How the RDR ban on commission has changed the distribution

landscape in the UK Peter Grimmett, Head of Fund Regulatory Development

EPFA - Prague, September 2015

Confidential and for investment professional use only

2

Context

• Founder of the mutual fund industry in

the UK – 1930’s

• Now fund manager for a wide range of

clients, including internal funds c/o

Prudential plc

• Fund management centralised in

London with 430 investment

professionals across the full range of

asset classes

• 2nd largest retail fund manager in UK

(Source IMA) and a UK provider with UK

UCITS product (OEIC – similar to Lux

SICAV) used to export to EU and more

widely.

Source: M&G, 31 December 2014

Offering straightforward products that clients understand and trust

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Diversifying distribution across Europe

#3 YTD in Europe in terms of net sales

France (2007)

Austria (2001)

Nordics

(2010)

Spain (2005)

Germany

(2001)

Italy (2003)

Switzerland (2005)

Source: M&G Management Services as at December 2013, sales rankings Lipper FMI SalesWatch

UK (1931)

Growing importance in Europe – Czech Republic to come!

Belgium (2014) ,

Netherlands (2010),

Luxembourg (2002)

Asia (Hong Kong

& Singapore)

2011

Chile

2006

Confidential and for investment professional use only

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RDR - UK distribution landscape

M&G

E.g.

stockbroker,

bank, wealth

manager Platform –

Supermarkets,

wraps, life links

Advisers,

Nationals &

Networks

Execution-

only platform

e.g.

Hargreaves

Lansdown or

via IFA

Adviser

Multiple points of access to M&G funds in the UK

Who are our clients?

Advised investor Advised investor Non-advised

investor

Non-advised

investor

Non-advised

investor

Advisory Partnerships Discretionary Execution-

only Direct

Confidential and for investment professional use only

5

Background to Retail Distribution Review (RDR)

• Why? - Retail investors subject to complex charging - Retail investors not understanding that they are paying for advice - Mis-selling - Low training requirements

• Aims to achieve: - Raise professional advice standards (exams) - Better capitalised advisers (big increase in some cases) - Improve consumer understanding of different types of advice - Improve transparency by moving away from commission to adviser charging through fees (reduces conflicts)

• M&G has worked closely with the regulator and sat on trade body working groups and steering committees, so we have been very engaged with this.

Took effect on 1 January 2013

Confidential and for investment professional use only

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Retail Distribution Review What does it mean for advisers?

All advisers have to

meet a certain level

of professional

standards

Advisers have to

categorise

themselves as

‘independent’+ or

‘restricted’*

Advisers can no

longer receive

commission on

new business

Creation of a dual

system of new vs

legacy business

+ Independent: able to consider all types of retail investment products (see Annex): “based on a

comprehensive and fair analysis of the relevant market; unbiased and unrestricted” * Restricted: only able to recommend certain products and / or providers

Confidential and for investment professional use only

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Retail Distribution Review What does it mean for fund management groups like M&G?

Potential shrink in

the adviser

universe (and

consolidation)

Increase in

restricted advisers

could reduce

exposure of M&G

funds

Major ongoing shift

of existing assets

to ‘clean’ share

classes

Transparency led

to pricing pressure

and ‘super-cleans’

Impact on our pricing and value proposition is key

Confidential and for investment professional use only

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“RDR 2”....we now have the full picture

From April 2014:

• FCA will look at applying rules to “adjacent markets” and may consult again.

• FCA expects funds to be priced at a lower level. New share classes may be

required.

Platforms are not be able to receive remuneration e.g. a cash rebate

from a fund provider, even if they pass this all back to the end investor

(some exceptions on what a platform can charge a provider)

Execution-only business is also brought in scope of the

ban of commission

We have built a business model that can cope with these changes

Confidential and for investment professional use only

9

RDR 2 – platform paper What did it mean?

Driving the industry towards ‘clean’ pricing

Cash rebates to

platforms banned

from April 2014

Non-advised in

scope

(and insured?)

Cash rebates for

legacy banned from

April 2016

All rebates now

taxed outside of tax

wrappers

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RDR 2 – platform paper What does it mean for platforms?

Consolidation expected but hasn’t started yet

Significant pricing

pressure – majority

have cut fees

‘Independent’

platforms look

under the most

pressure

Major ongoing IT

build for many

Many moving into

manufacturing and

distribution to

capture more of the

value chain

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M&G share class model post-RDR 1 and 2 How this has changed now all rebates are banned & X-O brought in scope

£A/X £R £I

Legacy business*

Direct

Platforms legacy business

(from RDR 1)

Direct advised

All platforms – new

business

Advisory divisions of

stockbrokers, wealth

managers etc.

Global banks

Discretionary channels

Some

European/global*

Share classes

Channels

*Will continue to receive commission

Discretionary channels

AMC on

standard

equity fund 150bps 100bps 75bps

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Execution only

(IFAs/platforms)

L&P insured links*

Confidential and for investment professional use only

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Who fills the “advice gap”?

0

50

100

150

200

£’000

- Self Directed

- Guided / Internet Solutions

- Multi Asset / Passive (ETFs / Index Tracking)

- Rise of “Robo-Adviser” / Discretionary Direct?

- Nutmeg, SCM Direct, Strawberry Invest

- Investec, HL Portfolio Plus, Barclays

- Can access face-to-face advice

“Can’t pay, won’t pay”

Less access to advice - £100ph x 4hrs work for £3,000 investment.

Increase in self-directed investing (execution only)

Robo-advice in US = £12.3bn (0.15% market share) - Numis

Confidential and for investment professional use only

“While advisers are

focusing their businesses

on higher net worth

clients, large numbers of

investors are being left

without access to

financial advice. Of the

UK’s investing

population, just 30% has

over £25,000 to invest,

leaving the majority well

below the level required

to receive tailored

individual advice.”

Wealth Horizon chief

executive Chris Williams

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Client agreed fees – different adviser business models

Source: Schroders Dec 2014

Can investors truly compare?

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How are platforms pricing?

Source: Platforum 2014

We are now seeing competition in this space

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Other emerging industry themes

1. Increased margin pressure

– Super-clean share classes

– Segregated mandates / Sub-advisory (e.g. Netherlands)

2. Multiple share classes / performance records on new share classes

3. “Dumbed down” funds (no alpha). Danger of low risk, cheap

products (rise in passive sales - ETF and index trackers)?

4. Consolidation and Integration – polarisation of industry, provider-

adviser, provider-platform

5. Concentration in ‘mega-funds’?

Regulator: FCA review already finding conflicts in deals between insurers and

advisers. Curbing non-monetary benefits – MiFID may go further?

Full impact of RDR yet to be realised in the UK

Confidential and for investment professional use only

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Future implications of RDR The cost of the product has gone down, but the total cost has gone up

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From FCA research

Based on an investment of £10,000 for equity funds or ISAs

Source: FCA - Dec 2014

“There is evidence that adviser charges have increased in some cases (certainly there is no notable evidence to

suggest that these have fallen), and lower product charges may not offset this.

“There is also the possibility that some advisers are channelling more of their clients’ portfolios to lower-charging

(i.e. passive) funds in order to keep total costs to clients low, rather than reducing their own charges.”

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Gross Retail Sales at Share Class Level Source: Investment Association based on over 2,500 funds sample

Adviser

rules

Platform

rules

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Impact on funds under management

Source: IMA

Confidential and for investment professional use only

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Summary

• Most agree RDR was poorly executed

• Still an uneven playing field, so further regulation likely

• It’s been expensive for everyone!

• All margins under pressure

• The advisers have met the challenge…BUT

• April 2016 is when the major impact will be felt (legacy)

Next up…MiFID II and inducements?

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Europe and wider

• Full ban in UK and Netherlands – latter seeing moves to guided architecture,

banks acting as asset managers, shift to EO.

• Nordics - Denmark trade body and Government report by end 2014.

Swedish report recommending ban for non-professional clients.

Finland staying with transparency. Norway - banned or full repayment to

client on DPM. No plans for ban on advisory business.

• Germany – law introducing fee based advice. Spain – IFAs already charge

fees, but do they take rebates too? Italy – banned for DPM

• Switzerland – no ban as such but discretionary moving to clean share

classes and advisory fighting possible ban (but plan to comply with MiFID II).

• Australia – banned in July 2013 (but reviewing?), India banned front end

load in 2009. South Africa consulting on ban. Hong Kong?

• But will the global banks or others drive change?

Will regulation, or commercial needs drive change in the future?

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The European dimension

The final impact of MiFID II remains uncertain

Continental Europe going down a similar route from January 2017?

• MiFID II Directive (Level 1) agreed in Europe:

– Inducements will be banned for advice and discretionary portfolio management

unless it is disclosed

– Where advice is on an ‘independent’ basis and discretionary portfolio

management then the acceptance of fees, commissions or non-monetary benefits

will be prohibited

– Member states can go further than this if they wish e.g. UK with RDR,

Netherlands from Jan 2014. Denmark and Sweden keen to follow? German law

introducing fee based advice.

• Only during development of level 2 will we have greater clarity on what it means in

practice – still difficult to retain inducements for non-independent advice under ESMA

final advice.

• Independent defined (good) or may be left up to interpretation of Member States

Confidential and for investment professional use only

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MiFID II – Key points

• Inducements cannot be retrained for independent advice and (discretionary)

portfolio management.

Minor non-monetary benefits permitted (moving beyond UK regime?).

• Independent defined as “sufficiently large”. Not whole of market, nor selling

your own products, so something in between.

ESMA advice is good – do you hold yourself out as independent and can you

justify it?

Tough tests for non-independent advisers retaining retrocessions though?

• Insurance not in scope – product bias?

• Structured UCITS no longer automatically “non-complex” (these funds

typically use financial derivative instruments, in most cases a total return

swap). But ESMA says all AIFs complex!

• Local/municipal authorities now retail clients (but can opt up).

More protections for professional investors.

Confidential and for investment professional use only

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Inducements – possible impacts

• Reduction in independent advice and hence choice

• Won’t impact UK RDR (or Netherlands)

• Only covers MiFID products (pensions and insurance out of scope). Leads to product arbitrage (against UCITS)? Good outcome?

• What about other forms of advice? Advice arbitrage? Independent advisers just say they are no longer independent?

• Wealth/discretionary managers impact – rebates back into fund or client cash account.

• But this current position could lead to global bank platforms going in-house again (although already seeing reduction in open architecture and possible move to sub-advisory). Discretionary PMs setting up own asset management arm?

• More guided/execution only sales?

Confidential and for investment professional use only

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Post MiFID II - inducements

How the new inducements regime might work

Bank

Execution Only Discretionary Business Advisory Business

Non independent Independent

Retrocessions No retrocessions

permitted (or pay back to client)

Can service wider retail market HNWs, fee payers

Not in scope No retrocessions

Retrocessions Most likely clean

permitted share classes?

Confidential and for investment professional use only

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Question

Do you believe in

the next 5-10

years that

inducements will

be completely

banned globally?

Thank you

This presentation is issued by M&G Securities Limited and M&G International Investments Ltd.

Both are authorised and regulated by the Financial Conduct Authority and have their registered offices

at Laurence Pountney Hill, London EC4R 0HH.

Confidential and for investment professional use only

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Annex: RDR – Retail Investment Products

• Collective Investment Schemes (inc. UCITS / ETFs)

• Life Policies

• Personal and Stakeholder Pensions

• Investment Trusts

• Structured capital-at-risk products

• any other designated investment which offers exposure to

underlying financial assets, in a packaged form which modifies

that exposure when compared with a direct holding in the

financial asset

Mortgages, general insurance - out of scope

Confidential and for investment professional use only