FCA clamps down on 'trail commission'

The FCA is clamping down on rebates from fund management companies to investment platforms such as Hargreaves Lansdown. This is good news for private investors.

Investment platforms such as Hargreaves Lansdown have become increasingly strong over the last few years. These platforms enable retail investors to buy and sell their investments online for relatively low charges.

The growing strength of platforms – also known as fund supermarkets – has largely been a good thing. The only problem has been the way they make money.

Traditionally, platforms have generated most of their revenue by taking commission from the fund management companies. This commission can be paid for years after the client made his initial investment. Usually platforms then rebate some of that commission back to the investor.

There are two problems with this approach:

The consumer may not truly understand how much he is paying for his investments. There’s a lack of clarity.
Platforms might be biased towards the funds that pay the highest commission to the platform.
Some platforms push selections of their favourite funds as a marketing device – a ‘top 50’ or some such. It’s possible that the selection process for these funds at least partly depends on the size of the commission paid by the fund management company.

The FCA is now clamping down on commission. Next year, platforms will no longer be able to take commission from any new investments made in April 2014 or later. And from April 2016, platforms won’t be able to take trail commission from any older investments either.

There are some exceptions to the clampdown, however. Fund management companies can still pay modest rebates, up to £1 a month for each investment. And fund management companies can also pay platforms for advertising.

Non-cash rebates will also be permitted. In other words, the investor might receive extra units in a fund rather than cash.

Good move

Overall, I think the FCA’s changes are very sensible. Greater clarity should boost competition. Some platforms already rebate all commission back to investors – for example, Alliance Trust Savings and rplan – and I’m delighted that everyone will have to go down that route soon.

Granted, if there’s no commission, all investors will have to pay some sort of fee to their platform, but I’ve no problem with that. And as I say, I hope that the greater clarity will drive greater competition between the platforms.

That said, I can’t really understand the exemption for rebates of £1 a month or less.

And I also don’t think that platforms should be allowed to negotiate preferential deals with the fund management industry. (In the industry jargon, this is known as offering ‘super-clean’ share classes.)

So fund management company 1 might normally levy an 0.75% annual management charge for its ‘UK Elite’ fund. But a large platform, Platform A, might be able to offer the fund to its customers with just an 0.72% charge to its customers. By contrast clients of a smaller platform, Platform B, might be charged the normal 0.75% fee.

In other words, Platform A could get a better deal for its customers by using its greater bargaining power.

In my book, that doesn’t promote competition, it will just mean that all the smaller players in the industry will be squeezed out. We need a level playing field for all the platforms – large and small.

Next step

The FCA and its predecessor - the FSA - have now clamped down on dodgy commission structures for both financial advisers and investment platforms. It should now turn its attention to the fund management industry.

It’s hard for an investor to ascertain exactly how much money he is paying to a fund management company. The most widely quoted statistic – the Annual Management Charge (AMC) – doesn’t tell the whole story, and even the Total Expense Ratio (TER) doesn’t necessarily include all the costs.

If the FCA can force the fund management industry to provide greater clarity, investors will at long last know discover how much they’re paying for their investments. That can only be a good thing.

More on investing and platforms:

The cheapest investment platforms – rivals to Hargreaves Lansdown

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