Platforms in the firing line in Australia’s advice review

Cerulli Global Edge, September 2009

Distribution and financial advice are under the microscope in Australia, and the outcome of the various inquiries and proposals underway could have significant impacts on Australia’s investment platform industry.

The Parliamentary Joint Committee on Corporations and Financial Services is the most salient of them. Set up following three financial scandals in Australia in which the provision of advice was questionable at best – Westpoint, Storm Financial and MFS – they are partly focusing on the whole model by which most Australians invest. Most Australians invest in mutual funds through an intermediated route: financial planners advise clients on their investment selections, and generally then make those investments through platforms, generally owned by the big banks, which access a menu of underlying funds. At issue is the method of remuneration through this chain: commissions and trail fees to financial planners, and rebates paid back to platforms by fund managers in exchange for volume.

Alongside this, two separate inquiries are looking into the whole structure and practice of Australia’s superannuation industry – worth over $1 trillion, although the precise value is naturally moving a lot at the moment given volatility in the stock markets – and the structure of tax matters as they relate to investment.

It’s the first of the committees and inquiries that has the greatest relevance to the platform industry, and already financial professionals are trying to get ahead of any sweeping recommendations that might come from it by announcing working papers, charters and proposals that promise to get their own house in order – the theory being that by doing so they will avoid more draconian legislation being enacted by government and regulators.

The Investment and Financial Services Association lodged its own submission in July, and made its submission public. Unsurprisingly it argues that legislative requirements on financial service providers are not “grossly inadequate”, but it does offer a host of what it calls “analysis and refinement” to improve the system. These include suggesting that the Australian Securities and Investments Commission, a key regulator, examine the role of licensing processes in financial advice; that margin lending be brought under the same regulatory remit of other financial services, so as to keep check on advice around leverage; surveillance of fringe operators; simpler and more effective disclosure (which has already been attempted progressively in Australia for years, with mixed results); and various other matters around PI insurance for planners, for example. But it argues hard for maintaining the status quo for the regulation of financial products themselves, and keeping platforms very much as they are. In fact, the specific recommendation on platforms proposes no change: “That the committee recognise the important role played by platform and wrap service providers in the financial services sector and not seek to introduce regulations which minimise the range of services they provide or the important role they play.”

IFSA’s premise in that regard is that platforms have allowed planners to focus on servicing their clients rather than spending their time on back office administration, and in turn have created cost reductions for investors through their economy of scale. While platforms all charge a fee, they also get access to mutual funds at wholesale rates, which means that the net cost to investors is usually similar or cheaper than going direct to the fund manager. Investors get a greater choice of funds, better and simpler reporting, and – a bigger claim this – are in some sense a monitor of the quality of funds that appear on their platforms (no major platform included the Westpoint investment, which subsequently collapsed, on its product list).

None of that’s really in doubt: what’s like to be under discussion is the method of payments, which come in three forms – investors paying for the use of the platform, financial advisory networks for use of the platform, and investment funds for placement on the platform. IFSA’s take is “should any of the above payments be proscribed, this could affect the underlying economics of platform providers and financial advisory networks that rely on a range of revenue sources to operate their businesses. This, in turn, could adversely affect the cost and provision of advice.” IFSA argues that there is already a joint industry guide on rebates, signed with the Financial Planning Association, dating back to 2004 in order to set standards on rebates and related payments in the wealth management industry to address conflicts. Disclosures have to be made about payments, clients have to know about remuneration received by licensees related to investment recommendations they receive, and so on.

The FPA has launched its own submission which is naturally more concerned with the financial planning industry, though it does make some interesting suggestions such as making fees for advice an income tax deduction and makes this big statement: “the retail client compensation system has fundamental flaws and should be urgently reviewed through extensive public consultation with industry, consumers and other stakeholders.”

In a separate charter, IFSA has called for the removal of commissions from superannuation products by 2012, so that from then, any client can negotiate or even veto a rate of commission. That’s out for discussion at the moment, but represents a bold suggestion and again fits in the context of the industry trying to move itself forward before the government takes matters out of the industry’s hands.

Platform operators are watching and waiting to see how this all plays out. The general sentiment seems to be that an examination of financial advice is warranted but that fundamental shifts to the payment structures around platforms is not, and would not serve the investor. Some feel, though, that even if they are not directly affected by the findings of the joint committee, the payment model as it exists today – rebates for volume, and so forth – is on its way out. Related to this, some see white labelling as a growth area, with a financial planner using the technology of a major platform, but under its own name, with a set fee to the platform for that back-office service.

White labelling has always been important but one now sees some of the major providers paying it more attention. Colonial First State, owned by the Commonwealth Bank of Australia, has long done very well with its FirstChoice investment platform, but has recently launched its First Wrap product, a relaunch of a business previously called Avanteos, which brings white labelling capabilities and focuses on investors with more complicated needs than those who use First Choice – direct equities and unlisted assets, for example. (It’s also a good option for self-managed super funds, one of the largest parts of the Australian investment industry). MLC also sees a trend towards more white labelling, and its own merger with Aviva helps with that capability.

Interestingly, the biggest merger in the industry isn’t actually likely to involve any major difference in scale or approach. Westpac’s merger with St George Bank, a defining transaction for those banks, has been predicated on Westpac CEO’s vision of brands: that there’s no need to turn St George branches into Westpac branches, because if you do, you lose the power of the St George brand. It is now clear that the same principle will apply to both banks’ wealth management divisions – BT from the Westpac side, Asgard from St George. The platforms will not be merged but will continue to run completely separately, with only the back office systems combined.

After a brief threat from technology-centred models like Praemium which sort to facilitate direct links between investors and funds once again, thus disintermediating platforms, the trend today appears to be that the big continue to get bigger. Nobody has forgotten Cerulli’s famed prediction a decade ago that only five or so platforms could survive in Australia; its subsequent revision to five profitable platforms, however, is widely believed to be more or less correct.