Publications / Financial Services

6 Dec 11
Future of financial advice reforms - tranche 2 bill

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The Government has released draft legislation containing the remaining reforms proposed under its Future of Financial Advice reforms program. Partner at McCullough Robertson, Tim Wiedman, summarises the key changes between the bill and the consultation draft released earlier this year.

The Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011 (Bill) covers the remaining measures of the Government’s Future of Financial Advice (FOFA) reforms package, namely the best interests obligation and ban on conflicted remuneration. The other measures proposed in the FOFA reforms package - specifically the requirement to provide disclosure of, and obtain consent to charge, ongoing fees; enhancement of ASIC’s banning and licensing powers; and the introduction of anti-avoidance measures - are contained in the Corporations Amendment (Future of Financial Advice) Bill 2011 (First Bill), which was discussed in our earlier article dated 24 November 2011.

The Bill, as with the First Bill, has been referred to the Parliamentary Joint Committee on Corporations and Financial Services (PJC) and the Senate Economics Legislation Committee (SELC) for inquiry and report. Therefore, the PJC and SELC are considering the Government’s entire FOFA reforms program.

Submissions to the PJC closed on 25 November 2011, and the PJC is scheduled to report on 29 February 2012. Submissions to the SELC close on 6 February 2012, with the SELC scheduled to report on 14 March 2012.

The Bill indicates the Government is proceeding with its targeted 1 July 2012 commencement date for the FOFA reforms. However, given the referral of the Bill and First Bill to the PJC and SELC, the supporting amendments to the Corporations Regulations 2001 (Cth) have not been released and the Bill and First Bill will need to be passed by both houses of Parliament, we believe the Government’s target commencement date is overly optimistic and will be deferred. 

Further, the reports of the PJC and SELC may result in amendments to the FOFA reforms as currently proposed by the Government. Accordingly, there is significant uncertainty as to the final composition of the FOFA reforms as well as the timing of the commencement of the reforms and, consequently, the impact on the financial services industry.

Best interests duty

The Bill proposes to amend the Corporations Act to require individuals who provide personal advice to retail clients to:

  • act in the best interests of the client when providing the advice, and
  • give priority to the interests of the client in the event of a conflict between those interests and the interests of the adviser, licensee, authorised representative or any of their associates.

These obligations will only apply to personal advice given to retail clients. They will not apply to:

  • general advice, or
  • personal advice given to wholesale clients.

Our earlier articles dated 7 September 2011 and 30 September 2011 summarised the proposed requirements of the best interests and client priority obligations contained in the exposure draft legislation which was released for consultation (Consultation Draft). Our comments below outline the changes between the obligations set out in the Consultation Draft and those contained in the Bill.

Satisfaction of best interests obligation

The Bill and Consultation Draft include a number of steps an adviser should undertake in discharging its best interests obligation. As discussed in our previous article (7 September 2011), we had serious concerns with two of the steps proposed in the Consultation Draft, namely the requirement for advisers to:

  • recommend a client obtain advice on another subject matter, where it is reasonably apparent that the client’s objectives could be better satisfied, or needs better met by doing so, and
  • assess whether the client’s objectives could be achieved or needs met through means other than the acquisition of financial products.

Our key concerns with these obligations were that they potentially required an adviser to:

  • make an assessment on, and recommend clients consider, financial products the adviser is not authorised or competent to provide advice on, and
  • to consider matters or ‘products’ beyond the financial services industry, which an adviser may have little or no expertise with. 

In our submission to the Government on the Consultation Draft we argued that persevering with these requirements:

  • is contrary to the general premise of the financial services regime which requires advisers to only advise on products they are competent to do so
  • will be of little value to clients as advisers will only be able to make very general, uninformed comments regarding financial products and other products which they have no expertise in, and
  • will lead to the inclusion of generic statements in a statement of advice in an attempt to discharge these obligations. 

In response to our and other submissions received on this issue, the Government has, favourably for advisers, removed these requirements as matters advisers will need to take into account in discharging their best interests obligations.  Instead, the Government has imposed a requirement for an adviser to take any other step which would reasonably be regarded as being in the interests of a client, given the client’s relevant circumstances.

Approved product list

The Consultation Draft expressly recognised, as highlighted in our earlier article (7 September 2011), if an adviser utilises an approved product list and no product on the list meet the needs and objectives of the client, then the adviser did not have to consider financial products beyond the list. 

However, the adviser could not recommend an unsuitable product from their approved product list and was required to inform the client they are unable to recommend a product from their list as being suitable. The explanatory memorandum accompanying the Consultation Draft also mentioned that the requirement to conduct reasonable investigations into products which may meet the client’s objectives and needs did not require an investigation of every product available on the market.

The provision expressly recognising that an adviser who did not have a suitable product on their approved product list can refrain from making a recommendation is not contained in the Bill. Further, the explanatory memorandum accompanying the Bill states that an adviser is expected to exercise professional judgment to determine whether discharging the best interests obligation requires going beyond their approved product list (if any).

This development is concerning and, in our view, fails to recognise the valuable risk management and quality control role approved product lists play for licensees and authorised representatives.  Specifically, requiring advisers to adhere to an approved product list can reduce the insurance premiums payable by licensees; ensure that an adviser is only providing advice on products they understand, having undertaken training provided by a licensee or authorised representative and ensuring advisers only recommend products which the licensee or authorised representative has reviewed and evaluated. 

A further concern is the Government appears to have ignored submissions received on the Consultation Draft explaining that it is unreasonable and commercially impracticable to require an adviser who is an employee of a product issuer licensee to potentially consider a competitor’s products in making recommendations to clients. 

We submit that a more appropriate requirement is for an adviser to ensure that the product recommended meets the client’s needs and objectives and, where the adviser is only considering the products of one issuer, the adviser should disclose this limitation to the client. Advisers who recommend the products of a single product issuer should not be expected to consider products offered by other issuers. We hope the issue is dealt with by the PJC and SELC inquiries.

General insurance

The best interests obligation has been watered down for general insurance products, such as travel insurance, car insurance, and home and contents insurance. An adviser providing personal advice to retail clients on general insurance products is only required to consider some of those steps or matters listed in the Bill as needing to be undertaken by an adviser to discharge their best interests obligation. 

For example, an adviser providing advice on general insurance products is not required to undertake a reasonable investigation into financial products which may achieve the objectives and meet the needs of the client. Therefore, an adviser employed by an insurer would not need to consider the products of other insurers in recommending a general insurance product to a client.

Giving priority to client’s interests

The Bill expands the list of persons whose interests the adviser must consider in ensuring it gives priority to the client’s interests when giving advice.  Specifically, in addition to considering whether there is a conflict between the interests of the client and the interests of the provider and their licensee or authorised representative, the adviser must also consider whether there is a conflict between the interests of the client and any associate of the provider, licensee or authorised representative.

Further, the obligation to give priority to client interests does not apply for advice given solely in relation to a basic banking product by an agent or employee of an Australian ADI.

Ban on conflicted remuneration

Licensees and authorised representatives will be prohibited from accepting monetary and non-monetary benefits where it has the potential to influence the financial product advice given, or financial product recommended, to retail clients.  The ban on conflicted remuneration applies to both personal and general advice given to a retail client.  Our previous article (30 September 2011) contained a detailed summary of how the ban on conflicted remuneration is proposed to operate. 

Change to the threshold

The Consultation Draft defined conflicted remuneration as any monetary or non-monetary benefit given to a licensee or representative that might influence or distort the advice given, by either influencing the choice of the financial product being recommended or the financial product advice provided more generally.

The Bill has slightly modified what constitutes conflicted remuneration, for the benefit of licensees and authorised representatives, by providing the benefit will only be conflicted remuneration if it could reasonably be expected to, rather than might, influence the choice of product recommended or advice provided.

The Consultation Draft deemed that certain benefits were conflicted remuneration, specifically benefits 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.

The Bill has tempered this obligation by providing that monetary or non-monetary benefits dependent on these matters are presumed to be conflicted remuneration unless the contrary is proven and also the ‘value of investment’ limb has been removed from the Bill. Therefore, a benefit dependent upon the value or number of financial products will be presumed, rather than absolutely taken, to be conflicted remuneration.

Exemption - fee for service

There are a number of exemptions to the ban on conflicted remuneration, as summarised in our earlier article (30 September 2011), including benefits given to the licensee or representative by a retail client in relation to the issue of sale of a financial product or financial product advice given.  This exemption permits ‘fee for service’ arrangements where the client is the person paying the adviser, even if the fee or commission is based on the number or value of financial products recommended.

The Bill has retained this exemption and the explanatory memorandum for the Bill clarifies the operation of this exemption. Specifically, the explanatory memorandum states the exemption covers any fee for service paid by the retail client whether the benefit is given directly by the retail client or is given by another party at the direction, or with the clear consent, of the retail client.

Accordingly, fees payable out of the balance of a client’s fund or application proceeds can be received by a licensee or authorised representative without contravening the conflicted remuneration ban, provided the client has directed or consented to the payment of the fee. For example, if an adviser recommends a client invest $100,000 in a managed investment scheme and the client directs the responsible entity to pay a 3% contribution fee to the adviser, then the responsible entity could issue $97,000 worth of units to the client and remit $3,000 to the adviser without contravening the conflicted remuneration ban. 

Similarly, an adviser and client could agree that the trustee of a superannuation fund can pay the adviser an annual adviser fee from the member’s balance and the payment of such fee would be covered by the exemption (though such fee would be subject to the ongoing fee arrangement provisions contained in the First Bill). This clarification is welcome news to the financial services industry and preserves the ability to charge a number of existing fees which are paid indirectly, but knowingly, by clients from their application or investment moneys.

Exemption - remuneration

The Consultation Draft expressly exempted from the ban on conflicted remuneration remuneration paid by the employer to the licensee or representative for work carried out, provided such remuneration was not based on the value or number of financial products recommended. This exemption is not included in the Bill. 

The explanatory memorandum to the Bill indicates that rather than including this as an exemption, a licensee or representative would need to have regard to all circumstances surrounding the remuneration payable to employees to consider whether such remuneration is conflicted remuneration or not. The explanatory memorandum suggests that this development is intended to provide flexibility for performance based remuneration arrangements. However, the lack of certainty that salaries are not conflicted remuneration is worrying and our preference is for such express exception to be retained.

Benefits given by product issuers and sellers

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

As summarised in our earlier article (30 September 2011), the Consultation Draft provided that this was absolute prohibition and applied even if the benefit would not influence or distort the financial product being recommended, or financial product advice being provided, to retail clients.

The Bill modifies this position by providing that a monetary or non-monetary benefit given by a product issuer or seller is only prohibited if it is conflicted remuneration, meaning that it could be expected to influence the advice given or product recommended to retail clients. This amendment is consistent with the clarification in the explanatory memorandum to the Bill on the operation of the fee for service exemption discussed above, and will enable the product issuer or seller to provide a benefit to a licensee or representative where it is given indirectly by the client at their direction or with their consent.

As a result of limiting the ban on product issuers and sellers to benefits which are conflicted remuneration, certain exemptions applying for product issuers and sellers contained in the Consultation Draft, and discussed in our previous article (30 September 2011), namely:

  • a fee for service, where the fee reasonably represents the market value of the service, or
  • the purchase price of property where the benefit reasonably represents the market value of the property,
  • have not been retained in the Bill. 

Volume based shelf-space fees

The Bill and Consultation Draft both provide that platform operators will be banned from receiving monetary or non-monetary benefits from fund managers where the benefit is dependent upon the total number or value of the fund manager’s financial products for which the platform operator provides a custodial arrangement. 

In addition to the exemption for certain discounts or rebates, as summarised in our earlier article (30 September 2011), the Bill also exempts from the ban on volume based shelf-space fees a reasonable fee for service provided to the fund manager by the platform operator or another person.

Application to existing arrangements

The Bill clarifies that the ban on conflicted remuneration does not apply to benefits given to the licensee or representative if the benefit is given under an arrangement entered into before the commencement date, which is scheduled for 1 July 2012.

However, conflicted remuneration paid to the licensee or representative by a platform operator will be prohibited from the commencement date even if an existing arrangement is in place. The explanatory memorandum to the Bill indicates that the timing on the ban for benefits given by platform operators will be dealt with in the regulations. Conversely, the ban on platform operators receiving (as opposed to giving) volume based shelf-space fees will not apply to fees payable under arrangements entered into prior to the commencement date. 

Similarly, the ban on asset based fees charged on borrowed funds, which is discussed in our earlier article (30 September 2011), only applies to borrowed amounts used to acquire financial products on or after the commencement date.  However, the restriction will apply if the financial products to which those borrowed amounts relate are sold after 1 July 2012 and new financial products purchased.

Moving forward

The differences between the Bill and Consultation Draft are generally positive for the financial services industry. However, the FOFA reforms remain a controversial and potentially onerous and economically damaging package for financial advisers. 

Accordingly, in addition to being aware of the proposed FOFA reforms and considering both their potential impact on your business and how your business may need to change, advisers, licensees and representatives should take advantage of the referral of the FOFA reforms to the PJC and SELC by providing submissions to the SELC (as the PJC submissions have closed) highlighting their concerns.

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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