FoFA: what happened?

Last-minute changes to FoFA have diluted the effectiveness of the reforms, but investors shouldn’t lose heart.

PORTFOLIO POINT: A last-minute change to opt-in arrangements will dilute the benefits of FoFA reforms, although much depends on ASIC’s guidance on codes of practice.

When two usual bedfellows break out in a spiteful stoush in an industry as big as financial services, you know something a bit fishy has gone on.

At first glance, there has been a serious watering down of an “iconic” (Prime Minister Julia Gillard’s description in December) aspect of the Future of Financial Advice legislation (FoFA). Specifically, the changes to the already diluted “opt-in” arrangements seem to be a significant concession to the advice industry.

The legislation got through the House of Representatives at about 7.00pm last night, hours after a deal on the opt-in clause – negotiated with the Financial Planning Association and Industry Super Network – was announced. Under the new laws, financial advisers who sign up to a professional code of conduct will be exempt from getting their clients to sign opt-ins for cost agreements every two years.

But not so fast; the devil, as always, will be in the detail. Unfortunately, that detail could be some time away.

The FPA/ISN deal was essentially hammered out to gain the support of independents, including Rob Oakeshott. It will give the Australian Securities and Investments Commission, the main regulator for financial advisers, the power to approve codes of conduct/practice.

Will those codes of practice have a back-door, two-year opt-in requirement anyway? It’s possible. If they do, the concession could mean Financial Services Minister Bill Shorten gets his way and there will be no benefit to financial advisers.

But the fact is that “opt-in” will be less effective and less enforceable as a result of the government’s amendments.

The last-minute deal has John Brogden, head of the Financial Services Council, seething at the FPA, which made the deal with the ISN, a traditional arch-rival of both the FSC and FPA. Brogden’s comments suggest the FSC was sidelined.

It also says something about Shorten’s determination to cut a deal. When “opt-in” was initially announced, it was going to require advisers to get an 'annual’ cost-agreement signature from clients.

Following intense lobbying, this agreement was watered down to two years. Now, some advisers will potentially not require a cost-agreement signature at all, if some other conditions are met.

The deal also follows Shorten’s announcement last week that FoFA compliance would be “voluntary” for the first year, until July 1, 2013. Essentially, it was too close to June 30 and the rules weren’t in place. There wasn’t enough time to comply.

Who will benefit? The likely biggest winner, you would assume, would be the FPA and other organisations that are able to get their codes of conduct approved by ASIC. If advisers have to be members of organisations that have ASIC-accredited codes of conduct, you would expect the FPA to be the first to gain such accreditation.

And on the other side of the ledger, it could be a disaster for smaller industry groups. Writing an acceptable code of conduct wouldn’t be hard, but getting members to adhere to it would take resources they simply might not have.

But what does FoFA mean to super members and investors at large?

Voluntary for the first year
Most of the rest of the FoFA package stays intact. It is important to understand that the changes will only apply to clients who sign up with advisers after July 1, 2012. (That’s now probably July 1, 2013, given the voluntary nature of the first year.)

Adviser fees and opt-in
The power is still with you to negotiate with your adviser, as it always has been.

If you don’t like the way your adviser is currently charging you, or don’t understand it, you have the right to question them about it.

And you can renegotiate your deal with your adviser at any time, including now. If you don’t like the new terms he/she is offering you, you can take your business elsewhere. You don’t have to wait until July 1, 2013.

When it comes to opt-in, if the backroom deal means that advisers end up having to sign codes of practice that include at least certain service levels provided in a two-year period, then consumers might still get the protection Shorten had wanted anyway.

Commissions
Commissions are still going to be banned from investment and super products. (Insurance commissions have not been included in the ban.)

The nasty part of commissions – as compared to other ways advisers can charge for their services – is that they are hidden. They are usually wrapped up in a total fee, paid through a product.

For example, the total fee that a client sees on their annual statement might be 1.8%. Of that, 1.2% goes to the platform and the fund manager, while 0.6% goes to the adviser. However, with commissions, you won’t know that your adviser is getting 0.6%, because it’s bundled into the one overall fee.

Non-commission methods of charging for advice include pure “fee-for-service” arrangements, agreed upfront and charged by invoice, or “adviser service fees”, which can be either a percentage or a flat dollar fee, but still usually paid through the product. The difference with adviser service fees is that clients will see what their adviser has charged them, or received from them, on their statements, which is clearly a far more honest way of charging for advice than hidden commissions.

No commissions will be payable on geared products.

Volume-based bonuses
Volume-based bonuses (sometimes known as “marketing allowances”, “overrides” or “rebates”) will also still be banned as originally intended. While these rebates are not paid by clients directly, they undoubtedly push up the cost of some financial products.

Theoretically, when these bonuses are banned, the provider could pocket the money themselves, leaving the adviser out of pocket.

Industry competition, though, will more likely drive down prices (fees) charged on products or platforms, which will benefit consumers.

Best interests
Advisers will have a fiduciary duty to act in their client’s best interests. While it might seem surprising that this wasn’t always the case, it simply replaces rules that said advisers had to provide a “reasonable basis for the advice”. Much of the advice given to Storm Financial clients, for example, would not have passed as reasonable.

Shorten’s FoFA reforms will undoubtedly raise the bar on professionalism in the financial services industry and increase protection for consumers.

The last-minute changes, however, are going to make the reforms a little less effective. We won’t know how much less effective until ASIC starts to outline what it considers reasonable in the way of a code of practice.

Most advisers will be breathing a little easier today. The most painful parts of the original draft of reforms have been diluted to the extent that they will reduce some potentially high compliance costs.

But that doesn’t mean that consumers shouldn’t be cheering – they should. Over time, the changes will improve the overall quality of financial advice provided in Australia.

The reforms aren’t revolutionary, they’re evolutionary, and they continue a process that began in the late 80s.

The aim is to create an industry that Australians trust for help with their finances. It’s a step in the right direction.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.

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