Head to Head: The MDA Guru on 2018

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In 2018, the MDA Guru, Peter Turbach, repeatedly stepped up to provide his expert, considered and often contentious views of Managed Discretionary Accounts.

How could we bring 2018 to close without him?

We had questions. He had answers. We had qualifications and objections.

A more detailed account of these issues has been published in “The Shades of Grey in the Managed Accounts World” on mdaguru.com.au

  1. Has 2018 delivered the certainty you argued the industry needed?

When attempting to define something, things are not always black or white. Try to get ASIC to define an Exchange Traded Fund (ETF) for example. It can be many things, a Managed Investment Scheme (MIS), a derivative, an exchange traded security.

One practice I know of wanted to advise and deal in ETFs and had all three of these authorities mentioned however were advised by lawyers to vary their licence to include, “MIS Other”.  A costly exercise that basically involves re-applying for your licence. Was this an overly conservative approach by the lawyers? Maybe. Was this ridiculous? Probably, however it was required by the practice in order to secure the business.

I think Peter’s trolling the lawyers a little bit here. ASIC generally consider that ETF’s are “a type of open-ended managed fund which is traded on a financial exchange (REP282). The “Managed Investment Scheme” authorisation would therefore be generally relevant for advising and dealing in Physical ETFs, but ASIC acknowledge that it’s difficult to be definitive given that there are physical ETFs, Synthetic ETFs and some products that “may 'look and feel' like ETFs, but they are not ETFs. Products labeled 'exchange traded commodities', 'exchange traded notes', 'exchange traded certificates', and 'exchange traded securities' are not ETFs.” Depending on the scope of your activity, you may need to review your authorisations. - SG

In the wake of the updated RG 179 issued in 2016, the small MDA advisers/operators that were operating under a ‘no action’ letter were forced to either vary their AFSL to include MDA authorisations (by October 2018) or move onto an external MDA Provider’s Platform. Some were able to get their variation through without disruption to their businesses.  Great! Some chose the latter and some chose to run for hills.


2. Who is responsible for the suitability of the client’s MDA program?

Under the previous RG 179 issued in 2004 - When an adviser advised a client into an MDA, they were usually making two recommendations. One into the MDA contract and one on the investment portfolio. This first step is deciding that an MDA is good for the client. The second step is then advising and implementing the portfolio as per the MDA contract. The latter was covered off by their MDA dealing authority and was referred to as the MDA Operator component while the MDA advice authority covered off the advising into the MDA and the Investment Program.

All was good and relatively simple from a compliance point of view.

External MDA Adviser - As MDA’s became more popular so did the utilisation of the External MDA Adviser. By outsourcing the MDA operations an efficient model developed in which the MDA Operator appointed the Financial Adviser as an External MDA Adviser.

In effect the Platform acting as the “MDA Provider” appoints the Adviser to recommend the Platform and an appropriate investment portfolio to clients for whom the platform would be appropriate. Two lines were drawn separating the advice component from the operating component.

The main issue that arose from this model is, who is responsible for the investment advice component?

In most cases the MDA Operator is the only entity with any MDA authorisations on its AFSL. There have been some disputes in the past where the External MDA Adviser and the MDA Operator pointed the finger at each other.  

This prompted ASIC to look at making changes.

Under the updated RG 179 (issued 2016) - The new RG clearly makes the MDA Provider responsible for two aspects of the Investment Manager’s advice.  

Like that of a Responsible Entity (RE) being responsible for an SMA, the provider is responsible for making sure the investment selection and weightings are in adherence to the MDA Investment program. The Provider is also responsible for the MDA client’s suitability to the Investment Program.


3. How can a Provider assess suitability?

That’s a good question. How can an MDA Provider, and one that is largely administrative platform, possibly assess suitability without knowing the client?

Well, it can’t.

It is entirely the MDA Provider’s risk that the adviser is conducting at least an annual review to ensure suitably or make appropriate changes. This can be hard enough to manage internally as a Licensee let alone externally as an administrative platform.

In practice, Providers have adopted a range of strategies to discharge this obligation. Some have engaged external parties to review each recommendation. Others have explored reg-tech solutions to give them oversight and effective record-keeping while some, instead, rely on the monitoring and supervision framework of the adviser’s Licensee. The last option is particularly problematic unless their supervision regime is both targeted and expansive. - SG

Many advisers wishing the efficiencies of MDAs choose to be an appointed External MDA Adviser as they are not required to hold any MDA authorisations on their AFSL. So long as they have authority to advise and deal in MIS, they are ok to advise and transact monies on their client’s behalf into an MDA arrangement via a Statement of Advice (SoA). The logic used here is that an MDA is in fact a type of MIS (but with relief from providing a PDS and requiring a RE). To act as an appointed External MDA Adviser, the adviser only requires advice authorisations for the investment types utilised within the MDA Investment Program. Under the old regime there were a lot of grey zones which have now been clarified to some extent.

The question now arises: Does the MDA Provider need an authority to advise on MDAs? While this has not been tested in a court of law, the answer appears to be ‘no, it does not’. So now begs the question how can the MDA Provider therefore be responsible for the on-going MDA client suitability advice without even being authorised to do so? The shades of grey just get greyer….


4. How can an adviser recommend their ‘own’ SMA without breaching their professional obligations?

For those who chose neither to vary their AFSL nor utilise an external MDA Provider, the SMA option appeared an ideal solution. Operationally it would have made sense for those under the ‘no action letter’ as their clients were already on the platform.

Their only hurdle was to persuade their platform provider to act as the RE over the new SMA.

When successful, the adviser suddenly find themselves in the product manufacturing business. Given that the ‘investment portfolio’ is now a financial product, how does the adviser manage the inherent conflicts, prioritise the clients’ interests and ensure they act in the best interests of their clients?

Conflicts of Interests occur. They happen. Its’s OK!

The main thing is how we manage them that counts, and always ensuring that the BID is met for each client. In the case of SMA’s its all about the fees and how they are charged. This is one of those shady grey areas and depends on which platform you talk to as to the best way to manage it.

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I’m not convinced that ‘managing’ these inherent conflicts are going to be acceptable in an environment that seems hostile to any overlap of manufacturing and distribution. While the Legislature’s vertical dis-integration of financial services may not be an immediate threat, negative public perception and reputation risk certainly are.In any event, disclosure alone is entirely unacceptable. In my view, both Advisers and Licensees need to more closely review their arrangements, conduct and inherent risks. - SG


5. How do you think conflicts should be managed?

Although I don’t necessarily agree with them all, here are some ways some platforms have suggested these conflicts could be managed pre the Royal Commission;

  • Ongoing investment management fees are not taken directly out of the SMA’s internal cash account but are taken from another cash account attached to the platform.

  • Don’t put all the client’s assets that are on the platform in the SMA but spread them around.

  • Don’t call the ongoing fee an “Investment Management Fee” but call it something else like an “Administrative fee”.

  • No ongoing fees are debited from the SMA or the platform. Instead the platform invoices the advice business a combined amount that includes all platform costs and SMA management costs. The advisory pays the invoice to the platform and invoices the client appropriately adding in a margin.

I’d personally argue against relying on wording changes and administrative strategies to address the inherent conflicts. In my opinion, the Adviser/Licensee needs to start at the beginning and define their approach to recommending SMA (particularly those in which they have an interest). They should publish an internal document that outlines their parameters and requirements for recommending SMA. This document should, for example, explain what clients are best suited to SMA (and which are not), what needs and objectives justify a recommendation and what ‘relevant personal circumstances’ would preclude the recommendation. The document should also explain the likely benefits the SMA will provide to the client and provide tools by which the adviser can confirm that the recommendation will be appropriate and suitable (demonstrating quantitative, qualitative and proportional benefits to the client). - SG

No matter how great you think your investment model is there will be someone else out there with better market performance and lower fees. Emphasis needs to be placed on whether you have given the client the means to be able to make an informed decision.

Does your FSG explain your Value Proposition and can you prove that the client received and understood it? What is your process and how did you inform and educate the client, and is it documented?

In my view, many advisers recognise the operational efficiencies (and other benefits) that MDA provide. Not all of them consider the benefits, if any, their client will receive as a result of their recommendation. In these cases, the ‘best interests’ duty is reduced to verbiage buried in the templated, generic and overlong SoA produced for the client. Where the likely benefits are notional or trivial, where the same recommendation is made to clients with vastly different circumstances, needs or objectives, or where the recommendation is a more complex (and often unnecessarily complex) than a simpler and cheaper solution, it’s difficult to identify that the adviser has acted in the client’s best interests. - SG

For many advisers that want to utilise managed accounts in today’s minefield they need to look at how they want to manage their client’s investment portfolios first and then build efficiencies around that.

  1. Categorise your client base as what is good for some would not be in the best interests of others; and

  2. Define the value proposition to each client base so that you can articulate it to your clients, and help them make an informed decision. This also helps you to charge the appropriate amount to cover costs. An SMA model may be a great low-cost solution for a certain client set while an MDA better for another. It is also not unheard of to manage a portfolio utilising both SMAs and MDAs and still be cost efficient.

For more information on how to navigate the shades of grey, refer to www.mdaguru.com.au