Where the Royal Commission will never go

With all the excitement of the Royal Commission underway, the left-wing journalists are already crowing about the need to extinguish vertical integration business models. But be ‘careful of what you wish for’ comes to mind.

For starters, allowing governments to mandate the business market is painfully idealistic if not paternal. It simply doesn’t work, it’s a global game in wealth and we don’t need an insular view of the world from journalists to vote seeking politicians.

The emotion is probably underpinned by consumer anger at the banks misbehaving in their duties of care for customers and in particularly the Life insurance area rather than investments – although it’s important not to rule out the need for change in the advice channels which created damage to life savings. But most of this can be fixed by good management and appropriate KPIs. One could argue the banks will learn from the damage and come back as stronger enterprises through time.

Vertical integration is not new and it’s not bad. It offers lower cost solutions sometimes and well managed it benefits consumers. Badly managed it’s a poor vehicle but that’s where competition is meant to step up with alternative value propositions. A free market offers that and it’s a better outlook than vengeance via commission that outlaws a perfectly legal structure on the world stage.

The IFA market is not isolated from this debate and some of the commentators would do well to think through the vitriolic demands for eliminating vertical integration. If anything, FoFA encourages vertical integration because of its cost imposts and now technology enables advisers to manage their own portfolios through managed accounts. Put the two together and vertical integration solves a host of compliance problems but introduces conflict through recommending ones’ own investment solution. Bit like the banks really so not much different if one is truthful, the only subtlety would be in-house investment teams.

The issue however is more complex than this. The industry trend is toward advisers moving from institutionally owned Licences in an effort to demonstrate independence (something they are not allowed to mention in writing one might add). As the adviser moves from a vertically integrated business with cross sell subsidies the truth emerges. The licence fee itself was subsidised so that the adviser had a lower cost of licensing but their clients typically paid a higher fee for the institutions platform. This is significant in dollar terms, though. A practice aligned to a bank could pay $30,000 a year for licensing but their client base could pay more than $200,000 in excess fees compared to a non-subsidised model. With client best interest this is hard to support but most aligned advisers do little about it because moving means paying the correct licencing rate and that’s around $100,000 a year based on the above example. Sticker price is a killer and that’s often why people don’t move despite all the rhetoric.

So the solution? Lower costs on better priced platform or fund offerings and charge more for advice. The challenge? Hard work and the source of truth in advice fees cripples many without a value proposition in advice so easier to stay put.

The industry direction? Some say ‘self-licensing’ and offer an in-house investment solution. The problem? Leaving a vertically integrated business model managed with capital adequacy and governance and start a vertically integrated business model with less so. Where does all this sit with the cry from the IFA market to eliminate vertical integration?

One starting point for a better future would be for Dealers to stop subsidising licensing fees –it’s a well voiced comment that it costs a minimum of $25,000 per annum to licence an authorised representative. This means a practice with four authorised reps would cost $100,000 minimum before profit is mentioned –and we need profitable licences more than anything. Looking into the industry few dealers charge that because they vertically integrate something to keep costs down and so the vicious circle starts again.

At least we can be comfortable that the Royal Commission will never dig this deep. But with good leadership from the dealership industry we can at least bypass this and make the changes to suit the future appetite for a profession. That would be a welcome debate at the next conference we all attend. It would be far better than moaning that ‘advice should be legislatively separated from product’. Be careful of what you wish for.

First published: 14 February 2018