FoFA Fearmongering A Blow To Deregulation

Never has so little been met with so much panic.

Alan Kohler has described the Abbott Government’s amendments to Labor’s Future of Financial Advice (known as FoFA) reforms as unseemly, suspicious and like blessing union corruption. Bernard Keane believes the Government’s plans are “a big blow to consumers’ rights”. Ian Verrender, at The Drum, says the changes will be “enormous”.

The Abbott Government intends to cut regulation across the board. But the hysteria about these FoFA amendments demonstrates how hard it is to get even minor deregulation done.

The original FoFA reforms were in response to a corporate collapse: that of Storm Financial and Opes Prime in October 2008, at the beginning of the Global Financial Crisis.

In 2010 the Labor government introduced a huge package of new regulations, new powers for regulators, and new obligations on firms that offer financial advice.

For our purposes, the key ones were a ban on financial advisors earning commissions from recommending investment products, and another one that required financial advisors to act in the “best interest” of their clients. The bulk of FoFA came into effect in 2012.

Now in 2014 it’s being amended.

That’s amended, not repealed. A casual reading of the press would suggest that Arthur Sinodinos, the Assistant Treasurer, plans to rip away every vestige of FoFA.

Instead, the Government intends to distinguish the regulation of personal financial advice – that given by an advisor who works closely with you, understands your specific goals and needs – from the regulation of “general” advice – that given over a bank counter, over the phone, or through promotions, investor newsletters, or advertisements.

For personal advice, everything important in Labor’s FoFA remains. Commission-driven advice is still banned. Advisors still have to act in their clients’ best interests.

The first controversial change is that the best interest rule is being modified to remove an ambiguous and all-encompassing “catch-all” provision.

There are nearly a dozen criteria that are used to determine if an advisor is acting in the best interest of their client. Things like: does the client understand the product? Is the advisor qualified to give the advice? These remain.

The catch-all provision (Section 961B(2(G)) of the Corporations Act if you’re playing along) is basically a “anything we haven’t thought of” step. It’s absurdly broad.

How – without scrutinising everything about a client’s life and finances, scrutiny which would cost thousands of dollars – could you be sure you knew absolutely everything a court might decide constituted the client’s best interests?

Would you want to give financial advice under that sort of legal uncertainty?

Simply put, FoFA’s best interest, know-your-client rule is massively, dangerously overwritten. The Government wants to slightly relax it. Not remove it.

The second change concerns general advice. This covers things like bank tellers making recommendations about travel insurance. Here, commissions, now banned, are to be made lawful once more. Sounds terrible? Hardly.

Commissions are a completely legitimate form of employee remuneration. FoFA describes commissions as “conflicted remuneration”. This is nonsense. A commission, in practice, is not so different from a sales target, or (for higher paid professions) a key performance indicator, or (for higher paid again) an annual bonus. It’s just a different way to slice the salary pie.

If you go into a bank and ask for recommendations about financial products, you ought to expect that they will try to sell you one of their products. Just like if you ask a Telstra store employee what mobile phone plan they recommend they’re probably going to recommend a Telstra plan. Regardless of whether they’re being paid a commission.

Banning commissions in these circumstances achieves no policy goal. Remember, all advisors, including general advisors, are still required to work in their clients’ best interests. Removing the ban on commissions just cleans up a little regulatory ludicrousness.

Perhaps you disagree with the Coalition’s FoFA changes.

But it is true that Labor’s original FoFA remains – in letter and spirit. It is not being gutted. The Coalition’s changes are not radical. They do not deserve the extreme hyperbole they have received.

More fundamentally, it is not the Government’s responsibility to restore the reputation of an industry.

Voluntary industry charters or private ratings agencies are common solutions to the reputation problem. Personal financial advisors had been reducing their reliance on commissions in the years before the FoFA reforms.

Regulation suppresses innovation, raises consumer prices, ties the sector down in compliance costs, and opens up opportunities for rent-seeking.

Indeed, rent-seeking is the real story of the FoFA reforms.

The battle here is between the super funds and the banks. Australia’s superannuation system has created a titanic financial industry based entirely on the compulsory acquisition of a portion of our salary. Super funds – particularly the union-managed industry super funds – lobbied hard for a crackdown on avenues of financial advice outside the superannuation system. With FoFA they got it.

Industry Super Australia is now predicting these minor FoFA adjustments will bring a wave of financial collapses. Sure they will. Storm Financial did not collapse because bank tellers were selling travel insurance on commission.

Where commentators fall on these changes is usually determined by their pre-existing attitudes towards the super funds and the banks.

Most of the debate has been a loose proxy for bigger questions about Australia’s financial system.

But minor tinkering of FoFA isn’t much to hang these questions on.

The backlash against the Government’s plans demonstrates just how hard deregulation really is – held back by a mire of special interests and an unfortunate natural human tendency for doomsaying and fearmongering.