The ongoing Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has shone a white-hot spotlight on the quality and value of financial advice and financial advisors.
I retired from the financial services industry three years ago, having spent 37 years as a chartered accountant and financial advisor. During that time, I witnessed the whole gamut of advice practices, from the malignant to the magnificent. The malpractices uncovered by the royal commission were not new to me and have been part of the fabric of the financial services industry and financial planning for decades. (I am being very careful to use the terminology ‘industry’ to describe financial services in Australia and not the word ‘profession’. I will come back to this characterisation later.)
The constant flow of bad news about financial advisers has created a real credibility problem for the industry. Australians need good quality financial advice more than ever but who can they trust?
Notwithstanding the revelations in the royal commission, there is still a strong core of well-regarded, highly ethical, client-focussed advisers who provide a highly valued service for Australians. But how do you find them? Before I get into that in my next column, it is useful to understand the history of the industry to comprehend how it has arrived at this impasse.
The reasons for the current malaise in the industry are largely founded in the way the industry was first born and developed. The financial planning industry was effectively born out of the life insurance sales industry. A key early development was with the introduction of lump-sum taxes on superannuation in 1983. Prior to this, all super payments were tax-free.
This led to the development of investment products such as ‘approved deposit funds’ and ‘deferred annuities’, the use of which allowed people with super to reduce or eliminate the impact of the new lump-sum taxes. In its early stages, the industry was essentially a sales and distribution platform for these products – there was very little in the way of actual advice but plenty of earnings for ‘advisers’ in the form of commissions. Businesses, which previously were just stockbroking firms, suddenly emerged as financial planning businesses because it meant they could now sell financial products other than simply buying and selling shares for their clients.
The introduction of the compulsory superannuation system in the early 1990s was a huge shot of adrenaline for the financial planning industry. Suddenly there was an enormous, legislated opportunity for the whole industry and a proliferation of products and services started to emerge in both super and non-super segments.
In time, some financial planning businesses actually commenced providing advice but this was relatively limited. The way in which clients paid for advice in the early days was largely upfront and then eventually through ongoing commissions. The ongoing commissions structures, where advisers are paid year after year by product providers and not the client, is at the root of the fees-for-no-service problem identified by the royal commission. This payment system (which is really just glorified sales commissions) resulted in clients (some deceased) paying fees, year after year, funded from their investments and receiving little or no service.
Hardly the hallmark of a profession!
Over time, more and more domestic and international fund managers and banks entered the rapidly growing Australian market, providing an ever-increasing number of financial products and services. All of these institutions needed to have a way to distribute (sell) their products and services and the emerging financial planning industry, with its connection to clients, represented an ideal opportunity. The larger institutions (particularly banks and insurance companies) wanted to be in a position to make money from all aspects of financial services – advice, administration and funds management. This led to what we now call vertical integration which has been roundly criticised in the royal commission.
Until recently, more than 80 percent of registered financial planners worked directly or indirectly for the banks or other large, vertically-integrated institutions. This unhealthy relationship between product manufacturers and advisers who work for the same master is at the core of many of the problems that exist in the industry today. When client’s best interests are subservient to a commercial relationship with product providers, it is very difficult to see clients getting the best outcome. Sales-based incentives massively intensified this problem over the years.
Over time, industry organisations started to emerge, such as the Financial Planning Association (FPA) in 1992, which, with 14,000 members, is currently the largest industry association in the financial planning industry. Originally, the FPA was dominated by institutional members, including employees of banks and insurance companies and fund managers, but over time it has morphed into a body representing all advisers – but it remains an industry association and not a professional body. The FPA is now attempting to reinvent itself as a professional body and whilst I applaud this, there is some distance to travel before it achieves that noble objective.