In Q2 2015, the U.S. Department of Labor issued a notice of proposed rulemaking, changing the definition of who can be considered a fiduciary to a retirement account or plan. The rule, which is currently in a comment period and should be implemented by Q2 2016, extends fiduciary responsibility to advisors, many of whom are currently under a less strict suitability standard of care. The U.S. government is undertaking this action for two reasons:

• Financial advisors operating under the suitability standard may be unduly influenced by conflicts of interest, based on commission differences among competing investment products they might recommend to individuals’ savings for retirement in defined contribution plans
• The large increase in individuals saving for retirement in self-directed defined contribution plans (instead of corporate directed defined benefit plans).

All U.S. based advisors operate under one of the following standards:

• Suitability standard of care: applies to broker/dealers and requires the broker to “have a reasonable basis to believe a recommended transaction or strategy is suitable for a customer”. The standard interpretation of this rule allows brokers to recommend a product which pays the broker a higher commission over a product that does not pay a higher commission
• Fiduciary care: requires investment advisors to act in the best interests of their clients and manage any conflicts of interest.

Currently the fiduciary standard of care applies to all investment advisors registered under the Investment Advisors Act of 1940, and covers all fee for assets under management (e.g. 1% fee for assets under management). Typically all commission-based advisors are covered under the suitability standard of care (e.g. fee commission for shares purchased or sold), which is much lower than the fiduciary standard. Advisors currently operating under the suitability standard can address this challenge in one of two ways:

• Change their business model from a commission-based model to a fee for assets under management model (thus eliminating commission-based conflicts of financial interest from their advisory services)
• Retain the commission-based compensation model and either offer a very small palette of investment choices or develop robust data analytics tools to address any conflicts of interest.

The second choice seems unlikely to be feasible given current technology, and even if it were, just one mistake could be prohibitively expensive.

Two other countries, U.K. and Australia, have adopted similar changes for their investment advisor fiduciary requirements. Those countries have experienced key changes to their investment industry as a result, including:

• Shift in product mix from brokerage of securities to advised wealth management
• Shift from many low-value accounts to fewer high-value accounts
• Reduction in number of advisors, leaving higher revenue advisors in the business
• Decline in local and mid-tier financial institutions offering investment services
• Increased outsourcing of wealth management processing services by financial institutions 
• Lower value accounts held at discount brokers (or similar) with limited or no advisory services.

The U.S. can expect similar changes in business organization across the wealth management industry with the implementation of the DOL proposed rule, and there will be implications for BPS services. The industry will primarily shift to a two-tier system:

• Tier one wealth managers: these firms will see an influx of business looking for advice, which is payed for with a fee for assets under management. Fees for this will be declining, and wealth managers will need to aggressively reduce costs to maintain profit margins under declining pricing. BPS services will be required that emphasize low cost, increased pricing accuracy, and standardized analytics delivered to advisors
• Mass wealth managers: these firms will see an influx of low-value accounts looking for very low cost, standardized services. BPS services will be required that emphasize very low cost and benchmark-based investments (funds).

The direction of this shift (lower cost, increased standardization) is consistent with current trends. In terms of the scale of the shift, we estimate a 30% shift of business across firms over a five-year period and a 30% reduction in cost of delivery required over the same timeframe. These shifts, which are consistent with the changes that have taken place in the U.K. and Australia, will be required to meet the challenges of the new regulations.