The Final Report of the Royal Commission has been released and its recommendations will fundamentally change financial advice and the distribution of financial products.
Vertical integration survives the Final Report
The Final Report specifically decided against structural separation of large licensees, forcing product manufacturing and product advice businesses to be separate. Structural separation was said to be costly and disruptive, with the Commissioner not being satisfied that the costs would outweigh the benefits. Despite this, the Final Report recommended the ACCC to undertake five-yearly studies on the effect of vertical and horizontal integration across the financial system.
Despite structural separation not being recommended, many large licensees have already made the decision to sell their advice businesses. Previously held subsidiaries which followed a group strategy will now be free to pursue their own objectives. The question remains as to how independent newly disaggregated advice entities may be in practice. Many advice entities also rely on group support, and previous forms of revenue such as grandfathering. It is yet to be tested how these newly disaggregated entities will operate in the brave new world of advice and distribution following the Final Report.
Ongoing fee arrangements (OFAs) have also come within scope, with the Final Report recommending that OFAs need to be renewed every year, have revised disclosure obligations, and that fees must be subject to express consumer consent at the time of or prior to deduction. This effectively creates a pay as you go model where consumers authorise the payment for advice as they receive it.
OFAs were subject to significant criticism as part of the ‘fees for no service’ issue in public hearings, but were also criticised as being inappropriate for consumers. There was concern that consumers did not require advice on an ongoing basis and may not have been aware of the fees they were being charged.
The Final Report’s recommendations go toward resolving these issues. A yearly renewal notice and revised disclosure goes even further toward forcing consumer engagement with their products. The reforms may also create new operational concerns for licensees. Previous consents which may have been built into disclosure documents such as PDSs may now need to be explicitly set out as part of the OFA itself.
The Final Report does not go further to address the suitability concerns of OFAs for consumers. Some industry participants held the view that most consumers did not need advice on an ongoing basis. A potential answer to this concern could have been a suitability duty, or another formulation of the “best interests” duty, requiring the adviser to determine whether the OFA was suitable for the customer, or even in their best interests. This would have been a significant regulatory jump, but the Final Report has stayed with only minor structural changes to OFAs. Revised OFAs will be more suitable for consumers due to the shorter nature of the product, but it is yet to be seen if these suitability concerns will be addressed.
The end of grandfathering
The Final Report has recommended the removal of grandfathered commissions from 1 January 2021. Grandfathering allows historical commission arrangements that would have otherwise been banned under the Future of Financial Advice reforms to continue. This will be a significant loss of revenue across the entirety of the wealth industry. Life risk insurance commissions have also become in scope, with the Final Report recommending a review of life risk insurance commissions in 2021, and unless there is clear justification for keeping them, removing those commissions entirely.
Smaller industry participants still depend heavily on grandfathered commissions. Boutique adviser firms may be facing the options of consolidating with larger firms, or exiting the industry. With the rising age of financial advisers, the increased FASEA education standards, and the increased regulatory focus and remediation requirements in the financial advice industry, the writing appears to be on the wall for a contraction in the financial advice market with many advisers set to leave the industry.
Large industry participants have been adapting and developing alternative sources of revenue anticipating the removal of grandfathered commissions. Some have already decided to voluntarily turn off grandfathering prior to the Final Report. Despite this, grandfathering was a significant source of revenue for these businesses. The industry will need to adapt and seek new sources of revenue, as the market is currently exploring, such as ‘fees for service’ models, and potentially robo advice.
Stronger regulation of individual advisers
The Royal Commission has shown that a small number of advisers are often responsible for a large percentage of misconduct in the industry. The Final Report contains several recommendations designed to target individual adviser misconduct and make advisers accountable.
Advisers now need to be individually registered on their own professional register, advice licensees need to implement ABA reference checking for financial advisers and report ‘serious compliance concerns’ about individual advisers, and a new centralised disciplinary body to handle adviser complaints has been recomended. These recommendations prevent ‘bad apples’ from moving around the industry, avoiding consequences for misconduct. Government has committed to bringing financial advisers in line with similar professions such as lawyers and accountants.
These changes should raise the quality of the advisers across the board and lead to better industry outcomes. The changes also make it more difficult to be a financial adviser with increased regulation, and may contribute to the decline of smaller boutique advice firms. Larger advice businesses will be well placed to implement compliance programs and individual adviser training to help advisers meet requirements, while smaller less resourced practices will struggle.
The recommendations place a new requirement on advisers where if they cannot meet the strict test for independence in section 923A of the Corporations Act, they must disclose to clients why they are not independent. The vast majority of the advice industry will not be able to satisfy the section 923A independence test.
Conflicts of interest was a major theme throughout the final report, with a key takeaway being that many industry participants preferred to be subject to a conflict of interest and then manage it, instead of avoiding the conflict of interest in the first place. The recommendation cuts toward this behaviour of managing conflicts, by requiring advisers to disclose why they are not independent to consumers. Increased disclosure to illuminate conflicts helps consumers make better decisions, however the effectiveness of disclosure was also a key theme throughout the public hearings. The key question will be whether having to disclose a conflict to clients will make an adviser avoid the conflict in the first place, or will the disclosure become one of many prescribed disclosures.