2 If a financial adviser is to give appropriate advice, they require a good knowledge of the economic environment. Discuss.

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1 Question 1 Discuss the background to the growth of the financial planning industry in Australia. Why is it important that people obtain good financial advice? A significant factor in the growth of the financial planning industry has been the growth of the size and affluence of the middle class. Other social factors such as longer life expectancy (an ageing population), lower preferred retirement age, longer child-rearing responsibilities, increased participation in tertiary education, more single parent families and larger homes have also impacted on the demand for financial planners to assist with accomplishing goal aspirations. In the late 1970s, independent insurance advisors began to take on this role, although they had almost no formal training. The early 1980s also saw an increase in the use of superannuation and the early 1990s saw the introduction of compulsory superannuation through the Superannuation Guarantee (Admin) Act 1992 which placed further demands on insurance companies to promote their product using commission-based incentives. By the early 1980s, an industry body consisting of independent advisors, the Association of Independent Professional Advisors (AIPA), which excluded banks and insurance companies, was formed in Australia. Later, Australia joined the International Association of Financial Planning (IAFP) and was granted a licence for the Certified Financial Planner (CFP) designation. In 1992, both associations joined together to form the Financial Planning Association (FPA). These institutional aspects played a major role in the beginning stages of developing the financial planning industry in Australia. In particular, the granting of the CFP designation through the FPA meant that the industry could now provide education specifically for financial planners. This began with a Diploma of Financial Planning (DFP) and was seen as a step in the direction of professionalism. Given the ageing population and dependence on social security, the Australian Government introduced compulsory superannuation. Hence, the push to self-funded retirement had begun. In order to ensure the success of this initiative, it is imperative that individuals get good advice in order to reach their goals and objectives. 2 If a financial adviser is to give appropriate advice, they require a good knowledge of the economic environment. Discuss. Unemployment, interest rates, the price of oil, and gross domestic product (GDP): it's hard to read stories about economic trends these days and not wonder how such things affect your investments and financial plan. And you would be right do so, according to financial planners and economists. Decisions on interest rates, unemployment data and other economic variables impact on the confidence of the markets generally. The uses of fiscal and monetary policies are especially important in that they impact directly on the disposable income of the individual. Page 1

2 Given this, the advisor needs to be aware of the economic cycle and in some cases particular variables which change the investment advice or strategies proposed by the adviser to meet the client s goals. 3 Discuss three economic variables and how they might impact the giving of financial advice. Possible answers could include: There are two main reasons why it is necessary for an adviser to have an understanding of the economic environment. The first concerns the behaviour of key economic variables, such as interest rates, unemployment rates and inflation, since monitoring such variables makes it possible to obtain an insight into trends over time, which is a valuable tool for predicting possible future movements. The second reason is that any change in the economic environment affects both industries and firms with respect to consumption investment patterns. This obviously impacts on share prices, which are a reflection of company earnings and investor confidence. If bond prices were increasing, we would expect investors to move out of shares and into bonds. This obviously plays a major role in the stability of the share market and the economy generally. If it is possible to predict such behaviour, it may be possible to cushion or modify the economic impact. Interest rates impact on bond versus share investment: high interest rates remove cash from individuals, making wealth creation more difficult due to limited resources. Another important economic indicator is the rate of unemployment. High unemployment means individuals become more conservative in their consumption and hence savings might increase. Unemployment statistics can swing drastically from one phase of a cycle to the next, and changes in unemployment rates can have severe consequences for financial stability. During periods of high unemployment, individuals have sharply reduced disposable income and relatively negligible saving capacity. High unemployment periods are normally accompanied by high rates of bankruptcy and rising interest rates. These factors would normally be associated with a recession phase of the economic cycle and would be reflected in zero or negative growth in the economy. This obviously impacts on the level of investment and wealth-creation ability of a client. Movements in these variables strike at the very core of a financial plan. Another economic indicator which must be taken into account in drafting a financial plan and/or a statement of advice, is inflation. Inflation plays a major role in determining interest rates. High rates of inflation increase the costs of borrowing, which in turn reduces an individual s capacity to save and invest. High inflation rates tend to have a detrimental effect on share prices, so normally we would expect share prices to decline. Such economic conditions can have far-reaching consequences for retirement plans and other long-term goals. Obviously, a period of low inflation and low interest rates has the opposite effect and would generally be perceived as a favourable economic environment for financial planning. 4 Discuss the role of the Financial Planning Association as the prime Page 2

3 professional body in the financial planning profession. The FPA has five key roles to play: 1 Represent professionals: to become a member of the FPA, financial planners need to meet higher standards than the minimum levels required by law, so it represents the true professionals in the financial planning industry. 2 Advocacy and lobbying: it is the collective voice of its members and their clients and influences government policies and regulations affecting financial planning. The FPA maintains a strong relationship with regulators, politicians and their advisers. 3 Setting and maintaining standards: it sets and enforces professional and ethical standards for members to make sure that they conduct business to the highest quality. 4 Awarding certifications: it is the only Australian professional body that assesses and awards the Certified Financial Planner or CFP mark, which is the highest certification available to financial planners worldwide. 5 Professional development: it designs and offers an industry-leading range of training programmes to help financial planners to keep their knowledge and skills upto-date. In 2009, the FPA became the first financial planning professional association in the world to launch a full suite of professional regulations, incorporating: a set of ethical principles; a complete set of practice standards; and a full range of professional conduct rules. Question 5 The ageing population is a problem for all Western economies. Discuss the issues that are important for government in addressing the ageing population dilemma. Australia's ageing population will increase government spending and slow economic growth over the next 40 years, according to the 2010 Intergenerational Report, Australia to 2050: Future Challenges. The report provides a comprehensive study of the challenges that Australia will face over the next 40 years, including an ageing population, escalating pressures on the health system, and the environmental and economic challenges of climate change. These challenges will place substantial pressure on economic growth, living standards and the federal budget. The report demonstrates just how critical it is to plan for the future, invest in productivity and participation, maintain fiscal discipline, and deal with dangerous climate change. Taking modest steps now means we can avoid the need for much more dramatic and painful adjustments in the future. The report shows clearly that the ageing of Australia's workforce will present a particular set of economic and social challenges. The proportion of Australia's population aged 65 and over is projected to almost double over the next 40 years. Today there are five working-aged people to every person aged 65 and over. By 2050, this ratio will fall to only 2.7 people. With proportionately fewer working-age Australians supporting a much larger population of older Australians, ageing and rising health costs are expected to result in spending exceeding revenue by around 2¾% of GDP in Today, around Page 3

4 a quarter of total Australian Government spending is directed to health, age-related pensions and aged care. The report shows this is expected to rise to around half by The report highlights that productivity growth producing more output with proportionately fewer workers will be the major contributor to increases in living standards over the next 40 years. The government is also taking steps to remove impediments to workforce participation and provide incentives and reward for those Australians who choose to remain in the workforce in their later years. Steps by the government to grow the economy and ensure strong fiscal discipline, including through the implementation of the government's fiscal strategy, will lower future adjustment costs and the economic impacts of the ageing population. 6 In recent times in Australia, we have seen a drastic change in the savings attitudes of the average Australian. Discuss the impact of such a shift from consumption to savings. From the mid-1980s to the mid-2000s, the aggregate household saving ratio declined significantly. Then, over the past half dozen years, this decline has been reversed, and the aggregate household saving ratio is now back to where it was in the mid-1980s. Glenn Stevens, Governor of the Reserve Bank, has recently spoken at length about why these changes took place. In particular, he drew attention to the fact that, as nominal interest rates declined and the availability of credit increased, household spending grew more quickly than income for around a decade or so. Although this adjustment was drawn out, it was, by nature, a one-off event. So even before the North Atlantic financial crisis, households were returning to more traditional norms of saving and borrowing, and, no doubt, the crisis accelerated this return. When we drill down into the data in more detail, an increase in saving ratios is apparent across the entire income distribution, although, not surprisingly, the increase is smallest for households with the lowest incomes. Many of these lowincome households spend a significant share of their income on the basic necessities and they have limited scope to increase the share of their income that they save. Taken together, this evidence is consistent with the idea that higher housing prices and debt levels have contributed to a reassessment of saving decisions, although, obviously, the reasons for the increase in saving go well beyond what has happened in the housing market. Higher housing prices have required higher deposits and this requires more savings. This trend has probably been reinforced by developments on the lending side, with most lenders lowering their maximum loan-to-valuation ratio over recent years. Saving decisions today are also likely being influenced by the earlier rise in debt levels relative to incomes and by debt servicing burdens that are staying higher for longer. The adjustments seem to have been particularly pronounced among younger households who are hoping to enter the housing market or who have recently entered the market This evidence is consistent with the idea that the fall in financial asset prices over recent years led households to increase their saving out of current income in order to rebuild their asset positions. When share prices fell, household wealth declined and, Page 4

5 as a consequence, increased saving was required to attain any desired level of wealth. This was particularly the case for those households that held a lot of financial assets. This experience is the flipside of what happened during the decade to the mid-2000s. During that period, household wealth increased substantially by way of increasing asset prices, despite households saving relatively little out of their current income. The second aspect of the individual-level data is the relationship between the change in the saving ratio and how much uncertainty a household feels about the future. During the last five years, uncertainty around the world increased greatly, with the result that both households and businesses delayed discretionary spending and increased their savings, amplifying the downturn in the global economy. So, in conclusion, there are significant changes in saving and spending patterns taking place in Australia. The effects of these changes are probably most pronounced in the retail sector, with both increased saving and the switch towards services lessening growth in spending on goods. As a result, conditions are quite difficult for many retailers. The increased household saving is, however, a positive development from a national risk-management perspective. Households are using some of their income growth to build up bigger financial buffers, and this should hold them in good stead in the uncertain world in which we live. These higher saving rates are likely to be quite persistent and they represent a return to more traditional patterns. While they partly reflect the ongoing adjustment to the earlier big run up in housing debt and housing prices, the evidence discussed above suggests that there are also other factors at play. In particular, many households appear to have increased their saving in response to the decline in equity prices and an increase in uncertainty about the future. It is reasonable to expect that, at some point, the impact of these factors will begin to wane, although exactly when remains an open question. 7 There have been several recent inquiries into the financial planning industry. These include the Ripoll and Cooper inquiries. Discuss the outcomes of these inquiries and the likely impact on the giving of financial advice. Ripoll Inquiry Australia's economy is set to benefit from the bedding down of the government's financial advice reforms, with the country's financial services industry now freed-up to promote itself as a financial services hub. In an opinion piece published in The Australian, 'Financial Advice Reforms Put Consumers in Front', Parliamentary Secretary to the Treasurer, Bernie Ripoll, said now that the government's Future of Financial Advice (FOFA) reforms are cemented in law, time can be spent on promoting the sector in the Asian Pacific region. We have the experience, we have the skills, we have the credibility, and now with FOFA we have the legislative and cultural shift to match, he said, adding that the FOFA reforms provide the right balance between appropriate regulation of the financial services sector and empowering investors and consumers, while the legislation has also provided participants in Australia's financial services sector with greater degree of professionalism. In principle, FOFA is about having the best interests of the consumer at the heart of Page 5

6 the advice model. Advisers must put the best interests of their clients first It is about setting new standards of service and removing conflicted remuneration by banning the payment of sales commissions. Once again, customer needs will be at the centre of advice and security giving consumers more control of their funds Increasing the number of people seeking advice will also boost financial literacy, the key to making sensible investment decisions. Outcomes of Ripoll Inquiry The eleven recommendations are: 1 that the Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an AFSL, requiring them to place their clients interests ahead of their own; 2 that the government ensure ASIC is appropriately resourced to perform effective risk-based surveillance of the advice provided by licensees and their authorised representatives. ASIC should also conduct financial advice shadow-shopping exercises annually. 3 that the Corporations Act be amended to require advisers to disclose more prominently in marketing material restrictions on the advice they are able to provide consumers and any potential conflicts of interest; 4 that the government consult with and support industry in developing the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers; 5 that the government consider the implications of making the cost of financial advice tax deductible for consumers as part of its response to the Treasury review into the tax system; 6 that section 920A of the Corporations Act be amended to provide extended powers for ASIC to ban individuals from the financial services industry; 7 that, as part of their licence conditions, ASIC require agribusiness MIS licensees to demonstrate they have sufficient working capital to meet current obligations; 8 that sections 913B and 915C of the Corporations Act be amended to allow ASIC to deny an application, or suspend or cancel a licence, where there is a reasonable belief that the licensee may not comply with their obligations under the licence; 9 that ASIC immediately begin consultation with the financial services industry on the establishment of an independent, industry-based professional standards board to oversee nomenclature, competency and conduct standards for financial advisers; 10 that the government investigate the costs and benefits of different models of a statutory last resort compensation fund for investors; and 11 that ASIC develop and deliver more effective education activities targeted to groups in the community who are likely to be seeking financial advice for the first time. Many of these recommendations formed the basis of the Future of Financial Advice Reforms (FOFA) which were passed into legislation in early 2012.Changes have occurred with the winding back of the original FOFA reforms where commissions are now payable in cases of general advice and some reduction in the best interest requirements. Also in October 2014 the government announced the creation of a National Financial Planners Register. Cooper Inquiry The review comprehensively examined and analysed the governance, efficiency, structure and operation of Australia s superannuation system, including both Page 6

7 compulsory and voluntary aspects, addressing, but not limited to, the following issues: Governance: examined the legal and regulatory framework of the superannuation system, including issues of trustee knowledge, skills and training; and thoroughly assessed the risks involved in the use of debt and leverage and the development of investment options that lead to a weakening of the diversification principle in the superannuation system. Efficiency: ensuring the most efficient operation of the superannuation system for all members, whether active or passive members and regardless of whether members are making compulsory or voluntary contributions. Encouraging the removal of unnecessary complexities from the system and operating the scheme in the most cost effective manner and in the best interests of members especially in light of its compulsory nature. Structure: promoting effective competition in the superannuation system that leads to downward pressure on system costs, examining current addon features of the superannuation system, and examining other structural legacy features of the system. Operation: maximising returns to members, including through minimising costs, covering both passive defaulting members, who should receive maximum returns and value for money through soundly regulated default products, and active selecting members, who should not be negatively impacted by conflicts of interest that may inhibit advice being in the best interests of members. Outcomes of Cooper Inquiry Although this list is not exhaustive, some of the outcomes included: Engagement Australians have contributions made to their super funds whether they like it or not. Members should not have to be interested, financially literate, or investment experts to get the most out of their super. If members want to engage and make choices, then the system ought to encourage and facilitate them doing so. If members are not interested, then the system should still work to provide optimal outcomes for them. The super system should work for its members, not vice versa. This is the basis of the panel s new choice architecture. MySuper MySuper is a simple, welldesigned product suitable for the majority of members. The MySuper concept is aimed at lowering overall costs while maintaining a competitive marketbased, private sector infrastructure for super. The concept draws on and enhances an existing and wellknown product (the default investment option). MySuper takes this product, simplifies it, and adds scale, transparency and comparability - all aimed at achieving better member outcomes Regulating for efficiency APRA would have an increased mandate to oversee and promote the overall efficiency and transparency of the superannuation system. To this end, APRA would be given a standardsmaking power in superannuation as a tool for driving transparency and comparability of member outcomes. Helping members compare In order to make meaningful choices (or to understand their personal situation), members need to be able to make like with like comparisons between competing Page 7

8 superannuation products. Standard product dashboards and standardised investment performance reporting would lift the fog that has clouded this area so far. Dollar savings for members Treasury estimates that the MySuper and SuperStream proposals would, in the long run, see a cut of around 40% in fees for the average member. This would lift their final superannuation balance by around $ or 7% after 37 years in the workforce. The review highlighted 10 superannuation policy principles: 1 Superannuation must always be for the benefit of members. The superannuation system does not exist to support intermediaries. Trustees must be relentless in seeking benefits for members. 2 The superannuation system needs to be well-regulated to address prudential and other risks so that members can have the confidence to invest their retirement savings for their long-term financial benefit. 3 Transparency and disclosure are essential for the effective operation of the system, but are not substitutes for well-designed products that work in members interests. Disclosure is a necessary, but not sufficient, condition for ensuring that member interests prevail. 4 Individual choices for members should be available and respected, but members must recognise and accept the increased responsibility that comes with making those choices. 5 The superannuation system must be supported by high quality research and data, as well as by intermediaries with high professional standards. 6 Financial literacy is an important long-term goal, but a compulsory superannuation system cannot depend on all its participants having the skills necessary to comprehend complex financial information or being investment experts. 7 Fees and costs matter; they detract from members retirement savings and need to be managed as diligently as the generation of investment returns. Technological improvements, and innovation generally, should be encouraged to help lower costs and benefit members. 8 Superannuation is a large and complex system with an increasingly important social and macroeconomic dimension. It must be regulated and administered coherently and rule changes, including to taxation rules, should be made sparingly and in a way that engenders member confidence. 9 The system must have sufficient flexibility to accommodate its inherent growth path and should strive for continual improvement, rather than abrupt changes. Where possible, government and trustee decisions about superannuation should be taken with a long-term perspective. 10 Governments should not seek to direct super fund trustees to invest in particular assets or asset classes, nor to prevent investments in certain types of assets or asset classes unless there are prudential or regulatory reasons for doing so. This is regardless of how much it might seem in the national interest to do so. There are 10 recommendations that come out of the report: 1. MySuper: introduction of a low-cost default fund for employees who don t actively choose a super fund. This recommendation will affect 80% of fund members. Available from 1 July SuperStream: according to the final report, key components [of SuperStream] are the increased use of technology, uniform data standards, use of the tax Page 8

9 file number as a key identifier and the straight-through processing of superannuation transactions. 3. Trustee governance: reduce conflicts of interest on trustee boards by establishing a code of Trustee Governance, and create a new position for superannuation trustees, known as trustee-director. 4. Investment governance: minimise the use of performance-based fees in relation to the new default product, MySuper, and further the objective of after-tax returns, rather than rewarding fund managers for gross returns. 5. Outcomes transparency: introduce standardised reporting of investment returns by super funds (such as net of fees and tax), especially in relation to MySuper products, and for APRA to track and publish all investment returns for MySuper products. 6. Insurance in superannuation: in MySuper products, life insurance and TPD insurance should be offered on an opt-out basis. In other super funds it can be offered opt-in or opt-out or not at all, and APRA super funds need to develop an insurance strategy for fund members. Commissions should be banned on insurance cover taken via super funds. 7. System integrity: the capital reserves required to be held by super funds should be increased. 8. Retirement: according to the final report, MySuper products must include one type of income stream product, either through the fund or in conjunction with another provider, so that members can remain in the fund and regard MySuper as a whole of life product. The government should consult comprehensively with industry before mandating the post-retirement arrangements to apply to MySuper products. 9. Self-managed super solutions: maximum number of SMSF trustees/members should continue to be capped at four members, introduce more flexibility in the penalties applicable for SMSF super breaches, improve the knowledge of advisers in the SMSF space, monitor the borrowing rules to ensure SMSF trustees don t get distracted from the main game of retirement, ban in-house assets, ban collectibles and provide SMSFs with five years to sell existing collectibles, and SMSF trustees must value SMSF assets at net market value. 10. Give APRA more power: the report also notes that the ATO needs to be sufficiently resourced to cope with extra administration role from the final report recommendations. Government response to Cooper recommendations The Stronger Super proposals considered four key areas of reform. In 2010, the government s response to these recommendations was: MySuper: the government has recommitted to MySuper, generally along the lines announced during the 2010 Federal election campaign. From 1 July 2013 the government intends that MySuper super products will be available, generally as recommended by the Cooper panel. However, the government has stated it will not prohibit cost-subsidisation of MySuper costs with other super products, instead requiring trustees to make a fair and reasonable allocation of costs. In addition, it will not be initially mandatory for trustees to provide retirement income stream products or intrafund advice to MySuper members. Following an appropriate transitional period, MySuper products will be the only products eligible to act as default funds for both Superannuation Guarantee (SG) Page 9

10 and award purposes. A similar transitional approach will apply to the conversion of existing default funds to MySuper funds. SuperStream. The government has supported the broad direction of the Review s SuperStream recommendations, which include proposals to: allow the use of tax file numbers (TFNs) as the primary account identifier. The government intends this to be in place from 1 July 2011; and encourage the use of technology to improve processing efficiency. It is expected that arrangements relating to common data standards and electronic transmission of data will be settled by 1 July Additionally, the government has also committed to: including information on employee s payslips about the amount of super actually paid into their account; and quarterly notification from an employee s superannuation fund if regular payments cease. Self Managed Super Funds (SMSFs). The government has reconfirmed that it supports and will implement many of the Super System Review s recommendations to reform the SMSF sector. Most of these recommendations reflect a need for appropriate oversight of SMSF service providers; that fund investments are consistent with the purpose of superannuation; and that illegal early access to super activity is curbed. Most measures will commence on 1 July Governance, integrity and other regulatory settings. The government has expressed its support for the objectives of the Review s recommendations aimed at heightening the obligations of superannuation fund trustees to manage their fund s superannuation assets prudently and in the best interests of all the members of the fund. The timing for the commencement of measures in this area, including any relevant transitional arrangements, will be determined following consultation. The government has also established a Stronger Super website at < Both the Ripoll and Cooper inquiries have had far reaching implications for the financial services industry as detailed above. The success of these reforms will take some time to result in a change in culture of the industry. This answer requires additional research by the student outside this chapter in relation to these two inquiries which are detailed at the following sites: wsletter%20non%20eoy%20clients.pdf geid=004&min=ceba&year=&doctype=2 8 The Future of Financial Advice reforms have been touted to be the solution to perceived conflicts of interest in the financial advice arena. Discuss. Further to the Corporations Amendment (Future of Financial Advice) Bill 2012, the bill amends the Corporations Act 2001 to: require financial advisers to act in the best Page 10

11 interests of their clients and to put their client s interests ahead of their own when providing advice; ban the payment and receipt of certain remuneration which has the potential to influence the financial product advice given to retail clients; ban volumebased shelf-space fees from asset managers or product issuers to platform operators; and ban asset-based fees on borrowed client monies. Legislation is effective from 1 July The opt-in provision has been watered down for advisors who are already members of associations with an ASIC approved Code of Conduct. A summary of the highlights of the reforms is below. The FoFA package includes the following significant reforms: 1. Ban on commissions: a prospective ban of all commissions, volume-based payments and conflicted remuneration structures in regard to the distribution, and advice provided in respect of, retail investment products. 2. Statutory fiduciary duty: the imposition of a duty which is aimed at creating a relationship of confidence and trust between advisers and their clients, where the party who has such a duty is required to act in the best interests of the other party. The FoFA proposes that such a fiduciary duty be imposed through statute, subject to a reasonable steps qualification, but which duty will clearly stipulate that the adviser is to place the best interests of their client ahead of their own when providing personal financial advice to retail clients. 3. Opt-in: this adviser charging regime will attempt to better align the interests of the adviser with their client through the provision of product-neutral charging where the client is able to opt in to the advice, which decision will be made in response to an annual renewal notice provided by the adviser to the client. 4. Percentage-based fees, otherwise known as Assets Under Management Fees, will be limited to ungeared products or investment amounts and will only be able to be levied with the consent of the retail client to which the product relates. 5. Low-cost simple advice: the FoFA aims at expanding the availability of lowcost simple advice in order to increase access and affordability of such advice to retail clients. 6. ASIC powers: the strengthening of ASIC s powers in order to act against unscrupulous operators is another mechanism through which the FoFA endeavours to achieve its aims. 7. Statutory compensation scheme: the FoFA recommends that the introduction of a statutory compensation scheme be examined by Richard St John, an expert on the financial services field. 8. Intra fund advice: the FoFA proposes that the present scope of intra-fund advice be extended to enable advisers to provide simple advice to clients regarding matters within their superannuation fund. The intent of the reforms is to seek to ensure that advisors act in the best interests of their clients and that any perceived bias in remuneration is removed. For most up-to-date changes see Chapter 1 of the text and the following website: Page 11