If the interim report from Royal Commissioner Ken Hayne provided one ray of hope for the Commonwealth Bank, ANZ Banking Group and National Australia Bank it was this: The decision to get rid of their wealth businesses has been completely and utterly justified.
If the report describes the entire banking sector as riven by greed, then the financial advice sector is the lowest of the low.
This is an industry where the interest of the client conflict so badly with those advising them that mums and dads seem more likely to have their interests trod on than not.
But it’s important to remember that while the banks may soon be rid of these wealth businesses, investors won’t be.
CBA and NAB look certain to spin their wealth businesses off to their investors at some stage over the next 12 to 18 months – goodness knows it’s highly unlikely they’ll find anyone to buy them. And it is IOOF’s investors that will soon own the ANZ wealth division.
So it is crucial that investors – and the current and potential clients of these financial advice businesses – understand exactly why Hayne’s interim report raises such huge questions about how the financial advice sector can continue in anything like its current form.
It’s notable that Hayne dedicates some time to tracing the history of the financial advice sector in his interim report, linking it particularly to the rise of superannuation, which means “Australians now have a far higher exposure to capital markets and since the 1980s Australians have increasingly seen a need for financial advice”.
The 90s, Hayne explains, saw even more consumers enter the market for financial products, services, and advice, as a “series of privatisations (such as CBA, Telstra and Qantas) and demutualisations (such as AMP and NRMA Insurance) increased middle class share ownership”.
A surge in lending and credit products across the industry, rising house prices, low interest rates and further deregulation of the financial sector provided the tailwinds for the banking sector’s big push into wealth management in the last two and half decades.
One of the best elements of Hayne’s report is his ability to distil seemingly complex ideas in financial services down to their essence. (Indeed, it often feels like the banking and wealth sectors like to keep things complex to underline just how much their customers apparently need their help).
His view of what each party’s interest in a financial advice situation goes to the problem at the conflicted heart of this sector.
The client’s interests, Hayne argues, are “to obtain the best financial advice reasonably available.”
The first consideration, he stresses, “is whether any step needs to be taken at all”.
This is surely a crucial point. It seems that for a chunk of the population – may be even a big chunk – financial advice need not be any more complicated than save a bit more (including through super), pay off as much debt as possible as quickly as possible and whack anything left over in a low-cost, low-touch investment option, such as an index fund or listed investment company.
Most people need little more than a chat for an hour, a copy of the Barefoot Investor , and see you in five years time.
It is when the client does need some financial product – and you can bet your bottom dollar many advisers will think they do – that things get ugly, Hayne argues.
“If the advice is for the client to acquire some financial product, it is in the client’s interests to obtain the best product: best in the sense that it is fit for purpose but best in the sense also that it is the cheapest and (as far as can reasonably be determined) the best performing product available.”
But the adviser’s best interest is “to further his or her career and to maximise financial reward”.
The interest of the licensee – that is, the bank or wealth manager that stands behind the adviser – is to maximise profit, Hayne says.
“Where an adviser is employed by, or aligned with and acts on behalf of, a principal who manufactures or sells financial products, the adviser’s interests (and the principal’s) will be advanced by persuading a client to acquire one of the principal’s products.”
The Future of Financial Advice reforms banned conflicted commissions, and created a duty for advisers to put the best interest of clients above their own.
But this prioritisation of interests simply has not worked.
Hayne points to a report into vertical integration and conflicts of interest produced by the Australian Securities and Investment Commission this year, which showed that in three quarters of files reviewed by the corporate regulator, the adviser did not provide what the law describes as “appropriate advice”.
In 75 per cent of the files reviewed, ASIC “found that the adviser appeared to have prioritised the adviser’s own interests. One in 10 files reviewed suggested the adviser had left the client worse off.
How does this happen? As Hayne points out, the same report showed two thirds of investments made by clients were into products manufactured by the institution from which they sought advice (that is, in-house products).
“They are results that demonstrate the validity of a basic observation of the world: that the choice between interest and duty is resolved, more often than not, in favour of self‑interest,” Hayne says.
But even more crucially, Hayne argues that the results “on their face, deny a fundamental premise for the legislative scheme of the FoFA reforms: that conflicts of interest can be ‘managed’ by saying to advisers, ‘prefer the client’s interests to your own’.
“Experience (too often, hard and bitter experience) shows that conflicts cannot be ‘managed’ by saying, ‘Be good. Do the right thing’. People rapidly persuade themselves that what suits them is what is right. And people can and will do that even when doing so harms the person for whom they are acting.”
You will note here that this discussion ignores the many examples of the sort of misconduct Hayne heard in evidence – not the systemic fee-for-no-service rip-off, not the provision of inappropriate advice, not the use of grandfathered commissions, and not even the charging of fees to dead people.
Let’s put all that to one side.
The big question for the wealth sector and the executives who will lead it once the banks wave goodbye, is really very simple.
Is there any way that they can guarantee – for surely a distrusting public will accept nothing less than that – that the conflicts so systemic in this sector, so ingrained in the way it operates, can be eliminated?
“When an entity provides financial advice, whether it provides the advice by its employees or by an authorised representative, it is the voice of risk and the customer voice that must dominate,” Hayne says.
“When considering the prevention of improper conduct and the promotion of desirable conduct it is those voices that must guide the entity.”
But in 75 per cent of cases, that’s simply not happening. The interests of the adviser are being placed above that of the client, whose voice appears to have been lost.
This is not simply a question of culture or conduct. It may be this sector needs to be broken down and rebuilt, bit by bit, before the community can have trust in it again.