Will Australia’s New Advisor Competency Standards Be A Roadmap For US Regulators?

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

Last week I was speaking in Sydney, Australia at a Finology conference, an event for financial advisors that is meant to focus specifically not just on investments or financial planning per se, but the challenges of better communicating recommendations to clients, getting their buy-in to actually implement the recommendations, and all the ways that everyone's relationships with money basically adversely impacts our ability to follow through on all those investment and financial planning recommendations.

But as I was there for the event, I found that the big buzz actually for financial advisors in Australia right now is a looming set of new competency standards that the Australian regulators just passed, that's going to lift up the minimum educational requirements to be a financial advisor in the first place in Australia going forward. And given that throughout the past decade Australia has actually been leading the U.S. on regulation of financial advisors, I think this is pretty notable because in essence, what's happening in Australia seems to be coming later to the U.S., which raises interesting questions about whether here in the U.S. we're at some point going to have competency standards coming and whether you can essentially future-proof your own career against the risk of future regulation.

Australian Fiduciary Reforms Under FOFA [Time - 1:31]

To set some context here, back in the summer of 2012, the Australian regulators implemented a bunch of new rules for their financial advisors under what they called their Future of Financial Advice reforms. It was called FOFA for short, F-O-F-A. And the core of the new FOFA reforms were that financial advisors would be required to act as fiduciaries that place the best interests of their clients ahead of their own. Now, that's not unlike what we've been discussing here in the U.S. in recent years under DoL's fiduciary rule, except we're still debating it since 2012 (actually the first proposal came out in 2010), and Australia just did it, fully implemented by the summer of 2013.

And Australia's version was actually even more stringent than what we've been talking about here in the U.S., as Australia flat-out banned all investment commissions for financial advisors. They also banned any kind of soft dollar payments, shelf space, and revenue-sharing agreements to Australian dealer groups, which are roughly the equivalent of our wirehouse broker-dealers here in the U.S. The FOFA reforms also eliminated the ability of advisors to get paid for switching dealer groups under the auspices that it's not the client's best interest for advisors to get paid to move to a new platform. Advisors only need to switch into a new platform because they want to for the benefit of their clients, not themselves.

FOFA rules also limited AUM fees to own leveraged portfolios to discourage anyone from taking out margin loans to increase the size of their portfolio assets for billing purposes, which doesn't happen much here in the U.S. but apparently was happening more there. And even required that clients have to re-opt in to their advisory agreements every two years just to ensure that they really want to still be clients, rather than just once you've got them as an AUM client, they just continue until they proactively fire you.

A lot of these changes should sound familiar because many are the same kinds of rules we've been debating here in the U.S. The Department of Labor's fiduciary rule would similarly require advisors to act in the best interests of their clients. And while DoL fiduciary didn't entirely ban commissions, it will trigger more scrutiny on whether they're really reasonable compensation under what situations. DoL fiduciary is already starting to curtail some broker-dealer back in revenue-sharing agreements, and FINRA has been examining for several years whether we at least need to require better disclosures of the compensation that advisors get when they switch broker-dealers. Although at this point FINRA is just talking about a requirement to disclose those payments, whereas in Australia, they were flat out banned under FOFA.

But again, the distinction here is that while the debate about DoL fiduciary has been stretching out almost 8 years since the very first proposal back in 2010 and almost 2 years since it was officially rolled out but with some provisions still on delay until mid-2019, the FOFA reforms were much more abrupt. ASIC, which is the Australian regulator, put the final rule out in mid-2012 and said, "You all have 12 months to figure it out." Boom. In the middle of 2013, the Australian advisory industry had the new rules in place and had to adjust. And that was that.

And so now that Australia is already almost four and a half or five years into their fiduciary rule, we can look to see how it's playing out there to get some perspective on what may be coming next in the U.S. based on what's happening in Australia in, call it a "post-fiduciary" world.

Australia Proposes Financial Advisor Competency Standards [Time - 4:46]

And what's come next in Australia, as I mentioned earlier, is that now they're going from their new rules on the fiduciary duty of loyalty to clients (to act and in client's best interests), to new financial advisor competency standards as well. Because the reality, as I've discussed previously on Nerd's Eye View, is that it's not enough to just have a fiduciary duty for advisors to act in the best interest of their clients, as it's also essential for the advisor to actually have the technical competency and training in the first place. Otherwise, you may not even know what's actually truly in the best interest of the client because their situation may be too complex for you to analyze if you haven't had much training, education, and experience in being a financial advisor.

Even here in the U.S., the core fiduciary duty itself has always recognized there are really two core duties that go with it. The first is the duty of loyalty (to act in the best interest of the client) and the second is what's called the duty of care (to only give advice in areas in which you're actually competent to do so). Other professions have this as well. A brain surgeon can act on your brain and that's fine, but if a brain surgeon operates on your knee, that's still a problem even though they're a doctor and a surgeon because they're not trained in knee surgery, they're trained in brain surgery. Very improper for them to do knee surgery if that's not the specific domain in which they're trained and competent.

And so, in this context, Australia followed up its first round of FOFA reforms requiring the fiduciary duty of loyalty to clients with the second round of reforms now specifically targeted at financial advisor competency. And in essence, the new competency rules would have four core requirements:

1. 1. All advisors would have to have a college bachelor's degree
   2. Full year of professional experience
   3. Passed a comprehensive exam to demonstrate their competency in core knowledge areas
   4. Commit to ongoing education with the code of ethics.

And a new independent body called the Financial Adviser Standards and Ethics Authority (or FASEA for short) will be responsible in Australia for determining all these details, such as which college degrees qualify, creating and administering their new advisor exam, setting continuing education requirements, and the new code of ethics for their financial advisors.

This is expected to be quite disruptive in Australia because the estimate is that currently, only about 25% of the advisors there would meet all these requirements as they exist today, and many don't necessarily have that much training in financial advice to pass the new competency exam either. And similarly, only about a quarter of Australian advisors have their CFP marks or some equivalent, which would also effectively cover advisors under the new competency rules as well.

So the Australian regulators are actually providing a rather substantial transition period for all the Australian advisors. New advisors will have to meet the new requirements starting in 2019, but existing advisors will have 3 years until 2021 to take the exam, and 6 years until 2024 to get their college degrees if they haven't already. All built around this fundamental concept that if you're going to give people financial advice, you should actually be required to know what you're talking about beyond just being trained in a handful of products maybe that your company offers, because this is the fundamental transition happening here around the world. We're not salespeople anymore, we're advisors who give advice about a lot more than a particular product.

The Rise Of Competency Standards For Financial Advisors [Time - 7:56]

For all of you who have CFP certification here in the U.S., these requirements being implemented in Australia, to have an education, pass an exam, get some experience, and meet a code of ethics, should sound vaguely familiar because it's the exact same framework as what we call the "four E's" requirements that already exists in the U.S.: education, exam, experience, and ethics requirements. In fact, the CFP Board implemented a bachelor's degree requirement back in 2007, already has a 2 or 3-year experience requirement, has had a comprehensive exam requirement since 1991, and has long had a code of ethics which we're now in the midst of updating.

In other words, while CFP certification itself is not actually required to be a financial advisor in the U.S., what the CFP Board requires for CFP certification actually looks exactly like the reforms now being proposed in Australia that would be a requirement for all financial advisors. Which suggests that this really may be the next shoe to drop in regulation for advisors in the U.S., whether it's literally to require the CFP marks to practice and making the CFP certification a minimum competency standard for all advisors rather than just the voluntary designation as today, or maybe it's similar to Australia, some separate but similar competency requirement that's administered by a government regulator or some independent entity the regulator creates for which CFP certificants would likely be grandfathered because they're already the higher standard that the profession is moving towards. Because again, what regulators are now recognizing is that it's not enough just to require that advisors act in their clients' best interests if we don't have the training to know what would be the best advice for clients in the first place.

Financial Advisor Competency Standards Increases Trust In Financial Advisors [Time - 9:33]

And it's worth noting, this ultimately isn't even just about improving competency to ensure there's good advice, it is also about improving consumer trust in financial advisors in the first place. And this was actually a point that really hit home for me from another presentation at the Finology conference last week by a gentleman named Herman Brodie of a firm called Prospecta, out of the UK. So Herman actually just wrote a book coming out in April about how consumers decide whether to trust a financial advisor and ultimately noted that from the research perspective, it basically comes down to two factors, warmth and competency.

Warmth here doesn't necessarily mean you have to be warm and friendly and extroverted with clients necessarily. It simply means that clients have to believe that you care and that you're actually there to try to benefit them and help them. Your warmth means they feel that you're warm towards them and want to actually help them get better outcomes. But Herman's research found that warmth alone is not enough. If clients are going to trust your advice, they also have to believe you're actually competent in the first place and that you really know what you're talking about, and that you can give them advice that they should trust based on your expertise.

As Herman showed, there are plenty of industries and firms (and particularly in financial services) where we're actually doing pretty good on the perceived competency, just we have no perceived warmth. Probably not big news in the financial service industry, but there are a lot of folks that feel that financial services firms are not out for the clients' best interest. Many feel that firms are just out for itself and its shareholders and it's all about the money and not the clients.

But I think sometimes we underestimate how much consumer trust in financial advisors has also been damaged by our low competency standards. Because again, you can hold out as a financial advisor and be responsible for someone's entire life savings with little more than a high school diploma and a three-hour Series licensing exam, and the Series exam doesn't actually test anything about your competency in financial advice, it just tests the regulations, and a high school diploma is actually optional.

So for the subset of us that voluntarily aspire towards what we need to know to actually be more competent in our advice to the clients by getting voluntary designations like the CFP marks, that's a wonderful and huge step forward, but bear in mind barely a 30% of all financial advisors have CFP certification, which means more than 70% do not. And while a few might have some reasonably comparable education designation like the ChFC or the PFS as a CPA, the majority of financial advisors don't have any substantive education or designations in the subject of financial advice.

Now, many that are experienced have learned a great deal from call it the "school of hard knocks" in working with clients, and that still means a lot of advisors simply don't have the education and competency to really be comprehensive advisors, despite what it says in their business cards. And even a lot of the ones who do may have learned through experience and unfortunately probably gave some not-so-great advice to the clients in their early years when they were learning, which isn't a good thing for clients as well.

I'm still appalled that when I started in the industry I got to give advice to clients with basically no training and education in what I was talking about, and, you know, fortunately, didn't cause any dramatic lasting harm. But I look back on some of the recommendations that I gave early on and I just had no idea what I was talking about. There was no requirement that I had to know. And if you just look at some of the public comment sections for consumer media articles about advisors to see the kind of negativity that a lot of consumers have towards us based on prior bad experiences or outright harm that's come from financial advisors that didn't have the knowledge to give the right advice, even if they were well-intentioned and meant to.

Future-Proofing Your Career As A Financial Advisor [Time - 13:09]

And so that's why I think it's such a big deal that Australia is now rolling out a financial advisor competency standard, because it's important to lift the quality of advice and trust in financial advisors, which actually makes it easier for us to get clients. It wasn't necessarily needed in a world where most financial advisors were primarily selling insurance and investment products. Then you really just needed to be competent in the products you were selling, but now most of us are still being regulated like product salespeople and not advisors, even though the whole industry in the U.S., Australia, UK, and worldwide are shifting from a product focus to becoming actual advisors where competency and advice matters – both to give good advice, and to know what good advice would be and to improve consumer trust in financial advisors.

And so while Australia may be the first to formally lift the financial advisor competency standards, I don't think they'll be the last. Just as they were one of the first to propose a fiduciary rule and they were certainly not the last. Which means, if you're a financial advisor that wants to "future-proof" your own career, you really should be looking at how you're going to reinvest into advancing your education with marks like CFP certification. Because as Australia has shown, there will probably be some grace period, some transition period, which means maybe if you're 5 to 10 years from retirement already, you're probably safe to just ride out the status quo, but if you're younger than that and have a longer time horizon in the business, there is an increasing risk that once the first round of fiduciary rule to act on client's best interest is done, the next round is going to be about competency standards. That will be the battle of the 2020s.

And I'm sure a lot of you are thinking, "It can't happen here and it won't happen here," Australia made the change even though fewer than 25% of advisors have the CFP marks. Which means the fact that we're approaching 30% of advisors with the CFP marks in the U.S means, in theory, it would be easier to do it here in the U.S. than what they already did in Australia. And I think that's both a real warning to the 70% of advisors here in the U.S. that don't have the CFP marks or something equivalent and are concerned about how to future-proof their career, I'd be working on that sooner rather than later.

And if you are a CFP certificant, don't rest on your laurels and use that to differentiate yourself, because when the other 70% of advisors are required to get CFP certification as well, your CFP marks don't differentiate you. Just as a lot of advisors are now finding that marketing as a fiduciary is not such a good differentiator in the world of DoL fiduciary where everyone is a fiduciary. The regulators lifting the standards eliminate these as differentiators. And that's why I talk so often about the importance of building towards a niche or a specialization or some kind of post-CFP education so that you stay one step ahead.

But I hope this helps a little as food for thought around the current trends of regulation for financial planners around the world and outside of the U.S. This is Office Hours with Michael Kitces, normally 1 p.m. East Coast time on Tuesdays. Thanks for joining us, everyone, and have a great day!

So what do you think? Will competency standards be the next big battle in the financial advisory industry? What should competency standards be? What should advisors be thinking about doing to "future-proof" their careers? Please share your thoughts in the comments below!