A GUEST POST BY HARRY CHEMAY
Commissioner Kenneth Hayne could not have been more forthright in his summation of the Australian financial advice sector.
There it was in black and white, all 1,069 pages of his Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry final report.
The Oxford-educated retired Justice of the High Court of Australia has a well-earned reputation for his forensic mind and legendary work ethic (he apparently was quite prepared to run the inquiry seven days a week but was convinced otherwise). He put both qualities to full use in the year in which the Royal Commission ran, concluding with the delivery of his final report to Treasurer Josh Frydenberg in early February this year.
In prefacing his findings Commissioner Hayne identified six principles that he felt should reflect the norms of conduct in financial services, these being:
obey the law;
do not mislead or deceive;
provide services that are fit for purpose;
deliver services with reasonable care and skill; and
when acting for another, act in the best interests of that other.
"These norms of conduct are fundamental precepts. Each is well-established, widely accepted, and easily understood," the Commissioner wrote in his report.
What Commissioner Hayne and his team found however, in case after case throughout the Royal Commission hearings, were instances where these principles were either ignored, disregarded or wilfully neglected in favour of individual and corporate self-interest.
Money for Nothing
Having heard evidence of appalling behaviour by mortgage brokers, insurance advisers and financial planners, Commissioner Hayne was particularly excoriating on one issue; that of how advisers and brokers are remunerated.
Case study after case study showed a common trait; that of commissions skewing the behaviour of advisers to the detriment of their clients, with the Commissioner noting that removing product sales as a factor in the provision of advice was a “chief challenge” that required addressing in the Australian financial system.
It needn’t have been the case, for financial advice at least, had sales commissions for wealth advice been retrospectively banned in July 2013 when new financial advice (Future of Financial Advice) laws were introduced in Australia. From that time onward all new commissions on wealth products were deemed ‘conflicted remuneration’, the receipt and payment of which was thereafter banned.
Political will did, however, cave under intense industry lobbying, with commissions generated from products first sold prior to 1 July 2013 allowed to be ‘grandfathered’. These trail commissions still flow between product manufacturer and adviser and, prior to the Royal Commission, were set to continue for as long as a client remained connected to a pre-1 July 2013 product.
Commissioner Hayne however clearly was no fan, as he outlined in his report:
"[I]t is necessary to look not only at how trail commissions are valuable to those that receive them, but why they are valuable to both the party receiving the payments and the party making them.
"The chief value of trail commissions to the recipient, to put it bluntly, is that they are money for nothing."
Fee for No Service
Australia’s financial advice landscape was, until the Royal Commission, dominated by four large banks; ANZ Bank, Commonwealth Bank, National Australia Bank and Westpac Bank, and two former mutuals turned listed wealth managers, IOOF and AMP (the one time owner of Henderson Group, now Janus Henderson). At their peak they either employed or licensed about 80% of Australia’s 26,000-odd financial advisers.
Adopting a transactional approach to a quintessentially relationship-driven business, the ‘Big 6’ approach to financial advice was, to put it mildly, problematic. These institutions established metrics that incentivised aligned advisers to put clients into in-house products and platforms, start those trail commissions flowing, then head out again in search of the next sale.
The banning of trail commissions from July 2013 onward on wealth products created an interesting new dynamic in the Australian financial advice landscape. In the new FoFA era ongoing advice is a contractual arrangement between adviser and client, the provision of which is typically made explicit in an ongoing service agreement.
And that is where the institutions that dominate Australia’s financial advice landscape came unstuck.
In damning evidence delivered during the Royal Commission it quickly became clear that the sales-driven, transaction-focussed financial advice delivered by the Big 6 hadn’t made the cultural shift to a post-FoFA world in 2013. Or anytime thereafter apparently.
In what has come to be known as the ‘fee-for-no-service’ (FFNS) scandal, all four big banks, together with AMP, were found to have charged clients fees without providing any on-going advisory services. While the final amount is yet to be determined, current estimates put the compensation for fees inappropriately charged by the majors conservatively at AUD $2 billion and possibly as high as $10 billion.
The reparation payments have only just started, will probably continue for years and litigation, in the form of class actions, has already commenced in some cases.
Many previously stellar corporate reputations were also tarnished through the process, with AMP, IOOF and NAB losing their Chairperson and CEO prior to the release of the final report.
To add injury to insult, the shareholders of AMP and IOOF (who unlike the banks are much more concentrated in wealth management) have seen their shares in these once-vaunted companies plunge in value, with some AUD $9 billion and $2 billion respectively in shareholder value lost since the start of the hearings. To say that these shareholders are not best pleased would be a major understatement.
Two Steps Forward, One Step Back
Among Commissioner Hayne’s recommendations for financial advice is that the grandfathering of trail commissions be brought to an end, effective 1 January 2021.
Three of the four big banks had clearly seen the writing on the wall and moved to divest themselves of their financial advice businesses ahead of the final report. Laggard Westpac Bank finally capitulated in March, acknowledging that it had questioned the sustainability of advice for a number of years leading up to its decision.
How big is the issue of grandfathered commissions? No one really knows, with forecasts ranging from less than 30% of recurring revenue for some advice providers to more than 70% for others. In light of this uncertainty, Australian Securities and Investments Commission (ASIC), the advice regulator, has written to all major advice providers seeking clarification from each on their book of grandfathered commissions.
Shortly after it was released, I wrote of some of Commissioner Hayne’s recommendations for financial advice in this Advice Reinvented piece. I closed the piece with an observation that:
"[Commissioner] Hayne understands that most of finance operates on the back of two proverbs — 'He Who Pays the Piper Calls the Tune' and 'There is No Such Thing as a Free Lunch'."
Commissions, grandfathered or otherwise, are a form of conflicted remuneration, where the product provider calls the tune. Advisers remunerated thus will invariably find themselves caught between the interests of the product provider supplying the remuneration and the client supplying the custom.
As the countdown to January 2021 begins and the big banks finalise their retreat from financial advice, one would have thought that the remaining non-bank owned advice providers would seek the high road and break free, once and for all, from the stain of conflicted remuneration. One would be mistaken.
In a remarkable manoeuvre one professional body, the Association of Independently Owned Financial Professionals (AIOFP), has signalled that it is prepared to challenge the proposed cessation of grandfathered commissions in the courts, on the basis that it amounts to an infringement of property rights and as such may not be constitutionally valid.
This while the highly regarded CFA Institute, in a recent paper ‘Professionalising Financial Advice’ co-authored with CFA Societies Australia, recommended that grandfathered commissions be banned “either immediately or within a short sunset period”.
As for commissions for life insurance advice, which broadly remained unaffected by the 2013 FoFA reforms of wealth advice, Commissioner Hayne’s recommendations for these too to cease has ignited a well-orchestrated campaign to prevent its implementation or dilute its policy intent.
This then is where the Australian advice sector now finds itself. Searching for a way forward through the uncertainty of the Hayne Royal Commission. Knowing it ought to leave behind the conflicted, sales-driven culture, yet loath part with a remuneration arrangement that will always lead to questions as to whose interests are best being served.
The next few years will be challenging for the Australian advice sector, of that there is no doubt. Change is never easy, less still when it requires the abandonment of a remuneration method that’s been the backbone of the industry for decades.
Yet amidst the rancour and acrimony, the first shoots of what the true future of Australian financial advice could look like are already in evidence, led by small band of visionaries whose zeal to be genuine fiduciaries stands them apart. Practitioners like David Andrew at Capital Partners in Perth and Peter Mancell of Mancell Financial Group in Tasmania, defining what it is to be an advice fiduciary in this day and age.
They may be small in number today, but these and other forward-thinking Australian advisers have welcomed the Royal Commission findings and want the advice industry to become a genuine, respected profession in its own right.
To them I say the future is yours to create. Stand up and counted, as there has never been a better time to be a genuine advice fiduciary. It’s what the 48 percent of adult Australians with unmet advice needs are crying out for. As with the rest of the world, the future of financial advice in Australia is genuinely positive for those who put the primacy of their client interests above all others.
HARRY CHEMAY is the co-founder of robo-advice provider Clover.com.au, based in Melbourne, Australia.