December 20, 2013

We are fast approaching the first anniversary of the implementation of the rules flowing from the “Retail Distribution Review” (or RDR) conducted by regulatory authorities in the United Kingdom. RDR provide a framework for distribution of financial products to non-instituional investors. Given that, earlier this month, Canada’s C.S.A. released a report on the status of their review of mutual fund fees, and given the growing interest of regulators in Ontario in the topic (the OSC held a roundtable discussion on CSA Paper 33-403 this summer), it is a worthwhile exercise to both review RDR as well as examine some of the potential implications of this new regime.

RDR had a threefold set of objectives: (i) to materially enhance the professional standards prevalent in the fund distribution industry, (ii) to render more clear the difference between varying types of financial product and service and (iii) to shine the light of disclosure on the cost of financial advice.

As regards standards, the UK has moved from a Canadian-like patchwork of financial qualifications to the requirement that all financial advisers the the Chartered Insurance Institute Diploma level (or equivalent). Advisers are also called upon to refresh their knowledge through ongoing training and development.

RDR serves the objective of rendering more clear the difference between types of financial advice by requiring advisers to be either “Independent” or “Restricted”. The former is obligated to research the whole range of financial products and generate appropriate recommendations for their clients. Given a client’s risk profile and objectives Independent Advisers must therefore consider not only funds, but also lower cost alternatives such as ETFs and unit trusts. “restricted” advisers can focus his or her practice around a more limited range of of offerings, and can be restricted to a fund range. The fact that the client is being counselled from a more limited palate of options must be disclosed.

RDR’s final goal of ensuring full disclosure of costs is structured to ensure that all initial commission fees, commission trailers and other forms of distribution-related compensation that can be obscured or buried are clearly revealed. Charges are to be fully disclosed and the client must agree to fees in advance of the provision of any advice.

The reactions of some players in the market have been interesting. Rathbones (RAT – LSE), for example, created a new class of shares that removed a 0.5% trailer fee and a 0.25% “platform fee”. Likewise Schroders (SDR – LON) created a new class of shares for its funds at a fee structure of 0.75% – half of the previous levels. The shares of both companies have performed extremely strongly over the course of 2013. Hargreaves Lansdown (HL – LON) moved to a core list of fewer funds wherein price/fee structure is a critical factor. HL shares have almost doubled over the course of 2013.

The CSA report referred to above highlights the ongoing tensions in this country. On the one hand it cites the views of industry stakeholders (such as the big banks with their conflict-of-interest-ridden in-house distribution networks of retail brokers) that embedded , hidden fees do not hurt investors and that their removal would create an “unlevel” playing field. The banks and other stakeholders are also advocating a delay in order to study the impact of RDR. Yet the CSA report also highlights the misalignment of interest in hidden, embedded compensation and its conflict with the duty to act in the best interests of investors.

How this plays out in Canada will be interesting. RDR is clearly signposting a way of giving individual investors much more clarity. Some forward-thinking, non-bank fund complexes may find that they are able to take advantage of the shifting ground and by leaping ahead of potential regulatory change by offering a range of lower-cost fund products with highly transparent fee structures.

This could have significant implications for asset management M&A in Canada as regards both product (the value of investment managers able to generate consistently high alpha could rise) and distribution (fund supermarkets could rise in attractiveness and the value of retail brokers and MFDA systems may change).