The federal government might have voted against a royal commission into misconduct in the banking and financial services industry 26 times but it’s making up for lost time.
This month the Senate passed the first substantive stand-alone piece of legislation relating to issues raised by the royal commission. The bill ends the payment of product commissions from fund managers, super funds, insurers and other financial product providers to financial planners and advisers.
The financial services industry is warning that, ironically, higher fees – not lower – could be one of the “unintended consequences” of the legislative change.
If that sounds a bit like deja vu, you’d be right. In 2012, the then Labor government banned commissions for advisers as part of the Future of Financial Advice reforms.
This represented an overhaul of the mainstream remuneration practice in the industry, meaning consumers, and not product manufacturers, would have to pay for the provision of advice. The thinking was that removing this “conflicted remuneration” would allow consumers to get more objective, impartial advice.
But the rule was not applied retrospectively, which meant advisers could continue to receive any ongoing commissions relating to investments they made before the legislation’s effective date of July 1, 2014, under a so-called grandfathering clause.
After evidence to the royal commission that consumers had been charged “fees for no service”, Commissioner Kenneth Hayne concluded that the carve-out allowing these grandfathered commissions should be “repealed as soon as reasonably practicable”.
After the Parliament did exactly that on October 14, Financial Services Assistant Minister Jane Hume said one of the key benefits of the reform is that it will end the conflict whereby some advisers may have been hesitant to move clients into newer, better-performing products because they were receiving an ongoing commission on the old one. “Consumers will benefit from lower fees following the removal of conflicted remuneration for financial advice,” Hume said.
But the financial services industry is warning that, ironically, higher fees –not lower – could be one of several “unintended consequences” of the legislative change.
Phil Anderson, a policy expert at the Association of Financial Advisers, says advisers have been reviewing whether their clients should be switched into newer products ever since the FoFA reforms, and the total size of the pool of commissions paid to advisers has been diminishing as a result.
But there are important, technical reasons why it might not be in the client’s interest to switch to a newer or cheaper product, he says, even though that seems counter to the government’s thinking and conclusion of the royal commission.
GCT and Centrelink triggers
He says there are certain circumstances where the stopping of grandfathered commissions could actually leave a consumer worse off.
“The requirement to move product could trigger a capital gains tax liability,” Anderson says. “In some cases, the client may be advised to defer the recognition of a capital gain to a later time, when they have a lower taxable income.”
In addition to CGT concerns, advised consumers could also lose Centrelink benefits. In 2004 and 2007, the federal government made changes to the assets test for eligibility for social security payments to include income streams such as annuities and account-based pensions, which were previously exempt.
But these changes were grandfathered so that people relying on the previous rules in planning for their retirement were not disadvantaged.
“If they were moved to modern products now, this grandfathering would be lost and the income stream would be fully included in the asset test,” Anderson says.
Another potential pitfall could face Australians in superannuation products that include a life insurance policy.
Switching to a new super fund could cause them to lose cover which might not be attainable at the same rate or in the same form if the client’s health circumstances have changed over that period.
If rebates of commissions that would have otherwise been paid to advisers are passed on to clients directly – as some of the large bank-owned wealth management companies are already implementing – this could also have implications for older clients.
“A rebate will in many cases be taxable income and in the case of partial-age-pension clients may reduce the client’s pension by 50¢ in the dollar,” Anderson says. “In a limited number of cases it may push the client above the maximum income test threshold for the pension.”
Regardless of age or life stage, switching to a new investment product could also result in hefty exit fees, Anderson adds.
Although exit fees have been banned in the superannuation system, they still exist on some other financial products.
John Ardino, chairman of Lifespan Financial Planning, agrees that clients could face Centrelink and CGT consequences, which could make switching them into newer products problematic.
Aside from these technical issues that could create unintended costs or losses in some circumstances, the industry also warns that ending commissions will simply push up the price of advice, making it more expensive for those who already have an adviser and less accessible for those who don’t.
“The result of all this for consumers is that it will raise the costs of advice, reduce access to advice and leave thousands of clients orphaned without any access to advice,” Ardino says. “This is a major disruption for clients
needing financial advice and a major disruption to the practices of advice providers.”
Anderson warns that if some clients whose advice is now subsidised by product commissions decide they cannot afford a fee for service, their investment portfolios and financial lives could be adversely affected.
“If clients lose access to advice, then they may find over time their asset allocation progressively moves away from their target asset allocation,” he adds.
Beware the warnings
But consumer advocacy group Choice, which has long argued that the grandfathered commissions carve-out should be repealed, said consumers should be wary about warnings from industry bodies and lobbyists.
“There have been countless instances where the industry has squealed about unintended consequences to prevent and slow down reform and there has been no basis to the concerns,” says Choice campaigns manager Erin Turner.
While she doesn’t dispute that switching products could result in complexities and even financial losses, she says that is precisely why conflicted payments needed to end.
“A good, holistic, expert adviser is going to consider those issues and will consider the costs as well as any potential benefits,” she adds. “At least you can now know that the conflict is not there and they can give you a more objective assessment.”