The Australian Securities and Investments Commission (ASIC) has released the results of its review into how the financial advice arms of Australia's largest banking and financial services institutions manage the conflicts of interest that arise as a result of providing advice to retail clients and also manufacturing financial products under a vertically integrated business model: Report 562 Financial advice: Vertically integrated institutions and conflicts of interest. The review identifies areas where improvements are needed in the management of conflicts of interest, identifies the steps being taken to address shortcomings and flags that ASIC will consult on plans to introduce more transparent public reporting on approved product lists, including where client funds are invested, for all 'vertically integrated firms'.  ASIC states that the report findings are relevant to all vertically integrated firms in the financial sector.

Scope of review: As part of ASIC's Wealth Management Project (a broad set of regulatory reviews of the wealth management and financial advice businesses of the largest banking and financial services institutions) ASIC reviewed the products that ANZ, CBA, NAB, Westpac and AMP financial advice licensees were recommending and at the quality of the advice provided on inhouse products. The review took place during 2015 to 2017.

The licensees included as part of the review were:

• AMP: AMP Financial Planning Pty Limited and Charter Financial Planning Limited
• ANZ: Millennium 3 Financial Planning Pty Ltd and ANZ Financial Planning
• CBA: Count Financial Limited and Commonwealth Financial Planning Limited
• NAB: GWM Adviser Services Limited and NAB Financial Planning
• Westpac: Securitor Financial Group Ltd and Westpac Financial Planning

Key points

• Conflicts of interest are 'inherent' in vertically integrated firms: The report states that that though vertical integration [which refers to the business model of combining activities at two (or more) different stages of production] can provide economies of scale and other benefits to both the customer and the financial institution, 'a vertically integrated business model also gives rise to an inherent conflict of interest. While the law permits this conflict to exist, it must be managed appropriately'.

• Advice to switch to inhouse products was not in best interests of clients in 75% of files reviewed: ASIC examined a sample of files to test whether advice to switch to inhouse products satisfied the 'best interests' requirements.ASIC found that in 75% of the advice files reviewed the advisers did not demonstrate compliance with the duty to act in the best interests of their clients.ASIC added that 10% of the advice reviewed was likely to leave the customer in a significantly worse financial position.ASIC stated that it 'will ensure that appropriate customer remediation takes place'.
• There was 'a clear weighting' in the products recommended by advisers towards inhouse products:The report found that overall, 79% of the financial products on the firms' approved products lists (APL) were external products and 21% were internal or 'inhouse' products. However, 68% of clients’ funds were invested in inhouse products.

ASIC to introduce more public reporting? To improve transparency around management of the 'inherent' conflicts of interests, ASIC stated that it will consult with the financial advice industry (and other relevant groups) on a proposal to introduce more transparent public reporting on approved product lists, including where client funds are invested, for advice licensees that are part of a vertically integrated business. Notably, ASIC added that any such requirement is likely to cover vertically integrated firms 'beyond those included in review'.

Actions to address the shortcomings identified

The Financial Services Council response the report

• The FSC is quoted in The Australian as commenting that the review 'shows there is still work to be done to address community and regulator concerns about the quality of advice in Australia'.The Australian reports that the FSC went on to say that it was concerned that ASIC failed to consult with the customer and the financial planner before marking the advice in question as a fail.Reportedly, CBA, Westpac, NAB, ANZ and AMP deferred comment on the report to the FSC.
• The Guardian quotes the Financial Services Council as stating that it would work with ASIC to implement processes for licensees to improve.The FSC reportedly said 'For the 19 out of 200 files reviewed where ASIC indicated significant concerns, individual licensees will work with the regulator to compensate clients and make things right'.The article goes on to say that the FSC questioned ASIC's definition of 'best interest duty', and as was reported in The Australian, stated that 'It is the FSC’s view that, before drawing definitive conclusions about the appropriateness of advice, the client and the adviser should be consulted'.
  
  [Note: ASIC provided an update on CBA financial planning compensation in a separate announcement. This is discussed in a separate post in the 29 January issue of Governance News.]

[Sources: 18-019MR ASIC reports on how large financial institutions manage conflicts of interest in financial advice; REP 562 Financial advice: Vertically integrated institutions and conflicts of interest; [registration required] The AFR 24/01/2018; [registration required] The Australian 25/01/2018; The Guardian 24/01/2018]