Executive Summary
For almost half a decade now, the United States has tried to implement Federal-level regulations requiring that those who are in the business of providing financial advice to serve as fiduciaries and be required to put their clients’ interests ahead of their own. Thus far, however, these regulatory reforms have failed to hold, as financial services industry product manufacturers and distributors have vehemently argued that such rulemaking would end out preventing consumers from receiving their (conflicted) financial advice in the first place, due to the “cumbersome” requirements inherent in any such fiduciary regulation.
The irony, however, is that despite all this tumult about the potentially adverse impact of fiduciary regulations in the U.S., another set of fiduciary regulations have been established and operating for the past six years in Australia, and are far more comprehensive and disruptive than anything proposed (or even hinted at) in the U.S.
In this guest post, Ashley Murphy, founder of Arete Wealth Strategies (a fee-only financial planning and investment management firm serving Australian/American expatriates), discusses the background and impact of Australia’s fiduciary reforms to its financial services industry, some recent developments as the Australian government evaluates the effects of their fiduciary efforts, and what the implications might be for the U.S. fiduciary movement going forward.
Originating in the aftermath of the Great Recession and first passed by the Australian Parliament in 2012, the Australian “Future of Financial Advice” (FoFA) reforms, which went into effect the following year, sought to address pervasive problems in an Australian financial services industry, which, at the time, lacked oversight and was rife with poor “advice”, scandal, and even outright fraud. It was against that backdrop that lawmakers passed two separate acts – the Corporations Amendment (Future of Financial Advice) Act 2012, and Corporations Amendment (Further Future of Financial Advice Measures) Act 2012 – which (among other things) sought to require financial advisors to act in their clients’ best interest, place a general ban on any payment that might influence any advice or recommendation, and require advisors to provide clients ongoing fee and engagement disclosures, at levels far beyond what the SEC has required of broker-dealers under Regulation Best Interest.
Despite ongoing criticism and intermittent tweaks to the original Acts, there is evidence that FoFA has (at the very least) accomplished some its original goals, as the number of complaints against advisors has decreased, and despite concerns that regulation would reduce access to advice in reality more and more Australians are seeking out financial advice after FoFA (suggesting a general increase in the public’s confidence in and therefore willingness to engage with the industry).
Nonetheless, a subsequent formal inquiry to investigate misconduct in the banking and financial services industry, known as the Hayne Commission, found that up to 90% of advisors who worked for firms that manufacture and sell financial products were still giving conflicted advice that wasn’t the in the best interest of their customers… even though the advisors were compensated solely by fees and/or salaries (because the advisors were still largely controlled by their product-manufacturing employers). Moreover, even when banks were found to be in violation of FoFA rules, the penalties were so lax that misconduct continued to be remarkably profitable.
Notwithstanding the industry condemnations from the Hayne Commission, critics feel that the final report fell short and failed to include some key recommendations, including a once-discussed outright ban on asset-based (i.e., AUM) fees and a potential breakup of vertically integrated financial services firms (to force a separation between products and advice). Nonetheless, the findings did throw light on the need for further regulation and enforcement in Australia’s financial services industry, and industry consultant Rice Warner suggests that Australians are receiving better advice at a lower cost and are experiencing better financial outcomes after Australia’s fiduciary reforms.
Ultimately, the key point is that the ongoing evolution of the reformation of Australia’s financial advice industry could serve as a model in the U.S., as regulators struggle with implementing a fiduciary standard. Because, while the SEC’s Regulation Best Interest, which is slated to take effect at the end of June, 2020, is a step in the right direction, it’s possible that the rule will only lead to further confusion among consumers who can’t tell the difference between salespeople and advisors, leaving the proverbial door open for increased regulation in the years ahead. While Australia’s experience shows that lifting fiduciary standards actually can result in an increase in the levels of advice delivered to consumers, as eliminating low-quality advisors and reducing the level of conflicted advice leads to an increase in trust that ultimately creates more opportunity for financial advisors to survive and thrive.
In recent years, the United States has been awash with proposed fiduciary rulemaking to better protect consumers from conflicted advice, from the Department of Labor’s fiduciary rule, to the SEC’s Regulation Best Interest, and now a growing number of states proposing their own fiduciary rules for advice provided in their states.
Much debate about these reforms has centered around how they could prove ruinous to the industry - for instance, by making companies more vulnerable to consumer lawsuits and reducing their sale of (proprietary) products, while limiting consumer access to advisors and advice. On the consumer side, the industry has argued that implementation of a fiduciary rule could potentially price as many as 28 million Americans out of retirement advice. Simply put, the financial services industry maintains that the various fiduciary rules proposed in the US would be burdensome or potentially prohibitively-costly regulation.
As we discuss, however, proposed fiduciary reforms in the United States pale in comparison to what is already well under way across the Pacific in Australia.
Since 2010 and in the aftermath of the Great Recession, Australian financial services industry reformers have worked to stamp out commissions and other “conflicted remuneration” models, which culminated in what was known as the “Future of Financial Advice” (FoFA) legislation, which went into effect in 2013. Just over 5 years later, in February 2019, a Royal Commission report argued for further reforms, prompting some prominent Australian observers to go so far as to call for the wholesale ban of fees based on assets under management, otherwise known as AUM fees.
Below, we dive into the Australian financial services industry before and after the Future of Financial Advice (FoFA) legislation, from tracking the path of the FoFA proposals through the Australian parliament, to reviewing the outcomes of the recent Royal Commission into Misconduct in the “Banking, Superannuation and Financial Services Industry,” and offer thoughts on how the Australian financial services industry will likely change further in the near future. Last but not least, we discuss how these developments in Australia’s financial services industry tie in to what’s potentially on the horizon for the United States.
Australia’s Financial Services Industry before FoFA
By the end of the first decade of the 21st century, the Australian financial planning industry was dominated by a handful of large firms whose main business was the sale of financial products. The number (and representation) of non-aligned (or truly independent) advisors was so small that an industry organization representing them, PIFA, only came into existence in 2009, and even now only have a couple dozen members. According to the Australian government, of the roughly 18,000 financial planners, 85% worked for a financial product manufacturer… and mostly for just five firms - four banks and AMP.
Their revenue was drawn from a complicated combination of upfront and ongoing commissions, as well as asset-based fees. And, at that time, planners were not held to any regulatory standard to act in clients’ best interests (i.e., a fiduciary standard).
These weren’t the only issues plaguing the industry, though. Other problems included a lack of oversight and training, a toxic culture of outright lies, churning, and coverups, and a philosophy of delivering either fully comprehensive advice, or nothing at all (versus the more incremental “scaled” or modular advice many consumers actually prefer).
Poor and sometimes even fraudulent advice led to the failure of several Australian wealth management firms. An investigation traced the low quality of advice back to the revenue model: among commission-based advisers, the rate of delivering “poor advice” was an incredible 45%, six times as high as advisers under a different compensation structure.
Quality aside, advice under a commission-based remuneration schedule was expensive. According to the ASIC, financial advice funded through commissions cost three times what the average Australia preferred to pay. That study also suggested Australians were being priced out of advice, with half claiming to have “unmet advising needs.”
Simply put, the industry was failing Australian consumers. Why was this happening?
According to industry observers and lawmakers, the root cause was an over-consolidated industry, with little competition or regulation.
Consequently, in the twilight of the worldwide Great Recession, the Australian government launched the Future of Financial Advice (FoFA) reforms. Their ultimate goal was to protect investors, and ensure financial advisers did right by them moving forward.
The Future of Financial Advice (FoFA) Reforms
The Future of Financial Advice (FoFA) reforms were passed by Parliament in June 2012 and introduced largely in response to the scandals rocking Australia’s banking industry since as far back as the early 2000s. Their mission: protect consumers from poor or fraudulent financial advice, and restore confidence in the industry.
The reforms consisted of two distinct acts: the Corporations Amendment (Future of Financial Advice) Act 2012, and Corporations Amendment (Further Future of Financial Advice Measures) Act 2012, and outlined several objectives, including:
- Best interest duty: Essentially a fiduciary rule, this part of FoFA outlined professional conduct and obligations required of financial advisers when working with clients. In the event of any conflict, advisers would be legally obligated to act in their clients’ best interests.
- A ban on conflicted remuneration: Any payment, e.g., commissions and volume-based payments, that could influence a financial product recommended or advice given to a client, would be banned (although existing commission trails at the time were grandfathered and allowed to continue).
- Ongoing client engagement and fee disclosure requirements: Financial advisers would be required to provide clients with annual fee disclosure statements, and follow other guidelines to give clients more transparency about what they’re paying for.
- Increased powers for the Australian Securities and Investments Commission (ASIC): Through the FoFA legislation, ASIC, the government body that regulates and enforces corporate financial laws in Australia, would be able to ban individuals that threaten consumer interests from providing financial services.
- Instituted an eight-step “safe harbour” for advisors: The ASIC created a set of eight steps for advisors to follow, including “identify the objectives… of the client”, “make reasonable inquiries to obtain complete and accurate [client] information,” and only behave in a way that “would reasonably be seen as being in the best interests of the client.” Advisors who could demonstrate they acted within these guidelines were in the “safe harbour” and therefore in compliance with the law.
Financial advisers were given one year to become compliant with the new requirements, their deadline being July 2013.
Amendments to FoFA
It wasn’t smooth sailing for the FoFA legislation after being passed by Parliament, though.
Following the 2013 federal election, the Australian government presented several amendments to take place in July 2014. Known as the Corporations Amendment (Streamlining FoFA) Regulation 2014, these included changes to FoFA’s fiduciary rule, removal of the fee disclosure requirements, as well as exemption of some advice from the conflicted remuneration ban. In other words, the Streamlining FoFA Regulation sought to undo several major pieces of the FoFA legislation aimed at protecting consumers.
According to its proponents, these reforms would save money in the long run by reducing implementation costs by $90 million and lowering compliance "burdens" by roughly $190 million annually.
However, less than five months after its launch, the Streamlining FoFA Regulation was ultimately disallowed by the Senate in November 2014. Instead, with just two minor amendments (the Corporations Amendment (Revising Future of Financial Advice) Regulation 2014 and the Corporations Amendment (Financial Advice) Regulation 2015), the original FoFA legislation would remain largely intact.
After FoFA: Australia’s Financial Services Industry
So did the FoFA legislation work?
It’s hard to say.
Some observers were quick to criticize the reforms’ effectiveness, skeptical of the amendments’ ability to truly protect consumers’ best interests. For instance, Martin North, principal of Digital Finance Analytics, points out various loopholes big enough to “drive a coach and horses through.” For instance, the law states that financial planners working for banks may not collect commissions for selling their own bank’s products. According to North, however, bank employees besides financial planners, such as bank tellers, have escaped such regulation. When working with clients, these employees do not complete a full fact finder, give only general advice, may recommend their bank’s products, and may collect performance bonuses based on the number of sales. North’s conclusion is that the reform leaves a system still “in favour of the big banks” - he believes these institutions collect high fees on subpar products and don’t provide genuine, informed financial planning.
In a similar vein, others felt that further reforms were needed to truly protect consumer interests. Most notably, ASIC expressed that it could better regulate the industry and control for misconduct if granted additional powers and enforcement options such as the ability to ban offenders from working in the financial services industry.
FoFA in Practice
In spite of these criticisms, the legislation has generally appeared to stand its ground. For example, there appears to be less misbehavior among financial planners. Between 2009 and 2016, the number of disputes filed against financial planners with the Financial Ombudsman Service dropped by half - from about 1,000 to about 500. Meanwhile, the total number of disputes filed against other non-financial-advisor-professionals increased from about 17,000 to about 24,500. And, this increase in disputes occurred when the number of Australians meeting with an advisor has increased substantially.
Despite the overall trend, not all firms have behaved themselves. As noted in the previous section, some firms found loopholes in the law to exploit. Worse yet, other firms have blatantly disregarded the reforms. Take, for example, the 2016 case against Melbourne’s Golden Financial Group Pty Ltd (formerly known as NSG Services), the first of its kind.
In that case, ASIC alleged that “NSG advisers did not act in the best interests of their clients” by almost always recommending consumers purchase life insurance products provided by the firm. During a two-year investigation, ASIC identified eight specific cases where NSG Services violated the act. Ultimately, the firm was required to pay a $1 million fine, and two of the company’s representatives were banned from the financial services industry.
A similar case against Dover Financial Advisers provided a bit more theatrics.
ASIC accused the firm of systemically giving bad advice and overcharging consumers. While testifying before the Royal Commission in April of 2018, their CEO Terry McMaster fainted. This disruption made national headlines in Australia but did little to earn the firm any pity.
Less than two months later, the firm’s executives elected to shut down the entire firm rather than face losing its license to give financial advice, an abrupt move that cost 408 financial advisers their jobs and disrupted their relationships with about 50,000 clients.
To date, the former top-10 advising firm in Australia is the largest casualty of the FoFA reforms. Supporters of FoFA may hope that seeing a high-profile firm close its doors is exactly what the rest of the industry needed to see to really make efforts to get compliant themselves. The fundamental problem - at least thus far - is that it wasn’t clear how much the new FoFA regulations were actually causing the industry to improve the quality and cost of financial advice.
The Hayne Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry
Although the enactment of FoFA may have signaled a change in course for financial regulation, it ultimately was not enough to ameliorate all of the industry’s problems. Enter the Banking Royal Commission.
In Australia, royal commissions are formal government inquiries conducted on issues of public importance, ranging anywhere from welfare to economics to national security. These investigations typically involve comprehensive research and take place over long, extended periods - even as long as two years.
Given the aforementioned banking controversies in the years leading up to FoFA and even afterward, it was perhaps no surprise when the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was established in December 2017.
Because of its lengthy name (like most other royal commissions), it is known more simply as the Banking Royal Commission, or the Hayne Royal Commission in reference to its commissioner, Kenneth Madison Hayne.
The inquiry was established to investigate misconduct in the banking and financial services industries - both of which had seen more than their fair share of scandals in the last decade, and even after the FoFA reforms were supposed to have cleaned up the industry. And it’s worth noting here that these scandals were not simply one-off cases. Mega-national firms in Australia like National Australia Bank (NAB), ANZ Bank, Macquarie, Westpac, and others were repeatedly fined or caught for some breach of consumer protections or general misconduct, both before and after the implementation of FoFA.
Yet in spite of these transgressions, ASIC has long taken a mild and inactive approach to punishing Australia’s banks. In fact, the corporate regulator is known for negotiating “enforceable undertakings” with misbehaving banks. That is, getting banks to agree to change their ways and make a charitable donation that’s often only a small fraction of the amount earned through misconduct in the first place.
For instance, the Commonwealth Bank was fined a meager $3 million, after taking nearly $120 million in fees while providing no substantive services for those fees (a concern known as “fee-for-no-service” in Australia, roughly akin to “reverse churning” in the U.S.).
According to critics, these lax penalties had enabled banks to continue acting against consumers’ best interests instead of changing for the better.
Background Of The Hayne Royal Commission
Despite long-standing calls for a royal commission from various other political parties going back to at least early 2016, the then Prime Minister Malcolm Turnbull opposed any such measure. In the same boat were his treasurer at the time, Scott Morrison, and several other high-ranking politicians, including former Prime Minister John Howard, Deputy Prime Minister Barnaby Joyce, and Financial Services Minister Kelly O’Dwyer.
These figures all acknowledged “cultural issues” in the banking industry, but remained skeptical of their severity and prevalence in the larger financial services sector. And, in the Prime Minister’s eyes, a royal commission did not seem particularly expedient or productive.
It was not until 18 months later, at the end of November 2017, that Turnbull announced official plans for a banking royal commission. The tipping point: overwhelming dissent and growing pressure from members of Parliament, as retail consumer complaints and concerns about ongoing problems with financial advice from the financial services industry were bubbling all the way up to the legislators themselves.
The Banking Royal Commission was thus established in December 2017 - and after over a year of investigation involving 68 days of hearings, 130 witnesses, and over 10,000 public submissions, it concluded on February 1, 2019. Its final report, released to the public shortly thereafter, included 76 recommendations for moving forward to (finally) clean up Australia’s financial advice industry.
The Banking Royal Commission’s Outcomes
So what exactly did the Banking Royal Commission’s final 530-page report say?
In short, it lambasted Australia’s banking and financial industry for taking advantage of consumers and forcing them into the hands of remuneration systems that generously rewarded employees.
“There was a marked imbalance of power and knowledge between those providing the product or service and those acquiring it,” Commissioner Hayne noted in the report.
Moreover, the report stated that:
“There can be no doubt that the primary responsibility for misconduct in the financial services industry lies with the entities concerned and those who managed and controlled those entities: their boards and senior management. Nothing that is said in this Report should be understood as diminishing that responsibility.”
With that in mind, Hayne’s 76 recommendations center around upending Australia’s banking and financial service sectors for stricter review and management.
The major recommendations by the Royal Commission include the following:
Financial Advice
- Review measures the effectiveness of FoFA by the end of 2022; unless there is “clear justification” for retaining the eight-step “safe harbour” checklist, it should be repealed.
- As soon as possible, repeal grandfathered provisions for “conflicted remuneration” (i.e., eliminate previously-grandfathered commission trails).
- Require that advisers disclose their lack of independence to clients - e.g., explaining why they are not unbiased - if that is the case.
- Compensate victims of misbehavior in the financial services industry. Without going into detail, the Hayne Commission recommends funding the program from 1) the proactive receipt of funds from the financial services “community” and 2) fines levied against regulatory violators.
- Require ongoing fee arrangements to be (re-)authorized annually, by all clients, in writing. Moreover, clients must be shown in writing the total amount of fees they will pay in the upcoming year.
Banking
- Remove the point-of-sale exemption established by the National Consumer Credit Protection (NCCP Act) reforms - a change intended to address how sellers at point of sale, e.g., retail bank staff sitting directly across from a consumer who had walked into the bank to buy something, were being remunerated without being licensed or authorized as representatives of a financial institution.
Superannuation (Retirement Plans)
- With limited exceptions, prohibit pulling advice fees from superannuation funds.
- Ban the unsolicited offer (i.e., “cold calling”) or sale of superannuation products.
Insurance
- Ban the unsolicited offer or sale of insurance products.
- Reduce commissions on life insurance (currently capped at 70% of first-year premiums), ultimately to zero by the end of 2022.
Remuneration, Governance, and Culture
- Require banks to annually review their remuneration systems for front-line staff to ensure staff is in compliance with FoFA.
Regulators
- Establish a new external body to oversee both the ASIC and the Australian Prudential Regulation Authority (APRA; the regulatory body that oversees the banking, insurance, and superannuation industries).
Twelve recommendations refer specifically to ASIC, and the regulator has already announced its commitment to implementing them. Principally, these recommendations seek to 1) increase the power of the ASIC to enforce regulations, especially in the courts, 2) focus as much as possible on regulating entities rather than individuals and 3) reduce the “non-enforcement contact” of ASIC enforcement staff with the people and entities they are regulating. In the big picture, then, these recommendations aim to 1) give the ASIC sharper “teeth”, 2) diminish the idea that regulatory failings are the fault of individual “bad apples” rather than systemic problems, and 3) reduce the likelihood that regulators will be regulating their friends and professional connections.
It is also worth noting what the Hayne report did not recommend. First, it did not go so far as to unbundle vertical product integrations: advisors may still sell their own firms’ products, be that mutual funds, insurance products, and so forth. Second, it did not recommend that AUM fees be eliminated.
Responding to the inquiry’s recommendations, the Australian government has initially agreed to take action on all 76 of them. Of course, in doing so, government officials make no promises about the timeline of implementation. Most notably, recently re-elected Prime Minister Scott Morrison (former treasurer) has stood his ground against quickly creating and passing financial legislation that would be “reckless.”
Reception of the Banking Royal Commission
The Hayne Royal Commission’s final report condemned the financial services industry for creating and upholding a sales culture that did not prioritize consumers’ best interests. Furthermore, Commissioner Hayne prescribes several drastic recommendations to overhaul the industry, especially with regard to mortgage brokering, insurance sales, and financial planning.
In spite of these recommendations, however, many believe it was not enough.
In fact, the majority of advisers and industry experts are skeptical of the royal commission’s effectiveness. According to a poll by Professional Planner, more than 70% of financial advisers felt that key areas were missed in the investigation. The overarching sentiment among these critics was that larger firms have not been held accountable in the same way smaller ones have for similar breaches. Another missed opportunity, according to critics, was the potential unbundling of products and advice.
Sure enough, though banks and financial service firms had awaited the inquiry’s outcomes very nervously, it seems that the final results ultimately “fell short” of their fears. Concerns that vertical product integration would be prohibited turned out to be unfounded. Banks will be able to continue to sell loans, investments, and other products to their customers - and, generally, these sales could come from advisors. Rather than seeing the end of banking in Australia as it had been known for decades, the report’s release instead re-affirmed that business could continue largely as usual.
Thus, in the aftermath of the report’s release, bank stocks had their biggest gains in a decade.
Missed Opportunities Of The Hayne Royal Commission
Critics cite a number of missed opportunities to describe why the Banking Royal Commission ultimately disappoints. They argue that the inquiry neglected to include key recommendations such as:
- Unbundling product manufacture from distribution: Conflict of interest is nothing new for firms that manufacture financial products and simultaneously provide related advice to clients (as a means to facilitate distributing their products to the clients as a way to implement that advice). In fact, a January 2018 report by ASIC on this subject found that 75% of the customer files reviewed did not demonstrate adviser adherence to the best interests duty. Yet in spite of this, the inquiry made no moves to fix the issue. Haynes writes in the report, “I am not persuaded that it is necessary to mandate structural separation between product and advice” (i.e., to eliminate vertical integration and require advice to be separated from product manufacturers). In his eyes, it would be “costly and disruptive” to enforce such a separation.
- A requirement that financial advisers be individually licensed: The Australian Financial Services License (AFSL) is a permit required of financial services businesses. Licensees include individuals as well as employees or authorized representatives of AFSL holders - meaning financial advisers are not required to be individually licensed if they are employed or authorized by a licensee (firm) that ostensibly oversees them. Experts suggest that requiring advisers to be licensed would raise the standard for advice by holding individuals accountable for their actions (especially given that firms aren’t always being held accountable either). It would also reduce conflicts of interest for advisers by giving them the flexibility to recommend products not offered by their firm (as in the current environment, advisors “have to” follow their firms’ directives, including to sell the company’s products, because the advisor has no way to maintain his/her license without the company).
- A complete ban of asset-based fees: Asset-based fees pose another conflict of interest by influencing the advice given to clients (e.g., by encouraging clients to accumulate assets rather than paying down debt). To this point, advisers are obligated to act according to the Corporation Act’s “best interests duty” - but as critics suggest, this requirement is ill-defined. Furthermore, with asset-based fees still in place, clients must pay regardless of how hard their adviser works and/or how well their portfolio performs.
All in all, critics blast the royal commission for being more bark than bite. Although it’s led to the exit of NAB CEO Andrew Thorburn, many industry experts feel that it will have little impact on Australia’s banking and financial services scene in the long run.
Regardless of these criticisms, a small minority of experts contest that the royal commission did its job given its limitations as a formal inquiry. Most importantly, it brought to light the depth of misconduct by the country’s major banks and financial firms. For instance, in one shocking public hearing, the inquiry found that Australia’s largest lender, the Commonwealth Bank of Australia (CBA), had been collecting monthly fees from a deceased client for over a decade.
This finding, along with many more, has helped shed light on the level of egregiousness rampant in Australia’s banking and financial services sector.
And, although the Hayne Royal Commission may not have achieved all that that many were hoping for, it has at least begun a new era of regulation and enforcement in Australia’s wealth management industry.
Looking Ahead: The Future of the Australian Financial Services Industry
Although it’s clear the Hayne Royal Commission’s outcomes failed to meet many expectations, industry observers have generally optimistic expectations about the Australian financial services industry in the aftermath of its fiduciary-style reforms, particularly from the consumer side.
Consumer Outlook After The Hayne Royal Commission
From many experts’ point of view, financial advice is expected to become much cheaper. By 2027, Rice Warner expects consumers to spend $1 billion less per year on advising fees.
These savings will be partly realized because certain relatively invisible fees, such as trailing commissions on insurance sales, will no longer be legal. Greater price transparency is also expected to make consumers more sensitive to the cost of advice, and more likely to seek lower prices. Firms are expected to reduce their overhead by leveraging new technologies and simplifying the delivery of advice as well. In fact, advancements in regulatory technology, or “RegTech,” present new opportunities for automating risk and compliance processes for financial service providers (at a lower cost that can be passed through to consumers).
But the biggest driver of these savings is expected to be a shift away from more full-service or comprehensive advice and toward more “scaled” or modular advice. This change is expected to dramatically increase the number of times consumers interact with financial advisors. In 2012, Rice Warner estimated that about 800,000 Australians interacted with a financial advisor, receiving some form of financial advice. And, they estimate that about 80% of that advice was comprehensive engagements, while only 20% was scaled.
Without the FoFA reforms, Rice Warner estimates that in 2027, the number of Australians interacting with an advisor would only grow to 900,000. With the reforms, however, 1,900,000 Australians are expected to receive financial advice—more than double the original projection. This advice, however, is less likely to be comprehensive. By 2027, Rice Warner estimates over 60% of financial advice will be scaled. They predict that approximately the same number of advisors will serve this much larger client base, increasing engagements per year from just 44 in 2012 to 107 in 2027.
With more Australians receiving less-conflicted (and, presumably, higher quality) advice, Rice Warner expects consumers to grow their private savings by roughly $144 billion in the next decade. And, as a result of the dramatic upticks in demand for advice and consumer assets, the Australian financial services industry is projected to see over a 100% increase in revenue - from $3.5 billion in 2012 to a projected $8 billion in 2027.
These projections were made 6 years ago - how accurate have they proven to be? According to the Royal Commission, the number of Australians receiving financial advice has increased substantially, as has industry revenue. In fact, the number of clients receiving advice now tops two million a year, closer to the number Rice Warner expected by the late 2020s.
Concurrently, the number of advisors has grown unexpectedly by over 40% to 25,000 while Rice Warner expected the number to remain steady around 18,000. By the time the dust settles on FoFA reforms, though, it may turn out that Rice Warner’s estimate was correct after all, because on January 1st, 2019, the newly established Financial Adviser Standards and Ethics Authority went into effect.
The primary function of FASEA is to establish and maintain educational standards for Australia’s financial advisors. By January 1st of 2021, all advisors must have attained a post-secondary education degree and completed an entrance exam, among other requirements. Moreover, they must now complete 40 hours per year of continuing education. Rather than meet these lofty standards, some advisors may retire or find other work while potential advisors may be turned off by these additional barriers. Industry observers warn that FASEA could lead to a doubling of fees as the number of advisors could drop by as much as a third... to exactly the number Rice Warner expected all along.
Australian Financial Corporations After The Hayne Royal Commission
The road ahead is also a little uncertain for financial corporations (i.e., financial services firms) themselves.
Labor leader Bill Shorten has called for the Australian Parliament to fast-track legislation based on the Banking Royal Commission’s recommendations—though, as mentioned earlier, Prime Minister Morrison has held firm against rushing any new legislation.
In the midst of this political tension, the shares of Australia’s major four banks saw an explosive surge on the day after the report was released - likely because the inquiry’s recommendations were not as harsh as they expected and feared (e.g., there was no recommendation to break up their vertically integrated models, as was being considered during the royal commission hearing process). Meanwhile, mortgage brokers including Mortgage Choice and Australian Finance Group took heavy blows.
Financial Professionals And New FASEA Requirements
The role of the financial planner will likely continue evolving in years to come (and beyond just the vicissitudes of the market itself). Several of the inquiry’s recommendations pave the way for its transformation into “a profession concerned with the provision of financial advice,” although Commissioner Hayne noted three changes necessary before such a transformation could fully take place:
- Prohibit the culture of charging “fees for no service”;
- Improve the quality of advice;
- And establish a disciplinary system for accountability.
Pending these changes, Australians might expect to see the tenuous line between salesperson and adviser become more distinct in the years to come. In fact, the role of financial advisers has already begun to see massive changes with the establishment of the Financial Adviser Standards and Ethics Authority (FASEA) in April 2017.
Responsible for implementing the Corporations Amendment (Professional Standards of Financial Advisers) Act 2017, FASEA has overhauled education, training, and ethical standards for those interested in entering Australia’s financial planning profession. Thanks to FASEA’s changes, as of January 1, 2019, new financial planners must:
- Have a bachelor’s degree or higher, or an equivalent form of education;
- Pass a competency (e.g., CFP-style) exam;
- Undertake what is known as a “professional year,” or a year of work and training;
- Meet continuous professional development (continuing education) requirements; and
- Abide by a professional code of conduct.
Meanwhile, preexisting financial advisers must meet these requirements by 2024 in order to maintain their license.
These reforms are significant for several reasons. First, they represent a major departure from less stringent traditional requirements when “financial advisors” were primarily salespeople (and trained as such) and not actually in the business of advice that they are today. In the past, prospective advisers had only to complete the minimum training set by Regulatory Guide 146 to qualify to sell financial products, which could be achieved in a three-day course. In fact, with stricter education requirements, a little more than 20% of “advisers” may leave the industry altogether.
The bulk of these advisers considering leaving are 60 or older - presumably gearing up for retirement, in lieu of trying to meet the new accreditation requirements to give advice that they don’t currently meet. Regardless, it’s possible the number of financial planners in Australia will decrease in the foreseeable future, given the increased barriers to entry.
Of course, while the number of advisers may decrease, the quality of financial advice is likely to improve and lead to better client outcomes (or at least, that’s the hope and intention of the FASEA reforms). It is also in this way that FASEA’s reforms signify a major turning point in the professionalization of financial advisers in Australia - putting them on par with other rigorous professions.
The Road to Hayne Commission Regulatory Implementation
With an Australian Federal election having taken place just two months ago, the actual timing of implementing the Hayne Royal Commission reforms to Australia’s financial services industry still appears murky. The country’s major political parties have incorporated discussion of the Royal Commission inquiry and its recommendations into their respective platforms. Generally speaking, the minority Labor Party has more strongly endorsed the implementation of the commission’s recommendations than has the majority Liberal Party.
For instance, the Labor Party announced plans to implement 75% of the inquiry’s recommendations if successfully elected. Moreover, they would establish a victim compensation package for those affected by the financial industry’s misconduct.
In response, current Prime Minister Scott Morrison has warned mortgage brokers across the country, urging against support of the Labor Party.
It remains too soon to know for sure how the Liberal victory in the 2019 election will affect the implementation of the Royal Commission’s recommendations. So far, at least, there has been no update to the Treasury’s March 2019 response to the recommendations. That response generally agreed with the proposed recommendations, with an implementation timeline that stretches from 2019 to 2022.
Australian Regulatory Implications for the American Financial Services Industry
To American financial advisors, the developments in Australia’s banking and financial services sectors over the last two decades are largely irrelevant to their professional practice, given that US advisors are subject to US laws and regulation, not Australia’s.
But, in breaking down its recent history and current events, there are interesting parallels and implications for the U.S. and its own financial services industry. Most relevant is the notion of a fiduciary rule - the legal obligation for financial advisers to act in their client’s best interest, which has been a recent debate in the U.S. as well, but is now actually becoming a global phenomenon for the financial advice industry.
In fact, while the U.S. boasts the world’s largest economy, just 57% of American adults are financially literate. As one can imagine, this makes many vulnerable Americans ripe for the picking by unethical financial salespeople providing often-limited or conflicted advice.
And indeed, when the Department of Labor, then under President Obama, proposed a fiduciary rule on retirement planners in 2016 (to take effect in 2017), they presented research suggesting that conflicts of interest in the financial services industry were responsible for Americans losing well over $17 billion a year. In other words, the same culture of sales that pervades Australia’s financial sector similarly affects the U.S.
Unfortunately, though, the product manufacturing and distribution lobbyists in the U.S. managed to push back the Department of Labor’s fiduciary rule, which was ultimately vacated by the U.S. Fifth Circuit Court of Appeals (reverting back to prior law with a mixture of a fiduciary duty for registered investment advisors but a lower sales-suitability standard for those working under broker-dealers).
The idea of a fiduciary rule isn’t completely dead in the U.S., though.
Lawmakers from several states, including New Jersey, Nevada, and Maryland, are attempting to blaze their own trails, suggesting that they need to fill the fiduciary void given the failed attempts of Federal fiduciary regulation.
Part of the issue, observers and state lawmakers argue, is that the term “fiduciary” is poorly defined in the U.S., and more importantly that due to a lack of any regulation of titles, consumers can’t tell the difference between fiduciary advisors and brokerage salespeople who have donned similar or identical titles. Thus, states have proposed consumer protection bills that define various financial professionals (e.g., broker-dealers and advisers) as fiduciaries based on how they hold out to consumers and the advice services they offer, making clear their obligation to act in their clients’ best interests when providing financial advice. Although notably, thus far, U.S. fiduciary rulemaking has primarily focused on the Duty of Loyalty to act in clients’ best interests, and not necessarily on enhanced education standards to help ensure better client outcomes and more qualified advisers in the financial space - raising questions of whether the U.S. will eventually engage in a second shift reminiscent of FASEA’s ongoing impact in Australia.
Will they succeed?
Only time will tell, and experts are eager to observe how such legislation will impact the industry.
Regardless of the outcome, this new, ongoing political development sets the scene for a larger discussion about fiduciary duties in the U.S. It also makes the country’s financial services industry a perfect foil to the financial landscape in Australia.
Although the U.S.’s wealth management industry dwarfs Australia’s, it’s appeared at nearly a standstill in terms of progress and meaningful fiduciary regulatory reform, as the product manufacturing and distribution industry beats back one fiduciary proposal after another. Meanwhile, the Future of Financial Advice legislation and the reforms to come as a result of the Hayne Royal Commission represent a major turning point in Australia’s advisory world.
In this way, Australia may very well serve as a strong model for potential changes to the way the U.S. regulates its financial advisers… and holds them accountable.
Note: Ashley would like to extend a special thank you to Dr. Matt Goren CFP®, who helped contribute to this article.
