FOFA carries a high price for financial planners

With draft legislation resulting from the Future of Financial Advice reforms due out within months, Mike Taylor writes that much more is at stake than how financial planners conduct their businesses.

The ‘opt-in’ proposals along with the fiduciary duty ‘best interests’ obligations contained within the Government’s Future of Financial Advice (FOFA) reforms are emerging as the crucial elements for the immediate future of Australian financial planning practices.

Taken separately, the two proposals present significant challenges for financial planners. Taken together, they represent a mammoth development with long-term impacts extending well beyond the way planners do business. In fact, it will affect the actual value of the businesses.

Much has already been written about the valuation of financial planning businesses based on the phasing out of commission-based remuneration and the adoption of fee-for-service, with most research suggesting that it would be new entrants to the industry who would be most affected.

Research conducted by Wealth Insights and published in Money Management last year suggested that planners with mature businesses and long-established client lists were less fazed by the implications of the FOFA changes than their younger colleagues looking to make a start.

At least a degree of the sanguine attitude being attributed to the older planners was seen as flowing from the fact that while they might have transitioned to fee-for-service for all new work, they would still benefit from long-established client relationships and trailing commissions.

The single greatest threat to legacy trailing commissions contained in the FOFA reforms is arguably the opt-in proposals. Savvy clients, compulsorily asked to make a decision about whether they want to keep taking advice have an ability to turn off those trails.

So the question which will be most on the minds of representatives from the Financial Planning Association (FPA), the Association of Financial Advisers (AFA) and similar bodies is whether the first draft of the FOFA legislation expected from the Treasury before the end of March will contain the original one-year opt-in proposal or the industry’s preferred three-year opt-in.

Planning firms that have been closely watching the discussions between the planning industry and the Government will be well aware that the industry superannuation funds have been pressing for an annual opt-in.

Some financial planners have also predicted that in the event that the Government does succeed in implementing legislation imposing an annual opt-in, it will open the way for the industry superannuation funds to mount a campaign urging consumers to exercise their choice to end their exposure to legacy (ie, commission) arrangements.

What has already become clear to many financial planning firm principals is that in a world without trails, the basis upon which financial planning practices are valued has changed and is continuing to change.

Trails meant recurrent income — something that will be less evident in an opt-in, fee-for-service environment.

The former chair of the Financial Planning Association and principal of Berry Financial Services, Julie Berry, believes that planners will have to start thinking about valuations of their businesses in the same context as accountants.

“I think we are looking at a change under which we will see practices valued in terms of EBIT [earnings before interest and tax],” she said.

Her analysis concurs with that of industry veteran Wes McMaster, who believes that the EBIT methodology not only captures the value of a business in terms of the income it derives, but also the cost of generating the income.

The impact of declining recurrent revenue was also acknowledged last year by the head of acquisition and succession for AXA’s financial advice network, Steve Davison, who told Money Management that financial planning practices were losing value in terms of recurring revenue multiples.

Davison said AXA was already seeing multiples come down to around 2.7 times recurring revenue, down from three times recurring revenue 18 months ago.

Similarly, Townsend Business and Corporate Lawyers principal Peter Townsend predicted the change would drive prices down.

“If accountants get 0.9 [recurring annual revenue], why would a financial planning practice get much more than the accountancy practice?” he asked.

Another element less discussed in terms of the valuation of individual financial planning businesses will also be covered in the FOFA proposals with respect to volume rebates.

While volume rebates are traditionally viewed as being integral to the relationship between platforms, product manufacturers and financial planning dealer groups, in many instances the underlying formula also sees a benefit flowing to planning practices commensurate with the support they are perceived to have given.

If the legislation resulting from the FOFA reforms sees volume bonuses banned or significantly curtailed, then dealer groups will need to change their own models and, in turn, the consequent commercial relationship with member planning firms.

The bottom line, therefore, is that in 2011 more is at stake for financial planners than simply the way they do business.