Why vertical integration in banking is past its use-by date
Australian banks are starting to get rid of wealth, funds, and insurance divisions in the wake of revelations of serious structural conflicts of interest coming out of (among others) the Royal Commission into financial services misconduct. So why, asks Aaron Drew, are the same banks’ New Zealand subsidiaries still talking about problems with ‘culture’?
In mid-September I spent a week in Sydney with various senior executives in firms across the financial services industry. The topic du jour was the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
It’s no exaggeration to say that public confidence in the financial services industry has been shattered. A recent survey by Deloitte of over 1,000 Australian consumers found that around half do not trust their own financial service provider. The Australian government has urged the regulator to apply much tougher penalties on miscreant firms.
Worse is expected when the commission turns to examine the retirement care sector. Anecdotes abound of huge commissions paid to advisers who recommend retirement care villages with very high fees.
No amount of well-meaning ‘cultural’ initiatives, like adopting industry- and firm-level codes of conduct, will fix the fundamental problem.
Here in New Zealand the problem is being described as one of ‘culture’ – senior management rewarding sales and profits at the expense of the customer. For example, our NZ banking industry categorises it as a cultural issue that Australian bank employees were incentivised to get customers to put their pensions into their own bank’s superannuation schemes - even when there was compelling evidence the bank-owned schemes were more expensive and poorer performing than the not-for-profit industry super funds.
The view I picked up from Australian industry figures was that no amount of well-meaning ‘cultural’ initiatives, like adopting industry- and firm-level codes of conduct, will fix the fundamental problem.
It has been well-known for many years that the vertically-integrated businesses within the financial services industry embed structural conflicts of interest that place advisers and staff in a continual dilemma. Do I serve my own and my employer’s best interests, or my clients’?
For this reason, most of the big banks in Australia are removing the temptation by divesting themselves of their wealth and asset management divisions or shareholdings. ANZ Wealth (Australia) has been sold to Melbourne-based financial services company IOOF, and Commonwealth Bank (the parent of ASB) has announced it will sell its wealth-management and mortgage-broking businesses into a separate company called CFS Group. Meanwhile, National Australia Bank (the parent of BNZ) plans to sell its wealth management division, MLC. Westpac is the exception, holding (for now) on to BT Financial Group.
What does this mean for New Zealand? Clearly the same structural conflict of interest is present in our banking system. Just last week in a routine call with my bank about a transaction, I was asked three times whether I would consider switching to its KiwiSaver and insurance options. Bank KiwiSaver and private client wealth management offerings are stuffed full of own-brand products, many of which are simple overlays on funds that can be obtained more cheaply by going direct to the underlying fund manager.
There is no way this can be seen as putting client interests first.
Given the Australian experience and the presence of the same underlying conflicts here, it seems untenable for the industry to remain unchanged in New Zealand. At the very least, we would expect to see an opening up of the offerings to a broader range of products, and more contestability and independence brought into the investment and advice processes that vertically integrated firms run.
We would also hope to see a lifting of standards from mere compliance with FMA regulations, to higher fiduciary standards of practices and conduct.
The experience in Australia clearly shows that regulatory compliance (even the tougher and more prescriptive regime across the ditch) does not guarantee that financial institutions will put their clients’ interests first.
Ultimately conflicts can only be avoided by the sector divesting from wealth, funds, and insurance divisions or businesses. While our local banks have so far remained steadfast in their commitment to vertical integration, surely their Australian parents will be closely considering their options? We may even see some follow the lead of CBA and spin out their wealth divisions onto the NZX.
Bigger is no longer necessarily cheaper
The historic argument in favour of vertical integration from the end consumer’s perspective was scale. In principle, a bigger business can better absorb the fixed costs of compliance and administration. It can also use its scale to get better pricing from suppliers - fund managers, insurance, and other providers.
In practice, the scale argument is becoming less and less compelling. The fintech revolution is rapidly reducing costs to the asset management industry across compliance, portfolio administration, funds management and custody.
Cost-competitive compliance and platform solutions are now available for businesses with smaller scale. In Australia, this market is intense, with over 30 investment platform providers contesting for market share. Relatively new entrants may offer better pricing and services than incumbent firms, given they are not encumbered by inefficient technologies. Over time, we would expect to see some of the Australian players look at our market in time given the current near duopoly between the platform providers FNZ and Aegis (part of ASB Bank).
On the compliance side, low cost ‘plug and play’ technologies are now enabling firms to scan their entire book daily, reducing the need for armies of compliance staff, and cutting the expense of external audits, or the risk that bad conduct will slip through the cracks.
Scale buying power is also eroding. Fund manager fees across most asset classes continue to fall, to the benefit of the end consumer. A range of simple low-fee index tracking products are now available for retail investors, regardless of scale. Funds offered by active managers are also increasingly being made available direct to the consumer whether through exchange-traded funds, or platforms such as InvestNow in New Zealand.
Independent adviser groups can often secure competitive wholesale pricing from fund managers without necessarily having a huge book. Simplicity’s KiwiSaver option clearly shows that cheap fund manager pricing can be achieved by a relatively small KiwiSaver provider.
Australia is going through a very disruptive time for all asset managers and investors. Compliance and regulatory burdens are set to rise, and technological disruption is rapidly changing value propositions.
These forces will all hit our shores in time; in fact we are already seeing some of the effects. For example, in May ANZ announced it will sell its OnePath Life NZ insurance operation to rival insurer Cigna for $700 million.
It is also notable that a number of senior advisers and fund managers have left the banks over the past year or so to go to work for independent New Zealand firms.
But no matter how exactly the Australian finance industry scandals play out here, the fundamental lesson is that providers will be expected to put a much greater focus on their clients and customers. In the meantime, the Australian experience clearly shows it is not wise to assume that regulation will ensure all providers are ‘fine’.
Aaron Drew is a director of investment consulting firm MyFiduciary.
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