Prompted by the recent criticisms of the Australian Securities and Investments Commission’s (ASIC) management of regulation and the Commonwealth Bank’s questionable treatment of investors, Paul Resnik examines why Australian regulation of financial advice lags in protecting investors, and proposes a fast way to catch up.
It’s useful to ask why the Australian community has lost so much confidence in the integrity of financial advisers. After examining what’s happened in comparable jurisdictions and what could be done to improve on the current unhappy state of play, my conclusion is that we need a stronger independent financial advisory community that meets higher international suitability standards.
What we see today in Australia is the result of poor decisions made by successive governments and their lack of commitment to strong consumer protections against unsuitable financial advice. Australian investors have inferior protection from poor investment advice compared to many of their peers around the world, compounded by decreasing availability of independent advice. And that’s not about to change any time soon given the current regulation, which is weak compared to that found in comparable offshore jurisdictions.
When the Federal Government began shifting responsibility for retirement funding from themselves to individuals they created a need for financial advice but left it to the market to satisfy that need. In the early 1990s the regulatory choice was made to follow a disclosure path rather than a quality of advice route. Hence, amongst other things, the very low entry standards required for financial advisors then, and now. What we have seen from the market and ASIC over the last 20 years is only what could have been expected given the regulatory intent.
This contrasts to the situation in the UK and Europe, and more latterly the US, where governments and regulators acted after the 2007-08 financial crisis to implement laws requiring financial advisers to give suitable investment advice.
Comparison between the banks’ behaviour in response to the new regulations could not reveal more different outcomes. In the UK, all of the major banks closed their investment advisory arms targeting the middle market whereas in Australia the reverse occurred, the big banks, and the other main product manufacturers, the industry superannuation funds, have consolidated their control and influence over advice.
On the Continent, the European Securities and Markets Authority (ESMA) has a rule under the Markets in Financial Instruments Directive (MiFID) relating to the suitability of investment advice and the compliance function. Before providing investment advice, investment firms must ensure that any investment product recommended is suitable for the client in question. MiFID requires investment firms to implement a series of systems and controls to ensure effective compliance and risk management. The definitions and obligations are much stronger than the equivalent to be found in Australian regulation.
The US-based Financial Industry Regulatory Authority (FINRA) has adopted an investment suitability rule, FINRA Rule 2111. This rule states that financial advisors or financial consultants “must have a reasonable basis to believe that a recommended transaction or investment strategy involving securities is suitable for the customer.”
In contrast, ASIC has been significantly more hands-off when it comes to the quality of investment advice and acting against dodgy advisers. The recent Senate Economics Committee inquiry found ASIC wanting in its protection role for several reasons, including its slow reaction time to problems, handling of whistleblowers and lack of transparency.
The flow of funds to SMSFs, which now exceeds 40% of retirement moneys and is growing faster than any other segment, bears testimony to the regulatory failure and loss of confidence in ‘regulated’ advice.
The situation isn’t expected to improve in the short term. Of the 61 recommendations recently made by the Senate Economic References Committee, not one goes meaningfully to the quality of advice and the suitability of recommendations taking into account the needs and circumstances of clients. While there are several references to work undertaken by the UK’s Financial Conduct Authority (FCA), none related to the detailed investment suitability obligations that exist there. None were they directed at diminishing the influence of the vertically integrated business models that now dominate Australian advice – with the big banks firmly entrenched at the top. The report did not recommend clearer disclosure of the conflicts of interest inherent in these vertically integrated businesses.
Clearly it’s time for a different approach. Australia needs a strong independent advisory community. Independent advisers keep the others, who are competing for business, honest. Around the world the independents more often than not set the quality standard and strive to reach higher goals. Big enterprises, on the other had, usually aim to meet the regulatory minimum. And even then they often fail.
So what’s the best way forward? Advisers should voluntarily accept and meet international standards when they are clearly better. It’s really professionalism from within, planner by planner, practice by practice; the status quo is too entrenched, too conflicted and too rigid. It’s always difficult to stand out from the crowd, but the rewards will amply compensate for the pain.
