Proposed Changes to the Australian Financial Services Industry
DRAFT
A Discussion Paper Presented to Minister Bill Shorten
1.1 The objective of this paper is to highlight some issues that exist in the Australian financial services industry that may not get raised by the Institutional and Industry Fund sectors but deserve serious consideration.
1.2 BASIC ASSUMPTION – The Government wants a healthy independently owned sector to maintain balance and choice for consumers with advice and product. The only other option is an industry totally dominated by the Banks, Life Offices [Institutions] and Industry Funds. The independent advice market represents approximately 15% and currently contracting due to Institutional purchasing activity and day to day operational difficulties smaller practice principals are facing. It is common for the smaller groups to sell/join the larger national independent groups who are then selling to the Institutions.
2.1 LOSS LEADING BUSINESS MODELS – The Institutions own or directly influence over 83% of the advisers in the market. The far majority of these institutionally owned practices operate at a significant annual loss whereas the independently owned sector must prove solvency to ASIC to maintain their AFSL. The Institutionally owned practices are permitted to ‘hide’ these annual losses in the balance sheet of their parent company and subside their practices with the embedded profits the Institutions make on the book of business accumulated in their wealth division [from the activity of the practice].
2.2 Essentially, the Institutional practice is a ‘funnel’ for client monies into their wealth division, they are permitted to operate at a loss and the wealth division profits subsidise the advice delivery. The ratio is around 10 to 1 i.e. for every $10 million the institutionally owned practice loses on advice they make $100 million on the embedded profits in the wealth division on the book of business the practice has delivered.
2.3 We have raised this matter with ASIC some time ago, they acknowledged its existence, dismissed it as irrelevant and declared ‘we must cater for all business models’.
2.4 Industry Funds are also operating unprofitable advice practices but are subsidising the practices out of general revenue from other profit centres within their platform business model.
3.1 FOFA REBATE PROPOSAL – The AIOFP agrees that commissions from investment products should be eliminated from the market but however contend that platform rebates/dividends should be treated differently. A Platform is an administration service that reports to its members, it is not a managed fund or similar. Consumers do not invest into a platform [like they do with a managed fund] they are charged a fee to use the platform to deliver a reporting service back to them. Industry Super Funds are also a platform with similar functionality and service to their members. It could be argued that all Industry Fund members pay for a loss leading advice function that only a fraction use.
3.2 Like Institutions and Industry Funds, Independents want to also use platform profit margins to subsidise advice delivery. Platform profits are a critical revenue source to the survival of the independent sector.
3.3 This begs the most obvious question – why can’t independents operate the same business model as the Institutions and Industry Funds with their white label and private label manufacturing platform models? This strategy allows the independents to use their scale with the Platform providers to get an institutional fee structure that delivers superior pricing to the consumer and a margin/dividend to the independent practice shareholder to subsidise advice delivery.
4.1 TRANSPARENCY IN ADVERTISING – Pre 2005, institutionally owned practices had to clearly demonstrate on all business cards, advertising and paperwork who owned the license they are operating under. This gave consumers upfront clarity on who they were dealing with and the likely direction of the advice.
4.2 Since 2005 this ‘mysteriously’ changed with Institutionally aligned advisers being allowed to masquerade as an ‘independent’ with no indication on any advertising who they are licensed to. They now only have to divulge their ownership in the FSG during the first client interview. At this point the ownership issue is used as a ‘comfort’ strategy after the adviser’s ‘sales pitch’ and all the clients monies would commonly be channelled in one direction. We raised this issue with Nick Sherry in 2007 who demonstrated genuine surprise the practice had changed.
4.3 Successive Government’s over the years have insisted on transparency as a key plank in the quest for a professional industry, this is a very fundamental function that has escaped scrutiny.
5.1 INDEPENDENT TRUSTEE/RE ROLE WITH ADMINISTRATION/FUNDS MANAGEMENT – During the 1980/90’s this role was exclusively with the independent trustee sector, the Institutions have now taken control of the functions in house with staff and paid ‘professionals’ on the trustee committee. Considering the function is largely a supervisory role ensuring that the administrator/custodian/fund manager is adhering to all laws and acting in the best interests of the clients/members, surely this should be performed by an APRA approved third party to avoid conflicts.
5.2 The institutions also treat it as a healthy profit centre charging clients around 12 basis points whereas the cost from the independent trustee sector can be as low as 4 basis points. A change in policy will provide consumers with lower costs and integrity in the process.
6.1 CONFLICTED RESEARCH HOUSE BUSINESS MODELS – Research is the most important function in a practice, it is fruitless to have the best staff, practice, administration and have a flawed approved product list. The practice is therefore an accident waiting to happen.
6.2 The industry largely relies upon Research House ratings to assist their client recommendations. Most advisers do not have the time, expertise or resources to perform the task personally or internally. Over the past 25 years it has become acceptable in Australia for product manufacturers to pay research houses to rate their products. This profoundly conflicted process has been blamed for a number of second tier product manufacturers ‘buying’ favourable ratings to give them legitimacy with the market. Basis Capital, Westpoint, Great Southern, Timbercorp, Astarra and Willmotts are only a few examples of groups that purchased a rating and ended in catastrophe.
6.3 If the Government is serious about protecting consumer assets this culture has to be eliminated. Elimination of conflicted research practises will lead to an elimination of “dodgy” product manufacturers from the market.
6.4 Product failure is by the far the greatest cost for consumers with in excess of $6 billion being lost over the past 5 years. The attached article (fig. 1) demonstrates that US Congress has finally dealt with the matter.
6.5 The major issues affecting the research industry are too many operators in the market, insufficient revenue and larger practices negotiating group discounted deals further diluting the revenue pool.
6.6 The Research Houses have become the ‘gate keepers’ in the industry with advisers needing a rating and product manufacturer’s needing inflows. These ingredients have lead to a conflicted dubious environment where inexplicable ratings have been ‘shopped’ around and paid for, leaving clients and advisers the victims.
6.7 Our suggestions are each adviser is levied a fee, the pool is managed by ASIC with 2-4 Research Houses tendering for revenue to deliver advice to advisers and paying for ratings legislated against. The other option is self regulation by boycotting those who accept conflicted payments. There are only 2 conflict free retail Research Houses in the market, Mercer and McGregor the other 8 accept conflicted payments of varying descriptions.
