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30 Sep 11
Future of financial advice reforms - draft legislation - tranche 2

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Summary

The draft Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011 (Bill) contains the legislative framework for the following FOFA reforms:

  • a ban on conflicted remuneration, where licensees or their representatives provide financial product advice to retail clients
  • a ban on product issuers giving monetary or non-monetary benefits to licensees or their representatives
  • a ban on volume-based shelf-space fees from asset managers or product issuers to platform operators
  • a ban on asset-based fees (being fees dependent on the amount of funds held or invested) being charged by licensees or representatives to retail clients where the client’s funds are ‘borrowed’ or ‘geared’, and
  • the introduction of anti-avoidance measures.


The Government is targeting a commencement date of 1 July 2012 for the reforms proposed in the draft Bill.

As with the first raft of FOFA reforms, the Government has imposed a short exposure period with any comments to be provided by Wednesday, 19 October 2011. This time frame suggests the Government intends to introduce the draft Bill to Parliament in its current form and does not propose to make substantive changes as a result of the consultation process.

The first tranche of the FOFA reforms, covering the statutory best interests duty, compulsory renewal requirement and enhancement of ASIC’s powers, was released at the end of August and the consultation period closed mid September.

This article summarises the key changes to be implemented by the draft Bill.

Ban on conflicted remuneration

Licensees and authorised representatives will be prohibited from accepting conflicted remuneration where it has the potential to influence financial product advice and recommendations provided to retail clients.

Importantly, the ban on conflicted remuneration applies to both personal and general advice given to a retail client. This is in contrast to the statutory duty to act in the client’s best interests proposed in the first tranche of the FOFA reforms which only relates to personal financial product advice.

What is conflicted remuneration?

Conflicted remuneration means any monetary or non-monetary benefit given to a licensee or representative that might influence or distort advice, by either influencing the choice of financial product being recommended or the financial product advice more generally.

The draft Bill provides examples of benefits which are conflicted remuneration, namely benefits which are dependent upon:

  • the value of financial products recommended
  • the number of financial products recommended, or
  • the value of investments by clients to whom the licensee or representative provides financial advice.

What are the exemptions?

The ban on conflicted remuneration only applies to financial product advice given to retail clients. Therefore, remuneration or other benefits which may constitute conflicted remuneration, including benefits based on the value or number of financial products recommended or the value of investments by clients, is still permitted for:

  • financial product advice provided to wholesale clients, and
  • financial services other than financial product advice. For example, a responsible entity can still charge fees associated with operating a registered scheme, such as a contribution fee on each amount invested in the scheme by a retail client.

Further, certain benefits are ‘carved out’ from the conflicted remuneration prohibition, specifically:

  • the following monetary benefits:
    • benefits given by a general insurer in relation to general insurance products. This means commissions may still be payable on home and contents insurance,    travel insurance, car insurance and other types of general insurance, and
    • benefits related to either life insurance which is not bundled with a superannuation product or individual life policies which are not connected with a default superannuation fund. Therefore, commissions are prohibited on group risk inside superannuation and on a life insurance policy which is for the benefit of members of a default superannuation fund. However, commissions on individual life risk policies within superannuation for non-default (‘choice’) funds and on life risk policies sold outside superannuation will still be permitted

 

  • the following non-monetary benefits:
    • benefits given by a general insurer in relation to general insurance products
    • benefits under the prescribed amount (proposed to be $300), so long as identical or similar benefits are not provided on a frequent or regular basis. This exclusion covers ‘soft-dollar’ benefits, such as sporting tickets, electronic devices, holiday vouchers, etc, of a small value
    • benefits with a genuine education or training purpose, which are relevant to the provision of financial advice to retail clients and which comply with any other requirements in the regulations (professional development exemption). The explanatory statement released with the draft Bill provides guidance on the proposed additional requirements being considered, namely that the professional development must be conducted in Australia or New Zealand, at least 75% of the time (based on a standard eight hour working day) has to be spent on professional development (which excludes other activities such as networking) and any travel costs, accommodation and entertainment outside of the professional development activity must be paid for by the participant, their employer or licensee
    • a benefit with a genuine education or training purpose, relevant to the provision of financial product advice and which complies with any other requirements in the regulations (administrative IT services). The explanatory statement does not identify any further requirements likely to be imposed by the Government. However, this exemption would cover a software program provided to advisers which enables them to prepare a statement of advice in the format required by the licensee
    • execution-only (non-advice) services. This will enable stockbrokers to continue to receive a commission on the purchase and sale of securities on behalf of clients where no advice has been provided (that is, where the client instructs the broker what to buy and sell). The explanatory statement also mentions that it is proposed to permit stockbrokers to receive third party ‘commission’ payments from companies where those payments relate to capital raising for products which will be traded on a financial market. This exemption is not currently contained in the draft Bill, although the draft Bill facilitates the making of exemptions by regulation
    • benefits given to the licensee or representative by a retail client in relation to either the issue or sale of a financial product to the client or to financial product advice given by the licensee or representative to the client. This exemption permits ‘fee for service’ arrangements where the client is the person paying the adviser, even if the fee is a commission or otherwise volume-based

 

  • the following monetary or non-monetary benefits:
    • benefits given to a licensee or representative by an employer which is remuneration for work carried out by the employee, that is not based on the value or number of financial products recommended or the value of investments held by clients to whom the advice is provided. For example, a salary paid by a licensee to an adviser employee will fall under this exemption but an additional bonus based on the adviser selling a particular number of financial products will not come within this exemption (and will be conflicted remuneration), and
    • benefits given to employees of an ADI to advise on and sell basic banking products. Therefore, such employees can receive sales incentives even though they are volume-based, but only on basic banking products.


Benefits from product issuers

Product issuers or sellers will be banned from giving any monetary or non-monetary benefits to a licensee or representative who provides financial product advice to retail clients.

This restriction is not subject to the conflicted remuneration requirement and is an absolute prohibition.

What are the exemptions to the ban on product issuers and sellers giving benefits?

This ban will not apply in the following circumstances:

  • the benefit is a fee for service and the fee reasonably represents the market value of the service
  • the benefit is the purchase price for property and the benefit reasonably represents the market value of the property
  • benefits given by a general insurer in relation to a general insurance product
  • benefits under the prescribed amount (proposed to be $300), so long as identical or similar benefits are not provided on a frequent or regular basis
  • benefits covered by the professional development exemption, and
  • benefits covered by the administrative IT services exemption.

Volume-based shelf-space fees

Platform operators will be banned from receiving monetary or non-monetary benefits from fund managers where the benefit is dependent on the total number or value of the fund manager’s financial products either:

  • about which information is included on the platform operator’s platform, or
  • which are issued through the platform.

However, a benefit which is a discount or rebate from the platform operator to the fund manager will not be prohibited, provided the value of the discount or rebate does not exceed the reasonable value of the scale efficiencies obtained by the fund manager because of the number of financial products for which the fund manager provides services to the platform operator.

Therefore, the draft Bill proposes to ban platform operators receiving volume based benefits to the extent such incentives are merely a means of product issuers or fund managers purchasing ‘shelf-space’ or preferential positions on administration platforms (e.g. inclusion in a model portfolio or menu selection). However, the draft Bill will not ban fund managers lowering their fees to platform operators where the discount rebates represent reasonable value for scale.

Ban on asset-based fees on borrowed funds

The draft Bill proposes to ban licensees and representatives from charging asset-based fees on geared funds to retail clients where the licensee or authorised representative has provided financial sproduct advice to the client.

An asset-based fee is defined as a fee dependent upon the amount of funds used to acquire financial products for the client, essentially a fee based upon the amount of funds held or invested. Geared funds encompass funds which are borrowed in any form, including secured or unsecured funds and funds available through a margin lending facility or credit facility.

Asset-based fees will continue to be able to be charged on ungeared funds. Also, where the client’s funds include both geared and ungeared amounts an asset-based fee can be charged on the ungeared amount.

The draft Bill protects advisers where they have no reason to believe the funds used are geared, though advisers will be subject to a duty to make reasonable enquiries to obtain complete and accurate information. Therefore, an adviser cannot deliberately or knowingly disregard relevant information or fail to make reasonable enquiries so they can charge an asset-based fee on geared funds.

The restrictions do not apply to wholesale clients, and therefore advisers can continue to charge asset-based fees on geared funds to wholesale clients.

Anti-avoidance

The draft Bill also includes anti-avoidance provisions which prohibit a person, either alone or with others, from entering into a scheme for the sole or dominant purpose of avoiding the application of any provision in the draft Bill, provided the scheme would have achieved that purpose.

Moving forward

The draft Bill has broad and significant implications for the remuneration and fee structures of product issuers, licensees and advisers in their dealings with retail clients. Though an exposure draft, the Government is committed to reforming how advisers are remunerated for advising retail clients, specifically prohibiting commissions and other monetary and non-monetary benefits paid to advisers other than by the client.

Licensees and representatives, who have not already made the change, should review their operations and commence preparations to change to a fee for service model in preparation for the proposed 1 July 2012 commencement date. Similarly, product issuers will also need to review and likely restructure their arrangements with platform operators, licensees and advisers in light of the proposed new regime.

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Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.
 

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