Regulation and oversight: A global perspective
South Africa is not alone in seeing increasingly regulatory involvement in the financial services industry. Currently, the financial industries in the United States, the United Kingdom and Australia are all undergoing an evolution as regulators tighten up
The global financial services industry, and the rules that govern it, is becoming increasingly complex.
New rules are implemented to address each new problem that occurs. This ongoing regulatory influx exponentially increases both the risk and the cost of doing business in a financial advisory business.
In 2004, the cost of compliance represented less than 6% of the total operating cost of advisory businesses in the USA. By 2006, it represented up to 15% of total costs and by 2009 it had escalated to over 25%! It is expected to increase by another 8% in 2010/2011!
Same problems, different country
The financial services industries in many countries share similar problems. A quick review of the issues that compromise the integrity of the financial service industry gives weight to the arguments of the proponents of over-regulation.
Suitability of investments - Unsuitable investments are the most common offences. It includes inadequate investment research and analysis, risky investments and under-diversifying client funds. Investments are becoming more complex and advisors are now being brought to book for recommending products to clients that they themselves do not understand.
Insufficient Know Your Client (KYC) – Failure to determine and understand a client’s personal circumstances and objectives results in recommendations that are not aligned with the client’s planning objectives and risk profile.
Acting like a portfolio manager- Some advisors recommend a standard investment strategy to their entire client base, irrespective of their KYC profile, acting as if they were portfolio managers, with the sole intention to increase funds under management - and their revenues – and with little regard for their responsibilities to their clients.
Failure to document – Internationally, this seems to be the most common mistake that advisors make. Advisors need to give appropriate advice, such as warning clients about the risks associated with certain products, but they also need to record that they have done so. This is not only a regulatory requirement but possibly the most important way advisors can protect themselves from litigation.
Unethical conduct - Advisors and authorised representatives must observe high standards of care, ethics and conduct in transacting their business. This includes refraining from business conduct that is unbecoming or detrimental to the public interest, such as misappropriating client funds or facilitating suspicious transactions.
Conflicts of interest – Financial advisors have a fiduciary responsibility which dictates that they put their clients’ interests before their own. Recommending changes in an investment strategy or switching a policy just to receive more commission can be a conflict of interest. If an advisor has an undisclosed financial interest in a recommended investment, it can also lead to a conflict of interest. Advisors must immediately disclose any possible conflict of interest to the client and address it with responsible business judgement.
Regulatory response
These common issues create the background for understanding the actions of legislators in different countries.
The United States
A Securities and Exchange Commission (SEC) report stemming from the new Financial Services Reform Bill was released in February 2011 and recommends raising standards for the delivery of financial advice by brokers and broker/dealers. It could represent a major push towards a more uniform regulatory framework for the fragmented wealth management business. In its study, the SEC recommended that all brokers and financial advisors adhere to the same strict fiduciary standard that currently applies to investment advisors when they provide personalised investment advice to retail customers.
A study of U.S. investors has shown overwhelming support for the notion that any financial professional providing investment advice should put clients’ interests ahead of their own, disclose any conflicts of interest that could potentially influence their advice and inform investors up front about any fees or commissions earned.
Developments in Australian standards
Over the last two years, various commissions on the Future of Financial Advice (FOFA) have investigated commissions on investments, and released recommendations that the practice be stopped as from 2012; that advisors should renegotiate their fees/commissions on an annual basis; and that education standards for financial planners should be increased.
The Australian Financial Planning Association has also recently proposed that the compulsory entry level qualification to the CFP qualification, called the RG146, be raised to a degree requirement.
According to the Federal Treasury in Australia, the cost of some components of the FOFA changes will be around $100 per client, which equates to an extra $100 000 a year in costs for the average financial planning practice. Assuming the figures are correct, and assuming the average financial planning practice turns over less than $1.5 million a year, the addition of $100 000 a year to the underlying cost of doing business is a substantial burden. Directly or indirectly, FOFA will drive up the cost of financial advice for many Australian consumers.
Pain in the United Kingdom
A report released in March 2011 by CoreData Research UK revealed that almost a quarter of the UK’s financial advisors are uncertain regarding their future professional status - a direct result of uncertainty around new training standards.
In addition, reforms in the UK will ensure that from the end of 2012, businesses will not be able to accept commissions for recommending specific products and the cost of advice cannot be linked to the cost of the product.
Retail investment advisors in the United Kingdom will also need a defined and officially recognised qualification — a Statement of Professional Standard — if they want to give independent or restricted advice after January 2013. These regulations will also require the status of the qualifications to be monitored by employers.
Concerns have been expressed that the efforts of the UK’s Financial Services Authority (FSA) to lift the educational requirements for the provision of financial advice, may end up causing a shortage of advisors and a reduction in consumer access to advice. The introduction of the new qualification - the equivalent to the first year of a degree - has a tight deadline, making it difficult for some current advisors to reach the new standard in time.
South African pressures
South Africa is emerging as a world leader in the development of financial services regulation, but the regulations implemented have also created some significant challenges.
Currently, almost 130 000 representatives and key individuals are gearing up to write Regulatory Exams which, on successful completion, will allow them to continue furnishing advice and providing intermediary services. Failure will result in advisors not being able to furnish advice or offer intermediary services.
As a result, we may find ourselves in a similar position as the United Kingdom, facing a shortage of advisors. This may be good news for those passing the exams, but it will certainly not be good news for clients who need financial advice.
Surely a simpler solution to “professionalise” our industry will be to follow global trends and increase the educational requirements for all representatives and key individuals. In this way, licence categories can be matched to qualifications and clients will receive better advice.
Understanding FAIS, the General Code of Conduct and FICA will not necessarily make representatives and key individuals better or more professional financial planners.
Understanding income tax, estate, retirement and investment planning, and being able to complete a comprehensive financial plan for clients, most certainly will.
