Pam Roberts
Technical

Facing the Chimera: Three key Government reviews are set to change the financial services industry

By Pam Roberts

The Chimera is a mythical beast: part lion, part dragon and part goat. In the Financial Services industry, we are facing our own Chimera, in the form of three major Government reviews that individually and collectively will have a major impact on the services we provide and how we conduct our business in the future. The reviews are:

1. The Parliamentary Joint Committee (“the PJC”) on Corporations and Financial Services’ inquiry into (non- super) financial products and services

  • The PJC inquiry, headed up by Bernie Ripoll, handed down its findings on 23 November 2009. The review looked into all aspects of financial services including the law, regulation, licensing, the role of advisers, remuneration issues and also the recent failures (particularly Storm Financial and Opus Prime).
  • The key recommendation is that a fiduciary relationship between the financial adviser and client be codified into the Corporations law. An analysis of the review findings and recommendations is set out below.

2. The Review into Australia’s future tax system (“the Henry Tax Review”)

  • The Panel reviewing Australia’s tax system is headed up by the Secretary of the Treasury, Dr Ken Henry, and is due to report to the Treasurer by the end of December 2009. The Treasurer will release the report with an initial Government response in early 2010.
  • The review will make recommendations on all aspects of tax but will leave alone the rate and breadth of the GST, tax-free super at 60 and certain announced aspirational personal tax goals.

3. Superannuation systems review (“the Cooper Super Review”)

This review focuses at the governance, operation, efficiency and structure of the superannuation system.

  • The Review Panel is headed up by Jeremy Cooper, formerly Deputy Chairman of ASIC and is due to report by 30 June 2010.
  • The Panel will look at the super system in three stages.
    1. Governance (preliminary recommendation due December 2009).
    2. Operation and efficiency. The issues paper has been released mid October 2009 and preliminary recommendations are due by April 2010.
    3. Structure (including SMSFs). The issues paper is due mid December 2009 with preliminary recommendations due by May 2010.

(I hear you ask, “So, if we are facing a metaphorical Chimera….. which of the reviews is the goat?)

Review Update

The Reviews are interdependent and although the PJC has already handed down its findings, the Government has announced it will respond to the PJC and the Cooper review recommendations together. The Henry and Cooper reviews are keeping their views and final recommendations close to their chests. However, a number of releases have given some indication of the direction the Government and the reviews are taking.

1. Ripoll Inquiry - Parliamentary Joint Committee

This has been one of the largest inquiries for a parliamentary committee ever. The PJC made 11 key recommendations. They are in summary:

  • include a fiduciary duty for advisers in the Corporations Act (CA);
  • increase resources to ASIC so it can perform risk based surveillance;
  • amend CA to disclose advise restrictions and conflicts of interest in marketing material;
  • Government consult with industry on how to cease payments from product manufacturers to advisers;
  • Henry Tax Review to consider making advice fees tax deductible;
  • ASIC given powers to ban individuals;
  • agribusinesses to demonstrate capital adequacy;
  • ASIC to have power to refuse, suspend or cancel an AFSL if it has reasonable belief of non-compliance with conditions;
  • ASIC and industry to co-operate in establishing a Professional Standards Board to raise education and accreditation standards for advisers;
  • Government to investigate a last resort compensation fund for investors; and
  • ASIC to develop better community education for those seeking advice.

Comments of the key recommendations

The Role of ASIC

It is fair to say that poor ASIC was hammered in the PJC hearing over the collapse of Storm Financial and certain managed investment schemes. However, ASIC came out fighting. ASIC wanted powers to be proactive in stopping bad/unacceptable behaviour and inappropriate business models before the (Storm like) collapse. The PJC didn’t go as far as ASIC wanted, down to the licensing of individual advisers, nor did the PJC recommend that ASIC have the power to ban products and product types. However, ASIC should be happy with the outcome given the greater resources and more powers recommended in the PJC report. The Government is likely to implement these recommendations.

Tax deductibility of adviser fees

This is terribly sensible, in particular for superannuation. Currently, a client can get a tax concession for adviser remuneration paid as commission via the super product but can’t get it if the client pays the remuneration directly to the adviser as a fee for service.

BUT as a rule, Treasury hates giving away revenue, especially in the form of tax deductions. There have already been rumblings that this recommendation is a free kick to advisers. It is reasonable to expect this will happen eventually, as the current tax treatment of advice fees is obviously counter productive, but it could take some time. It will depend on how much the Government is prepared to take on the Treasury mandarins.

Codifying a fiduciary relationship in the Corporations law

This is the most controversial recommendation. The controversy arises largely because everyone appears to have a different view of what a fiduciary is. Many submissions to the PJC said that there already was a fiduciary relationship between adviser and client and consequently a legislative change was not necessary. However, a fiduciary relationship could have a far wider impact than expected.

What is a fiduciary?

It is a relationship of trust, from which duties arise. Certain relationships are deemed to be fiduciary relationships e.g. a solicitor/client relationship or a trustee/beneficiary relationship. A fiduciary must put their client’s interests ahead of their own and must seek to avoid conflicts of interest. If they receive remuneration in breach of their duties as a fiduciary (such as receiving commission), they must “account for profits” unless the client has provided informed consent. Informed consent is more than mere disclosure. So you can have remuneration paid as commission, but the client must give consent to the payment.

If it is codified in the CA, it is likely to apply to both the client’s financial adviser and financial adviser’s dealer group (as the licensee under the CA). So it may extend beyond the obvious issue of commissions but to product manufacturer rebates, sponsorship etc. One group will clearly do well out of this - that will be the lawyers.

Observations about the PJC Report

The PJC report is bipartisan and, for the most part, restrained and balanced (compared with the Cooper review below!). However, some voices got more airplay than they probably deserved. As it should, the PJC report referred to and quoted from the wide range of submissions made to it. However, it was disconcerting that the report quoted very extensively from the Industry Super Network‘s (ISN) submission. The ISN has a clear right to make a submission and it should be considered. This, however, was purportedly an inquiry into non-superannuation financial services, not an area where ISN has a recognised voice. Clearly, any distinction between super and non-super financial services and advice is largely superficial, but the PJC inquiry imposed that limitation on itself and consequently it was disappointing that it gave the ISN views such prominence.

2. Henry Tax Review

Dr Henry is keeping things very close to his chest at the moment. But fortunately others “in the know” are dropping hints about the direction of the review in some areas.

The key issue with any recommendation coming out of the review is that the recommendations will be implemented slowly. Clearly no-one wants the hysteria that happened with the introduction of CGT in 1985. The review will recommend an “ideal” taxation system and the Government will move towards it. The Government expects that the reforms will be rolled out over 10 years.

Developments so far

  • General acceptance that a “realisation” based CGT is out of date and can undermine the tax system. However accrual based taxation is not yet feasible.
  • A key concern of Dr Henry is that the taxation of savings (other than super) is unfair as it does not take into account any allowance for inflation.
  • In a recent speech1, Dr Henry was clear that domestic savings needs to be encouraged and superannuation should continue to be supported as a vehicle for retirement saving. He pointed out that the current pool of super savings has had a role de-leveraging the debt levels within Australian corporations and thus limiting the impact of the GFC.
  • However there are inequities in the tax concessions afforded superannuation savings, benefiting the higher income earner over the lower income earner. Both the Government and the Opposition agree on this point and support moves to a more equitable tax system for contributions. ASFA and the industry super funds also agree with this position, but offer different solutions:
    • ASFA supports retaining the tax deductibility of superannuation contributions; whereas
    • the industry funds support replacing tax deductions with a co-contribution.

3. Cooper Super Review

The latest developments in the Super Review have some disconcerting signs for retail superannuation providers and fund managers. As you can see from quotes below from his speech to the recent ASFA conference2 , Jeremy Cooper made it clear that “although the super industry has come out of the GFC well, reform will not just be a tweak or two but will involve substantial reform”.

Key points to note

  • The funds management industry needs to look out.
    “You could be excused for thinking that super was meant to serve funds management; to shape itself around the funds management way of doing things. This, of course, might have been the case in 1992, but super needs to stand on its own two feet now. It needs its own agenda and identity.”
  • The focus should be on members and not service providers.
    “How has it come to pass that the commercial conflicts and the conflicting duties that directors might have to service providers have become so acceptable?”
  • In the future scale and focussing on long term returns will be key. Cooper envisaged in the future larger super funds investing directly into infrastructure, direct property and private equity.
    “Iinvesting is going to have to be much more than just trading pieces of paper to make short term profits. Increasingly, it has to be about getting access to real cash flow.”

A copy of the speech can be accessed by clicking on this Super System Review link.

The review is in its early stages. However, what is clear is that the Cooper Super Review will not be just a whitewash or a summary of recommendations from the submissions received.

And Finally

All three reviews will be making recommendations over the next seven months. However what isn’t clear is how far the Government will go in implementing the recommendations and over what time frame. The Government faces an election in 12 to 18 months3and will be setting its own agenda with that in mind. The Government has said it will respond to the PJC and Cooper reviews together and that would presumably delay any response to the second half of 2010, when Government will be in election mode. So implementation may be after the next election.

What is clear is that we are facing an era of fundamental change in the wealth management industry. We will keep you informed of the Reviews and recommendations as the findings come to hand.

1 Dr Ken Henry’s address to CEDA 1/10/09. 

2Jeremy Cooper’s speech to the ASFA conference 12/11/09

3The Government may have a double dissolution trigger if the Emissions Trading Scheme does not pass through the Senate, but as a rule Governments prefer to go to full term.