The wealth management industry is working through the Federal Government’s response to the report delivered last year by the Parliamentary Joint Committee on Corporations and Financial Services (the Ripoll Report). The response has been dubbed “The Future of Financial Advice”, and proposes important reforms to the way that financial advice is delivered and paid for.A key reform is that from 1 July 2012 financial planners will no longer be able to be remunerated through commissions, volume based payments or fees based on borrowed amounts.
The aim of the prohibition on such remuneration is to create product neutral charging structures that more directly link fees charged to the advice provided. However, some payment arrangements have been left intact, which raises questions around how the industry will adapt to comply with the new regime.
An end to remuneration conflicts
Along with the wider reform agenda, the ban on conflicted remuneration is aimed at rebuilding trust in the financial planning community after coming under fire in recent times. Highly publicised failures such as Westpoint and Storm Financial have shone a light on the fees that planners have been taking from sometimes heavily leveraged client portfolios. These events have accelerated the regulatory response to long-standing concerns about the conflict of interest that arises from planners earning up-front sales commissions and trail fees from investments that they recommend to their clients. A related policy objective is to introduce a fiduciary dimension. This is proposed to take the form of a so-called statutory fiduciary obligation on planners to act in the clients’ best interests. As a result of the reform, planners will be required to adopt the high level of consideration for clients’ interests already imposed on responsible entities of registered managed investment schemes.
The issue of conflicts of interest has arguably held back the financial planning industry from achieving the same status of other qualified professional advisory bodies. In a sense the reforms can be seen as raising the bar for advice generally and will reward those many dealer groups with professional and robust compliance infrastructure. It also stands to the credit of the industry generally that non-binding standards have already been adopted by several large dealer groups to address perceived conflicts of interest.
Impact on the funds management industry
While the changes are clearly targeted at the financial planning industry, they cannot be viewed in isolation because they have the potential to be felt along the distribution chain. If the rationale of commission and volume-based remuneration structures is to drive product sales, then prohibiting them has the potential to disrupt the business models of not only financial planners but also platforms and product manufacturers. A core issue, therefore, is how platforms and fund managers will adapt in the lead up to enacting reform. Clearly any changes to the current distribution framework will be incremental, something that is arguably recognised in the delayed start date for the ban.
One potential implication arising is the potential to put pressure on the management fees charged by product manufacturers. It is possible that, in the face of separate service-based fees being imposed by dealer groups, clients will object to the same levels of fees being charged by fund managers where previously a component of those fees was paid to the planners as commission for recommending the product. Whether this has the effect of exerting downward pressure on management fees remains to be seen, and will in part be driven by the degree of influence clients have through the distribution chain.
A further implication arises from the potential loss of revenue created by the prohibition. Dealer groups will potentially have to identify alternative income sources in order to remain viable. One possible solution would be for dealer groups to effectively move into the manufacturing and intermediation space by developing their own products and pooled administration services. Regulatory, experience and infrastructure barriers would need to be overcome, since this would represent a major departure from the traditional advice-only model that typically relies on the back-office support of third party platforms. However, white label platform services have been in existence for some time, which could develop further as dealer groups explore more fully integrated service structures. More generally, combinations of outsourced service providers such as asset consultants, model portfolio providers and technology infrastructure specialists may be brought together by dealer groups to fill the gap. This could lead to product-like services such as managed discretionary accounts becoming more popular. These types of initiatives would represent competition to fund managers in an already crowded market place.
While it is possible to foresee any number of potential implications from the reforms, it is worth noting that two key remuneration methods are currently proposed to be left untouched. It will still be possible for a planner to charge fees based on the level of assets under advice so long as any geared investments are excluded. In addition, while platforms will no longer be able to charge volume-based shelf space fees to product manufacturers, they will still be able to charge a service fee so long as it is not explicitly volume based. These exceptions may in practice allow the industry to structure around the intent of the reforms. Whether this turns out to be the case or not will potentially depend on how the existing and proposed statutory conflicts and best interest requirements are embedded into the distribution chain. Certainly, for the time being there is plenty to think about for both the industry and those responsible for putting the fine detail behind the broad policy objectives.