FOFA's missing pieces

Although the process involving the upcoming FOFA reforms commenced a few years ago, the reforms package still looks like an unsolved jigsaw puzzle, writes Pam Roberts.

Although legislation introducing the Future of Financial Advice (FOFA) reforms has been tabled in Parliament, the reforms continue to look like a jigsaw puzzle with half of the pieces missing.

The question that immediately springs to mind is: “Why has introducing FOFA been so hard? Why have these reforms been so complex, unclear and such a moveable feast?” 

On the face of it, the reform process should not have been this difficult. Unlike other big reforms this Government has taken on, such as introducing a carbon tax, there has been substantial agreement across the industry about the fundamentals of FOFA.

Although the industry and the Government have disagreed in respect of ‘opt-in’ and commission on risk premiums, the fundamental principle of unbundling financial advice and product fees for investments (which effectively bans commission) is not at issue.

Industry bodies, such as the Association of Financial Advisers, the Financial Planning Association and the Financial Services Council, have long drawn a line in the sand of 1 July 2012 for unbundling of financial advice fees and product fees.

As for the introduction of a statutory fiduciary duty for financial advisers, the main criticism was that the duty was already there in the advice process and it didn’t need to be put into statute.

So why have we struggled with this reform agenda?

Legislation by instalment 

The frustration we have all felt with this reform process starts with the fact that the legislation was not released in one package, but rather in a series of tranches: 

• Tranche 1: Corporations Amendment (Future of Financial Advice) Bill 2011 was tabled in Parliament on 13 October, 2011 (referred to below as FOFA 1); and 
• Tranche 2: Corporations Amendment (Further Future of Financial Advice) Bill 2011 was tabled on 24 November, the last sitting day of Parliament for 2011 (referred to below as FOFA 2).

It is arguable that the Government did not have a choice here, given the complexity and scope of the policy issues involved.

Also, releasing draft legislation in component form for public comment may be preferable to the inevitable delays involved in waiting for the release until all drafting has been completed.

However, this method has its own inherent problems when it is not clear what will be in the next instalment of legislation.

Implementing some reforms requires extensive planning and resourcing. Additionally, some clarity as to what the requirements are and when they will be released is essential for that planning.

The other problem with legislation by instalment is that we aren’t clear on what is to come. Will there be a third tranche of FOFA legislation? Or will the gaps be filled by regulations?

Annual disclosure of ongoing financial advice fees to all clients

The Government has been clear that these reforms are ‘prospective’ and don’t apply to existing arrangements in place on 30 June, 2012.

This includes the requirement to ‘opt-in’ to ongoing financial advice fees every two years, and to disclose those fees (both past and prospective) on an annual basis.

However, the explanatory memorandum to FOFA 1 extended annual disclosure of ongoing financial advice fees to all clients, “including where those arrangements began or the clients were engaged prior to the commencement day”.

This would be both retrospective (as it would apply to commission clients) and a significant cost to financial advisers and licensees. Furthermore, the proposal had not been flagged with the industry before.

The other issue is that the actual draft legislation appears to contradict the explanatory memorandum. According to the actual draft legislation, annual disclosure applies to:

• Category 1 clients: New clients entering into new contracts from 1 July, 2012. These clients receive annual disclosure and must opt-in every two years; and
• Category 2 clients: Existing clients who commence with new contracts (arrangements) from 1 July, 2012. These clients receive annual disclosure but do not have to opt-in every two years. 

For the third category of client, those on pre-1 July, 2012 contracts (including contracts paying commission), the draft legislation indicates that the opt-in and annual disclosure provisions should not apply.

This is because the annual disclosure provisions are set out in a new Division 3, which starts on 1 July, 2012. Division 3 applies where “a financial services licensee enters into an ongoing fee arrangement with another person (the client)”.

As pre-1 July, 2012 contracts have already been entered into prior to the start date (1 July, 2012) they should be excluded from annual disclosure requirements.

Recent statements by the Minister for Financial Services and Superannuation, Bill Shorten, suggest that annual disclosure of pre-1 July, 2012 commission arrangements may be excluded from annual disclosure.

However, until such time as we receive further clarification, the confusion will continue.

Deciphering the rules for grandfathering of existing arrangements 

Probably the most confusing area for financial planners and product providers is the grandfathering of existing commission arrangements. Ironically, it is probably the area where we need the greatest clarity and at the earliest time in order to implement.

It should be reasonably straightforward.

This has always been a ‘prospective ban’ and Minister Shorten has clearly said that, although commissions will be banned from 1 July, 2012, “the ban on conflicted remuneration (including the ban on commissions) will not apply to existing contractual rights of a financial adviser to receive ongoing product commissions”.

In line with this, FOFA 2 includes a new Part 10.18 which covers the grandfathering rules.

However, trying to pinpoint just what is grandfathered from the legislation from recent statements by the Government has become increasingly difficult:

The platform exclusion in FOFA 2.

The second tranche of FOFA itself only grandfathers a benefit from a product provider if the benefit is given under “an arrangement entered into” before 1 July, 2012 and is not given by a platform provider (including a master super fund).

Considering the wide use of platforms by financial advisers over the past decade, this carve-out seems puzzling.

Although the supporting explanatory memorandum says that benefits from platform providers will be covered by regulations, presumably this relates to previously announced special rules for grandfathering platform rebates to dealer groups.

But why the holistic carve-out? The best we can hope for is an early release of draft regulations, but until then the puzzle remains unclear.

Does the grandfathering apply only to trail commission?

The second tranche of FOFA grandfathers a benefit paid to a financial adviser under a pre-1 July, 2012 contract.

However it also provides for regulations that may include in the ban some payments to financial advisers under pre-1 July 2012 contracts.  

The only limitation on this will be where it would otherwise trigger compensation by the Government under the ‘just terms’ provision in section 51(xxxi) of the Australian Constitution.  

The concern here is that recent statements by the Minister (including the second reading speech to the bill) have referred to grandfathering of trail commissions and stated that “commissions on new business and clients after 1 July 2012 will not be allowed”.

So where does that put upfront commission on new contributions made to pre-1 July, 2012 super and investment contracts?

Hopefully we are just dealing with a case of mixed messages by the Minister.

Note that Treasury has consistently maintained that commission arrangements on existing contracts will be grandfathered and that would include both upfront and trail commission.

It would be clearly unfair if the goal posts were changed now.

Commission on life insurance

The Government has gone ahead with a ban on risk commission under group insurance contracts in superannuation, and individual contracts in default super (ie, corporate/employer super plans). It has advised that this would apply from 1 July, 2013.

FOFA 2 however starts on 1 July, 2012, and this includes the ban on commission in super.

However, the explanatory memorandum says that regulations are likely to push out the start date for the ban to 1 July, 2013.

Again, we have to wait for regulations and it is not clear just what grandfathering will apply to risk commission arrangements in super from 1 July, 2013.

The Stronger Super reforms recommended an absolute ban on risk commission for super in the MySuper default fund.

This may mean that existing risk commission under personal super (albeit under a group insurance contract) will be grandfathered from 2013 but corporate/employer super will not.

A looming 2012 start date

The real problem we face with FOFA is time. The level of complexity of this legislation, and the fact that so much is still unclear, is daunting.

Despite a welcome release from the Australian Securities and Investments Commission saying it will “go soft” on financial services providers for the first 12 months, the start date remains 1 July, 2012.

To put this into context: the FOFA legislation must pass through both Houses of Parliament.

Although both FOFA bills have been tabled in the House of Representatives, both have been sent off to parliamentary committees for review and reports are expected back by 14 March, 2012 at the latest.

Parliament doesn’t sit in April; and May is traditionally reserved for the Budget.

This means that, unless the legislation passes by 22 March, 2012, the likelihood of FOFA being passed before the end of June 2012 becomes increasingly remote.

In addition, the super reforms which are running alongside the FOFA reforms will require as many, if not more, resources to implement.

However the super reforms start from 1 July, 2013. It would be preferable if the start dates for FOFA and the Stronger Super reforms were aligned.

Conclusion

It is not that the financial services industry is unfamiliar with change. As an industry, we have undergone substantial reform in the past, and sometimes substantial reform can take time to bed down.

It’s nearly a decade since the industry implemented the sweeping Financial Services Reforms (FSR) and looking back, there were a lot of problems with FSR in the beginning.

Substance gave way to form – in the form of 50-page Statements of Advice and 100-page Product Disclosure Statements (PDS).

It took some time for these problems to settle. But the difference between FOFA and FSR is that FSR allowed two years for implementation.

From the passing of legislation, the industry had two years to implement it; to clarify procedures and for Government to get the rules right. With FOFA, unless the start date gets pushed out, we could have a couple of months.

Pam Roberts is the technical services manager at IOOF.