Most people are financially illiterate.
Not because they are stupid, but rather because insurance, investment and superannuation are all unnecessarily complex and the guidance consumers need to navigate these uncertain areas is largely unavailable – with legislative barriers being a significant contributor.
Everyone agrees that good financial advice is beneficial and indeed essential at certain times, such as when entering retirement. However, the laws of financial advice are incomprehensible and poorly structured. Consumers are not familiar with financial advice and many struggle to find out where they can get it. When they do meet an adviser, the fees are often unaffordable for most consumers.
It has been like this for some time despite decades of legal changes which have attempted to protect consumers and to gradually convert financial advisers from the product-floggers of the 1990s into today’s professional consultants. Incremental changes were made to protect consumers following each new revelation of misdoing. Unfortunately, as the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry showed, many (otherwise reputable) financial institutions recklessly broke the new laws and were forced to make large remedial payments back to consumers.
The result has been even more focus on compliance and enforcement which has led to cumbersome processes, huge documentation and, inevitably, higher costs. Ironically, this has transformed financial advice into a service for wealthy Australians only and left a void for middle-Australia.
Quality of Advice Review
Everyone agrees a catalyst for change was required and one of the last acts of the Morrison Coalition government was to establish a Quality of Advice Review run by lawyer Michelle Levy and supported by a team from Treasury. Despite the importance of this Review, it was not headed by a panel of independent experts, and it was only given 9 months to report back by 16 December last year. A comprehensive Issues Paper was released in March 2022 to which 134 submissions were received.
The abbreviated timeframe meant there was no public consultation, nor draft report. A Proposal Paper was issued in August, setting out an innovative yet controversial new model which addressed many of the existing well-known problems.
The Proposal Paper sought answers to 14 specific questions related to the proposed changes, and subsequently received 178 responses showing a wide range of support and dissent. Despite the clear opposition to some of the proposals, the final report was presented to the government in December 2021 with no material change.
The Assistant Treasurer released the final report on 8 February this year. There was none of the usual supportive commentary but a comment that the recommendations would be further reviewed by experts. This suggests that the government had some reservations about the recommendations.
Despite initial promises that the system would be changed as a priority, the government has been silent, and there was no announcement even of a timetable for change in the recent May Budget.
The final report correctly notes that the current regulatory framework is a significant impediment to consumers accessing financial advice. It also prevents advisers and institutions providing advice and assistance to their customers. It recognised that substantial change to the system is needed, and it has suggested some major changes which are intended both to cut the cost of delivering advice, but also to expand the take-up of advice to many more consumers. A theme is to remove prescriptive legislation and replace it with a set of principles.
The key (proposed) changes:
- The Review introduced the concept of Good Advice, stating that this should be the main test for whether consumers are being assisted. Good Advice is Personal Advice that is fit for purpose. Existing educational standards would remain unchanged.
- The definition of Personal Advice is expanded to include any financial product advice, being any recommendation or opinion or provision of information to an individual relevant to a financial product or class of products.
- The current definition of General Advice is removed. This would expand the opportunities for people to give broad information about products and strategies provided it is not aimed directly at an individual (when it becomes Personal Advice).
- Personal advice can be provided by entities other than licensed financial advisers. Controversially, these entities do not have to follow a Best Interests Duty (!).
- Intra-fund advice within superannuation should be expanded to allow funds to provide a service for those transitioning into retirement.
- The current regime is based on consumers receiving comprehensive advice and sets out onerous compliance with extensive obtuse and prescriptive documentation (such as the Statement of Advice, SoA). This is replaced by the provider providing “Good Advice” and then documenting this as they see fit.
- Advisers must set out the total fee they will charge and the services they are providing. Where the service is ongoing, the total fee must be shown annually.
One of the major changes is that it would be much easier to provide advice on a single subject, and it would open a market for simple advice to be delivered electronically, including by some who are not licensed as financial advisers. This recognises that many people need single issue advice periodically during their life, and they don’t need an ongoing retainer across all their financial needs.
The prime objective of the report appears to have been to remove compliance costs to make advice cheaper and thereby, hopefully, more accessible. Consumer protections appear to have been a secondary consideration. Further, the government missed the opportunity to change the scope of the review to reconsider what constitutes financial advice (with mortgage broking the major omission from the regime).
Quality of Report
Within the framework, the general theme of the Report is excellent, but some of the recommendations did not take into account commentary from consumer groups and some industry experts. The report and recommendations appear to be based on the logic that the primary detriment to consumers is the cost of delivering financial advice; that the primary cause of the excessive cost is the overly complex compliance requirements; that the best/only way to remove the consumer detriment is, therefore, to reduce and remove the compliance requirements; and, furthermore, that reducing and removing the compliance requirements will remove all consumer detriments.
The author clearly disagreed with some of the issues raised within the submissions, particularly those from consumer groups. Her subsequent public statements indicate that she does not accept that some of the compliance requirements were imposed to deal with specific inappropriate behaviours and that removing them will likely lead to a re-emergence of those behaviours. In our opinion, it will require considerable changes to some of the recommendations to protect consumers, but (providing these are addressed) we do have the nucleus of a sound new system.
One critical weakness is the lack of differentiation between types of advice. The key to cutting the cost of compliance whilst maintaining consumer protection is to ensure that the level of compliance is appropriate to the level of risk, that is, the level of potential loss, that consumers face. In other words, compliance and its cost can be reduced or removed where it is adding no or little value but must be maintained where it is necessary.
In our opinion, financial advice legislation should be tailored to the risk of harm for consumers. In fact, this was set out in a submission we made during the consultation process. Unfortunately, the Quality of Advice recommendations do not differentiate between a simple piece of harmless advice and a complicated risky strategy. Consequently, the bar for Good Advice appears to be set too low. It is not a requirement to provide “best advice”, but simply to provide advice that is likely to benefit the client. Consumers can still be put in expensive or risky products when better strategies might be available.
Past attempts to legislate “advice”
It is worth considering the route by which financial advice has reached this point. The original legislative framework for the industry flowed from the Wallis Committee in 1996 which established our modern regulatory environment for financial services. A key recommendation was to provide a brief description of a financial product, and a clear and unambiguous statement both for the risks involved and of fees, commission, and charges (which are comparable with other products). Sadly, anyone reading a Statement of Advice (SoA) will recognise that this aim has not been achieved.
One of the key considerations in implementing the recommendations of the Wallis Committee was how to specify the quality of advice that would be required. The UK model of “Best Advice” was considered and rejected because it had resulted in an impossible position for advisers in that litigious customers were able to point out, in retrospect, that a different set of advice would have produced a better outcome, so the advice given was clearly not “Best Advice”.
After some industry debate, the decision was made to require financial intermediaries (advisers) to provide “Appropriate Advice”. The advice did not need to be the “Best” because that could not be defined, but it needed to be fit-for-purpose and suitable and reasonable for the consumer’s circumstances – Appropriate!
This proved to be insufficient because advisers, especially those employed by product manufacturers, could argue that their advice, within the constraints of their product list, was not inappropriate – which is the definition of Appropriate – despite being highly conflicted and suboptimal. Reaction to the resulting scandals and consumer losses resulted in the further layers of compliance legislation we see today.
The recommendations in the Quality of Advice Report, unfortunately, appear to be to move back to the original legislative regime with the term “Appropriate Advice” replaced by the term “Good Advice”. The original regime did not work. There is nothing to indicate that it will now. There is nothing wrong with “Good Advice”. “Good Advice” is necessary, but it is not sufficient to protect consumers.
Conflicts which will remain
Many financial advice strategies are complex, due to the complicated personal circumstances of the consumer and the implementation which needs to consider many issues including taxation, time horizon and risks.
However, when we expand the advice regime to middle-Australia, the solutions are much simpler. Most of these people will be comfortable with a MySuper (default) superannuation, simple investments (mainstream ETFs backed perhaps with some high-dividend blue chip Australian shares) and simple life insurance. These solutions can be provided at a much lower cost than existing structures, representing Good Advice for most consumers.
There is still a weakness within the industry with commissions and asset-based fees. These encourage advisers to oversell products as they benefit personally from higher volumes. Further, in some cases, the desire to obtain asset-based fees means that advisers often favour investment platforms or SMSFs when a MySuper product would be more appropriate for many consumers. This shows that the same advice could be Good Advice for some but not for others.
The failures in the original regime show that there is not just a need to ensure “Good Advice”, there is also a need to ensure that the interests of consumers are protected and that these are placed ahead of the interests of advisers and product providers. The “Best Interests” duty was intended to do this, but, unfortunately, has been interpreted by both ASIC and lawyers for advisers as a “Best Advice” requirement. The argument now is that if an adviser could have proposed something that was better, they could not have acted in their client’s best interests. Consequently, we have over-complexity of Fact Finds, Statements of Advice and the rest to protect financial advisers and product manufacturers rather than to protect consumers.
There is a need to maintain a requirement for advisers, and especially those who act for product providers to act in the interests of consumers and to put the consumers’ interests ahead of their own without descending into the unintended “Best Advice” nonsense that has developed. This is unquestionably a difficult, tricky issue, but it should be possible for advisers to have a “Customer’s Interests” duty that includes a requirement to put the customer’s interests ahead of the adviser’s interests.
Conflicts are not limited to financial advisers. Consider the proposed extension of intra-fund advice to advice on retirement products. Superannuation funds are now required to put members into cohorts when forming their Retirement Income Strategies. They may well use entitlement to a full, part, or no Age Pension at the time of retirement to be one of the criteria for allocating members into a cohort. Giving members guidance as to the default structures for these cohorts is sensible.
However, there remain some conflicts which the Review glosses over. We know that about 70% of members will be married when they enter retirement – and their spouse will usually not be in the same fund unless they have an SMSF. They will need to know whether to stay in separate funds or whether a new fund might be more suitable for both.
They will be offered a longevity product, but is this suitable if they are a homeowner? These members might prefer to wait until later in life and buy a reverse mortgage to supplement their income rather than allocate money to a longevity product with an uncertain outcome (noting that in many cases the value of future benefits could depend on the longevity of all members).
Clearly their own superannuation fund will be conflicted in giving advice in these areas – and the default cohort structure will not always represent Good Advice.
In time, financial advice might change like stockbroking where the emergence of online brokers has provided much lower fees for consumers. New entrants offering financial strategies and who are ambivalent on financial products could provide a low-cost valuable service for many.
Simplifying the compliance regime for those offering relatively harmless advice will provide many consumers with appropriate low-cost advice about simple issues. Technology will provide the tools for existing advisers and newcomers to provide these services.
Riskier structures will continue to need higher compliance to ensure adequate protection. However, even in these areas, we should expect simpler documentation and processes.
And we will need enforceable requirements for advisers and product providers to put consumers’ interests ahead of their own.
While it is hoped that this Review will be the catalyst to develop a sensible relevant financial advice structure, much further work is needed before the legislation can be prepared.
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