Arguably the single most important objective of the Financial Services Royal Commission was to uncover systemic drivers of poor consumer outcomes.
In a continuation of our series on Financial Consumer Protection, this article examines the latest raft of regulatory changes that will impact – directly and indirectly – financial advisers from 2021 onwards. Self-licensed advisers in particular may find themselves surprised about how much work is involved in meeting their new obligations, with the devil – as always – in the detail.
2021 will see new regulations take effect across several key categories:
- Supervision and standards (the dismantling of FASEA)
- Financial advice
- Life insurance
- Superannuation.
To help financial advisers understand these new obligations, and the possible implications for their business models, we’ve compiled this handy chronological ‘Year at a Glance’ summary.
April 5th: Unfair Contract Terms (UCT) extended to insurance (life and general)
Unfair contract terms
General and Life Insurance contracts have previously been exempted from 2010 legislation banning unfair contract terms (terms deemed to result in a contract being unfairly one-sided) in the standard form contracts seen across most sectors, including energy, telecommunications, and finance.
This exemption has now been removed, in line with Recommendation 4.7 of the Hayne Royal Commission[1].
From an adviser perspective, the most obvious impact of this change has been the industry wide review and updating of PDSs to reflect new terms. (For example, PDS and Policy documents now contain a lot more detail about the fact that future premium may increase across a product series, and the factors that can drive such an increase).
Despite media reporting of licensee concerns[2], fears about adverse implications for existing customers have largely proved unfounded.
To the extent that the new requirements offer more equity and protections for individual policyholders (the changes don’t apply to Group Life schemes), it remains to be seen how future court challenges to contract terms play out. The courts will undoubtedly test the assumptions made by insurers when relying on conditions and exclusions, requiring them to analyse their underwriting and claims data to ensure that exclusions and conditions accurately reflect the actual risk exposure.
July 1st: Annual review of fee arrangements, and independence disclosure requirements
In the context of impact to adviser processes, the most substantive changes for the year take effect from the 1st of July. New requirements – as summarised in three ASIC instruments[3] (2021/124 to 2021/126) – apply to:
- the disclosure of lack of independence that an AFSL or authorised representative must give clients where they would breach s923A of the Corporations Act if they used words such as “independence”, “impartial” or “unbiased”
- the written consent that a fee recipient must obtain from a client before deducting, or arranging to deduct, advice fees from a client account as part of an ongoing fee arrangement
- the written consent that a superannuation trustee must obtain from a member before deducting advice fees from a superannuation account under a non-ongoing fee arrangement.
Disclosing lack of independence
Most advisers would be aware of the conditions that prevent them being able to describe themselves as independent[4] (including the acceptance by themselves or their AFSL of commissions and/or volume related payments, and tightly managed APLs). In that context, the vast majority of advisers will need to comply with requirements to disclose their ‘lack of independence’.
ASIC’s instrument[5] is – thankfully – reasonably prescriptive in its requirements in this regard, stipulating:
- that a statement about not being independent must be included on the first page of the FSG
- that it must be in a box, and in a bold font
- that it can’t be hidden away, either by using a smaller font size, or in footnotes, or under misleading headings such as ‘Our Independence’
- that it explains the reasons for the adviser’s lack of independence.
More details on the requirements can be found on the ASIC website[6].
Ongoing fee arrangements
Ongoing fee arrangements (those extending beyond 12 months) were a major area of enquiry during the Royal Commission. Whilst noting no in-principle issues[7] with the deduction of ongoing fees from client accounts, some concerns were expressed about the transparency of fees deducted from superannuation accounts.
Whilst the ability to deduct advice fees from superannuation was already limited under the Sole Purpose Test, additional requirements now apply.
All ongoing fee arrangements, including those including those commenced prior to 1 July 2013, will need to be renewed by the client annually. In a win of sorts for adviser advocacy groups[8], a separate renewal notice is no longer required, and instead can be incorporated into a Fee Disclosure Statement.
In addition to information about the services and fees provided (and used) over the prior 12 months, the enhanced FDS must also incorporate a forward estimate over the next 12 months, including the following information[9]:
- the actual or estimated fees your client will pay over the coming 12 months
- the services to be offered/provided over the next 12 months
- a renewal authorisation (doesn’t need to be a separate document anymore).
Financial advisers must also seek annual agreement from clients for fees to be collected from products (except credit cards and basic banking accounts). The client’s consent to fees will need to be passed on to product providers annually.
New guidelines also apply to anniversary dates and timeframes for issuing FDS documents. As an example, FDSs will also need to incorporate specific information relating to the renewal of the client’s ongoing fee arrangement, including a statement that the arrangement will terminate if it is not renewed in writing within 120 days of the anniversary day.
A transitionary period of 12 months applies, enabling advisers to move grandfathered and bi-annual renewing clients to the new regime.
Deducting advice fees from superannuation
In addition to existing requirements that only fees for advice relating to actual or intended superannuation investments (including account consolidation, fund or product selection and asset allocation within a fund), can be paid from superannuation, tighter requirements now apply around fee disclosure and consents.
Trustees of superannuation funds can only pass on advice fees to members when they are in accordance with an arrangement the member has entered into and consented to, and a copy of that consent has been provided to the trustee. This is true for both choice and MySuper accounts.
Additionally, advice fee deductions from MySuper accounts are now limited to one-off fees.
Advisers should be aware that super funds are likely to vary in their consent processes and should therefore take the time to become familiar with the specific requirements for different funds.
October 1st: Breach reporting, remediation, reference checking and information sharing, Disability Income
Strengthened breach reporting and remediation obligations
The breach reporting regime for AFSL holders under section 912D of the Corporations Act will be overhauled, with amendments which will:
- expand the kinds of situations that need to be reported by licensees to ASIC
- require licensees to lodge breach reports with ASIC
- require ASIC to publish data about breach reports on its website[10].
The new legislation is designed to address concerns about the existing breach reporting regime, mainly relating to the test for whether a breach is significant and therefore reportable.
Specific changes include[11]:
- the introduction of two tests for assessing when a breach is significant, including the “deemed significance test” that deems that a breach of a “core obligation” is taken to be significant if certain circumstances apply
- a requirement for AFSLs to report to ASIC any investigations they undertake
- amended timing obligations for reporting breaches
- the requirement to report serious compliance concerns about advisers of other licensees.
These new requirements have prompted a great deal of industry discussion, with fears that reporting levels may increase exponentially[12].
The need to report misconduct by advisers at other licensees – and provide that report to both ASIC and the other licensee is particularly fraught, especially in terms of deciding reasonable grounds for making such a report.
This obligation may also present unique challenges for self-licensed ideas who often share ideas and problems with other advisers.
Investigating and remediating misconduct
The new legislation extends an existing framework to ensure that the extent of an adviser’s misconduct is identified in a timely manner and clients are informed and remediated promptly.
The legislation will introduce new obligations on AFS Licensees:
- to investigate reportable situations that may cause loss or damage to retail clients who received personal advice
- to notify those potentially affected clients
- to pay compensation to affected clients within 30 days of completing the investigation.
Reference checking and information sharing
Borne out of Royal Commission Recommendation 2.7, new obligations on licensees will severely curtail the ability of ‘bad apples’ within the advice profession to simply roll from one barrel to the next[13].
The Royal Commission found that shortcomings in both the way some licensees responded to requests for references, and in the way they treated information they did receive. The new legislation formalises the reference checking process and introduces civil penalties for contraventions of the obligations – either failing to obtain or share information, or not acting on the information.
Questions that employers must answer honestly include whether an adviser has had any involvement in dishonest or unprofessional conduct. Breaches of compliance requirements or the Adviser Code of Ethics must also be disclosed.
Those who share information would be given a “qualified privilege” defence[14], so they cannot be sued for defamation by any employee who is given an unfavourable reference.
The full scope of the new reference-checking protocols will be made clearer in ASIC regulatory instruments (not released at the time this article was first published).
Individual Disability Income (IDII) changes
APRA’s intervention to improve the sustainability of IDII contracts has already seen the abolition of agreed value contracts. Following industry consultation, APRA has introduced further measures[15], impacting insurable amounts, replacement ratios and contract terms.
Headline changes include:
- ‘Income at risk’ for policyholders with stable incomes is their income at time of claim and not more than 12 months old
- ‘Income at risk for policyholders with variable incomes will be based on average earnings over a time appropriate to their occupation
- replacement ratios do not exceed 90 per cent of earnings at time of claim for the first six months of the claim and do not exceed 70 per cent of earnings thereafter
- the policy contract is for a term not exceeding five years.
These changes will have major ramifications for all policyholders, especially new ones, and advisers should expect a flurry of new product launches and insurer communication in the lead up to them taking effect.
[Note: Subsequent to this article being published, APRA announced that the implementation of this measure would be delayed 12 months, to October 1st, 2022.]
October 5th: Design & Distribution Obligations, Duty of Disclosure abolished, hawking and others
DDO
The essence of the DDO regime is to ensure financial products are targeted at the right people. Its very existence challenges the notion that suitable disclosure leads to informed consumer decision-making.
Products captured under DDO mainly include those that require a PDS or some sort of disclosure to investors.
The design obligations applicable to product issuers include requirements to make a target market determination (TMD) and make it publicly available.
The distribution obligations applicable to distributors (AFSLs and their representatives) include requirements[16] to:
- not engage in retail product distribution without a TMD
- not engage in retail product distribution where a TMD may no longer be appropriate
- take reasonable steps so that distribution is in accordance with the TMD
- collect, keep and provide distribution information
- notify the issuer of any significant dealings inconsistent with the TMD.
DDO – Practical implications for advisers
Whilst ASIC maintains that a financial adviser should consider the TMD for a product when providing personal advice and meeting their best interests duty, and whilst licensees must take reasonable steps to ensure products are aligned with client segments, RG 274 also notes that financial advisers providing personal advice are not required to meet the reasonable steps obligation under DDO:
“When a distributor provides personal advice, it will not be required to take reasonable steps that will, or are reasonably likely to, result in distribution of a financial product being consistent with the TMD: see s994E (3) and the definition of excluded conduct in s994A (1).” ASIC RG274.200
Potentially the biggest challenge for advisers will lie in the collection of data relating to product usage and customer complaints. This is because distributors are required under DDO to report to issuers:
- Whether it received complaints about the product during a reporting period and if so, the number of complaints received
- Information of the kind specified by the issuer in the TMD that was acquired by the distributor during a reporting period
- Significant dealings in the product that are inconsistent with the TMD.
To minimise the administrative burden – and therefore the cost – to both issuers and distributors, the Financial Services Council (FSC) has worked with a range of industry providers to standardise data collection methodologies and TMD templates.
“Standardisation of information and data is important to the success of the DDO regime. Given the potential for complexity – and associated cost – from hundreds of different templates and data standards, the FSC has developed templates which will assist companies write TMDs for the products they issue.” Sally Loane, CEO, Financial Services Council[17].
Duty of ‘Reasonable care not to make a misrepresentation’
From 5th October 2021, applicants for life insurance (and indeed all types of ‘consumer insurance’) will no longer be bound by a Duty of Disclosure. Nor will they face a general prohibition against making a misrepresentation. Instead, an insured entering into a consumer insurance contract will owe a duty ‘to take reasonable care not to make a misrepresentation’.
Often perceived as a catch all ‘get out clause’ relied on by insurers, the Duty of Disclosure was problematic in that it didn’t recognise the gap between what a consumer knows and what an insurer knows is relevant to the decision of the insurer whether – and on what terms – to accept a risk.
The new duty to take reasonable care not to make a misrepresentation places more of a burden on insurers to collect the information they need, rather than requiring applicants to guess what information might be important to an insurer.
Possible implications for the application process
Although a lower burden of responsibility is undoubtedly a better outcome for consumers, it is yet to be seen how this change impacts the application process. The shift in burden could well see personal statements become even longer, as life insurers are forced to be even more prescriptive – and detailed – about the types of information applicants need to provide.
Other changes advisers should be aware of
For the purposes of this article, we have focused on those regulations likely to be most applicable to financial advisers. Other changes coming online throughout 2021 include:
- July 1st: Registrable Superannuation Entities (RSEs) prohibited from assuming obligations other than as a trustee
- October 5th: New anti-hawking regime applies to insurance and superannuation, and deferred sales models mandated for ‘add on insurances’.
A word about FASEA
The Government has committed to introduce legislation to support the abolition of FASEA and establishment a new supervisory and standards regime for financial advisers, however at the time this article was originally published, no details about the legislation, including timeframe, were available.
LIF review
The LIF review, which was due to commence in late 2021, has been taken out of the hands of ASIC[18] and will form part of the late 2022 review into the quality of advice (RC Recommendation 2.3).
Conclusion
Arguably the single most important objective of the Financial Services Royal Commission was to uncover systemic drivers of poor consumer outcomes. Its 76 recommendations are intended to strengthen consumer protections across the sector. Although at the time of publishing less than half the recommendations had been acted on, the massive volume of new financial regulation applying to product providers and advisers is virtually without precedent. With all industry stakeholders at risk of regulatory fatigue, it is vital for all advisers to understand the details of all new regulations, so as to avoid any lurking ‘sting in the tail’. Being across the detail of these new obligations not only helps ensure compliance, but helps advisers understand how their processes are impacted, and how they may need to be adjusted.
Read the previous articles in the series:
CPD: Financial consumer protection – part 1 – practical framework for financial advisers
CPD: Financial consumer protection – part 2 – the art of the conversation (having, recording, storing, using, protecting)
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