Paul Resnik says the US sub-prime debacle shold tell those that regulate and participate in financial planning a great deal, if only they care to listen.
At its core, the financial system relies on trust. When trust is damaged all participants suffer. The sub-prime collapse has resulted in a fundamental loss of trust. Put simply, the issuers, knowing that they would not be holders of the loans in the long term and could make their profits upfront, showed no concern or compassion for any of the other key participants; the borrowers, the mortgage brokers or the eventual holders of the paper.
Not only Americans, but most participants in the world’s financial system, are being irretrievably punished as a consequence. In simple terms, it was the failure of individuals in the system to assert any personal responsibility that lies at the heart of the problem.
While no-one would argue that Australian financial planners have a mis-selling problem of the magnitude of that found in the USA, there is little doubt that our regulators – the Government, the ASIC and the FPA – will be taking their cue from offshore. Fraught with difficulties as it has been, financial services reform will continue and financial planning will be a prominent recipient of that concern. Everyone left standing must now be seen to be active. Governments must enact. Regulators must lead. Heads must roll. The response must be quick. The response must be blunt. It always is.
Could any of this have been different? Are we forever to be subject to an endless cycle of regulation, de-regulation and regulation again? The answer is that it is possible for us to self-regulate, but to do so, each of us in the system needs to answer yes to the question: “Are we treating our customers fairly?”.
The story of risk profiling in Australia is a good illustration of the “I know nothing” approach that puts investors’ interests second. After 17 years of share and property market growth, many Australian investors had a lesser notion of conservative investing than might have been expected, given their risk tolerances and risk capacity. FinaMetrica’s analysis of its Australian database suggests that often there is a significant difference in the riskiness of the asset allocation recommended and the client’s risk tolerance.
Those drawing down on their assets to produce a living are likely to have little ability to recover their losses. Their only options are a significant lifestyle change, such as returning to work, or limiting spending. There is no doubt that there will be a wall of bitter criticism when the media discovers that many pensioners were unprepared for the negative impact on their portfolios and consequent retirement plans.
Academic research shows that the vast majority of risk-profiling questionnaires are both dangerous and inherently flawed. They conflate risk needed to achieve goals with risk tolerance and in so doing depersonalise the most important decision an investor needs to make: how much risk they accept in their financial plan.
Over the last few months I have spoken with a number of influential people in the financial services industry about the current state of both investment markets and financial planning. Most refuse either to acknowledge the gravity of the situation or to take any personal responsibility for it.
They usually end our conversation by saying something like, “I was simply doing my job” or “my first priority is to my shareholders”. Other typical comments when discussing risk profiling are: “It’s not my responsibility; it’s not in my job brief.”
“It takes too long to do risk profiling properly.”
“We simply couldn’t suggest that there was a correct way to assess an individual’s risk tolerance if along the way you might receive a commercial advantage.”
What actually was happening was similar to what occurred in the US. No-one was prepared to take personal responsibility. No-one was prepared to say that what was going on was wrong. The agenda set by the regulators was all that the planning industry needed to achieve. That the standard was poorly articulated, wrong and inconsistent was never questioned.
“We will do only that which is asked of us directly” was the prevailing approach. So what is the way forward? The key, as ever, is to pre-empt the regulatory onslaught. One good place to start is ISO 22222, the international standard for financial planning, which provides a robust and well-thought-through process to deliver client-centric financial plans.
Another significant complement to prescriptive regulation can be found in the UK’s “Treating Customers Fairly”, or TCF. We all have to hope that TCF, or something similar, will be introduced in Australia. TCF is about setting personal professional standards, not just ticking compliance boxes. Prescriptive regulation is never sufficient by itself. There has to be a higher moral obligation in play. In the end, each of us has to be prepared to stand up when things are obviously wrong. If we don’t, we deserve the regulation we get.
Paul Resnik is a financial service commentator and a director and co-founder of FinaMetrica.
