Upcoming Mallesons seminarsFinancial product issuers and financial advisers
What do you need to do?Financial advisers and product issuers will need to work out what it means for advisers to place their clients' interests ahead of their own. The challenge to industry might be to provide investment advice to clients rather than a distribution channel for product issuers notwithstanding commission based remuneration.
Jim Boynton
Partner
Michael Mathieson
Senior Associate
Jim Boynton
Partner
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Stephen Jaggers
Partner
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Sydney
John Edstein
Martin James
Michelle Levy
Mark McFarlane
Damien Richard
Melbourne
John Malon
Last night Bernie Ripoll MP tabled the Parliamentary Joint Committee’s report into financial products and services in Australia. After considering hundreds of submissions and holding nine public hearings, the Committee has recommended the government consult with and support industry to develop mechanisms to cease payments from product manufacturers to financial advisers. The Committee’s recommendation adds to the steps already taken by industry towards an environment where product issuers will no longer make payments to financial advisers, which will lead to a paradigm shift with far reaching consequences for the future of the financial services industry.
Comments from the Government suggest, however, that consultation will be delayed until after Jeremy Cooper tables his report into the superannuation system in June next year. The Government is concerned about access to and the affordability of financial advice in a no-commission environment.
The Committee has recommended that the Corporations Act be amended to include a fiduciary-style duty for financial advisers to place their clients’ interests ahead of their own. It has done so in the face of evidence that financial advisers already owe a fiduciary duty to their clients under the general law.
These are two of eleven recommendations. The recommendations, as well as proposals not adopted, are divided below into three categories: “positively recommended”; “ideas rejected”; and “further consideration”.
Positively recommended
The Committee has positively recommended that:
- Government and industry consult to eliminate commissions: the Committee has asked the government to consult with and support industry in finding ways to cease payments from product manufacturers to financial advisers. It appears that in recommending consultation, the Committee has favoured the cautious approach of Treasury who submitted: “It may be worth allowing some time for industry to implement [a transition to fee based remuneration] and further explore the implications of taking legislative action”;
- statutory fiduciary-style duty: a statutory fiduciary-style duty be introduced for financial advisers acting under an AFSL, which requires them to place their clients’ interests ahead of their own. ASIC advocated a duty of this kind in its submission. If the government adopts this recommendation, a key issue will be the precise scope and content of the duty, for example - would it apply to financial services provided to wholesale clients?
- ASIC resourcing: ASIC be appropriately resourced to perform effective risk-based surveillance of advice practices, including by annual financial advice shadow-shopping exercises. This reflects a theme of the debate that the existing law may be adequate (or close to adequate) but what is needed is more effective enforcement;
- marketing materials: advisers be required to prominently disclose in marketing materials restrictions on their advice and any potential conflicts of interest. Again, ASIC advocated rules of this kind in its submission;
- banning and licensing: ASIC be given greater powers to ban individuals from the financial services industry and to deny AFS licence applications, or suspend or cancel a licence;
- professional standards board: a professional standards board be established, with those wishing to call themselves “financial planners” or “financial advisers” having to be members and adhere to its requirements. The Committee also supports ASIC’s consultation with industry over the most sensible way to raise training and qualification standards set by Regulatory Guide 146.
Ideas rejected
The Committee has rejected, or else not endorsed, these proposals:
- two tier system: the Committee rejected calls for a two tier system, of sales advice and independent advice, such as the model adopted in the UK;
- product limitations and suitability: the Committee did not take up ASIC’s suggestions of a duty of suitability for product issuers and intermediaries and greater prescription of product features and product availability, baldly stating: “it is not for the parliament or the government to determine for whom particular investment products are appropriate”. It will be interesting to see whether ASIC continues its project that is considering licence conditions about the delivery of high-risk products in order to mitigate retail investor risk ;
- risk ratings: the Committee did not favour ASIC or other government agencies imposing risk ratings on products. This would seem to contradict ASIC’s notion of products involving “swimming between the flags” or outside of them;
- capital adequacy and prudential regulation: the Committee has not supported calls for greater financial requirements to be imposed on AFS licensees through capital adequacy rules. It will be interesting to see whether ASIC continues its current review of the capital and other resource requirements given the Committee’s comments that ASIC is not a prudential regulator;
- licensing individual planners and investors: the Committee did not see any virtue in the proposal to licence individual planners or investors.
Further consideration
The Committee identified the following ideas as meriting further consideration:
- tax deductibility of adviser fees: the Committee noted that the full implications of this idea would need to be considered in conjunction with the Henry Tax Review’s report;
- statutory compensation scheme: the Committee noted the shortcomings of compensation arrangements that are dependent on professional indemnity insurance but, again, recognised that the full implications of any statutory compensation scheme would require careful consideration.
Structural changes
We do not consider that the imposition of a legislative fiduciary duty will, of itself, drive structural change in the industry. More significant is the Committee’s recommendation that payments from product manufacturers to advisers cease (albeit after consultation with industry about the mechanism for achieving that result). This has far reaching implications for the way in which financial products are distributed and financial services businesses are structured. Rather than focus on the form remuneration takes, how it is described or its timing, the Committee is concerned with the identity of the person making the payment, as it is this that creates the potential for a conflict of interest. The Committee’s report is another step on the path to a new paradigm for the financial services industry where fees paid for a product are transparently distinct from the fees paid for advice. This will dramatically alter the financial services industry over the long term.
Some distribution platforms are better structured to accommodate this model than others. Further, some industry participants have been moving away from commission based remuneration for some time. The Committee’s recommendation for consultation and the Government’s intention to await the Cooper Review give the industry some time to move to this model. The winners are likely to be those who take this opportunity to move quickly to adapt to this new paradigm.
Next steps
The Government’s initial reaction is that it will consider the Committee’s report together with the report of Jeremy Cooper into superannuation.
In addition, it is possible that ASIC may implement some of its recommendations made to the Committee prior to any response from Government (eg. increasing licensee’s capital requirements).
The financial services industry will continue to reinvent itself to cope with changes to its business model.