The future of financial advice
On 26 April 2010 Mr Christopher Bowen, the then Minister for Financial Services, Superannuation and Corporate Law, announced far reaching and sweeping changes to the Australian financial planning industry.
These changes comprised the Future of Financial Advice reforms and collectively comprised the most significant development in the history of the Australian Financial Services Industry. In twenty year’s time the Future of Financial Advice reforms, with the central tenets of advice neutrality and adviser duty of care, essential characteristics of any professional occupation, will mark the end of the financial planning as a product distribution industry at the beck and call of the fund managers and insurers, and the start of financial planning as a true profession, with significant overlaps and inter-connections with the legal and accounting professions.
The Future of Financial Advice (FoFA) package of legislation is contained in two separate but related Bills covering the best interests duty, ban on conflicted forms of remuneration, opt-in and changes to ASIC‘s licensing and banning powers.
The FoFA legislation was passed by Parliament on 25 June 2012. The FoFA legislation amends the Corporations Act as follows:
- bans conflicted remuneration structures including commissions and volume based payments, in relation to the distribution of and advice about a range of retail investment products. Some products are exempt including:
- general insurance products;
- basic banking products;
- financial product advice given to wholesale clients; and
- advice where the client pays the benefit to the provider (e.g. fee for service arrangements);
- a duty for financial advisers to act in the best interests of their clients, subject to a ‘reasonable steps’ qualification, and place the best interests of their clients ahead of their own when providing personal advice to retail clients;
- an opt-in obligation that requires advice providers to renew their clients’ agreement to ongoing fees every two-years. ASIC may exempt advisers from the opt-in obligation if it is satisfied the adviser is signed up to a professional code which makes the need for the opt-in provisions unnecessary; and
- extended ASIC powers.
The FOFA reforms applied from 1 July 2012 on a voluntary basis, but are now mandatory as of 1 July 2013.
More than 90% of Australian financial planners derived most of their income from commissions. Changing to a fee for service based model will be difficult and some have fallen by the wayside. Survival requires adaptability, and the best will do more than just survive: they will prosper, and win clients and market share from the competition including accountants and business lawyers, as well as other financial planners.
E & W Strategic Partners some it up well when they say:
“The danger for many financial planning businesses is thinking that simply converting to a fee for service pricing will suffice. While it is a critical step to break free of commissions, it fails to take advantage of the many growth opportunities that come from adopting a commissions-free model. This, in part, is why many practices have had only varying success in the past in integrating commission free models into their businesses, due to the limited approaches taken.”
Dover shares this view. Dover believes the commission reforms create an unrivalled opportunity for financial planners to expand the range of services they provide to their clients and to establish themselves as the primary adviser to their clients on all financial matters, and not just matters relating to financial products. The commission reforms establish financial planners as true professionals and create an environment where growth and success is more achievable than ever before.
Advisers who are commission-based salespeople rather than true advisers have traditionally not provided advice which is truly in the client’s best interests. This is evident from the big financial organisation collapses over the years. All of them were paying large commissions to financial “advisers” (including accountants and lawyers) to
sell recommend their products to clients. Timbercorp, Westpoint, Great Southern and Storm all paid between 7 and 10% upfront commission to the advisers recommending their products – and then paid ongoing ‘trailing’ commissions as well.
These collapses have cost Australians billions of dollars. The FoFA reforms are aimed at preventing these kinds of financial disasters.
What is a fee for service financial planning model?
A fee for service model is one where the client pays the adviser for the work done for the client. This is distinct from the commission model, under which the product provider paid the adviser.
In a fee for service model, the client‘s payment may be based on one of four main models:
|The time taken to complete the task at an agreed hourly rate, say $250 to $350 an hour.||A SOA will be prepared costing $2,500, being ten hours work at $250 an hour, plus implementation time by para-planners at $120 an hour based on time expended (estimate ten hours)|
|An agreed fee for completing the task, irrespective of how long it takes.||$2,500 for completing a comprehensive SOA plus $1,200 for implementing its recommendations|
|An agreed percentage of funds under management.||1% of FUM up to $300,000 for preparing and implementing a comprehensive SOA based on $300,000 of FUM|
|Success or performance fee||Say $2,000 per year plus 20% of any return above the average of the all ordinaries index|
Permutations abound. For example, a firm may quote a time based fee up to a maximum of say $3,000, or an agreed % of FUM, plus a performance fee for any above average results. But when the variations and permutations are analysed they can always be broken down into one of these four methods, or some combination of them.
The amount of the fee will generally reflect the amount of work needed to complete the agreed tasks, the degree of difficulty involved, the risks connected to the advice, the prices charged by competitors for similar tasks and what the client is prepared to pay, ie their fee expectation. This is the case whichever method is used.
|COMPARISON OF FOUR MAIN FEE FOR SERVICE BILLING METHODS|
|Fee model||Disadvantages||Advantages||Likely client applications|
|Time based fees||Can create an incentive to over-complicate advices to increase time on the clock and hence client fees. Can create an incentive and reward for inefficiency (this can be reduced by imposing caps, eg time based up to a limit of $3,000.Basing fees on time reduces scalability and makes growth more dependent on attracting and retaining key staff.||No conflict of interest. Fees can be verified by reference to time sheets and in this sense are transparent. Suits on-going relationships with recurring tasks (cf to one-off advices). Familiar to clients, and perceived to be associated with high professional standards (accounting / law)||Suited to one off transactions and practices that do not have a homogenous client base|
|Agreed fees||Risk of misquoting is borne by the practice.||No conflict of interest. Limited scope for dispute/complaints based purely on fees.Encourages efficiency. Scalable. Greater ability to connect value to the client with the price paid by the client.||Suited to a homogenous client base and where client presentations are similar and recurring. Use of precedents can create efficiencies|
|% of FUM||There is a conflict of interest and a bias to recommending a limited class of investments and ignoring other investments. The practice‘s income is linked to the market‘s performance, and is to that extent not able to be controlled. Poorly perceived by clients: there is a lot more to financial planning than this. Does not reward the firm for work done in other areas, eg tax planning or general business advice.Exposed to competition from more complete advisers.||Built in performance reward for the practice. Easy to measure. Minimal change from existing commission based practice model.
No need to develop new competencies.
|Suited to practices that concentrate on advising on managed funds and similar retail products, and which can persuade clients to opt in to the on-going fee arrangements.|
|Performance based fees||Can be hard to measure and may lead to dispute. Incentive to focus on certain investments to the detriment of other client needs. Lose income and clients if the market falls.||Goal congruency: the interests of the adviser and the client are aligned. Limited potential for a conflict of interest. Clear and transparent. Income increases if the market rises.||Suited to high end clients, who require a more active asset management program and closer adviser involvement.|
The advantages of a fee for service model
The advantages of a fee for service model relative to a commission model include:
- all or some of the fee may be tax deductible, whereas generally commissions are not tax deductible. This reduces the after tax cost of the service to your client by up to 47%, creating a significant advantage for the fee for service model. The deductibility of fee for service fee notes is discussed below;
- the potential for a conflict of interest is reduced or even eliminated because the adviser does not have any interest in the outcome of the client‘s decision, and in particular is not paid by a third party whose interests are different to the client‘s interests. This means the financial planner can genuinely present as a professional on equal footing with accountants and solicitors;
- clients will value the advice, provided it is created in a professional and competent manner;
- there is an incentive for efficiency, particularly in the fixed fee model, and an incentive for the adviser to draw in resources (ie junior staff) that match the degree of difficulty connected to the task;
- greater transparency. Clients know exactly how much the adviser is being paid and who is paying it;
- greater client recognition and retention. Clients perceive the adviser as being just that, an adviser, who is a professional and who is on their side, and not as a salesman getting a commission. This translates to improved client retention rates and an advice based long term business model, rather than a sales based short term business model; and
- the financial planner can provide a greater range of financial services to clients, competing and succeeding in areas traditionally occupied by accountants and some business lawyers, which creates extra profit, extra (CGT free) value and, importantly, extra challenges for the adviser and, more importantly, better results for the client.