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The big trail loophole - will discretionary fund managers get caught out?

The big trail loophole - will discretionary fund managers get caught out?

Ill-prepared private client firms could feel the heat if the Financial Conduct Authority (FCA) presses ahead with an outright trail commission ban for discretionary managers.

While after 1 April, advisers and platforms will not be able to take trail commission from funds on new business and have two years to eradicate any legacy rebates, discretionary fund managers (DFMs) are not subject to the same restrictions.

Whether discretionary firms want to admit it or not, trail could still account for a chunk of their income. Some suggest that planning for an outright commission ban might be the best course of action.

For businesses that have discretionary fund management as their primary proposition, trail is still ‘likely to still form part of their budget and provide a significant slice of revenue’, in consultant Mike Browning’s view.

While he advises DFMs to manoeuvre out of trail-paying units now, he said the impact of a broader FCA ban will depend on ‘how well prepared and organised they are’.

‘By now they should be preparing budgets where trail is not part of the profit and loss forecast or cash flow,’ Browning said.

Compromising discretionary propositions

George Kirby, a consultant at Knadel, agreed most discretionary firms had recognised the need to move all their clients into clean share classes, although the decision still depends on the firm’s business model.

‘In a less centralised model, a lot of advisers can stay in dirty share classes until they have to do new business for clients,’ he explained.

While trail does not form a significant part of its revenues, Charles Stanley has not yet rolled out a centralised policy regarding trail commission for its discretionary business, preferring to leave it at the discretion of individual brokers.

Clean share classes are purchased for new business, although there are still trail-paying legacy units in the business.

A Charles Stanley spokesman told Wealth Manager some brokers had switched into clean share classes whereas others had not, although it represents a small and declining portion of revenue for investment managers.

‘We are not forcing it from the centre. We’re not telling our brokers “you must switch’’,’
he said.

He added that Charles Stanley will face ‘the moment we have to [come out of trail], but it will be as and when, and down to the broker’.

‘The problem we have as brokers is that most are set up as almost “flags of convenience”. Each individual broker [often self-employed] will have his own runway as to when they will do it.’

In line with the platform pricing deadline, the spokesman added the firm is looking towards a 2016 deadline to go completely clean.

Kirby added that discretionary firms should take into account that clients are better informed and could see clients moving away if they realise they are paying trail commission.

Biting the bullet

However, some firms have bitten the bullet and decided to orchestrate a wholesale shift out of trail-paying share classes. Brewin Dolphin is one such business.

Over the fourth quarter of 2013 the firm announced it had taken a short-term £4 million hit resulting from the loss of trail, forming part of a 40.8% decline in ‘other non-core’ income to £5.9 million.

Pamela Reid (pictured), executive director and head of Quilter Cheviot’s Bristol office, said the company’s policy has been to buy clean share classes for many years.

She said while trail is not a revenue stream that Quilter Cheviot is expecting to retain at all, some legacy or historical trail holdings remained in client portfolios.

However, she added: ‘This is not a major issue as we do not have trail holdings in models.’

Stockbroker WH Ireland confirmed it is in a similar position. Investment manager Andrew Hough-Smith, who is based in the company’s Manchester office, explained the firm is applying a centralised policy to take clients out of legacy trail-paying units.

The FCA made its position clear that it will look to ban rebates for discretionary managers in its PS13/1 paper issued in April 2013, but little has progressed since then.

No ban plans yet

A spokesman confirmed the FCA had no immediate plans to roll out a ban but highlighted minutes from an FCA board meeting last June where the issue was discussed: ‘It is worth noting that the FCA’s board has previously discussed whether an end-date should be created. The board was concerned, that its [trail] continuation could result in poor consumer outcomes.’

Charles Stanley, Quilter Cheviot and WH Ireland were unable to disclose how much they still have invested in trail-paying units.

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