In recent times, the business pages of Australian newspapers have published numerous articles about commissions paid to financial planners. The press coverage has been almost uniformly negative.
Two Federal Government inquiries are currently considering the matter. Two industry bodies, the Financial Planning Association (FPA) and the Investment and Financial Services Association (IFSA), have announced a self-imposed ban on commissions.
It is also a focus for the Australian Securities and Investments Commission (ASIC) in terms of both policy development and dealing with headline cases. Comments by the chairman of ASIC at IFSA’s annual conference in August 2009 have reinforced the sense of the policy tide turning against commissions.
Given these developments and the current financial and political environment, it would be no surprise if the Federal Government moved to impose a ban on commissions. Assuming this happens, what will the ban look like? How will existing products with associated commissions be treated? What are the implications for the future design and distribution of financial products?
The Financial Services Authority (FSA) in the UK has provided something of a crystal ball with which to foresee the possible answers to these questions.
Towards the end of June 2009, the FSA announced that it would ban commissions on ‘advised’ products with effect from the end of 2012. The FSA proposal is set out in a consultation paper on the distribution of retail investments. The FSA has given considerable thought to financial planner remuneration and produced a reasonably sophisticated policy.
The FSA’s paper also sets out a proposal to improve the description of financial advice (as ‘independent’ or ‘restricted’).
Various sectors of the industry could learn some valuable lessons from the FSA’s policy. There are elements of the policy that some sectors are likely to want to adopt and promote to policymakers in Australia. Equally, there are elements that the same sectors may want to argue against becoming part of any new Australian regulatory regime.
The key elements of the FSA policy on commissions are:
- ‘adviser charges’ must be agreed to by customers and financial planners and, in default of any positive agreement, no fees will apply;
- commissions will be banned, with the ban relevant to both product providers and financial planning groups; and
- customers should still be able to use their investment products to pay for fees for service.
The FSA’s rationale for the policy is based on the potential conflicts of interest created by commissions and, specifically, the potential for commissions to distort advice given by financial planners.
The FSA does not propose to prescribe the method of charging used by financial planners. In addition to fixed fees and time-based charging, the FSA expressly flags the prospect of charges based on a percentage of funds invested. The retail sector wants to maintain the ability to charge on this basis, as reflected in the FPA’s discussion paper (released in April) and IFSA’s draft ‘super charter’ (released in June). The FPA and IFSA can now point to the FSA being comfortable with the concept of asset-based charging.
Even so, the FSA insists that charges must ‘reflect’ the services provided and must be set ‘responsibly’ by financial planners. Charges should not ‘vary inappropriately’ according to the product provider or the product type, although the FSA gives little meaningful guidance on what is meant by ‘vary inappropriately’.
Further, financial planners should not be influenced by facilities offered by product providers to collect planner charges. In other words, the convenience to the planner of being able to be paid by deduction from the product, rather than out of the client’s pocket, should not be a factor in the planner’s product recommendation.
In essence, the FSA is saying that asset-based charging is possible, but not if the charge is actually a commission and not a fee for service. This means the charge must be for services provided to the customer, not to the product provider, which in turn requires a genuine link between the planner’s service and the charge.
Consistent with this, the FSA is clear that ongoing charges require ongoing services. A permitted exception is the deferred payment (by instalments) of what would otherwise be an upfront charge for an upfront service. This exception aside, if there is no real ongoing service, the charge clearly cannot ‘reflect’ a service, as required by the policy.
The FSA considers that rebating commissions is not enough. This is apparently because even though the customer can influence the planner’s remuneration through a rebate, the remuneration is for the wrong service (a service to the product provider, not the customer), and the default position is the wrong position (commissions apply unless rebated, compared with no charges applying unless and until positively agreed to by the customer).
In banning commissions and replacing them with fees for service, the FSA does not propose to distinguish between what it calls ‘vertically-integrated firms’ and third-party distribution arrangements, even though the risks (including the likelihood of commissions distorting advice) differ between these situations.
Although the FSA’s ban on commissions will extend to product providers, they can still choose to offer facilities for planner charges to be paid through deductions from investment products. If product providers choose to offer these facilities, product charges and planner charges must be distinguished and the product provider must ensure ‘it is still the customer and the adviser firm that determines the adviser charges to be paid’.
This means the product provider must, if offering a payment facility, offer a reasonable flexibility of charges. They must also match payments deducted from products with payments to planner firms. This is intended to prevent the practice of ‘factoring’, where a product provider pays the planner a large upfront sum from its own funds and reimburses itself by periodic deductions (even though authorised) from the customer’s product.
Perhaps, most worryingly from the perspective of retail product manufacturers, those offering payment facilities must ‘validate and monitor adviser charges’.
This seems to require ongoing consideration by the product provider of the impact of deducting planner charges on the performance of the product.
Why the product provider should have this obligation, particularly where the customer has received advice from a planner in respect of the product, is unclear. Any proposal to have a corresponding obligation as part of any new Australian regime should be carefully considered.
The FSA policy recognises the need for a reasonable transition framework. Consistent with the proposals from the FPA and IFSA, the FSA will permit commissions to continue to be charged on existing products, including on further amounts contributed to those products after the ban commences.
However, the FSA will not allow existing commissions to be renegotiated, apparently fearing abuses and additional charging if renegotiation is permitted.
In many respects, the FSA policy aligns with the FPA and IFSA proposal, including:
- no planner charges unless agreed with the customer;
- charges only for services provided to the customer; and
- asset-based charging permitted.
There are some differences, both objective and in emphasis, including the fact that giving the customer the ability to ‘turn off’ a fee is a necessary but not a sufficient condition under the FPA policy.
Finally, there are some aspects of the FSA policy that some sectors of the industry may want to resist in terms of the development of any reform proposals here in Australia.
In short, all sectors of industry have much to learn from the FSA’s paper in preparing to engage with each other, regulators and the Federal Government over the coming months.
Michael Mathieson is a senior associate at Mallesons Stephen Jaques.
This article originally appeared in Financial Services Newsletter, Vol 8, No 3, Aug 09.
