For years, the leaders of Europe’s exchange-traded fund (ETF) industry have been vocal about the positive impact of regulatory change. Initiatives like the UK’s Retail Distribution Review (RDR), which forced financial advisers to charge fees for their services, rather than relying on rebated commissions from fund providers, were expected to lead to a big uptick in the demand for low-cost, index-tracking funds.
RDR came into force at the beginning of January.
So far in 2013 the European ETF market’s growth has been modest, lagging that in the US and Asia and suggesting that RDR-related growth predictions may have been wrong.
But according to ETF issuers, it’s simply a matter of time before the true effect of regulatory change is felt.
“A lot of people thought that come 2 January 2013 there’d be an explosion in ETF demand. That was never going to happen,” says Frank Spiteri, European head of retail strategy at ETF Securities. [Disclosure—I’m doing contract writing work for ETF Securities]
“But regulation has opened the door to passive products,” explains Spiteri, “whereas previously most advisers’ business models were unfair to ETFs and, ultimately to those advisers’ clients. A fee-based model is now in place and there’s an extra emphasis on costs, which favours ETFs.”
However, according to Nick Blake, head of retail at Vanguard Investments UK, many advisers have been slow to adapt to the new regulatory environment and to its impact on their business models.
“Broadly speaking, 10-15 percent of advisers are now truly adapted to RDR, both from a regulatory perspective and culturally,” Blake told IndexUniverse.eu.
“40-50 percent of advisers are still transitioning to RDR, and the remaining advisers still seem to hope that RDR might get called off,” he jokes. “We can expect to see some attrition amongst advisory firms that can't make it in the new environment.”
And a wholesale switch away from commission-based charging for financial advice hasn’t yet taken place, despite the introduction of RDR, notes Blake.
“In the old world an adviser might be paid 3 percent from a fund sale, paid out of the fund’s initial charge, plus half a percent a year in trail (recurring) commission. A lot of advisers seem to think they can continue to charge the same fees,” Blake said. “Some are focused on how to set up the same collection mechanism under the new rules, rather than the value they are actually adding to clients.”
Part of the reason for the delayed reaction to the new regulatory framework was a pragmatic move by the UK’s Financial Conduct Authority (FCA) to allow fund “platforms”—via which advisers’ clients buy funds, as well as receiving post-purchase services like valuations and reports—a grace period, ending in 2016, before they have to charge explicitly for their services. Until then, platforms can continue to accept rebates from fund providers.
Historically, many leading UK platforms like Skandia, Fidelity FundsNetwork and Cofunds excluded ETFs from their product range, favouring the high-commission actively managed funds that allowed advisers to reap commissions from fund houses.
However, according to ETF Securities’ Spiteri, the historical barriers to ETF distribution that resulted from the tight relationship between fund firms, advisers and platforms are now in the process of breaking down.
“As an independent financial advisor (IFA) you now need to give ‘whole of market’ advice,” says Spiteri. “It’s not an excuse to say that ‘ETFs were not on my fund platform and so we can’t include them in our clients’ portfolios’.”
To prepare for RDR, many fund providers started to offer new “clean fee” share classes of popular funds, currently offered in parallel to funds offering so-called “bundled” charging. Under the old, bundled charging regime, a typical fund’s annual management fee—say, 1.5 percent—was directed three ways: 75 basis points to the fund manager, 25 to the platform and 50 as trail commission to the financial adviser.
According to some critics of RDR, the charges for “clean fee” share classes have not come down by enough to compensate for the new, explicit charges for IFA and platform, threatening an overall increase in the costs of retail fund investing.
Money Observer recently reported that it had conducted a survey of new charging structures and found that clients faced an increase of up to 24 percent in annual investment costs by switching away from the old type of fund, where commission is rebated to the adviser directly from the fund fee.