The Code – Issues for advisers (Part Two)

Your Guide to the Code, Part Two is a must-read. It covers off many of the issues causing debate, including: Duty of care; Will you need a degree? Your competence.

This commentary looks at the new Code of Conduct and issues, opportunities and challenges for adviser businesses. It is written by John Berry, a member of the Code Working Group (CWG), in his capacity as a commentator on NZ financial markets and as CEO of Pathfinder.  This commentary therefore contains his personal opinions and is not written on behalf of the CWG. 

Last week in Part One, I presented an overview of the process and challenges faced by the CWG in developing a new Code.  This Part Two focuses on two key issues for which adviser input continues to be welcomed by the CWG: 

  1. What is an appropriate level of duty of care; and 
  2. What is an appropriate base level of adviser competency? 

This leaves several further issues for Part Three.

Good advice outcomes

The CWG’s 12 March 2018 consultation paper proposed a duty of care level based on what the CWG termed as “good advice outcomes”.  This was intended to mean that a consumer receiving advice could reasonably expect quality advice meeting their needs and expectations.  The term reflects the FMA’s guidance on what constitutes good conduct (i.e., a “good outcome”).

I acknowledge the widely held view from advisers that using the word “outcome” in describing a level of care may be unhelpful. This may lead consumers to believe a financial product will always produce a “good outcome” when the term is intended to refer to a “good advice outcome”.

Referencing back to the FMA’s definition of “good”, they state, “ … good does not mean that customers are insulated from risk or that a product always makes money”.  In other words, “good” insurance, mortgage or investment advice may eventually result in an unexpected bad financial outcome.

Alternative terms for “good advice outcomes” were suggested at the CWG roadshows, including:  good advice, quality advice, good advice experience, good advice framework, good advice output, good advice process, competent advice and several others. I encourage all advisers to make their views known to the CWG. 

A high-level duty for advisers?

Regardless of the final terminology used when describing an adviser’s duty of care, the underlying issue is what level of duty should govern financial advice? This question applies consistently across all advice:  investment, risk, mortgage or financial planning.

I’ve published personal views previously for investment advisers, believing that advisers should act in their client’s “best interests” (a fiduciary standard) as opposed to simply “… placing the interests of the client first” (a suitability standard, a lower duty of care).  My view favouring the higher standard is/was not widely supported by adviser associations. 

Mandating a fiduciary duty of care in New Zealand presents challenges given the deep integration of vertically integrated organisations (VIOs) into New Zealand’s financial marketplace.  VIO’s both manufacture financial products and provide advice.  This makes a broad “best interests” duty impossible without clearly limiting scope of engagement, but that in turn would undermine the intent, of the “best interests” principle.  An alternative could be to restate the existing Code of Conduct’s “client interests first” duty (Code Standard One).

Setting in place a high-level duty for advice can benefit both consumers and advisers.  Such a duty helps consumers become more confident in seeking financial advice. At the same time it underlines a level of professionalism for financial advice and advisers. 

That said, any broad-based high-level duty mandated in a revised Code of Conduct will struggle to be tightly defined and enforceable. This leads to a further question –  if it doesn’t add to existing statutory duties, then why have it?

Take some time to consider your position on this important discussion.  If you think there should be a broad-based standard duty of care:

  1. What should it be? Why? (You may even think the new Code should stick with the existing “client first” principle).
  2. Should such a duty be enforceable? An alternative could be to have it included as a “spirit of the code” provision useful for interpretation.

Competence, knowledge and skill – “aggregation”

A primary area of work for the CWG is to determine competence requirements.  These are divided into two streams:

  1. General competence requirements (apply to all advice situations); and
  2. Particular competence requirements (apply only to some advice situations). 

A key point in the CWG consultation paper is that to measure competence the “competence, knowledge and skill” of both the individual adviser and the financial advice entity for which the adviser provides advice are combined (or aggregated). This covers two clear extremes and many different business models that fall in between:

  • If the financial adviser is a sole practitioner the test will rely on that adviser’s individual competence, knowledge and skill.
  • If the advice is robo-advice offered online, the test will likely rely solely on the entity’s competence, knowledge and skill.
  • If advice is delivered by a human but they are one of many staff in a corporate with structures and processes for advice delivery, then the competence, knowledge and skill will be measured by combining those of the individual and the corporate.

I would argue that the latter model of aggregation is simply a variant of the existing QFE model. 

The rationale behind the aggregation model for competence, knowledge and skill is that it allows a single code standard (for individuals, robo-advice and large entities).  This contrasts with, say, the different view held by SIFA that suggests two separate codes are needed (one for advice delivered by humans and another for robo-advice). 

To understand what this means in practice we need to drill down further on competence requirements under the Bill.  These are divided into general and particular competence, knowledge and skill.

General competence

The Bill provides that “the Code must provide for minimum standards of professional conduct …. including … of general competence, knowledge, and skills”.  These may be “… different standards … in respect of different types of financial advice, financial advice products, or other circumstances.”

The CWG consultation paper suggests two general competence standards that apply to all advice situations:

Competence standard How is it achieved or demonstrated?
The aggregate of the individual adviser and entity’s competence must deliver good advice to the customer. The entity has processes in place to ensure good advice is delivered to clients.  These must be documented. For a sole practitioner or small adviser business relying on the adviser’s individual skill, this could be a short document.  For a large organisation this should be a major piece of work.
The adviser and entity must be up to date with consumer protections (i.e. consumer law etc). For an individual adviser this means establishing s/he understands obligations to the same level as someone who completed Level 5 Unit Standard 26360 within the last 3 years. For an entity – it will need to prove it has controls to make sure these consumer obligations are complied with.

As it stands, general competence requirements will largely remain ‘as is’ for a sole practitioner AFA under the current Code, i.e., Code Standard 14 already requires an AFA to have the competence, knowledge and skill to provide a financial adviser service. What is new is that this will apply to robo advice and RFAs. 

Particular competence

This is where the rubber really hits the road.  The Bill states that “the Code must provide for minimum standards of professional conduct …. including … of particular competence, knowledge, and skills”.  In this regard, the Code must identify “… different types of financial advice, financial advice products, or other circumstances.” Note how this contrasts to the “may” for general competence requirements in the Bill.  In other words, the CWG must now address particular competencies, determining the best way to differentiate how advice is being provided.  This rates as one of the toughest challenges of the Code.

Should differentiation for particular competence, knowledge and skills be made by type of financial advice, type of product or another set of circumstances? 
The CWG consultation paper proposes differentiating for particular competence by considering product and planning.  The rationale here is that a similar differentiation exists in the Bill’s definitions where:

  • Product advice means any financial advice about a product (remember financial advice includes giving an opinion/recommendation to buy or sell a financial product and it will capture what many regard as “sales”). 
  • Planning involves broader situations where a higher level of thinking is required for competent advice (i.e., where many variables, factors and judgements are considered in the formation of advice).   

Here’s what the CWG has suggested for product advice and planning competence standards:

  Competence standard How is it achieved or demonstrated?
Product advice Competence equals the standard of an individual who has Level 5  One (obvious) way is for the individual to have the Level 5 qualification.  But this is a “combined” or “aggregate” test – so the entity may have structures and processes that ensure the output is of Level 5 standard, even if the individual does not have Level 5.
Financial planning Competence equals the standard of an individual who has a degree qualification plus Level 6 financial planning qualification. One (obvious) way is for the individual to have the degree qualification.  But this is a “combined” or “aggregate” test – so the entity may have structures and processes that ensure the output is of the degree standard, even if the individual does not have a degree.

It has been argued that the “financial planning” category may inadvertently capture large numbers of advisers and result in unexpected outcomes – simply because they may look at needs/goals of a client when recommending one financial product.  This could encourage creep towards product advice and away from any activity that could be characterised as financial planning.  That would be unhelpful to consumers.

The CWG again welcomes further submissions on this topic.

So, do advisers need a degree?

The CWG proposal is that there be a combined (or aggregate) test of both the individual adviser and the entity for which the adviser provides financial services and advice.  Individuals would not necessarily be required to have a degree.  What they must be able to do is provide evidence that their advice process delivers to the standard of someone who has a degree.  It is important to highlight that this suggests the focus is on advice output (quality), not input (having a degree). 

There are several other points to think about in relation to degree requirements. 

  • For a small advice business where an adviser does not have a degree, the business can comply with the ‘degree requirement’ by having processes, procedures and controls to ensure advice consistency and quality.  How would you envisage this working in practice?
  • The CWG paper mentions degrees in financial planning, accountancy, business, commerce, economics, finance or management.  Is knowledge taught in these degrees essential for giving advice?
  • Are there other degrees that could be equally important, such as psychology for understanding client behaviour?
  • Is it not so much the knowledge imparted by a degree, but rather that a degree proves you’ve got the ability to think, analyse and problem solve to a high level? 
  • If you don’t believe a degree is even remotely relevant to the discussion, what other minimum standard would you set? 

Share your thoughts with the CWG on this critical issue of competency.

A final key point for the discussion around degrees is also how should existing advisers (with or without a degree) transition into the new regime.  Let’s consider that in Part Three of this commentary.

A final reminder – this commentary expresses the personal views of John Berry and Pathfinder (it does not represent official views of the Code Working Group).
John Berry is co-founder and CEO of Pathfinder Asset Management, a boutique responsible investment fund manager.  He is also a member of the Code Working Group.

Useful links:

The Code Working Group’s consultation paper (start with the executive summary on page 8)

Slides from the Code Working Group’s public presentations in March

Financial Services Legislation Amendment Bill (it can be hard work reading legislation - may be start by looking through the headings to clause 27)

MBIE’s discussion document on financial advice disclosure.

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