There has been a lot of discussion and speculation about the ending of grandfathering for clients already receiving advice prior to the introduction of FOFA in 2014 and the subsequent abolition of commissions for investment advice. This commentary has typically focused on the impact on cash flows and valuations for the affected advice businesses, and how they will need to reorient their business models to fee-for-service, in some cases simply to stay in business. However, but there are a raft of other consequences to this action.
If this change is to be legislated, as we expect it will, there needs to be a reasonable transition period to allow an orderly process for advice groups to change to ensure their sustainability while also minimising any related client attrition that may occur as clients are confronted with an overt fee-for-service proposition, in some cases for the first time.
However, there may be unintended consequences from ending grandfathering, specifically with investment products that have traditionally paid fees to advisers for recommending the product or to platforms and licensees for inclusion in menus and approved product lists (APLs).
By definition these products have origins pre-FOFA introduction in 2014 and in many cases are much older legacy products with management fees, features and performance that do not warrant being included in contemporary platform menus, APLs or even model portfolios. Will these legacy products stand scrutiny when compared against the latest and greatest offerings, when grandfathered fees are removed? And if this change leads to an overall renovation of menus and APLs, what does this unwinding process look like?
One challenge is that many of these products have been sold to clients through master funds and master trusts. In these situations, transfer of clients from a legacy product to a contemporary product would catalyse a potentially unsavoury CGT event, although the benefits of moving to a more contemporary, better rated fund may outweigh the total cost considerations including tax impact in the long-term.
But let's keep exploring this scenario.
In this situation, are the advisers likely to recommend clients stay with the same fund manager or will they switch managers? And while it probably shouldn't, will it catalyse a modification of their asset allocation at the same time? And lastly, once extracted from the master trust, will advisers recommend they switch platforms or move off-platform into managed accounts or SMSF structures?
There is also the question of potential compensation for advisers. As one adviser has mentioned in commenting on the issue:
"Ending grandfathered commissions is not simply switching off payments. When FoFA came in grandfathered commissions were allowed because the Australian Constitution protects private property. Compensation would have been payable to all advisers by the Australian Government. Apparently the Commonwealth Government Solicitor General confirmed this in legal advice to the then Minister Bill Shorten.
There is also the question of cost borne by the wider advice industry, including product manufacturers who would be forced to close or renovate products.
What about the potential for special treatment for sections of the industry or tax concessions for individuals facing CGT issues brought on by any legislative changes? Or a time frame for the full transition?
The bottom line is that the end-to-grandfathering debate is far more than simply a discussion about the future of financial advice businesses, but may have profound impacts on the entire investment product marketplace and distribution framework.
We’d love to know what advisers think about these issues. We expect grandfathering will eventually cease – the question is how and when.