Financial advisers ‘ whether they are an IFA, a mortgage broker or a specialist in the sale of non-regulated life and general insurance products ‘ will have some important decisions to make during the coming year.
At their most basic level these decisions all address a fundamental issue: how do you want to generate your income in the future? Mortgage brokers have presumably already made the first key decision ‘ whether to become a qualified mortgage adviser, or focus on the sale of other financial products and either move away from mortgage sales or pass on leads to a qualified adviser who can look after a client’s mortgage needs instead.
According to the Mortgage Code Compliance Board, 51,000 advisers have obtained their mortgage qualifications, so the overwhelming decision appears to be to continue with mortgage advice. Hardly surprising, considering it is an £219bn market in which property values increased by some 23% in the past year and are predicted to continue rising this year, albeit at a slower rate.
With the FTSE continuing to languish below the 4,000 mark, and the sale of pensions and investments stagnating as a result, it is also not surprising that IFAs are turning to mortgages as a source of valuable additional income.
Assuming that a broker has given the mortgage market the thumbs up and decided to become a qualified adviser, they now need to face up to the next important decision to become directly authorised by the Financial Services Authority (FSA), or to take on ‘appointed representative’ status and let someone else worry about compliance issues?
In December 2002, the FSA released a consultation paper on this issue, CP159. In summary, what CP159 does is spell out the choices open to financial advisers regarding authorisation. Advisers can choose to either become directly authorised by the FSA and take responsibility for their own compliance issues, or take on ‘appointed representative’ status and let an authorised ‘principal’ look after compliance for them. Everyone involved in the mortgage market (and those involved in the sale of investment and general insurance products) have until 31 March 2003 to make their views known to the FSA.
In its deliberations, the FSA considered two options for appointed representative status. The first option was to restrict advisers so that they would only be allowed to have a single ‘principal’ covering all products, but it recognised this would have been overly restrictive.
The second option, and the one it favours, is to let appointed representatives have more than one principal, but insist they have the same principal for products sold from a specified ‘substitutable’ product category (by this, it means groups of products which could be offered to consumers as alternatives). The FSA has created 13 separate product categories: one for investments, two for mortgages and 10 for general insurance.
The two mortgage product categories are lifetime (equity release) and mainstream. If mortgages are their only line of business, advisers can have a maximum of two principals, but cannot switch product categories between them. So if one principal is responsible for equity release, advisers can use that principal for equity release but not mainstream products. Advisers can, however, have one principal who looks after both product types. In reality, if an adviser deals with investments, general insurance and mortgages, they could end up with 13 different principals ‘ a nightmare scenario and one few brokers will relish.
No doubt many mortgage brokers will see the appointed representative option as attractive, and with good cause. Becoming directly authorised is not for the faint-hearted, as there will be a considerable responsibility for ensuring adequate compliance checking. Furthermore, there will also be considerable cost implications. At the moment, market speculation is that the direct cost of regulation (for example, fees) could increase by as much as 400%, and this does not include increases in professional indemnity costs and indirect costs which will arise from the need to recruit specialist staff, enhance computer systems and beef up administration.
For larger firms and IFAs who are already used to working in a regulated market, direct authorisation might be worth considering, but for smaller firms and individuals who have hitherto worked in unregulated markets, appointed representative status makes good sense.
If appointed representative status is the route that most small firms are likely to choose, what types of organisations are likely to act as principals and what issues should be taken into consideration when choosing an organisation to work with?
To answer the first question, it seems likely IFA networks, mortgage clubs and life assurance companies will all elect to become directly authorised and therefore be capable of acting as principals. Larger packaging firms and firms of IFAs will also probably choose to do likewise and are therefore potential partners too.
Selecting a principal
Which brings us on to the second question: what issues need to be taken into consideration when selecting a principal?
This is where life becomes interesting. Bearing in mind that the choice of principal for mainstream mortgages (everything bar equity release and those products which remain unregulated, for example, commercial loans and second charge business) will determine the panel of lenders that advisers are able to deal with. If the principal offers access to the whole of the market, fine, but if they work with a restricted panel advisers will have no choice but to do likewise. Principals will therefore control distribution ‘ a fact most lenders have not been slow to realise. These will undoubtedly be considerable jostling between lenders to secure a position on mortgage panels during the year ahead.
This issue could also change the shape of the overall market. Packagers will inevitably feel the pressure, as brokers who have previously used their services decide whether they want to continue to do so, or change allegiance and throw their towel in with a larger network such as Misys, which has already announced it will offer members access to ‘whole of market.’ Some packagers will possibly decide to become principals and offer a compliance service to their brokers and others will either give up packaging (for example, the small packager firms), or take their businesses in a different direction.
At this point, it is interesting to take a backward look at what happened when the Financial Services Act was first introduced in 1988. Interestingly, what happened then was considerable consolidation among the product providers, with life company mergers taking place and life companies exerting a greater stranglehold over distribution as a result. The number of financial advisers operating in the market did not reduce dramatically.
The same could happen in the mortgage market, with the major networks, operating as principals, exerting a stronger influence over distribution. They could, for example, dictate whether brokers continue to use packagers or not ‘ another cause for concern among the packager community. Only time will tell what the mortgage market will look like post-regulation.
Another issue to consider is the number of relationships advisers wish to have with principals. The most a mortgage broker can have is two, but if they also write general insurance and non-regulated life business ‘ which many mortgage brokers do because they are related products ‘ then the number of principals could increase to 12. Again, a point for consideration is how advisers want to manage their life and general insurance business and if they want a single principal, or perhaps two principals, who can look after their entire business needs. This is an area where some larger networks will be setting out their stall by offering a comprehensive one-stop service.
So plenty of food for thought. If brokers believed they had addressed the key issue in their working life by becoming a qualified mortgage adviser, they were wrong. There are plenty of critical decisions still to take. Of course, CP159 is a consultative paper and the eventual regulatory framework may change, but many suspect it will not change an awful lot. What is clear therefore, is that not making a decision about your future status ‘ direct authorisation or appointed representative ‘ is not an option.Furthermore it will have a profound impact on the potential earnings capability of advisers, so it is a decision which needs to be right.
Now is definitely the time to start considering your options.