All four major banks have staunchly defended their vertically integrated models, arguing that a conflicted ‘one-stop shop’ approach to advice benefits customers.
In his interim report to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Commissioner Hayne questioned vertical integration as it relates to financial advice.
“The one-stop shop has an incentive to promote the owner’s products above others, even where they may not be ideal for the consumer,” Hayne said.
“From the perspective of banks, vertical integration always promised the benefit of cross-selling opportunities (the opportunities for cross-selling financial products to existing and new customers).
Evidence about platform fees and the provision of financial advice at the royal commission posed significant questions about the aspects of ‘one-stop shop’ models in advice industry.
In particular, it invited attention to how the vertical integration of the industry may harm clients by protecting platform entities associated with advice licensees from competitive pressures.
The commissioner claimed that clients end up paying more for platform services than other providers would charge for the same service.
In their response to the interim report, Australia’s largest financial institutions acknowledged that conflicts of interest exist but stressed that they can be managed effectively.
“Vertical integration provides benefits to consumers and while conflicts of interest exist, these can be effectively managed,” CBA said in its submission.
Australia’s biggest bank by market capitalisation further argued that structural change to the model is likely to have unintended consequences that will adversely affect consumers.
“The conduct examined by the royal commission, and that has emerged across the industry more generally, while occurring in a market where vertical integration exists, was (with some exceptions) not caused by that structure,” the bank said.
CBA noted that vertically integrated institutions are typically “larger and better capitalised” than stand-alone distribution or product manufacture businesses.
“This size creates economies of scale that can benefit customers by reducing costs and also increasing investment in innovation and technology,” the bank said.
“Customers also value safety and strength. When markets are difficult or volatile, vertically integrated institutions can be more stable and are potentially better at managing these conditions. Larger and more diversified institutions also have the capacity to invest larger sums on risk management and compliance frameworks, are subject to more scrutiny in their efforts to do the right thing by customers, and can be effectively supervised using a range of tools, including close and continuous monitoring.”
CBA’s management and compliance frameworks have faced significant scrutiny over the last 12 months.
Last month the bank announced that it has spent $850 million on a combination of customer remediation, administering that remediation and investing in its advice business.
“If I take a step back from that, I think that we should have implemented FOFA in full,” CBA chief executive Matt Comyn told a parliamentary committee on Thursday, 11 October.
“I don’t think we went far enough in terms of removing things like conflicted remuneration. When we consider how that occurred, I think at times we focused on things like adviser viability, because the structural reform of any business, including the financial advice industry, is a complex one.”
In its submission to the royal commission’s interim report, CBA stated that where conflicts exist, they can be managed effectively and do not require structural separation.
“An integrated business must acknowledge the potential for conflicts and put in place measures including governance (particularly for related-party transactions), risk management (controls and monitoring), remuneration frameworks and processes and sales practices to manage those conflicts,” it said.
NAB, which is in the process of offloading its MLC wealth business, shares CBA’s view that conflicts of interest and duty are capable of being managed.
“NAB recognises the challenges that have been raised to the capacity of financial services institutions to manage conflicts, that managing conflicts is complex and needs rigorous attention to detail, and that we may not have got it right in the past.”
The bank acknowledged the potential in vertically integrated wealth businesses for remuneration structures to be conflicted and for the overselling of ‘in-house’ products.
“However, NAB believes that these risks can be adequately managed through conflicts management controls, policies and processes that are client-focussed, known, understood, and enforced,” it said, adding that the bank is enhancing and refining its conflicts management controls, policies and processes.
“NAB also notes that many businesses within the financial services sector are vertically integrated, including many industry funds and some self-licensed advice businesses. As such, the impact of any enforced separation should not be underestimated. Disaggregating the manufacture or sale of financial products, on the one hand, and financial advice, on the other, would be a radical change affecting businesses of all sizes, and many individuals, across Australia.”
Westpac’s submission suggested that even with separate ownership, a perceived conflict could arise through an exclusive distribution agreement. However, the bank is confident that it too can manage conflicts by implementing the same controls in relation to related party financial advisers as external financial advisers.
Westpac believes that education and training to financial advisers on their financial advice and their ethical and professional obligations can also mitigate the risk of conflicted interests.
ANZ made some interesting observations about how the advice industry has developed over time to focus on sales.
“As a generalisation, it can be said that, over a number of years and due to various events, the financial services industry developed a culture that became overly focused on revenue and sales,” the bank’s submission states.
“As identified in the Interim Report, the roots of the financial advice industry are in sales and that industry is moving towards becoming a profession.”
Where a financial adviser is an employee or authorised representative of a licensee that manufactures financial products, ANZ accepts that the licensee will have a commercial interest in maximising sales of that product.
“However, this will not be the sole interest of the licensee,” the bank said.
“The licensee will also have an interest in the conduct of its financial advice business in a manner that complies with the law, including the statutory duties owed by its employed or authorised financial advisers to their clients, and protects the licensee's reputation (including by having advisers known for providing quality advice such that customers will wish to engage them).”
Like its big four peers, ANZ believes structural change prohibiting related entities from providing financial advice and being involved in the manufacture of financial products is not necessary.