16 Apr 2015

Swimming between the flags: are financial advisers the new product lifeguards?

by Matthew Daley, Michelle Plumb

Financial advisers should continue to follow best practice and ensure they comply with their obligations regarding the provision of advice and distribution generally.

The financial services industry has been the subject of significant regulatory reform over the last 15 years, starting with the introduction of the Financial Services Reform Act in 2001 and most recently, the Future of Financial Advice reforms.

Many attempts have been made to strike an appropriate balance between promoting a free and open financial services market and providing necessary consumer protections.

In the latest attempt to restrike this balance, the Financial System Inquiry (FSI) report, released in December 2014, makes a number of recommendations.

Of these, two have proven to be particularly controversial:

  • the proposal to introduce a principles-based product design and distribution obligation (see recommendation 21) to ensure that products are designed and distributed having regard to target markets ie. requiring product designers to make it clear who should be swimming between the red and yellow safety flags; and
  • the recommendation that ASIC be given product intervention power (see recommendation 22) or in other words, the power to ensure that investors are only ever able to swim in safe waters.

Product design: the red and yellow flags

Recommendation 21 of the FSI report recommends that product issuers and distributors be required to consider a range of factors when designing products and distribution strategies.

These factors include the target consumer and the distribution channel best suited to distributing the product.

The intent behind the recommendation is that consumers only buy products that are appropriately matched to their needs. The subtext is that without strict controls, investors cannot be trusted to read and understand disclosure documents (or that disclosure documents do not include appropriate or sufficient information).

The other implication is that distribution channels themselves have not, to date, appropriately controlled the distribution of certain types of products.

Product intervention power: the shark siren

Recommendation 22 of the FSI report proposes that ASIC be granted a "proactive product intervention power".

The power is intended to assist ASIC in preventing losses to investors where there is a "risk of significant consumer detriment" by giving it power to require or impose amendments to disclosure materials, require warnings to consumers and appropriate labelling, and to ban or restrict the distribution of products.

FSI chair David Murray stated that the power was only to be used in "the most obvious and extreme circumstances". It has been modelled on the equivalent power invested in the UK's Financial Conduct Authority (FCA). The FCA has a large degree of flexibility in how it exercises the power, and can make rules as "appear necessary or expedient for the purpose of advancing one or more of its operational objectives".

The proposed "intervention power" comes with some built-in safeguards. It would only allow ASIC to intervene temporarily, with any intervention action lasting 12 months, after which it could be extended by the government in limited circumstances.

Further, ASIC will be required to consult with APRA before using the power in circumstances where the intervention action may affect an APRA-regulated body.

Presumably, this is intended to avoid any legal conflict or regulatory double-dipping.

A myriad of concerns have been expressed about the proposed 'intervention power'. Some have suggested that ASIC would be overly zealous in using the power, negatively impacting industry confidence. Others have expressed concern that consumers will view a lack of intervention by ASIC as implying that the product is low or risk free.

Many product issuers have also expressed concern that once a product is subject to an intervention order it will be "blacklisted" by customers.

Advisers: the lifeguards?

So what role will advisers play given there is scant reference to "advisers" in each of the recommendations?

Perhaps ASIC would be less likely to use its intervention power if the product issuer could demonstrate that an appropriate distribution strategy (inclusive of an adviser education campaign) was in place.

Maybe a product issuer could shift the burden of ensuring a product is appropriate and "true to label" by requiring an adviser to always act in a manner that is consistent with the agreed distribution strategy for that product.

In this regard, will advisers be required to not only ensure they meet their existing statutory obligations regarding the delivery of personal advice but also show it was given in a manner consistent with a product issuer's distribution strategy design? And will these two competing obligations always be reconcilable?

Many commentators and industry experts warn that a new "intervention power" will be the last straw for advisers, who are already labouring under the burden of regulation. They question whether the power will require advisers to take the extra step of considering not only whether a particular product is in the best interests of the customer but also whether it is actually appropriate for a particular class of client.

This raises the further question of how an adviser's statutory and general law obligations to act in the best interests of consumers will sit in a world where products have labels and may be pulled from distribution by the regulator at any time.

While these concerns are understandable, it seems unlikely that the FSI intends the intervention power to be any more than another be any more than another form of safeguard to give ASIC the ability to step in where parliament is slow to enact any necessary regulatory reforms.

In any case, it's important to remember that ASIC already has broad and far-reaching powers of intervention.

For example, it has the power to implement stop orders on certain disclosure documents that it believes are misleading or deceptive, non-compliant or that are not "clear concise and effective".

It remains to be seen how the new product appropriateness rules and ASIC's product intervention power would play out practically if implemented and, in particular, what role advisers will play.

In the meantime, advisers should continue to follow best practice and ensure they comply with their obligations regarding the provision of advice and distribution generally.


This article was first published in the Independent Financial Advisor, 1 April 2015

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.