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Grandfathered commissions: what’s it about?

Investment Trends recently released its 2018 Financial Advice Report, an in-depth survey of the appetite and use of financial advice among Australian adults. The Financial Services Royal Commission has profoundly affected perceptions of the financial planning industry and trust in financial planners and banks is at all-time lows.

Among the major issues at the Commission, fees for no service, charging fees to dead people and dud insurance policies are easy concepts to grasp. However, grandfathered commission is more difficult for most people to get their head around. Various groups have been vocally calling for blanket bans, and banks have been backing away from commitments made to financial planning groups in order to placate an angry population.

How did it all start?

The dictionary definition of grandfathering is to exempt someone or something from a new law or regulation. In the financial advice context, grandfathering concerns investment commissions, superannuation commissions and insurance policies linked to super accounts.

Let's step back. In the 1980s, financial institutions started marketing managed investments, where investors could access the share market by pooling their money with other like-minded people in a managed fund. The investment managers did not have a means to sell the concept: no sales force, no client service departments and no real way to communicate with potential end-investors. They enlisted the support of intermediaries. They charged the investor entry fees into the managed fund which they passed to the intermediaries as upfront commission. Since July 2013, these commissions have been banned.

The intermediaries were also paid ongoing (trailing) commission, usually 0.3% or 0.4% per annum on the value of an investor’s account balance. It is these commissions which most of the fuss is about. The payments were intended to subsidise the cost of providing ongoing service to people who bought the managed funds.

Who pays it and who gets it?

Two important factors to note.

First, the trail commissions were paid by the investment manager out of their management fee. It was not an added fee that was deducted from the investor’s account. Consequently, it did not (and still doesn’t) show up specifically as a debit on investor statements. If an investor didn’t invest via a financial adviser, the fund manager invariably retained the money and didn’t rebate it to the investor. These managers didn’t really want a direct relationship with investors, and they certainly didn’t want to jeopardise their adviser distribution arrangements. At the time, any fund manager who ‘went direct’ or discounted fees risked being blacklisted by angry advisers.

Second, these commissions were not paid directly to financial advisers, and still aren’t. The vast majority of financial advisers are authorised representatives of a 'licensee' (sometimes referred to as a 'dealer group') rather than take on the responsibilities and risks involved with having their own licence. This spawned the creation of a group of independent licensees, some of which attracted large numbers of financial advisers. Investment managers paid commissions to the licensees who passed them on to financial advisers after deducting a percentage to cover the costs and profit margins of the licensee.

Along came vertical integration

In the late 1990s, banks recognised the profit opportunities that vertical integration could deliver, and retail banks bought fund managers, administration platforms and licensees. They derived profits from the management fees created by fund managers, admin fees from the platform and a share of the commissions created by financial advisers. Furthermore, their profits were bolstered by the mushrooming size of the superannuation market which grew from virtually nothing in 1992 to more than $2.7 trillion today.

Over time, the legal and compliance demands on financial planners grew to such an extent that trail commission was nowhere near enough money to cover the costs of financial advice. Consequently, many advisers tacked on an adviser service fee to the client’s account. This fee had to be agreed with the client in writing, via a signed copy of the application form, and was directly deducted from the client’s account and was specifically itemised on the client statement.

Some adviser groups rebated the entire trail commission and covered their costs by charging adviser service fees. Others used a combination of trail and adviser service fee.

The ban on commissions

Rumblings about commissions had been growing for a while but really blew up when the industry funds started spending big money on advertising. These ‘compare the pair’ advertisements graphically revealed how much money could be ‘lost’ by ordinary Australians over the course of a lifetime. The Labor Government introduced a package of measures designed to eliminate commissions and increase transparency, including:

  • A ban on upfront and trail commissions on all new investments.
  • Super funds had to invest all new super contributions into new low-cost investment options which didn’t pay commissions.
  • All existing super accounts would have to be transferred to the new low-cost investment option unless the member had actively selected a non-default option, or the fund received notification from the member saying they wanted to remain where they were.
  • Advisers had to provide Fee Disclosure Statements every year.
  • Clients had to sign an Ongoing Service Agreement every two years which clearly stated the services that were to be provided and what they were being charged.

The key date was 1 July 2013 but many of the measures had grace periods and different implementation dates. This confusion was amplified when the Coalition won power and announced they would roll back some of the changes, but the cross benchers objected.

Grandfathering of commissions

The measures that were eventually introduced contained some sweeteners, omissions or mistakes, depending on your view. The major concession was that trail commissions on existing investments were grandfathered. In other words, if an investor remained in an investment, trail would continue to be paid until the investment was redeemed, in theory forever.

Due to the forcible transfer of commission-based superannuation accounts to commission-free accounts, grandfathered commission was expected to die out relatively quickly. However, they are an important part of the revenue structure of many advice groups, although certainly not all.

What isn’t generally recognised is that many superannuation members are actually better off in commission-paying investment options.

First, low cost super funds often underperform other investment options, even after fees. Second, when MySuper and FoFA were introduced, many retail super funds found other ways to earn revenue, ostensibly because of the additional legal and risk costs. While they deducted the trail from the management fee, some increased their administration fees, inserted an adviser service fee or added a regulatory reform fee to cover the costs of compliance. Overall, management fees went down but perhaps not as much as expected.

Some workplace super funds also changed their fee structure so that management fee discounts were lower on the new MySuper products. These discounts often started when the workplace super fund reached $1 million but following the introduction of MySuper, the starting point for the discounts on some new low-cost options moved $5 million. This sometimes wiped out any cost savings accruing from MySuper. Also, many financial advisers were rebating some or all of their trail commission, and this benefit was lost to MySuper members under the new fee regime.

Grandfathering rights were also extended to allow advisers job flexibility and retirement options:

  • If a financial adviser leaves his current licensee and joins another licensee, the trail continues to be grandfathered and the new licensee receives the commissions instead.
  • If the adviser retires and sells his business to another financial adviser, the new financial adviser can inherit the commissions.
  • If the adviser’s licensee buys his business the licensee inherits the trail commission.

In my opinion, these allowances are reasonable otherwise it creates a restriction on advisers to practice, dramatically limits their employment options, decreases the value of their business and reduces their retirement choices. Grandfathering is an expected concession when changes are made to legislation (and listen to the howls of complaint when it is denied!) so why should financial advisers be treated any different?

Bigger FoFA mistakes

I believe the biggest mistake the government made when introducing FoFA was that Fee Disclosure Statements and Ongoing Service Agreements did not have to disclose trail commissions. This gave advisers the opportunity to be economical with the truth, and it is probable that many investors remain completely unaware of exactly how much money advisers are making on their investment. Many advisers did not disclose trail commissions. In their view, commissions are payments made by the super fund from their management fees and not a direct cost to the client.

While history is on their side, the future is not.

Before retiring in June 2018, I spent 26 years in the investment and financial planning industry including with two fund managers, two banks and three financial planning organisations. Even with this background, I may have overlooked an important aspect of commissions so please feel free to chime in!

 

Prior to retirement, Rick Cosier was a financial adviser for 26 years and Principal of Healthy Finances Ltd. This article is for general information only and does not consider the circumstances of any individual.

 

16 Comments
Dean
December 02, 2018

One widely overlooked aspect of superannuation commissions is the cross subsidy they provide for advice costs.

We hear a lot from outraged consumers who have paid $X in commissions over the years and never received anything for it. But we rarely hear from those consumers who receive thousands of dollars worth of useful advice which they only paid a pittance for. These consumers are often older people with very small superannuation account balances, who need lots of complex ongoing advice in relation to age pension, aged care and estate planning issues. Because their balances are low their adviser receives a very small amount of commission from their account. Much less than the true cost of the advice they are provided with. These people are being cross subsidised by commissions from consumers with higher account balances who don't seek advice.

If grandfathered commissions are terminated, expect to hear a lot more "victim" stories from older people with small super balances who can no longer access the advice they need at an affordable price.

Gen Y
November 26, 2018

You're right that one of the biggest failings of FoFA was carving out the disclosure of trailing commissions from FDS... it created a system where the cost of maintaining a commission client was lower than a fee client (as the admin overheads of issuing FDS were not applicable), alongside the reduced transparency.

The second failing of FoFA was simply not having a sunset date for trailing commissions. 5 years should have been ample time to give business to re-arrange their revenue streams. Unfortunately the vested interest lobby groups were the ones who ultimately drafted the FoFA legislation...

Julie Matheson, CFP
November 25, 2018

Rick, thank you so much for this article. It's a pretty good overview of how funds management and licensee commissions evolved in Australia - hand-cuffed to licensing.

The introduction of "Wholesale Funds" was also in the mix. These funds were meant to be "commission free" (no trail paid to the licensee) yet a licensee could negotiate volume bonuses or shelf fees for the wholesale fund to be on their approved list, and not disclosed to a Proper Authority Holder or Authorised Representative (financial planner).

I'll save this article for the history books, and an exam I might have to do to prove I know something about licensing and funds management.

Graeme
November 25, 2018

Long ago I made a one-off superannuation investment (they were called super bonds back then) with a very large institution. Despite having gone direct, I was allocated an adviser who I later found out was paid most of the up-front fee and a trailing commission. This 'adviser' was located on the diametrically opposite side of Sydney to where I lived.

A couple of years later I came across someone who had also made a direct investment with the same institution. Despite their living not far from my 'adviser', they were allocated an 'adviser' in the next suburb to me.

While gross inefficiency was the favourite, I always wondered whether it may have been part of some sweetener deal where the advisers lock in fees forever with the least likelihood of them having to provide any service. The RC suggests this to be entirely possible.

Garry
November 24, 2018

To me, there is always going to be a misalignment of expectation between what people hope to achieve with their investment decisions and what they actually achieve.
Unlike the purchase of products and services which are consumed immediately and hence provides immediate feedback,the value of financial advice can only be gauged after the elapse of considerable time.
As nobody can predict the future, the advice may have been sound but not achieve the objective , or could have been faulty but successful.
Everybody is wise after the event and the weaknesses self evident.

Dane
November 23, 2018

Interesting read. What seems to be forgotten in all this is the client's best interests. If you are operating in a space where you receive payments from fund managers to direct client money into their product, it creates a direct conflict. It will be nigh impossible for an adviser not to be influenced by these commissions when deciding which products to recommend. If you have two funds that are reasonably similar but one pays a higher commission then an adviser's livelihood becomes tied to recommending the one with the higher commission. If you have one actively managed fund with a trail and a low-cost passive fund with no trail then we both know where the client's money will go. This is despite the overwhelming evidence to suggest that low-cost investing creates better long-term outcomes. Against this backdrop, the comment around lower-cost funds often under-performing other investment options is rather perplexing.

We have large sections of the advice industry crying out that their businesses are being impacted by all these changes including with commissions, educations standards etc. If your business model is unable to sustain itself and prosper without fleecing your clients in some way then you shouldn't be in business. Life doesn't owe you a living at the expense of those who save their hard earned and are looking for impartial guidance. Until this space gets cleaned up, is ridden of conflicts and education standards improve, advisers will continue to be put alongside used-car salesmen and real estate agents in terms of trustworthiness

David Close
November 22, 2018

I have a managed fund which I have had for over 20 yrs
During that time the original adviser, who only provided the service of removing the entry fee, onsold to another company. I have never received any service or contact from either of these advisers but find they have received a trailing commission of $60 each month for NO SERVICE. Of course I only found this out by asking the direct question which I should have done years ago.
All advisers who have taken part in this will of course try to justify it -to do otherwise would be to admit to others and to themselves that they have been ripping off clients (whom they have never once contacted), for decades.Sure the commission is paid by the fund (also receiving NO SERVICE) but the client pays in the management fee.

SMSF Trustee
November 24, 2018

More fool the fund manager who kept on paying out of their pockets to an adviser that they didn't need to.

But it hasn't cost you a cent. Such fees are absorbed in the MER that you've signed up to. How the fund manager chooses to spend the fee you pay them is their business, isn't it?

If the fundie stopped paying that adviser, do you think your MER would be any lower? It wouldn't. In economic terms, the incidence - where it impacts - of this payment to the adviser falls on the provider of the product, not its consumer.

I hope the Royal Commission understands this and isn't punishing fund managers for hitting themselves in the face.

Paul
November 22, 2018

Good read.

Commissions though were not initially paid solely as a proxy for service. They were paid as a share of revenue - the adviser introduced the business to a fund manager who sat in a big building charging clients 6 times more than the 0.3% the adviser got.

20 years after advisers helped fund mangers build billions of dollars of FUA and build massive businesses, now they want to stop paying them ? (that they have contracted to pay).

The adviser and fund manager have a contracted arrangement here.

The simple answer isn't just turning them off and allowing the fund manager to keep charging the client their fund manager fees (even if it is reduced by the cost of the trail)

1. Get rid of commissions yes. It's time they go.

2. The fund manager pays out a capital sum to reflect the business they will continue to have that they will continue to earn fees from.

3. the fund manager reduces the fee to the client by the amount of trail commission.


It is like when Comym was asked about the mortgage broking industry..

Commissioner (KH): Are there any ongoing services supplied by a mortgage broker ?

MC: I think they would be limited, Commissioner.

KH: Well, limited or none?

MC: Much closer to none (and he laughed)

Comyn never had a problem paying them when the brokers were recommending CBA loans and helping CBA build a massive loan business.

What Comyn should have said was, these ongoing commissions are a revenue share we pay brokers for introducing the loan to us. Our margin a typical loan is x% and we pay the broker 0.25% of that. Its a way that we distribute product. We don't have an expectation for them to provide an ongoing service, but going forward we could look to change this.

But no economic loss to Comyn, or a fund manager, so let's just throw the adviser under the bus, and tell everyone they are the greedy and dirty ones.

Neil
November 22, 2018

This is a good article. But I get so frustrated about the misuse or ignoring of facts in this overall discussion.

Commission was a tax effective, cash flow funded, administratively efficient way to move from big upfront life commission to a world where advisers provide advice which is paid for over a period of years and where hopefully there is a level of ongoing service.

It was a step ahead of badly flawed system towards a better system. ASIC and the Royal Commission are now condemning adviser behaviour based on ten year old evidence and current rules.

It is easy to be critical when you avoid the facts and level of change for the better.

Advisers do care. They have made a contribution to overall wealth of Australians which is growing. Have lawyers? or do they just take their share of other people’s money?

Greg
November 25, 2018

It's interesting to note Comyns comments on mortgage brokers and contrast them with planners. I was astounded recently to find that brokers have no ongoing access to their clients loans or banking info after they introduce a loan to a lender. As a planner i have full access to super, investment and insurance that i put in place for my clients. After all, how can i provide ongoing service without up to date information? Mortgage brokers are the same.

Dean
December 02, 2018

Not quite true. Some lenders do provide brokers with ongoing access to client loan details to facilitate ongoing service. They have web portals very similar to those used by planners.

Conversely, some super funds make it very difficult for planners to access ongoing client information even when it's needed to provide ongoing advice. Most union ("Industry") funds are extremely uncooperative in this regard. It is one of the main reasons planners are reluctant to recommend union funds.

An oddity in this picture is AMP. Their portal has the capability to show loan details for AMP bank products. But only AMP licensed brokers can access it. AMP doesn't allow web access by non AMP brokers.

Ross
November 22, 2018

Very good article and explains the history and how we got to where we have. What I still have trouble in understanding why adviser can't confront their clients and say this is the fee you will be charged for the services I am providing. We continue to go around the back door and not be transparent with the fees.

Richard Brannelly
November 22, 2018

When the Royal Commission revealed some Licensees & Planners (including AMPFP) still received up to 70% of their total revenue from grandfathered commissions I was truly shocked. These commissions were banned for all new investments since 2013 and the writing was on the wall long before then. In our business grandfathered revenue is 3% of total income and those few remaining accounts have all been intensely scrutinised. They are being retained for very valid reasons such as large unrealised capital gains or preferential Centrelink assessment. It is beyond credibility that 70% of a planners clientele would be in this position in 2018. New legislation will need to be enforced for this to change.

Cynical Abused Adviser
November 25, 2018

Well you are the golden haired boy. Some of us purchased financial planning businesses from bank owned licensees, funded by the said bank, locked in for a period of time from changing licensee. Since that time, have been slowly moving clients (if in their best interest of course) to fee only. Funny tho, a very limited APL (Platform)has stopped us from recommending product away from bank owned licensee. See the issue? Bank loses nothing and shifts all compliance requirements to adviser yet retains all profits. Funny thing tho, since the RC our bank owned licensee has “opened up” their APL to include none aligned platform providers..I am very cynical about the timing.
Finally, we have had our restriction to move licensees raised and are in the process of doing this. Another diabolical exercise with current licensee making us jump through hoops. What keeps us going? The clients who rely on our ongoing advice and help to reach their goals. But we have been raped and pillaged by this industry in the process and remain scathing of the system that allowed this in the first place.

Frank
November 22, 2018

Most in the industry expected commissions to be gone by now, given they were banned on new arrangements since 2013, but there's been creativity to keep them in place. AMP estimates 70% of advice revenue comes from trail so they're unlikely to abandon soon, especially with David Murray in charge.

 

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