Does salaried advice need a new (tied) regulatory model?

Here’s the latest Trialogue – in the traditional format as ever, and there is also a video if that’s how you prefer to consume the content.

In the aftermath of the Royal Commission, best interest duty has been a topic of much discussion.  It’s a really important part of the regulatory construct and instrumental to the way financial advice is given.

But, focussing too much on the product recommendations that are made, is a very narrow view of best interest duty.  Which platform an adviser puts a client onto is a relatively minuscule part of the advice process, and arguably a negligibly small part of the value that the client is getting from the relationship.

It often costs more to manufacture a piece of financial advice than what consumers are prepared to pay.  And that means that financial advice firms often lose money if viewed on a standalone basis.  As a result, there is a value transfer from product providers into the advice businesses, which generates a conflict of interest as the adviser has an interest in the sale of a particular product.  At first blush this seems less than ideal, but what happens if that relationship breaks down? If advice firms can no longer be subsidised by product revenues?

Let’s look at some numbers.

There are 25 million people in Australia and 21,000 active financial advisers with around 200 clients each, so there are about 4.4m Australians under active financial advice.

Of the 4.4m receiving advice, about 20% are ‘mass market’ individuals (with investable assets <$300k).  This is the part of the market that is often reliant on the vertically-integrated groups for the provision of financial advice and they generally pay quite a low fee for this advice (less than the cost of actually producing that advice).  And, this is the segment that would seem to be the least likely to have the ability and appetite to pay more for advice if it could no longer be cross-subsidised by product revenues generated through the vertically-integrated models.

If vertically integrated advice models can no longer be tolerated, or the cost of regulation renders it unfeasible, that means around 900 thousand Australians would be left without any financial advice at all. In the search for true independence will consumers actually be better off?  What presents is a potentially sizeable advice gap.

So where to from here?

One option is to have a new advice regulatory framework for ‘tied advice’, as operates in the UK, (where it is known as restricted advice).  This involves a very clear understanding between the customer and the adviser that only in-house product will be offered.  There is ample opportunity to control for the risk that the provider abuses its position by providing low quality, expensive product – for example by having a maximum annual fee for products distributed through the tied channel (with reference to market averages, perhaps), and a MySuper-like licensing regime for tied platform products.

Tied advice is just as much in the interests of industry funds as it is their for-profit peers.  As it stands, industry funds currently offer either intra-fund advice and/or full holistic advice.  Intra fund advice is low cost and low risk, but also limited value to members (eg it doesn’t even allow the adviser to consider the superannuation balance of a spouse).  At the other end of the spectrum, holistic advice is costly and potentially over-services many members.  A tied advice model would allow industry funds to offer a valuable, lower-cost proposition to more members than they can realistically target today.

It’s difficult to believe the regulator might entertain a tied advice regime right now, but in our view at least, consumers would be well served by a third regulatory framework for financial advice that recognises the cost of maintaining true independence in advice may be more than the average Australian is prepared to pay.

Where to now?

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