After weeks of reading the Financial Services Royal Commission Final Report on a screen, my hard copies arrived recently. Anyone can order them for free here. There’s something different about sitting down with a book, like in the good old days, and it’s surprisingly easy to read. Kenneth Hayne does not write in a legalistic way, but he is chatty in places, as if writing as his thoughts form. Someone should have given it a good edit but my guess is nobody was willing to suggest this to Mr Hayne. He’s even elegant in places:
“It is time to ignore the ghostly apparition of constitutional challenge conjured forth.”
“Saying only that there may be a ‘disruption’ or ‘unintended consequences’ is nothing but a naked appeal to fear of the future.”
Revelations in the Table of Contents
But something jumped out even before I left the Table of Contents section. There’s not much in the ‘Banking’ section. It’s often called the Banking Royal Commission (and in fact, Cuffelinks bought the domain name bankingroyalcommission.com although we never activated it). The Banking section starts on page 51 and finishes on page 118, only 67 pages. Even in there, 28 pages are devoted to mortgage brokers and intermediation. Surely a wider range of banking services should have been the Commission’s primary target, not a mere 40 pages.
Look at the topics in the Table of Contents:
- Intermediated home lending
- Intermediated vehicle and consumer good lending
- Access to banking services
- Farm debt mediation
- Valuation of land
- Charging default interest
- Distressed agricultural loans
- Enforceability of industry codes
- Processing and administrative errors
Among the vast array of products and services banks offer, are these the most important? Farm debt mediation! Valuation of land! Distressed agricultural loans! It’s a rural banking review. Nothing much on how banks price products, credit card lending and rates, transaction services, foreign exchange, fees on loans and deposits, closure of bank branches … the list goes on. Why is a cheque dishonour fee $30 for an automated process? Why are some credit card rates over 20%? Why are term deposit rollover rates worse than new offers? The Commission only scratched the surface.
It matters because bankers are now focussing on the issues raised by Kenneth Hayne, leaving some major issues untouched.
Then ‘Financial advice’ starts on page 119 and goes for 100 pages, after which ‘Superannuation’, which also deals with financial advice, kicks in and covers another 47 pages.
There’s twice as much on financial advice as banking (even acknowledging there are general sections on culture and remuneration later). It’s more like the Financial Advice Royal Commission.
What about stockbrokers and FoFA?
The instructions given to the Royal Commission are in the Letters Patent. It refers to ‘financial services’, and it invites the Commissioner to inquire into almost anything that he considers relevant to “peace, order and good governance”. The massive industry of listed securities, stockbroking and the ways companies raise money on exchanges barely rates a mention. Meanwhile, financial planning was pilloried in the witness box month after month, as if the remuneration and market practices of one industry are any less questionable than the other. Who can forget the well-justified trials on the Future of Financial Advice (FoFA) misdeeds, grandfathered commissions and the evidence of financial adviser, Sam Henderson and others?
The Terms of Reference make no more direction towards financial advice than stockbroking, and the official name of the inquiry is the Royal Commission into Banking, Superannuation and Financial Services Industry.
Since FoFA and financial advice were front and centre for months, why wasn’t an activity which has close operational parallels to financial advice (such as distribution of products for commissions, raising of capital for companies, provision of advice to consumers) examined? Stockbrokers and financial planners carry far more similarities than differences.
In a previous article, 8 problems the Royal Commission missed, I wrote about the ability of fund managers and other market participants to avoid the FoFA rules by using the Listed Investment Company (LIC) structure. It was good to see Christopher Joye write a quality analysis in The Australian Financial Review on 8 March 2019 entitled, ‘Boiler rooms are back as listed investment companies’. He notes:
“Fund managers have figured out how to circumvent the vital Future of Financial Advice (FOFA) consumer protection laws to pay gigantic sales commissions worth more than $150 million to brokers and advisers despite FOFA being implemented to prevent precisely this practice …
When these laws were introduced in 2012, they applied to all investment entities, including listed and unlisted funds and investment companies. In 2014, however, sustained industry lobbying convinced politicians to exempt listed investment companies and trusts from FOFA’s all-important reach …
In dollar terms, fund managers have paid more than $150 million in conflicted commissions to get brokers/advisers to push their products to retail investors, often in incredibly short time frames …
For the vast majority of fund managers rushing to exploit this huge loophole, there is zero chance they could secure this volume of capital as quickly as they can on the ASX through normal FOFA-compliant channels.”
The legislation Joye is referring to includes 7.7A.12.B of Consolidated Regulations. It says:
“A monetary benefit is not conflicted remuneration if it is a stamping fee given to facilitate an approved capital raising.”
So call commission a ‘stamping fee’ for ‘an approved capital raising’ and we’re off to the races. Call a commission a conflicted remuneration from a product provider to a financial adviser, and we’re off to the slammer.
Redefining financial advice
Given both political parties have indicated that Hayne’s report will be adopted in full with only one or two exceptions, what does it say about the future role of financial advice? Here is a sting in the tale that financial advisers should worry about.
For a start, there is plenty of evidence that Hayne is unconvinced about the merits of advice. For example:
“ … poor advice which, too often, is the result of the conflicts of interest that continue to characterise the financial advice industry. Other professions are not so pervaded by conflicts of interest and do not have such a high tolerance for the continued existence of conflicts of interest. Until something is done to address these conflicts, the financial advice industry will not be a profession.”
“the existing disciplinary arrangements for financial advisers are fragmented, and hampered by inadequate sharing of information.”
“Not all advisers (financial or other) are equally skilled or diligent. In some cases, reasonable advisers may form radically different views about what should be done.”
“In 10% of all the files ASIC reviewed, ASIC ‘had significant concerns about the potential impact of the advice on the customer’s financial situation’.”
Has Hayne misunderstood where financial advice was heading?
Powerful implications for financial advice start on page 238 of the Final Report. I will quote extensively because these findings are a redefinition of the future of financial advice, and the industry is not reacting enough. Advisers are shell shocked and keeping their heads down. Kenneth Hayne writes:
“It is not consistent with the sole purpose test for a trustee to apply funds held by the trustee in paying fees charged by an adviser to consider, or re‑consider, how best the member may order his or her financial affairs generally or may best make provision for post‑retirement income.
“It follows that the nature of the advice that may properly be paid for from a superannuation account is limited to advice about particular actual or intended superannuation investments. This may include such matters as consolidation of superannuation accounts, selection of superannuation funds or products, or asset allocations within a fund. It would not include broad advice on how the member might best provide for their retirement or maximise their wealth generally. Any practice by trustees of allowing fees for these latter kinds of financial advice to be deducted from superannuation accounts must end. (my bolding).
“I would modify the general rule in respect of MySuper accounts, and permit no deduction for advice fees of any kind … It is difficult to imagine circumstances in which a member would require financial advice about their MySuper account. If a member wants financial advice, the cost of that advice should be charged to and paid by the member directly.
Perhaps a superannuation member invested through a platform would benefit – or believe they would benefit – from ongoing financial advice in respect of their superannuation investments. But such benefits would be relatively modest, and would accrue to relatively few members … the advice in respect of which fees may be charged is limited to advice about particular superannuation investments.”
This recommendation flies in the face of current practice and will result in fewer people obtaining financial advice. Many superannuation funds allow the cost of financial advice fees to be charged to the super account. For example, an adviser telling a MySuper client about co-contributions, or dividing up an estate between dependants, or transferring from accumulation to pension, or aged care. Advice fees on such issues will no longer be chargeable to the super account.
Financial advice should not be predominantly about investments, as Hayne will encourage, but it is a holistic solution to satisfy future goals, especially retirement. It is no more relevant to advise about investing for retirement than it is about estate planning, aged care, lifestyle coaching, budgeting, property and tax advice. Kenneth Hayne is pushing the industry back to an old model where advisers were stock pickers and fund managers, and this should not be the primary skill.
The advice industry is fruitlessly fighting against the banning of grandfathered commissions, but Hayne’s proposed change in their fundamental model is far more important. In fact, one of the reasons managed accounts have become so successful is that advisers put their clients into model portfolios designed by investment experts, allowing advisers to concentrate more on the non-investment side of their client’s future goals and retirement plans. Most members will not pay for advice from their own pockets, and denying payment by their super fund will result in less people obtaining the advice they need.
Graham Hand is Managing Editor of Cuffelinks.