Oughts and Crosses: The changing role of licensee management


The future of advice

2018 has been a tumultuous year for licensees and advisers.

The introduction of the Life Insurance Framework, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry and the collapse of Terry McMaster (followed quickly by the collapse of Dover) have buffeted an industry already reeling from prolonged media and political pressure.

While ASIC argue for the prohibition of trailing commissions, Licensees and advisers face a challenging and uncertain future. Insurance premiums and operational costs are almost certain to increase.

FASEA's goal of creating an advice profession will not be achieved without significant disruption.  Not every adviser will find a place in the new world. Few have seriously considered that possibility; fewer still have anticipated it.

Businesses currently for sale are already finding prospective purchasers hesitating from fear of liability or in anticipation of further regulatory change. Those that are considering a future sale, face the possibility that their current delay may significantly reduce the future value of their business.

We engage with businesses and advisers across Australia and this gives us an enviable perspective of our industry. Here are our top five observations of, and predictions for, the financial services industry. 

1. The dog in the night time

Inspector Gregory: “Is there any other point to which you would wish to draw my attention?”
Holmes: “To the curious incident of the dog in the night-time.
Gregory: “The dog did nothing in the night-time.”
Holmes: “That was the curious incident.
— Arthur Conan Doyle, "The Adventure of Silver Blaze"

In some respects, the ultimate findings of the Hayne Royal Commission may be largely irrelevant in shaping the evolution of the financial services industry.

While the Commission declined to address vertical integration per se, its merciless examination of AMP, CBA and ANZ highlighted the inevitable, and insidious, effects of these conflicted arrangements.

Whether in anticipation of the Commissioner's findings, or for commercial or other reasons, vertical disintegration has been embraced by ANZ, CBA and NAB.

Westpac, while continuing to defend the model, have announced they'll no longer accept 'grandfathered' payments. Macquarie followed

Curiously, profound changes are occurring without the Commission doing anything. 

The larger players in the industry (excepting IOOF) seem to accept that their dominance of distribution will not be allowed to continue. They may well be right but their predictions about the future may simply become a self-fulfilling prophecy. By anticipating legislative reform they're making the need for legislative reform less pressing.

In any event, their apprehension directly benefits both IOOF and Westpac. Less obviously, it also creates opportunities for mid-tier licensees (and inspired boutiques). 

2. Pivots and Pirouettes

If your time to you
Is worth savin’
Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.
— Bob Dylan "The Times They Are A-Changin'"

We've previously observed that every period of regulatory reform generates tendencies to fragmentation and consolidation. Larger entities fragment in response to costs and liabilities, smaller entities consolidate to gain efficiencies and scale. 

We're seeing these trends gaining momentum and we anticipate that increasing insurance and operational costs will exacerbate these in the next six months.

Add in FASEA, and its subtle threat to sustainability and succession, and you'll recognise the intimidating challenge facing licensees and advisers; increasing uncertainty, rising costs, declining revenue and compounding liability.

What you may not immediately recognise are the strategic plays being made by the mid-tier licensees and some ambitious boutiques.

They're responding to the uncertainty in the market by leaning into it, by growing and pivoting while their competitors wait for the uncertainty to pass. They've recognised that, whatever the outcome of the Royal Commission, people are still going to need and want advice.

So, rather than panicking, they're getting their houses in order, investing in their compliance and expanding the scope of their activities. 

3. A shift in accountability

The first thing we’ll do, lets kill all the lawyers
— William Shakespeare's Henry VI, Part 2, Act IV, Scene 2.

It's a declaration against self-interest, but one of the most positive consequences of the Commission's exposure of AMP's culture, is that Licensees and Advisers are no longer automatically deferring to their lawyers.

In our experience, we've seen numerous examples of licensees and advisers taking action they know, or strongly suspect, is wrong on the basis of legal advice. AMP have showed the dangers of this approach.

Thankfully, we're seeing more businesses either challenge the advice or more closely consider its qualifications and limitations.

We know what we can do. Our job is to decide whether we ought to do it.
— Mark, Licensee Chairman

It's premature to announce the eradication of the anxiety, timidity and conservatism that has infected Licensee management.

But what we are seeing, and what we anticipate will continue, is that the better Licensees are focusing less on short-term benefits (and the corresponding incentives) and more on the sustainability of their businesses.

Further, the sense of entitlement and ennui that often characterises the management teams of their competitors is entirely absent in their businesses.

Even the language has changed; 'ethics' and 'stewardship' have replaced 'share of wallet' and 'leadership'.

One might conclude that the energy and enthusiasm displayed by these businesses is a direct consequence of their assumption of clear accountability. These leaders seek advice, but make decisions based on their own careful consideration of the issues. Interestingly, these businesses are also engaging their risk and compliance professionals earlier in the decision making process. 

Obtaining professional advice, legal or otherwise, is often valuable but it should never be a substitute for one's own reason. The advice you receive should inform your considered judgment and not replace it.

In reality, legal opinions often focus on 'can' issues rather than "should', they're built on detailed disclaimers (reasonably enough) and they often lack the context to properly consider the matter. 

For example, in the last six months we've seen:

  • Statements of Advice produced by a law firm signed off as compliant. The templates met all the legal requirements but frustrated clients' understanding. The lawyers, lacking practical experience in advice, failed to realise that compliance is not comprehensibility. Information about fees, costs and charges was spread throughout the document (and often duplicated) so only the most determined engineer could properly understand the financial consequences and implications of the recommendations. The documents were also dense and over-burdened with disclaimers.
  • A compliance manual produced for a licensee was entirely generic. In addition to instructions to "customise this section" the manual did not reflect the nature, scale and complexity of the licensee. As a guide for advisers, it was worse than useless given that it had chapters of compliance obligations for activities that were not relevant, and did not apply, to either the Licensee or their advisers. The text disclaiming the Firm's liability for the content was very well drafted.
  • Statements of Advice were signed off by lawyers retained by the Licensee as complying with the Best Interest Duty and approved for presentation to the client. The documents lacked, for example, replacement product information, identified needs and objectives, product research, alternative strategies and adequate detail about the strategy and its benefits. 

In our view, it's great to see Licensees and advisers assume accountability for their decisions rather than unquestioningly defer to legal advice. We hope this trend continues to gain momentum. 

4. Managing growth: Recruitment risk and zero appetite

We've addressed recruitment in some detail in previous posts and we've observed that Licensees are, in general, balancing their need to grow with their interest in the sustainability of their business.

This hasn't always been the case.

Whether as a result of the Royal Commission or ASIC's warnings, licensees are taking more care in their recruitment processes. Their embrace of due diligence processes, and their willingness to engage third-party reviewers, is a marked break with industry tradition.

Another departure from tradition, is that managers are less concerned with the benefits that will flow from the appointment (FUA, FUM and fees) than they are with the 'fit' of the potential recruit.

A Due Diligence process is designed to identify current and anticipated risks and to assist the Licensee to determine whether, and to what extent, the potential recruit operates in a manner consistent with the Licensee’s culture, risk tolerance and business strategy.

We are used to Managers talking about 'Cultural fit', but we are now seeing a more robust assessment of risk and a more structured consideration of the adviser's activities against the Licensee's risk appetite.

The approach varies between Licensees but most businesses have processes for filtering out the advisers that don't fit the Licensee's model. Each Licensee's risk appetite is different but most competent Licensees have non-financial parameters that influence their recruitment decisions. 

An example of an exclusionary recruitment framework based on risk appetite is provided below. 

Exclusionary framework for recruiting based on risk appetite. 

Exclusionary framework for recruiting based on risk appetite. 

Another consequence of the shift in accountability, is the recruiting Licensee's willingness to assume responsibility for their recruitment decisions.

Licensees specifically focusing on the competence, capability and character of the potential recruits and automatically excluding those where the review suggests, or notes, ethical or professional failures. They're also intently focusing on remediation, accepting an obligation to appropriately monitor, retrain and remediate any adviser they recruit. 

5. Insight and understanding

If you don’t know me by now, You will never never never know me
— Kenneth Gamble / Leon Huff "If You Don't Know Me by Now"

Until recently, few licensees acknowledged that effective regulatory supervision is data-driven. Until they needed to produce information for the Royal Commission, most underestimated the importance of granular and contextual data  

While some licensees remain encumbered by legacy systems, the ambitious middle tier seem to have recognised that an investment in regulatory technology is critical for any advice business that aspires to scale. The companies with whom we work have seen how reg-tech simplifies and standardises compliance measures, eliminates redundancies and frees licensees to focus their limited resources more intently on growth.

What is most surprising are Licensees' eagerness for granular analysis, comparative reporting and structured remediation. The better licensees are demanding deeper insights into their business. Some might cynically suggest that they're simply seeking to avoid being embarrassed at the Royal Commission, but, in our view, it's a direct consequence of the increased capability and competence of Licensee management. The 'back-slapping boys clubs' that have traditionally run licensees have, slowly but inevitably, been replaced by conscientious, competent and capable management teams.

This may be too late for some but it's a tendency that we expect to develop into a tradition.