FOFA reforms: are financial planners the biggest losers?

Money Management recently hosted a roundtable about the effects of the Government’s proposed Future of Financial Advice reforms. The key concern of those present was that big banks, institutions and industry funds would benefit at the expense of mid-sized dealer groups and IFAs.

Mike Taylor (MT) Thank you everyone for joining us. We’ve reached a very interesting point with respect to financial planning and financial services generally.

We’re on the cusp of the minister making a statement with regard to the Future of Financial Advice (FOFA) reforms. But the bottom line seems to be that the industry probably won’t get an entirely desirable environment to operate in, and the first thing on the list for most people here would be volume rebates and the form they’ll take after any legislation the Government imposes.

Andrew, what do you think will be the situation confronting dealer groups and others in the post-FOFA environment?

Andrew Gale (AG) Obviously the Government is going through its final deliberations on that and in terms of volume related payments there’s two primary models on the table. One is the so-called purist model, which would prohibit all volume related payments.

The other one is the pragmatic model, which says if you’ve got volume related payments that conflict advice or have the potential to conflict advice they’d be prohibited – but if you have payments that don’t conflict advice and are in fact an advantage to clients perhaps they should continue. So they’re the two primary models being looked at.

The Government really needs to work through what the implications are going to be if they pursue any particular path. I think one of the issues with the so-called purist model is some of the out workings of that. I think some of the out workings would be that it would confer additional power to the vertically integrated organisations in the market. It would have a greater degree of disruption.

Some of the large licensees are well positioned to deal with that because they would basically change their business models – especially looking at taking on platform manufacture or responsible entity type roles. So larger licensees can do that, but it’s more challenging to smaller to mid size licensees.

A likely consequence if you went down the purist model route is some industry consolidation and arguably the diminution of independence of advice in the marketplace, which I don’t think would be a great outcome. That’s not to say that’s not the path that the Government will or won’t go down ultimately, but I think they really need to go in with their eyes wide open regarding what the flow on consequences are.

MT Indy, do you have a view?

Iindy Singh (IS) Not much of a view because we don’t take volume rebates, we don’t pay volume rebates because of our model. But what we see is that it will always be difficult to distinguish between where the conflict arises, whether it’s a purist model or a conflicted model or a pragmatic model. And the proof will lie eventually in how a dealer that is accepting a volume rebate can justify that payment.

In many instances in the past, from my discussions with people, it hasn’t exactly been disclosed fully because apparently it goes to a dealer.

And it might be much simpler to add to the total fee and explain to the client that the total fee is whatever the percentage of the rebate is added to the adviser fee, which then makes it much higher than what is represented. I think if it is not clearly disclosed, I think that’s an error. You must disclose fully and I think that’s where the difficulty will rise.

AG If I can respond to that a little bit. There are a range of business models out there and each of them, as you say, are slightly different. But there are certainly what are called volume rebate payments out there which are basically fee structures through platforms and Count has got that in place but it’s basically a margin which we’ve effectively determined.

There’s no conflicts involved, it doesn’t influence asset allocation, it doesn’t influence fund manager selection, it’s platform neutral, it’s product neutral, it’s transparent, it’s fully disclosed, it doesn’t conflict advice in any way. It’s simply that the margin that is involved in financing licensee activities is reflected through the platform mechanism, is fully disclosed, and doesn’t conflict advice.

Our contention would be that those sorts of arrangements are sound and are in the client’s interest because there is no conflicted advice – and you can tap into scale limits through accessing some of our large platforms.

MT Marianne, you’re coming from a different position from 18 months ago, how do you see it?

Marianne Perkovic (MP) Andrew’s comment about the Government needing to go in with its eyes wide open is a very clear one. Without rebates and clarity around whether white label payments are included, the advice businesses will become product manufacturers. You will then have people whose core competency is to give advice and run the licence now having to be a product manufacturer.

There are some businesses like Indy’s that have done that and can do that, but there’s a lot of other businesses that don’t have that capability. So it will either lead to consolidation or a whole group of businesses running these products.

If you have a think about what’s in the best interests of the clients, are they better off to have been an advice giver who got a rebate or an adviser that’s now become a product manufacturer? I think that would be a greater risk. So post FOFA and if rebates go, that will be the discussion we’ll have: is the industry reinventing itself, and are more product manufacturers coming?

IS Marianne, you’ve been involved with large scale financial planning and there’s been a move for a number of small or independent dealer groups to start clubbing together to force a platform operator to give them a rebate because they then have muscle of coming together. Isn’t it actually a function of their ability to survive? I mean, if they do not get these rebates, their survival comes into question because they don’t have the revenue. So as you said, the Government needs to look very carefully or it will destroy the independent advisers who got together.

MP Under the current discussion on banning rebates there’s less choice for a consumer to go to an adviser, and they’ll be forced to become vertically integrated or institutionally owned. But that’s been brought to their attention many times. I get the feeling they don’t care about it. 

IS There’s many other things too. 

MP Yes, and a couple of the minister’s staff have made it clear in making comments about the fact that these businesses are such a small part of the industry, change will force structural change, but it’s such a small part of the industry that they don’t seem to care.

 

ASIC scrutiny of aggregators

IS So do you see problems with these structures of cooperatives that just got together to get a better fee from a platform?

MP Yes. ASIC has already come out to say that their focus for 2011 is to look at aggregated models and I think that’s a good thing because they’ve all just banded together to get a rebate. And institutions that pay rebates are actually – obviously I can talk about Colonial First State (CFS) – thinking about whether under this new environment, is it right for people to club together and get paid a rebate that is passed onto the adviser.

IS Is there a broader question that the dealer who’s got this disparate group of advisers doing pretty much what they like is abrogating their responsibility as a dealer. 

MP It’s a bigger risk to the industry, yes. 

AG I think one of the core issues is that if what you end up with is business models where in some cases the licensee or dealer function is disintermediated, then I think there’s some risk issues. Licensees and dealers exist for a reason and part of it is a scale advantage. But it’s also around risk and compliance, and quality assurance processes and constructing Approved Product Lists, and practice management and all those things.

If you set up a framework whereby some of that role gets diminished or is restricted by some of the regulatory changes in terms of the commercial model, then I think you actually increase the risk in the system by diminishing the role of the dealers and licensees. And I don’t think that point is clearly understood.

One of the points I’ve certainly submitted to some of these regulators and public policy makers is to look at the UK experience. There’s 20 years of experience there to look at. They brought in their Financial Services Act in the late 1980s, the intention of which was to increase the independence of advice. They set the hurdle so high in terms of what was independence of advice that it had precisely the opposite effect – you had a big shift towards aligned advisers, and a big reduction in independent brokers. And they’ve spent the last 20 years playing around with that system trying to clean it up.

Now whenever you’ve got regulatory change, one of the big issues is always the law of unintended consequences. They are absolutely at large with whether you’re talking about the volume-related payments or opt-in issues etc, thinking through the real consequences and some of the unintended consequences.

The same thing applies with opt-in. Some people argue that opt-in isn’t actually in the client’s interest. I think there’s some very potent arguments as to why opt-in is actually against client interest. Now some of the consumer representative bodies such as Choice and the like may not want to listen to those arguments closely – maybe that doesn’t resonate politically. 

Brad Fox (BF) I’d like to make a comment. Minister Shorten said that he is a true believer of the law of unintended consequences and the Association of Financial Advisers’ (AFA’s) view regarding volume bonus payments is that this is precisely the likely sort of thing we will see, because what we don’t need is increasing concentration in the marketplace. And the likely outcome of this is that it will put a real squeeze on the mid tier dealer group. And we tend to agree that we’ll see vertically integrated dealer groups creating their own product, which perhaps creates more bias around advice rather than less.

So if we’re going to put the consumer first, we need to separate product from strategy advice (knowing that at times there will be overlap) but we do need to separate that as much as we can. And having a well-preserved advice marketplace is the key and we don’t think volume payments will achieve that. By banning volume payments, we don’t think that will achieve that.

 

Valuing advice

MT Gerard, you’re coming at it from a somewhat different perspective and I would like to think a dispassionate observer almost at this point. What’s your feel on where it’s going? 

GD I’d make a couple of comments. Firstly, Australia is well ahead of the world in heading down the path that it’s heading down. In the majority of countries, commissions still live and volume rebates still live – and in large countries, with loads of money flow. So Australia is at the leading edge, or bleeding edge, of this. We’re a much better quality financial planning world than the majority of countries (maybe the US I’d say is equal, maybe Canada) but well behind in other countries where products are still flogged with rebates. So I think we should be proud that we’ve got an industry that’s been able to progress so well.

As a bystander, I’ve seen this. If you play the devil’s advocate you’d have to ask, I listened to Brad’s comments there and I’m probably echoing some of what’s going on in the minds of regulators I talk to. If advice is so valuable, why can’t advice stand alone and justify a fee purely for advice alone? And that’s where this volume rebating comes from, whether it’s a good rebate or a bad rebate, it’s still a payment that’s coming from somewhere else to cover the cost of advice. So their thinking is: ‘Why can’t advice stand completely by itself if it’s so valuable?’

We’ve got to think through the way the regulator is thinking about this and argue against its perspective. I certainly think having product separate from advice is important, the question is, can advice live without product? Can you run an advice business without a product being able to generate the fees? That’s the critical issue. And they’re posing the question, surely you should be able to do that. But there needs to be a long transition. So if you’re going to introduce a world like that you don’t do it quickly, you do it gradually.

AG I think if you’ve got payment structures, either from fund managers or platforms, which go through to advisers that either conflicts advice or has the potential to conflict advice, which in many cases it would, then those sort of arrangements shouldn’t exist in the industry because they do have the potential to influence advice. So in the main I think advice by the adviser will still stand on its own with explicit advice fees and some base fees or retainers. The issue is if you then also have a licensee function, what’s the commercial model that is going to apply for funding a licensee function? And there’s a couple of models there. One could be that there’s an explicit margin for licensees and that gets bundled in with the advice margin and that’s fully disclosed, that’s one model.

Another model is that you’ve got a margin for licensees that they determine and if a lot of the advice is executed through platforms – as long as that’s on a platform neutral basis and it’s not related to volume targets or anything like that, in other words its non conflicted – that’s another model that can apply. So I think the advice portion provided by the adviser is already largely stand-alone and explicit. Obviously there’s an opt-in/opt-out issue to sort out. But part of the model is how do you fund some of the licensee functions and one of the risks with the purist model is that that becomes a lot less transparent in vertically integrated organisations.

GD I was going to go on and say that the challenge to me is the licensee. You could probably have a world of advisers who are purely paid on advice with no conflict, but how does a licensee – particularly one outside the vertically integrated group – survive?

You could argue firstly do we need them to survive and I think the answer is yes. And then how should they survive, their raison d’être is advice, not product. And that’s once again the regulator saying: ‘Hang on, isn’t the licensee part of the advice function?’. So the people who choose to take advice have to pay for the licensee and all that goes with that and the advice.

So I understand how the regulator thinks and from the sidelines you can see why they’re asking those questions, but that takes us as I say right to the bleeding edge globally. And what would worry me is if you did it quickly you’d drop a whole bunch of licensees out which drops a whole bunch of financial planners out, and we end up with a world that’s got five or six very large industry funds and five very large banks and insurance companies. 

AG So the potential irony is that the initial concern was around conflicted advice or biased advice, and the outcome of the process is if you went down that path you end up with a significant increase in the vertically integrated, which probably by definition means I guess more independent advice and a greater degree of advice which is oriented to in-house institutions. 

GD The argument against that is there’ll be no advice that’s anything but independent. All advice must be independent. By the definition of the fiduciary role it must be independent.

MP The main point is businesses like Count, Andrew’s business, that sit in that independent space now become product manufacturers, and that’s okay, who have to be forced to come up with their own funds, their own model portfolios, their own ETFs, etc. So ultimately then the losers are stand-alone investment businesses and others because they’re not going to outsource that or use best of breed. For them it’s going to be about looking at where that revenue has got to come from.

AG That’s just best quality Marianne.

MP I know.

IS I would like to make a point. The point really is conflicted advice and I think we’ve made a mountain out of a molehill because there’s been few instances of conflicted advice but magnified to a substantial degree. You talked about an adviser charging and being independent.

 Let me put the point before you: how many people would go to a GP if they had to pay the cash or the cheque by themselves? It’s a collection mechanism. The Government collects from us and pays the GP. The GP does not have to be charging because of a drug or a product, and the drug manufacturers don’t have to disclose how much each percentage or every little component of a drug costs.

There’s a drug in France that I had something to do with years ago. But there are reports of 500 to 1000 people who have died taking this drug. So are they suing the doctor or are they suing the product manufacturer? They’re suing the product manufacturer.

I say one thing all the time, I’m saying how far is the responsibility taken by the Financial Services Council, and ASIC, because rarely ever has it been found that an adviser has got into trouble because a product has not failed. Very rarely. It’s only got to be bad strategy. And there has to be a sense of responsibility there but they just walk away from it.

When a product fails the financial planner is the softest target and we will always be attacked in spite of the good work we do. So when an adviser says he would like to charge a percentage, we’ve had Chris Bowen who’s the minister come out and say an asset-based charge is allowed.

ASIC has put out a statement on its website saying ‘do not trust an adviser who charges an asset-based fee’. Well, I’d love to see a Wikileak on it. Where is Julian Assange when we need him? Who actually got these guys to put it on the website and what right do they have independently and unilaterally to do that when 80 per cent of the industry is already involved in this. So I don’t believe that it’s always the fault of the adviser.

You have lawyers and you would know when they manage a deceased estate they charge a percentage; you have a real estate agent who sells your property who charges a percentage; you have a person who produces a loan for you for a mortgage, they charge a percentage. What’s wrong with us?

GD I wasn’t saying any of that, I was simply saying that the regulator wants to see that advice is separated from the product decision. And the issue that the whole thing raises, the biggest issue for me is where does the dealer fit in all of this, because the dealer is not currently sharing the advice fee – they’re making their fees elsewhere. But under the rebate, if rebating goes, then that whole model is tipped upside down.

AG I think the difficulty is that when public policy makers or regulators seek to start getting involved and determining which particular business models are endorsed or legitimate or valid in their view and which may not be, and they make that as an explicit or an implicit decision, I think that’s a dangerous decision to get to in terms of public policy.

They’re saying let’s get the principles right. Principle number one should be non-conflicted remuneration and payment structures. We shouldn’t have remuneration and payment structures and commercial models which conflict advice. If you’ve got that as one fundamental principle, you’ve got a second fundamental principle which is the best interest that is still being defined.

But if you’ve got a best interest obligation to have proper regard to a client’s circumstances, to give them appropriate advice and in the event of a conflict you put the client’s interest ahead of the adviser’s interest, if you’ve got that framework in place and you’ve got non-conflicting commercial models, they’re the two fundamental underpinnings. And it then goes on to say if you’ve got those underpinnings, what’s the need for something like an opt-in which can be shown to be not in the client’s interest and what’s the need to be basically giving blessing to certain commercial models and limiting the other ones, rather than just sticking to the principles.

 

Intra-fund advice

MT Brad I’ll throw to you. I notice today that you guys were out saying once again that in this whole debate that advice provided in the form of intra-fund advice ought to be treated in the same way under the FOFA changes as any other advice. I take it that’s based on your belief that the dispensation that was offered for intra-fund was not appropriate in the first place anyway?

BF A couple of elements to that Mike. One is that when we go to the charging structures of some of the Industry Super Network members there is free financial advice that goes above and beyond RG200 exclusion that is available to any member who calls up and chooses to accept that advice. In those models we would suggest that in the administration fee there’s a means of paying which is a percentage of fund, which is the same way most advisers are paid.

But the percentage of what they’re paying is obviously been allocated for the fund generally to provide these advisers on a salary, they’re available to all members. So by inference, every member of that fund is paying something for financial advice whether they receive it or not. So wouldn’t it then be reasonable to expect every member of that fund paying some portion of their ongoing cost for advice to also be subject to an opt-in regime?

The second part would be that in a level playing field debate the exclusion available there is they’re extended to too many segments of so called simple advice. We think that has an enormous potential to cause a further negative view of financial advice as a whole.

Hypothetically, you can imagine the story on Today Tonight. Someone sought advice. They did it over the phone. They got a bit of advice on a transition-to-retirement strategy at this point, perhaps a bit on salary sacrifice at another point, another bit around estate planning, another bit around insurance and somehow it all ends up pear shaped. They end up on Today Tonight saying: ‘Look, I went to all the trouble, I got financial advice, and look what’s happened to me’.

Once those sort of things surface it’s tarred not against the super fund it will be tarred against advisers generally as an occupation. So it concerns us greatly that they may get far more than they bargained for in terms of what gets through in advice.

IS I tend to agree with Brad in that you can’t have partial advice, you can’t have half-baked advice, you need holistic and complete advice. And a financial planner in the commercial sector has to go through some serious regulatory requirements, including as Gerard said about fiduciary responsibility where their liabilities are not just $500 but $200,000, which is something a financial planner would earn in a few years no matter what people might think.

The Government doesn’t fully understand the difference between what they’re trying to push for the industry funds and the unions in terms of intra-fund advice to compete with the commercial sector and the way that we in the commercial sector actually have a contract with our clients to provide a certain level of advice. And to meet that commitment through an agreement with the client.

There’s a lot of difference between corporate superannuation where an adviser may not see one member out of 5,000, but where we come from it’s a one-on-one personal contract. And I can’t understand – as I think Andrew referred to in the opt-in situation – how a Government can interfere with my contract with my client.

AG Just on the advice models, I’ve got a slightly different perspective on that one. I think intra-fund advice has got a very valuable role to play, especially within super funds, where people have got simple enquiries and advice requirements relating to their current superannuation interest if it’s contained to that, and I think that’s a valuable role.

What we want to be doing is increasing access to advice for all Australians and I think that means there’s a whole range of advice models that are legitimate and valid. So I think intra-fund advice has a role to play, as does limited, scoped and comprehensive advice.

If anything, I think intra-fund advice should be extended to being an intra-advice concept. And for a lot of advisers they can actually use that framework to look after their clients, especially clients with smaller contribution levels and smaller account balances. They actually can have the same framework which applies under the class order exemption within super funds. It’s important that something similar to this is available to advisers, especially those who look after their clients.

I think it’s the case that for middle Australia, the most common form of advice five years out is going to be what I would call serial limited advice, a series of limited bits of advice. So we just need to make sure that the framework and consumer protections we’ve got in place for that sort of thing apply. Now there’s a couple of key principles here.

The reality is a lot of the super funds, especially the industry funds, are running a subsidised advice model. There’s a large portion of them that offer intra-fund advice on a no-cost basis and there’s a significant portion which offer scoped advice or limited advice also on a free basis. Now it is a subsidised model and it’s not transparent. So there is a real issue about a non-level playing field, because this is a margin that all the super fund members are paying for advice that is provided to a portion and it’s not transparent. And if the Government is true to its principles it should really sort that out.

Secondly, if you’re going to have a best interests obligation in terms of duty of care which the industry is working through at the moment, it’s important that the duty of care concept applies right across the advice level and it suits what’s called stratified advice models.

It’s not just that there’s a duty of care requirement that applies for comprehensive advice – there’s a duty of care obligation that applies to limited or scoped advice and also for intra. You can scope the advice up front in your discussion with the client as to whether it’s intra or limited or comprehensive, but within that scope you need to then fulfil the best interest obligation.

BF The difficult thing with scoping is clients don’t understand the terminology.

MP I think as an industry we’ve just got to improve because at the end of the day I think you’ve got to sit back and say there’s only 20 per cent of Australians who currently get advice and how do we reach that 80 per cent. So in the business that I run we have a limited advice ASFL that just focuses on clients with simple advice needs.

This is continuing to be more and more popular throughout our dealerships because clients are saying: ‘I don’t necessarily need to sit across a table and go through my whole life story and have this full page document plan come out. Today all I need to know is where do I put this money that I saved or what superannuation options do I have’. And I think probably more advice businesses need to have a look at how to extend and offer those capabilities.

There’s a lot of cross-subsidisation. We cross subsidise in our industry, industry funds are cross-subsidising, but we have to just work out how we can leverage and use and continue to get the intra-fund advice extended to advisers to make that easier. I think that’s got to be the focus of associations and the industries.