The long awaited final report into the banking Royal Commission was released on Monday. It included 76 recommendations from Commissioner Hayne. While some say the report missed the opportunity to fundamentally change the Australian Financial Sector for the good, there is no doubt there are potentially big changes on the way which will affect the way Australian’s go about their financial lives.
Barking and Biting
Many have suggested the reports bark was worse than its bite – particularly where the major banks were concerned. As an example of the bark, Hayne stated:
"There remains unwillingness, in at least some entities, to recognise and give effect to the obligation to ensure that the relevant services are provided efficiently, honestly and fairly, without first having the regulator agree with what the entity judges to be required to meet the standard.
"That is, there remains a reluctance of some entities to form and then to give practical effect to their understanding of what is ethical, of what is efficient, honest and fair, of what is the 'right' thing to do.
"Instead, the entity contents itself with statements of purpose, vision or values, too often express in terms that say little or nothing about those basic standards that underpin both the concept of misconduct and the community's standards and expectations. These observations do not apply to all entities."
Pretty scathing - all well and good. So what of the actions recommended in the report – the bite? The big banks saw their share prices rise around 5% immediately following the report’s release on Monday. This tells you what the markets thought of the report. Admittedly, banks stocks may have been somewhat discounted due to fear of what the report might contain, along with prevailing economic conditions, but on the surface, the rise indicated that overall, the banks are not expected to lose much – at least initially, from the findings. By and large, the big banks and their core businesses set to continue unscathed.
The report did make 24 referrals to regulators to take action over misconduct. All the big banks were named apart from Westpac. These referrals will take time to be initiated and their consequences remain to be seen.
There are however significant reforms embedded in Commissioner Kenneth Hayne's report, which include 76 recommendations, which the government has promised to act upon. Many of these changes will have positive consumer outcomes, especially around accountability for conduct. The regulators have been heavily criticised for their practises, but have been given notice, as well as $170 million in extra funding already, to be more aggressive in their efforts to curtail and punish misconduct and breaches of the law. What is certain is that the recommendations will greatly impact some financial service industries which will have a direct consequence for the millions of Australians who use their services. These include financial advice, superannuation and mortgage broking. Here we take a brief look at Financial Advice.
Financial Advice: Ending Commissions – Grandfathered and Insurance Commissions:
At present, financial advisers may get paid commissions from product manufacturers (ie Banks and other financial entities) when they use a particular investment or insurance product for their client. While commissions have been outlawed for investment products for several years, for various reasons some of these commissions have been exempt from the ban and advisers continue to be paid ‘grandfathered” commissions. Commissions paid on insurance products are still allowed, mainly because of Australia’s chronic under insurance problem.
Hayne has recommended banning or limiting commissions, and increasing the duties of insurers to their customers. However, many of the changes would depend upon the outcome of a review by the Australian Securities and Investments Commission (Asic) in 2022. In addition to recommending the abolition of grandfathered commissions on all financial products, Commissioner Hayne said commissions on life insurance (which are now exempt) should be dialled down and eventually phased out following the 2022 review... "Unless there is a clear justification for retaining those commissions, the cap should ultimately be reduced to zero".
Other changes include outlawing "Fees for no service", making mandatory the renewal of all ongoing fee arrangements by a client every year, and the establishment of a new disciplinary body for oversight of all financial advisers who must be registered in order to provide financial advice. Hayne stated that the aim of the disciplinary system is to ensure that advisers who engage in misconduct face appropriate consequences. We think the establishment of such a body should be welcomed, as is the mandatory obligations placed on individual advisers and authorising licensees to report serious misconduct. This should facilitate the appropriate action being taken against any adviser engaging in misconduct, furthering the protections for Australian consumers.
Bottom Lines Effected
If these recommendations are actioned, the immediate consequences for many clients of financial advice will be a rise in the direct cost of advice. The removal of commissions will mean that many advisers will not be able to rely on what is a substantial revenue steam for their businesses. In order to replace this revenue, advisers will most likely be required to increase their up-front fees, making the initial cost of advice more expensive. Rather than paying for advice “indirectly” (via admin fees, service changes or interest on the financial product), advice clients would pay an up-front “fee-for-service” directly to an adviser.
The idea is to take the “conflict” out of the decision to take up a particular product – if the adviser isn’t getting paid a commission – their advice is less likely to be “conflicted”.
Of course, many advisers already operate this “fee-for-service” model. The industry has long been arguing about the merits or otherwise of commission payments. Some advisers have been ethically opposed to them, while others say they help allow clients to afford a fuller suite of services (by effectively "subsidising" adviser revenue) that otherwise would not be available to their clients. Other still, have anticipated such a ban and have worked hard on transforming their businesses, so that they are no longer reliant of such commissions.
Cost of Advice
The up-shot for the consumer is that advisers operating on commissions could generally charge less initially (because they got paid in other ways, rather than directly from the client). Adviser Ratings has done some modelling on the effect removing commission payments might have on adviser revenues and the initial findings indicate that the average annual fee paid to advisers by their clients will rise from $2,300 to $4000 - a rise of 74%.
There are further recommendations in the report aimed at making sure misconduct is identified and punished, including giving more money and teeth to the responsible government regulators. The commission has identified and recommended solutions aimed at further professionalising the advice industry and identified ways to help protect consumers. Generally speaking, the changes to a “fee-for-service” model was where the industry was heading anyway, albeit in a slow and meandering way – the recommendations made give the transition a more definitive timeline, but there will be some negative impacts in the short to medium term. First and foremost, ostensibly mandating the change of fee structure for those in the advice industry who are yet to change to fee for service model will lead to a rationalisation of clients by these advisers. Some advice firms will decide that the cost of servicing “low value” clients will become too high. The fact that the cost of advice is likely to rise for clients of these businesses means that some Australian will no longer be able to afford – or justify the cost of financial advice. An "advice gap", similar to what occurred in the UK after regulatory changes, looks to be an inevitable result.
While change in the industry is necessary, inevitably there will be winners and losers. In the longer term, the implementation of the commissions recommendations should make the advice process more transparent and accountable. However, in the short term, the increasing cost of fee for service advice risks alienating clients who will no longer be able to afford the up-front fee. Many Australian's who potentially would have sought advice will no longer do so - or at least, they will have to wait till newer business models emerge that can service their needs.