Where to for Australia’s platforms?

Cerulli – Global Edge, July 2010

Australia’s financial services industry has been awash with inquiries, reviews, commissions and responses for the last two years, and their impact is finally beginning to be felt. They could lead to a change of the remuneration models commonplace in investment platforms, with a knock-on effect on the ability of smaller fund managers to get access to investment menus.

Australia has had three separate reviews running in tandem: the Parliamentary Joint Committee on Corporations and Financial Services, also known as the Ripoll report, which has mainly looked at the payment structures around financial advice; the Henry Review, a comprehensive analysis of the tax system; and the Cooper review, which is a study of the superannuation (pension) industry. Each of those, once issued, then prompts a government response, and it’s on the back of that response that policy will be formulated.

From the perspective of the platform industry, it’s the first of these which has the biggest consequences, and now that the government has issued a formal response to it – a policy called The Future of Financial Advice, announced by Minister for Financial Services Chris Bowen – we can finally start to draw some conclusions about what the impact will be.

First, a summary of how investment management links from the consumer to the fund manager might be useful. Australia is an extraordinarily intermediated market: financial planners, their dealer groups, and investment platforms (known as mastertrusts and wraps) are all exceptionally important. It is comparatively rare these days that anyone invests in a fund by contacting a fund manager directly. Instead, the more common model is that people seek advice from financial planners, who are usually part of collectives called dealer groups; and based on the advice of these planners they invest in particular funds through platforms, which offer menus of hundreds of different funds people can invest in.

Investors come out of this arrangement well because they pay only a wholesale rather than a retail fee to the fund manager and gain other administrative benefits; on top of the fund manager fee they pay a platform administrative fee, which is the main source of the platform’s own revenue. The financial planner and dealer group (historically, anyway) get their money in commissions that come back down the line from the fund manager and, sometimes, rebates from the platform itself. Fund managers don’t have a lot of choice in this arrangement since the power of platforms is so absolute, but in theory they gain access to a great deal more potential volume then they would be able to reach individually.

However within this elaborate set of connections, the fee structures, commissions and rebates can be muddy, and there has been a growing feeling that the existing model creates conflicts of interest. This was a key area of focus of the Ripoll report and the government’s response to it.

The keystone of the review and the government response is a package of three reforms on financial advice that will come into effect from July 1 2012. These are a ban on conflicted remuneration structures, including commissions and any form of volume-based payment; a statutory fiduciary duty for financial advisers requiring them to act in the best interest of their client, placing those interests ahead of their own; and the introduction of an adviser charging regime, bringing flexible options for consumers paying for advice.

What does this mean for the powerful platform industry in Australia? It depends on how the platform has been structured. It has been widespread practice in Australia for funds to secure space on investment platforms (also known as mastertrusts and wraps) by paying what is known as a shelf space fee; there is frequently also a complex system of rebates which are linked to the volume of business the funds or dealer groups bring to the platform. This whole system is likely to be changed.

Some platforms have been preparing for this for some time, most notably MLC, which since at least 2006 has been not only expecting this shift but lobbying for it. Under the MLC approach, which is now likely to become much more widespread, there is no payment from a fund manager to get onto a platform. The management expense ratio charged by a fund manager on the platform goes in its entirety to the manager; the whole platform administration fee goes to the platform administrator (MLC). This system, in which the intra-payments between various players from the financial planner to the fund manager and platform have been removed, may well become a template after 2012. A system like this only really works if financial planners move to a model where they make their money not from commissions, but by charging fee for service; this approach, little used a few years ago, is rapidly catching on and with the banning of commissions from 2012 should now become the norm.

For other platforms, and for those in the value chain who deal with them from the fund manager to the planner and the client, there is going to be a serious period of adjustment. The reason Bowen did not attempt to bring the changes into effect from 2011 was partly because of a recognition of just how much of a shift is going to need to take place. It will affect arrangements and relationships between platforms and everyone who deals with them; may have a significant IT cost; and will require detailed modelling of how the new rules will affect their business model and profitability.

The government recommendation is not to get rid of shelf space fees entirely, however. There is a distinction made between shelf space fee payments based on volume – which will be banned – and those that are not (including product access payments), which will be permitted. It’s the volume part that the government wants to eradicate.

Going further, the changes should, in theory, mean more of a meritocracy in funds getting access to end clients. In the past it has been possible for fund managers to acquire distribution and size without necessarily having matched it with ability: they could, in a sense, buy exposure. With volume payments and commissions removed, it should be more of a level playing field for fund managers. This should, in turn, be to the benefit of smaller fund managers and boutiques.

Additionally, these trends are likely to increase the consolidation of Australian investment platforms among a few select leaders. According to Plan for Life data, as of December 2009 the top five providers (National Australia Bank/MLC, AMP, Commonwealth/Colonial, BT Financial and ING) controlled 64.3% of funds under management in what Plan for Life calls Masterfunds (wraps, platforms and mastertrusts). This trend has been gathering momentum for years anyway: at the end of 2007 20.8% of the industry was held by names outside the top 10, but that figure has now fallen to 13.8%. It is likely that the structural changes that come with this government review will make it harder still for new or weak institutions to penetrate the top level, which could lead to a period of greater consolidation.

Is it likely to change the dominance of platforms themselves? After all, platforms have become dominant partly because they suit financial advisors, and the advisory industry is being changed dramatically by these reviews. But most in the industry think platforms are now so entrenched that their power will not be undermined.

The government response is still up for discussion: stakeholders have time to lodge their own submissions, although the reforms themselves have not been presented as proposals so much as absolute changes. They must still be navigated through parliament, but the mood in the industry today is not to wait for that to happen but to start changing practices now.