Question
What's the logic behind the proposed FSA ban on cash rebates suggested by this Money Marketing article?
I presume this refers to commission rebates that platforms such as Cofunds and H-L provide. It strikes me that rebates are in the clients' interest so what are the downsides of rebates for the client? Answer
This is all part of the FSA’s Retail Distribution Review (more info in my article here) which, amongst other things, aims to stop financial advisers from receiving commission as payment for financial advice.
In an ideal world this would mean private investors enjoying ‘institutional’ fund charges (i.e. without commission built in) and then paying an explicit fee to an adviser for advice, if required. For example, fund A might charge 3% initially and 1.5% annually from which 3% initial and 0.5% annual commission is paid, as well as a 0.25% annual fee to fund supermarkets/platforms (where relevant). The institutional version of fund A would probably have no initial charge and a 0.75% annual management fee (i.e. 1.5 – 0.5 – 0.25).
But life might not be that simple. For starters, the FSA will allow fund providers to continue paying fund supermarkets/platforms for their services, which would likely continue to be incorporated into fund charges. So there would need to be another fund share class in addition to institutional units (which don’t normally incorporate platform fees). Institutional units also tend to have minimum deal sizes, which might not be practical for platforms when dealing low volume niche funds.
So it seems the FSA is happy for providers to continue building ‘commissions’ into their fund charges, but this will not be allowed to be paid to customers in the form of a cash rebate for fear some advisers might then take that cash as their advice fee – i.e. the commission system would basically persist. Allowing this system risks advisers recommending funds with the biggest rebates then taking that as their fee.
The FSA instead proposes that rebates may be given in the form of extra fund units, which achieves a similar result to reduced fund charges. So in the above example fund A could charge 3% initially and 1.5% a year but rebate 3% initially and 0.5% a year via additional fund units, effectively giving zero initial charge and a 1% annual charge (which is a similar net result as using the cheapest discount brokers currently).
Bottom line, you should still be able to benefit from using discount brokers, but rather than cash rebates you’ll receive additional units (assuming institutional funds aren’t used).
In my view it would be far simpler to ban extra potential fees from being included within fund charges altogether and simply offer rock bottom cost institutional units to everyone. Any platform fees etc would then be paid directly by consumers, which should create greater competition between platforms and provide better overall transparency.
What's the logic behind the proposed FSA ban on cash rebates suggested by this Money Marketing article?
I presume this refers to commission rebates that platforms such as Cofunds and H-L provide. It strikes me that rebates are in the clients' interest so what are the downsides of rebates for the client? Answer
This is all part of the FSA’s Retail Distribution Review (more info in my article here) which, amongst other things, aims to stop financial advisers from receiving commission as payment for financial advice.
In an ideal world this would mean private investors enjoying ‘institutional’ fund charges (i.e. without commission built in) and then paying an explicit fee to an adviser for advice, if required. For example, fund A might charge 3% initially and 1.5% annually from which 3% initial and 0.5% annual commission is paid, as well as a 0.25% annual fee to fund supermarkets/platforms (where relevant). The institutional version of fund A would probably have no initial charge and a 0.75% annual management fee (i.e. 1.5 – 0.5 – 0.25).
But life might not be that simple. For starters, the FSA will allow fund providers to continue paying fund supermarkets/platforms for their services, which would likely continue to be incorporated into fund charges. So there would need to be another fund share class in addition to institutional units (which don’t normally incorporate platform fees). Institutional units also tend to have minimum deal sizes, which might not be practical for platforms when dealing low volume niche funds.
So it seems the FSA is happy for providers to continue building ‘commissions’ into their fund charges, but this will not be allowed to be paid to customers in the form of a cash rebate for fear some advisers might then take that cash as their advice fee – i.e. the commission system would basically persist. Allowing this system risks advisers recommending funds with the biggest rebates then taking that as their fee.
The FSA instead proposes that rebates may be given in the form of extra fund units, which achieves a similar result to reduced fund charges. So in the above example fund A could charge 3% initially and 1.5% a year but rebate 3% initially and 0.5% a year via additional fund units, effectively giving zero initial charge and a 1% annual charge (which is a similar net result as using the cheapest discount brokers currently).
Bottom line, you should still be able to benefit from using discount brokers, but rather than cash rebates you’ll receive additional units (assuming institutional funds aren’t used).
In my view it would be far simpler to ban extra potential fees from being included within fund charges altogether and simply offer rock bottom cost institutional units to everyone. Any platform fees etc would then be paid directly by consumers, which should create greater competition between platforms and provide better overall transparency.
Read this Q and A at http://www.candidmoney.com/questions/question394.aspx
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