The second tranche of the Future of Financial Advice (FoFA) legislation was released yesterday.  It includes a number of bans relating to conflicted remuneration and other payments.  The release contains a second exposure draft Bill and explanatory memorandum and follows the release of tranche one on 29 August 2011.  Please click here to see our Alert for the first tranche

The Bill will introduce a broad range of bans aimed at payments that could be considered as having the potential to influence financial product advice to retail clients.  Some bans are wider than or different to the bans that were previously described in Government announcements on FoFA.  There are bans on both giving benefits and accepting benefits.  There are some limited exceptions and regulations are intended to cover other exceptions (eg for stockbroking activities).  Surprisingly, the second tranche does not expressly cover any grandfathering of payment arrangements entered into before 1 July 2012.  As anticipated, the second tranche does include broad anti-avoidance provisions.

The bans can be broken down into:

  • bans on financial services licensees (“AFS Licensees”), authorised representatives and representatives accepting conflicted remuneration (including both monetary and non-monetary benefits);
  • bans on product issuers and sellers giving benefits to AFS Licensees and their representatives;
  • a ban on AFS Licensees and APRA regulated superannuation trustees (“RSE Licensees”) receiving volume-based shelf space fees;
  • a ban on charging retail clients an asset based fee on geared funds used to acquire financial products; and
  • restrictions on payments and other incentives for employees of AFS Licensees.  

Bans on financial services licencees, authorised representatives and representatives

Ban on accepting conflicted remuneration

The draft  Bill contains a ban on AFS Licensees and authorised representatives (“ARs”) of AFS Licensees accepting “conflicted remuneration”.

An AR will not be in breach of the prohibition if it was not aware the remuneration was conflicted remuneration because it reasonably relied on information provided by the AFS Licensee.

An AFS Licensee will also breach the law if a representative of the AFS Licensee, other than an AR, accepts conflicted remuneration where the AFS Licensee is responsible for the representative’s conduct.  This would include, for example, employees of AFS Licensees who are not ARs.  The AFS Licensee must take reasonable steps to ensure that representatives do not accept conflicted remuneration.

The representative is also banned from accepting the conflicted remuneration, unless it is remuneration which an employer is not banned from providing (see below about benefits for employees).

Definition of conflicted remuneration

“Conflicted remuneration” is defined broadly to mean any benefit, whether monetary or non-monetary, given to an AFS Licensee or a representative of an AFS Licensee “who provides financial product advice to persons as retail clients” that, because of the nature of the benefit or the circumstances in which it is given:

  • might influence the choice of financial product recommended by the AFS Licensee or representative to retail clients; or
  • might otherwise influence the financial product advice given to retail clients by the AFS Licensee or representative.  

Note that this is not limited to personal advice and, therefore, will have a very broad application.  The definition also specifically includes “volume based benefits”, which are benefits that are dependent on the total value or number of financial products recommended by the AFS Licensee or representative, or benefits dependent on the value of investments made by retail clients to whom the AFS Licensee or representative provides financial product advice.

Earlier Government announcements focused on volume-based payments.  However conflicted remuneration need not be volume-based to be “conflicted remuneration”.  The draft explanatory memorandum states “any flat payment received by a licensee would on its face be conflicted remuneration”.

Exceptions

Specific types of monetary and non-monetary (“soft-dollar”) benefits are excluded from the definition of conflicted remuneration and so the ban on accepting conflicted remuneration will not apply to these types of benefits:

  • General insurance - monetary and non-monetary benefits given by a general insurer in relation to general insurance products.
  • Life insurance - monetary benefits given by a registered life company in relation to life risk insurance products (not investment-linked) outside of super or in relation to an individual policy within super where the member has exercised choice of fund.  However, the ban will apply to monetary benefits given in relation to group life insurance in super and individual policies in default super funds where the member has not exercised choice of fund.
  • Execution only- monetary benefits given in relation to an issue or sale of a financial product where no financial product advice in relation to the product or the class of products has been given to the person as a retail client by the AFS Licensee, a representative, or an associate of either.
  • Advice to wholesale clients - the execution only exception also applies if advice is given to the person as a wholesale client.
  • Benefit provided by retail client - monetary and non-monetary benefits given by a retail client in relation to the issue or sale of a financial product, or in relation to financial product advice given, by the AFS Licensee or representative to the client. Therefore volume-based charges for advice are permitted (except to the extent that geared funds are involved).
  • Education - non-monetary benefits in the nature of genuine education or training relevant to the provision of financial product advice to persons as retail clients, subject to regulations to be prescribed.
  • Information technology software or support - non-monetary benefits of this nature related to the provision of financial product advice to persons as retail clients in relation to the financial products issued or sold by the benefit provider, subject to regulations to be prescribed.
  • Soft dollar benefits under $300 - non-monetary benefits of an amount prescribed by regulations (expected to be $300) where identical or similar benefits are not provided on a frequent or regular basis.
  • Stockbroking services - the draft explanatory memorandum says that it is proposed to exclude certain stockbroking activities from being considered conflicted remuneration, and that the precise scope will be subject to further consultation.
  • Employee brokers - the draft explanatory memorandum says that regulations will ensure that the traditional arrangements of employee brokers are “not unduly impacted” by the conflicted remuneration measures.  

Other excluded benefits may be prescribed by regulations. 

This ban and the other bans proposed by the draft Bill will apply from 1 July 2012.  Despite previous announcements, there is no specific grandfathering of arrangements entered into before 1 July 2012.  The only mention of grandfathering is a tangential reference in an example in the draft explanatory memorandum.  It is surprising that such a key exception is not expressly outlined in the second tranche.

Bans on product issuers and sellers

The Bill also includes a ban on an issuer or “seller” of a financial product giving any benefit (whether monetary or non monetary) to an AFS Licensee or its representatives if the recipient provides financial product advice to retail clients.  This is a very broad ban with significant ramifications.  The term “seller” is not defined.

The ban will not apply if the benefit is a “fee for service and the fee reasonably represents the market value of the service”.  However, this exception could only assist the product issuer or “seller”.  It would not assist the AFS Licensee or its representative if the benefit was also conflicted remuneration.

There are other exceptions to the ban:

  • if the benefit is the purchase price for property and the benefit reasonably represents the market value of the property;
  • if the benefit relates to general insurance, life insurance, genuine education or training purpose or IT software or support in a similar way to the exceptions for conflicted remuneration.  

The ban puts the onus on product issuers to know the status of those they give benefits to, or to satisfy themselves that there is a genuine “fee for service” or that some other exception applies.

Benefits for employees

An employer of a representative (or an employer of an AFS Licensee, if the licensee is an individual) must not give the representative (or licensee) conflicted remuneration for work done (or to be done) by them as an employee of that employer.  However, the ban does not apply if either:

  • the benefit is not a “volume based benefit” (see above); or
  • the employer is an Australian ADI, the benefit depends on the recipient recommending a basic banking product and no other financial product advice is provided as part of the recommendation.  

Volume-based shelf space fees

The ban on volume-based shelf space fees is broader than contemplated in previous announcements, extending to benefits well beyond those that would be described in the industry as “shelf space fees”.  Features that were not previously anticipated include:

  • First, the ban extends beyond traditional platforms (ie, IDPS operators, master funds and superannuation platforms).  The scope of the “platforms” to which the ban relates are defined in functional terms as “a facility through which financial services licensees and their representatives can obtain information about financial products or a facility through which financial products are issued”.  In addition to platform menus this would capture approved product lists and electronic information portals of research houses.  It would also extend to electronic and physical brochure/PDS libraries.  On a broad view, it could even extend to advertising of financial products in print and electronic media (although a ban would only apply if the operator of these facilities holds an AFS Licence or an RSE Licence).
  • Secondly, volume-based benefits are defined not only by reference to benefits based on the value of the products, but also include benefits based on the number of products.  This would seem to ban a flat fee per product, independent of the value.
  • Thirdly, there is a limited exception where volume-based shelf space fees are effectively set-off against amounts the platform operator has agreed to pay a product issuer for services provided by the product issuer.  This is subject to a limit, linked to the reasonable value of scale efficiencies for the product issuer in providing those services.  

The provisions ban an AFS Licensee and an RSE Licensee from accepting a volume-based shelf space fee.

Clients paying for advice and products

As noted above, there is an exception to the ban on conflicted remuneration for monetary and non-monetary benefits given “by a retail client” in relation to the issue or sale of a financial product, or in relation to financial product advice given, by the AFS Licensee or representative to the client.  It should be possible for a client to pay for advice calculated on assets under management as well as other fees for service (eg hourly rates or flat fees).

A benefit may be given “by” a client if the client is able to redeem their investment and direct the issuer to pay the redemption proceeds to the AFS Licensee or representative.  This will not always be possible, for example where the investment is superannuation and no condition of release has been satisfied.

There is a separate ban on charging retail clients an asset based fee on geared funds used to acquire financial products.  The ban will apply where financial product advice is provided to a retail client and so will apply even where only general advice is provided.  “Geared funds” are borrowed funds and “borrowed funds” are defined very broadly and expressly includes raising funds through margin lending facilities. 

The ban is applies only to geared funds and only to the extent that they have not been repaid.  This is a sensible narrowing of the April announcement by the Government which suggested if any component of a strategy was geared, the asset based fee ban would apply to the entire strategy.

Anti-avoidance

  • The Bill also outlines the proposed anti-avoidance provision.  The provision is broadly drafted and prohibits any person from entering into a scheme (either individually or together with others) if:
  • it “would be concluded” that they entered into that scheme for the “sole or dominant purpose” of avoiding the application of the relevant Part of the Act (proposed Part 7.7A); and 
  • the scheme has achieved or would achieve that purpose.  

Breach of the anti-avoidance provision will trigger a declaration of contravention by the Court.   

The anti-avoidance provision will have a lot of work to do, because the bans only apply to benefits given to or by, or accepted by, persons of particular kinds – AFS Licensees, issuers, etc.  To the extent the bans are intended to apply to other entities that give or accept benefits (for example, an associated entity of an AFS Licensee), they will only apply indirectly - by virtue of the anti-avoidance provision.

Timing

Comments are due on the second tranche by Wednesday, 19 October 2011.    The Bills are intended to come into effect on 1 July 2012.

A number of announced FoFA reforms are not covered under the first and second tranches FoFA Bills. These include the amended retail/wholesale client test, a statutory compensation scheme and the accountant’s AFSL exemption.  

Conclusion

Some initial thoughts on the second tranche of draft FoFA legislation:

  • planners and dealer groups should review how they charge their clients and remunerate advisers and decide whether they will have different price models for retail and wholesale clients and different remuneration structures for any grandfathered and new staff;
  • planners who currently have bundled fee structures will need to unbundle product fees from advice fees;
  • all AFS Licensees and RSE Licensees will need to review all payments they make to all other AFS Licensees, RSE Licensees and ARs, as the broad drafting of the bans may capture many business to business and intra-group payments beyond those contemplated in previous announcements and beyond the apparent intention set out in the draft Explanatory Memorandum;
  • product issuers should review their distribution and pricing models, soft dollar arrangements and any products that involve geared funds and amend product disclosure statements and distribution agreements;
  • systems changes will need to be made to reflect new payment structures;
  • the industry will be eagerly awaiting details of any grandfathering arrangements.