We Would Be Grateful If You Could Submit Any Responses to James King at James

ABI DRAFT GUIDANCE ON BASIC ADVICE

Consultation on draft Model Guide for Consumers on Basic Advice and Guidance for Providers of Basic Advice on Stakeholder Products

JUNE 2005 Introduction

The ABI seeks your comments on the enclosed draft guidance on basic advice.

When the Financial Services Authority (FSA) published its rules1 for the new basic advice regime, it suggested they should be supplemented by industry guidance. The FSA added it believed the Financial Ombudsman Service (FOS) would take account of good industry practice in determining complaints. The ABI also sees value for both providers and consumers in the issuing of guidance.

Early market development since the launch of the basic advice regime in April 2005 has been limited. A handful of providers are offering the new stakeholder products, and so far at least, fewer are offering basic advice. But the ABI hopes that by producing initial guidance we can improve consumer confidence, address some of the barriers to market entry, and identify barriers that need to be addressed by others.

This consultation is intended to enhance the guidance and to foster a shared understanding about the standards expected of advisers. We intend to review the guidance next year in the light of market and regulatory developments.

Two-part guidance

The ABI has developed two-part guidance:

 ABI Model Guide for Consumers on Basic Advice: Helping you to understand basic financial advice  ABI Guidance for Providers of Basic Advice

The ABI’s objective in producing a Model Guide for Consumers on Basic Advice is to raise consumer understanding both of what basic advice is and what they can expect of an adviser offering basic advice. The Guide is drafted for consumers, and is for use by ABI members when (and if) they regard it as appropriate. There will be no requirement to produce the Guide in the form of a leaflet for all users of basic advice. But ABI members will be free to make it available, in a tailored format, to consumers before a basic advice meeting. Other firms may find it helpful to issue the Guide to the customer in advance of a pre-arranged appointment with the adviser. It will also be made available on the ABI website for any member of the public who wishes to know more about basic advice.

The ABI Guidance for Providers of Basic Advice is more technical, and is directed at ABI member firms. It addresses ambiguities in the FSA rules regarding what an adviser can and cannot do. Our main objective in producing the Guidance for Providers is to develop a shared understanding of the standards that are expected of basic advisers. We also see this as a

1 FSA, Policy Statement 04/22 A basic advice regime for the sale of stakeholder products, November 2004.

2 statement about treating customers fairly in the context of basic advice sales of regulated products.

The draft Guidance for Providers does not address the issue of consumer debt and the ‘affordability’ of stakeholder products. The British Bankers’ Association (BBA) has led industry discussions on this issue, and may at a future stage issue specific guidance. The ABI does not wish to duplicate or complicate this work by producing alternative guidance on debt and affordability. The ABI will take a keen interest in the development of any BBA guidance, and we may incorporate it in the final ABI Guidance for Providers of Basic Advice.

Consultation

The draft guidance has been developed in consultation with ABI members and with the BBA. We have also had meetings with the Treasury, FSA, FOS and consumer groups to discuss the guidance. We are now consulting more formally with the main interested parties.

Any comments on any aspect of the draft Guide for Consumers or the Guidance for Providers, or on any other issues that you think should be addressed in the guidance, would be very welcome. We would be grateful if you could submit responses to James King at [email protected] by Friday 15th July.

Next steps

The ABI will consider the consultation responses over the summer. The Guide for Consumers and Guidance for Providers will then be issued to our members in the autumn and placed on the ABI website.

As basic advice is a new service, we currently plan to review the guidance in 2006. This will be conducted in the light of market development and the FSA’s post implementation review of the basic advice regime.

3 ABI Model Guide for Consumers on Basic Advice

Helping you to understand basic financial advice

This short guide will help you to understand what ‘basic’ financial advice is and what you can expect from a financial adviser offering basic advice. If there is anything you don’t understand you can ask your adviser at any time.

A financial adviser helps you to make better decisions on managing your money and will offer you products if appropriate. There are two main types of financial advice available: basic advice and full advice.

What is ‘basic’ advice? Basic advice is a short, simple form of financial advice, which could suit many people, including those who are new to saving and investing, or whose financial needs are relatively straightforward. You will be asked standard questions to determine whether a product from within the limited range of ‘stakeholder’ products offered by the adviser is suitable for you. Stakeholders are savings/investment products that must comply with Government requirements and the product charges are ‘capped’ so they are low cost.

The adviser will recommend a stakeholder product if your answers suggest that it suits your needs. Your adviser may alternatively help you to identify other financial priorities, such as paying off any outstanding credit card debt or purchasing protection for you and your family. You will not normally pay a fee directly to the adviser but, if you buy a product, the product charges you pay may be used to fund commissions to your adviser.

What other options are available?

An adviser offering ‘full’ financial advice will undertake a longer and more comprehensive assessment of your current circumstances and financial aims. This type of advice is suited to people who have more complex financial needs or who want a wider range of product options. For example, if you want advice on any existing savings and investments you have, or want to discuss how to invest directly in the stock market, you should seek full financial advice. Because this is a more extensive service it may cost you more than basic advice, either in fees charged by your adviser or in the price of any product you buy.

If you do not think you need financial advice at all, the adviser or a product provider may be able to provide you with general information and leaflets about the products they offer. If you are not using an advice service, recommendations based on your personal circumstances cannot be made and the choices you make are up to you. Many people – particularly those who are new to saving and investing – are likely to find it helpful to take advice before purchasing stakeholder products.

4 What does basic advice involve? When giving you basic advice, your adviser will ask some standard questions about you, your money and your aims in saving and investing. That may involve asking you:

 How much money you have left over after paying for essentials  Whether you have insurance for you and your family  What your timeframe and objectives are for saving/investing  Whether you are comfortable with some risk to your money  Whether you have access to a work-based pension scheme

Once your adviser has a better picture of your needs, they will talk you through the stakeholder product(s) that they offer. If they recommend a product they will explain why it is being recommended. At the end, your adviser will give you a summary sheet showing any recommendations he or she has made to you and the basis on which the recommendations are made.

Understanding risk There is risk in many things we do that involve finances. For example, if you invest in a house and take out a mortgage, there is a chance that the house price will fall and you will lose money rather than make money. There is also a risk that by not saving for retirement you will not have a large enough income to meet your needs later in life.

The ‘return’ is the money you make on your investment. If a product is low risk there is little chance of losing money, but the return is likely to be lower. If a product is higher risk, there is a chance you may lose some money, but there is a possibility of a high return. If you are willing and able to invest for a longer period, the risk of loss is reduced relative to shorter periods.

It is important that you say what level of risk you are most comfortable with, so that your adviser can make a recommendation that matches this. It is very important that you think about this carefully, because what you say will determine what product is recommended. An adviser will not recommend an investment product if you say you do not want your money to be at any risk.

Preparing to meet your adviser You will be asked about your financial circumstances, such as your monthly outgoings, your outstanding debts and whether your employer offers you a pension. So it would be helpful to prepare any relevant information before the meeting (or telephone conversation) with your adviser. Recommendations will be based on the answers you give to the adviser, so it is important that your answers are clear, accurate and complete.

What if you’re unhappy about something? If you are subsequently unhappy with the service you got from your adviser, they will let you know how to submit a complaint to the company the adviser works for, which will seek to resolve the issue. If you are still dissatisfied, you can ask the Financial Ombudsman Service to investigate the issue. 5

6 ABI Guidance for Providers of Basic Advice

1. This guidance should be read alongside the FSA rules and guidance on basic advice. It is an industry statement on treating customers fairly in the provision of basic advice on stakeholder products.

2. The ABI have also produced a Model Guide for Consumers on Basic Advice for use by its members – Helping you to understand basic financial advice.

3. As an adviser offering basic advice (‘adviser’) is not required to offer the full range of stakeholder products, the product-specific content of this guidance should be tailored and read accordingly.

General

4. The adviser should disclose the range of products on which they are offering advice. The adviser does not need to discuss stakeholder products that are not included within their product range.

5. If an adviser starts to offer advice or a non-advised service on non-stakeholder products, they must make it clear to the consumer that they are no longer offering basic advice. If the adviser subsequently returns to offering basic advice on stakeholder products, they must make this clear to the consumer.

6. If a consumer decides to save or invest in a stakeholder product, an adviser cannot make recommendations on how much they should save or invest. The adviser can provide information to the consumer to help them to make this decision (e.g. ABI pensions calculator).

7. The adviser is entitled to base his or her recommendations on the consumer’s answers to scripted questions. The adviser is not required to collect additional information in relation to the consumer (including information that may already be held within the firm). But if recommendations are based solely on the consumer’s answers, this should be made clear to the consumer at the outset.

8. The adviser should:

 Be open and transparent about the nature of investment risk in relation to the stakeholder investment products.  Use plain language to explain risk and ascertain the consumer’s willingness to accept the risk of loss of capital.

7  Explain that for many people meeting protection needs will be a higher financial priority than purchasing investment products.

9. The adviser can:

 Explain that stakeholder investment products are subject to Government requirements that control their risk (lifestyling in the case of the pension and Child Trust Fund; 60 per cent limit on equity/property investment in the case of the medium-term products), but it should be made clear that there are still investment risks associated with the products.  Explain the risk/return relationship, and refer to the better potential performance of investments relative to deposit saving over the medium/long-term.  Explain the risk of loss of capital reduces the longer the period of your investment.  Explain that inflation erodes the real value of deposit savings.

10.The adviser should not:

 Describe the stakeholder investment products as being ‘Government guaranteed’ or ‘risk free’.  Sell a stakeholder investment product to a consumer who does not want to be exposed to any investment risk.

Medium-term unit-linked product

11.The adviser should:

 Explain the unit-linked product could be subject to significant fluctuations in value, as up to 60% of the fund can be invested in equities/property.  Explain the possible consequences (in terms of a loss of capital) of cashing-in the product when markets are performing poorly.  Explain the unit-linked product is unsuitable if the saving horizon of the consumer is less than 5 years.

12.The adviser can:

 Explain the basic reason to invest in a medium-term stakeholder product is to save for the medium-term (5 years or more) in a low-cost product, which offers access to the potentially higher medium-term returns of equities/property.  Explain that no exit charges apply to the product.  Explain any restrictions on the amount that can be invested in a given tax year.

8 Smoothed investment fund (This section is included in the draft guidance as an indicator of the guidance the ABI would issue in the event of the FSA deciding to permit basic advice sales of the stakeholder smoothed investment fund)

 Explain the main differences between the smoothed and unsmoothed products, but make clear that the consumer makes the final choice between the smoothed and the unsmoothed product (This applies only if the adviser is offering both the smoothed and unsmoothed products).  Explain the smoothed product involves investment risk and is not suitable for consumers who do not want to be exposed to any investment risk.  Explain that smoothing reduces the impact of increases and decreases in the stock market on the value of your fund.  Explain that, relative to a unit-linked product, the smoothed product offers reduced volatility in value  Explain the smoothed product is subject to an additional charge (if applicable) to cover the costs of offering reduced volatility.  Explain a reduction in the value of your smoothed fund may be made in exceptional circumstances (as outlined in the customer- friendly PPFM which will be made available to the consumer from January 2006).

Pension

 Ask whether the consumer has access to an alternative pension scheme to which their employer does make contributions, or would be willing to make contributions.  Suspend the discussion about pensions if the consumer states they are uncertain whether they have access to employer contributions into an alternative pension.  State that the Government currently provides means-tested top- up income in retirement, and explain to the consumer that they should seek alternative advice or information if they require a more detailed explanation.  Explain the standard approach is for the pension fund to be ‘lifestyled’ – ie. the investment strategy will change to reduce the volatility of returns in the years approaching retirement. (But if the consumer is offered and opts for a non-lifestyled investment option, the adviser should make it clear that lifestyling will not occur unless the consumer later changes their mind.)  Explain the pension fund is designed to provide income in retirement and money in the fund cannot be accessed until you reach the minimum age specified by the Government (currently 50, changing to 55 from 2010). 9  Explain that, under current rules, up to a quarter of the fund can be taken as tax-free cash when you retire.

15.The adviser can:

 Explain the basic reason to invest in a stakeholder pension – to build up funds in a low-cost product in order to provide income in retirement.  Explain that state pensions/benefits may not be enough to provide the consumer with the standard of living they want in retirement, so they may need to save in a pension.  Explain that Government currently provides tax relief on contributions made by the consumer (including to those who do not pay income tax).  Explain that for a given contribution, and return on investments, the benefits from pension saving are usually greater the earlier you start saving and the longer you continue to make contributions.  Explain that advice cannot be offered on whether you should contract-out of the additional state pension (State Second Pension), so the consumer should seek alternative advice or information if they require a more detailed explanation.

 Recommend a pension if the consumer states their employer does make contributions, or would be willing to make contributions, to an alternative pension scheme.  Recommend a pension if the consumer is aged over 50 or has less than five years until their expected retirement date.

17.If, following clear, fair and reasonable questions, the consumer states clearly that they do not have access to employer contributions to a pension, then the adviser is not responsible if the consumer is mistaken.

Child Trust Fund (CTF)

 Explain the risks and benefits of investing in equities/property in the stakeholder CTF.  Explain that additional contributions can be made to a CTF account (subject to an annual limit of £1,200).  Explain that contributions made into a CTF cannot be withdrawn by your child until they reach age 18.  Explain that all contributions made to a CTF account belong to the child.

10  Explain the standard approach is for the CTF to be subject to lifestyling – i.e. the investment strategy will change to reduce the volatility of returns as the child approaches 18 years of age. (But if the consumer is offered and opts for a non-lifestyled investment option, the adviser should make it clear that lifestyling will not occur unless the consumer later changes their mind.)

19.The adviser can:

 Explain the basic reason to invest in a stakeholder CTF is to build up a fund for your child in a low cost product, which benefits from Government payments and any additional contributions, so they will have an asset when they reach 18.  Explain that the Government currently intends to make a further contribution to the CTF when the child reaches 7 years of age.  Offer advice on transferring from a deposit-based CTF to a stakeholder CTF.

 Recommend a stakeholder CTF to a consumer who states they do not want the CTF to be subject to any investment risk.

Systems and Controls

21.This section is intended to help companies consider the elements of good systems and controls for their basic advice operations.

22.Companies should maintain:

 Scripts or computerised processes to prevent a basic advice interview going into inappropriate areas and to safeguard customers in view of the different requirements for training and competence for advisers offering basic advice compared with full advisers;  Evidence that staff are trained in the use of such systems and that quality checks are undertaken to confirm that they are followed in practice;  Records of individual customer meetings, including evidence that the customer has been given  an appropriate Initial Disclosure Document;  a copy of his/her answers to questions and of any product recommendation;  notice of his or her responsibility to point out material errors in the record of the meeting, and to raise any concerns about undue pressure;  notice of his or her right to change his mind;  a clear statement of his or her responsibility to offer accurate information in answer to questions;

11  a clear understanding that any recommendation is based only on his or her answers to questions;  a clear understanding of areas where the customer has not received advice (e.g. amount to save, fund choice);  a clear understanding of the extent to which the firm will take account of any prior or wider relationship with the customer;  evidence that the form and language of this material is suitable for the level of sophistication of customers anticipated to use basic advice.

23.Companies should design their systems to take account of:

 The usefulness of obtaining a customer signature. However, firms should also consider the potential for devaluing it if the document being signed is hard to understand, includes unreasonable disclaimers, or if the customer is asked to sign many times (e.g. against each question and answer). In addition, obtaining a signature may not be practical for a telephone-based basic advice service.  The benefits of showing records that the firm’s and customer’s copies were identical and produced at the same time in the same place.