Why the reforms to financial planning should come as no surprise

While recent government announcements mean Australia's financial planners are facing significant change, Damon Taylor writes that the shift in policy direction was well telegraphed and ought to have been well understood.

The topic on everyone’s lips at the moment is the Government’s response to both the Parliamentary Joint Committee’s Inquiry into Financial Products and Services and the Australia’s Future Tax System Review.

Yet the reality for the financial advice industry is that it was on a path to change long before the ANZAC Day long weekend.

The reports, known more commonly as Ripoll and Henry, and indeed long-term moves by the Financial Planning Association (FPA) and the Association of Financial Advisers (AFA) have all been part of significant progression, but it is progression that has been occurring for some time.

Change to financial advice policy was inevitable — the challenge, according to Richard Klipin, chief executive officer of the AFA, lies in how the industry navigates that change.

“There’s undoubtedly been revolutionary change announced in the last two weeks,” Klipin said.

“It’s been a significant shifting of the plates, but it has put the industry on a path that is in consumers’ best interests.

“Trust, transparency and clarity are front and centre in this and that’s a good thing,” Klipin continued. “There is a question of whether a revolution was required or whether evolution would have been sufficient, but it’s now a moot point.

“The changes have been announced and it’s a path the industry has been on for some time.”

Looking at the impacts of the recently announced financial advice reforms and the Government’s response to the Henry Tax Review from multiple perspectives, Klipin said the industry would need to do varying amounts of transitional work.

“Financial advisers will need to be very clear on their value proposition, on the price of that proposition and on ensuring their practice delivers to its target audience,” he said.

“It raises the question of what the best advice model to put in place is [as well as whether it is] best to be general or is it best to focus?

“In the case of licensees, their practices will need to be well down the path of operating on fees even though many will already be doing so,” Klipin continued.

“And product manufacturers will need to look to products in the super space that can be unbundled.

“The industry’s been on the right path since FSR [Financial Services Reform] came in, but these reforms have given us a hurry up, a line in the sand and a very clear sense of the future.”

Deen Sanders, acting chief executive officer of the FPA, said the FPA’s reform focus had been firmly fixed on professionalism but he admitted that these changes had come at a rapid pace.

“The question we’ve been looking to answer is how we can ensure that financial planning is recognised by the Government and the community as the profession that it is,” he said.

“For us, there are three pillars of change: government regulation, professional regulation and business application, but the Bowen [Minister for Financial Services, Superannuation and Corporate Law Chris Bowen] reforms are only one part of that.

“As an industry body, I think we’d have preferred it if the profession had been allowed to apply these changes itself,” continued Sanders.

“Unfortunately, that hasn’t been the case and, as a consequence, this change has come at an absolute rate of knots.

“But make no bones about it — we support these changes and agree that this is the right track to be following. In 10 or even 20 years’ time, we want a robust, professional financial planning industry, and to do that we have to recognise that there are rapids to contend with and windy mountain paths to climb.”

Commissions

Not surprisingly, the most significant outcome from the Government’s response to the Ripoll report has been the abolition of commissions being paid by product providers to financial advisers.

Bowen’s contention was that commissions misaligned financial planner incentives, but according to Rick Di Cristoforo, managing director of Matrix Planning Solutions, the issue is not so simple.

“I would agree that it is possible to perceive that [view] about certain parts of the financial planning industry, but I’d disagree that it applies to the industry in its entirety,” he said.

“And this is a large part of the reason why I feel this reform will punish areas of the industry that deserve it and areas that don’t as well.

“To give you an example, at an initial meeting Matrix advisers explain how much their client would be paying, and the question then is how the client would like to pay,” continued Di Cristoforo.

“We can give them a number of options, but the issue is that a lot of that choice has now been removed.

“I think to say arbitrarily that commissions are a bad thing is very short sighted. I’ve always said that this debate is simply about payment mechanisms.”

Commenting on the financial advice reforms as a whole, Di Cristoforo said the path before Australia’s financial planning industry was one of change and additional professionalism.

“I say ‘additional’ because I believe professionalism already exists throughout most of the industry,” he said.

“Certainly, most of the elements and tracks that have been put in place by these reforms are quite positive and already part of what Matrix planners do.

“The fiduciary duty, for example; there isn’t a single Matrix financial planner who isn’t already doing this — the legislation is just formalising what we already do,” Di Cristoforo continued.

“Likewise, fee-for-service is something we’ve done for some time.

“But the concern is that these changes are mucking around with peoples’ commercial arrangements and creating an uneven playing field between institutional and non-institutional advisers.”

According to Di Cristoforo, modifying the payment structure of the financial planning industry played into the hands of large vertically-integrated institutions because for them, revenue could come from either products or advisers.

“They don’t care where the money comes from, but small independent advisers can’t rely on that,” he said. “And it’s the products that have been created by some of these institutions that have been causing the issues.

“So why is it that the product providers that failed aren’t being taken to task?” asked Di Cristoforo. “An adviser only knows what an adviser knows, but there have been plenty of product providers creating overly complex products.

“There’s no doubt that it will be good to make some changes in this industry, but that change has to be on an even playing field.”

Alternatively, AMP director of financial planning advice solutions Steven Helmich said AMP was already well ahead of the financial advice reforms when it came to fee-for-service and that he could see a degree of practicality behind the decision to remove commissions.

“I think the position that’s been taken is that we want to remove as many of the conflicts and inhibitors that stop people from getting advice as possible,” he said.

“If people have hesitated in obtaining financial advice in the past, especially on account of commissions-bias, that’s a barrier that has gone now.

“I’ve been around the financial advice industry for years now and there’s only ever been a small minority of advisers who have abused the system,” Helmich continued. “But removing that minority has to be a good thing.”

An advocate of fee for service, Phil Butterworth, chief executive officer of DKN Financial Group, said the removal of commissions would go a long way to building credibility and professionalism in the financial planning industry.

“It means that if something goes wrong in the future, the discussion won’t be around commissions or the bias of the adviser, it will be about the advice that was provided,” he said.

“Commissions have been a good mechanism for certain people to get advice in the past, but they have also inspired activity that has pushed products that have fallen over and paid advisers too much in the process.

“Personally, I’d have liked to see the debate focus on why these particular products failed rather than how the advisers were remunerated,” continued Butterworth.

“Because it’s unfortunate that commissions have led to some poor decisions.

“But most importantly, they’ve damaged the reputation of the industry, and that’s what needs to be fixed.”

However, while Butterworth stated that the core of the Government’s financial advice reforms were on target, he said he could see fringe issues and consequences emerging.

“I think clients’ ability to opt in to advice fees every year may be going too far,” he said. “They are, after all, able to turn their advice fees off at any time.

“The removal of rebates to advisers will be another interesting one,” Butterworth continued.

“At the dealer group level, there are advisory dealerships that have heavily relied on rebate payments for top line revenue, so when they’re turned off, I think there’ll be a number of advisers looking at their product providers and asking themselves whether they’re really the best thing for the practice, let alone their clients.

“But to be honest, I think that’s a fantastic result and [one] likely to open up opportunities for an incredibly competitive and innovative environment.”

Fiduciary responsibility

It is arguable that the second of Bowen’s financial advice reform announcements, the introduction of a statutory fiduciary responsibility, has been almost inevitable for some time now.

Of course, there have also been arguments that its introduction alone could have guaranteed consumer protection and made the banning of commissions unnecessary, and for Klipin, it is an argument that certainly has merit.

“I think there’s a question of whether the Government has over-baked the cake or over-engineered outcomes here,” he said.

“For the majority of the industry, putting clients’ interests first is a moral duty and the reason financial advisers are in business for the long haul.

“Unfortunately, there are a minority of cases in which this does not apply, so I can understand the reasons behind the Government’s action,” Klipin added.

“But the question here is one of unintended consequences and the potential that exists for the price of financial advice to go up.

“If this puts lower income Australia into the nil advice or lower advice brackets, we will be left with a whole different range of issues to deal with.”

Reiterating his previous statements, Di Cristoforo said the introduction of a fiduciary duty was an attempt to base legislation upon a moral or ethical code.

“I would absolutely agree that the introduction of a fiduciary duty would have been sufficient,” he said. “It’s a much more desirable outcome as opposed to simply banning something.”

However, for Butterworth, the necessity of having a fiduciary duty in combination with the removal of commissions comes back to what happens when something goes wrong.

“Financial planners have full disclosure requirements now,” he said. “But that doesn’t help the industry if something goes wrong and commissions are involved.

“That possibility alone necessitates having both.”

Remuneration

Yet if the removal of commissions and the introduction of a fiduciary duty are the clear cut outcomes of Bowen’s financial advice reforms, it seems there remain question marks on planner remuneration models, the options available and whether there is enough flexibility in what the Government plans to instigate.

Di Cristoforo said that, for him at least, what models would be available remained unclear.

“There are at least a few questions in my mind about whether some payment options are still available or not,” he said. “There’s probably a need for further discussion with the Government and the broader industry to clarify what’s available and where we’re at.

“It seems to be a bit of a work in progress area.”

As to whether the Government had delivered enough flexibility within the planner remuneration models available, Helmich indicated that he could see sufficient room to move.

“There’s a lot of different value propositions out there for clients,” he said. “And by the same token, I think clients are looking for a range of different services.

“Some want ‘set and forget’ type advice and some will want to establish a detailed financial plan and a close relationship with their adviser,” Helmich continued.

“Within that, I think there are many ways that advice can be paid for, and at least one of those should fit most people, if not all.”

Agreeing with some of Di Cristoforo’s sentiments, Klipin said a lot of the framework behind planner remuneration models had yet to take shape.

“I think the framework Bowen’s put out has yet to take shape in terms of action and policy,” he said. “But that’s an area of consultation that he’s keen to see through, and that’s a good thing.

“The Government hasn’t set out to kneecap the industry with these reforms,” Klipin continued. “They’re looking to enhance consumer outcomes and, in line with that, these reforms have a degree of flexibility built in.

“I have no doubt that good advisers with good practices will flourish within this new environment.”

Professionalism

When it comes to increasing the professionalism of the financial planning industry, there seem to be few complaints about what the Government’s financial advice reforms have delivered.

However, in the lead-up to the ANZAC Day long weekend, there were suggestions that increased regulation and increased standards of competency could lead to planners exiting the industry, and the key question seems to be: is this an acceptable price to pay?

Unfortunately, the answer, according to Sanders, isn’t clear cut.

“There seems to be a bit of a misconception in both the minister’s mind and in others’ that there is incompetence in the marketplace, and I’m not sure that’s true,” he said.

“The FPA has the highest standards of competency, and others within the industry have similar standards, but we’ve all been concerned about what level is being provided by RG 146 [Regulatory Guideline 146, outlined within FSR] alone.

“The FPA has been on record many times as not being confident about people with only that qualification entering the marketplace, and this is the Government’s response,” Sanders continued.

“I’m hopeful that doesn’t mean we’ll see people exiting the industry and I’m hopeful that people will want to confirm their compliance.

“Many will be highly reluctant to do so, but I’m confident that they will be able to do it and do it well.”

Offering an alternate perspective, Di Cristoforo said he didn’t get a sense that a mass planner exodus was coming in his particular patch of the woods.

“I’d say that, as with FSR, there will be some exits,” he said.

“Major change does cause some discomfort, but likewise I think there’ll be people attracted to the industry following these reforms and joining as a consequence.

“You have to remember that the thing that triggered the Ripoll report was the failure of Storm Financial,” Di Cristoforo continued. “But that was a microcosm of the industry.

“For the most part, financial planners already have high standards of training, education and competency.”

While it is also doubtful that financial planners would be exiting the industry on the back of these reforms, Helmich said he could not help but be quite bullish about the industry’s prospects.

“I think it’s a strange conclusion to come to,” he said. “In a time when more people are more confident in advice and more are also seeking that advice, how can the market do anything but grow?

“I’m quite bullish about financial planner numbers,” Helmich added. “And I’d be quite surprised if numbers didn’t grow in light of consumers’ increased confidence.”

Nonetheless, Klipin said some of the commentary coming through since the announcement of the financial advice reforms indicated that it was definitely a question that needed to be asked.

“It’s certainly a question we’d like to explore further with the Government,” he said. “Australia is already an under-advised community, and having any loss of advisers due to structural reform is a serious concern.

“Part of the solution to this problem will be helping people to understand what it means for them and what it means for their clients,” Klipin continued.

“But all of the dialogue thus far has been around advice pricing and what’s wrong with these reforms; people haven’t been talking about what’s right and how these reforms are allowing advisers to better serve consumers.

“Focusing on why advice is good for Australians will be a key part of this moving forward because that’s the passion that drives people here.”

Costs

Of course, beyond the cost in terms of planner numbers there is also the question of what these reforms may cost monetarily, and according to Di Cristoforo, the answer to that particular question is easy.

“It’s a bit of a no-brainer really,” he said. “Even if this was the change I’d been waiting for my whole life, it would still come at a cost.

“We have a zero sum game here and as planners we can’t be expected to do the same job for less income,” Di Cristoforo continued. “Unfortunately, the only outcome of this will be increased costs for the consumer, and that’s exactly what we don’t want.”

For Klipin, there are two answers to the question of increased planner costs.

“For full service, high advice and complex offers the real cost will obviously be borne by the community,” he said.

“For example, if you’re a small business with complex financial needs that run all the way through to superannuation, then that’s the sweet spot for advisers because it represents value and efficiency.

“So in that market, it may well be that prices go up,” Klipin continued.

“But outside of that, I’m also expecting a significant amount of innovation because there will be a number of planners asking themselves how they can best service certain categories of clients, and it may be that some sort of single-issue advice will be the answer.

“At the end of the day, dealing with clients in a cost-effective and high-value manner is what will ensure peoples’ businesses [prosper] and look after their clients in the best possible way.”

Sanders said the sheer scale of the financial advice reforms meant that they had to come at a cost.

“The fact that business processes have to change and documentation has to be rewritten means there has to be a cost involved,” he said. “The FPA, along with the

Government, is endeavouring to ensure that the introduction of these reforms won’t be a costly exercise, but they will come at a cost, and we can’t expect that cost not to pass through to consumers.

“With the removal of commissions, these reforms have been assumed to be quite one-sided, and I think to some extent that’s true,” Sanders continued. “In order for them to be successful, the Government has to provide incentives for obtaining advice and remove the barriers that may be hindering it.

“An increase in costs makes that a necessity.”

Tax deductibility

Of course, the key incentive referred to by Sanders is tax deductibility. Its mention has not been a part of the Government’s response to either Ripoll or Henry, and according to Klipin, its omission is a serious oversight.

“We’ve always argued that taking away commissions needed to be done hand-in-glove with tax deductibility as an incentive to obtain advice,” he said.

“That hasn’t happened, so we will watch and wait for what may come from the Federal Budget.

“However, at the AFA we do see these two things as hand-in-glove and we will continue to debate it in the public domain so that incentives to obtain advice remain on the agenda.”

Providing a contrast to Klipin’s view, Helmich indicated that the tax deductibility of advice fees would have been nice, but that it was not essential.

“I don’t really see it as an oversight,” he said. “It would have been nice, but it isn’t something that’s crucial.

“I think quality financial advice from quality financial planners stands on its own two feet.”

For his part, Sanders said he could almost guarantee that the upcoming Federal Budget wouldn’t include the introduction of tax-deductible financial advice fees.

“But we are very concerned that this was something raised in Henry and then not dealt with,” he said.

“In fact, I’ve had this specific conversation with the minister in the last 24 hours and he’s assured me that the tax deductibility of advice fees isn’t off the table.

“At this point, I think the Government is uncertain about its ability to pay for it and its ability to justify it,” Sanders added. “There is room to negotiate, but that discussion has to be part of a concerted industry effort to prove its value.”

Future changes

As things stand, Australia’s financial planning industry has been given approximately two years to assimilate the changes introduced by the Government’s financial advice reforms, yet the superannuation review led by Jeremy Cooper, former deputy chairman of the Australian Securities and Investments Commission, remains in the wings.

One would think that financial planners have seen all of the reforms likely to impact their businesses, but Di Cristoforo indicated that there were no guarantees.

“It’s hard to say,” he said. “In this industry I never cease being surprised."

“Bowen has obviously gazumped a number of Cooper’s observations, so I think they must have had a fireside chat at some point,” Di Cristoforo added.

“But you never know; Cooper may yet have something up his sleeve.”

Sanders said regardless of what came out of the Cooper Review, the FPA was prepared for an exhausting and challenging two years.

“Eighty-five per cent of FPA members are already able to offer fee-for-service, so I expect most will be waiting at the finish line in two years’ time having prepared as much as was possible,” he said.

“There will be others on the other side of that, but our members will be ready to adapt to the changes that are already in train.

“We’ll also be building policies to support them in that and working to ensure our planners get across the line in the best fashion they can.”

Reflecting on what the financial planning landscape would look like in two years’ time, Klipin said getting to that point would be an interesting journey.

“At the moment, I think there’s still a land grab on and it’s for distribution,” he said.

“The big institutions will continue to look for a competitive advantage in size and, for them, the focus will be managing risk and enabling the delivery of good advice.

“The key question is whether there is a future for good, independent, non-institutional advice, and

I think that there absolutely is,” Klipin continued. “I’m expecting a marked evolution of advice models and the industry will need to be clear on those models and on client segmentation.

“We’re set for some interesting years, but my overwhelming feeling is one of optimism.”