Banking royal commission failed on financial advice reform

All the Hayne report’s fine words are undone by the fact that he bottled it on obvious reforms.

Financial services royal commissioner Kenneth Hayne. Picture: Supplied.

Kenneth Hayne’s final report was a stiff and eloquent ticking off of the financial services industries. But it is also a failure.

Specifically, his decision to not call for the separation of product and advice is both inexplicable and egregious. Another significant failure is that he has nothing to say about percentage fees and the high cost of financial advice. In fact, he seems to applaud it.

Overall, Hayne’s report was well summed up by UBS’s bank analyst Jonathan Mott: it “fell well short of market expectations”. And none of the 76 recommendations “by themselves will have a material financial impact on the banks”.

You might expect an analyst to celebrate that, but far from it: “We are concerned that ensuring lasting cultural change over the years may be difficult, especially as management and Boards rotate,” Mott says.

Quite. And the commissioner’s biggest lapse, in my view, is the decision to continue to allow banks and wealth managers like AMP and IOOF to use financial advice for the distribution of wealth products.

The conflicts of interest inherent in those organisations employing or controlling financial advisers is central to the corruption in financial services that led to the Hayne Inquiry and which he exposed so brilliantly, and also central to the companies’ business models – especially AMP’s.

Time and again, the results of the disconnect between clients thinking they’re getting advice when they’re actually getting sales were highlighted during the commission’s hearings and in the final report. Yet Hayne concludes: “I am not persuaded that it is necessary to mandate structural separation between product and advice.”

Why not? Because it would be disruptive, he says.

And his honour seems to have been influenced to a large extent by both ASIC and the Productivity Commission recommending against it.

But ASIC’s submission on that subject was a mealy-mouthed suggestion that structural separation be simply put off until they do some more work on the extent and effect of conflicts of interest, as if that were needed. Meanwhile, the PC report quoted by Hayne had nothing to say about conflicts of interest and looked at the integration of product and advice only in the context of competition, which is a different matter entirely and not part of Hayne’s brief.

In its submission to the royal commission, ASIC noted that “in 75 per cent of the advice files reviewed, the advisers did not demonstrate compliance with the duty to act in the best interests of their clients, including by ‘switching’ clients from external to in-house products in circumstances where the pre-existing product appeared to be suitable”.

So three-quarters of the files were crook!

Yet far from sounding the air-raid siren and launching a major crackdown, ASIC said it’s “working on a proposal … to provide more transparency” and “discussing with each of the licensees … an appropriate response to its findings”. Words fail me.

Not only did Hayne decide to go with that, but incredibly, the other main reason he chose not to recommend the forced separation of product and advice was that the cost of compliance is so high that more banks and wealth managers are switching to cheaper straight-out sales anyway, instead of using “advice-based distribution”, as the companies put it.

“As further changes to the regulation of the financial advice industry take effect over the coming years, those costs are likely to increase – or, at the least, are unlikely to reduce. It follows that the trend away from vertically integrated institutions may well continue, even if structural separation is not mandated.”

What Hayne fails to address is the obvious reason that costs are so high and rising: the regulations and regulators are turning themselves inside out trying to deal with the conflicts of interest inherent in product manufacturers employing advisers.

And unless separation is mandated, the rules will always need to assume that conflicts exist, no matter how many drift away from vertical integration for cost reasons.

The fundamental problem is that because dealing with the conflicts of interest that are embedded in financial services has made the cost of financial advice prohibitive, the only way the system works is if the adviser is actually a sales person on commission or charges a compounding percentage “fee for service” over decades, so the lifetime value of the client is enormous.

Commissions for wealth management and superannuation products have been banned already, so that’s all about long-term compounding percentage fees now. Meanwhile life insurance and mortgages still pay commissions, which Hayne now wants to ban. But that’s pointless without dealing with the cost of advice – life insurance and mortgage broking will simply collapse.

The issue was neatly described in The Australian on Monday by Eugene Ardino, chief of Lifespan Financial Planning: “There is no way you can do a full and comprehensive review of a new client’s situation and future needs, [and] go through the entire research and advice process through to implementation, in less than 25 to 35 hours,” he said.

“If you consider a reasonable hourly rate to be $250-$400, then the real price for this advice ranges from about $6,000-$14,000.

“Advisers are prepared to initially service clients at a massive loss because of the possibility of an ongoing relationship with the client on a retainer basis with an ongoing fee arrangement,” he wrote.

Forcibly separating product and advice would be disruptive, as Hayne says, but it is the only effective, and cost-effective, way to deal with conflicts of interest.

Interestingly, Hayne also proposes individual registration of financial advisers, on top of the AFSL regime that applies to “dealer groups” (financial planning firms).

Under his proposal, all financial advisers would have to be registered and only those who were registered would be allowed to give financial advice. There would be a central disciplinary body with the power impose sanctions, with the most serious being cancellation of registration.

It’s hard to know whether this would simply be another cost burden or a revolution, or worse, both: belt and braces.

If the disciplinary body was well-resourced, and the sanctions were swift and tough, then it’s possible to imagine that individual registration could become the main compliance regime for financial advisers, because that’s the one that would get their attention.

Which would be fine, as long as the other one – the AFSL regime that controls their employers – disappeared. Otherwise it’s belt and braces and just an extra compliance cost.

Alan Kohler is Editor in Chief of InvestSMART