Wealth management faces a crisis of confidence

As the world looks to right the wrongs of the global financial crisis, one major problem still needs to be tackled, writes Janine Mace - consumer confidence.

Despite a strong rebound from the worst of the global financial crisis (GFC), the wealth management industry still faces major problems when it comes to investor confidence.

This is encouraging regulators and governments around the globe to step in and beef up their consumer protection regimes.

Ernst & Young’s (E&Y’s) UK-based head of global asset management, Ratan Engineer, painted a stark picture of the problem in a recent paper, titled ‘What now for asset management?’

“From the customer standpoint, there is growing disbelief in asset managers’ performance promises. The GFC has had the effect of focusing attention on just how badly broken performance promises have become, and on how wide the gap between fees charged and value conferred has grown,” Engineer notes.

Principal Global Investors (Australia) chief executive officer Grant Forster agrees this is a big issue. “In Australia it is hard to appreciate how much confidence has been damaged,” he says.

This is particularly the case in the US where the return from equities markets over the past decade is negative. “Investors have been told to continue saving over the long term, but they have not had a win in 10 years,” Forster notes.

“You can’t have equity and investment markets losing money for long periods and not see a decline in confidence.”

Introducing regulatory changes to improve consumer protection is a trend emerging around the world, according to Institute of Chartered Accountants of Australia general for manager leadership and quality, Lee White.

“There is a redesign of the regulatory system occurring in light of the lessons learnt [from the GFC] and in particular in the area of consumer protection,” he explains.

E&Y’s Oceania sector leader asset management, Graeme McKenzie, believes this trend will have many flow-on effects for the wealth management industry.

“Confidence in asset management models has been substantially damaged, and this has led to pressure to restore confidence and also on the fees they can charge. We are seeing increased fee pressure and transparency over net returns,” he explains.

Protection around the world

The new emphasis on consumer protection is occurring in jurisdictions everywhere.

In the US for example, the recent Dodd-Frank Wall Street Reform and Consumer Protection Act set up a new Bureau of Consumer Financial Protection within the US Federal Reserve. It is tasked with regulating consumer financial products and services in compliance with federal law.

In the UK, the third arm of its new regulatory structure includes a Consumer Protection and Markets Authority, which will regulate retail and wholesale firms and act as a ‘consumer champion’.

In Singapore, the Monetary Authority of Singapore is working on a package of proposals to enhance safeguards for retail customers, including new obligation on financial advisers “to formally assess a retail customer’s investment knowledge or experience before selling investment products to the customer”.

Customers without relevant knowledge or experience must be given advice before being able to purchase a product.

In May, the Securities and Future Commission in Hong Kong announced a package of measures to strengthen its regulatory regime for investment products.

These measures include changes to Product Disclosure Statements to ensure they summarise key features and risks, with issuers now required to provide a ‘cooling-off’ or ‘unwind’ right.

New conduct requirements for intermediaries have been introduced to encourage enhanced selling practices.

Protection from products

The move towards enhanced product disclosure is occurring globally, according to Forster. “All the main jurisdictions are introducing short-form simplified prospectuses,” he says.

The changes also extend to the availability of some products.

“We might find retail investors are not allowed to engage with certain products that they would previously have been allowed to participate in under previous regulatory regimes,” White says.

He cites the Australian Securities and Investments Commission’s (ASIC’s) recent warnings about contracts for difference as an example of this trend. “ASIC has been using fairly emotive language to warn consumers,” he says.

White believes the trend will continue, as the GFC highlighted the limits to the public’s understanding of financial products. “Recent events showed investors often do not understand the products they are going into, or even who their counterparties are.”

Regulators are already taking a more active stance at the product level, particularly with lightly regulated products such as hedge funds.

For example, in the US the Dodd-Frank legislation will increase hedge fund reporting, while the European Alternative Investment Fund Manager’s Directive intends to impose a comprehensive regulatory regime on the managers of all collective investment vehicles.

“There will be increasing regulation of previously unregulated or lightly regulated markets,” Forster says.

While product providers are feeling the heat, financial advisers are also receiving increasing attention with many jurisdictions looking to strengthen their regulatory regime for financial advice.

New Zealand is currently introducing a new Code of Professional Conduct for Authorised Financial Advisers, which specifies 18 minimum standards covering client care, ethical behaviour, competence, skills and continuing professional training.

According to the chair of the Code Committee for Financial Advisers, Ross Butler, the new rules require authorised financial advisers “to place the interests of their clients first”. They will also promote sound and efficient delivery of finance advice and “encourage public confidence in financial advisers”.

Impact of the trends

Regulatory demands for greater transparency dovetail neatly with consumers’ desire for simple investment products.

“We will see increased transparency in products and will see them become a lot simpler and not as structured as in the past,” McKenzie says.

“We may also see a decline in the number of products, as there is less interest in complex and hard to understand products. Investors now want to understand products and not take them on faith.”

Forster agrees: “People don’t want complex, difficult-to-understand products.”

A flow-on from this is growing global interest in products offering more return certainty.

“It is logical to expect demand for lower-risk, more certain investment outcomes to increase over the long term. Individual investors – especially the older and less affluent – will place far greater value of capital preservation and income generation than capital growth,” Engineer says.

Forster expects to see more interest in products that focus on outcomes, such as target-date funds and cash-plus products.

Engineer agrees: “Overall, individuals’ investment goals will become more closely aligned with their anticipated spending requirements. In effect, long-term retail savings products will move closer to the liability-driven approach favoured by many pension funds.”

The changes in the wealth management industry will also affect product availability, according to Forster.

“As the industry becomes more institutional with increasing mergers and consolidations, companies will want fewer products on their shelf.”

McKenzie believes the new regulatory regime is likely to influence how investors choose to invest and what they are prepared to pay.

“Potentially, we will see a move to the passive style of investment which could lead less liquidity in the market and fewer fees.”

However, he believes the role of financial advisers remains crucial.

“Service will be increasingly important as a differentiator for asset managers and also for financial planners. Good financial planners who deliver service to clients could end up in a better and stronger position with clients in the current environment,” McKenzie says.