Platform operator must not accept volume-based shelf-space fees and financial services licensees (and its representative) must not charge asset-based fees on borrowed amounts

The Australian Government's Future of Financial Advice (FOFA) reform commenced on 1 July 2012 and compliance will be mandatory from 1 July 2013.

In our last article we looked at the ban on conflicted remuneration in detail. In this article we'll look at the ban on other remuneration, namely, the ban on volume-based shelf-space fees and the ban on asset-based fees on borrowed amounts.

Ban on volume-based shelf-space fees

In the industry, it is common place for a platform operator to charge a "shelf-space fee" to a product issuer or funds manager in exchange for making a product issuer's or funds manager's product available through the platform operator's platform.

Section 964A of the Corporations Act 2001 establishes a ban on the receipt by platform operators of volume-based shelf space fee. Essentially, platform operators must not accept volume-based benefits to the extent that such incentives are a means of a product issuer or funds managers purchasing shelf space or preferential positions on administration platforms. The intention of this ban is to prohibit any benefit which is intended to gain a placement on a platform or preferential treatment on a platform (for example: a position on a model portfolio or menu selection).

A "platform operator" is defined as a financial services licensee or RSE licensee that is, or offers to be, the provider of a custodial arrangement. The term "custodial arrangement" is defined in existing section 1012IA of the Act as, broadly, an arrangement where the client may instruct the platform to acquire certain financial products, and the products are then either held on trust for the client, or the client retains some interest in the product. It is important to note that, since "custodial arrangement" has a broad definition, it not only covers typical financial products such as superannuation master trusts, investor directed portfolio services (IDPSs) and IDPS-like, but also nominee or custody services arrangements.

Sub-section 964A(2) of the Act presumes a benefit to be a volume-based shelf-space fee, if the benefit or its value is wholly or partly dependant on the number or value of a funds manager's financial products to which the custodial arrangement relates. In paragraph 50 of "Regulatory Guide 246: Conflicted Remuneration" (RG 246), ASIC stated that this presumption will include:

  • a fee that is based on past, current or projected volumes, even if other factors were considered in determining the value of the benefit; and
  • a fee that is paid by a funds manager, calculated by reference to each of its products on the platform.

However, the presumption (discussed in the paragraph above) does not apply if the platform operator can prove that all or part of the benefit is:

  • a reasonable fee for a service provided to the funds manager by the platform operator or another person (this is known as the fee-for-service exclusion); or
  • a discount on an amount payable, or a rebate of an amount paid, to the funds manager by the platform operator, so long as the value of the benefit does not exceed an amount that may reasonably be attributed to efficiencies gained by the funds manager because of the number or value of financial products in relation to which the funds manager provides services to the platform operator, or through the platform operator to another person (this is known as the scale efficiencies exclusion).

The onus of proving that the benefit ought not be presumed a volume-based shelf-space fee lies with the platform operator. This is because the Government believes that it is reasonable to expect that the platform operator will be aware of the nature of any discount or rebate it receives, and will therefore be aware of whether a payment is a genuine fee for service, or represents genuine scale efficiencies.

In addition to the above exclusion, ASIC has indicated in RG 246.162 that it will not take any action against a platform operator who accepts a volume-based shelf-space fee if that fee is passed on promptly to its clients.

"Fee-for-service" exclusion

ASIC has stated that whether the "fee-for-service" exclusion can be relied on depends on the circumstances of the case. The type of fees to which ASIC believes this exclusion apply include:

  • fees charged to cover the platform operator’s costs in listing a product on its platform; and
  • fees for reporting services provided by the platform operator to the funds manager about clients who have invested in its products and advisers who have recommended its products.

If the "fee-for-service" exclusion is being relied on, ASIC is more likely to scrutinise a fee if:

  • there is a sudden increase in the fee after the commencement of section 964A of the Act that is unrelated to the platform operator’s costs;
  • the fee is based on the value of funds under management as these fees are unlikely to correlate with the platform operator’s costs in providing the service;
  • the fee is inconsistent with the fees charged for similar services provided to other funds managers; or
  • the fee is inconsistent with the average fees charged by other platform operators.

Therefore, a careful review of the services provided by a platform operator to a funds manager should be undertaken. In addition, a platform operator must ensure that any fees it charges a funds manager are reasonable and, more importantly, a platform operator must ensure that there is a correlation between the fees charged with the platform operator's cost in providing the services.

"Scale efficiencies" exclusion

ASIC has stated that to rely on the scale efficiencies exclusion a platform operator must be able to demonstrate how a rebate or discount was arrived at and how it is referable to scale efficiencies or estimated scale efficiencies gained by the funds manager from distributing its products through the platform.

ASIC has helpfully provided an example of how a platform operator may do this. A platform operator could rely upon the scale efficiencies exclusion by receiving and keeping regular and appropriately verified written analysis from the funds manager about its costs and how the value of the rebate or discount is referable to scale efficiencies or estimated scale efficiencies. ASIC further stated that the analysis should set out details about how the funds manager’s fixed costs (as opposed to costs that vary with each financial product sold) have reduced by reference to the number or value of financial products that are acquired by clients using the platform.

However, ASIC has clearly stated that a platform operator could not rely upon the scale efficiencies exclusion by just receiving a written confirmation from a funds manager (which states that a discount or rebate is referrable to the scale efficiencies gained by the funds manager) without providing further information.

Ban on asset-based fees on borrowed amounts

Sections 964D and 964E of the Act establish a ban on asset-based fees on borrowed amounts, where a licensee or its representative provides financial product advice to retail clients. The licensee or its representatives must not charge asset-based fees to retail clients on borrowed amounts to be used to acquire financial products by or on behalf of the clients. The intention of this ban is to prevent advisers from artificially increasing the size of their advice fees by "gearing up" their clients.

The Act defines an "asset-based fees" to be any fee for providing financial product advice that is dependant upon the amount of funds to be used to acquire financial products. Please note that if a fee is partly dependant on that amount of funds, then it is an asset based fee to that extent. A "borrowed amount" is defined to mean an amount borrowed in any form, whether secured or unsecured, including the raising of funds through a credit or margin lending facility.

The ban does not apply if it is not reasonably apparent that the amounts used to acquire financial products has been borrowed. An objective test is applied to determine whether something is "reasonably apparent". Something is "reasonably apparent" if it would be apparent to a person with a reasonable level of expertise in the subject matter of the advice, exercising care and assessing the client's information objectively. Please note that this exception does not absolve a licensee or its authorised representatives from its best interests duty as prescribed in section 961B of the Act. As you are probably aware, under this duty, licensees or their authorised representatives must make reasonable inquiries to obtain complete and accurate information from their clients. Therefore, advisers cannot deliberately or knowingly disregard relevant information they have discovered in the course of making these client inquiries when determining whether an amount is borrowed for the purposes of the ban on charging asset-based fees on borrowed amount.

In RG 246, ASIC has indicated that the following circumstances will attract the ban on asset-based fees on borrowed amounts:

  • when a client holds an instalment warrant, the ban on asset-based fees on borrowed amounts applies to the extent an asset-based fee is referrable to the debt component of an instalment warrant; and
  • when a client has a portfolio of products purchased with a combination of borrowed and non-borrowed amounts, an asset-based fee cannot be charged on any portion of the portfolio which has been acquired by borrowed amounts. To be able to charge asset-based fees, the net value of the portfolio should be determined, and the amount borrowed (less any amount repaid) should then be deducted from this net value.

ASIC has also indicated that the following circumstances will not attract the ban on asset-based fees on borrowed amounts:

  • if a fee charged is not for providing financial product advice (for example, application fees and the interest charged on a loan taken out by a client to purchase financial products) the ban on asset-based fees on borrowed amounts does not apply to the fee; and
  • when a client acquires a financial product and participates in a dividend or distribution reinvestment plan in relation to that holding, the ban on asset-based fees on borrowed amounts does not apply to products issued under the dividend or distribution reinvestment plan.

Also, the ban on asset-based fees on borrowed amounts also potentially operates so as to ban brokerage charged for transactions which settle to a margin loan (and where personal or general advice is provided to a retail client). Therefore, when borrowed amounts are used to acquire financial products, a careful review of any asset-based fees charged should be undertaken to ensure that it does not violate the ban on asset-based fees on borrowed amounts.