Drowning in compliance

There is no doubt that financial advisers have a lot on their plate and in the months from the time of writing leading up to October 2021, advisers will be hit with five heavy regulatory changes.

These are the independence disclosure on 1 July, ongoing fee arrangements and fixed term agreements requirements on 1 July, new breach reporting requirements on 1

October ,new complaints handling requirements on 5 October, and design and distribution obligations (DDO) on 5 October. 

Holley Nethercote partner, Paul Derham, told Money Management that advisers were facing a “landslide” of regulatory reform.

Derham said the load of compliance was tough work for advisers who just wanted to provide good advice to their clients.

“Politically, the Government wants to be seen to be implementing the Royal Commission recommendations and it seems to be just putting on more layers of obligations. Why doesn’t the Government remove obligations that doesn’t spark anyone’s joy?” he said.

“They introduced best interests in 2013, why don’t they get rid of statement of advice (SoA) content requirements and just leave it as best interests obligations?

“They introduced this new fee arrangement regime and they’ve made it more rigid than before. This is not ASIC [the Australian Securities and Investments Commission], it is the government that has introduced a new breach regime that is so onerous that it’s going to drastically increase the amount of reportable situations.”

ONGOING FEE ARRANGEMENTS

From 1 July, advisers must introduce an annual renewal of ongoing fee arrangements and there is a requirement that Australian financial services (AFS) licensees cannot deduct ongoing fees without the client’s consent.

Herbert Smith Freehills partner, Michael Vrisakis, said from a compliance and regulatory point of view there were provisions in the legislation which were very turgid and quite difficult to achieve 100% compliance around.

Vrisakis pointed to the ongoing fee arrangements as being one where it was difficult to achieve 100% compliance due to the technical requirements.

“It’s not just the technical requirements but the actual reporting obligations that you need to get completely correct otherwise you could potentially breach the Fee Disclosure Statement [FDS] provisions,” he said.

“For clients under ongoing fee arrangements for more than 12 months, advisers have got to do an FDS, and the FDS is only satisfied if you record all the fees 100% accurately and all the services 100% accurately. 

“If you have any of the fees wrong even if they’re a $1 out then technically you have not got a compliant FDS. That’s something I think was unintended. But it’s pretty significant in terms of advisers being aware that the regime is one that is difficult to navigate.” 

Vrisakis noted this compliance complexity was the reason there would be many advisers preferring to go with 12 months or less fee arrangements.

“It’s not that people don’t want to comply, it’s just really hard to achieve 100% compliance because of some of the technical nature of some of those provisions,” he said.

To avoid a breach advisers would need more automation and compliance controls to verify inputs, Vrisakis said.

However, spending more money on technology on top of all the other financial advice business costs was another stress point, which he said was a reason why advice businesses were more challenged from a compliance perspective and from a financial outlay point of view. 

“The majority of advisers have responded to the challenges but there’s a difference between bona fide energetic responses to the challenges and actually sometimes not being able to achieve impossible standards of legislative compliance,” he said.

Derham said the ongoing fee arrangements was the main legal pitfall for advisers at the moment and that advice practices should have a proactive compliance framework.

“They need some kind of compliance and risk committee to look ahead and not just to react. It’s not a legal requirement per se but I think it’s the best way to go,” he said.

“Any company should have regular board meetings and the role of that is part of their governance structure, but most businesses can’t deal with everything on the board level.

“So, the idea of having a purpose-built committee that can be really lean is an efficient way to deal with things. They might only need external support once a year and then run it internally the rest of the year.”

Derham noted there were many inexpensive compliance committee tools advisers could use. 

DECLARATION OF (NON)-INDEPENDENCE

According to an analysis by The Fold Legal, only 2% of advisers would be able to declare themselves as ‘independent’ under the new obligations. From 1 July, advisers and advice firms that issued an FSG would need to disclose their lack of independence on the front page of the FSG.

The Fold said to qualify as ‘independent’ advisers, their AFS licensee and all authorised representatives:

• Do not receive insurance commissions (or rebate them back to clients in full);
• Do not receive any gifts or benefits from product providers;
• Have no restrictions regarding the products you can recommend; and
• Do not own, are not owned by, and do not have any interest or association with any product providers.

If advisers did not qualify as ‘independent’ they needed to disclose if they were not independent, impartial, or unbiased, and explain why.

Derham said if advisers wanted to meet the definition of ‘independent’ they needed to answer the question of “how far are you willing to go?”.

“Are you willing to not even let clients pay for your lunch? It’s not a black and white question this definition of being eligible for independence and you’ve got to be able to apply some analysis to it,” he said.

He noted that there was behavioural science research that found that that kind of disclosure often had a trust-building impact rather than leading to the audience questioning whether they should go ahead as a counter-intuitive effect.

Vrisakis warned that to qualify as ‘independent’ advisers needed to ensure they had a “clean slate” before they could make this claim and that he had been seeing some auditing done by licensees to make sure these claims could be made. 

Hall and Wilcox partner, Adrian Verdnik’s main concern with this obligation is that it would further alarm clients as to whether the advice they received was independently considered.

He said this was another burden for advisers in terms of servicing retail clients.

“Advisers will have to have discussions with clients as to why that disclosure is necessary and appropriate and how that has an impact on the adviser’s ability to discharge their obligations to ensure the advice given is in best interest of clients,” he said.

“It’s going to require advisers think through how they have that discussion with clients and give them some assurance they are still going to be delivering advice as they are required to do in the best interest of their clients.”

Verdnik said he had seen a number of approaches by advisers to articulate the disclosure which ranged from long disclosures to brief statements that complied with the law.

“As with the case with any new law, it’s open to take different approaches until some stage the regulator or a court gives guidance as to what the appropriate approach is [to articulate the disclosure],” he said.

“That’s another challenge for advisers to face and it will prompt discussions with clients who read that and ask ‘what does that mean for me and does that mean I cannot trust advice you give me?’. 

“Advisers need to have a clear idea as to how to respond to queries from clients.”

DESIGN AND DISTRIBUTION OBLIGATIONS

Verdnik also said the new DDO laws were yet another onerous compliance layer that would make dealing with retail clients under a fee-for-service basis much more difficult.
He said there were exemptions in the DDO laws around personal advice but they were strictly limited to giving personal advice and implementing recommendations from personal advice.

“For dealer groups and advisers who don’t just give personal advice but have other work streams that are likely going to get drawn into complying with DDO, that’s going to be a lot of work because there are reporting obligations, record-keeping obligations, and obligations notifying issuers about significant dealings with financial products,” he said.

“If an issuer comes up with target market determination for a particular financial product and the adviser recommends two clients who are not in this target market that require this product, then there seems to be a misalignment between what the product issuer thinks what the product does and who the target market is and what adviser thinks. That needs to be notified to issuers. 

“For dealer groups who have complex products having to now comply with yet another onerous compliance obligation when dealing with retail clients is just going to make a fee-for-service basis so much more difficult.”

Vrisakis said the exemption from personal advice related to enquiring about client’s “personal circumstances for the purposes of ascertaining if they fit within the target market determination”.

“But you can only use the exception for that purpose and where a target market determination is required to be made,” Vrisakis said.

“Advisers therefore need to be careful that it’s only for such enquiry purposes and not for the purposes of actually giving personal advice more broadly in circumstances unconnected with this ascertaining process.”
Verdnik warned that a lot of advisers felt the personal advice exemption in DDO was a complete carve-out but it was not. 

To avoid issues with DDO, Verdnik said, advisers needed to engage with product issuers now to understand what their target market determinations for those products were going to look like and what kind of distribution conditions the issuer was going to place, before the obligations went live in October.

“There’s some conjecture in the industry now as to whether product issuers will or will not enter into formal legal distribution agreements with advisers that commonly distribute their product,” he said.

“Advisers need to make sure they have arrangements in place including internal governance arrangements to make sure they understand those conditions and to meet them.”
Verdnik stressed advisers needed to start thinking about it now but that it was difficult given the amount of compliance obligations coming into place over the next few months. 

“There’s this continuum that is pushing advisers to a particular way of practicing and it involves a whole lot of compliance, and this approach places a heavy unreasonable burden when giving advice to retail clients,” he said.