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Current regulation of financial products and services in Australia
This chapter provides a broad overview of the current regulatory
arrangements for financial products and services in Australia. It also provides
a brief snapshot of the Australian financial services sector at the time of
Financial services regulation in Australia
The regulation of financial services providers has been designed to maximise
market efficiency, with minimal regulatory intervention to protect investors. The
Australian Securities and Investments Commission (ASIC) informed the committee:
The fundamental policy settings of the FSR regime were
developed following the principles set out in the Financial System Inquiry
Report 1997 (the Wallis Report). These principles are based on ‘efficient
markets theory’, a belief that markets drive efficiency and that regulatory
intervention should be kept to a minimum to allow markets to achieve maximum
efficiency. The ‘efficient markets theory’ has shaped both the FSR regime and
ASIC’s role and powers.
Regulation to protect investors is limited to conduct and disclosure
requirements imposed on Australian Financial Services Licence (AFSL) holders.
The purpose of these is:
conduct regulation – rules designed to ensure industry
participants behave with honesty, fairness, integrity and competence, as well
as rules relating to the settlement of disputes between market participants and
disclosure regulation – rules designed to:
overcome the information
asymmetry between industry participants and investors by requiring disclosure
of information required to facilitate informed decisions by investors; and
promote transparency in
ASIC described the system as designed to be 'largely self-executing',
with ASIC's role being 'to oversee and enforce compliance'.
The financial services licensing system and the associated conduct and
disclosure requirements are outlined in more detail below.
ASIC's role in administering the licensing process, or monitoring and
enforcing compliance with licensees' regulatory obligations, does not include ASIC
vetting licensees' business models or preventing the availability of complex or
high risk financial products to unsophisticated investors. ASIC noted:
Conduct and disclosure regulation does not involve any
guarantee that regulated products and institutions will not fail and that
promises made to retail investors will be met. Under a conduct and disclosure
regime retail investors are still subject to risks.
Section 911A of the Corporations Act 2001 (Corporations Act)
stipulates that financial services businesses, including those who provide
financial product advice, must hold an Australian Financial Services Licence (AFSL).
As part of its responsibility for regulating the financial services industry,
licences are issued and monitored by ASIC.
Section 766A of the Corporations Act states that the provision of a
financial service includes the following:
providing financial product advice;
dealing in financial products;
making a market for financial products;
operating a registered scheme; or
providing a custodial or depository service.
Section 763A of the Corporations Act defines a financial product as a
facility where a person makes a financial investment, manages financial risk or
makes non-cash payments.
An AFSL imposes a number of obligations on licensees and their
representatives, including the scope of the financial services the licensee is
authorised to provide.
All financial services providers hold a single category of licence, though the
conditions attached to their AFSL may vary between licensees. In accordance
with section 914A of the Corporations Act, ASIC has the discretion to alter the
conditions attached to AFS licences. This includes exemptions to particular
licence conditions in certain circumstances.
Section 911A provides that authorised representatives or employees of
AFSL holders (licensees) are not required to hold a licence themselves. The
licensee is responsible for the financial service or advice delivered by their
representative. If a person is providing a financial service or advice without
supervision, if their conduct is not covered by someone else's compensation
arrangements, or if client assets and payments are held in their name or paid
into their account and commissions are received directly, then they are likely
to require an AFSL in their own right.
Prospective licensees are required to undertake a number of steps in
order to demonstrate to ASIC that they are going to be able to meet the
conditions applying to licence holders. These include (but are not limited to)
the requirements for licensees to provide the following information or documentation:
details of the financial services business, including the nature
of the services to be provided and to whom they will be offered, and an
information on the prospective licensee's responsible managers to
enable ASIC to assess organisational competence, including criminal and
bankruptcy checks, references and qualifications against their role; and
demonstrations that the prospective licensee has the necessary
financial resources to carry on the proposed business, including financial
statements and cash flow projections.
ASIC noted that it has limited grounds on which to deny an application
for a licence:
ASIC must grant an AFS licence if:
the application is made properly;
is satisfied that the applicant or the applicant’s responsible managers are of
has no reason to believe that the applicant will not comply with licensee
applicant has provided ASIC with any additional information requested for the
purposes of assessing the application.
ASIC cannot refuse an application for an AFS licence for
reasons beyond the above-specified criteria (e.g. ASIC cannot refuse to grant a
licence on the basis of the licensee’s proposed business model). ASIC cannot
refuse to grant a licence without giving the applicant an opportunity to be
heard and a refusal to grant a licence can be appealed to the Administrative
Appeals Tribunal (AAT).
The Corporations Act sets out a number of conditions or obligations
applying to AFSL holders and their representatives. These include the following
general obligations under section 912A:
providing relevant financial services efficiently, honestly and
arrangements to manage conflicts of interest;
complying with licence conditions and relevant financial services
laws, including taking reasonable measures to ensure that authorised
representatives do this;
having adequate resources;
maintaining competence to provide the financial service,
including training representatives to maintain their competence;
adequate risk management systems; and
a dispute resolution system and compensation arrangements for
Licensees must also meet other legislative obligations including:
notifying ASIC of any likely breach of their licensee obligations
disclosure requirements under the Corporations Act, including the
requirement to provide clients with information on remuneration, commissions
and other benefits derived from the advice being provided (sections 941-943 and
a requirement for personal advice to have a reasonable basis and
be appropriate for the client (s945A);
market conduct provisions in the Corporations Act; and
consumer protection provisions of the ASIC Act.
The conduct and disclosure requirements most relevant to this inquiry
are explained in more detail below.
Licensees authorised to provide advice about financial products are
required to meet certain minimum legislative standards when advising clients.
The Corporations Act outlines the circumstances that constitute the
provision of financial product advice, split into two categories: personal
advice and general advice. Under section 766B(1) of the Corporations Act,
financial product advice is defined as:
...a recommendation or a statement of opinion, or a report of
either of those things, that:
is intended to influence a person or persons in
making a decision in relation to a particular financial product or class of
financial products, or an interest in a particular financial product or class
of financial products; or
could reasonably be regarded as being intended to
have such an influence.
Section 766B(3) of the Act defines personal advice as:
...financial product advice that is given or directed to a
person (including by electronic means) in circumstances where:
the provider of the advice has considered one or
more of the person's objectives, financial situation and needs...; or
a reasonable person might have expected the provider
to consider one or more of those matters.
Section 766B(4) defines general advice as: '...financial product advice
that is not personal advice.'
Advisers providing personal financial advice must ensure that there is a
reasonable basis for that advice, often referred to as the 'suitability rule'.
Section 945A of the Corporations Act stipulates that:
The providing entity must only provide the advice to the
the providing entity:
determines the relevant
personal circumstances in relation to giving the advice; and
makes reasonable inquiries
in relation to those personal circumstances; and
having regard to information
obtained from the client in relation to those personal circumstances, the
providing entity has given such consideration to, and conducted such
investigation of, the subject matter of the advice as is reasonable in all of
the circumstances; and
the advice is appropriate to
the client, having regard to that consideration and investigation.
In other words, the adviser must know their client, know the product and/or
strategy they are recommending, and ensure that the product and/or strategy is
appropriate to the clients' particular needs. This standard does not require
that personal advice needs to be 'ideal, perfect or best'.
A more detailed explanation of the requirement to provide advice of a standard
that complies with section 945A is included in ASIC's Regulatory Guide 175.
Section 949A of the Corporations Act requires that licensees providing
general advice to clients warn them that the advice does not take into account
their personal objectives, financial situation or needs.
Part 7.7 of the Corporations Act requires licensees and their authorised
representatives to provide certain disclosure material to retail clients.
All retail clients of financial services providers must be given a
Financial Services Guide (FSG):
The FSG provisions are designed to ensure that the client is
given sufficient information to enable them to decide whether to obtain the
financial services from the providing entity. An FSG must also include
kinds of financial services the providing entity is authorised to provide under
its AFS licence;
the providing entity acts for when providing the authorised services;
(including commission) or other benefits connected to providing the authorised
interests, associations or relationships that might be expected to be or have
been capable of influencing the providing entity in providing the authorised
dispute resolution systems.
Where a licensee provides personal financial advice to a retail client,
a Statement of Advice (SOA) must also be provided:
An SOA must set out the advice and the basis on which it was
given. It must also contain:
the name and contact details of the provider of the
about remuneration (including commissions) or other benefits that the provider
and related or associated persons or entities may receive (these amounts must
be disclosed in dollars unless otherwise permitted by ASIC relief); and
about other interests, associations or relationships that might be expected to
be or have been capable of influencing the advice.
These obligations require licensees and authorised representatives to
disclose any potential conflicts of interest when providing financial advice,
either because of their particular ownership or remunerative arrangements. Section
947B(6) of the Corporations Act states that the information provided in the SOA
'must be worded in a clear, concise and effective manner'.
Competency and training
A general obligation for licensees under section 912A of the
Corporations Act is to ensure that authorised representatives are adequately
trained and competent to provide the relevant financial services. The level of
training required of financial advisers is commensurate with the complexity of
the products they advise on and whether the advice is of a general or personal
Products are divided into Tier 1 and Tier 2 categories, with the latter
being comprised of more straightforward products such as general insurance
products and basic deposit products.
ASIC's Regulatory Guide 146 sets out in detail the various minimum training
standards for advisers and how these can be met. The most arduous minimum
training requirements, applying to financial advisers providing personal advice
on more complex financial products, are equivalent to diploma level
Professional indemnity (PI)
Section 912B of the Corporations Act requires that licensees have
compensation arrangements for loss or damage caused by breaches of their
legislative obligations under Chapter 7 of the Act:
Under these arrangements, licensees must obtain PI insurance
that is adequate having regard to the nature of the licensees business and its
potential liability for compensation claims, or be approved by ASIC as
alternative arrangements. In determining what is adequate insurance, ASIC will
take into account what is available in the market.
ASIC has established a transition period for the implementation of
compulsory PI insurance:
To achieve this objective, we will take a staged approach to
administering these requirements:
For an implementation period
of two years after the requirements commenced on 1 January 2008, we consider it
to be adequate for licensees to have PI insurance based on what is available in
the market, provided it meets some minimum standards.
At the end of the two-year
implementation period, we will expect licensees to have PI insurance that
reliably delivers on all aspects of the policy objective (for the avoidance of
doubt, licensees are not required to obtain automatic run-off cover from 1
Compulsory PI insurance is intended to reduce the risk that retail
clients are left without compensation because the licensee does not have
sufficient resources to meet claims. However, PI insurance is limited in its
ability to protect consumers, being designed to protect the insured (the
licensee) against losses from providing non‑compliant financial advice.
It does not cover losses incurred where a licensee becomes insolvent and their
policy consequently ceases to exist. Protection is also limited by the
circumstances insurers are willing to include in the cover they offer
Margin lending refers to the practice of lending for the purpose of
investing, usually in shares, with the loan secured against the value of the
borrower's investment portfolio. When the value of the borrowers' equity falls
below an agreed proportion of the value of their portfolio (the loan to value
ratio, or LVR), a margin call is made requiring the borrower to rectify this by
either contributing additional equity or selling some of their shares.
Prior to October 2009 margin loan products were not regulated as a
financial product under the Corporations Act. Margin lenders were not therefore
subject to the conduct and disclosure requirements of AFSL holders.
On October 26 2009 the parliament passed a bill to amend the
Corporations Act to ensure that margin loans are regulated as financial products
under the Act, and anyone providing or advising on margin loans will be
required to be licensed to do so, either by applying for an AFSL or varying
their existing one. The bill also introduced a responsible lending requirement
for margin lenders and clarified margin call arrangements.
ASIC is responsible for ensuring compliance with AFS licence conditions,
comprised of monitoring, surveillance and intervention measures. Enforcement
action is tailored to 'encourage compliance with the law and raise business
competence and conduct standards'.
Non-compliance issues are brought to ASIC's attention via a number of
means. These include mandatory breach reporting by licensees, complaints from
external sources, targeted surveillance activities and document reviews.
Enforcement action may include administrative, civil or criminal action
to address breaches. Administrative action available to ASIC includes
suspending or cancelling the licence, banning the licensee from providing
financial services or varying the conditions of the licence. ASIC also uses
enforceable undertakings as an alternative to pursuing other remedies.
Finally, ASIC may take civil and criminal action in accordance with the
provisions of the Corporations Act dealing with breaches of the Act.
ASIC is unable to take action in anticipation of a licensee not
complying with its obligations.
In the financial year 2006-07, there were five ASIC-initiated licence
cancellations; 20 in 2007-08; and 21 in 2008-09. ASIC also reported that most
licences are granted with modification (88 per cent in 2007-08) and a
considerable number are withdrawn during the application process (6 per cent in
Financial services sector in Australia
The focus for this inquiry has been on retail investment in financial
products (excluding superannuation) made on the basis of personal financial
advice. This includes investment in shares, non-superannuation managed funds
and debt securities (including debentures). The total value of household
investment in these products is around $350 billion, though this includes
investment that was not made on the basis of advice.
ASIC indicated that around 34 per cent of retail investors who hold shares
directly get advice from a financial adviser; debentures are infrequently sold
via an adviser; while just over half the funds in managed fund products are
placed through advisers.
The most common method for providing financial advisory services in
Australia is through one of the approximately 160 dealer groups currently
operating in Australia. There are just over 18,000 financial advisers in
Australia working for 749 advisory groups operating over 8,000 practices. The
largest 20 dealer groups hold approximately 50 per cent of market share.
Around 85 per cent of financial advisers are associated with a product
manufacturer, either as financial advisers working within the group and using
the dealer's support services or as directly employed authorised
representatives under that corporate entity's AFSL.
ASIC explained the various business models used in the industry:
Medium to large sized ‘dealer groups’ that often operate
like a franchise where the licensee offers back office support. The advisers
operate as authorised representatives who retain a right to take clients with
them if they move to another licensee. The licensee is paid a proportion of the
remuneration made by the authorised representative. Example: AMP Financial
Institutional-owned financial adviser firms with employed
advisers. Advisers in bank owned financial adviser firms are generally employed
by the bank. Advisers are paid a proportion of the commissions earned or
salaries or a combination of both. Example: Westpac Financial Planning.
Smaller firms that have their own licence and might
outsource compliance functions to specialist dealer services providers such as Paragem
Partners or to large dealer groups who provide dealer to dealer compliance
services. Example: Securitor.
Financial advisers are paid through a variety of remuneration models,
including fee-for-service, commissions and bonuses. Fee-for-service charges are
paid by clients to the adviser and may be an hourly rate or a proportion of
funds under management (FUM). Commissions are paid by product manufacturers to
advisers, usually as up-front payments as a proportion of the investment or as
an ongoing trailing commission. Bonuses are generally paid by manufacturers to
providers for meeting certain volume targets. ASIC described commission-based
remuneration as the most common industry practice:
Because an explicit fee for service would likely be perceived
by retail investors as high in relation to the value of advisory services, most
financial advisers tend to charge low or zero fees for service, in order to
encourage business. They then get remuneration indirectly by receiving
commissions from product manufacturers on the funds invested by retail
investors. Product manufacturers recover the costs of commissions from the
overall charges within the investment products.
Trailing commissions (usually 0.6% of account balances) are
the main remuneration method for financial planners, with seven in ten planners
citing them as a form of remuneration. Other forms of remuneration include
initial commission on new investment/contribution (up to 4-5% of
contributions), volume bonuses (i.e. additional commission of up to 0.25% of
account balances), and fee for service charged to the client (up to 1% of
account balance, or a flat fee, perhaps related to the hours involved). These amounts
would not all be paid at the maximum level.
Only 16 per cent of total financial adviser revenue in 2008 came from
fee‑for‑service charges. Independent advisers are more likely to
earn a majority of their revenue from fee-for-service than aligned planners or
bank planners, while affluent clients are more likely to pay fee-for-service
than those in the low to mid-wealth range.
The effect of the industry's ownership and remuneration arrangements on
the quality and cost of financial advice is explored in detail in Chapter 5 of
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