- Reshaping financial advice in Australia,
- an overhaul for financial regulation,
- however little fresh news for the banks
After a year long review the Hayne Royal Commission (RC) into Misconduct in Financial Services has laid out recommendations. This reshaping of the financial services industry has significant implications and received strong political support, ahead of a likely election by 18 May 2019. It is possible that the Labor Party may have a harsher interpretation of potential changes than the RC recommends.
The final RC has been widely anticipated and the development of Hayne’s views have been consistently in the public domain from day one. Perhaps the continued surprise has been the focus on wealth management more than actual banking practices. As a result, the final report’s recommendations are relatively hard-hitting on wealth management firms that lack independence where material industry change seems highly likely. The regulatory structure also gets a significant overhaul with a new super oversight authority. Banks seem to get little in the way of fresh issues to deal with at this stage.
Vertical integration maintained (just)
The report recommends structural change to address issues of greed, skewed incentives and a lack of consumer focus. But in contrast to expectations, the report recommended against the removal of vertically integrated business models. Instead a tighter set of rules around vertical integration in the wealth management and financial advice sector will make it tougher to inappropriately incentivise and sell financial products through purely aligned channels. Banks are addressing how they might divest wealth management and mortgage broker businesses. The report says that changes in remuneration practices should be made over two to three years. The RC says that lenders will be prohibited from paying trail commissions to mortgage brokers and that mortgage brokers should be subject to financial product advice laws.
Wealth managers face tougher issues to ensure advisers place clients first. Specifically, advisers must, when “providing personal advice to a retail client, give to the client a written statement (in or to the effect of a form to be prescribed) explaining simply and concisely why the adviser is not independent, impartial and unbiased.”
Responsible consumer lending
A key focus of the RC was the extent of inappropriate lending, and aspects of the RC hearings are still making their way through the courts creating a grey area to address. The RC has observed that lending practices have improved significantly over the last two years, albeit further recommendations are made with respect to using intermediaries and understanding living expenses. However, the RC final report continues to embolden the regulators to place scrutiny on lending. The ability to automatically cross-sell insurance and up-sell other “value-add” services will be under tighter scrutiny.
The report says:
“Both income and expenditure must be considered in first inquiring about, and then verifying, the customer’s financial situation. I said in the Interim Report that I consider that verification means doing more than taking the customer at his or her word. I do not consider this to be a novel proposition.
Since the first round of the Commission’s hearings, a number of banks have altered their lending processes and procedures by introducing additional inquiries about a borrower’s financial situation and by taking some further steps to verify that situation.”
No recommendation is made to change the NCCP Act (National Consumer Credit Protection Act 2009). Instead banks and the regulators should apply the law as it stands. However, Commissioner Hayne recommended 24 referrals for prosecution of institutions.
Fees for service (or no service) and conflicted remuneration
Banks have already set aside provisions for historical fees charged for no service. More provisions (manageable for the banks) are likely. In addition, the RC recommends the withdrawal of grandfathered commissions (which most of the banks have addressed). The removal of incentives for sales (or volume sales) is an obvious negative for some wealth management practices that rely on commissioned-based sales. Further ASIC should consider further reducing the cap on commissions in respect of life risk insurance products. Unless there is a clear justification for retaining those commissions, the cap should ultimately be reduced to zero.
The Australian Treasurer, Josh Frydenberg, has responded to the Royal Commission report confirming that the payment of grandfathered commissions will be outlawed from 1 January 2021. This is likely to result in a flow of advisors, and client wealth, from conflicted platforms to the independent platforms. The two-year timeframe for implementation will allow for an unwinding, or revision, of advisors’ contractual terms.
A key recommendation in the RC is a stronger regulatory presence, higher fines and more litigation. The report recommends retaining the twin regulatory approaches of APRA (Australian Prudential Regulation Authority) and ASIC (Australian Securities and Investments Commission) with increased powers of co-regulation, with ASIC focusing on conduct and APRA licensing and prudential supervision. In addition, the report recommends a new oversight authority for APRA and ASIC required to report to the Minister.
Remuneration and culture
Unsurprisingly, the report focuses on leadership and governance practices to enshrine change at the top. In particular, in revising its prudential standards and guidance about the design and implementation of remuneration systems, APRA should:
- require APRA-regulated institutions to design their remuneration systems to encourage sound management of non-financial risks, and to reduce the risk of misconduct;
- require the board of an APRA-regulated institution (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging sound management of non-financial risks, and reducing the risk of misconduct;
- set limits on the use of financial metrics in connection with long-term variable remuneration;
- require APRA-regulated institutions to provide for the entity, in appropriate circumstances, to claw-back remuneration that has vested; and
- encourage APRA-regulated institutions to improve the quality of information being provided to boards and their committees about risk management performance and remuneration decisions.
Overall the final report has seen the wealth management sector facing significant pressure to continue to pivot a total focus to client outcomes. These changes tend to favour new business models which see specialisation and an upending of longstanding remuneration and business models. The big four banks have emerged relatively unscathed in terms of their core operations although further changes for remuneration of mortgage brokers will see change over a two to three-year period. The key regulators will get more clarity, more money and their own oversight body. As Australia moves into an election cycle there is plenty of potential for the Hayne report to continue to provide headlines, as one commentator has noted, this is the end of the beginning1.
1Matthew Wilson, Deutsche Bank. Hayne Royal Commission: End of the Beginning, 5 February 2019.
IMPORTANT NOTICE AND DISCLAIMER
Harbour Asset Management Limited is the issuer and manager of the Harbour Investment Funds. Investors must receive and should read carefully the Product Disclosure Statement, available at www.harbourasset.co.nz. We are required to publish quarterly Fund updates showing returns and total fees during the previous year, also available at www.harbourasset.co.nz. Harbour Asset Management Limited also manages wholesale unit trusts. To invest as a Wholesale Investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013. This publication is provided in good faith for general information purposes only. Information has been prepared from sources believed to be reliable and accurate at the time of publication, but this is not guaranteed. Information, analysis or views contained herein reflect a judgement at the date of publication and are subject to change without notice. This is not intended to constitute advice to any person. To the extent that any such information, analysis, opinions or views constitutes advice, it does not consider any person’s particular financial situation or goals and, accordingly, does not constitute personalised advice under the Financial Advisers Act 2008. This does not constitute advice of a legal, accounting, tax or other nature to any persons. You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. The price, value and income derived from investments may fluctuate and investors may get back less than originally invested. Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Actual performance will be affected by fund charges as well as the timing of an investor’s cash flows into or out of the Fund. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. Neither Harbour Asset Management Limited nor any other person guarantees repayment of any capital or any returns on capital invested in the investments. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this or its contents.