Conflicted remuneration - new ASIC policy guidance

Articles Written by Austin Bell (Partner), Andrew Moore

Executive summary

Executive summary

ASIC has released guidance on its approach to administering the conflicted remuneration provisions of Part 7.7A of the Corporations Act 2001 (Act): Regulatory Guide 246 (RG 246). These provisions generally apply to benefits given or accepted under arrangements entered into on or after 1 July 2013 (however, there are proposed changes to grandfathering, discussed below). This note discusses some of the key points of RG 246.

What is conflicted remuneration?

Section 963A of the Act provides that:

Conflicted Remuneration means any benefit, whether monetary or non-monetary, given to a licensee or their representative, who provides financial product advice to persons as retail clients that, because of the nature of the benefit or the circumstances in which it is given:

  1. could reasonably be expected to influence the choice of financial product recommended by the licensee or representative to retail clients; or
  2. could reasonably be expected to influence the financial product advice given to retail clients by the licensee or representative.1

A financial services licensee and its representatives must not accept conflicted remuneration: s.963H. Product issuers and sellers may not give conflicted remuneration: s.963K. In addition, employers of an AFS licensee or representative may not give their AFS licensee or representative employees conflicted remuneration for work they carry out as an employee: s.963J.

Volume-based benefits (i.e. benefits related to the number or value of financial products recommended or acquired) are presumed to be conflicted remuneration: s.963L.

Other banned remuneration

Part 7.7A of the Act also deals with other types of remuneration:

  1. a platform operator may not (subject to certain exclusions) accept a volume-based shelf-space fee from a funds manager: s.964A(1); and
  2. an AFS licensee, or its representative, who provides financial product advice to a retail client must not charge asset-based fees on borrowed amounts used to acquire financial products by, or on behalf of, the client: s.964D.

How will the policy affect financial advisers and product issuers?

How will the policy affect financial advisers and product issuers?

Some of the key points discussed in RG 246 are:

General

  • Substance over form: in deciding whethera benefit is conflicted remuneration, ASIC will look at the substance of the benefit over form; not surprisingly, renaming the benefit as something that is not prohibited (e.g. an asset fee),2 or stating in documentation that a benefit is not intended to influence the advice given, will not be effective to take a benefit out of the conflicted remuneration regime (RG 246.51).

Exceptions from conflicted remuneration

  • Passing on benefits: a benefit is not conflicted remuneration if it is given by a retail client in relation to financial product advice given by the AFS licensee or representative to the client (s.963B(1)(d)) (e.g. fees paid by retail clients are not conflicted remuneration). ASIC's policy now clarifies its view that the benefit can initially be given to a third person that passes on the benefit to the AFS licensee or representative (as applicable). For example, if the client consents, a product issuer could collect the benefit on behalf of a dealer group that distributes the relevant products and then pass the benefit on to the dealer group. The exclusion will only apply if the client has authorised passing on the benefits in this way.

Volume-based benefits

  • Licensed dealer groups that are product issuers: RG 246 states that if an AFS licensee is a licensed dealer group and also a platform operator or other product issuer, some benefits provided to the AFS licensee in its capacity as platform operator or other product issuer may be conflicted remuneration.

For example, where the increased use of the platform or other product would increase the benefit given to the AFS licensee (e.g. management fees for the product) and thus the benefit is volume based, the onus will be on the AFS licensee to rebut the presumption in s.963L and show that the volume-based benefits are not conflicted remuneration: RG 246.99. The licensee can do this by showing that the benefit could not reasonably be expected to influence the advice given. If the benefit is not volume based, it is still conflicted remuneration if the benefit could reasonably be expected to influence the advice given.

ASIC's position seems to relate only to the situation where one AFS licensee entity provides both advice services and products, and thus the AFS licensee automatically obtains the benefit of any increase in management fees.

  • Management fees charged by product issuers: ASIC has decided to take a no-action position in relation to a product issuer (e.g. a responsible entity) that gives general financial product advice3 in relation to its own financial products, resulting in an increase in, or the maintenance of, management or administration fees payable out of a fund (RG 246.112).4 ASIC confirms that, in its view, the acceptance of the management or administration provisions in this situation may breach the conflicted remuneration provisions; however, it will not take action in relation to such a breach. Note, however, that an ASIC no-action position does not affect the rights of third parties, (e.g. retail clients of the product issuer), to take action in relation to a breach of the law.
  • Equity arrangements: representatives and other AFS licensees may receive shares or other interests in the AFS licensee's business. Such arrangements may enable representatives to receive volume-based payments in the form of dividends or other profit-sharing benefits, which may be conflicted remuneration. ASIC notes, however, that an equity arrangement is only conflicted remuneration if it could reasonably be expected to influence the advice that the representative gives (RG 246.108). One of the factors in determining whether an equity arrangement with a representative is conflicted remuneration is the directness of the link between the value of the equity arrangement and the value or number of financial products recommended or acquired based on the advice of the representative. It is not clear from the discussion in RG 246 why, for example, an equity arrangement for an AFS licensee business that relies on fee income would give rise to conflicted remuneration.
  • Volume-based benefits that may not be conflicted remuneration: ASIC considers that some volume-based benefits will generally not be conflicted remuneration (RG 246.117); these include:
    • where the AFS licensee or representative accepts the benefit on the condition that it will be passed on to the client, and it is passed on promptly to the client (as soon as practicable but no later than three months after receiving the benefit); and
    • where a licensed dealer group receives benefits that are not passed on to the representative that is the advice provider, but are instead used for operating expenses (which may include expenses of representatives). RG 246 states that in this case, ASIC is less likely to scrutinise the benefit if there are controls in place to ensure that the benefit does not influence the advice given by representatives of the dealer group: RG 246.123.

Performance benefits for employees

  • Performance benefits and conflicted remuneration: according to RG 246, not all performance benefits given to employees who provide financial product advice to retail clients are conflicted remuneration (RG 246.124). These benefits are only conflicted remuneration if they could reasonably be expected to influence the advice given by an employee that is an AFS licensee or representative. A performance benefit that is based only on non-volume-based criteria (e.g., complying with the law, client satisfaction, number of new clients, training undertaken) is not presumed to be conflicted remuneration. RG 246 sets out a number of factors to consider in evaluating whether performance benefits give rise to conflicted remuneration (RG 246.142). However, RG 246 goes on to state that complying with the conflicted remuneration provisions may mean that remuneration arrangements used in many financial services businesses may need to change (RG 246.126).

Volume-based shelf-space fees

  • Prohibition: platform operators are prohibited from accepting volume-based shelf-space fees from fund managers: s.964A(1) of the Act. A shelf-space fee is a fee for making the product available through the platform.
  • Exclusions: a benefit is generally presumed5 to be a volume-based shelf-space fee if the benefit, or the value of the benefit, is wholly or partly dependent on the total number or value of the fund manager's financial products to which the platform arrangement relates: s.964A(2). There are 2 key exclusions to this presumption:
    • where the benefit is a reasonable fee for a service provided to the funds manager by the platform operator or another person (the fee-for-service exclusion): s.964A(3)(a); or
    • where the benefit is a discount or rebate to the fund manager by the platform operator, where the value of this benefit does not exceed the efficiencies gained by the fund manager, because of the number or value of financial products in relation to which the fund manager provides services to the platform operator, or through the platform operator to another person: s.964A(3)(b) (the scale efficiencies exclusion).
  • Fee-for-service exclusion: this exclusion may for example apply to fees charged to cover the platform operator's costs in listing a product on its platform, or fees for reporting services provided by the platform operator to the funds manager (RG 246.154). RG 246 takes the view that for the exclusion to be applicable, there should generally be a correlation between the fee and the platform operator's costs in providing the service. ASIC lists certain matters (RG 246.155) that will cause it to scrutinise a fee to determine whether it is a prohibited volume-based shelf-space fee (e.g. if the fee is based on funds under management rather than the operator's costs, or if the fee is inconsistent with average fees charged by other platform operators).
  • Scale efficiencies exclusion: to rely on the scale efficiencies exclusion, a platform operator must be able to demonstrate how a rebate or discount was arrived at and how it is referable to scale efficiencies or estimated scale efficiencies gained by the fund manager from distributing its products through the platform (RG 246.157). ASIC does not consider that receiving a written confirmation from a funds manager alone that states that a discount or rebate is referable to the scale efficiencies gained by the fund manager will be adequate (RG 246.161).

Asset-based fees on borrowed amounts

  • Prohibition: AFS licensees and authorised representatives that provide financial product advice to retail clients are generally prohibited from charging asset-based fees on borrowed amounts that are to be used to acquire financial products by or on behalf of a client: s.964D and 964E of the Act. A fee for providing financial product adviceto a person as a retail client is an asset-based fee to the extent that it is dependent upon the amount of funds used or to be used to acquire financial products by or on behalf of the person: s.964F.
  • No knowledge of borrowing: RG 246 states(consistently with s.964E(2) of the Act) that the ban on charging asset-based fees will not apply to an AFS licensee or authorised representative if they do not know that an amount used to acquire financial products by or on behalf of a client has been borrowed, as long as this fact is not reasonably apparent (RG 246.180).6 ASIC states that AFS licensees and representatives cannot ignore the information they have discovered in the course of making the client enquiries that they are required to make under s.961B of the Act (as part of their best interest duty) when determining whether an amount is borrowed.
  • Portfolio of products: where the client has a portfolio of products purchased with a combination of borrowed and non-borrowed amounts, asset-based fees can only be charged on the portfolio's net value.RG 246 states that if the borrowed proportion varies from time to time, this may require adjustments in the fee arrangements: RG 246.178.

Transitional

  • Current position: generally,the conflicted remuneration provisions do not apply to a benefit given to an AFS licensee or representative if the benefit is given under an arrangement entered into before 1 July 2013.7 Grandfathering also applies to volume-based shelf-space fees and asset-based fees on borrowed amounts.8
  • Arrangement: the term arrangement is very broad. RG 246.194 and following discusses the circumstances in which ASIC will regard an amendment to an arrangement as amounting to a new arrangement (so that benefits under the new arrangement are no longer grandfathered). ASIC states that:
  • "If an arrangement that is in place before the application day [the date from which the conflicted remuneration provisions apply] is changed on or after the application day, benefits under the arrangement may not be grandfathered if the changes are so material that the arrangement is no longer the arrangement that was in place before the application day. Whether this is the case will depend on the circumstances" (at RG 246.196).
  • Proposed changes to grandfathering:9 Treasury has proposed changes to grandfathering:
    • Platform operators: under draft regulation 7.7A.16, benefits given under pre-FOFA arrangements would be grandfathered except where they relate to a new client coming onto the platform after 1 July 2014. Arrangements between financial services licensees and platform operators entered into after 1 July 2013 will not be grandfathered and must be negotiated on a FOFA-compliant basis.
    • Non-platform operators: under draft regulation 7.7A.16A, grandfathering would be limited to conflicted remuneration paid under pre-FOFA arrangements relating to the existing investments of clients at 1 July 2014. Conflicted remuneration from non-platform operators will be subject to the ban for new investments in different products after 1 July 2014 regardless of whether these investments are made through a platform/custodian or directly by the client.10
    • Significance: It remains to be seen whether these proposed changes will be introduced in this form. The significance of the changes is that, if they are introduced, the FOFA conflicted remuneration provisions will apply to certain benefits given under a pre-FOFA arrangement, as follows:
  1. in relation to platform operators, to new clients after 1 July 2014; and
  2. in relation to non-platform operators, to new clients, or existing clients investing in different products, after 1 July 2014.

Anti-avoidance

  • Prohibition: a person may not enter into or carry out a scheme to avoid the application of any provision in Pt 7.7A of the Act (including the conflicted remuneration provisions): s.965 of the Act.11 This provision applies from 1 July 2012.
  • Purpose: in RG 246.215, ASIC states thatthe anti-avoidance provision is designed to ensure that the policy intent of the FOFA reforms, including the conflicted remuneration provisions, is not avoided through industry or transaction structuring. Further, ASIC states that it is more likely to scrutinise a scheme that appears to have no commercial purpose other than to avoid the application of the conflicted remuneration provisions: RG 246.218. In RG 246.219, ASIC gives an example of a financial services business deliberately structured so as to avoid the conflicted remuneration provisions.
  • Non-volume based shelf space fees: at RG 246.220, ASIC states thata scheme may be an avoidance scheme if it is structured so that a platform operator is given or accepts a large flat fee that has no connection to the volume of financial products recommended or acquired by clients, or the number or value of financial products available through a platform. ASIC states that these fees may be used to "purchase" preferential positions on a platform, whereas the purpose of the ban on volume-based shelf-space fees is to prevent such arrangements from occurring. Such flat fees would presumably not be subject to the prohibition on volume-based shelf-space fees, because they are not related to volume. However, a benefit that is a flat fee could be conflicted remuneration in circumstances where the platform operator receives flat fees from more than one product issuer, and the fee paid by one product issuer is higher than for another product issuer.

1 So, for example, a benefit that influences a financial adviser to choose to recommend the acquisition of financial products, rather than choosing to provide strategic advice that does not include a product recommendation, can be conflicted remuneration. That is, it is possible for a product-neutral benefit (a benefit that is the same regardless of which financial products a client acquires) to be conflicted remuneration (RG 246.55).

2 In RG 246, an asset fee is a fee paid by a client to a financial adviser, the amount of which is determined by the amount of funds that the adviser holds on the client's behalf.

3 The conflicted remuneration provisions, unlike a number of other provisions of Part 7.7A of the Act, apply to both generaland personalfinancial product advice.

4 In relation to the responsible entity of a registered managed investment scheme, ASIC will also not take action for any breach of s.601FC(1)(k) (which requires, among other things, that all payments made out of scheme property are made in accordance with the Act).

5 Even if the presumption does not apply, because of the exclusions, it is still possible for the benefit to be a volume-based shelf-space fee (RG 246.152).

6 Something is reasonably apparentif it would be apparent to a person with a reasonable level of expertise in the subject matter of the advice that has been sought by the client, were that person exercising care and objectively assessing the information given to the financial services licensee, or the representative of the financial services licensee, by the client: s.964H. RG 246.179 states that this is an objective standard.

7 An AFS licensee or other person may lodge a notice with ASIC electing to comply with Pt 7.7A of the Act before this date, in which case the Pt 7.7A provisions (including conflicted remuneration) will apply from the date specified in the notice.

8 RG 246.207 - RG 246.211.

9 Set out in a Treasury draft Explanatory Statement for the relevant regulations. These proposed changes are mentioned, but not described in detail, in RG 246. ASIC proposes to update RG 246 when they are finalised: RG 246.190.

10 In relation to non-platform operators, clients will be able to increase their interest in an existing managed investment scheme or superannuation scheme without being taken to have acquired a new financial product. This means that non-platform operators will be able to continue to pay conflicted remuneration in relation to clients who increase their exposure to a product that the client held before 1 July 2014.

11 The effect of the anti-avoidance provision is that a person must not, either alone or with other people, enter into or carry out a scheme if (a) it would be concluded that they did so for the sole or non-incidental purpose of avoiding the application of any provision of Pt 7.7A; and (b) the scheme or part of the scheme has achieved - or, apart from s.965, would achieve, that purpose.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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