17 Dec 2009
The PJC's Financial Services Inquiry
by Matthew Daley, John Moutsopoulos
The Government has indicated that it will wait for the Cooper review of the superannuation industry expected in June of next year before making a decision on the Parliamentary Joint Committee's recommendations.
On 25 February 2009 the Parliamentary Joint Committee on Corporations and Financial Services resolved to inquire into issues associated with recent financial product and services provider collapses, such as Storm Financial, Opes Prime and others.
On 23 November 2009, the Committee provided Parliament with a written report arising out of its inquiry and findings. Interestingly, the report did not accept that isolated corporate failures such as Storm Financial or Opes Prime were necessarily indicative of the broader financial services industry or, in indeed, that they were caused by regulatory failure.
Nonetheless, the report contained 11 recommendations which will have an impact (either directly or indirectly) on distributors, platform providers and product manufacturers, as well as the financial services industry generally.
The Government has indicated that it will wait for the Cooper review of the superannuation industry expected in June of next year before making a decision on the PJC's recommendations.
It should be noted however that it is possible that ASIC may implement those of the Committee's recommendations which concern it prior to any response from the Government. Indeed ASIC may seek to put in place the recommendations that it made to the Committee but which were not accepted (for example, suitability requirements for high risk products or increasing the capital requirements for a holder of an Australian financial services licence (AFSL)).
What has been recommended?
The Committee's recommendations were:
- Remuneration: While the Committee has not recommended an outright ban on commissions, the Committee has recommended that the Government consult with industry about ceasing payments from product providers to advisers.
It is interesting to note that the Committee has used this language and has not limited its recommendation to commission payments. In this respect, there is understandable concern in the industry that the removal of all product manufacturer payments to advisers irrespective of their nature or purpose (for example, volume rebates paid to dealer groups) may affect the financial viability of many dealer groups.
It also appears that an outright ban on product manufacturer to adviser payments was seen by the Committee as so significant that the removal of these types of payments would have to be done with industry consultation and with a transition period.
- Fiduciary duty: Amendments to the Corporations Act to explicitly include a "fiduciary duty" for advisers requiring them to place their clients' interests ahead of their own.
The Committee has stopped short of outlining how it sees this fiduciary duty impacting the remuneration structures adopted by advisers but has noted that wherever the Government and industry get to in relation to the "Remuneration" recommendation above must be consistent with this duty.
- ASIC's powers: Amendments to the Corporations Act which expand ASIC's powers:
- to require advisers to disclose restrictions on the advice they are able to provide consumers and any potential conflicts of interest more prominently in marketing material. Again, the scope of the disclosure which will be required is unclear. This recommendation presumably has been made in acknowledgement that the majority of the distribution industry is tied to a product manufacturer and limited to an Approved Product List
- to ban individuals from the financial services industry; and
- to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee "may not comply" with their obligations under the licence. This appears to be designed to give jurisdiction to ASIC in relation to an applicant's business model (in an apparent attempt to enable ASIC to prevent a future Opes Prime operating in the retail space) and enables ASIC to take action before a breach occurs.
- Tax deductibility of payments: The Government to consider the implications of making payments for financial advice tax-deductible for consumers. The Committee noted that this recommendation would need to be considered by the Government in light of the Henry Tax Review.
- ASIC surveillance: ASIC to be appropriately resourced to perform effective risk-based surveillance of the advice provided by licensees and their authorised representatives. ASIC should also conduct financial advice shadow shopping exercises annually.
- Agribusiness: As part of the Australian financial services licensing process, agribusiness managed investments scheme licensees to demonstrate that they have sufficient working capital to meet current obligations. There is some doubt as to whether the reference to "working capital" in this Committee recommendation is a reference to the scheme's capital or the responsible entity's capital. It is also interesting that the Committee has specifically targeted agribusiness managed investment scheme and has not otherwise commented on the managed investment scheme sector more generally, which is suggestive that the managed investment scheme industry has escaped direct criticism.
- Professional Standards Board: ASIC to immediately begin consultation with the financial services industry on the establishment of an independent industry-based Professional Standards Board to oversee competency / standards of financial advisers.
- Compensation Fund: The Government to investigate the costs and benefits of the establishment of a "last resort compensation fund". This recommendation has been met with mixed response from industry; the concern being that where the compensation pool is to be funded by a licensee levy that the end client will end up bearing the burden (and thereby reducing the access to advice because of the increased costs).
- Financial literacy / education: ASIC to lift financial literacy through increased education programs targeted particularly to groups in the community who are likely to be seeking financial advice for the first time.
Submissions not picked up by the Committee
The Committee did not address the following key submissions in its recommendations:
- prudential regulation and capital adequacy requirements: calls for the prudential regulation of particular financial products (including debentures) and the imposition of capital adequacy requirements for the holders of AFSLs. However, it has recommended the establishment of a "last resort compensation fund" which could be viewed as a back stop in this context.
- product suitability and design requirements: calls for product manufacturers to be required to consider the suitability and design of their products for investors (particularly in relation to high risk products).
- "Independent" vs "Restricted or Sales advice": calls for a two-tier system such as that adopted by the UK FSA where advisers must make clear whether they are providing independent or restricted (or sales) advice.
- risk ratings: the imposition of risk ratings by ASIC or other Government agencies.
- increased licensing scope: the requirement for individual planners to be licensed.
Of the 11 recommendations made by the report, there are a few which will significantly impact on the financial services industry and which raise a number of fundamental unanswered questions:
- What will be the scope of the "fiduciary duty"?
For example, will financial advisers have a fiduciary duty to clients when they provide general advice or other financial services (or only where they provide personal advice) and will a distinction be drawn as between "retail" and "wholesale" clients?
As it is described in the report, the proposed duty requires an adviser prefer the interests of its clients. How this ties into remuneration structures will be interesting to see. The report however recognised that "remuneration structures that are incompatible with a financial advisers' proposed fiduciary duty should be removed". This raises the question as to whether other forms of remuneration aside from commissions (eg. all forms of hard and soft dollar remuneration) will be targeted by the Government as part of the industry consultation process.
It also raises the question of whether product fees themselves (which, of course, fund the payments from product manufacturers to advisers targeted by the Committee) will reduce where the Government bans payments to advisers. Indeed, will the Government mandate a corresponding reduction in product fees?
It is possible that, depending on how the Government takes up the Committee's recommendations, and in particular the extent to which the Government bans payments from product manufacturers to advisers, that there could be industry structural change and consolidation. The Government will need to carefully consider the impact of any payment ban on the accessibility of advice.
Also, the general law fiduciary duty imposes a negative duty (not a positive duty), whereas the Committee's recommendation appears to suggest that the proposed Corporations Act fiduciary duty will positively require the adviser to place their clients' interests ahead of their own.
How the Government seeks to define and implement the fiduciary duty recommended by the Committee will determine the extent of the structural change in the industry required to accommodate the change.
- Will the "fiduciary duty" to be included in the Corporations Act countenance any exceptions similar to the general law?
An adviser could, today, on the facts of a particular case, be in a fiduciary relationship with their client. There are exceptions at general law to the normal incidents of a fiduciary relationship such as modification in the client agreement or obtaining the fully informed consent of the client. Will exceptions be countenanced in respect of the proposed statutory "fiduciary duty"?
Indeed, how will the "fiduciary duty" to be included in the Corporations Act sit alongside the possibility that an adviser is a general law fiduciary?
- What will the role of the professional standards board be regarding the weeding out of bad apples in the industry?
Relevant to this is the Committee's recommendation asking for ASIC's banning powers to be amended and that ASIC should be focused on individuals operating on the fringes of the industry. The Committee has also recommended that the professional standards board have a role in identifying and addressing problems early and receiving better intelligence at industry level early.
In addition, will the professional standards board be adopting the Australasian Compliance Institute's recommendation of maintaining a publicly available adviser register which will include details of their qualifications and disciplinary action taken against them?