As public hearings into the Future of Financial Advice’s Senate inquiry begin on Thursday, it’s probably not overstating the case to say the financial planning industry is at a crossroads.
With the F0FA regime currently in place, the opportunity presents itself for a new generation of financial planners committed to serving the best interests of consumers, without the conflicting incentive of commissions.
Unfortunately the old generation of financial planners appears intent on rejecting this opportunity. It’s probably not surprising given that, according to 2011 figures from the Mortgage and Finance Association of Australia (MFAA), only 11% of planners are aged under 30, and around 80% of planners are either owned or affiliated with the major banks. Hence the sales culture of the older planners and their vertically integrated organisations, wishing to cross-sell as much product as possible, is well entrenched.
As a consequence we are seeing an ongoing campaign (notably by some of the big banks) to water down the FOFA legislation, which has only been in place since July 2013.
The proposed reforms to FOFA include removing the “opt-in” requirement where clients of financial advisers must indicate annually that they wish to continue the service, removing the need for an annual fee disclosure for clients engaging before July 1, 2013, and a watering down of the “best interest” duty and provisions directed at removing conflicted remuneration; that is the payment of commissions, on general advice.
The process was postponed in March when assistant treasurer Arthur Sinodinos stepped aside and finance minister Mathias Cormann referred the legislative package to the Senate Economics Legislation Committee, but media reports suggest the government may soon unveil its plans.
The banking industry claims much has changed since the impact of the global financial crisis revealed the extent of shameful practices in the advice industry.
The financial advice collapses in Australia between 2006 and 2010 - involving Storm Financial, Opes Prime, Trio Capital and Westpoint Property Group - resulted in more than A$6 billion in losses and involved more than 120,000 people.
All involved conflicted remuneration structures and high commissions as fundamental issues.
Advisers in these cases exploited their clients by offering advice that prioritised their own best interest over that of their clients.
It is difficult to understand the extent of this exploitation without reference to specifics. In one of the key cases surrounding the Storm Financial collapse, ASIC pursued Macquarie Bank and Bank of Queensland on behalf of two investors aged in their sixties, Barry and Deanna Doyle.
Despite the fact that the Doyles had indicated to their advisers that they had a low risk appetite, they were “double-geared” into the stock market by borrowing against their home and using the cash to raise yet more money to invest.
With only part-time income of less than $20,000, some Centrelink payments, and assets which consisted of a house worth $450,000 and $640,000 in superannuation savings, the Doyles ended up owning a share portfolio costing $2.26 million, on which annual interest payments eventually rose to $191,800.
Following the fall in asset prices the Doyles’ highly leveraged share portfolio was sold, consuming all of their superannuation savings. They were left with a debt of $456,000 on their previously unencumbered home, with insufficient income to make the repayments. In return for this disastrous investment advice, which saw them increase their borrowings or exposure to the stock market no fewer than 11 times in 25 months, the Doyles paid Storm $152,000 in fees.
Not surprising then that at the heart of the FOFA legislation are two key “gatekeeper” requirements to address conflicted remuneration. First, planners must prioritise their clients interests over their own, and second, the advice must be appropriate to the client’s own situation.
It is important to note here that there are advisers who do routinely act in their client’s best interest. This is reflected in the Financial Planning Association of Australia’s submission to the Financial System Inquiry, which argues that rather than water down the FOFA legislation, there is a good case to extend this “gatekeeper standard” to other areas of financial services to protect the interests of investors more broadly.
As we have been reminded only too often over recent weeks, we have an ageing population, increasing demands on the welfare system, and a very real need to maximise our retirement savings to ensure greater self-reliance in retirement. Given the generally poor level of financial literacy in this country, this is most unlikely to happen unless individuals can access low cost and scalable advice to assist in their retirement planning. The opportunities for the financial advice industry, and the investment community more generally, is therefore enormous.
The willingness with which individuals seek such advice, however, will depend on their confidence in the financial planning industry. Research from Rice Warner indicates that as a result of collapses such as those listed above, consumers hold a low view of financial advisers, with only 25% regarding them as ethical and honest. This mistrust results in Australians not seeking financial advice when it could be beneficial for them to do so.
The FOFA legislation presents a great opportunity for the financial advice industry collectively to adopt a more ethical client focused approach, re-instilling confidence in the industry. Without that confidence, individuals will not seek the advice they need, retirement savings will not be maximised, and there is likely to be an even greater need to rely on the age pension.