FAAA urges literacy test to determine wholesale investors

Instituting a financial literacy test could help create a “more equitable framework” without removing access to high quality growth opportunities for appropriate clients, according to the Financial Advice Association Australia (FAAA).

Speaking at a parliamentary joint committee on corporations and financial services inquiry hearing into the wholesale investor and wholesale client tests on 10 October, FAAA general manager policy, advocacy and standards, Phil Anderson, argued that changes are necessary to ensure clients are correctly classified.

Anderson said the inquiry is a “crucial opportunity to address increasingly outdated aspects of the wholesale client regime”, however he added that it should still have a role in financial services.

“While this wholesale regime works in the interests of those clients who are suitable, it does not work for those who lack the required experience, financial sophistication and capacity to sustain losses,” he said.

“Genuine wholesale clients often have an entrepreneurial mindset and are actively engaged with their financial circumstances. Such clients seek to improve their return on investment by investing in high-risk opportunities that they understand and are comfortable with.

“These clients do not want to be bogged down in disclosure. They typically consider the requirements in the retail client regime as unnecessarily burdensome.”

Ultimately, Anderson explained, there needs to be a higher barrier to entry into the wholesale investment space to protect more vulnerable consumers from being misclassified.

“This must start with modernising the wholesale client thresholds to reflect today’s economic realities. Without these updates, an increasing number of consumers who lack the client experience, financial sophistication and capacity to sustain loss could be misclassified as wholesale clients, forfeiting essential protections,” he added.

“We have proposed the following: an increase in the threshold for the asset and income test, the removal of the principal place of residence from the asset test, [and] the indexation of these thresholds.

“We also propose the introduction of a financial literacy or capability test to ensure that clients who are qualified as wholesale clients truly understand the complexities of the financial products they are being offered. This would be done in conjunction with not as a replacement of the asset and income test.”

The financial literacy test, Anderson said, would aim to put a “higher hurdle” in place and make clients reflect on whether they are appropriate to be treated as a wholesale client.

“If they are absolutely committed, and they understand what they’re doing, and they can make that informed decision that they should be treated as wholesale, then that’s a good outcome,” he said.

“I think that, as I said previously, we don’t want to stand in the way of clients as wholesale, if they are genuinely appropriate to be treated in that way.”

While the goal is to limit misclassification of clients, the FAAA’s proposed test would be online and “relatively short”, with it only needing to be sufficient to filter out clients with limited understanding.

“Our incentive here is to protect those people who do not have the financial sophistication, who are being placed into products through the wholesale regime that they are simply not appropriate or suitable for,” Anderson added.

Asked by Labor MP Zaneta Mascarenhas about the possibility of people cheating on a test such as the one proposed, he responded that they would only be “cheating themselves”.

“If they are willing to participate in a test and for some reason are able to cheat, it’s only them who stand to be disadvantaged if they’re inappropriately classified as wholesale,” Anderson said.

No recommendation for stricter controls on wholesale providers

As part of Anderson’s evidence on the risk of harm to misclassified clients, he argued that the strict rules in the retail advice space and the lack of these in the wholesale sector has created a large gulf in consumer protections.

Shadow financial services minister Luke Howarth, noting that “some of the regulation that your advisers have is completely over the top”, asked if the FAAA was “advocating for greater change and more regulation on the wholesale side”.

However, Anderson stressed that the association is not arguing that there should be higher standards that apply in the wholesale space.

“Let me just be very clear on that: we were not suggesting that there should be any increase,” he said.

“I absolutely agree with your point that we have excess regulation in the retail space. I was simply making the point that all those protections are not available to wholesale clients, and thus, the decision as to treat someone as a retail client versus a wholesale client is particularly important if they don’t have the financial knowledge, sophistication and capacity to sustain loss.

“It is quite a different point. We are not in any way speaking against the existence of the wholesale client space, and we’re not in any way suggesting that higher standards should apply in terms of advice provided to wholesale clients. We are saying that the identification and selection process of people who are treated as wholesale needs to be reviewed, such that those standards are increased and that there is a more definitive test on whether someone has the financial sophistication in order to be treated as wholesale.”