The Final Report (Report) of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services industry (Commission) made more than 16 recommendations that will impact on the Australian financial advice industry.
The Government is under considerable pressure to implement the recommendations fully and quickly with Labor this week presenting draft laws for a handful of changes proposed to be implemented before the election. While the Government maintains that it would be reckless to rush legislation through parliament, it proposes to start releasing draft legislation this week as well.
The politicized nature of the implementation of the recommendations increases the risk of further regulatory dislocation where the prevailing legal framework for the provision of financial advice is already characterised by a complex patchwork of legislation and the general law. As explored by Corrs here, the history of financial services reform in Australia is that legislative ‘simplification’ can often be a difficult and costly endeavour.
Most of the financial advice recommendations in the Report, while not radical, will require legislation and that will take time if the changes are to operate effectively with existing laws. This will be a difficult time for the industry given uncertainty about future regulatory changes – exacerbated by tensions among stakeholders and the emergence of disruptive technologies, changing demography and possible changes in governments.
But companies can overcome these obstacles by making regulation a core element of strategy, while the industry needs to deal with regulation less like art and more like science.
Decline of the vertically integrated model?
The effect of the recommendations will be to increase the cost of advice, making the economics of the financial advice industry more challenging. At a minimum, lower revenues and materially increased compliance and costs should be expected.
The findings of the Commission indicate that there are considerable challenges in making a decent return from delivering personalised, bespoke, and un-conflicted financial advice – without cross subsidisation from selling products. The Commission has disclosed the challenges for the vertical integration model.
An augmented robo-advice model?
This could bode well for the designers and promoters of ‘robo advice’ in that digital financial advice will perhaps be the only low margin, mass market model that will survive in the long term.
This highly scalable, lower cost model might be more easily crafted to better suite lower margin ‘advice’, especially if it can lower the costs associated with compliance (e.g. by providing inbuilt compliant advice and reauthorising advice fees and giving written notices to clients annually – one of the recommendations from the Report) but the role for an individual advisor is unlikely to be completely removed especially for complex advice and high value clients (albeit they too may be supported by sophisticated back office online platforms and algorithms).
Transforming financial planners into a profession
In the Report, Commissioner Hayne encouraged the continued evolution of financial planners into a profession concerned with the provision of financial advice, as distinct from the sale of financial products. This can be seen through many of the financial planning recommendations, which are aimed at:
- the removal of conflicts between duty and interest;
- enhanced disclosure of conflicts where they exit;
- requiring fees for the provision of valuable ongoing services; and
- a new professional body and disciplinary system where the ultimate sanction is expulsion from the profession.
Low valuations and market risk mitigations built into transaction agreements
Following the findings of the Report, the financial planning industry is now set to see changing regulations, reduced revenues, increased compliance costs and a more muscular regulator who will be more likely to use the courts to enforce the law.
ASIC has recently announced it will set up a functionally separate Office of Enforcement with a focus on deterrence, public denunciation and punishment of wrongdoing by way of litigation. ASIC is already taking a more active approach with a 15% increase in the number of ASIC enforcement investigations and a 50% increase in the number of ASIC enforcement investigations of misconduct in respect of large financial institutions. ASIC expects these investigations to result in a number of referrals to the Commonwealth Director of Public Prosecutions.
All of these factors are likely to further depress valuations of practices across the industry.
So, in a buyers’ market, we expect to see more rigorous due diligence on the quality of the planners, the client book, the practice revenues, conflicts and compliance systems and processes.
Reflecting the general uncertainty in the market, we expect that payment models are likely to continue to require a significant proportion of the purchase price to be deferred for up to three years post completion to fund any instances of poor advice or compliance issues only discovered post completion.
We also predict an increase in no material adverse change conditions to address any significant risks to valuation or the business identified pre completion. All of this is bad news for those industry participants looking for a clean exit within the next couple of years – but perhaps a great opportunity for others.
The financial advice industry will be shaken by uncertainty about future regulatory changes — exacerbated by tensions among stakeholders and the emergence of disruptive technologies in the sector.
As Beardsley says, the far-reaching impact of regulation means that for companies owning and planning to own wealth management businesses to maximise their long-term value, they must link up their regulatory strategies with their corporate strategies. This will require an understanding of:
- the economic, social, and strategic impact of regulation;
- other stakeholders, so that coalitions can be built to support a chosen regulatory strategy; and
- the fact that regulation needs to be on the agenda of senior management.
The future of the financial advice business will be one where regulation is more intrusive and demanding. To prosper, participants will need to learn how to manage the intersection between their business and the regulation and regulators. This will demand an astute understanding of regulations and the changing community expectations that drive its creation and administration.
Financial advice recommendations – a snapshot
Recommendation 2.4 – Grandfathered commissions
Trailing commissions: The Future of Financial Advice laws banned upfront and trailing commissions but a concession allowed pre-2013 arrangements to continue; they were ‘grandfathered’. In a move that will change the economics of a number of advice businesses, trailing commissions that were previously allowed under the grandfathering provisions will be removed as of 1 January 2021. After 1 January 2021, payments of any previously grandfathered conflicted remuneration still contained in contracts will need to be rebated to clients. This signals the end date for grandfathered commissions, but their phasing out has already begun with each of the major banks having already announced steps to reduce or eliminate them. This is likely to further depress valuations of practices across the financial planning industry.
Recommendation 2.5 & 2.6 – Life risk insurance commissions
Insurance commissions: Until last year, commissions on life risk insurance products were also exempt from the ban on conflicted remuneration. This meant life insurance companies could pay financial upfront and trailing commissions to encourage the advisers to recommend their product. These types of commissions have been capped, but Commissioner Hayne believes they should be removed entirely as soon as possible. We expect there will be a considerable push to do so.
Recommendation 2.1 – Annual renewal and payment
Ongoing advice fees: These will need to be reauthorised every year rather than biannually, and customers must give written authority before the deduction of ongoing fees from their accounts is authorised. It will take some time to assess the cost of the annual reviews of ongoing service fees. Advisers must record in writing each year the services the client will be entitled to receive and the total of the fees to be charged. They cannot permit or require payment of fees from any account held for or on behalf of the client except on the client’s express written authority.
Recommendation 3.2 – No deducting advice fees from MySuper accounts
Prohibiting of advice fees on MySuper accounts: There will be a prohibition on deducting any advice fee (other than for intra-fund advice) from a MySuper account. Watch to see how the Government reconciles this idea with recent recommendations in the Productivity Commission’s report on superannuation, in particular the proposal to fundamentally redesign the selection of default superannuation funds in Australia.
Recommendation 2.10 – A new reporting and disciplinary system
Improving the professionalism of financial advice sector: The core recommendations in relation to improving professionalism includes financial advisers individually registering to a new disciplinary body and mandatory reporting of compliance concerns. Financial advisers will need to be individually registered. A single disciplinary body would be responsible for imposing sanctions for misconduct, with the most severe punishment being deregistration. The exact shape of this body remains to be seen but it would seem that it will not be left to the existing ASIC banning order powers.
Recommendation 2.8 & 2.9 – Reporting compliance concerns and misconduct by financial advisers
Along with reporting misconduct to the new disciplinary body, AFSL holders will be required to report serious compliance concerns about individual financial advisers to ASIC as a condition of their licence.
Recommendation 2.7 – Reference checking and information sharing
All AFSL holders should be required, as a condition of their licence, to give effect to reference checking and information-sharing protocols for financial advisers, to the same effect as now provided by the ABA in its ‘Financial Advice – Recruitment and Termination Reference Checking and Information Sharing Protocol’.
Recommendation 2.2 – Disclosure of lack of independence
Managing conflicts of interest: If a financial adviser wishes to use the words, ‘independent’, ‘impartial’ and ‘unbiased’ but cannot meet the requirements to be classified as independent’, ‘impartial’ and ‘unbiased’, they must advise their clients of that fact before providing any financial advice.
Commissioner Hayne has recommended an amendment to section 923A of the Corporations Act which, in effect, mandates non-independent advice to be outlined in a written statement to clients which goes beyond the general disclosures required in the Financial Services Guide. Depending on how this is implemented, it has the potential to shine a spotlight on ‘vertical integration’ and the conflicts this creates for the product issuers and affiliated providers of advice, adding to the costs of this model. (Elsewhere in the Report, Commissioner Hayne has left ‘vertical integration’ intact and subject only to scrutiny from the ACCC at a future date).
Recommendation 2.3 – Review of measures to improve the quality of advice
In three years’ time, there should be a review by Government in consultation with ASIC of the effectiveness of measures that have been implemented by the Government, regulators, and financial services entities to improve the quality of financial advice. The review should preferably be completed by 30 June 2022, but no later than 31 December 2022.
Further, he has recommended section 961B(2) of the Corporations Act 2001, the ‘safe harbour’ provisions, be repealed no later than 31 December 2022. This will require financial planners to take extra steps to ensure they act in the best interests of their clients.
None of this is surprising and indeed was likely to be the subject of enhanced scrutiny from ASIC since their 2018 Review showed 75% of advices did not demonstrate compliance with the ‘best interest’ duty and related obligations and 10% required client compensation. ASIC said that this is a clear example of a “conflict of interest between the advice licensee’s interest in selling its in-house products and the customer’s interest in receiving advice that is in their best interests”.
Recommendation 3.4 – No hawking
Prohibition on the unsolicited offer or sale of superannuation products:Unsolicited offers or sales of superannuation should be prohibited except to those who are not retail clients and except for offers made under an eligible employee share scheme. This recommendation is set to have a significant impact on the superannuation industry and will switch the debate away from the current difficulties the industry faces in distinguishing between general advice and personal advice, and in turn, the way superannuation products are marketed to consumers.
Skills: Commissioner Hayne considers enhanced education and training essential to the elevation of financial planning to a profession. It’s worth remembering that this will be in addition to the new Financial Adviser Standards and Ethics Authority regime that is already imposing further costs on the industry.
Recommendation 3.5 – One default account
Nominating default funds: There is currently significant confusion and duplication in this area, with many Australians having multiple accounts from different employers. A single, default superannuation account for each person (created for new workers, or workers without a superannuation account). This recommendation addresses the erosion of multiple accounts through secretive and unknown account fees, particularly for young and part-time workers.