Last Updated: 22 September 2023
The UK’s financial market regulator, the FCA (formerly FSA) has spent years trying to shift financial advisers away from the traditional model of being paid by commission to a new, fee-based approach.
The rationale for doing this is clear. If you’re a financial adviser being guaranteed several years of “trail” commission from a fund manager for recommending one of its funds, you are less likely to put your client into a fund that doesn’t pay a kickback.
Even better (for advisers), so-called retrocessions were hard for the end-client to spot because the investor didn’t see the money passing hands. A third party called a fund platform would divert part of the hefty annual fund fee paid by the investor back to the adviser as the rebate.
The platforms also kept part of funds’ annual management charges for themselves, something which meant several leading platforms didn’t offer cheap index trackers at all: no rebates, no access.
Now the FCA has moved to ban platforms from accepting rebates, something that should level the playing field between the different kinds of funds available on platforms (if you’re a retail investor, you don’t have to use a platform, but if you use a financial advisor of any type you’ll probably end up on one).
So the tide appears to be turning against Europe’s rebate-driven fund distribution model.
Interestingly, in Germany, where regulators haven’t been dictating how the funds market should operate, things seem to be heading in the same direction as in the UK.
The “Verbund Deutscher Honorarberater”, an online resource for Germany’s fee-based financial advisers, has recently started publishing the level of kickbacks paid by the managers of nearly 12,000 mutual funds on sale to investors in that country.
Some funds offered by industry giants like BlackRock, Fidelity and Schroders pay rebates of over 1.5 percent a year to the intermediaries selling them to clients.
Think index funds and ETFs are commission-free? Think again. Most index funds offered for sale in Germany don’t pay kickbacks to advisors, but some managed by Pictet, BNY Mellon, HSBC, UBS, Credit Suisse and Deutsche Bank do.
And several of State Street’s SPDR Europe ETFs offer rebates to advisors, as do a number of funds of ETFs. Fund of funds managers often advertise themselves as offering access to “cheap” ETFs, then go back to bad habits by paying commissions.
Fund managers can also “manufacture” commission-type payments in the ETF market by offering preferred clients superior tracking versus the index than others receive. This is particularly easy to do when the index being tracked has a high deduction for dividend withholding taxes and the managers can achieve a better post-tax dividend rate in the securities lending or derivatives markets.
Kickbacks die hard, in other words. Although Europe’s financial advisory market is seeing a welcome new trend towards clean charging for advice and greater transparency over fees, you need to check closely to see if you’re being offered the best deal you can possibly get. That’s true even in the ETF market, which is not as rebate-free as it likes to claim.