What FOFA means for Australian asset management

Cerulli – Global Edge, December 2011

Australia’s financial advice industry is going through the greatest period of change in its history. As market participants prepare for a host of new measures that will start to take effect next year, it’s already clear that reforms targeted at superannuation and financial planners will have knock-on effects on the whole distribution sector of the asset management industry.

To recap, three separate streams of reform have been happening together: the Future of Financial Advice (FOFA) reforms on financial planning; the Henry review, which seeks to streamline tax; and the Cooper review, which is a re-evaluation of the country’s powerful superannuation (pension) industry. The FOFA and Cooper reviews, the ones most relevant to fund managers and distributors, have both now reached the point of draft legislation and have undergone detailed periods of consultation and review.

FOFA will be the first to come into effect, largely applying from July 1 2012. Chiefly this affects the way that financial planners are remunerated for their advice, and the way that fund managers and investment platforms reward those planners for distribution. It will, for example, ban commissions from product manufacturers to financial planners in exchange for recommending their products; it will ban volume-based payments; and will introduce a compulsory, annual or bi-annual renewal notice for all advice clients, requiring them to opt in for financial advice rather than it just rolling from year to year.

One argument is that this favours vertically integrated companies – those that, within a single institution, combine product management and a financial advisory force, since they have greater flexibility in how they remunerate. Nomura, for example, argues this favours IOOF Holdings, whose companies and brands include investment management (Perennial Investment Partners, IOOF Multimix), financial advice (Bridges, Ord Minnett, Lonsdale), platform management and distribution (AustChoice, IOOF Pursuit, Spectrum Super) and estate planning and trustee services.

Another argument is that it favours those groups that have long seen the writing on the wall for commissions and removed them from their approach to distribution. MLC, the asset management arm of National Australia Bank, has been taking this approach for about a decade and is therefore well placed for the new environment.

For individual fund managers, the hope is that they will find their way on to the menus of investment platforms based purely on merit and returns, rather than a relationship – however contrived – with a financial planner or distribution arm. One positive way of looking at this is to see how exchange-traded funds, which have never paid commission, have taken off since the advice industry has started to move towards fee-for-service; previously they would rarely be recommended because there was no monetary sense in planners doing so. Any objective view would suggest this is a good thing; ETFs have a useful role to play in a client portfolio but were previously impeded from doing so because of advice remuneration structures. Perhaps the same can happen more broadly with managed funds.

Set against that, there’s still a feeling that this is a move that helps the big get bigger, in terms of distribution platforms; anything that streamlines tends to favour those with scale. The distribution industry has been consolidating for years anyway – there are over 60 platforms in Australia but almost all the business resides within the top 10, and the vast majority the top five.

Within the grass-roots advisory industry itself, though, it’s clear that the changes will have a significant impact. The research group Investment Trends, which this year surveyed almost 1,400 financial planners, found that 45% of them had received soft-dollar benefits from third parties in the last year, and that 16% had received both financial and non-financial incentives to recommend their licensees’ products. The most common soft-dollar benefits may seem rather anodyne – they included professional development (58% of advisers), technical services (43%) and compliance services (22%), compared to just 7% who said they have received cash, gifts or entertainment valued at over A$300 from third parties. But there’s still going to be a significant period of adjustment in the industry model.

There is no shortage of dissenting views in the advice industry about these changes; many feel unfairly targeted, and one particularly controversial element has been a proposed ban on commissions related to insurance in superannuation, with people arguing the ban will discourage people from taking up insurance at all. There is some debate about costs, too; actuaries Rice Warner calculated that the opt-in provisions, for example, would cost $11 per client per year, a calculation widely broadcast by the government in supporting the measures. Rice Warner, which was swiftly belittled by the financial planning industry for understating the cost, has since rushed out a clarification saying this represents the ongoing cost and excludes opt-in implementation costs or any other cost related to FOFA. Its clarification said that a dealer group would on average face $105,000 of one-off costs and $110,000 ongoing per year; and that a product provider would face $1.4 million and $450,000 of costs respectively, bringing an industry total of $46 million in one-off costs followed by $22 million per annum. The $11 figure came from dividing that $22 million figure by the number of people who receive advice every year – estimated at 2 million.

Alongside FOFA, there are potentially more influential changes afoot in the superannuation industry. A previous column has looked at the so-called stronger super reforms; the key measure is the introduction of the MySuper product, which is a low-fee, no-frills superannuation option that will be the default fund for most Australians if they do not specifically opt to be in something else. A host of different MySuper products will be developed by funds, which will come into effect from October 2013, with balances required to be migrated to them by July 2017; they are all likely to look rather similar, offering a balanced portfolio with a lot of the exposure delivered passively in order to keep costs down.

SuperRatings, a research group in Sydney, has estimated that 80% of superannuants fall into the default option, so clearly building a successful MySuper product must be a priority for super funds and the manufacturers they engage. There’s not going to be much room for fees in these things – SuperRatings estimates the average fee will fall to about 1 per cent, whereas many people today pay twice that – but then again the economies of scale should be considerable.

A third change, also highly significant for the funds management industry, is the Superannuation Guarantee (Administration) Amendment Bill, which entered the House of Representatives – one of the two halves of Australia’s parliamentary system – in November. The key measure this will implement, if passed, is to increase the superannuation guarantee (the proportion of salary that an employer must put into super directly for an employee) to 12% from 9% today. This would take place in 0.25 percentage point increments between July 1 2013 and 2020. It will also abolish the age limit for superannuation contributions, again potentially increasing the inflows of assets into the industry.

It’s no surprise that the bodies representing funds are fully behind these changes. The Association of Superannuation Funds of Australia has been swift to urge parliament to pass the legislation. The move would clearly increase retirement savings for most Australian workers – the Treasury reckons a worker aged 30 on A$70,000 a year would have an extra A$108,000 in retirement with the new rate – but it would clearly also boost assets under management in superannuation, which at A$1.3 trillion already represent one of the largest asset pools in the world, all the more so as the Australian dollar continues to climb against the greenback.

ASFA tells Cerulli that each on quarter of a percentage point increase will generate about $1 billion extra in superannuation contributions each year, based on current contributions of about $45 billion a year. So 12% versus 9% means an additional $15 billion per year – or, by 2020, likely $22 billion a year, ASFA says. It estimates that total superannuation assets could increase by 17% of GDP by 2028 as a result of the increase; if that’s right, there will be a total of $450 billion more in assets as a consequence of the rule change.

One interesting impact of all of these reforms is that for many funds and advisors, member retention – particularly at retirement – has become the most pressing issue, more so than engaging new clients in the first place. Some groups will clearly thrive and find new business in this revised environment, but the impression today is of a great urgency for funds and firms to hang on to what they’ve already got.