Putting vertical integration into perspective
It’s time to put the vexed question of financial advice and vertical integration into perspective, writes David O’Reilly.
The great strength of the Australian financial services industry is not our regulatory regime but competition, innovation and investment in the industry.
Much of that competition, innovation and investment has been driven by vertically integrated organisations. Our financial services market is well contested, highly competitive and has delivered significant financial and economic benefits to clients.
To some extent, the industry has been a victim of its own success and has attracted a significant regulatory burden.
The raft of recent financial services laws has imposed significant additional costs on industry, created barriers to entry and possibly resulted in a lessening of competition.
In response to these new laws the financial services industry is continuing in a process of restructuring both financial products and the delivery of financial services.
While for many financial planners it is business as usual, changes are evolving in the face of regulatory uncertainty and many planners are electing to become a part of, or more directly associated with, a vertically integrated group.
Related party arrangements within conglomerates have been a common feature of the Australian financial services industry for some time.
The operation of vertically integrated financial services organisations has provided clients with efficient and cost-effective access to a range of investment products and services.
Vertical integration
So is there anything wrong with vertical integration?
There is a considerable amount of academic research on various industries looking at the positives and negatives of vertical integration.
It seems that vertical integration, in general, delivers significant efficiencies for clients and only becomes a problem in a poorly contested market where it can result in less competition and market manipulation.
While the Future of Financial Advice (FOFA) requirements are primarily directed at removing conflicts of interest, some interested parties are quick to point to the potential for conflicts of interest in vertically integrated financial services organisations.
I underline “potential” because products and services provided by a vertically integrated organisation may not, in fact, be conflicted. The provision of financial products and services should result in a win-win for all parties involved – the client, the financial planner, and the product provider.
However, the mere inference of conflicts of interests, combined with the regulatory threat of the “new” statutory best interest requirement, produces a level of uncertainty that is both disruptive and counterproductive to business operations.
I have certainly read the competing views of the various interested parties (vertically integrated financial services organisations, aligned financial planners, and independent financial planners) about both the positives and negatives associated with vertically integrated financial services organisations.
Understandably, each argues passionately in support of their own business structure – integrated, aligned or independent.
Each also makes valid points but seems to leave out that critical element of what the client wants and, if it is in the client’s best interests, how does the advice fit into the client’s overall financial strategy and plan?
The diversity within the financial services industry is a significant strength and offers clients a wide range of investment choices to clients. In the process of making a purchase decision, clients are influenced by a plethora of factors.
Those matters include reputation, efficiency, resources, reliability, risk, accessibility and trust from current and past dealings.
Vertically integrated organisations supporting a financial planner satisfy those matters for many clients. They can provide clients with cost effective access to a range of approved investment products and services supported by extensive research and analysis.
Many are prepared to pay more for the professional service and certainty of institutional backing and as well the confidence and reassurance that things work.
The requirements of the law are the same for vertically integrated financial services organisations, aligned financial planners, and independent financial planners.
So how does an association with a vertically integrated financial services organisation somehow taint the financial services or financial products recommended? The short answer is it doesn’t.
Even in a simplistic assessment, it seems illogical and even ridiculous to propose that a platform or investment product may be suitable for use for clients by some 20,000 financial planners in Australia, but not the 60 to 100 financial planners who operate under an AFSL associated with a platform operator.
The role of the financial planner is to present investment opportunities to clients, assist in financial management and provide strategic advice to the client. This is a tough job in a world where investments are the subject of economic, environmental and political change.
The FOFA requirements are well intentioned but the nagging issue of conflicts of interest needs to be addressed in a more positive way.
If it isn’t, the new financial services laws and regulatory approach to their administration has the real potential to undermine the strengths of our industry, service delivery, the benefits to clients and their confidence.
What’s a solution?
Rather than prohibiting behaviour, why not acknowledge the benefits of vertical integration and recognise that where a financial planner is associated with a particular financial services organisation, then a client can expect to be recommended the products and services offered by that organisation.
The Government doesn’t seem to have any problems with the provision of intra-fund advice by superannuation funds, so I don’t see that there should be any issue with an aligned adviser recommending financial products of an associated entity.
Both super fund and aligned adviser have a duty to act in the best interests of the client and each has a restricted approved product list.
This should not remove the obligation to ensure systems and controls that act in the best interest of their clients and avoid any misalignment of interests.
Conclusion
Taken to its extreme, avoidance of conflicts of interest would have the effect of undermining existing industry structures and operations. This needs to be addressed in a positive fashion. These structures have delivered significant industry efficiencies and benefits to clients.
David O’Reilly is general counsel at Fiducian Portfolio Services.
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