Shaping the future with confidence: Your business post-Financial Services Royal Commission
Round 2: Financial Advice
Michelle Levy, Michael Mathieson and Samantha Naylor Brown
In her summary my colleague, Michelle Levy, said her initial reaction was that the recommendations in the Final Report were modest but, on a second reading, some would set a cat among the pigeons.. We think the recommendations concerning mortgage brokers are in the 'cat and pigeon' category, while the recommendations concerning financial advisers are firmly in the 'modest' category. In this article, we explain why.
The Commissioner's dislike for grandfathered trail commissions paid to financial advisers is well-known, and he recommended that they cease as soon as reasonably practicable. He did not specify a date but the Government did, settling on 1 January 2021. This will, obviously enough, be a little while after the Ripoll Inquiry recommended (in 2009) that all value-based payments from product issuers to financial advisers should cease. The Government says it expects the benefits of ending grandfathered commissions to be passed on to customers and that ASIC will monitor whether they are.
The Commissioner has doubts about claims that abolishing commissions on life insurance could result in underinsurance. He says most life insurance is opt-out insurance held through superannuation and that if someone is not prepared to pay for something it gives a fair indication of the value they attach to it. Even so, he does not recommend abolishing commissions immediately or at all. Instead, he says that when ASIC conducts its post-implementation review of the Life Insurance Framework in 2021, it should consider the results and then consider reducing the caps on commissions to zero at that time. It is notable that the caps only apply to hybrid commissions that need to fit within the benefit ratio and clawback requirements under ASIC's LIF Instrument. There is nothing in the Final Report about level commissions, and the Government's response tends to indicate that level commissions, which are uncapped, would remain even if hybrid commissions were phased out.
Again, the Commissioner has taken a surprisingly cautious approach to commissions on general insurance and consumer credit insurance. He simply says ASIC should consider, in 2021, whether the exceptions to conflicted remuneration for such products should be removed.
Ongoing fee arrangements
The Commissioner's views on the phenomenon referred to as 'fees for no service' were made perfectly clear in the Interim Report, and they are no more benign in the Final Report, going so far as to suggest the conduct might amount to 'dishonest conduct' under s1041G of the Corporations Act 2001 (Cth) – a provision that can be prosecuted as a criminal offence. This makes it a little surprising that the Commissioner did not recommend banning ongoing adviser fees outright, or at least the deduction of ongoing adviser fees from superannuation.
Instead, the Commissioner recommended that the opt-in requirement that applies to ongoing fee arrangements be expanded and upgraded. Specifically, he recommends that the opt-in requirement:
- apply to all ongoing fee arrangements (irrespective of when they were first entered into);
- apply more frequently (every year rather than every two years);
- apply not just to the advice licensee but also to the product issuer who will deduct and pay the fee; and
- require that the opt-in notice specify the services that are to be provided over the year ahead.
And while advice fees will not be able to be deducted from MySuper products, they will be able to be deducted from Choice superannuation products if the annual opt-in requirement is satisfied.
For those who remember, the requirement that an opt-in notice specify the service that will be provided was included when the Future of Financial Advice (FoFA) was being formulated, but had been removed by the time FoFA was legislated.
Duties, conflicts and vertical integration
The remaining recommendations are undeniably modest. Indeed, what the Commissioner did not recommend is arguably more interesting than what he did.
He recommended that where a financial adviser would not be independent within section 923A of the Corporations Act, they will need to give the client a concise explanation of why they are not independent. He also recommended that if the quality of advice has not improved by the end of 2022, the safe harbour should be removed from the legislative best interests duty. This stands in contrast to the criticism that the Commissioner poured onto the safe harbour in the Interim Report.
The Commissioner did not recommend that there be a requirement to eliminate conflicts. This is despite his finding that the management of conflicts has not prevented the problems that have occurred. Therefore, it appears there will be no change to the conflicts-priority duty for financial advisers or, for AFS licensees, the obligation to have adequate arrangements for the management of conflicts.
Finally (almost) – vertical integration. As you already know, the Commissioner did not recommend that it be abolished. He noted the cost and disruption that such a recommendation would cause and was not persuaded that they would be outweighed by any benefit. And so, vertical integration survives, although given how difficult it will likely be to sell superannuation products and life insurance in the future, significant challenges will remain. (We will cover selling superannuation products and life insurance in a separate article.)
Registration and disciplinary arrangements
Although the Commissioner was hesitant to make specific recommendations directed at improving the quality of advice, he was less reserved in his criticism of the industry's 'aspiring' professionalism. The cause? At least in part, a fragmented yet overlapping system of professional discipline that is hindered by its gaps.
In the last two years, the Government, ASIC and the industry have each introduced measures directed at increasing professionalism in the industry. The most recent of these involves phasing out RG146 and education standards in favour of new requirements, including a code of ethics to be overseen by the Financial Adviser Standards and Ethics Authority.
The Commissioner, however, cautioned against conflating the purposes and importance of codes of ethics with laws. As was a theme throughout the final report, in the Commissioner's view, any disciplinary system should give 'proper weight' to denunciation and punishment. To this end, the Commissioner has recommended that a single, central disciplinary body be introduced which can impose a wide range of sanctions. All financial advisers must register with that body and their registration will be on the line as a disciplinary tool.
To further strengthen reporting and disciplinary arrangements, the Commissioner has also recommended new licence conditions requiring compliance with the Australian Banking Association's reference checking and information sharing protocol, reporting of serious compliance concerns to ASIC on a quarterly basis and, where financial adviser misconduct is identified, obligations on Australian Financial Services Licence (AFSL) holders to undertake inquiries as are reasonably necessary to determine the nature of misconduct and to inform and remediate affected clients.
It remains to be seen whether this new world of adviser discipline will improve standards and discipline in the industry. As the Commissioner himself acknowledged, primary responsibility for discipline will still be retained by AFSL holders. Even though he doubted the appropriateness of a 'one-size fits all' approach to consequence management, ASIC has been encouraged to consider providing 'best practice' guidance in this area – watch this space.