The Hayne Royal Commission into the Australian financial services industry held its first public hearings on 13 March and more will happen throughout 2018. Already it has become clear that the Commission’s broad remit will publicise a number of fundamental issues that need to be addressed by the industry.
Key among these for financial advisers is the vertically integrated wealth management business model, which will see changes designed to give Australian investors and savers – whether based in Australia or abroad – a better deal in future. It’s important that you understand what stones are being turned over by the Commission, and what this may mean for you and your approach to seeking financial advice.
Vertical integration – what it really means
Vertical integration is the model of combining business activities at two (or more) stages of production, which in wealth management terms means that the firms selling savings and investment products and services also manufacture those products and services. In other words, customer officers have been able (and incentivised) to channel punters to an adviser controlled by their firm, who guides them through the firm’s platforms into products produced in-house.
While a case may be made for the synergies created by cross-selling, this system is vulnerable to conflicts of interest and commission gouging; we have seen examples of both in the January 2018 Australian Securities and Investments Commission (ASIC) report on vertical integration and in depositions to the Commission.
Mind the gap
In addition, this model has also produced an ‘advice gap’, where many investors shun investment advice as being too costly, so that firms advise only high-income investors. ASIC’s research shows that while only 21% of advisers’ product lists comprised in-house products, after receiving advice from vertically integrated firms, customers committed 68% of their investments to in-house products.
It also revealed that 75% of advice was ‘non-compliant’ with existing rules governing the quality and independence of advice. So vertically-integrated advisers are structurally conflicted: it is not necessarily in customers’ best interests to incentivise the selling of investment products – there is a systemic risk of bad advice. And because the big firms control 80% of the wealth management industry, there is a lack of choice for investors looking for advisory services.
These findings by ASIC and the Royal Commission have led to calls for better standards and licensing for financial advisers. Greater disclosure requirements have been proposed with the intention of rebuilding trust in investment advice by ensuring customers’ interests are prioritised over the institutions’ drive to maximise profits and shareholder value.
In the future, the cost of higher compliance may make the vertically integrated model less profitable and therefore less attractive as a revenue driver. In 2017, performance in the majors’ wealth management and insurance businesses fell to $10 billion – a decrease of 29.7% largely from the impact of exiting non-core businesses. It’s possible that they will leave the wealth management business if it’s not as profitable as previously: NAB and ANZ have scaled back their wealth offerings, with NAB selling 80% of its life insurance business and ANZ divesting its Asian wealth business with indications that it may dispose of its entire wealth division. Westpac has also sold part of its BT Investment Management business.
Whether this is a wholesale departure from the vertical integration model or a process of firms tightening their structure to respond to criticism and keep it profitable remains to be seen. Well before the ASIC report and the start of the Commission, a 2016 report by KPMG said the major players continuing to refine their business models and exit some markets altogether was “inevitable” in response to changing industry conditions – including growing competition from industry- and self-managed super funds.
While the large firms may still keep these businesses, lower returns, stricter compliance requirements, and damaged trust mean there is now a greater opportunity for independent specialist advisory firms with transparent fee structures to capture customers’ business.
New options emerge
New, greater transparency requirements in the market are alerting investors to the risks inherent in staying with particular wealth managers, and the possibility of a public register of independent advisers raises the prospect of greater access to good information about where else to seek trustworthy advice. Last December, the Independent Financial Advisers Association of Australia (IFAAA) announced its intention to become a profession by submitting an application to the Professional Standards Councils (PSC). While numbers of such advisers are currently low, this measure is predicted to rapidly increase advisers’ ranks by establishing a more-prominent and trustworthy profile for them.
Advisers able to demonstrate the right affiliations – and most importantly, a track record of impartiality – now have the opening they need to compete effectively with the wealth management arms of the majors. For Australians living overseas, there has never been a better time to ensure their plans for the future, including the treatment of their superannuation and their tax affairs, are managed effectively and without undue cost by experts with a background in – and a commitment to – unbiased advice.
By David Pugh
Tel: +65 6225 0825