The Federal Government has told the financial planning industry in no uncertain terms: find a solution to the conflicts of interest embedded in commission-based advice, or we’ll legislate – and potentially cap your income. Speaking at a Fee for Service Group* meeting in Sydney on July 8, Senator Nick Sherry, Minister for Superannuation and Corporate Law, announced an extensive review of the operation, structure and cost of Australia’s compulsory superannuation system, including the provision of financial advice.
He applauded the objective of the group to work on a fee-for-service basis, and put the onus on the industry to propose alternative models to commission-based remuneration. The review of fees and charges forms part of Sherry’s wider plans for “structural, micro-economic reform” of the superannuation sector. “In my view, it is an appropriate time for discussing and considering alternative models in the provision of advice in superannuation,” he told the Fee for Service Group. “Why is it an appropriate time? There is a new government… and compulsory superannuation is entering its 20th year. I say it’s time to renovate the house.”
{sidebar id=12} Treasury estimates that the average management expense ratio (MER) charged by the superannuation industry, including all fees and charges, as well as commissions on financial advice and product distribution, is 1.25 per cent of funds under management a year. According to Treasury, annual superannuation fees range from 0.6 per cent to 2 per cent of assets. Sherry said the cost could be broken down into three segments: the fee for administration, the funds management charge (which varies depending on the investment option), and the fee for advice. As administration is highly commoditised, and market forces largely determine funds management fees, he suggested the opportunity for cost reduction is in the area of advice (read: “trail commissions”).
“My considered view is that an average of 1.25 per cent is too expensive, it needs to come down to below 1 per cent, and the range [0.6 per cent to 2 per cent] is too high,” he told the group. “The onus is on government to make the system simpler but the onus is on the funds to consider solutions to bring down the cost.” The superannuation review will take place alongside the Government’s tax review, headed by Treasury secretary Ken Henry, which is examining the adequacy of superannuation. However, Sherry says he is not prepared to increase the superannuation guarantee levy above the current 9 per cent of wages until fees and charges are addressed.
The rather large carrot the Government is dangling is the huge potential benefit for advisers – in the form of higher investable assets flowing into the superannuation system through increased mandatory contributions – in tackling the challenge at hand. “[Reform to the superannuation sector] needs to go hand-in-hand with adequacy and other levels of compulsion,” Sherry said. “I’m not prepared to support greater levels of compulsion without structured reform to improve the cost structures and fees within superannuation across the board.”
Sherry added that he would rather not divorce product and advice, as is the approach being taken in the UK as part of the Financial Services Authority’s review of the retail distribution of financial services, saying he would prefer to let market forces do that. “The most radical step would be structural separation [of advice from product],” he said. “We are past that point in Australia; it would be too radical.” He also suggested that banning commissions entirely was not the right approach. “As you would be aware, it is still common for financial advice to be paid for through sales commissions and trailing commissions. The commissions, of course, are paid from the fund managers and financial products that the adviser recommends to the customer,” he told the group.
“The potential for conflict of interest in this situation is very real and does exist. The adviser does have a strong incentive to recommend a product or super fund that pays a commission – whether or not this is the best option for the client. “While the potential for conflict of interest cannot be discounted, the argument for removing commission-based payments is not straightforward. One driver of the cost of advice has been the complexity of disclosure under FSR [Financial Services Reform Act]. Requiring financial advice to be only on a fee-for-service basis could lock out some Australians from receiving financial advice without a significant overhaul of the FSR requirements.”
Sherry said it is apparent that retail investors are generally disinclined to pay for financial advice on a fee-for-service basis. John Prowse, managing director of Pinnacle Financial Services, referred to this reluctance to pay upfront as a form of “money illusion” – the tendency to think in terms of nominal rather than real monetary values. When asked by Nigel Stewart, chairman and chief executive officer of Stewart Partners, whether the Government will consider the issue of tax deductibility of fees, Sherry said it could form part of broader reforms. “I’m going to get some figures on that,” he said.
“But that in itself is not sufficient. I’m happy to include it, but as part of a package.” He said the debate about whether full disclosure is enough to deal with the potential conflicts of interest associated with commission-based fees was a worthy debate. To date, the Government has dealt with conflicts of interest via disclosure-based regulation. The May restructure of the Australian Securities and Investments Commission (ASIC), including the creation of a dedicated financial advice team which will look at issues that affect the ability of individuals to access advice, is also expected to benefit the industry. In February, the government set up the Financial Services Working Group (FSWG) with the aim of facilitating short, simple and readable disclosure documents.
The FSWG has developed a four-page product disclosure statement (PDS) for the First Home Saver Account, which Sherry says will have close application to intra-product financial advice. “Major work that needs to be done in the future of financial advice and provision is the development of a simpler financial services disclosure regime,” Sherry said. “[The First Home Saver Account PDS] is a useful template for how we can proceed with financial product advice in superannuation. We will look at how advice can be given with legal immunity in a simple and cost-effective way. The shorter PDS will reduce costs and provide the industry with greater clarity and certainty in meeting its legal requirements.”
Sherry said conferring legal immunity will require a change to FSR. After that, it is up to the industry to change the way in which it operates. “I want a level playing field. Reducing the cost of advice is not sufficient; we need to look at how it’s paid for,” he told the group. “We’ve managed to get simple, standardised advice. The onus is on the industry to come up with a set of solutions.” Attendees at the Fee for Service Group meeting expressed informal support for setting a deadline in the future for phasing out commissions entirely. “It is my personal view that we have to say [that] by 2010, or whenever it is, manufacturers won’t pay commissions.
That’s the only way to avoid nasty regulation,” says Steve Tucker, chief executive officer at MLC. “A regulatory response to payments and fees is not a good outcome for us as an industry. But unless we do something that’s industry-wide, that’s where [the Government] is going to go. The next six months will make clear the outcomes we can expect – we need to increase transparency. If we don’t do that, there is a real possibility that [they] will regulate.” Chris Corneil, head of the investor services group at Russell Investments, says volume rebates are “the more insidious part” of the industry, as they are barely visible to the end consumer.
The Financial Planning Association of Australia (FPA) says it will actively participate in any review of the superannuation system. “If we need to provide greater clarity to Australians on the various business models that exist, which includes remuneration structures, and that ultimately engenders greater confidence in the system, that’s a good thing and we welcome it,” says Deen Sanders, deputy chief executive of the FPA.
He says the FPA already requires the separation of fees for advice and fees for products through its Principles to Manage Conflicts of Interest, which are enforceable. “We have a remuneration committee looking into definitions, payments, and benefits, and we will bring all of this work to the review,” he adds. However the Association of Financial Advisers (AFA) remains resolute against calls for the abolition of commissions. “Mandating a single model of remuneration is wrong and it distracts everyone from the main purpose of working with advisers, which is building, protecting and managing wealth for Australians,” says AFA president Dennis Bateman. {mos_fb_discuss:19}
