The Future of Financial Advice (FOFA) reforms ban “conflicted remuneration” … in the future
Many people will be unfamiliar with the new FOFA reforms that came into effect on 1 July 2013.
The intent of the FOFA reforms is to improve the quality of financial advice in Australia. One of the key elements of the reforms is to ban “conflicted remuneration” i.e. the payment of commissions and rebates by financial product issuers to advisers who recommend their product to a client. This reform is not peculiar to Australia – there has been a worldwide push to remove commission based financial products.
One of the key characteristics of failed investment schemes has been the high commission rates paid to promoters/advisers. It’s been one of the most effective ways for sub-optimal financial products to capture a slice of the market.
So, it’s hard to question the rationale for this reform. Yet, it does beg the question as to why it’s taken so long to come into play. To understand this, you need to appreciate the strength of the lobbyists representing the financial product issuers.
From July 2013, there is a ban on both the receipt and payment of benefits that could reasonably be expected to have an influence on the choice of financial products. On the face of it, that’s good news … if you’re a new client or buying a new financial product.
However, if you were a client prior to 1 July 2013, then the old rules are grandfathered. This means that conflicted remuneration can still be paid and received, provided the arrangements are not materially changed. It makes you wonder what incentive there is for an adviser receiving commissions to recommend a change to your pre July 2013 arrangement.
The cost of financial advice may not be more transparent
My first experience with a financial planner many years ago was to be offered a glass of red wine and then brainstorm some ideas on his whiteboard. Half an hour later he recommended a financial solution (product) that seemed to fit his suggestions perfectly. There was no mention of payment – apparently the service was free. I subsequently discovered he was receiving an upfront commission of 4% plus an ongoing trailing commission from the product issuer. Whose interest was he serving?
The regulators subsequently introduced disclosure requirements, in the belief that if clients were advised of the commissions and conflicts they would be able to make more informed decisions. Yet, the disclosures were rarely discussed openly (and more often than not hidden within a lengthy advice document). Additionally, most clients had difficulty in understanding the fee explanations.
The banning of conflicted remuneration would seem to solve these problems. But, grandfathering means that they will still be around for some time yet. So, it’s important to understand the types of conflicted remuneration that can be paid under these grandfathering provisions:
If you invested in a commission based financial product prior to 1 July 2013, then the commissions can continue to be paid to your financial adviser and their dealer group (the licensee); and
If you have invested via an administration (wrap) platform that paid volume rebates prior to 1 July 2013, these rebates can continue to be paid to the dealer group.
For all new arrangements, the adviser/dealer group cannot be remunerated by a third party [1.] – they must receive payment directly from you. While that should make things clearer for those commencing a new advice relationship, unfortunately it’s not quite that simple.
One of the major responses to the FOFA reforms has been the massive acceleration in the merging of financial advice firms with financial product issuers (predominantly the banks). The vast majority of advisers in Australia are now aligned with a major financial product issuer.
This alignment is likely to make the cost of financial advice even less transparent than previously. Unfortunately, there is no requirement to “unbundle” product fees from advice fees. While third party commissions may be banned, there is nothing to stop product issuers from loading the cost of their administration wrap services and products in order to subsidise advice fees.
Of course, to a financial adviser that is not aligned to a product issuer, these loaded products would not be overly attractive for their clients because of the inflated cost. But the product issuers no longer need to attract third party advisers via product related incentives. They now directly employ most financial advisers, who on the one hand have an obligation to act in the best interest of their client, but on the other have an obligation to their employer.
It will be interesting to observe how (aligned) advisers manage the relationship between their client and their employer. On the surface, the relationship seems conflicted. We suspect that many (aligned) advisers will eventually need to re-think their positions in order to overcome the undeniable moral dilemma – opting in favour of their clients (at the expense of their employer) or vice versa (which is illegal under the new reforms).
The solution is to remove the opportunity for conflicted advice
As a non-aligned adviser, it can be difficult at times to get people to appreciate the true cost of advice, particularly when that true cost has been (and can continue to be) shifted and hidden within product and administration fees.
Yet, under our direct fee arrangement, we’re able (and willing) to access products and services that are often far cheaper than the over-inflated offerings of the much larger adviser/product issuer organisations. Plus, we’re able to offer unbiased advice as we have no obligations to product issuers. In most cases, our clients end up with a much cheaper advice and product bundle than that offered by the “big guys”.
Unfortunately for Australian consumers, the FOFA reforms still allow for the true cost of financial advice to be hidden and for the adviser/product issuer conflict to persist.
We’ve made a conscious decision to invest in and establish an environment that removes the opportunity for conflicts. This leaves us free to act in the best interest of our clients. We think this is the path that all advice providers need to take for personal financial advice to become a profession (regardless of what the loopholes allow you to do).
Wealth Foundations (ABN 95 965 896 114) is a corporate authorised representative of Wealth Leadership Services Pty Ltd (Corporate Authorised Representative No. 319641). Wealth Leadership Services Pty Limited (ABN 36 121 535 993) is a licensed Australian financial services firm (AFS Licence No. 317369).
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[1.] Subject to the grandfathering rules (which can extend in certain circumstances to new investments/arrangements entered into prior to 1 July 2014).
The material contained in this article is for general purposes only and should not be used as a substitute for personal financial advice. This article does not take into account your specific objectives, financial situation or needs. No person should act or refrain from acting solely on the basis of this material. Before making a financial planning or investment decision, you should consider if it is appropriate for your circumstances. You should read and understand any relevant Product Disclosure Statements or any other associated documentation relevant to your individual situation.