Four key regulation issues facing advisers

By Jayson Forrest - Managing Editor  - IMAP Perspectives

It’s a point not lost on the Chair of the IMAP Regulatory Group, Jenny Mulders, who, along with other group members - Simon Carrodus (The Fold Legal), Eylem Kamerakkas (Macquarie), Luyen Tan (Praemium), Jesse Vermiglio (Holley Nethercote), Katie Gill (Implemented Portfolios) and Toby Potter (IMAP) - have been at the coalface of dealing with a wide range of regulatory issues that provide significant challenges for financial advisers and licensees working in the managed accounts sector.

Four of these key challenges for the sector that Jenny identifies are:

1. the implementation of the FASEA Code of Ethics;
   
   
2. ASIC’s review of scaled advice;
   
   
3. professional indemnity insurance; and
   
   
4. the Design and Distribution Obligations (DDO).

According to Jenny, the implementation of the FASEA Code of Ethics is a key issue for IMAP, particularly with respect to how the code affects advisers and the managed accounts sector. Of particular interest to the IMAP Regulatory Group is Standard 3, with FASEA’s latest guidance failing to fully resolve issues previously raised by IMAP on this standard.

Standard 3, which applies to ethical behaviour, states: You must not advise, refer or act in any other manner where you have a conflict of interest or duty.

Jenny acknowledges that the latest guidance has been broadened to clarify that, where the advice is demonstrably in the best interests of the client, the safe harbour steps have been followed, the fees and charges are fair and reasonable, and appropriate disclosure has been made to (and consent received from) the client, then Standard 3 is likely to have been met. However, she adds the IMAP Regulatory Group believes the guidance is still misleading and confusing, particularly in relation to how the ‘disinterested person test’ is described.

“We believe that this wording should be changed to be more in line with the intention of Standard 3 - being that where a conflict cannot be appropriately managed, it must be avoided. Conflicts are generally assessed as ‘potential’, ‘perceived’ or ‘actual’. In this and previous guidance, FASEA has suggested that Standard 3 only applies when there is an ‘actual’ conflict.”

According to Jenny, the disinterested person test sets out a ‘perceived’ conflict and defines it as ‘actual’. It states that if a “disinterested person” ... “would reasonably conclude”… “that the arrangements could induce the adviser to act..”. She believes this is more aligned to the definition of a ‘perceived’ conflict and it is not helpful in terms of achieving the intention of Standard 3, which is to ensure that the adviser avoids all ‘actual’ conflicts that cannot be satisfactorily managed.

“Personal advice is, by definition, peculiar to each individual client. It cannot be assessed in bulk fashion. It must be assessed on a case-by-case and client-by-client basis,” Jenny says. “Whether an adviser has managed a potential or perceived conflict will be determined on the strength of each client file, in particular the Statement of Advice,” Jenny says

“An adviser cannot fail Standard 3 in bulk any more than they can comply with Standard 3 in bulk. They need to apply their mind to Standard 3 and the rest of the Code every time they provide advice to a client.”

As an example, Jenny says if you reviewed 50 client files of a given adviser, you may find that 45 of the files demonstrate compliance with Standard 3, and five do not. However, the IMAP Regulatory Group fears that the disinterested person test could be used as a broadsword to ‘knock out’ all 50 files in one hit, based on a perceived conflict by a disinterested person - without any reference to the specific recommendations made to each client.

“The key issue with Standard 3 is the actual wording of the legislation,” says Jenny. “It goes far beyond any other type of legislation that applies to any other industry. Until we get the wording of Standard 3 more consistent with the well developed legal standards for managing conflicts of interest, this standard is going to continue to be a real sticking point for the financial services profession.”

In addition to Standard 3, another issue the IMAP Regulatory Group has taken FASEA to task over with its Code of Ethics has been its avoidance of the ‘hot topic’ of in-house products. This is a specific issue IMAP has previously raised with FASEA, and will continue to pursue with the Government authority.

However, despite concerns with Standard 3 and in-house products, Jenny is pleased to acknowledge that some of the standards applying to the FASEA Code of Ethics actually support the use of managed accounts by advisers.

For example, Standard 9 - All advice you give, and all products you recommend, to a client must be offered in good faith and with competence and be neither misleading nor deceptive - is ideally suited for managed accounts, because it moves the liability of making investment decisions away from advisers to investment committees who have the expertise to make portfolio management decisions.

“When managed accounts are done well, it reduces the risk for clients, provides greater client engagement, and client costs can be reduced,” she says. “Where there is a robust framework in place and you are able to manage risks for your clients and stakeholders through times of volatility, that will put advisers and advice businesses in a better place when it comes to negotiating their insurance or being challenged by ASIC.”

Another challenge facing the industry is a review by ASIC into scaled advice.

Jenny believes the review impacts some advisers recommending a managed account, as they may be doing this under scaled advice.

“So, we need to consider how this review is going to impact those advisers, including how the managed account providers and the sector will respond to this review.”

The third issue of concern for the IMAP Regulatory Group is the ability for advisers to be able to maintain the required level of professional indemnity insurance at an affordable cost, in order to continue to operate their businesses.

“The number of professional indemnity insurers is decreasing, so it’s becoming particularly hard for any financial services provider to find affordable insurance in the current market,” Jenny says. “This has become a key issue for businesses, and it’s something IMAP is working hard with underwriters to address.”

The IMAP Professional Indemnity Insurance Project was set up in August 2020 to engage with insurance brokers and underwriters to better understand the issues for insurers when providing insurance to advisers, while enabling IMAP to better educate these insurers about the risks and benefits of managed accounts.

“Insurers see managed accounts as complex and possibly confusing for retail investors. As an industry, we need to make the definitions simpler, so that investors and stakeholders really understand the benefits of this investment solution,” says Jenny.

In response to the significant hike in insurance premiums this year for the financial services industry, the IMAP Regulatory Group consulted with a number of IMAP members, as well as two insurance brokers that were willing to be involved in the process, to help IMAP better understand why these premium increases occurred and what could be done to reduce premiums for advisers and advice businesses moving forward.

“Through this consultation process, we were able to form a good picture of what was happening across a number of different subsets of the managed accounts sector,” Jenny says.

Following this initial consultation process, the next step in the project will be to closely engage with the insurance underwriters to gauge whether there is an appetite to service managed account providers and where they see the risks for the sector.

“Our goal with this project is to demonstrate to the insurers that managed accounts definitely have a place within financial services, by reducing the level of risk for licensees and advisers when implemented correctly.

“At the heart of this initiative is education,” Jenny says. “We want to educate the insurance underwriters about managed accounts by showing them the benefits of this solution to advice businesses and their clients. Managed accounts work. There are very limited complaints or issues lodged about them with ASIC or the Australian Financial Complaints Authority (AFCA).

“Our aim is to make this an open conversation between the underwriters and IMAP. So, when the underwriters identify specific risks with managed accounts, often resulting in an increase to their premiums, we want to be able to explain these risks and how managed account providers are controlling them.

“Managed accounts are not a ‘one-size-fits-all’ model. Through open dialogue and engagement, we want to help insurers better understand managed accounts, which will enable them to provide better weightings on their insurance.”

Jenny adds that through this engagement process with insurers, IMAP will be able to provide greater clarity to members about the potential insurance costs for their respective business models. This includes which business models will attract higher or lower premiums, and how they could improve their risk controls to present better to the insurance market.

“Based on the feedback we get back from insurers, some advice businesses may have to rethink their setup because their insurance premiums will cost them more down the track or they may struggle to get insurance if they continue with their existing business model. That’s the type of insights we will be able to eventually share with IMAP members.” 

Also on the IMAP Regulatory Group’s radar are the Design and Distribution Obligations (DDO). These obligations were due to come into effect in April 2021, but this implementation timeline has been pushed back six months to October 2021.

“We need to closely consider how DDO will impact the managed accounts sector, particularly in relation to retail MDA providers,” says Jenny.

She confirms the IMAP Regulatory Group is currently considering making an application to ASIC for relief in relation to the DDO on the basis that MDA disclosure should be exempt from this requirement, as all investors must already be provided with personal advice - a level of protection already ahead of the requirements of DDO. So, watch this space!

“We have a number of ongoing consultations,” Jenny says. “We have been engaging with FASEA for the last 18 months and its CEO, Stephen Glenfield, has been very generous with his time when meeting with us.”

Jenny also reveals that the IMAP Regulatory Group is looking to push deeper into the advice area in relation to managed accounts, particularly in relation to ASIC’s review of scaled advice.

“ASIC commissioner, Danielle Press is running the scaled advice review. So, we are trying to engage with her team to see how IMAP can become more involved in the review’s consultation process.”

“The first thing,” says Jenny, “is we need to be positive going into 2021. Both ASIC and AFCA have received minimal complaints about the managed accounts sector, so that’s something we need to ensure continues.”

However, Jenny accepts that maintaining the managed account sector’s good reputation with the regulators will be a challenge, as more new entrants progressively join the sector.

“There will be an increasing need for IMAP and existing industry participants to watch out for these new entrants, who may look upon managed accounts as an easy way to increase their business revenue, which would taint the sector’s good record,” she warns.

Jenny adds that another challenge for the sector will be ensuring that existing providers maintain robust systems and frameworks that will stand up during periods of volatility, while also being able to demonstrate tangible benefits to their clients.

The other key challenge Jenny identifies for the sector over the next couple of years will be seeing how the FASEA Code of Ethics is applied once a Code Monitoring Body is in place.

“Working to the FASEA Code of Ethics and adhering to the standards will be the new norm for advisers and advice businesses. When it comes to recommending managed accounts or any other products or services, advisers need to be able to clearly articulate how they are meeting the FASEA standards and their Best Interest Duty.

“And an important part of this is the ability of advisers to challenge the suitability of any products with their licensee in a constructive manner. Advisers need to be confident that they fully understand a product or strategy and how it will meet a client’s goals before recommending it to that client.”

Jenny believes that by keeping the products and services appropriate for the needs of clients, advisers will be able to achieve a much better outcome for their clients, which will ultimately benefit both the managed accounts sector and the broader financial services industry.

Jenny Mulders is Chair of the IMAP Regulatory Group, and Director and Founder of QRC Consulting https://qrc.net.au

The IMAP Regulatory Group comprises of: Jenny Mulders (QRC Consulting), Simon Carrodus (The Fold Legal), Eylem Kamerakkas (Macquarie), Luyen Tan (Praemium), Jesse Vermiglio (Holley Nethercote), Katie Gill (Implemented Portfolios) and Toby Potter (IMAP).