MOMENTUM swings are all part of the investment market cycle. And we are in the middle of another right now. A few short months ago the “R” word meant just one thing – recession.
Now financial advisers are beginning to worry about a different word – regulation.
The pendulum between the free market forces at one end of the spectrum and the regulatory intervention position at the other is clearly on the move.
Australia has weathered the global financial crisis better than almost every other western economy. Yet the pressures on the system have exposed short comings and failings in our regulatory environment when it came to protecting investors. Storm, Opes Prime, Timbercorp, Great Southern will all provide lessons for a new generation of investors and regulators.
What went wrong needs to be understood and learnt from. It may surprise some investors – and possibly some advisers - to know that Australia’s financial services regulatory environment starts from the underlying philosophy of a minimum approach to regulatory intervention.
But that is precisely what one of our two key regulators – the Australian Securities and Investments Commission (ASIC) – reminded us of this week with its submission to the Parliamentary Joint Committee inquiry into Financial Products and Services in Australia.
The ASIC submission ought to be mandatory reading for every new investor. It highlights the challenges and risks that every investor faces.(Download it from www.asic.gov.au)
Back in 1997 the fundamental policy settings and regulatory approach was set by the Wallis Report. The result was what is known as the Australian financial services regulatory regime and it is based on the premise that markets play a vital role in providing competitive, efficient and innovative means of meeting customer’s needs.
So while some regulation was deemed necessary in financial services because of the complexity of products and the adverse impacts when things go wrong the thrust of the Wallis Report was that regulation should be the minimum necessary to respond to market failures.
A lot of faith therefore was put in open markets and disclosure. Full disclosure was the best protection investor’s could have – or perhaps expect was the catch cry of the day.
What we have learned from recent times is of course that disclosure is worthless if investors – and possibly advisers and product manufacturers as well – do not understand the underlying products and risks. Low levels of financial literacy will defeat the best in disclosure every time.
ASIC acknowledges as much when it says the parliamentary inquiry “may need to reassess the balance reached by the Wallis Inquiry between market efficiency and retail investor protection because ASIC and industry action may not, within current policy settings of the FSR regime, adequately protect retail investors”.
In saying that ASIC has identified two key reforms it believes will be the most effective at redressing the balance and afford investors better protection in the future.
The first is to impose a greater duty of care on advisers by imposing a fiduciary-style duty to act in the best interests of clients. This would be along similar lines to what company directors and trustees of super funds work under today.
The second – and probably more contentious – is to outlaw remuneration structures that may create conflicts of interest that adversely affect the quality of advice.
As long as commissions are paid to advisers by product manufacturers – either directly or via master trusts and wrap accounts – financial planners will never truly be able to say their interests and their clients are perfectly aligned.
This is the financial planning industry’s biggest challenge – to design a remuneration structure that works as a profitable business model while removing the perceived or real conflict of interest around commission payments.
Doubtless there will be many predicting the death of the financial advice industry. That is non-sensical.
The need for professional advice has probably never been greater. The same global financial crisis that is pushing the regulatory pendulum has seen to that.
Robin Bowerman is Head of Retail at index fund manager Vanguard Investments Australia. To receive this column by email each week go to www.vanguard.com.au and register with smart investing.
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