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The RDR Ripple Effect - Dion Global Solutions

Mark Wilkinson

Dion Solutons

22 April 2013

The Retail Distribution Review programme of reforms to the UK financial advisory industry has been in force since the start of the year.  But its implementation is not the end of the story. Instead it could be the catalyst for further and more fundamental changes in the financial advisory landscape argues Mark Wilkinson, sales manager at Dion Global Solutions.

Now that the RDR has had a few months to bed in, the independent financial advisor community has more or less come to terms with the profound changes it has introduced to the financial advisory market. How investors will respond to the fundamental change in their relationship with advisors will become apparent over the next twelve months - although most sensible firms have spent the preparation period communicating and explaining the changes to their clients.

What is less widely discussed is the impact that the RDR will have in the wider financial services market – most particularly for the wealth management community. This seems likely to be fertile ground for future debate, particularly as the implementation of the RDR has pushed IFAs closer to the wealth management business model.

In effect, the architects of the RDR looked at the advantages offered to investors by the wealth management business model, and demanded that they be made available to investors at the retail end of the market. Hence the new direct fee structures and the qualification requirements.

Of course, the fees and the minimum investment thresholds that typify wealth management are not appropriate to the IFA market or their clients. And so the new regulation has created significant tension between the need to improve service and transparency with the need to keep costs low.

Consequently, justifying the direct charges that have replaced commission-based fees from product providers has become a primary concern for IFAs – particularly when it comes to renewals or repeat advice. Equally, the ability to offer discretionary investment services and manage complex portfolios, if qualified to do so, is not necessarily compatible with the IFAs’ typical volume-based, relationship-driven business model.

In effect, the Retail Distribution Review requires IFAs to offer the benefits of a "wealth-management lite" service, without wealth management fees. Not surprisingly, managing this new business model is likely to be the primary challenge for IFAs in the new legislative environment.

However, a growing number of innovative IFAs and smart wealth managers recognise that this challenge is also an important business opportunity. We are seeing creative partnerships develop in which IFAs outsource the provision of discretionary services to carefully selected wealth managers. In practice, this allows IFAs to offer tailored portfolios to match individual client mandates and risk profiles in place of more generic funds that broadly fit their criteria. In return, wealth managers offer value-added services, including high-quality reporting to both the IFA and the end-client as a low-cost means of extending their reach and increasing their assets under management.

For the IFA, the benefit is clear. They can develop an enhanced and differentiated service that includes access to actively managed portfolios and, crucially, the ability to rebalance those portfolios in response to rapid changes in market conditions. Given the recent shocks to the macroeconomic climate in both Europe and the US, this is a particularly attractive proposition that can justify the fees that IFAs must now directly charge to their clients.

What’s more, by choosing to work with wealth management firms who have a demonstrable track record in beating benchmarks, IFAs can offer this more granular and personal service without having to acquire the time and resource-intensive qualifications mandated by the Retail Distribution Review.

This type of partnership also helps address a longer-term structural problem. The internet has enabled a growing number of small-time investors to follow the DIY route and disintermediate IFAs from the research and investment process. The availability of wealth management services without the typical wealth management price tag acts as a useful counter-attack to this trend.

For the wealth manager, entering into a partnership with an IFA opens up new channels for distributing their investment IP and extends it into new areas. A straightforward outsourcing deal as described above is still relatively inefficient because it requires portfolios to be managed on an individual basis. Creating funds that are directly marketed to IFAs can remove some of these inefficiencies, since what is being sold is units of the fund, requiring only one investment decision. A number of firms are already discovering that it is a relatively short step from offering services to an individual IFA’s aggregated client list to developing products to offer out to the independent financial advisor market as a whole.

However, for both partners to realise these mutual benefits, a large degree of process automation is required. The wealth manager’s underlying technology in particular will need to be configured to deliver the efficiencies required at every stage.

Wealth managers will struggle to offer their services to this new client base without a core system that is configured to provide portfolio management, straight-through processing of trade executions and settlement, and full custody functionality. The wealth manager will also need a complex and sophisticated integration model that supports the seamless connection between platforms, IFA back-office technology, and online services. Implementation of such a system will deliver scale and efficiency to all players in the value chain.

Wealth managers will also need specific functionality to handle RDR-compliant charging. Now that responsibility for remunerating IFAs has passed from product provider to investor, systems that can only apply charges to the underlying investors are not enough. Instead, it needs to be able to take the wealth manager’s own cut as well as that of the independent financial advisor – and provide all the accompanying reporting and accounting functions. In addition, the system has to be able to scale commissions around a third party’s charges as well as the wealth manager’s own fees.

The success of the IFA-wealth management partnership model will also depend on the wealth manager’s ability to offer white-labelled reporting that includes online valuations. As we have established, more sophisticated analysis and regular reporting of activity is a critical differentiator between bespoke fund management that investors are prepared to pay for and the free, but generic, investment advice they have received so far. Detailed portfolio analysis across multiple individual holdings allows the provider to deliver a far higher quality of reporting than standard, institutionalised, fund-based solutions.

RDR could have a genuinely transformative effect on the relationship between IFAs and wealth managers, and on the services made available to investors. For the same reasons, pension provision, self invested personal pensions, group pension schemes and all the other areas of financial planning which have been in the hands of institutional providers could be equally transformed. All of this could shift IFA services into a much higher gear and enable them to be delivered with the touch and feel of a bespoke portfolio management service.

The implementation of RDR is not the end of the story. In fact, the RDR could be the beginning of a truly transformational journey, which delivers fundamental changes across the entire range of IFA services – with wealth managers best placed to be the earliest beneficiaries.

However, as the burden of due diligence will continue to be shouldered by IFAs, they will not enter into such partnerships lightly. They will need to assure themselves of the capabilities of their chosen partner; in turn, wealth managers will need to demonstrate that they have the sophisticated technology needed to manage multiple portfolios alongside their fund management expertise. Those that can prove they have what it takes to generate attractive returns at low cost will be in the best position to reap the rewards of the post-RDR world.