The Royal Commission and the future of financial advice
The fallout from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry will change the financial planning industry forever.
It has already had an immense impact on the banks and AMP, but this is just the tip of the iceberg.
The final result is likely to be positive, both for consumer and for the financial advice industry, and there will be opportunities that will emerge out of the commission for smart advice practices.
But it is likely to be a painful process for the remainder of the year, with more appalling revelations which will continue to damage the industry in the eyes of the public.
The fallout is not entirely unexpected.
Vertical integration is a controversial advice model that has tainted the industry for the past 25 years, and many people have long recognised that this structure has been living on borrowed time.
The Royal Commission has sped up the transition away from a vertically integrated system, but it is a transition that was already underway.
As a result, it must now be recognised that offering conflict free advice is no longer a choice but a necessity for financial planners.
And they need to make the shift at once, if not sooner.
With the banks already taking steps to exit the advice space, there will be thousands of financial planning business facing crunch time.
The question they must deal with is, where to from here?
What does the future hold?
When making their decision, planners need to consider what they think the financial planning industry of the future will look like, and then what licencing option will be right for them.
While our crystal ball is no better than anyone else’s, here are some predictions on the future:
The vertically integrated model will disappear
It seems likely that one outcome of the Royal Commission is that the vertically integrated business model will be substantially diminished or even banned.
It is now clear that this model has perverted the financial advice process, to the detriment of clients and also to the industry.
Defenders of the model argue that the one benefit it provides is the capacity to compensate clients when things go wrong; however clients pay a hefty premium in poorer outcomes from the limited approved product lists (APLs).
Many aligned dealer groups will either be sold, or shut down
Vertical integration is not limited to institutions only, of course, and it is entirely feasible that we will see the end of “grandfathered arrangements” that have compromised many clients.
Regulators will step up their activities
It is inevitable that the Australian Securities and Investments Commission (ASIC) will become more interventionist as a result of the Royal Commission.
Support from the government for the regulator and its activities will be much stronger, and it will be expected to have oversight and monitoring of all licences, rather than primarily the large institutional dealer groups as has been the case in the past.
The current dealer group model will change
While the dealer group model isn’t dead, it is broken.
Dealer groups will no longer be able to rely on product subsidies to drive down costs, and will therefore need to increase their client fees in order to survive.
Even so, they will probably struggle to break even. Institutional dealer groups will not continue in their current ownership structure.
It will be a buyer’s market for adviser portfolios
The sale by the banks of their wealth divisions, coupled with the predictions that as many as 8,000 advisers will leave the industry as a result of the new education requirements, will mean that there will be over-supply of practices for sale.
Good practices will find a new home; practices that cannot prove their value proposition and that they have a clean compliance record will struggle.
Size may matter
One outcome of these changes is that we will start to see some very large advice businesses, with significant buying power.
Product manufacturers will need to review their distribution strategy and structure
Prior to the advent of dealer Australian Financial Services Licences (AFSLs), the distribution of products was more challenging.
The days of dealers being able to demonstrate any levels of production support will be further diminished.
As sole licensees grow in number and themselves become bigger through the acquisition of cheaper portfolios, the gap in capability among business development teams will become a chasm.
What are the options?
In this changed landscape, the key question for financial planning practices is: can the dealer model survive, or is getting your own AFSL the best solution?
There are a number of advantages to running your own AFSL.
For many practices, the big one is control – it allows complete autonomy over every element of the business.
However, it is not a cheap option, and it is likely to become more expensive in the financial services landscape of the future.
We will release the results of our detailed research of the obligations and costs in running an AFSL in the next few months, but our estimates show that for a business that turns over $3 million annually, the cost of establishing an AFSL is at least $40,000, and there are significant ongoing costs of around $140,000 a year, plus professional indemnity costs.
It will be vital for any practice with its own AFSL to commit significant resources to governance and client management, including aspects such as data management, technology and platforms, and audit.
For those who wish to focus solely on offering advice, without the distraction of managing an AFSL, a dealer group is likely to be the best model, but not the dealer group model of old.
A key element will be fees.
We believe the costs to a dealer group to properly supervise an authorised representative ranges between $37,000 to $40,000 before a profit margin is included.
Obviously there is scale for larger businesses which is why many dealer groups cap their fees.
The institutional dealer groups were able to keep fees down because they were subsidised by product.
But this approach is no longer feasible.
The new dealer group model, which will be either independently-owned or adviser-owned, will need to use scale and leverage to drive down the price on platforms and product, so they can reduce fees while still recouping costs and making a reasonable profit.
We are likely to see the formation of buyers’ groups that will give these smaller dealer groups the scale needed to drive down costs.
Such buyers’ groups will allow advisers to choose which services best suit their own clients and their business, and select from the best options available.
This could include compliance services as well as platforms and products.
Conflict-free is key
Regardless of which option practices choose, the one thing they do not have a choice about is going conflict-free – what we call the green zone.
It is becoming increasingly clear that acting in client’s best interest is also the key driver of growth for a practice, creating better outcomes for both client and adviser.
There are also business benefits from this approach.
It will encourage product and platform competitiveness and innovation based on offering rather than fee.
Offering useful and reliable advice and client service will become the focus, while technology will become a tool to access a broader range of administration solutions and enable greater value for money from the best fund managers available.
In short, the ongoing industry disruption should be seen as an opportunity rather than a threat.
This may be an annus horribilis for the financial planning industry, but it should also be the year that sets us on the path to professionalism, and lays the foundations for financial advice becoming truly valued by the community as a whole.
Geoff Rimmer is co-founder of GreenZone Australia.
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