Future Proofing Your Business From Regulatory Change

One of the fundamental pillars of financial markets working is consumer confidence in the integrity of systems and participants. Without this confidence, there is a lack of participants, it has for capital to be raised or traded and confidence in markets and the systems can be dented - we may remember  what happened to the credit market in 2008 due to the discovery of the in-transparent nature of credit default swaps, leading to a ‘run of the banks’ in some parts of the world.

In July, I introduced on the blog the concept of the ‘Social Regulator’ and how the industry is reforming – not only in response to regulation, which is largely reactionary, but also through leading indicator of how business models should develop is relation to what is reasonably acceptable to both consumers and public opinion generally (who are increasingly being championed by the media in the face of high profile advice scandals).

The latest validation of this thinking in Australia is the defeat of widely anticipated watering down of Future of Financial Advice (FoFA) laws in the Senate, which means Financial advisers must now fully comply with Labor's original version of FOFA. With the ammunition of recent scandals still very much in the papers and social consciousness, Labor, the Greens and four crossbenchers, argued the Coalition's proposed changes would leave investors vulnerable to a future financial collapse.

It means that on balance, the politicians believe that the fundamental pillar of confidence, which is so necessary in properly functioning financial markets, is broken. In the case of CBA and Macquarie, despite the vast resources of these institutions, if they cannot be trusted to act in the public’s best interest in the pursuit of profits, how can anybody argue something isn’t broken here?

Some anecdotes being prescribed for the industry point to more training, regulation and red tape, and some, such as a public register of advisers, are an attempt by the industry to appear more professional and transparent.  Our views are that whilst a step forward, these seem more like a band-aid solution when what is really needed is a fundamental rethink. 

For firms trying to decide on a winning business model going forward, the environment may appear stifling, with FOFA still around and FSI and who knows whatever else around the corner. This creates a dilemma in many financial advice organisations in terms of how can I achieve the right balance of compliance and business competitiveness? The trend at the moment is to hire more compliance staff (at the expense of advisers and other revenue generating headcount) and commit to ‘higher training and professionalism standards’. With margins in financial services already compressing fast, the last thing advice businesses need are more non-revenue generating costs.

Financial Simplicity believe compliance cost blowouts are first and foremost a cultural problem – not necessarily at the organisational level but rather at the industry level – and to improve compliance requires taking a step back and considering compliance in sometimes completely different ways.

If compliance frameworks exist to regulate and monitor the quality of advice provided to clients, but are largely administered manually through compliance teams, documentation and training programmes, this becomes a non-scalable and expensive solution, that will most likely have some holes in it's approach. The compliance effort is also a product of the organisational culture and leadership, and pressure to produce results can also see compliance pushed to the bottom draw.

Rather, Financial Simplicity views compliance as a fundamental embedded part of a firms operating model (ie EVERYTHING IS COMPLIANT) rather than a framework that is imposed on top with costly checking resources.. And because everyone else is so pre-occupied by keeping their compliance frameworks up to date, those with compliance embedded into their operating model, operate at a competitive advantage, with resources directed towards client and revenue generating activities.

Financial Simplicity has, for more than a decade enabled embedded portfolio and investments compliance to be automated and systemised in our clients’ businesses, to the extent that they don’t even have dedicated compliance resources or think about compliance in terms of explicit costs or periodic audits - they just know it is all OK. It is embedded directly into their revenue generating advice activities and often taken for granted as compliance is an ‘outcome’ that is systematically applied through automated and technologically-driven processing.

If you are currently concerned about how to ‘future proof’ your business and revenue against future regulation, it may be time to talk to Financial Simplicity about how we can radically reduce your compliance costs while positioning your business for growth.  

The arrival of the 'social' regulator

In Australia we are starting to see considerable debate in the public domain about the possible shortcomings of the recent regulatory frameworks, and also differing ideas of what 'should' be done to improve the situation, with many firms, organisations and associations putting in their 'ten cents' worth.

Whilst some of the comments and suggestions appear to defensive about past practices, and some of it being about a desire to take the high moral ground, with an inference that other views may be lesser, my observation is that most of it has merit, and we are inching towards the development of a new set of standards and regulation.

Whilst some of this new era standards and regulation may be in the form of training and qualifications, some in the form of removing conflicted remuneration, my guess is that the whole industry is finding it's way towards what is becoming acceptable to both consumers (otherwise consumers will go elsewhere) and / or the mass public opinion (otherwise it gets attacked in the media). I call this the 'social regulator'.

As we are seeing in the UK now, the 'social regulator' is getting increased coverage and attention, fuelled by media campaigns by the Telegraph and other papers. Not suggesting that this is the only influence, but it does appear to have to have some influence on policy, and feedback associated with setting such. It looks like there is nowhere to hide for regulators and politicians now and there is equal political and reputational risk of doing nothing as well as making changes.

In Australia recent responses and suggestions include the suggestion of a consumer standard way of measuring or assessing financial advisers, which has merit. I do however think that this theme needs to be extended not just for advisers or money managers, etc, as I think it is the segregation of these roles that confuses much of society. We need consumer opinion of the overall experience and proposition by industry participants, and if the social regulator theme continues, I suspect it will be happening quite soon.

At Financial Simplicity we have been working on this theme for some time to help firms assess their overall proposition to consumers, provide a basis for comparing against others, and identify remedial and pro-active ways to improve such. Ultimately I think that either the 'social regulator' and / or consumers themselves are going to force this change, and my tip to industry participants is to be very clear on what is your value add, or be at the risk that your customers and social commentators start publically scrutinise what you are doing.  A far better result that we help firms with is to help firms articulate this proposition and constantly communicate with their clients to be one step ahead of the public debate.

Why an ASX trading platform may be best for delivering your firm’s SMSF proposition

There has been much recent debate regarding the future of the platform market as competing services and technologies are starting to emerge, that provide legitimate alternatives for practices that are looking to gain a competitive edge.

Lets be clear from the start - with net positive fund flows in excess of $27bill during 2013 (Plan For Life) , wrap operators are not really insecure about their market position. FOFA has struggled to address the largest conflict in the advice market, with vertical integration of banking / financial service conglomerates being allowed to persist.

Given the emerging landscape, in order to remain competitive and relevant, non-aligned wealth advisory groups and boutique IFAs have little choice but to consider alternatives rather than support platforms controlled by these institutionalised groups, and at the same time need to consider how to create a new, FOFA compliant revenue stream. All FOFA seemed to do for independents is increase regulatory scrutiny around both product and platform recommendations, in addition to financial revenue derived from recommending either being phased out.

A major trend so far has been to set up or ‘white label’ competing platforms, or deliver similar looking products through SMA platforms. The enhancement to the value proposition being around transparency, portfolio customisation and individual tax management – all relevant to the type of investor these groups should be targeting (HNW and SMSF).

The question is whether replacing a wrap platform with an SMA platform will really provide independent groups the edge and differentiation they need to compete and create a new sustainable revenue model. What they are effectively doing is replacing one product-platform solution with another, and probably for a similar level of fees.

If you consider the needs and desires of HNW and SMSF investors, they are after value for money advice service compared with a ‘do it myself’ alternative – nothing more, nothing less. The vast majority of these people do not have a financial adviser, are invested in cash (term deposits), and direct shares which they have purchased through an online broker.

If a firm wants to attract this type of investor, they need to think like them, and consider using an ASX trading platform in favour of another margin-clipping product-driven administration platform to support the provision a value-for-money service-led advisory proposition. It’s not that self-directed investors don’t want to, or don’t see the value in seeking advice, it’s just that there is not a great deal of confidence in the current format where it is integrated with platforms and products, hence the growth of SMSFs in the first place.

The first and foremost advantage ASX trading platforms have is they do not have the stigma of other wrap platforms and fund products in terms of kickbacks, trailing commissions, rebates, soft-dollar arrangements, volume-based incentives and under the table remuneration arrangements at the expense of clients’ hard-earned savings. What a firm is doing by executing through an ASX trading platform is saying to your prospective clients is that you too, care about the cost and transparency. Instead of units holdings in trust and nominee structures, all of their holdings are CHESS registered (secure and portable) in their name which has considerable perceived benefits to many.

The key consideration here is the opportunity to offer a truly service-led proposition that focuses on tailoring a portfolio of shares, ETFs, and listed securities (the client is already somewhat familiar with), rather than funds and products through another platform that has similar constraints such as investment, liquidity, control extra fees and a proprietary tied execution platform.  

What about all the other great things wrap and SMA platforms do, such as consolidation of assets, and tax and reporting? Firstly it should be considered that reporting provided by wraps (due to the way they process data) are generally insufficient for tax reporting and audit purposes for SMSF investors. Secondly there is ongoing innovation in the portfolio administration service provider market that effectively renders much of the reporting capabilities of wrap platforms obsolete. We consider the impact and viability of some of the emerging wrap alternatives below.

• For advisers who still prefer to access fund manager skill, the launch of ASX’s mFund service which now allows the purchase of (a limited, though increasing range) of managed funds at wholesale fee rates, through a broker, just like any other listed security. Up until now, discount brokers only offered sale of (retail fee rate) funds by effectively having a PDS download and entry fee rebate service.
• Portfolio administration and other innovative technology-based service providers are allowing advisers to replicate or improve on many of the functions wraps currently provide, with more tailoring to business and client requirements. This includes replacing tax and reporting functions with SMSF friendly auditable double-entry accounting systems, as well as enhanced portfolio management features that wrap operators are on the back foot trying to replicate
• More flexible managed account solutions are emerging, that enable advice businesses to run large numbers of individually customised and tax managed portfolios with scale and systemisation, under a number of business and advice model scenarios. MDA operators have dominated this space, however there are now options for firms that run an advisory model with scale, that can address the concerns of not wanting to give up control of their client assets to a third party.

These emerging trends mean that, for the cost of brokerage and (sourcing or producing research) research, more savvy wealth management firms realise that it is now possible to replicate the features and benefits of wrap and SMA platforms and fund managers, and take the investment management function (and margin) in-house. The benefit to their clients is they receive a more tailored, transparent investment service at a lower cost of delivery that is in line with their current experiences and understandings.

The challenge for wealth firms that wish to bypass platforms is to source all of the services relevant to their firm and integrate them in a way that achieves desired outcomes. Depending on the business and advice model, services can be offered on either a discretionary or advisory basis to clients, and research/ model portfolios can be either be produced internally or sourced from preferred third parties.

The investment universe is now perhaps wider than a wrap platform of relevant investments, and only defined by the range of trading platforms used (it could be multiple, including access of direct overseas shares and securities on other exchanges). Firms need to consider what this means for their business processes and what combination of technologies and solutions will best power their desired operating model and business outcomes.

It is this flexibility to adapt to different business needs that is becoming attractive to firms looking for a platform alternatives they increasingly service different client segments, run multiple brands or offer different types of portfolio services. The challenge of putting it together can be complex, however the rewards, and potential to create a sustainable revenue stream while delivering real client satisfaction within a FOFA-proof business model are , on a number of measures, likely to be more attractive than doing nothing.

To find out more, contact us at Financial Simplicity.

July 2014.

Copyright Financial Simplicity 2014.

Does not acting in consumers best interest means consumers are themselves are an adviser ?

There is a lot of discussion in Australia about winding back the obligation of financial planners / advisers to act in the best interests of their clients, with a lot of discussion being about the costs to deliver such. But I notion that the costs of delivering this may be offset against the cost to the investor of not enforcing this.

Some thoughts... If anyone is offering services that are about a consumers’ financial future, and they are not working in the best interests of their clients, then this highlights to a 'researching' consumer that they may be encouraged to evaluate a range of possible service providers to see which of their service offers is most aligned to the consumers best interests (if the consumer actually knows what their best interests are...)

The need to evaluate each service provider then takes up both the consumers time ('selection costs') as well as the service provider’s time, and the marketing costs to attract them, ultimately adding to the cost of attracting the clients, which must be recovered some how in the cost of servicing them.

This also then places a burden on the consumer to make a decision as to which adviser / service provider to use which forces them to be to some extent their own ‘adviser adviser’ – which many would suggest most may struggle with as it is usually a rare occurance in one's life to perform such a selection process...

So far, this is looking confusing and expensive for both the consumer and the providers pitching for the work....

I guess as being highlighted in the press recently about 'buyer beware for financial planners', like most industries I'd suggest that big brands are likely to be the beneficiaries, using brand equity to help overcome consumer confusion or lack of knowledge.

However if the alternative is where an adviser must act in the best interest of the consumer investor,  this increases trust, perhaps even advocacy, and theoretically this ultimately reduces overall costs through eliminating (or reducing) the 'selection costs' , and should improve both consumer outcomes, and long term savings outcomes.....perhaps in the best interest of society...

Model Portfolios - Commonality in the Chaos

Professional fund managers employ significant intellectual resources and systems firepower in order that they can extract excess return from markets in a structured and consistent manner. Of utmost importance to the investors they represent, the ability to explain the sources of return and attribute them to a repeatable process is key in gaining investor confidence and attracting funds, and also retaining funds when returns aren’t the best. 

Similarly, high net worth investors that entrust their funds to professional wealth managers also seek the confidence of knowing the process - in which their life savings are being invested – is a robust and repeatable process that is managed in a structured manner, rather than choose services based on something opaque, such the ‘knowledge and experience’ of some guru stock picker. 

For most wealth management firms, model or guidance portfolios is the crystalisation of the firms’ research process and represents its best portfolio ideas at the time in a hypothetical sense (i.e. if a client portfolio was being implemented from scratch today).  Having a common research basis for portfolio recommendations across the entire client base is extremely useful from a scalability and compliance point of view (having a demonstrable basis of recommendations). It is also widely recognised that having structure and definition around a ‘best ideas’ portfolio in terms of security selection and weightings is an important aspect of risk management and ensuring appropriate diversifications across the client base.    

However, as a basis of portfolio recommendations, model portfolios introduce the paradox of scalability benefits, coupled with implementation inefficiencies.
The implementation efficiencies arise because of:
1)    Legacy positions in existing portfolios
2)    Customisations for each client related to tax positions, preferences, exclusions and other specific instructions not perfectly in line with the prevailing model

In most practices a significant proportion of adviser and paraplanning time is utilised to align the hypothetical model portfolio with client portfolios overlayed with client rules, tax management and instructions. And while model portfolios introduce a thread of commonality across client portfolios, the process of custom overlay creates chaos in the kitchen from an admin perspective and often the use of spreadsheets (that are often prone to error) and manual tasks is prolific. 

The modern day reality is that in order for a wealth business to scale (through alleviating the time required by client advisers to implement a model portfolio with client customisation) the overlay process needs to be become systemised, scalable, and repeatable. In a world of limited resources, the only alternatives are all negative (higher cost of delivery, less client engagement time, less customisation, less frequent reviews, more propensity for operational errors). 

This is why Financial Simplicity has researched and finessed over time the process of aligning model portfolios to client portfolios incorporating personal overlays for each client. This is also the reason why if you are operating a wealth management business and want to deliver  tailored portfolios to clients in an efficient manner that also adds value to their experience and your business, it may be worth your while to call Financial Simplicity today for a  confidential discussion about how we can scale the delivery of your firm’s best ideas across your client base. 

Australian Super Fee reports highlights poor outcomes of product distribution model

The Grattan Institute has recently been released a report alleging that Australians pay $10bill too much fees collectively per annum. The net effect this has to the average Australian is a cut in retirement income of up to 20 percent. 

Overpaying for the seemingly simple function of holding and investing assets is not news to most of us with a superannuation or pension fund in Australia. However, the fact that Grattan has come out with a specific figure of $10bill per annum, I would suggest is quite a revelation as to the extent of inflated margins being facilitated by the institutions that are entrusted with our retirement savings.

If anyone has doubts to the basis of these figures, perhaps you would rather listen the Treasury, who earlier this month described Australia's superannuation system is one of the world's least efficient and most expensive (http://www.smh.com.au/business/super-system-expensive-and-inefficient-says-treasury-20140406-366re.html#ixzz30FXZtVGP). Of the 15 OECD nations whose pension operating expenses it graphs, Australia's are exceeded only by those of Spain, Hungary, Mexico and the Czech Republic. 

It is not the entire Super system that is seemingly overcharging, as is highlighted in one of the charts extracted from the report which shows that public sector and corporate funds are a paying fees of a third to half what industry and retail funds pay.

It is clearly the Retail sector of funds that pass to their members the additional costs of sales and distribution needed to market their products to advisers and consumers. FOFA reforms should be a catalyst for fees to come down as costs of commissions payed to advisers is no longer allowed. This of course, does not reflect reality as fund managers attempt to recover costs in a more competitive market. Treasury also suggests that the separation of the ownership of funds from those who manage them ''opens up the risk that managers rationally maximise their own interests at the expense of fund members''.

Unfortunately, the truth is that without an overriding consumer disruption, retail funds and fund managers have had no incentive to lower fees. As such, the Grattan report declares “Fees in Australia are high for one main reason. The system relies on account-holders and employers to put pressure on fees, but many do not.”

They are referring to the extent of member disengagement which is another feature of our superannuation system. The vast majority of retail fund members are still in a retail fund because they have been put in there by an employer, are disengaged and uninterested in switching funds or even investment options.

For those who have read my previous papers, you will know that I have been arguing for years that the industry has too many fee and admin layers in delivering the basic function of holding and investing assets. In addition, super fund back office processes are still highly manual, leading to costs incurred in the deployment of expensive human resources, and the clean up of errors that human involvement leads to.

Excluded from these charts are SMSFs, who according to the report, average fees in the range of 0.85-1%. The fact that this has been the fastest growing segment of the super fund market for some time we believe reflects the fact that a large proportion of members with larger balances are attracted to the ability to have increased transparency, engagement, and lower fees than retail fund options.

Skills in going from professional sellers of investments to professiona buyers

With changing regulation around the world either in place, or moving to be in place quite soon, there is a fundamental shift occuring in the wealth management industry. This shift in many ways is that people who made their living from the selling of investment products (and were paid product commissions to do so), now are being forced to move to the other side of the table and make a living by charging their clients for buying investments on their behalf.

Simple..?

Those in the industry will be well aware on the substantial investment that has gone into systems, proceses, compliance changes etc in order to support this change. At a simplisitic level it could be that rather than the professionals being paid by the product providers, they are now paid by the client instead under methods some call 'adviser charging'. OK, now lets move on....

Whilst what could be seen as a small change, there is a very different reality as to the business model of that professional's business though in this transition in terms of a) exposure to change in revenues b) demonstration of the value to support revenues, c) the perceived value of those revenues to consumers in a world where access to investments on-line has never been easier (and more confusing some would argue !)

Fundamentally the value proposition of professionals has moved form being about access to investments for sale in 'regulated' way, to one to how much value do they add in the eyes of the clients. Some key points here:

a) value is now perceived by the client, not the product provider -requiring a considerable change in identity and context
b) with tightening consumer wallets, this value is more transparent and will undergo more scrutiny, especially in a world where there is vast amounts of consumer information and commentary on-line, often around low cost access to investments also

What does this mean in terms of skill sets for wealth advisory professionals ?

I'd suggest that it means about extending skills in understanding client context, demonstrating on going value with ongoing suggestions in terms of investments in a portfolio, and operating a business that absolutely maximises and optimises the value-time equation with clients, not just number of clients.

Whilst many are well equpped to deal with the client facing aspects of this, many are struggling with a componnt of this which is amounting to them essentially have to become portfolio managers / investment managers themselves, which is not suprising as it is probrally not their skill sets. This is a specialist area that is not for the faint hearted, is often multi-dimensional, and can have deep consequences for client portfolios if not properly operated, overseen and managed.

It is this latter aspect of portfolio management that Financial Simplicity helps our clients with, helping them use business intelligence and sysemised workflows to operate such a portfolio management funciton with lower costs and risks, allowing them to spend more time on the essentials... adding value to clients lives.