By Susan Guthrie
It’s been a long time coming, but the new regime around financial advice is due to come into effect on 1 July.
While the message the new regime wants to send is very clear – we can expect standards of advice to improve – in reality, will much change?
The new regime is based on rules that are a complex mix of high level principles and prescriptions embedded with important qualifications and exemptions – when it all pans out in practice will investors get better advice?
One key tool for delivering better standards is the decision to restrict the business of giving personal financial advice to just some advisers – those who qualify for the newly created title of 'Authorised Financial Adviser' or 'AFA'.
AFAs have to comply with a Code of Professional Conduct which includes, among other things, a minimum standard of knowledge and skill (in practice, set at a level something below a university degree), minimum practice standards (for example, on record-keeping) and conduct requirements. Of these, it is surely the conduct standards which offer the greatest potential gains – adviser self-interest rather than client needs drove many investment recommendations in the past (to the detriment of clients) and the new competency and practice standards, after all, seem similar to levels that prevailed in the past.
What, then, can you expect from the newly minted AFAs (1,103 of them at the last count)?
Well, they must put their client’s interests “first”. However they don’t have to be independent of any product supplier, which begs the question “What does “first” mean?”.
AFAs can continue to recommend products for which they earn sales commissions and the range of investments they can advise on may be restricted by commitments to product suppliers (for example, by quota arrangements). So an AFA may promise to put a client’s interest’s first, but that doesn’t necessarily mean delivering the best portfolio around – they may be restricted in their ability to do this.
The good news is that if an adviser claims to be "independent" (an extremely important differentiating factor now) they are not going to be conflicted by links to providers (but nevertheless, they may still be paid their salary by one as long as they’re not restricted in recommending any product on merit).
As well as limiting entry to the AFA club, the new regime introduces new avenues for clients to claim losses from advisers. Previously, for those with large losses, court was the only real option. However court action is a costly and uncertain business and few tried it. A recent court case involving a Turangi-based financial adviser received a lot of attention partly because it was so rare – unbelievably, given the amounts lost by advisers’ clients in recent years, it is likely to be an important precedent for future disputes (it seems likely that the judge’s decision in favour of the client will be appealed by the adviser, so the final outcome in the case is as yet unknown).
Under the new regime, all financial advisers must be a member of a registered disputes resolution scheme. This means clients with losses (or claims) up to $200,000 can have their dispute heard by an independent tribunal at no direct cost to themselves (the schemes are funded by members). This provides a welcome alternative to court.
The Turangi case was important because it revealed that advice can be successfully challenged. Proving poor advice and establishing the losses it caused are no easy tasks. Where the level of competency is low, but perhaps no lower than the average practitioner, how is the advice to be assessed? And some of the losses may be due to investment risks the client may reasonably have been exposed to even if they had received ideal advice. That the judge in the Turangi case navigated these difficult waters, and found in favour of the client, bodes well for the new disputes schemes – taking a case there won’t necessarily be a futile exercise.
However, as well as the fact that AFAs can receive commissions and are permitted to have other ties to product providers, many fish-hooks remain in the new regime.
It is possible for clients and their advisers to mutually agree to “contract out” of some of the Code’s protections – for example, the requirement that advisers “must take reasonable steps to ensure that the personalised service is suitable for the client”. This introduces a possible route for minimising liability that some advisers might try to exploit.
Potentially complex investments can also be sold by non-AFA advisers - for example, products issued or promoted by approved providers known as 'Qualifying Financial Entities' or 'QFEs' (and sold by advisers nominated by the QFE) and some types of bank PIEs – this must surely raise questions about how restrictive the licensing regime really is.
What, then, are the prospects for investors seeking advice under the new regime?
The new AFA designation is useful as it marks out those who have met the minimum levels of competency at least and provides clarity around what standard of care can be expected (but many advisers aren’t AFAs, so it will pay to check).
Having "independent" attached to 'AFA' is an added bonus (if it can be found).
However, the new competency standards don’t guarantee that AFAs will consistently make wise investment recommendations – only that they will follow processes that reduce the likelihood of very poor recommendations (which is at least something).
Neither the AFA standards, nor the new disputes resolution schemes, remove the inherent risks in investing. Most investment products, bar those which have a government guarantee, come with no firm promise of performance. Advice about investments therefore comes with no guarantee either.
No matter how charming or well-equipped your adviser, if the investments they recommend turn to custard the best rule of thumb you have is that you and you alone will ultimately bear the risk.
So 'buyer beware' remains important.
Investors have a responsibility to make sure they understand the risks of what they do (or are being advised to do) and to establish that they can survive if the worst eventuates.
Acting on "blind faith" in an adviser has never been a good idea – and changing the rules hasn’t altered this fact.
Susan Guthrie is as economist at Gareth Morgan Investments
This article was first published in the NZ Herald.