FX brokers work on volume commission, yet traditional financial advisers are charging £10,000 fees. Why?

Thirty years ago, the traditional retail financial services industry in Britain was dominated by large life assurance companies, which provided traditional non-bank investment products such as endowment policies with fixed maturity dates, and the word ‘life’ became an industry buzzword for non-bank investments which were often sold by home service representatives to a domestic retail audience.

Companies such as Commercial Union, General Accident and Lloyd’s Bank’s Black Horse Life were dominant. When South African entrepreneur Mark Weinberg invented the Unit Trust in the early 1980s and established vast financial services firm Allied Dunbar in Swindon, England, a new era was entered in terms of sales.

Allied Dunbar moved away from fully employing financial advisers, breaking away from the traditional model by which investment products were delivered to retail customers.

Commercial Union, Legal and General and General Accident, to name three of the largest in the UK at the time, used to employ a sales team who would be on a salary, and receive commission for each product sold as a one-off payment (no volume or incremental commission) and a company car – cue the bright red Vauxhall Cavalier! – for the representatives to visit their clients.

Allied Dunbar did away with this model and instead of relying on long-term employees with corporate knowledge, recruited self-employed agents with no salary and no provision by the company of any resources, but would remunerate them with very high commissions on a one off and ongoing basis, leading to in some cases the unscrupulous sale of unsuitable products, which in turn led then prime minister Margaret Thatcher to introduce the Financial Services Authority (now the FCA).

Thus, inadvertently, Allied Dunbar had effectively introduced an IB model.

The end of the 1980s, the establishment of what are now giants in the electronic trading world, with their proprietary platforms and sophisticated trading environments, marked the initial point at which retail investors would be able to access the global financial markets in the way that only professional traders employed within institutions in London, New York or Chicago to trade proprietary accounts or hedge funds would have done previously.

With firms such as FXCM, Saxo Bank, IG Group and CMC Markets rapidly rising to prominence in the early 1990s, the days of the Independent Financial Adviser (IFA) were numbered and the man with the pinstripe suit and briefcase soon faded into as much of a distant memory as his accompanying accouterments, the Guards Red Porsche 944 and paper, ring-bound Filofax.

Let’s not forget, Hargreaves Lansdown was founded in 1982 as an Independent Financial Adviser in Bristol, England, and was an intermediary with arrangements with large life assurance firms to provide everything from pensions to life assurance, and from mortgages to endowments on an intermediary basis, and has evolved and adapted to become Britain’s largest retail electronic trading firm.

Or were they?

The home service representative may well be a distant thing of the past in most people’s mind, especially nowadays when the plethora of electronic trading platforms that exist globally have shrunk the world and empowered many self-directed investors and traders, however the traditional financial adviser is still well and truly alive, and in some cases is indulging in a fee-charging practice that is not only highly profitable, but outstrips the monetization method used by so many electronic trading firms.

It is quite widely accepted in the FX industry that many small to medium sized retail FX brokerages which do not have their own trading infrastructure and therefore use third party software such as MetaTrader face a value proposition issue, which has resulted in a race to the bottom in terms of attempting to outprice each other, often resulting in very small margins.

On that note, trading platforms such as MetaTrader 4 may pose an issue given that the ubiquitous trading platform acts both as a key facet with which to onboard clients and as a retention problem, becoming one of the main criteria when choosing a broker to open an account with, which also means those brokers risk being easily substituted following a minor incident or an aggressive marketing campaign by a competitor.

This may well appear as though it is a complex lesson in mathematics; a matter in which accountants must balance the cost of leasing trading infrastructure from a third party platform supplier against the cost of buying media and generating leads, then subsequently factoring in the cost of sales staff to call the leads and then add up the profit post-conversion.

The reality is that in today’s retail FX industry, where the end users have become ever more sophisticated and can absolutely tell if a broker is surviving from their deposited capital instead of connecting to a live market, which has exponentially improved the standards in terms of execution of trades within many medium sized retail brokerages, however it has left a conundrum, that being the completely outmoded marketing model which is not compatible with the commission business that brokerages offering genuine market execution now provide.

If we are so sophisticated, why is the traditional financial adviser outpacing us?

This would be eliminated if commission on trading was either abolished or became irrelevant and brokerage charges were able to be charged.

The retail FX world has ‘educated’ its client base in such a way that it is highly unlikely that any retail client anywhere in the world would pay a fee for brokerage use, especially up front.

This, however, is what some of the remaining traditional financial advisers in the UK are doing, in some cases up to £10,000 for independent financial advice.

Introducing brokers in the FX world – which effectively perform the function of Independent Financial Advisers in the traditional non-bank investment world – cannot charge fees to their clients, especially in Western markets, largely because they have been subjected to a revenue sharing model which is now manifesting itself as problematic.

Here is a good example of the issues concerned.

Today, however, reports in the UK show that many people have been sent invoices for fees by independent financial advisors, often on a monthly basis, and are happily paying them. I challenge any employee of an FX brokerage to receive a positive response to paying external fees like that when calling a client.

The answer would be no. Yet in many cases, despite unwillingness to pay fees by retail clients to FX brokers, the alternative often represents a conflict of interest.

“We have been retired for three years now and have our pension invested through our financial adviser. We have been paying his fees on a monthly basis during this time” explained one retired couple to a British investigative reporter today. “Yesterday we received a letter from him saying he wanted his fees paying upfront in a lump sum almost immediately. We feel uneasy at this as it is £10,000.”

Jenni Allen, Managing Director of Which? Money, replied “You’re right to be wary of a sudden change to your fees, especially as your financial adviser is asking for a substantial amount”, a response that immediately denotes the acceptability of charging external fees.

Under Financial Conduct Authority rules financial advisers are required to disclose charging structures and any changes in writing before the advice process starts, hence fee charging is indeed acceptable and compliant with regulations.

More than that, last November, FinanceFeeds reported that in the advent of the European Securities and Markets Authority (ESMA)’s at the time proposed implementation of MiFID II infrastructure directive in January 2018, a regulatory official from the Financial Conduct Authority (FCA) addressed senior industry executives in the Square Mile, stating that under the new rulings, that if a sales trader provided an idea with “substantive” analysis or insight to a retail client, that would need to be paid for by an asset manager to avoid being classed as an inducement, according to multiple sources who attended the event.

The response from the brokerage industry to this rather ambiguous statement from the FCA was reactive, to say the least, yet nobody bats an eyelid at monthly fees and one-off five figure charges issued to retail investors by independent financial advisers.

“Whilst this is logically consistent with everything the FCA has said on unbundling, it will still come as a bombshell,” said Richard Balarkas, director of Quendon Consulting and former chief executive of Instinet, an agency broker at the time.

This is effectively a surprise to agency firms and internalizers alike, as the FCA has previously stated that research that is provided to traders should be ‘unbundled’ from the price charged, however to now learn that asset managers must charge clients an external fee for research adds an extra cost to the retail trading ecosystem, negating its previous advantage over hedge funds, wealth managers and exchanges, that being market access to multi-asset, liquid assets for a fraction of the cost.

Speaking today to several institutional FX and electronic trading industry executives in London, FinanceFeeds can glean that this FCA official was alluding to a stipulation under MiFID II that any advice or market ‘color’ or analysis will have to be paid for on a fee basis and provided by an independent asset manager, rather than be included in the services provided by brokerages.

This has been interpreted by various professionals in the industry in London as a measure to stop the research costs being bundled into the cost of trading. One brokerage executive today explained to FinanceFeeds in London “It’s the parallel with what the retail brokers do that worries me.”

Another executive demonstrated concern over the costs associated with this that may arise from such legislation. “Asset manager then morphs to small hedge fund which morphs to a MAM account which morphs down to a successful day trader. Conversely, can IG Group, or a similarly large retail firm, run an introduction to trading seminar? Let’s say this costs them £1000, and attracts 10 clients, and they onboard 1 who then pays back the £1000 plus some more perhaps, or would IG Group need to charge everyone £100?”

£100, not £10,000, and a noise was made….