Regulatory Changes Outlaw “Bundling” of Services with Advice

As we have heard in recent months from the Royal Commission all the major banks and AMP have run into trouble as a result of bundling financial advice with the other services they offer.  This is simply because the conflicts of interest arising through acting in a position of trust to independently advise clients on the best products and services to meet their needs while being remunerated either directly or indirectly through selling the same in-house products and services as those recommended have proved impossible to manage in practice.   As a result, the major banks have now all taken some steps to separate their advisory businesses from those that also provide products or services[1].

Within NSW local government, the need to separate independent advice from the distribution of product was recognised in 2008 as part of the Cole Report; all of whose recommendations were adopted by the Office of Local Government but specifically:

• Recommendation 3: Product manufacturers / distributors should be excluded from being appointed investment advisors to Councils.

Michael Cole concluded from his investigations no amount of processes and procedures could effectively manage the inherent conflicts of interest and therefore the functions needed to be separated for the advice to be considered “independent”.  The recommendation says simply that if you are involved in or remunerated directly or indirectly through the distribution of financial products in anyway this compromises your ability to provide independent advice to clients who may be looking to buy those products[2].

Most recently, the regulator ASIC, also revised its regulations along similar lines specifically expanding the scope of “transactional” activities that now require a markets license saying this affects any organisation who operates a market with the definition of a market now “applying to any form of technology or physical infrastructure that would enable persons to make or accept offers or invitations [to buy or sell financial products] by means of this facility”[3].

It is quite clear nearly all the cloud based on-line market trading and reporting platforms available now fall into this category, particularly if they have a “request for quote” facility.  The revised ASIC Regulatory Guide 172 devotes 52 pages to the obligations of those that operate a market which are summarised as “Market operators must comply with their obligations under the market integrity rules”[4].

A key obligation of the market integrity rules is a fiduciary duty to seek the “Best Client Outcome Obligation” under 3.8.1.  Within this legislation ASIC takes a very dim view of the practice of “bundling” advice with trade execution, essentially saying it falls outside the Regulatory Guidelines as below.

“Bundling is the practice of providing other services (such as advice, research, data and analytical tools) in conjunction with trade execution. We consider that transmitting a client order to a licensed market, market participant or other service provider which offers bundled services does not in itself meet the best execution obligation because it may not result in the best outcome being obtained for a client. Such activity may breach Rule 3.8.1.  We consider that the best execution obligation requires client orders to be transmitted based on best execution for the client independently of any bundled services.”[5]

Therefore under the legislation if you are operating a market place and hold a markets license, then this is the core function that requires your focus and conflicts of interest arise if you also provide advice or other services that direct clients to either use your market as opposed to not trade at all or source product outside your market or to favour one trade over another in your market.  Hence for example if you operate a Term Deposit or Floating Rate Note trading platform and have different product manufacturers who pay you differing amounts of brokerage or other forms of “platform fees” to offer their products on your market you should not be offering advice to those buying on your platform as there is a clear incentive to recommend product from the manufacturers who offer the highest fees or brokerage to you as a platform operator and secondarily to advise the buyer to trade on your platform even if there is more suitable product for the client that is not offered on your platform (for example either not trading at all, buying an FRN or Term Deposit that is priced more efficiently through a third party offline bank, broker or other platform provider or purchasing a product not available on the platform).  This conflict of interest also extends to those platform providers who also trade as principal through their own platform, buying from third parties at a lower price and selling at a higher price directly to customers.

Following the conclusion of the Hayne Royal Commission there is now pressure for regulators to separate advice from the provision of product and services across all markets with the final report due in February likely to recommend such an outcome.  This is one of the reasons the banks have moved pre-emptively as everyone is coming to the same conclusion as Michael Cole did in 2008.

[1] ANZ sold its wealth management business to IOOF in 2017.  CBA announced its sale of Colonial First State in October 2018. NAB has committed to sell MLC by the end of 2019.  Westpac was officially reviewing its financial planning arm in September 2018 and according to the AFR was testing the market for a possible sale at this time.

[2] Paragraph 4.17 of Cole Report April 2008, “A party performing more than a single function [advice, product promotion and investment management] has a responsibility to deal with the conflict of interest in a transparent manner. There is anecdotal evidence this was not the case.”

[3] Direct quote from “What is a financial market” RG 172.30

[4] Key Points – Overview of Part 2, ASIC RG 172

[5] ASIC RG 265.187