‘Buck stops with us’: Licensees on their APL selection process

As the industry navigates the fallout from recent major product failures, two Australian Financial Services Licensees (AFSLs) suggested strict approved product list (APL) processes are essential in holding the line against potentially harmful products.

Earlier this month, ASIC chair Joe Longo warned AFSLs that they are the “first line of defence” when it comes to potential product failure, flagging the problems around Shield Master Fund and First Guardian. 

Appearing at the Financial Services Council (FSC) conference in Sydney, he said: “There’s a reason why we are focusing on the role of licensees in our enforcement work – you are the first line of defence. You must have strong quality controls for your approved product lists.

“You’re not responsible for overseeing the production of everything you sell, or the day-to-day management of the companies that make them – but you are expected to check that the product is fit for purpose, because you have chosen to put them on your shelves.”

Speaking with Money Management, Lifespan chief executive Eugene Ardino and Centrepoint Alliance chief investment officer Daniel Stojanovski shared how they go about selecting funds with their APL.

Centrepoint, which has more than 500 advisers and is the third-largest advice licensee, has up to 1,000 funds on its APL, while the smaller Lifespan APL has between 300 and 350 funds. 

Ardino said that, while some may take an open approach to APLs, he believes licensees need to be selective in this regard because “the buck really stops with us” in the event of any problems.

“From a from a legal point of view, if a fund blows up, it doesn’t necessarily mean the adviser or the licensee is responsible, but that is the first place everybody’s going to look and rightly so because it would have been their responsibility to do a reasonable amount of due diligence and and have a reasonable basis for putting it on the APL.

“The licensee is responsible for the advice, and the advice generally always involves a recommendation of an investment or an insurance product, 90 per cent plus of advice includes that, whether it’s to buy a new one or even to hold onto something existing.”

In the event that a licensee were to find itself tangled up in a product failure, Ardino suggested that referencing a product’s research house recommendation would be insufficient as a defence, highlighting the need to do their own due diligence and research. This is especially important as the research rating won’t take into account the risk tolerance of the clients which will vary between licensees.

“If you get the research wrong, and you put a toxic fund into your APL and all your advisers recommend it, even before your compliance was good and you relied on a reputable and large research house, it can still destroy the business. So, we’ve always felt that research is one of the most important parts to our business,” he said.

“Obviously, research houses have way more resources than we do and we might take 80 per cent of our research for a fund from that research house, but we want to be looking at it separately.”

Looking at Lifespan’s APL, Ardino said it is a rather conservative licensee, with just 300 to 350 funds on its APL and employs a strict approach to product assessment. 

When it comes to what the AFSL will allow, Ardino said they prioritise diversification, liquidity, and very highly rated issuers while largely avoiding fringe asset classes, such as private debt and private equity.

“For all the major asset classes that we’re comfortable with, we want to make sure that advisers have plenty of funds to choose from, and good quality funds. Having a decent rating from one of the main research houses is an important part, but just because there is that rating doesn’t mean it gets onto our APL.

“We don’t just trust what’s in a research report. We’ll meet the managers ourselves, and we’ll make sure the people behind the strategy are good people and know what they’re doing and have a track record. So, it’s a fairly extensive process for us.”

Reflecting on recent product failures, Ardino said: “Our process would have probably filtered out funds like the ones that have blown up, largely on the fact that they weren’t highly rated, they didn’t appear to be liquid, they didn’t really have long track records, and they weren’t widely distributed.”

Similar to Lifespan, Stojanovski told Money Management that the AFSL only considers funds that are Morningstar “medallist” or “recommended plus” from Lonsec for the APL, and conducts regular reviews of this list to ensure it meets their standards. It also avoids anything that is investment grade or below.

He said Centrepoint has its own internal research team of three individuals who consider the APL in a sector review cycle, in addition to the work by the research houses. 

While Centrepoint does have a much larger APL than Lifespan, with between 800 and 1,000 funds at any given time, Stojanvski explained that it has a process in place that flags funds that fall below the minimum standard and places it into a separate field called “fund watch”, allowing advisers to easily distinguish funds that have been flagged.

With this, advisers also have access to all of Centrepoint’s research findings on funds and details, explaining what has changed and why it was flagged.

“There’s only very special circumstances where we’ll look into a strategy if there’s an adviser that feels like something is out of whack and we could take it to committee, but essentially we do rely on that process that we have and it is a strong process. 

“It means that things like Shield and First Guardian would have never made it on the APL, even if we had those funds rated, which just shows the process is there for a reason and is working.”

Notably, even with consideration to recent events, both Ardino and Stojanovski said neither have made any significant changes to their respective APLs in recent years, but simply expanded or adjusted according to demand, with both expressing confidence in their strict product assessment processes.

Meanwhile, others in the industry have been prompted into action in the wake of these events. For example, at the end of July, Clime announced it would be conducting a review and overhaul of its APL selection.

The firm said at the time: “The approved product list is being audited, and only products that comply with our reporting framework will be deemed suitable for investment. Considering recent product failures, our approach to approved products will be – trust but verify.”

Then early August saw Sequoia, which has recently come under fire over its roles in the Shield Master Fund and First Guardian Master Fund, set up a governance committee, chaired by former ASIC commissioner Danielle Press.

“This new committee reflects Sequoia’s ongoing commitment to the highest standards of regulatory alignment, governance maturity and risk management,” the firm said in a statement at the time.

“It introduces an elevated and independent governance layer above the operational compliance structures of each AFSL and will in conjunction with the executive report to the Sequoia board’s risk and compliance committee.”