By Nicholas Melas, Financial Planning Association

SYDNEY - 15 April 2014: The Coalition’s exposure draft of their “streamlining” amendments to the Future of Financial Advice reforms has become an intense flashpoint in the debate between the major institutional banks, Industry Super Australia, and professional financial planning bodies in Australia. The politics of the Future of Financial Advice (FoFA) reforms which fuel the debate emerge on two issues; conflicted remuneration and the duty of financial advisers towards their clients. However, despite all the sound and fury around FoFA, the last six years of political commissions around commissions and the adviser’s duty of care has entirely missed the point of regulating financial advice in Australia.

FoFA is about defining the social contract between retail investors and our financial institutions.

Everything that has been said about financial advice in Australia in the last six years - whether against or in favour of commissions on various forms of advice, disclosure obligations, best interests duties, conflict prioritisation, or scaled advice - is silently established on an ideological conception of the rights and obligations of everyday Australians when interacting with these institutions.

At a more subtle and fundamental level, the politics of financial services regulation offer two competing perceptions of the Australian financial citizen. These perceptions attempt to illustrate the nature and characteristics of the retail client as she interacts with our financial institutions. These interactions and perceptions, despite the economic language used to describe them, are value-laden, and enmeshed in ideological, social, and cultural interpretations of citizenship.

Political concepts of financial citizenship thereby end up positioned and articulated in our laws, regulations, and regulatory strategy. Each reform carries an implicit message about ordinary Australians, and provides a political response to the subtle and fundamental questions about financial citizens in Australia.

The Future of Financial Advice is a political response to pressing questions that emerged from the loss and suffering of Australians in the wake of the Global Financial Crisis. These are questions such as:

• What information does a retail investor require?
• How much of this information can they understand?
• Can we afford to advise them well enough to compensate for information gaps?
• What degree of protection can we offer them with respect to that advice?
• What degree of financial literacy for retail investors is a reasonable aim?

The FoFA debate has rarely directly engaged with these questions, so it is worthwhile to examine the implicit illustration and legal substantiation of the retail client in Australian financial life, in the terms of the original FoFA legislation and in the Coalition’s proposed amendments to FoFA.

The rights and obligations of financial citizens

The first fundamental difference in the political substantiation of the retail client lies in the rights and obligations of the Australian financial citizen. In FoFA, the best interests duty and scaled advice have been the most significant sites of contention used to implicitly establish the rights and obligations of Australian financial citizens vis a vis their financial institutions.

By framing the debate over scaled advice and the best interests duty as a matter of efficiency versus consumer protection, we dilute the intention of these reforms to an economic basis, as opposed to a value-laden debate over financial citizenship. However, this language is intended to mask the real issue at stake in the politics of FoFA. The degree to which Australia’s financial advisory institutions are expected to compensate for the irrationality of their client's financial decision-making remains as the core issue of the debate.

If the retail client is considered as a consumer of financial advice, then the most which they can expect is the adviser to act within the confines of their safe harbour and stay within the warranty of their service. On the other hand, if the retail client is considered as holding rights as a financial citizen, then they can expect far more - to the extent that financial advisers are an institutional gatekeeper against poor financial decisions made by retail clients.

To understand the underlying intent of the original FoFA legislation, it is crucial to understand that the structure of FoFA means that the rest of the regulations depend entirely on the operation of the best interests duty. In order to operate, the language of FoFA relies on ‘relevant circumstances’, ‘interests’, and the ‘objectives, financial situation and needs of the client’ - all of which are determined in practice by the adviser’s execution of their best interests duty. For example, the adviser can only prioritise the client’s interests ahead of their own (section 961J) if they have first considered what those interests are, and so the richness of the concept of ‘interests’ in the legislation directly influences the extent of an adviser’s conflict management.

Since the best interests duty informs every other financial advice obligation implemented through FoFA, it is the cornerstone of FoFA’s political objectives and policy ambition. The controversial ‘catch-all’ provision of the best interests duty is the highest expression of a gatekeeper obligation in financial advice regulation anywhere in the world. Under that provision, the requirement is to take 'any further steps' in respect to their best interests obligations that a 'reasonable expert' would take given the relevant circumstances of the client, which in turn inform every other duty owed to the client. It is the legal implementation of gatekeeper standard for financial advice, far beyond that required for consumer protection on a cost/benefit analysis of regulation.  Though it is a standard defined by reasonableness, the ambiguity attendant on its phrasing directly challenges the assumption that an adviser's responsibility for their advice ought to be limited at all.

Where the original FoFA legislation incorporated a minimum gatekeeper standard for advisers, the Coalition’s amendments to FoFA would qualify personal advice by establishing that subject matter of the advice, as agreed by the client and adviser, will define the scope of the adviser's responsibilities. It is this precise language in the proposed subsection 961B(4A) that the client and provider may "agree" on the scope of the advice which reveals the ideological assumptions built into these proposed amendments.

Rather than speak of rights or obligations, the amendments would formally assert the bargaining equality between the client and their adviser. As there is no obligation in the amended best interests duty for the adviser to determine whether or not the scale of advice is in the client's best interests, the amendments substantiate the legal fiction of bargaining equality between advice providers and retail clients. The language of agreement provides a wholly effective safe harbour for the scope of advice.

It is also communicated through the muting of language dedicated to creating rights and obligations as between client and adviser. Subtle changes to the wording and structure of the best interests duty will privilege business models which seek to limit the scope of advice as far as possible. The amendments no longer refer to "client instructions" in section 961B(2). Instead the adviser must fulfil their duties based on information "available" to the adviser. The difference implies a wider variety of processes of advice that can be considered personal, which can rely on information already known to the advice provider. This is supported by changes to the order of steps in the best interests duty, which indicate that the subject matter of the advice should be determined before an investigation into the objectives, needs, and financial situation of the client.

The sum effect is that the amendments place greater emphasis on client discretion within the advice process, and share the risk of providing scaled advice to the client. Furthermore, as the best interest duty is encapsulated within the scope of the advice, there is no overt assignment of risk regarding the interactions between advice provider and client which generate the scope of the advice. The client is therefore obliged to accept the risk that the agreed scale of advice will not be in their best interests, where that advice was provided competently and in good faith.

The FoFA legislation and the proposed amendments therefore reveal significant differences in the fundamental conceptions of the rights and obligations of financial citizens in Australia. The original legislation holds the retail client as the beneficiary of cultural norms that extend responsibility and ownership of the client's financial outcomes to the financial adviser. Conversely, the political, social, and ethical framework of the financial citizen holds personal responsibility and the freedom of choice as the overriding political objective of financial advice regulation.

The nature of the financial citizen

The other fundamental point of difference behind the politics of financial advice regulation in Australia lies in how we perceive the nature of the financial citizen herself. As all employed Australians are required to be investors, and are almost always involved in life insurance within superannuation, we have relatively high expectations of our financial citizens. Since participation in our financial institutions is mandatory for the majority of Australians, financial advice offers a way for more Australians to enable fuller participation in Australia’s financial life.

The Future of Financial Advice reforms aimed to address perverse incentives for unethical and/or illegal behaviour in financial advice. This behaviour is made possible by the informational asymmetry between retail investors and more financially sophisticated participants in Australia’s financial sector. Abuses of trust are also possible due to the behavioural biases which affect all decisions, but particularly those decisions which are made under uncertainty. The appropriate regulatory response to that uncertainty is one of the fundamental political underpinnings of FoFA.

The FoFA legislation which followed from the Ripoll report places far greater responsibility for the advice onto the advice provider, as discussed above. However, the underlying assumption about the retail client’s financial illiteracy extends beyond the realm of products and strategy. Providers of financial product advice (critically, for both general and personal advice) as a collective institution are tasked with compensating for the client’s lack of information about financial product advice.

Conflicted remuneration is a case in point, as the laws mandate certain behaviour regardless of the client’s capacity to understand remuneration structures for financial advice. Implicit in the discussion on conflicted remuneration are assumptions about how Australians approach financial subjects. The ban on conflicted remuneration in connection with general advice is justified by the belief that the consumers of general advice face significant uncertainty in their interaction with general advice providers. Research from ASIC, such as Reports 377, 384, as well as foreign and international regulatory bodies, indicates that forms of advice which rely on marketing and product advertising do have an impact on client decisions. When faced with uncertainty about financial products and financial advice, FoFA’s policy ambition is to protect the retail consumer from market practices which use conflicted remuneration as an incentive to sell financial products regardless of their suitability or effectiveness for the client’s objectives and needs..

The amendments to FoFA pose a very different set of assumptions about retail investors. Every exception from the application of the ban on conflicted remuneration imposes a corresponding disclosure obligation on the advice provider - if any at all. The consequence is that retail investors bear the risk of their uncertainty about both the product and the regulatory framework of financial advice. In particular, here are some of the matters for which the retail client is bears the risk under the FoFA amendments;

• The difference between personal advice, general advice, intra-fund advice, and execution-only services, as well as which of these services will meet their financial needs.
• How limiting the scope of advice will affect the advice and product recommendations, and exactly how they should design the scope of the advice to suit their interests.
• Understanding the scale of advice may also involve a level of knowledge about the different financial products which might suit their needs.
• Finally, they must be able to understand how fee structures and remuneration relationships will influence the outcome of the advice and the motivations of their adviser.

Rather than these two vastly different regulatory regimes, adviser obligations could be implemented which require advice providers to formulate and justify their remuneration, scaling, and service strategies. This would provide a third concept of the financial citizen - one who can choose between advice strategies which an advice provider can justify to that client and to the satisfaction of regulators as reasonable. The politics of financial regulation has instead arrived at illustrations of Australian financial citizens which reflect the ideological preconceptions of our major political parties.

Two clients; two standards; two cities

At the heart of FoFA is the political project of redefining the social contract between retail investors and our financial institutions in the wake of the Global Financial Crisis. This project is bitterly divided between two concepts of the financial citizen. Regardless of which concept of the financial citizen is most accurate or appealing, the FoFA reforms would inevitably require further work to achieve their policy objectives.

For example, the ‘catch-all’ provision of the current FoFA laws cannot operate to create the intended consumer protection standard in isolation from regulatory changes to the entire financial product issuance and distribution chain. While a model where advice providers take full responsibility for their advice is conceptually consistent, they ought not to be forced to take responsibility for the work of research houses, product providers, and other components of the financial services sector which affect financial product advice. Fiduciary standards in financial product advice have to be matched by similar duties at every stage; this is the only way to build lasting financial institutions worthy of Australian financial citizens.

A financial system inquiry which commits to this project will have to examine every piece in this chain. This means abandoning the politics of two clients, two standards, and ultimately two cities which divide Australians based on their ability to participate in Australia’s financial life.

The vexing issue, once there is a commitment to abandon the politics of two cities, is to tailor our political concepts of rights and obligations for Australian financial citizenship to the nature and experience of Australians. In order to realise an Australian political concept of the financial citizen, it must be responsive to the idiosyncratic experience of Australian society and culture. We must strengthen our financial institutions with civic values. Our financial institutions must understand their rights and obligations with respect to retail clients as financial citizens within an Australian understanding of that term, and not derived from foreign jurisdictions, international standards, or ideological commitments.

Australians do not negotiate their rights under a Rawlsian veil of ignorance, or as rarefied rational calculators under a Chicago/Austrian school economic model. Most Australians are excellent at saving and budgeting, but they have expensive mortgages, little insurance, some understanding of superannuation, a basic education, and a hope that the Aged Pension will be around when they get old (just in case). So long as we pretend otherwise, our politics will continue to divide us. It is past time that our financial services laws respond to this reality, and for financial advice to unify Australia's two cities.