After several years of significant regulator attention, damning reports into industry practice and a considerable amount of legal and regulatory change, the Banking Royal Commission has cast doubt on whether fundamental conflicts within the financial advice industry, particularly in vertically integrated business models, are being adequately managed.
For the last twenty years, ASIC has repeatedly raised concerns with the financial service industry’s ability to manage conflicts of interest, largely arising from certain business structures, remuneration structures and incentives. This is particularly noticeable when financial advice is being provided whilst relying on financial incentives via commission payments.
In 2011, the FoFA reforms were introduced to try and address some of the worst conflicted areas, such as commission payments, but many proposals under FoFA were the subject of exclusions and exemptions. The result was, and still is, a significant pool of ‘conflicted remuneration’ across the industry.
Financial services conflicts are generally managed through controls (e.g policies, training or the way in which products and services are structured) and/or disclosure. ASIC does not expect all conflicts to be avoided – they simply expect them to be adequately managed.
A key factor within the advice sector when managing conflicts relies on advisers upholding their fundamental obligation to provide advice efficiently, honestly and fairly. There can be the best control procedures in place but if an individual (or an entire business) has a poor cultural approach to their fundamental obligations, then the output is often conflicted advice.
Although the new FoFA reforms came into effect on 1 July 2013, there were grandfathering provisions which allowed for the continuance of commission payments if the arrangement granting the commission payment was in place prior to 1 July 2013. This was extended to provide for the continued commission payments on certain accounts and relevant products (such as platforms, super funds or managed investment scheme) which were entered into prior to 1 July 2014.
As part of the Banking Royal Commission, we have seen all four big banks confirm that they are heavily reliant on the revenue that grandfathered commission payments bring, and to withdraw the provisions would have an adverse impact on the industry, the advisers personally, and the products themselves.
Although the industry may be reluctant to see the withdrawal of the grandfathering provisions, AMP, CBA and Westpac have all made positive comments that in principle, a fee for service arrangement could replace the commission structure and remove some of the current conflicts.
Fees For No Service
Ongoing fee arrangements tend to be closely associated with commission payments under the grandfathering provisions, but they also refer to any other fee which is paid in connection to a financial service or product. The most prominent example coming out of the Banking Royal Commission is AMP and their fees for no service which saw advice boss, Jack Regan, acknowledge that AMP had failed to act honestly and fairly in relation to their ongoing fee arrangements. During questioning, it emerged that AMP’s fees for no service included access to the adviser, the ‘offer’ of a full or partial periodic review, the provision of educational material and a review of investment correspondence.
ASIC’s concern is that many clients who hold moderate/small, simple and risk adverse products are unlikely to benefit from costly reviews. Such payments tend to be deducted from the client’s investment portfolio and so there is a hidden veil between the client and the fees being charged.
Vertically Integrated Business Models
Perhaps the biggest area of focus leading into the Royal Commission (see ASIC’s Report 562) are vertically integrated business models. The emergence of these businesses are championed for the economies of scale benefits that they bring, and in an emerging world where the community expects to be able to find a ”one stop shop” for their goods and services, it is certainly attractive. ASIC agrees, suggesting that such business models can potentially improve cost efficiencies, whilst acknowledging that they do contain inherent conflicts that need to be adequately managed.
One particular area of focus in ASIC’s Report 562 are ”approved product lists”. Some of the key issues raised in this Report are being highlighted in the Banking Royal Commission, with AMP telling the Banking Royal Commission that their advisers invested more than 90% of new clients’ funds via in-house products between 2013-2017, despite their in-house products only representing 30-40% of the ”approved product list”.
AMP is not alone with figures like this. ASIC’s Report 562 found that two of the largest advice licensees included 79% of external products compared to 21% in-house products on the approved lists, and yet 68% of all investments were made in in-house products. These findings were further bolstered by the product types which were often legacy products, or products which retained the commission payments from the grandfathering provisions discussed above.
Of course, this is not suggesting that just because the majority of investments were directed in-house that the advice was conflicted, or not in the client’s best interests. But the sheer frequency and volume does not sit comfortably with the regulator and will be subject to further review going forwards.
Encouraging Ethical Conduct
The terms ”good culture” and ”ethical advice” have been raised on a daily basis since the commencement of the Banking Royal Commission, but how does an industry encompass this when it is heavily influenced by financial incentives? Upton Sinclair once wrote that ‘It is difficult to get a man to understand something when his salary depends upon his not understanding it’.
FASEA’s Code of Ethics is designed to encourage a higher standard of behaviour, professionalism and overall culture within the industry. However, it is still subject to industry objections, particualry the proposed educational requirements for current and incoming advisers.
The financial advice industry is seemingly torn between commercial drivers, increasing regulatory pressure and now the expectations of the wider community. It is clear that there are plenty of changes ahead, focusing on removing further conflicts that exist within the industry.