DIY investing charges to be made clearer after watchdog bans commission 'rebates' from fund industry
Watchdogs are to make fund supermarket charges clearer by banning the backdoor commission 'rebates' they receive from fund managers.
Investing platforms - which give investors access to funds while keeping all their investments in one place online - will be funded by the fees they charge to investors rather than propped up by such hidden deals, the Financial Conduct Authority (FCA) confirmed today.
The changes follow the Retail Distribution Review which has already barred financial advisers from taking payments for pushing products in January.
Commission ban: DIY platform services will be funded by the fees they charge to investors rather than propped up by private industry deals in future
The commission system means that at present 'some platforms are able to give the impression they are offering a free service, which means that the investor may not understand the true cost,' the Financial Conduct Authority said.
The FCA believes this makes it difficult for investors to compare prices and products on different platforms, and also risks services showing bias towards products from fund managers willing to shell out commission.
DIY fund supermarkets had been waiting for regulators to extend the commission ban to them after similar payments to financial advisers were ended. Many had started handing back some or all of their commission to their customers, or switched to offering commission-free 'clean funds'. (Read our full guide to clean funds below.)
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The move to clean funds on DIY investing platforms was hastened by a recent surprise raid by the taxman on commission rebates from April 6. Investors now have to pay basic or higher-rate income tax on that money - although payouts on Isa and Sipp investments are exempt.
Clean funds are expected to become more popular among investors if only to avoid the hassle and annoyance of paying the tax.
Watchdog issues clean fund price warning
The FCA today warned fund managers not to use the introduction of clean funds as an excuse to jack up fees.
The ban on platform commission is expected to speed up the transition to clean funds. And as these funds already have commission stripped out, they should be cheaper as a result. Even after admin charges are added back in again they offer the opportunity for higher returns over time.
WHAT IS TER?
Total Expense Ratio or TER is the benchmark of fund running costs which is the current best estimate for taking all the administration and dealing charges into account. The bigger it is, the costlier the fund is to run.
But the FCA said today it had received feedback from platforms that fund providers were making their new clean funds more costly than the old kind.
It cited reports that the Total Expense Ratio (TER) - a benchmark of fund running costs - on clean funds was higher than those for funds with commission built in.
'We do not expect these policy changes to be used as a reason by the industry to increase the fees they are able to receive,' said the FCA, which recently announced a probe into high and complex fund fees.
In a thinly-disguised warning to fund houses, it added: 'With regard to the TER on funds, if we see the average TER across the industry increase as a result of these changes and the movement to clean share classes, this will add weight to the concerns we have around pricing and competition in this market.'
What are the new charging rules for DIY investor services?
The FCA is banning cash rebates from fund providers to prevent these payments masking the true costs of platforms' charging structures.
The rules will apply from April 2014 for new clients but fund platforms will have until April 2016 to move existing customers to the new transparent charging model.
In certain circumstances, platforms will still be allowed to accept money from fund providers. Exceptions include payments for work correcting pricing errors, dealing with corporate actions by fund managers, providing information on clients, and advertising.
Platforms will also be allowed to pass on to investors cash rebates of £1 or less per fund per month for practical purposes, such as avoiding costly microtransactions during the administration of a client's business. The FCA considers this sum small enough not to influence platforms' overall pricing models.
The watchdog plans to look at extending the rules to other sectors of the finance industry like the Sipp (Self-Invested Personal Pension) market in future.
Sparkly fresh: FCA has warned fund houses not to use the introduction of clean funds as an excuse to jack up fees
What does the finance industry say?
Leading industry player Hargreaves Lansdown, which refunds on average 0.17 per cent of commission as a loyalty bonus to customers, said it was pleased to have confirmation of rules which bring clarity.
'At first sight the rules, implementation timescales and "sunset clause" are broadly as expected. We have planned for all of these,' said chief executive Ian Gorham.
'As we have said for some time, we expect to offer all Hargreaves Lansdown clients the ability to buy commission-free units in due course.
'The new rules allow us to finalise our plans for this. As we have done successfully for many years, we will continue to seek to use our negotiating power to reduce the cost of investing for our clients.'
Hargreaves added that although Sipp operators are technically excluded from the new rules, it intends to apply them to this part of its business too.
Ian Gorham: 'We will continue to seek to use our negotiating power to reduce the cost of investing for our clients'
Business advisory firm Deloitte said the FCA’s decision to ban cash rebates on new business from 2014 and legacy business from 2016 for investment platforms will increase complexity for fund managers and put further downward pressure on their charges.
Andrew Power, a partner at the firm, said: 'Platforms are likely to accelerate the move to clean share classes and they will want to negotiate deals with fund managers for individual discounted share classes.
'This will be challenging for fund managers who will not want the time-consuming and expensive process of creating multiple share classes for the same fund. The creation of a sunset clause for legacy rebates will accelerate the timescales and the demand.
'It will also hasten consolidation in the platform market as some platforms utilise their scale and capabilities to negotiate better terms from fund managers.'
Peter Hall, chief executive of Bestinvest, said he was strongly supportive of the new rules.
'Unlike many firms operating in the execution-only space, Bestinvest also has a substantial advisory and discretionary investment management business. In these latter areas, which account for half of our business, we have been operating on an explicit fee basis for some time,' he said.
'We have undertaken considerable work in recent months in preparation for a potential new fee structure in the non-advised part of our business which will be based around commission-free "clean" share classes and explicit platform charges.'
Regarding fund fees, he added: 'We are encouraged that the FCA has flagged that where a business has previously been able to negotiate a rebate from a fund provider, the move to clean share classes should not be used as a reason by the funds industry to increase their fees.
'We have always sought to use our scale to get attractive terms for our investors and will of course seek to access as low cost clean share classes as possible on those funds which are rated highly by our research team. Our ratings will however never be driven by price negotiations but based on rigorous and impartial research.'
Patrick Mill, managing Director of Alliance Trust Savings, which launched clean funds on its platform last year, said: 'Alliance Trust Savings wholeheartedly welcomes today’s announcement by the regulator on rebates.
'We have always been supporters of transparency and firmly believe consumers deserve to know and understand the charges they are paying. It is a harsh truth that as a result of these changes many consumers will for the first time realise the true cost of these services.'
Stuart Welch, chief executive of TD Direct Investing, said: 'Today’s announcement from the FCA that it is banning cash rebates on legacy fund business is something we welcome. Indeed, we have been passing on to our clients 100 per cent of the trail commission we receive since July 20121. However, investors don’t have to wait until 2016 to avoid having to pay trail commission all together.
'We don’t need a two-year sunset clause to be ready because we have already made clean share classes (or "clean funds") available to DIY investors now, before any requirement to do so by the FCA.
'Today’s news makes us even more determined to push fund managers to make more clean funds available to us, because this is in the investor’s best interests. Once we are certain our clients can access the most popular funds in clean form it will be our intention to stop selling trail bearing funds in the near future.'
Julie Patterson of fund manager industry body the Investment Management Association said: 'These rules provide some much-needed certainty that enables fund managers to take informed decisions about the range of share classes they wish to offer and the appropriate setting of the annual management charge.
'We share the view that the new rules on payments to platforms should relate to both new and legacy business.
'Allowing indefinite payments on legacy business could cause distortions in the platform market. It is also a pragmatic response to enable a reasonable period for system changes. We continue to want a sunset clause for payments to advisers for the same reasons.'
WHAT ARE CLEAN FUNDS?
'Clean funds' are versions of existing funds that include no commissions for financial advisers, supermarkets or brokers - just the fee levied by the fund manager.
The difference between clean funds and the traditional kind is down to their cost structure once this commission is taken out.
As a rule of thumb, the old charge usually came in at around 1.5 per cent. The way this breaks down is about 0.75 per cent goes to the fund manager, 0.50 per cent to the adviser and 0.25 per cent to a supermarket or broker who does the administration.
So when commission for the adviser and platform is stripped out, that just leaves the fund manager charge of around 0.75 per cent to pay on clean funds.
That does not mean you necessarily get out of paying the other charges. You could end up paying an adviser an annual percentage or a by-the-hour charge for their services.
And while it may be removed from the fund manager's charge, investors still have to stump up administration costs to a supermarket, broker or other intermediary.
The charges have just been 'unbundled', in the industry jargon.
Why were they launched?
Clean funds were introduced due to the huge shake-up in the way money advice is delivered and paid for - officially known as the the Retail Distribution Review or RDR - which means advisers are now prevented from taking commissions.
Fund brokers and supermarkets can still take commission, although many are rebating it automatically to customers ahead a ban under the next stage of the RDR.
The Financial Conduct Authority has just published the final new rules for these fund platforms. They will apply from April 2014 for new clients but platforms will have until April 2016 to move existing customers to the new transparent charging model.
Not all fund providers have launched clean funds yet. Industry body the Investment Management Association said firms were reluctant to change the name of share classes until the platform rules had been finalised, since it is possible they would have to do it all twice and this would only create more confusion.
How to find clean funds
Those fund houses which have introduced clean funds are giving them a baffling array of names, making it hard for investors to tell them apart from the old kind.
For instance, the 'clean' version of the top-selling Invesco Perpetual High Income fund is named Invesco Perpetual High Income No Trail, or 'NT'.
The old Aberdeen Emerging Markets fund which carries trail commission is tagged 'A', while its clean version is called 'I'. The old Blackrock Gold & General fund is also tagged 'A', but the clean one is named D.
Investors looking for clean funds can search on their platform website, contact a fund provider direct or ask their adviser if they have one, but there is no straightforward way to identify them.
The Investment Management Association has been waiting for the new FSA rules before deciding what to do about standardising names.
Should you convert your old funds to clean ones?
Clean funds have most fees stripped out so even after admin charges are added back in again they offer the opportunity for higher returns over time.
However, the continuing existence of commission for platforms and their varying policies towards rebates muddies the question of whether they will always be cheaper than old funds.
It is still possible to end up paying more for a clean fund, depending on the kind of commission deals your fund supermarket has in place with fund providers, and what its rebate arrangements are for customers.
But the FCA today warned fund managers not to use the introduction of clean funds as an excuse to jack up fees.
You can convert your old funds into clean ones quite easily - but you will have to take the initiative and ask as it won't be done for you automatically.
It will be quick and probably free via a platform, but an adviser may charge.