Out with the old money, in with the new

WHEN the Future of Financial Advice legislation comes into effect there will be two classes of investors in Australia, those with old money and those with new.

By InvestSMART · 12 Apr 2012

By InvestSMART ·
12 Apr 2012

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WHEN the Future of Financial Advice legislation comes into effect there will be two classes of investors in Australia, those with old money and those with new.

People with old money will need it to work harder as their returns will continue to be eroded by commissions. Those with new money will have their investment returns protected by FOFA.

Despite the huge pressure exerted by financial planning and investment industry groups, the FOFA reforms as they were first announced will remain intact with few changes. One of the changes does affect when the reforms will become a mandatory code of practice. Originally, FOFA was to apply from July 1, but now the new code of practice will be voluntary for 12 months and come into full effect on July 1 next year.

The delay does provide this important question that investors can ask after July 1, 2012, when seeking financial advice: "Do you voluntarily comply with all the FOFA reforms?" If the answer is no, keep looking until you find an adviser that says yes.

The two most powerful components of the reform are the best-interest obligation and the ban on conflicted remuneration.

The best-interest obligation requires anyone giving financial advice to put the interest of their clients first ahead of all other considerations, especially before their own ability to earn income from clients.

The inclusion of this component of FOFA means there has been financial planners that have put their interests ahead of clients'.

The ban on conflicted remuneration is effectively a ban on commissions. From July 1 next year, all licensed financial service companies and their representatives will be banned from receiving any benefit that might have influenced financial product advice given to retail clients. The exceptions include life insurance, general insurance and sharebroking services.

One win the financial planning industry had in relation to the reforms was the compulsory opt-in requirements. Originally all advisers would have had to obtain their clients' permission every two years to continue to charge a fee for ongoing financial advice.

The opt-in requirement was included, as Bill Shorten put it, "to ensure clients do not pay open-ended ongoing fees while receiving little or no service".

As a result of the changes advisers can be exempted from the opt-in provisions if they are bound by a professional code of conduct. The exemption must be in writing and will be issued by the Australian Securities and Investments Commission if it is satisfied that the code of conduct means the opt-in requirement need not apply.

The FOFA regulations will apply to contracts after July 1 next year, effectively creating new-money investors. Anyone who invested before then will need to review their investments, including superannuation, to ensure their returns are not subject to commissions, specifically trailing commissions, which are often embedded in financial products.

Those with old-money investments can either change the investment product they are in after July 1, 2013, or they can change to an adviser now that has always been fee-for-service and will rebate in full the trailing commission.

The important message is people must make the effort to review their investments to see if they need to change.

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Frequently Asked Questions about this Article…

What is the FOFA (Future of Financial Advice) reform and how will it affect everyday investors?

FOFA is the Future of Financial Advice legislation designed to improve financial advice standards. For everyday investors it introduces a best-interest obligation for advisers and bans conflicted remuneration (commissions) for most retail advice. The reforms create a clear split between investors whose contracts start after the FOFA effective date (new-money) and those with investments in place before then (old-money), with new-money receiving stronger protection from commission-driven advice.

What does 'old money' versus 'new money' mean under FOFA and why does it matter to my investments?

'New money' refers to contracts and investments entered into after the FOFA regulations come into effect; those clients will be protected by the reforms. 'Old money' refers to investments made before FOFA applies — those arrangements may still carry commissions or trailing fees that can erode returns. If you have old-money investments you should review them (including superannuation) to check for embedded trailing commissions and consider changing products or advisers.

What is the best-interest obligation and why is it important for people seeking financial advice?

The best-interest obligation requires anyone giving financial advice to put the client's interests ahead of all other considerations, including their own ability to earn income from clients. It's important because it aims to stop advisers from recommending products that benefit them more than the client, improving the likelihood that advice is genuinely in your financial interest.

What does the ban on conflicted remuneration mean — are commissions being banned?

Yes — the ban on conflicted remuneration is effectively a ban on commissions for much retail financial advice. From the FOFA start date, all licensed financial service companies and their representatives will be banned from receiving benefits that might have influenced advice to retail clients. There are specific exceptions, including life insurance, general insurance and sharebroking services.

What happened to the compulsory opt-in requirement for ongoing advice fees under FOFA?

Originally advisers would have needed client permission every two years to continue charging ongoing fees. The industry secured a concession: advisers can be exempt from the opt-in requirement if they are bound by a recognised professional code of conduct. The exemption must be issued in writing by ASIC if it is satisfied the code makes the opt-in redundant.

When will the FOFA code of practice become mandatory, and what should I ask my adviser about compliance?

The timing was adjusted so the new code of practice will be voluntary for 12 months and come into full effect on July 1 next year. After the voluntary period you can and should ask prospective advisers whether they voluntarily comply with all FOFA reforms — if they don’t, the article recommends you keep looking until you find one who does.

How can investors with pre-FOFA ('old-money') investments stop commissions from eroding their returns?

According to the article, old-money investors can either change the investment product they hold after the relevant FOFA date or switch now to an adviser who operates on a fee-for-service basis and rebates trailing commissions in full. The key action is to review your investments to identify embedded trailing commissions and act if your returns are being reduced by such fees.

Who decides if an adviser can be exempt from the FOFA opt-in, and what must that exemption look like?

The Australian Securities and Investments Commission (ASIC) issues opt-in exemptions in writing. ASIC will grant an exemption if it is satisfied that the adviser's professional code of conduct means the opt-in requirement does not need to apply. The exemption must be documented in writing.