The end of exceptions?
“Recommendation 2.4 – Grandfathered commissions
Grandfathering provisions for conflicted remuneration should be repealed as soon as is reasonably practicable. ”
— COMMISSIONER KENNETH HAYNE, FINAL REPORT, FSRC
On 22 February 2019, Treasury released exposure draft legislation which, if ever introduced, passed and enacted, will prohibit the payment to financial advisers of grandfathering conflicted remuneration.
These grandfathering arrangements in relation to financial advice to retail clients are proposed to be removed from 1 January 2021.
If you, like many advisers, are concerned about how this could be effected without triggering an entitlement to compensation for compulsory acquisition, you should read the draft Treasury Laws Amendment (Ending Grandfathered Conflicted Remuneration) Bill 2019 and the recently released draft regulations.
Essentially, the Bill invalidates the entitlement to compensation, and side-steps the ‘acquisition’ and ‘enrichment’ issues, by requiring that ‘grandfathered benefits’ are passed through to the customer to whom they relate. The draft regulations, and the ‘pass through’ requirement, also introduce additional record keeping obligations on the parties involved in the arrangements.
Why ban grandfathered benefits?
“Conflicted remuneration is where the payment of a benefit to a financial adviser may incentivise them to recommend to a consumer a financial product that may not be in their best interests. ”
— The Hon Josh Frydenberg MP, 22 February 2019
One of the key elements of the FOFA reforms, was the banning of conflicted remuneration.
The public policy reasons for this prohibition were clear, but the ‘grandfathering provisions’ exempted:
- benefits paid under arrangements entered into before 1 July 2013 except with respect to benefits given by a platform operator;
- volume-based shelf-space benefits paid under arrangements entered into before 1 July 2013; and
- asset-based fees on borrowed amounts used to acquire financial products on or after 1 July 2013.
These benefits were not considered to be ‘conflicted remuneration’ and could therefore continue to be offered, paid and received despite the prohibition.
The exemptions themselves are structured in a particular fashion. If you review them, you’ll note that a common element of these provisions is that regulations made in respect of these matters do not apply where the acquisition of property (other than on just terms) would result.
The new law repeals this protection.
Regulation, in respect of these benefits, can be made even where they result in the acquisition of property other than on just terms.
The new law also removes the entitlement for compensation for compulsory acquisition in respect of a benefit given to a financial services licensee, or a representative of a financial services licensee.
The argument for change
“At the time the grandfathering arrangements were first introduced, participants in the industry could say that sudden change in remuneration arrangements may bring untoward consequences for countervailing benefits that would not outweigh the harms of disruption. In the seventh round of hearings, Mr Comyn cast doubt on whether that argument was ever valid. He described the decision by banks to lobby for the grandfathering exemption as a ‘poor decision’. Even if the arguments relied on to justify the grandfathering exception were valid when that exception was introduced, it is now clear that they have outlived their validity”
— COMMISSIONER KENNETH HAYNE, FINAL REPORT, FSRC , 240
Sidestepping ‘acquisition’ (and unjust enrichment)
“To bring the constitutional provision into play it is not enough that legislation adversely affects or terminates a pre-existing right that an owner enjoys in relation to his property; there must be an acquisition whereby the Commonwealth or another acquires an interest in property, however slight or insubstantial it may be.”
— MASON J, Commonwealth v Tasmania (“Tasmanian Dam case”) [1983] HCA 21; (1983) 158 CLR 1 (1 July 1983)
Some lawyers may argue that banning the payment of conflicted remuneration is an acquisition of property that, in accordance with the Constitution, can only be acquired on just terms and the payment of compensation for compulsory acquisition (s51(xxxi)).
I’ll leave that argument for the constitutional lawyers and simply highlight that it is neither Justice Hayne’s view nor one convincingly supported by binding precedents.
In fact, JT International SA v Commonwealth of Australia British American Tobacco Australasia Limited v The Commonwealth [2012] HCA 43, might alarm some of those depending on litigation to protect their grandfathered income.
For example, one key takeout from the Tobacco Advertising Case (at 42) is that “acquisition is .. not made out by mere extinguishment of rights” but requires acquisition of property by the Commonwealth.
By banning conflicted remuneration, the Government does not acquire any property. Therefore, there’s neither any compulsory acquisition nor any entitlement to compensation. In simple terms, in the absence of what Deane J described in 1983 as “an identifiable and measurable advantage” for the Commonwealth, there is no acquisition.
There may be an argument that the retention of the benefits by the Issuer represents ‘acquisition’ (or unjust enrichment), but the new law avoids this entanglement by allowing “benefits that would otherwise have been paid as conflicted remuneration” to be rebated, after 1 January 2021, to affected retail clients.
The ‘acquisition of benefits’ argument is further undermined, and potentially invalidated but the return of those benefits to the persons to whom they relate.
The Government seems to intend for the rebates, payments or fee reductions to “be based on the conflicted remuneration that would be paid in relation to the affected clients”, but the practicality of this requirement may be more challenging than they anticipate.
Why this matters
“Come writers and critics
Who prophesize with your pen
And keep your eyes wide
The chance won’t come again”
— Bob Dylan, “The times, they are a’ changin'”
Until 25 April 2019, you have the opportunity to submit responses to Treasury’s consultation.
Take the time to consider the proposed changes. Take additional time to consider whether, and to what extent, accepting the Government’s position allows future governments to take a similar position on risk insurance commissions. There’s no immediate threat to Life Insurance given the rearguard action being fought by some Insurers, but the possibility exists.
If their reasoning is valid, the current exemptions could be easily disallowed.
As some commentators have noted, the impact of these changes could be significant.
“Adviser Ratings estimates that the removal of grandfathered commissions will slash the average adviser income by 42 per cent. For some firms, it could be as much as 75 per cent.”
— Adele Ferguson, “Tough times before the mast as AMP voyages to the new world”, AFR, April 8 2019
