Most Historians agree that Germany’s success in Battle of the Bulge was due, at least in part, to their success in surprising their opponents; surprise built on their opponent’s overconfidence and their opponents’ preoccupation with their offensive strategies.The Government’s success in securing their FOFA reforms, in a hostile or uncertain Senate, was successful for similar reasons.
On 14 July 2014, the Labor Party introduced the Government’s amending Regulations in the Senate, confident of their ability to disallow the regulations and therefore derail the Government’s proposed changes to Labor’s regulatory framework.
On the weekend following this move, political pundits were confidently predicting that Government’s reform of financial services was dead in the water.
However, despite the considerable forces massed against them, the Government out-manoeuvred the Opposition in the Senate and secured the support they needed to undermine the motion. This was FOFA’s Battle of the Bulge and the surprising defection of the Palmer United Party eliminated any immediate threat to the Government’s program of regulatory reform (although a motion for partial disallowance will be tabled by the Opposition on 26 August 2014).
The Corporations Amendment (Streamlining Future of Financial Advice) Regulation 2014, effective from 1 July 2014, addressed the majority of the Government’s intended reforms and promised certainty in regards to grandfathering, opt-in and best interests. The practical impact of these changes may be somewhat different.
The Regulation qualifies the grandfathering arrangements for the ban on conflicted remuneration. Consequently;
- Grandfathered benefits – grandfathered arrangements (an entitlement to receive remuneration that might otherwise be conflicted remuneration) can move between Licensees and practices with the Authorised Representative. “Materially different” arrangements are excluded (7.7A.16F) but the Regulation removes the regulatory impediment that had artificially restricted the movement of advisers.
- Switching superannuation benefits from Growth to Pension phase is not “the acquisition of a new financial product” that would invalidate the continued receipt of grandfathered benefits (7.7A.16B(5A)
- The entitlement of Authorised Representatives to receive grandfathered benefits is an interest that can be sold, reassigned or transferred. The Regulation maintains the right to receive grandfathered remuneration even if the adviser’s business is sold or acquired 7.7A.16BA. This introduces the concept of ‘pass-through’ which, in some respects, redefines the role and function of the Licensee. Critically, “Passing through” benefits is a discretion enjoyed by the Licensee, but not an obligation. The Licensee now has the right to “pass through” benefits to a new Licensee but is not compelled to do so. Historically, and legally, it was the Licensee that, prior to 1 July 2013, entered into arrangements with the Product Manufacturers to receive conflicted remuneration – such as volume bonuses – and it was the Licensee that retained or distributed these benefits.
“Grandfathering” in practice
Most Licensees recognised that the adviser had a beneficial interest in those benefits – such as overrides or volume bonuses – that were earned as a consequence of the adviser’s activity. But many Licensees also chose to retain some or all of those benefits to defray the costs of operating the License and providing services. Since this regulatory amendment, it is uncertain whether, and to what extent, these arrangements can continue. Where there is an Authorised Representative Agreement in place that covers these benefits the application is simple, but how will it apply in those situations where the adviser is unaware of the conflicted remuneration retained by the Licensee? Where the Authorised Representative Agreement doesn’t cover the “passing through” of grandfathered benefits, how will an adviser compel their old Licensee to do so?
Think too about the practicality of transferring grandfathered benefits when an adviser leaves one Licensee for another:
- Will the first licensee agree to transfer an entitlement secured under their commercial agreement with a product manufacturer to the New Licensee?
- Will the New Licensee “pass though” benefits to the adviser in the same way as the previous Licensee did (and are they obliged to do so)?
- Will the manufacturer agree to continue to pay the conflicted remuneration to a Licensee that was not part of the initial negotiations or agreement?
So what do I think will be the likely consequences of these regulations?
- The payment and receipt of conflicted remuneration will be eroded over time because of the practical difficulty of securing all parties’ consent;
- Product manufacturers will recognise the opportunity provided by the regulations to reduce the number of parties to whom they pay benefits. This may lead to increased payments for key accounts but the manufacturers may also choose to simply retain the amounts previously paid either as profit or use these retained payments to fund increased marketing or to offset their operational costs;
- The regulations could paradoxically lead to increased consolidation of the financial planning industry because only sizeable and established planning businesses will have the influence to secure consent or insist on continued payments.
“Balanced scorecards” are simple performance management tools used by a variety of businesses to measure and recognise employee performance.
In many financial services businesses, a balanced scorecard – containing revenue or financial product sales targets – is used to determine bonuses provided to staff or representatives. Because they are linked to financial products these bonus payments would be “conflicted remuneration”.
The Regulation establishes that benefits or bonuses paid under a balanced scorecard arrangement are not conflicted remuneration “where an employee receives remuneration that is calculated by reference to both volume-based and non-volume based factors. Under section 963L “any volume based benefits … are presumed to be conflicted remuneration unless it could be proved that the benefit could not reasonably be expected to influence the product recommended or the financial product advice provided to a retail client.”
The regulation establishes that a benefit, that is partly dependent on the value and number of financial products recommended to, or acquired by, retail clients will not be conflicted remuneration where the benefit is low in proportion to their total remuneration. So, there are two important elements to consider. The first is proportionality; for the benefit or bonus to be permissible the weighting attributed to the benefit must be balanced or outweighed by the other matters. Logically, the weighting must be less than 50%. Second, the benefit must be “Low”. “Low” is not specifically defined but it’s presumed that a benefit is “low” if it is less than10% of employee’s total remuneration.
The balanced scorecard requirements might not apply until 1 July 2015, but participants might need all that time to ponder the effectiveness of these provisions in motivating employee representatives and employees are likely to need time to adjust to performance targets that focus more on non-sales factors such as compliance and customer service.
Advice and the Advice Process
Consistent with their intent to remove onerous compliance burdens, Item 7 of the amending regulation amends the advice environment created by FOFA by:
- Explicitly confirming that scaled advice is consistent with the ‘best interests’ duty
- Removing the ‘catch all’ provision from the “safe harbour” steps contained in s961B(2). (until 31 December 2015)
- Substituting a new 961B(2)(b) into the safe harbour. The adviser’s consideration and recommendation must identify “the objectives, financial situation and needs of the clients that are disclosed to the provider by the client” (Applies until 31 December 2015)
- Removing the ‘opt in’ requirement (applies until 31 December 2015) r7.7A.7
- Providing that non-cash payment facilities are included in ‘basic deposit product’ definition
- Removing the obligation to provide annual FDS for arrangements prior to 1 July 2013 (applies until 31 December 2015) r7.7A.8
- Excluding basic deposit products from the obligations imposed by the Best Interests Duty;
- Confirming that the costs of Intra fund advice can be collectively levied under s99F of the SIS Act (r7.7A.10)
- Confirming that payments can be made from a members’ superannuation (r7.7A.12) if the client provides “clear consent” and if consistent with the sole purpose test under s62 of the Corporations Act.
- Clarifying that benefits for ‘execution-only services’ are permitted if the licensee or representative has not provided financial product advice to the client in relation to the product that is issued or sold – or advice on a class of financial product, of which the product is one – in the previous 12 months. (r7.7A.12.EC).
Some key objectives of FOFA were to remove conflicts of interests and drive increased professionalism. Unsurprisingly, the focus on restricting conflicted remuneration (soft dollar benefits) extended to restricting perceived junkets disguised as professional development. Although the industry generally agreed with the regulatory intent, Licensees were concerned that the restrictions on the payment and receipt of conflicted remuneration would have the harmful and unintended consequence of restricting funding for legitimate adviser training and development. The amending regulation addressed this apprehension by clarifying, in r7.7A.15A, that benefits paid for education and training are not conflicted remuneration if
- they have a genuine education or training purpose; and
- they are relevant to the carrying on of a financial services business; and
- they comply with the regulations
Those changes that will sunset on 31 December 2015 are intended to be replaced by legislation. Given an uncertain and potentially hostile Senate the Government chose to proceed with their partial rollback of FOFA through regulation rather than legislation. The Government has acknowledged that this is a temporary measure which is reflected in the clear termination dates applied to key provisions.
Conflicted Remuneration and General Advice
“The Government considers that the current application of the ban on conflicted remuneration imposes unnecessary burdens on industry.”
Introducing the right to pay, and receive, “conflicted remuneration” for the provision of general advice (r7.7A.12F) was presented in the popular media as a contentious and retrograde step. Opposition to the proposal was vocal and persistent. Nevertheless, it was introduced.
The regulation specifies that benefits paid in relation to general advice are not conflicted remuneration as long as certain conditions are met. Only employees or persons in ‘employee-like’ situations are eligible to utilise the provision. They must be
- An employee of the licensee, or a related body corporate of the licensee
- An employee of an authorised representative of the licensee; or
- A sub-authorised person.
The employee must also operate under the name, trade mark or business name of the licensee and the advice must relate to a product issued or sold by the licensee or a related body corporate (or by an entity operating under the name of the licensee, their trade mark or business name).
The Regulation may therefore have limited applicability outside vertically integrated financial services businesses. Despite the media response to this proposal being the reintroduction of conflicted remuneration it is, perhaps, simply the extension of the ‘intra fund’ advice principles beyond superannuation.
While this reform may allow retail fund providers to compete on the same terms as the Industry Funds, the Government has sought to restrict the applicability of the general advice exemption to prevent financial planners exploiting the provision to minimise their disclosure and compliance obligations.
The regulation introduces a ‘proximity’ threshold and prohibits “recurring payments ..[from] the general advice … [or] a payment made solely because of a financial product of a class … issued or sold to the client.”
In simple terms, a person cannot receive conflicted remuneration (performance bonuses excluded) for general advice where personal advice has been provided to the client in the preceding 12 months.
In reality, these regulations will do little to prevent a financial planner from restructuring their business to minimise their compliance obligations and continue to receive conflicted remuneration. Doing so is neither illegal nor unethical and may be the logical extension of recognising that all advice is scaled to some extent. Despite the recurring emphasis on the value of personal advice, there may be clients that don’t recognise the asserted value and simply want guidance and general advice rather than specific recommendations and personalised advice. In reality, the biggest obstacle for existing financial planners utilising this provision is a reputational issue; an emerging profession that continues to emphasise the value and importance of their personal relationship with their clients is not well placed to embrace a more transactional advice model anticipated by these regulations.
Reform, Consumer protection and the Palmer United Party
Although the Government’s FOFA refinements were broadly supported by the industry, the mainstream media reported a general apprehension that they significantly undermined required consumer protection measures and the intent of FOFA. Accordingly, the Opposition tabled the FOFA Regulations in the Senate on 10 July 2014 with the intent of disallowing the Regulations that became effective from 1 July 2014.
The motion created uncertainty in the industry and confusion amongst participants about the risk of relying on regulations that might be invalidated. Without a clear majority in the Senate, the Government faced a real possibility that their FOFA Regulations would have been disallowed. But the Opposition was outmanoeuvred.
In his letter dated 15 July 2014, Senator Matthias Cormann confirmed that the Palmer United Party (and Senator Muir) had reversed their confirmed support of the disallowance motion to support the Government.
To secure the Palmer United Party’s support, the Government committed to implementing measures to require financial advisers to:
- Act in the best interests of their clients and prioritise the clients’ interests
- Provide an annual fee disclosure statement to arrangements that commenced after 1 July 2013
- Confirm a 14 day cooling off period for financial products
- Confirm the client’s right to change their instructions; and
- Ensure that instructions to alter or review client instructions are provided in writing, signed by the client and acknowledged by the adviser.
Given that these concessions are already reflected by existing legislation, regulation and practice the Government had little difficulty in agreeing with PUP’s demands. The Palmer United Party’s strategy was unusual; most understood that PUP would oppose the regulations unless the Government made concessions; but few expected that PUP would demand that the Government do what they had already done or committed to do. Nevertheless, the FPA is heralding Palmer’s contribution and the Government has however undertaken to introduce regulation to ensure these matters are reflected in any Statement of Advice provided to a retail client.
The 15 July 2014 letter also confirmed the Government’s intention to “establish an enhanced public register of financial advisers (including employee advisers) which includes a record of each adviser’s credentials and status in the industry”. What this register will contain, and what information will be made publicly available has yet to be determined. A register of advisers is easily achievable but “credentials and status” may be more problematic. The Register maintained by the UK’s Financial Services Authority has information on all firms that are, or have been:
- authorised by them;
- registered with them to conduct regulated activities; or
- provide certain regulated products or services in the UK.
In contrast, the initial press coverage of the proposed register suggests that it will enable consumers “to easily identify all licensed financial planners who have an agreed set of credentials,” which suggests a significant broadening of the existing Authorised Representative Register to include qualifications, membership and ownership.
 16 December 1944 – 25 January 1945
 The Regulation also clarified the application of the stamping fee provision to capital raising activities and broadened its application to include investment entities. It amended the application of the existing brokerage fee provisions to include brokerage fees paid in relation to financial products traded on the ASX24. The amending regulation also ensures that the wholesale and retail client distinction that currently applies in other parts of the Act also applies in respect of the FOFA provisions and clarifies the operation of the ‘mixed benefits’ provisions.”