Hong Kong’s financial advisory market is still evolving and while we have moved on from the era of unregulated and unscrupulous financial advisers, the market is still heavily influenced by sales commission. Stewart Aldcroft assesses the experience in other markets and how this might play out in Hong Kong.
Asia, especially Hong Kong, has not yet had the debate that has occurred in many other locations, over whether there should be a commission-ban on the sale of financial products. When this occurs, there will likely be many different opinions, from within the financial services industry, depending on the perspective of the commentator. What is particularly interesting, however, is that in most locations where a commission-ban has been introduced, it was necessary for there to be changes in the regulations to ‘impose’ the ban, rather than to seek a consensus from the market to do it voluntarily.
Why is a Commission-ban of Benefit?
The usual argument is that financial advisers are influenced by the size of the commission they may receive for the sale of a financial product. This can lead to a choice of product that might be less suitable for a client than might otherwise have been the case. This has been a perennial problem in the investment linked insurance market, and in the mutual funds space it is something the Exchange Traded Funds providers cite, when comparing their products to mainstream mutual funds. Experience suggests a commission﹣ban would level the playing field for the benefit of the consumer. It was demonstrated in the UK that after the introduction of their commission ban, advisers did considerably increase their usage of ETFs over other mutual funds.
Another argument is that by placing a ban on commission, the overall cost to clients of the products they might use will be reduced. Again, this can be particularly applied to mutual funds, where the front-end load of 5% may be eliminated (thus becoming zero), and management fees reduced to reflect lower costs also. These lower costs have the benefit of increasing the amount available for investment return to the investor.
Why is Commission Important, and What is the Alternative?
The principal reason financial advisers seek and receive commission is to enable them to provide advice and guidance to their clients without charging fees. This has been the traditional way in which such advice has been supplied in many parts of the world. However, as clients become more sophisticated, they get a better understanding of the variety of costs and options involved in the provision of financial advice, so some resistance occurs. This initially takes the form of discounts off the amount of the front-end load for fund sales, reducing these to less than the usual 5% amount. Of course, for those that invest large amounts, they have far more negotiation power, and can reduce their loads substantially.
Another factor that has significant implications in the Asian region, is that there is still a high degree of client education required when providing advice and guidance, which takes time and needs to be paid for. Commissions do that, if a product is actually sold, but it still remains the case that many clients are ‘just looking’, and may not actually proceed, thus receiving their advice free of charge. This too incurs costs which need to be recovered.
It is generally believed that in Asia there is substantial resistance to clients paying a fee to receive their financial advice, which assumes they are more willing to accept the idea of there being a negotiable commission if they proceed. Often the debate also refers to the thought that fees are only paid to professional advisers, such as lawyers and accountants, which might be seen to be a negative connotation on whether financial advisers are “professional” or not.
The alternative to commissions is generally for there to be a fee being charged. Whereas the usual assumption is that this fee is paid “up front”, for those that provide advice on investments, it could more easily be paid as a percentage of the assets being advised, i.e. an “asset-based fee” that can be received by the adviser regularly over the time period of any investments advised upon. This is usually much more acceptable to clients, who understand that their advisers need to be remunerated, and to some extent incentivised, to provide continuous advice.
Will Asia Introduce a Commission-ban?
In some respects, it is an inevitable conclusion to the long-running saga. In both the UK (which introduced the ban from 2013, following the Retail Distribution Review) and in Australia also in 2013 following a similar government sponsored review, the commission-ban initially had a negative impact on the number of advisers in operation, with many ceasing to operate as a consequence. Other firms were able to take advantage of this, having prepared their businesses in advance of the introduction, and acquired clients, advisers and firms accordingly.
n my view, for what it is worth, any ban would most likely need to be done in the form of a coordinated approach between the Securities Regulators of the region. Thus, most likely, Singapore, Hong Kong and Taiwan would need to do this together, for there to be anything achieved effectively.
The views expressed in this article are Stewart Aldcroft’s own and do not reflect Citi policy.