, but that’s a misnomer. What we actually have is a large and sophisticated financial products industry, in which service has too frequently been an illusion or, worse, a confidence trick. Too little of what has happened so far will do much to address this fundamental problem.
Of all the scandals that have tried the patience of savers and investors in the five or so years since the financial crisis began, one stands above them all—the mis-selling of insurance policies linked to bank loans. The true scale of this debacle is still unclear but it has touched millions. Even the squeaky clean Co-operative Bank has found itself embroiled.
The major lenders have so far set aside around £14bn to cover compensation payments, but some believe the figure will eventually reach £15bn or more. The unprecedented size of the scandal over payment protection insurance (PPI) has rightly caught the public’s attention, but its repercussions are making themselves felt in other parts of the financial world, and particularly in the way that British consumers invest their savings.
Few will have seen much about it in the press, but over the past two years virtually all the major banks and building societies have decided to stop offering investment advice to everyone except their wealthiest customers. Barclays was the first to jump, in early 2011, while the most recent was Santander, which said in March that it would close down its advice arm, putting nearly 900 jobs at risk. In doing so, the banks are seeking to head off what might otherwise have become their next major public relations disaster: widespread provision of poor quality and biased investment advice.
The thread that connects the PPI scandal with the banks’ quiet withdrawal from offering mass-market investment advice is not difficult to spot: it’s all about incentives. In the run-up to the financial crisis, large numbers of people were taking out loans and banks knew they could make significant additional profit by selling them PPI policies. So incentive schemes were put in place to encourage frontline staff to sell their socks off, which they duly did with disastrous results. Much the same applies to bank staff who provide investment advice. A significant portion of their rewards over the years has depended on meeting targets, otherwise known as “shifting product.”
If the potential (and actual) problems with this situation are so obvious, the mystery is why it took a scandal the size of the PPI disaster to bring it into the open. At last, however, there are signs that things are changing and grounds, therefore, for some hope that one of the major potential causes of harm to retail investors may eventually be addressed.
In a speech last September, Martin Wheatley, head of the new Financial Conduct Authority, made clear that financial firms’ incentive schemes were going to have to change. “It has been too easy, for too long, for those selling or giving advice to be motivated solely by the rewards on offer to them, rather than how to enrich their customer,” he said. “It’s clear that people no longer believe that they will be treated fairly.”
Wheatley said that regulators had recently examined sales practices at “22 firms of all sizes, including high street banks, building societies, insurance companies and investment firms. And what we found is not pretty. Most of the incentive schemes we looked at were likely to drive people to mis-sell to meet targets and receive a bonus.”
So the FCA will look hard at how firms run their incentive schemes in future to head off the danger of people earning bonuses by pushing unsuitable products at consumers who lack the knowledge and confidence to know when they are being misdirected. But the major victory might already have been won: if banks are no longer going to provide investment advice to the broad mass of retail customers, one of the biggest potential sources of mis-sold investment products has arguably been removed. However, as always, this victory comes at a price. Which?, the consumer group, says that now banks and building societies have largely shut up shop, a large group of smaller investors have been left with no obvious place to go for investment advice. Unless and until new alternatives emerge, most will have to fend for themselves.
Another victory, and one that has received far greater publicity, is the arrival at the end of last year (after a mere six years’ preparation) of the Retail Distribution Review (RDR). This banned the universal practice of fund managers paying commission to financial advisers for channelling clients’ money into their funds, a system that gave unwitting consumers the impression that financial advice was somehow free. Nowadays, clients have to pay for advice separately, which makes the whole system a lot more transparent. In addition, the RDR made advisers gain proper professional qualifications and state whether they are independent (in which case they have to assess the whole market in making recommendations), or whether they offer “restricted advice,” covering products from a limited range of providers. It is the need for proper professional training that some observers believe prompted the banks to quit the market, since the cost of bringing large teams of advisers up to scratch would have been too great for them.
So in view of all this, are retail investors better served now than a few years ago, before the crisis began? Much depends on what sort of investor you’re talking about, says Robin Keyte, an independent financial adviser based in the West Country.
“High net worth investors who are savvy enough to negotiate on the fees, and in particular those prepared to take the time to find a service that doesn’t charge on a percentage basis, are better served than they ever have been,” he says. “The concern is for those investors who aren’t quite so savvy. I think they’re worse off because although RDR has made transparent the layers of cost—the fund management cost, the platform cost and the advisory cost—what we’re seeing is those layers of cost coming up to a total that’s more expensive than before in most cases.”
So transparency on its own is not enough, and in some cases it could even be making it harder for small investors with relatively modest portfolios (say £50,000 or less) to receive advice—either because no one will want to take them on, since the cost of providing advice will be out of proportion to the sums they are able to invest, or because they will balk at paying a separate bill for advice. As leading financial planner Amanda Davidson, of Baigrie Davies, points out, for all its failings the old system at least enabled people with relatively little money to gain access to an adviser because they benefited from an effective cross subsidy thanks to the larger commission advisers could make from their wealthier clients. The price of a properly transparent market has been the removal of that cross subsidy.
And those who applaud the demise of sales targets and opaque commission systems need to recognise that there’s more than one way to mis-sell an investment. You can do as much damage by failing to ensure your customers know their rights as you can by offering your sales people bonuses for meeting targets, or paying commissions to ostensibly independent advisers. Take the annuity market, where most people simply convert their pension pot into an annuity from the same provider that holds their savings. The majority are unaware that since 1975 they have had the right to shop around for the best deal on an annuity (which can be up to 30 per cent better, according to the Pensions Advisory Service) under the so-called Open Market Option. They are unaware or perhaps can’t be bothered and, not surprisingly, for many years pension providers were content to keep it that way.
Now, thanks to the extraordinary economic measures made necessary by the financial crisis, the incomes available from annuities have sunk to extreme lows. As a consequence, consumers can do themselves considerable damage by failing to shop around before they buy a financial product that must last for the rest of their life and that, once purchased, cannot be traded in or amended. In previous years this problem was—apparently—small enough to ignore. Now that approach will no longer wash and the industry is making belated efforts to make sure people realise they have a choice. But again, why has it taken a financial disaster to make clear the need to do something as basic as this?
If we are only now fixing things that, when set down in black and white, are so obviously unsatisfactory, then we can be no more than a few steps along the road towards a market that works in the interests of the people who pay the wages. That is not to decry the steps that are being taken, and the strong indications that more will follow as the FCA’s approach to protecting consumers evolves, but it’s important to recognise that the changes we have seen so far are a work, as yet, barely in progress.
Investors today who are relatively confident and knowledgeable have a far better range of tools, data and commentary available to help them navigate the market than was the case a few years ago. The sums we can protect each year in an Isa are far higher now than they were a few years ago (although the rules on pensions are much stingier). Services such as Stockopedia are a godsend to those with the time and inclination to do their own investment research (and the money to make the exercise worthwhile). There are even signs that new providers are emerging that will offer high quality, mass-market investment services at competitive prices: Nutmeg is one eye-catching example; others will surely follow.
But we are less than halfway there, and the basic reason is this: in Britain we like to think we have a large and sophisticated financial services industry, but that’s a misnomer. What we actually have is a large and sophisticated financial products industry, in which service has too frequently been an illusion or, worse, a confidence trick. Too little of what has happened so far will do much to address this fundamental problem.
