The Dixon Advisory collapse is an awful reminder of the pitfalls of vertical integration when it goes wrong, but it does provide a timely prompt for the Quality of Advice Review to reassess the union between product and advice.
Rather than hide behind the fact that Hayne didn’t recommend the banning of vertical integration, the review needs to conduct more than a binary debate on the merits of vertical integration, and whether the appropriate policy, regulatory and disclosure settings are in place to protect consumers. If not explored in detail, the credibility of the Quality of Advice Review would be undermined.
Reviewing vertical integration would benefit both consumers and industry. It would also clear the way for policymakers to address the issue of large-scale provision of retirement guidance – a current stumbling block in retirement income policy.
Consumers deserve a policymaker review of vertical integration
The Hayne royal commission didn’t ban vertical integration, calling the enforced separation of product and advice a “very large step” that would be “costly and disruptive”.
“I cannot say that the benefits of requiring separation would outweigh the costs,” Hayne continued. “I am not persuaded that it is necessary to mandate structural separation between product and advice.”
Rather, Hayne acknowledged improving education standards and the Design and Distribution Obligations. His recommendations focused on more stringent disclosure around lack of independence, along with banning grandfathered commissions and directing a strong review of other commission types. He also called on the ACCC to regularly (every five years) review the effects of vertical integration in the financial system.
Yet costly failures of vertically integrated models continue to occur. Beyond the primary element of the vertical integration debate (the ability to manage conflicts of duty and interests), there are two further issues which require careful consideration.
One issue is the large variety of vertically integrated models. They’re not all created equal.
Consider a financial planning firm which constructs its own multi-manager products incorporating a manager selection and portfolio construction process.
Compare this to an advice firm which creates bespoke investment products – such as a special opportunities fund like a niche real estate venture in New York – which could involve a combination of direct investment and leveraging.
The downside risks between these two models could be quite different; while the former has the potential to underperform, the latter has much more scope for the kind of results we’ve seen at Dixons.
Both are vertically integrated, and inherently conflicted. But they’re not the same; clearly they carry different risk profiles.
The other issue is how effectively disclosures relating to conflicted remuneration are explained to consumers and understood by them. Hayne referred to work by Professor Sunita Sah from Cornell University which suggests that disclosure can, in fact, infer greater trust.
In combination, while the disclosure regimes (risk and conflicts) should be sufficient to distinguish between the different internal vertically integrated models, there is a question mark around how well consumers understand what is being presented to them.
It’s unrealistic to expect consumers to understand the varying levels of risk that come with different vertically integrated models.
While prosecuting vertical integration would be stressful right now for some advice businesses that operate those models, deferring this would only continue business model uncertainty.
The question mark that hangs over vertical integration now, post-Dixons Advisory’s failure, and which will reappear after any future negative event, means that some advice business models are built on uncertain foundations.
Clearing this up can only improve business certainty and strengthen the sustainability of the industry.
The retirement guidance challenge
Unfortunately, as it currently stands, retirement income policy won’t work. The largest policy gap is the delivery mechanism: how super funds, given the present legal and regulatory environment for financial advice, can match their members to appropriate retirement solutions.
If these shortcoming remains unaddressed, it is difficult for funds to justify and prioritise the business case for developing product solutions to guide retirees in decumulation.
Many candidate solutions to this problem involve vertical integration, including creating an internal licensee model or an expansion of intra-fund advice. In January, we heard the shadow financial services minister, Stephen Jones, say he was “intensely uncomfortable” with vertically integrated models in intra-fund advice.
Once again, this problem is best addressed once vertical integration policy is set in stone.
The Quality of Advice review presents a timely opportunity to do this.