THE COST OF REGULATION REPORT: NOVEMBER 2016

Introduction Since 2014, APFA has conducted an annual survey of advisers about the costs of regulation that firms have to pay. This takes place against a backdrop where one of the biggest concerns for our members is the business cost both of the total amount of direct fees that the sector pays in respect of the FCA, FOS, FSCS and MAS and the indirect costs of regulation and compliance. This report summarises the findings of our research into the cost of regulation in 2015/16. Our sincere thanks go to all those firms who took the time to complete the survey. With the current review of the FSCS levy approach just around the corner and the government and regulator proceeding with the FAMR recommendations to boost access to advice, data on the costs of regulation to firms is more important than ever. Summary of the research findings Our research found that on average, small to mid-sized firms are spending 11% of their income on direct and indirect regulatory costs. Of this, 3% is spent on direct fees and levies, and 8% on indirect costs. The proportion of income spent on direct fees is the same as over the previous two years while for indirect costs it has fallen from 9% in both 2013/2014 and 2014/15. However, in absolute terms, for all businesses with revenue of less than £1m, average direct fees went up from £6k to £9k. With total revenue earned from all regulated business done by financial advice firms in 2015 amounting to £4.27bn, this means the sector spent an estimated £470 million on regulation in 2015. In 2014 regulatory costs to adviser firms were also estimated at £470m, while for 2013 the figure was £460m. Assuming these costs are all passed on to the consumer, we estimate that the average client is paying in the region of £160 each year towards the cost of regulation. Further details about our research can be found below. Notes on the methodology used can be found on p.6.

How much does an advice firm spend on regulation? For all firms with revenue less than £1m in 2015/16, both direct and indirect costs have risen in absolute terms over the last year against a background of rising revenue. Figures 1 and 2 show the changes in direct and indirect costs over the last two years for each size category of firm.

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Figure 1: Direct costs of regulation by firm size 25,000

Direct costs (£)

20,000 15,000 10,000 5,000 0 Under 100k

£100k £250k

£250k-£500k

£500k - £1m

2015/16

3,699

5,462

11,232

22,184

2014/15

2,739

4,870

14,985

15,023

Figure 2: Indirect costs of regulation by firm size 60,000

Indirect costs (£)

50,000 40,000 30,000 20,000 10,000 0 Under 100k

£100k £250k

£250k-£500k

£500k - £1m

2015/16

5,854

12,630

44,656

40,900

2014/15

10,833

15,863

30,597

49,455

Direct costs for nearly every size firm have increased since last year in absolute terms. The one exception to this is for firms in the £250 - £500k revenue category; however, last year’s average direct costs for this firm size were pulled up by a firm entering an exceptionally high figure. In contrast, indirect costs for most firms have fallen since 2014/15 in absolute terms. The exception is the £250k - £500k category where costs have risen substantially to £45k (from just over £30k the year before). This increase has been driven by large increases in the costs of internal compliance measures and internal staff.

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Figure 3: Average direct and indirect costs for all firms under £1m in revenue.

45,000 Costs of Regulation (£)

40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0

2015/16

2014/15

2013/14

Indirect costs

22,551

21,211

30,727

Direct costs

9,319

6,323

9,984

What proportion of turnover is spent on regulation? Our research found that the firms surveyed are spending, on average, 11% of their regulated income on direct and indirect regulatory costs (compared with 12% for both 2014/15 and 2013/14). Of this, 3% is spent on direct fees and levies and 8% on indirect costs. Direct fees and levies include those paid to the FCA, FOS, MAS and other bodies while indirect costs include the money spent in terms of compliance, reporting and management time. For the smallest firms (with turnover of less than £100k per year), the percentage of revenue spent on regulatory costs increases to around 19%. This is a decrease on last year’s value of 28% but broadly in line with figures for 2013/14. The absolute level of costs for these firms went up too. We attribute this to the rising cost of the FSCS. Figure 4 shows the direct and indirect cost for firms as a proportion of revenue with income up to £1 million, analysed by firm size. The largest element of indirect costs remains the amount spent on internal compliance staff and/or external compliance support with the amount spent, as per the previous two years, at approximately 5% of income. For smaller firms, the percentage spent on external compliance staff is higher than for internal compliance spend, reflecting the fact that many smaller firms need to rely on external support to deal with regulatory and compliance issues.

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Figure 4: Direct and indirect costs as a percentage of revenue, analysed by firm size

% of Total Regulated Income

25 20 15 10 5 0 Under 100k

£100k £250k

£250k £500k

£500k £1m

All under £1m

Indirect

12

7

12

6

8

Direct

7

3

3

3

3

Last year, one counter intuitive result was that as a proportion of revenue, indirect costs for firms in the £100-£250k bracket had decreased since the previous year and in fact the first year of the survey saw the proportion of regulatory cost steadily decrease as firms got larger. We committed to monitoring this further. This year has seen the proportion of indirect costs for this income bracket fall still further, to 7.2% as a proportion of income as well as in absolute terms, from £16k to £12k.

How much is regulation costing the financial advice sector? Based on the findings from our research, as in previous years we have estimated the annual cost of regulation for the financial advice industry over 2015/16. Aggregated RMAR data from the FCA shows that the total revenue earned from all regulated business done by financial advice firms in 2015 was £4.27billion1. If on average firms are spending 11% of their revenue on regulation, this means approximately £470m (last year: £475m) has been spent on regulation across the sector in 2015.

How much is regulation costing the consumer? We have also estimated the impact regulation has on the cost of advice for clients. This is particularly relevant at a time when concern within the industry and amongst politicians and regulators about the “advice gap” remains at an all-time high and where there are some consumers who would like financial advice but who cannot afford it2. NMG survey data3 shows that on average an adviser has approximately 121 active clients. With 23,864 advisers in the market this means approximately 2.9 million people are being advised on a regular basis. Assuming that the annual cost to the industry of £470 million is being passed on to clients, each client is paying an approximate average of £160 per year to cover the cost of regulation. Last year’s figure was also £160 (£170 for 2013/14).

1

“Financial Adviser Market : In Numbers” Edition 4.0, APFA, April 2016 “The Four Advice Gaps”, Citizens Advice, October 2015 3 NMG Q3 2016 Business Trends Report 2

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The methodology for making these estimates has remained the same as last year’s for ease of comparability over time. In making these calculations, however, we have had to make a series of assumptions in arriving at our estimates and so it is not necessarily possible to derive a precise number. We believe these estimates remain useful in enabling us to arrive at an indication of the order of magnitude – with each client still paying hundreds of pounds a year just to cover the cost of regulation being borne by the financial advice industry. Adviser viewpoint In addition to asking respondents for figures relating to their direct and indirect costs, we also ask advisers for their views about the cost of regulation. As in the previous two years, the consensus amongst advisers is that regulatory costs – be they direct or indirect – have been steadily increasing over recent years. Several advisers mentioned in the detail the impact on their businesses with some specifically citing the high costs of regulation as the reason behind either joining/remaining with a network or “[turning down] more work which becomes commercially unviable”. Nearly all the comments mentioned the FSCS levies specifically; this may be because the survey was published at the same time as firms got their FSCS and FCA levy reminders. It is also the case that, with a forthcoming review of FSCS levies and informal discussions already underway between the regulator and advisers about potential solutions, the way the FSCS is funded is at the forefront of everyone’s minds. Adviser comments on the FSCS included some from those who felt that they had seen significant recent increases in their FSCS fees e.g. a “tripl[ing] over the previous two years”. This is in line with the survey finding that for all firms with revenue of less than £1m, the average amount spent on direct fees increased from £6k to £9k. Others took the opportunity to outline their opposition to the current FSCS approach, describing the FSCS levy “…as presently constituted…a pure moral hazard” or saying that “[the] FSCS is the good guys paying for the bad guys and must be overhauled”. A significant proportion of respondents also commented on the issue of the longstop: “The longstop issue is very important to the long-term survival, particularly of the smaller-medium sized firm”; “…without the existence of a “longstop”, there is the constant fear of retrospective opinion on advice given many years before a complaint might arise…it cannot be acceptable that advisers are open to attack”… and “the lack of a longstop/long-term fund for complaints will mean that I cannot have a retirement without worry - why should that be?”

Conclusions A key aspect to APFA’s campaigns has been to emphasise the impact on the market of the costs of regulation, in an environment where the government is keen to boost access to financial advice and specifically encourage financial advisers to become involved in markets such as DB to DC pension transfers. It is clear both from the quantitative results and from advisers’ comments that regulatory costs remain a source of frustration for advisers. This is underlined by the fact that nearly 50% of all respondents took the time to give us additional comments and details. APFA has long been campaigning to reduce the regulatory cost burden on advisers and we have seen some progress since the last Cost of Regulation report: 

Changes to the FSCS levy approach – After APFA’s long-standing campaign for significant change to the funding levy approach at the FSCS, the FCA will shortly be Page 5 of 6

undertaking a Review. The issue also achieved prominence in the FAMR Final Report. We will continue to campaign for a fairer approach for advisers. 

Getting rid of unnecessary regulation – Much of the cost incurred by firms arises as a direct result of the complexity of the rule book and surrounding regulations and guidance. Having previously discussed specific rules and regulations that our members deem unhelpful with the regulator, we were pleased to note that the FCA made a commitment to Sustainable Regulation in its 2016/17 Business Plan. We have continued to work with members to feed in views as to how to streamline the current rules.



The liability longstop – We believe that introducing a 15-year longstop would cut advisers’ PI costs significantly. We welcomed the decision of the FAMR team to explicitly examine the case for the longstop although we remain disappointed with the outcome. APFA is continuing to take the case for a fairer approach to adviser liability to senior politicians and regulators in advance of a formal government Review of progress against the FAMR recommendations in 2019.



Reducing reporting requirements – Whilst some changes have been made to the RMAR, there is still scope for the FCA to undertake further reform. We will push hard for reporting requirements to be explicitly examined as part of the FCA’s Sustainable Regulation agenda (see above).



Cutting the cost of public financial guidance – Advisers pay a significant proportion of the costs of the money and pension guidance services. APFA called for these organisations to be rationalised and we welcome the decision of the government to merge the public guidance bodies into one organisation.

On all the above issues – as well as others – APFA continues to work to get a better deal for advisers. However, we would also urge firms to be transparent about the cost of regulation to clients. Last year we came up with the following disclosure wording, to be used as a template and part of the disclosure documents to clients. An updated version is below: “Our firm is regulated by the Financial Conduct Authority (FCA), which means that you are protected through the work of regulatory bodies including the Financial Ombudsman Service (FOS) and the Financial Services Compensation Scheme (FSCS). These organisations settle disputes between consumers and UK financial services businesses, as well as providing a fund of last resort. Financial advice firms like ours fund these bodies through direct fees and levies and are also required to comply with rules set by the FCA, which necessitates investment in compliance staff and technology as well as further costs in the form of Professional Indemnity (PI) Insurance. For the 2015/2016 period the Association of Professional Financial Advisers (APFA) has estimated, across the profession, that the cost to each client for the regulatory costs that a firm like ours incurs is £160.”

Methodology APFA conducted in-depth surveys with 99 adviser firms between June and September 2016. We asked advisers to estimate how much they spent each year both on direct regulatory fees (FCA, FOS etc.) and on indirect costs such as compliance, reporting, management time etc. We then used this information to estimate what percentage of firms’ turnover was spent on regulation, the total cost to the industry and how much regulation adds to the cost of advice for the average client.

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