Following the release of the Final Report of the 'Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry' and its recommendation to repeal grandfathering provisions (Recommendation 2.4) Treasury last week released Exposure Draft Legislation to finally remove any conflicted or other banned remuneration from arrangements that were grandfathered under the Future of Financial Advice (FOFA) regime. This is proposed to also include ceasing grandfathered volume-based shelf-space fees and asset-based fees on borrowed amounts.
Currently, these amounts may generally be paid if the benefit is paid under a grandfathered arrangement entered into before the implementation of the FOFA reforms (ordinarily 1 July 2013).
ASIC's earlier submission
Following Round 2 of the Royal Commission hearing that focused on financial advice, the Australian Securities and Investments Commission (ASIC) strongly expressed its view that all grandfathered commissions should cease as soon as reasonably practicable. Its reasoning was on the basis that although trailing commissions do not directly incentivise new advice, their existence effectively continued to incentivise advisers to keep clients in legacy products where ongoing commissions continued to be paid. Clearly its view was that the best interests duty which should ensure that only the ideal product is recommended could not override the underlying incentive to do otherwise.
Of course, once the conflicted remuneration elements of existing arrangements cease, licensee's and their advisers will need to be wary of the new incentive to remove their clients from their current investment which may already be (or will become, depending on the rebate mechanism implemented by regulations) in the client's best interests (potentially because trailing commissions had already been priced in and now they are being rebated). This may become a concern in the lead up to the cessation of grandfathering in 2021.
Initially, grandfathering was retained on the basis that it was unconstitutional to legislate to prevent 'property' that was contractually owed to advisers. At the time it was considered that compensation would have therefore been owed by the government if agreements weren't grandfathered under section 1350 of the Corporations Act. The exposure draft clarifies that section 1350 will not apply to grandfathered arrangements from 2021. Of note, Hayne did not address this line of reasoning in his summary dismissal of any defence for preserving grandfathering.
Government adds in potential for rebates
The exposure draft has also specifically enabled regulations to prescribe a mechanism for ensuring that amounts that would have otherwise been paid under the grandfathering provisions to be rebated to the client. This appears to be another example of the Government proposing to go beyond the recommendations of Hayne's Final Report, although this time even beyond ASIC's submission on the topic. What remains to be seen is details of such mechanisms, including any practical guidance on how it will be tracked and how frequently paid, including the ongoing costs on industry to do so (and at whose expense).
What may result in an unintended outcome is for such amounts to then be paid, at the client's direction (under an exemption to the conflicted remuneration provisions) back to the licensee or elsewhere. However it is also possible that the anti-avoidance provisions would prevent this from occurring.
Direction to ASIC
To further enforce the proposed legislation, on 27 February 2019, Treasury issued a directive to ASIC (Australian Securities and Investments Commission (Investigation into Grandfathered Conflicted Remuneration for Financial Advice) Direction 2019) requiring ASIC to actively investigate the extent to which persons who are currently giving or accepting grandfathered conflicted remuneration cease by 1 January 2021, and the extent to which any benefits not passed on are rebated to clients (directly or otherwise).
If you currently receive or make payments of conflicted or banned remuneration under a grandfathered arrangement and would like to discuss your current and future compliance with these provisions or require assistance in making a submission to Treasury, we encourage you to contact us to discuss.
Submissions close 22 March 2019.