11 April 2012

Institute of Public Accountants Cocktail Event, Brisbane

Thank you to Andrew for the kind introduction.

Before turning to the Future of Financial Advice Reforms I want to spend some time talking about the Australian economy in the broader world economic environment.

Global Economy

At the end of 2011, we saw the most acute bout of financial instability since the global financial crisis.

Italian and Spanish debt yields hit Euro-era highs, and violent swings in equity markets as the debt crisis escalated.

4 out of the 7 major advanced economies contracted in the December – including Germany, UK, Italy and Japan.

Since the start of the year we have witnessed signs of stabilisation, and the mood of global financial markets has generally improved.

Recent action has reduced the worst fears surrounding Europe.

A relatively smooth Greek debt restructure, and recently European finance ministers agreed to increase the size of their defences to ward off further threats

We've also seen more faith in the strength of the recovery in the United States, most evident in the better employment outcomes in recent months

While markets did show some concern about some recent data out of China, China is still growing solidly (8.9 per cent in Dec quarter), authorities there appear to be engineering a soft landing, with a rebalancing towards domestic demand taking place.

Of course, Europe still has a long way to go in resolving its sovereign debt crisis, and risks still project a haze across the global horizon.

In recent weeks, Spain has come under pressure again after exceeding its 2011 deficit target, with substantial downgrades to growth forecasts exacerbating fears about fiscal sustainability.

European authorities need to use this window of opportunity to get their medium term public finances on a sustainable footing.

Europe has been in recession for some months now, and near term austerity measures remain a key risk –there is an urgent need for growth.

Australian Economy

Australia's economic fundamentals remain strong.

This was demonstrated by the impressive resilience our economy showed in 2011.

A year bookended by the most costly natural disasters in Australian history, and the worst bout of global instability the world has seen since the Global Financial Crisis.

The fact that our economy is moving towards trend growth — at a time when our international counterparts prepare for weak or negative growth — further testifies to our economic credentials.

Our healthy public finances, contained inflation, low debt, and record investment pipeline make us the envy of many other advanced economies.

And let's not forget our unemployment rate, currently standing at 5.2 per cent, around half that of the euro area and well below that of the United States.

These factors mean that the Government's decision to return the Budget to surplus in 2012-13 is the right one.

Maintaining our credible fiscal policy sends a strong message of confidence to investors locally and across the world in these uncertain times.

This was demonstrated at the end of last year when Australia received the gold‑plated AAA credit rating from all three major international agencies — something never achieved before in our history and making us one of only eight nations to have a AAA rating with a stable outlook from Moody's, Standard & Poor's and Fitch.

Our financial strength is evidenced in the fact that our return to surplus in 2012-13 is well in advance of other major developed economies.

Most of them are yet to halve their deficits, while our net debt will peak this year at less than a tenth, that's 10 per cent of the level of other major advanced economies.

Returning the Budget to surplus ensures that we won't be adding to the price pressures of a strengthening economy experiencing a once-in-a-generation investment boom.

This in turn provides more flexibility for the Reserve Bank to cut interest rates if they think this is warranted.

Of course the Reserve Bank takes these decisions independently, but it has on many occasions acknowledged the Government's strict fiscal policy and has said it has room to cut interest rates further if it thinks that's necessary.

Obviously delivering a surplus has been made much harder due to the crisis in Europe which has weakened global growth and further reduced government revenues here.

Since the GFC, we've seen write-downs in revenue of $140 billion and that figure is likely to be revised up at the Budget.

The changing structure of the economy means tax revenue as a share of GDP is likely to remain lower than it was before the global downturn for some time to come.

Our strategy of sticking to a strict fiscal discipline, and making the right policy decisions, enabled us to weather the worst of the Global Financial Crisis, staving off a recession and creating jobs in the worst global conditions we have seen in our lifetime.

And this strategy will stand us in good stead if the global economy deteriorates further.

Budget

I'm sure you have heard this before from politicians of all persuasions, but I am not going to speculate on what specific measures may or may not be included in this year's Budget.

Unfortunately Andrew there is no exclusive here for the IPA tonight.

But I do want to talk briefly about some of the principals that underpin our thinking when preparing the Budget.

It can be summed up quickly with three short sentences:

  1. Labor will keep supporting jobs, just like we did during the GFC, while we continue to build a strong economy for the future.  
  2. Our plan for Australia's economy is to lock in confidence by delivering a surplus, despite the challenges of an economy in transition, challenges such as a high dollar.
  3. But we will also stay true to the things we have always stood for – front-line services for working Australians, jobs and help for those who need it most.  

Future of Financial Advice

Still, the impact of the Global Financial Crisis – and of the collapse of financial service providers such as Storm Financial, Opes Prime and Trio – remind us of the importance of safeguarding the investments of an ageing Australian population, in the good times as much as in the bad.

The Government is responding to these factors by strengthening investor protection and improving access to financial advice.

The Future of Financial Advice reforms – or, the FOFA reforms – will begin a fundamental change to the financial services industry.

The FOFA reforms represent the Government's response to the Parliamentary inquiry into Financial Products and Services in Australia – an inquiry I chaired.

The inquiry's bipartisan report found there was a case for a series of carefully considered recommendations to enhance professionalism within the sector, and enhance consumer confidence and protection.

The legislative elements of the FOFA reforms passed through the House of Representatives on 22 March 2012, and are on track to become law on 1 July 2012.  The measures will become mandatory for all industry participants on 1 July 2013.

The FOFA reforms focus on improving the quality of financial advice, particularly product recommendations, and expanding the availability of more affordable forms of advice. By removing regulatory barriers to the provision of different forms of advice it is anticipated that new markets will open up for financial planners, helping them to reach more clients with less complex advice needs.

This will ultimately improve investor protection and confidence in the financial planning industry.

Key Components

The FOFA reforms include a number of key components:

The introduction of a best interest's duty means advisers will be required to act in the best interests of their clients and place retail client interests ahead of their own when providing personal advice.

Financial advisers can establish that they have met this requirement by undertaking a number of steps to assist in determining what the best interests of the client are. 

Advisers need to establish that they have met the best interests duty by taking these steps they must also take any other reasonable steps (in addition to those specified) if it is in the best interests' of the client to do so at the time the advice was given.

Advisers will be required to request their retail clients' opt-in, or renew, their advice agreement every two years - where there is an ongoing fee arrangement with the client.  This will mean advisers will be in regular contact with their clients and will be aware of their ongoing situation.

As an alternative to this, ASIC will be given the power to exempt advisers from the renewal obligations where they are bound by a code of conduct approved by ASIC which achieves the same outcome.

A further reform will see a ban on conflicted remuneration structures including commissions.  The ban will only capture payments which have the capacity to influence the advice provided to retail clients. It will not include payments relating to other services such as sale or execution only services.

Volume payments (payments dependent on the total volume of financial products of a particular class or classes) will be presumed to be conflicted but it will be open to advisers to prove that they are not.

This will encourage financial advisers to become more client-focused, as more of their fees are paid directly by the client rather than product manufacturers through product commissions. 

The FOFA package also contains a ban on non-monetary ('soft-dollar') benefits given to advisers who provide financial product advice to retail clients.  There are exceptions to the ban for benefits such as IT support, education and training and benefits under $300.

Through these reforms, the Government is also facilitating the expansion of limited or scaled advice both within and outside of superannuation.

Scaled advice is advice about a specific area of an investor's needs, for example insurance. It is expected this will enable consumers to access beneficial advice at an affordable cost

Accountants Exemption

An important element of the FOFA reforms is the replacement of the current exemption that allows accountants to provide certain pieces of advice in relation to self-managed superannuation funds without an Australian Financial Services Licence.

As the Government has announced, the exemption will be replaced with an appropriate alternative, and I know that Treasury and ASIC are working closely with accounting bodies in developing this alternative.

While the details of this measure are a matter for Minister Shorten, I can assure you that the Government is conscious of the concerns of the professional accounting bodies, and is working hard to ensure a workable transition for the profession to the new arrangements

Impacts of FOFA

While FOFA has attracted a vocal amount of criticism from a minority within the industry, I am pleased that the vast majority of the industry has already moved to adopt these reforms.

For many in the advice industry the FOFA changes are business as usual.

Much of the criticism has been around the impact that FOFA will have on the quantity of advice given and therefore on employment within the industry.

While some see only a potential threat offered by FOFA the Government sees an opportunity for the industry.

FOFA with the changes to the superannuation guarantee from 9 to 12 per cent means more funds in the superannuation sector and more advice needed by more people.

Independent research shows that this will result in a growth of the sector.

FOFA will also facilitate and drive an increasing level of professionalism in the financial services industry, underpinning trust and confidence in the sector for Australia's retail investors.

The Government believes that the post‑FOFA industry – an industry in which advisers act in the best interests of their clients and do not receive conflicted commissions – will grow to be well placed to meet the increasing need for quality financial advice demanded by an ageing population.

Rice Warner's January 2012 report on The Financial Advice Industry Post FoFA found that by 2025/2026, 1.77 million pieces of advice will be provided – more than double the 831,000 pieces of advice under a 'no reform' scenario.

The bulk of this increase will come from the provision of 'scaled advice' – something that accountants are ideally suited to provide.

Advice is also expected to be cheaper on average, from $2,135 before the reforms to $1,188 after the reforms by 2025/2026, in 2011 dollars.

Impact on Regulatory Burden

The reforms will have a significant impact on the way financial advisers go about their business.

However, the reforms are about much more than adding to the regulations with which financial advisers must comply.  The reforms are intended to transform the industry and improve the quality of financial advice and overall consumer outcomes.

There will be some compliance costs for businesses as the industry makes this transition, but these are necessary to secure improved consumer outcomes.

The benefits to consumers are expected to outweigh the costs significantly.  This will lead to greater trust and confidence in the finance industry and in turn more work in the sector.

The Government is mindful of the need to minimise ongoing compliance costs as much as possible, and has taken steps to reduce unnecessary red tape.

For example, the 'opt in' measure was to apply initially on an annual basis, but the Government has decided that the benefits to consumers can be achieved by having them opt in every two years instead. There is also significant flexibility in the way businesses will be able to apply the reforms.

The principles-based approach to the ban on conflicted remuneration, for example, allows businesses to structure their remuneration arrangements in any way that will not conflict advice, rather than prescribing or prohibiting particular means of making payments.

How can we be sure the benefits of the reforms outweigh the costs?

The Government is positive the benefits of reform will far outweigh the cost and the overarching benefit of professionalising the sector will continue to benefit the financial services sector.

Since the initial FOFA reforms were announced the Government has taken a number of decisions concerning the detail of the reforms. 

Many of these decisions relieve businesses from some of the regulatory burdens associated with the original proposals. 

Broadly, the benefits of the reforms are:

  1. adviser interests will become aligned with the client's interests, leading to more client-focused advice;
  2. more engagement with clients;
  3. a more competitive advice market;
  4. greater availability of advice;
  5. no incentive for advisers to recommend strategies that rely heavily on borrowed funds;
  6. reduction in product fees which will result in significant savings for consumers; and
  7. removal of non-complying advisers from the industry.

As with any significant structural reforms there will be costs associated with the implementation of FOFA. Industry will face costs when restructuring their administrative and IT systems in order to comply with the requirements. However, because the reforms will not apply to payments that pre-date the legislation, implementation will be gradual and costs reduced.

For all of us – Government and Industry – consumers are the primary focus of the reforms and the Government believes that despite the cost of implementation, consumers will greatly benefit from a structural change in the financial advice industry.

Conclusion

In conclusion, Australia's ageing population presents an opportunity for the financial services industry.

In 1970 there were 7.5 people in the workforce for every person aged 65 years or older. Today that figure is 5. In 2050 it will be 2.7.

In 2050 there will be twice as many 65 year olds as today and 4 times as many 80 year olds.

Surveys have shown that not enough Australians access financial advice – a 2007 survey had that figure at only 22 per cent.

There are many barriers to people accessing financial advice. Barriers such as they don't understand it, the cost, the perception that they will be sold a complete solution when all they want is simple advice and unfortunately after the collapse of Storm, as an example, the belief that the adviser will be looking to put their own interests ahead of their clients.

The Government's FOFA reforms will help the industry to overcome these barriers and prosper from the proposed changes.

With an estimated $6.8 trillion of funds under management by the year 2036, there is a bright future ahead for the financial services industry.