The Royal Commission has the financial services industry on edge. Both large institutions and small are sitting up and paying attention as they have never before. Big changes are afoot; probably the biggest ever. Industry opinion is calling for a ban on conflicted remuneration grandfathered under FoFA. Eyebrows are being raised at the revenue models of advisers that run virtual portfolio services and perhaps the service providers that support such enterprises. Advisory firms that receive brokerage, in addition to portfolio management fees and advice fees may be feeling nervous, if not vulnerable. And this could be just the tip of the iceberg. The Royal Commission appears to be pointing to reform to directly address the embedded sources of conflict.
How did we get here?
The industry advice model typically bundles planning advice fees and portfolio advice fees. It is the unintended consequence of policy responses to past dysfunctional behaviour relating to product sales promoted by large financial institutions. Despite several rounds of policy and legislation, there has been insufficient recognition of and differentiation between planning advice and portfolio (product) advice, which has continued to promote a product-oriented culture within the industry. The large institutions, as the largest stakeholders and proponents of industry self-regulation have been largely responsible for developing today's advice model under this flawed framework. The "institutional advice model" has facilitated a culture of unabated product sales, which has long been the lifeblood of the advice industry.
It is well known that the major institutions actively developed product manufacturing capabilities to build investment products and subsequently investment platform technology as distribution channels for their high margin investment products. By incorporating platforms as an integral operational component within adviser business models, it secured the wholesale support of advisers under the guise of "technology". These significant distribution capabilities have enabled institutions to actively market investment products (many of which are in-house products) to their captive customers as well as external adviser networks that are compelled to operate within the system.
In truth, it's the way business is done and how the advice market essentially operates. While the vast majority of advisers conduct themselves with their clients' best interests in mind, the advice system largely straightjackets them. There is no objective framework that enables advisers to consistently account for the value they are providing. They are essentially being gamed by the house; and as we all know, the house always wins. The product-oriented advice model has long been understood by many service providers who have actively subscribed to the adage "if you can't beat them, join them."
Where does this leave investor best interests?
How to best serve clients' interests is now the subject of growing interest and speculation. The old guard is sticking to its guns and arguing that a ban on grandfathered revenue will unfairly result in excessive profits flowing to the institutional product manufacturers and further create a large body of severely underserviced consumers. This sounds a little like moved cheese. Some suggest that sales titles should be imposed on those who deal in product advice; and that the designations of financial planner and/or financial adviser should be restricted to those that receive no remuneration for product advice. Others yet are calling for preferred tax treatment on fees charged by advisers that do not receive any remuneration for product advice. In general, we believe a more inclusive response to reform is preferred to such restrictive approaches.
Accountability through transparency
Bundling planning advice and product advice is the source of the embedded conflict that has distorted the advice industry for so long; we all know this and so does the Royal Commission. Separating product fees from advice fees is the first step to addressing the underlying conflict. It imposes transparency upon the system, which is key to sustaining consumer best interests. It allows consumers to better understand what service they are receiving; and to confidently benchmark and compare their services (and costs) with other readily available options in the market. Providing accountability through transparency is in large, the only way advisers can sustain a successful long-term relationship with their clients.
The current advice model clearly must change.