The spectacular break down of the financial services value chain is gathering steam, and the demolition will be extensively completed in the next 12 months (although a few outliers will remain).
The end result will be profitable standalone advisory businesses, profitable standalone licensees and a strong, emerging profession. Products and platforms will compete on merit in an open market. Goodbye Approved Product Lists (APLs).
Like any relationship break-up, this separation creates a new set of challenges that need to be worked through.
Advisers will still need robust systems, processes and oversight plus services like technical support, product research and technology but these have traditionally been provided by loss-making licensees. They will need to carefully reassemble the value chain.
In doing so, advisers and licensees must be careful not to make the same mistakes as the vertically-integrated institutions, which created vehicles to capture margin. They must be aligned on commercial objectives.
They must keep their operations focused on a value chain that begins at the advice end. Whichever component parts they choose to build, buy or rent must be strictly for the benefit of clients. These horizontal partnerships must enable the delivery of high quality advice.
In reconstructing the value chain, licensees and advisers have a unique opportunity to put the client in their rightful place at the centre of everything they do. If everything they do comes back to, “What’s best for the client?” then there can’t be a pre-determined outcome. The right advice will be personal and bespoke.
The prevailing question on everyone’s mind is: what is the best model for a fruitful, sustainable long-term future?
From a licensee’s perspective, the discussion revolves around cost and scale. Regulatory certainty is also critically important because it will help with managing risk.
Making professional advice more affordable and accessible is a key focus for the regulator, but advice fees are on the rise for a myriad of reasons. For example, advice today is generally more comprehensive and more valuable. Hence, advisers are more confident asking to be adequately remunerated. Capacity and reduced supply is another major factor.
Then there’s the rising cost of delivering advice, due largely to higher licensing and compliance costs including PI insurance premiums.
Some argue that these are artificial costs are imposed by licensees, but governance, supervision and monitoring obligations are a legal requirements. They apply whether an adviser operates under their own AFSL or somebody else’s. The main role of a licensee is to interpret and synthesize the various, applicable laws; set standards and put appropriate systems and processes in place; and ensure advisers meet their obligations.
The hefty associated costs are not new. They have always existed only now they are not being subsidised by manufacturers.
What is new is the level of vigour and diligence being shown by many licensees. Previously, most licensees served dual purposes (licensee services and product distribution). This misalignment of interests led to lax policy settings and compliance standards, as exposed by the Hayne Royal Commission.
There is no question that the mounting compliance burden is unsustainable. It is a major impediment to affordable advice, it deters new entrants and undermines the industry’s long-term future. Obligations around compliant advice in the best interest of clients should not go away, how we meet them need to change.
As the value chain unravels, only licensees with scale will survive.
The pursuit of scale is behind the frenzy of M&A activity currently taking place across the industry.
Scale creates operational and cost efficiencies. Without it, licensees struggle to manage their costs or continue investing in key areas like technology and risk management which is a required and necessary if we are to see a step change in costs.
Historically, there has been very little innovation and investment in advice. The vertically integrated model made it possible for institutions to underinvest in every area from dealer services to product. It supported mediocrity at every level.
But ongoing investment in advice is critical to the industry’s growth. Licensees need scale to do it. They need to be big enough.
While achieving requisite scale will take time, the institutional exit from personal advice has created unprecedented organic growth opportunities.
Across the industry, advisers and licensees are scrambling to get scale and transition to a sustainable model. Unfortunately, the cost of sustainability – whether it’s licensee fees, advice fees or life insurance premiums – will simply be more than some are able to pay.
From a shareholders’ perspective, if people can’t pay and they can’t get a decent risk-adjusted return on their investment, they won’t play there. While some stubborn groups cling to various forms of subsidisation, this is merely a short-term sugar fix. It is only delaying the inevitable and it is thoroughly unhelpful for everyone in the meantime.
The Royal Commission reinforced that personal advice is risky business. Yet many advisers still do not fully understand the risk in their business. Fortunately, many recognise this and accept that they need experienced, capable people looking out for them.
With the breakdown of the value chain, the true cost of managing risk is being passed back to advisers. That is the cost of a strong, sustainable advice profession.
*Neil Younger is Group Chief Executive Officer and Managing Director of Fortnum Private Wealth.