Will Australian Financial Reforms Be a Template for the U.S.? Pt. 1

Changes include a ban on investment commissions and fiduciary duty for those giving advice

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As regulatory reform for financial services moves along slowly here in the U.S., halfway around the world in Australia a new set of regulatory reforms entitled the "Future of Financial Advice" are now being implemented. The changes will include a ban on all investment commissions, and a fiduciary duty for those giving financial advice, not unlike similar reforms scheduled in the U.K. under their Retail Distribution Review (RDR) set to take effect in 2013.

Notably, though, while Australian reforms may have leapfrogged past the U.S., the Australian marketplace looks more like the U.S. did nearly 20 years ago, as approximately 80% of advisors work under a small number of dealer groups and there are almost no independent firms. With Australian firms required to adopt fee-only models, including assets under management, retainer and hourly, within a year, the evolution of business models in the U.S. may provide a glimpse to what is coming for Australia.

Yet while the US offers Australia a glimpse of fee-only business models, Australia may provide the U.S. a first glimpse at how financial services shift in a fiduciary, fee-only environment—providing a live, real-world environment to evaluate questions like whether the less affluent marketplace really is served effectively without commissions, and whether there's still a place for broker-dealers in a fiduciary world.

The inspiration for today's blog post was my recent trip to Sydney, Australia, for a speaking engagement, where I had a chance to see firsthand how financial advisors are reacting to the recent Future of Financial Advice (FOFA) reforms that are in the midst of being implemented. In many ways, the somewhat smaller Australian financial services industry is "behind" the U.S. in the evolution of how financial advisors work with the public—but thanks to their reforms, which have come what may be several years ahead of the U.S., the Australian market may catch up quickly. In the same way that the U.S. may provide hints for Australians about how the industry will evolve in light of the recent FOFA reforms, in the coming years Australia may provide some guidance about how proposed U.S. regulatory reforms might play out.

What Is FOFA?

The FOFA reforms in Australia first took effect "voluntarily" on July 1, and they become mandatory on July 1, 2013. The one-year voluntarily phase-in period is intended to give the Australian financial services industry time to adapt to the changes.

The FOFA major reform changes include:

A ban on commissions for investment products. Commission trails on previously implemented products are still allowed, but not on new sales after the FOFA mandatory effective date. Notably, some exceptions apply, including basic banking products, and general insurance (including life insurance) as long as the insurance is not being bought inside a Superannuation fund (which is an Australian retirement account with flexible investments similar to IRAs in the U.S., but contributions are mandatory similar to Social Security). Other "conflicted remuneration" arrangements, like many types of soft dollar payments and shelf-space agreements, are also banned.

A statutory fiduciary duty that financial advisors must place the best interests of their clients ahead of their own when providing personal advice to retail clients. Advisors can demonstrate adherence to the rule by taking "reasonable steps" to ensure proper due diligence, including making "reasonable inquiries" to obtain client information (recognizing that clients may not always be forthcoming with full information) and conducting a "reasonable investigation" into relevant financial products. 

 A two-year opt-in renewal requirement for recurring fee arrangements, requiring clients to affirmatively complete and sign a form every two years to continue to renew their ongoing management arrangement, along with an annual disclosure detailing fees paid and services rendered in the preceding 12 months. 

 A limit on AUM fees to apply only to unleveraged investments, preventing advisors from earning additional fees by taking on margin or other loans to increase the amount of investment dollars under management.

In response to concerns that these limits may make it difficult to obtain limited-scope advice on specific issues (what we in the US. often call "modular planning" and the Australians call "scaled advice"), upcoming FOFA guidance is anticipated that will clarify how to meet a best-interests fiduciary duty when providing scaled advice. 

Australian Delivery Of Financial Advice

Notably, unlike the US, in the Australian marketplace the delivery of financial advice has remained heavily concentrated in dealer groups (roughly the equivalent of wirehouse broker-dealers in the U.S.); advisors in Australia indicated to me that approximately 80% of all advisors there work for one of four major dealer groups. 

Notably, this means that the distribution of financial advice in Australia looks more similar to the U.S. in the early 1990s, before the rise of independent custodians and the emergence of RIA firms outside of institutional or ultrahigh-net-worth money management. Although in practice, it may be more accurate to characterize most Australian advisors in a form of hybrid broker-dealer/RIA model, as I found it was relatively common for advisors to run a business that generates a blend of ongoing AUM fees, ongoing fees from trailing commissions (similar to A-share or C-share trailing fees from mutual funds in the U.S.), and some segment of upfront commissions.

Nonetheless, the ban on commissions in Australia will rapidly force the Australians there to adapt to a purely fee model— some blend of AUM, retainer fees or even hourly fees (which appear to have almost no presence in Australia yet).

In the second part of our post, we'll look into U.S. implications for the Australian marketplace.

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