The Federal Government’s Future of Financial Advice (FoFA) reform agenda is forcing many financial planning firms to take a fresh look at their business models. In particular, the proposed prohibition on commissions, volume based payments and fees based on borrowed amounts threaten the future profitability of those advice businesses built around these revenue streams. In order to continue, these businesses will have to adapt to the new world order of transparent fee structures which are connected to the advice provided. In this new world, ‘fee-for-service’ is the paradigm and the benefits, both reputational and commercial, are potentially significant for the industry as a whole. However, individual planning firms working through this transition face significant strategic, operational and compliance challenges.
The most obvious options available for the fee-for-service model are time based fees, fixed fees and asset based fees. These alternatives have been described as ‘client-directed’ on the basis that the fees are paid directly by the client, rather than by a third party such as a platform or a product manufacturer. In this sense they are consistent with the policy objective of the FoFA reforms to improve transparency in the way clients pay for their advice. However, firms moving to charge asset based fees, calculated as a percentage of the amount of assets under advice, will not be able to apply them to leveraged portfolios under the FoFA reforms. This restriction brings out a conceptual and ethical difficulty with categorising asset based fees as ‘fees-for-service’. The fact that a client’s portfolio is significant in value does not automatically mean it is complex to manage or requires extensive advice. On the other hand, it has been argued that asset based fees are positive from the client’s perspective since they create economic alignment between the client and the planner. Either way, the proposed adviser charging regime under FoFA is aimed at giving clients an opportunity every two years to review and approve asset based and other fees in light of the level of servicing they have actually received (the ‘opt-in’ arrangement).
As a result of the Government’s announcement on 28 April 2011, the client opt-in will now be supplemented by an intervening annual disclosure notice to be provided to the client which will include fee and service information for the previous and upcoming year and remind the client of their right to opt-out at any time. Consultation by the Government on the practicalities of the opt-in policy is ongoing and we can expect to see further detail on how advisers are expected to meet this new disclosure obligation.
The reality for many planning firms may be that a hybrid model for charging is the optimal approach. Fixed fees may be appropriate for strategic work, whereas asset based fees may be best suited to portfolio management. There will be challenges for those firms which have clients who differ in terms of the type and extent of planning services they require. Firms will need to think creatively about the pricing models for those different client groups and one outcome could be the move to tiered standard pricing for services. Open discussions with clients up front about which pricing bracket they fit into may in fact carry the ancillary benefit of more positive client engagement at the start of the advice process. That said, the risk with this type of approach is that clients’ circumstances change and there is ‘scope creep’. This will need to be managed through regular engagement and open client communication.
Beyond the specifics of the charging structure, planning firms will need to undertake a systematic review of all their client-facing documentation. Financial services guides, statements of advice, client agreements, adviser charging regime notices and marketing materials will all need to be considered in light of the new remuneration approach taken by the firm. Disclosure about how fees will be charged will need to be presented clearly and consistently across all these documents. Significant changes may also be needed to back-office systems, as they are adapted to new ways of collecting and recording revenue. Imposing client directed fees raises a number of issues by itself, including debtor tracking and the relationship management issues associated with asking clients to pay for the first time for something they previously received apparently (although not in fact) ‘for free’.
From an operational perspective, a key value proposition for many planning firms is that expensive and time intensive compliance obligations are taken care of by dealer groups. This is demonstrated perhaps most clearly where the dealer group holds the Australian financial services licence under which each individual practice operates as an authorised representative. The individual planners, in turn, rely on authorisations which stem from the umbrella licence. In this way, the compliance function is effectively centralised in the dealer group, and largely frees up the planning firms to get on with the business of providing advice.
‘Outsourcing’ the compliance function in this way comes at a cost to the individual firm. The advent of a fee-for-service environment will inevitably cause firms to take a closer look at their cost base. For some firms this will mean greater clarity around where their core value propositions lie and expose areas of expense which need to be trimmed to provide clients with affordable advisory services. In the dealer group setting, star performer firms may be forced to re-evaluate the commercial drivers behind their alignment with a dealer group. Some may opt to avoid dealer group fees by breaking away and in-housing compliance services. While widespread disintermediation in the industry may be tempered by the broader increase in compliance obligations under FoFA, the potential impact on the dealer group value proposition illustrates how broadly the commercial impact may spread from these reforms.