Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 1 Best interests obligation

Outline of chapter

1.1 Schedule 1 to the Bill amends Part 7.7A of the Corporations Act 2001 (Corporations Act) to: remove the 'catch-all' provision from the list of steps an advice provider may take in order to satisfy the best interests duty; better facilitate the provision of scaled advice; make consequential changes to the modified best interests duty; and a minor change to the definition of a basic banking product.

Context of amendments

1.2 The Government has committed to provide certainty and reduce compliance costs for small business, and financial advisers, whilst maintaining the quality of advice for consumers who access financial advice. See Outline above for further information.

Removal of the 'catch-all' provision

1.3 Currently, the law-in subsection 961B(1) of the Corporations Act-requires advice providers to act in their client's best interests when providing personal advice. Subsection 961B(2) lists a number of steps that a provider may take in order to show they have satisfied the best interests duty. There are seven steps, the last of which is paragraph (g), also known as the 'catch-all' provision. Paragraph (g) states that a provider must prove that they have 'taken any other step [in addition to the six preceding ones] that ... would reasonably be regarded as being in the best interest of the client.'

1.4 The Government has committed to removing the catch-all provision to remove legal uncertainty on how to satisfy the best interests duty.

Facilitating scaled advice

1.5 Scaled advice is personal advice where the scope of the advice has been limited or scaled. There is currently uncertainty over the amount of work that is required for providers to satisfy their best interests duty when providing scaled advice. There is also uncertainty over the ability for providers and clients to agree on the scope of scaled advice.

1.6 The Government has committed to amending the legislation to better facilitate the provision of scaled advice to reduce uncertainty and enable cost-effective scaled advice to be provided to consumers.

Modified best interests obligation

1.7 The current best interests duty in the FOFA provisions provides a modified best interests duty for certain advice providers who provide advice on basic banking products or general insurance products.

1.8 Consequential changes to the modified best interests obligation are required given the Government's commitment to include consumer credit insurance products in section 963D of the Corporations Act.

The client priority obligation

1.9 Under the current law, the client priority obligation in section 961J does not need to be satisfied if the advice sought by the client relates solely to a basic banking product or a general insurance product.

1.10 To ensure consistency with the amendments to the modified best interests duty that flow on from the inclusion of consumer credit insurance in the basic banking provision, consequential changes to the client priority obligation are required.

Definition of basic banking products

1.11 Under the current law, section 961F defines a 'basic banking product' as, amongst other things, a non-cash payment facility linked to a basic deposit product.

1.12 The Bill removes the requirement that non-cash payment facilities must be related to a basic deposit product so as to include products that are functionally equivalent to those already listed in the definition, or products that may not always be related to a basic banking product.

Summary of new law

1.13 The Bill amends the best interests duty in section 961B by:

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removing paragraph (g) (the catch-all provision) from the best interests duty;

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better facilitating scaled advice by explicitly allowing clients and providers to agree the scope of advice to be provided and indicating the best interest duty applies to this agreed scope; and

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consequential changes to the modified best interests duty.

1.14 The Bill also amends the appropriate advice requirement in section 961G to clarify that it operates as a separate provision; makes consequential amendments to the client priority obligation; and a minor change to the definition of a basic banking product.

Comparison of key features of new law and current law

Detailed explanation of new law

Remove the 'catch-all' provision

1.15 The Bill addresses concerns that there is significant legal uncertainty over how financial providers can satisfy their duties to their clients.

1.16 Currently, subsection 961B(1) of the Corporations Act establishes a best interest duty. It states that a provider 'must act in the best interests of the client' when providing personal advice to a retail client.

1.17 Subsection 961B(2) currently provides seven steps that a provider may take to satisfy the best interests duty. Paragraph 961B(2)(g) is the last of the seven steps. It states that a provider must be able to prove that they have 'taken any other step [in addition to the six preceding ones] that, at the time the advice is provided, would reasonably be regarded as being in the best interest of the client, given the client's relevant circumstances.' Paragraph 961B(2)(g) is known as the 'catch-all' provision.

1.18 The Bill removes paragraph 961B(2)(g), and makes a related consequential amendment to section 961E by removing it; section 961E specifies what would reasonably be regarded as being in the best interests of the client. As the phrase 'reasonably be regarded as being in the best interests of the client' is only contained in paragraph 961B(2)(g), which is being removed, section 961E is not required. [Schedule 1, items 9, 10 and 14, section 961E and subsections 961B(2)(f) and 961B(2)(g)]

1.19 The removal of paragraph 961B(2)(g) removes the legal uncertainty over how advice providers can satisfy their best interests duty whilst maintaining consumer protections. Even without paragraph 961B(2)(g), subsection 961B(2) still sets a high standard for providers to show they have acted in the best interests of their client.

Interaction with other best interest obligations

1.20 It should be noted that the best interest duty established by subsection 961B(1) remains-unaltered-in the legislation. Further, it should be noted that the best interest duty from section 961B works in conjunction with related obligations in Division 2 of Part 7.7A; namely:

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section 961G, which requires the advice to be appropriate;

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section 961H, which requires an adviser to provide a warning if there is any incomplete or inaccurate information;

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section 961J, which requires a provider to prioritise their client's interests ahead of their own; and

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section 961L, which requires licensees to ensure that their representatives are complying with these sections.

1.21 These obligations will continue to remain in the law.

Facilitating scaled advice

1.22 The Bill amends the best interests obligation to better facilitate the provision of scaled advice: the Bill clarifies that an advice provider and a client may agree on the scope of advice to be provided. The Bill provides that the best interests duty, and the other obligations of Division 2 of Part 7.7A of the Act, applies to the scope or subject matter of the advice agreed upon between the client and the provider.

1.23 The Bill also clarifies the appropriateness of advice requirement.

1.24 As mentioned previously, the best interest duty applies to personal advice provided to retail clients. Personal advice is advice that considers the financial objectives, situation, and needs of a person (as defined in subsection 766B(3) of the Corporations Act). All personal advice is 'scaled' or 'limited in scope' to some extent: advice is either less or more comprehensive in scope along a continuous spectrum.

1.25 Whilst scaled advice is not specifically defined in the Corporations Act, it is usually referred to in the industry as a targeted form of personal advice. For example, scaled advice may cover a specific area of a client's needs such as insurance or superannuation, and can be contrasted to holistic advice that usually considers all of the client's financial needs.

1.26 The limited scope of scaled advice usually makes it much cheaper than more fulsome personal advice. This may be due to the fact that a provider does not need to consider as many of the client's circumstances, needs and objectives to provide the advice.

1.27 As holistic personal advice can often be expensive, scaled advice is an affordable avenue for many consumers seeking personal advice.

1.28 The Bill addresses uncertainty over whether a client and adviser can agree on the scope of the advice to be provided by inserting a specific provision indicating that such an agreement can occur. [Schedule 1, item 13, subsection 961B(4A)]

1.29 It is quite common for a client-who may not have had any prior contact with a provider-to initially seek advice on a broad range of services. However, due to the breadth of scope, such advice may not be affordable for the client. In other instances, a client may not be sure of the advice they really want or need. Nonetheless, even if the client knows the advice they want or need, the client may not be able to afford the advice; thus, the scope may need to be limited in some form to reduce the cost of the advice.

1.30 Where the scope is limited in some form, a provider and their client will usually have a series of conversations to explore and understand the advice the client wants; these conversations help to better define possible subjects of the advice.

1.31 Once the provider and client have explored and better understood what the client wants, agreement between the provider and the client on the subject of the advice usually occurs. The new provision explicitly indicates that this agreement can take place. [Schedule 1, item 13, subsection 961B(4A)]

1.32 The new provision also clarifies that the obligations of Division 2 of Part 7.7A of the Act apply to the advice ultimately sought. As such, the advice that is provided to the client-even though limited in scope-must still be in the best interests of the client, be appropriate for the client, have prioritised the client's needs, and a warning must be given if the advice is based on incomplete or inaccurate information. An adviser should be mindful of the obligations of Division 2 of Part 7.7A when engaging in conversations to arrive at the scope of the advice to be sought.

1.33 It is important to note that this new provision does not alter the operation of section 947D; section 947D requires an advice provider to disclose certain information about the costs and benefits of switching between one financial product and another financial product. As such, providers must still be mindful of their section 947D obligations when providing scaled advice.

1.34 In agreeing the subject of the advice, there needs to be a 'meeting of the minds' between both the provider and the client. The provider should clearly explain to the client the consequences of not receiving advice on other subjects.

1.35 For example, a retail client, who does not want to spend too much money on financial advice, seeks advice on financial matters. After having a conversation about the client's financial objectives, circumstances and needs, the client and provider agree that advice on superannuation, debt consolidation, and life insurance are topics that are particularly relevant to the client at this time.

1.36 The client, being only able to afford to receive advice on one of these topics, and having been informed-and having considered-the benefits and drawbacks of receiving advice on only one of these topics, can agree with the provider to receive advice on a particular topic. For the purposes of this example, assume the client decides to receive advice on debt consolidation; the new law clarifies that the client and provider can agree that advice on debt consolidation will be provided.

1.37 There is currently uncertainty over the advice that the best interest duty applies to; in particular, there is uncertainty over how the best interest duty-and related obligations-applies to scaled advice. Some industry stakeholders have questioned whether the duty applies to the advice as initially sought by the client (in the scenario above, the advice as initially sought would be advice on the broad topic of financial matters), or whether the duty applies to the advice as ultimately sought.

1.38 The Bill inserts an example of a client and provider agreeing the subject matter of advice. The example clarifies that the best interests obligations apply to the advice ultimately sought (in the scenario above: the advice ultimately sought is the advice on debt consolidation). [Schedule 1, item 13, subsection 961B(4A)(example)]

1.39 There is also currently uncertainty over the extent of the investigations that are required to be undertaken when providing scaled advice.

1.40 A number of industry participants consider that the current paragraph 961B(2)(a), which is the first of the steps in the best interests duty-and which requires the provider to identify the objectives, financial situations and needs of the client that were disclosed to the provider by the client through instructions-requires the provider to perform a 'full fact-find' with the client before any other steps are to be taken.

1.41 A full fact-find is generally associated with holistic advice, and requires a provider to consider-in great detail-the client's financial objectives, circumstances and needs. Given the time taken by a provider in considering these details, advice provided when a full fact-find is undertaken is usually quite expensive.

1.42 A full fact-find was never the intention behind paragraph 961B(2)(a); rather, paragraph 961B(2)(a) requires consideration of the objectives, circumstances and needs relevant to the client and the advice that is sought. The relevant objectives, circumstances and needs usually only become apparent after talking to the client to understand the advice they are after.

1.43 The Bill removes doubt about the necessity of a full fact-find by repealing paragraph 961B(2)(a) and inserting a new paragraph that requires the provider to identify the objectives, financial situation and needs of the client that are disclosed to the provider by the client. [Schedule 1, items 7 and 8, paragraphs 961B(2)(a) and (ba)]

1.44 Notwithstanding the fact that the steps in subsection 961B(2) do not need to be followed in the order as written, the position of the new paragraph-after paragraph 961B(2)(b)-should help alleviate concerns that an up-front full fact-find is required to be performed ahead of any other steps.

1.45 The new paragraph requires the provider to assess the facts that have been presented by the client, and to perform a comparison between the facts disclosed and the facts that would be relevant to the advice sought as required by subparagraph 961B(2)(b)(ii); subparagraph 961B(2)(b)(ii) requires the provider to identify the objectives, financial situation and needs of the client that would reasonably be considered as relevant to advice sought on that subject matter (the client's relevant circumstances).

1.46 The Bill further clarifies that the investigations a provider needs to conduct when providing advice-regardless of the scope-are those that are reasonably considered as relevant to the subject matter of the advice sought. [Schedule 1, item 11, subsections 961B(2)(note)]

Operation with the appropriate advice requirement

1.47 The best interests duty operates in conjunction with the appropriate advice requirement set out in section 961G; but, both operate as separate obligations. Currently, section 961G requires advice provided to be appropriate had the best interests duty been satisfied.

1.48 To ensure the appropriateness requirement operates as a separate obligation, the Bill amends section 961G to provide that advisers must only provide advice to the client if it would be reasonable to conclude that the advice is appropriate to the client 'having regard to' section 961B. [Schedule 1, item 15, subsection section 961G]

1.49 By specifying that a provider must have regard to section 961B, the best interests duty forms a central, although not absolute, basis for determining the appropriateness of the advice. In some instances, consideration of the best interests duty may be sufficient; in other instances, other factors may also need to be considered.

1.50 Consumers who seek financial advice expect that their adviser will act in their best interests and that, as a result, the advice provided will leave them in a better position. In addition, consumers expect that any advice provided will be tailored to their relevant circumstances. Accordingly, when determining the appropriateness of advice, an adviser must consider whether the advice provided could reasonably be expected to leave the client in a better position given their relevant circumstances.

1.51 To be clear, the appropriate advice requirement is not an outcomes test: it does not require that the client must be in a better position after the advice is provided; rather, it requires an adviser to consider whether a client would reasonably be expected to be in a better position.

1.52 Whilst the changes to the best interests duty explicitly allow a client and adviser to agree the scope of the advice, it does not allow a client and adviser to agree that the advice is appropriate for the client: this is a judgement call for the adviser. As such, agreeing on the scope of advice does not mean that inappropriate advice can be given; the appropriateness of the advice will need to be assessed by reference to the information obtained from the client and the client's relevant circumstances.

1.53 In certain circumstances, it may not be appropriate for the adviser to provide advice on the agreed topic, and so it may be necessary to warn the client or advise that certain action will not be appropriate; in other instances, a warning may not be necessary. This is ultimately an 'on balance' decision that will depend on the facts at hand and will require the adviser to exercise their professional judgement using their skills and experience.

1.54 Where the adviser, in having regard to section 961B, concludes that it is not appropriate to provide advice on a subject matter that has been agreed upon, the adviser should not provide that advice to the client.

Modified best interests obligation

1.55 The Bill makes consequential changes to the modified best interests duty as a result of the inclusion of consumer credit insurance products in section 963D of the Corporations Act.

1.56 Currently under subsection 961B(3), an agent or employee of an ADI is not required to satisfy the steps of the best interests duty (in paragraphs 961B(2)(d) to (g)) when the subject matter of the advice sought by the client is solely in relation to a basic banking product. Subsection 961B(4) further provides that a provider need not satisfy those steps when the subject matter of the advice sought by the client is solely in relation to a general insurance product.

1.57 The Corporations Regulations also provide that an agent or employee of an ADI need not satisfy the steps in paragraphs 961B(2)(d) to (g) when the only personal advice provided is in relation to a basic banking product and a general insurance product.

1.58 The Regulations also provide that the steps in paragraphs 961B(2)(d) to (g) do not need to be followed by any provider if the subject matter of the advice relates to a general insurance product.

1.59 The new law provides that an agent or employee of an ADI need not satisfy the steps in paragraphs 961B(2)(d) to (f) of the best interests duty in relation to personal advice on a basic banking or general insurance product where the subject matter sought by the client relates to a basic banking product, a general insurance product, a consumer credit insurance product, or a combination of these products. [Schedule 1, item 12, subsection 961B(3)]

1.60 To the extent that the subject matter of the advice sought by the client is a general insurance product, the provider satisfies the best interests duty if the provider takes the steps outlined in paragraphs (2)(b), (ba) and (c). [Schedule 1, item 12, subsection 961B(4)]

1.61 It is important to note that this amendment does not extend the modified best interests duty (under the current law, the need to satisfy the steps in paragraphs 961B(2)(a) to (c) but not paragraphs 961B(2)(d) to (g) when personal advice is provided) to the provision of consumer credit insurance; rather, it allows the modified best interests duty to apply to a basic banking product and/or general insurance product where the subject matter of the advice sought also relates to consumer credit insurance.

1.62 As such, the provision of advice on consumer credit insurance still requires all the steps in subsection 961B(2) (the best interests duty) to be satisfied.

The client priority obligation

1.63 The Bill amends the client priority obligation to ensure consistency with the amendments to the modified best interests duty that flow on from the inclusion of consumer credit insurance in the basic banking provision.

1.64 Section 961J places an obligation on the provider to give priority to the client's interests when the provider knows or reasonably ought to know that there is a conflict between the client's interests and the provider's interests, or the interests of one of the other parties listed in subsection 961J(1).

1.65 Under the current law, an agent or employee of an ADI is not required to satisfy the client priority obligation if the subject matter of the advice sought by the client relates only to a basic banking product. Further, all providers do not need to satisfy the obligation if the subject matter of the advice sought by the client relates only to a general insurance product.

1.66 The Bill makes consequential amendments to the circumstances in which a provider is not required to satisfy the provision.

1.67 An agent or employee of an ADI will not be required to satisfy the client priority obligation in relation to advice that relates to a basic banking product, a general insurance product, or a combination of these products, if the subject matter of the advice sought by the client relates only to a basic banking product, a general insurance product, a consumer credit insurance product, or a combination of any of these products. The client priority rule will continue to apply to advice provided in relation to a consumer credit insurance product. [Schedule 1, item 16, subsection 961J(2)]

1.68 Further, all providers will not be required to satisfy the client priority obligation in relation to advice on a general insurance product to the extent that the subject matter of the advice sought by the client relates to a general insurance product. The client priority obligation will continue to apply in providing advice on matters not relating to a general insurance product. [Schedule 1, item 16, subsection 961J(3)]

Basic banking products

1.69 Section 961F of the Act defines a 'basic banking product'. This definition captures a range of products, including first home saver accounts, basic deposit products, non-cash payment facilities linked to a basic deposit product, and traveller's cheques.

1.70 This definition was established in late 2011 when the FOFA legislation was first introduced into Parliament. Since this time, the banking industry has developed, and consumers have demanded, alternative products that are functionally equivalent or may not always be related to a basic banking product. For example:

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pre-paid travel cards instead of traveller's cheques; and

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pre-paid debit cards instead of a debit card that is linked to a bank account.

1.71 The Bill removes the requirement that non-cash payment facilities must be related to a basic deposit product so as to include products that are functionally equivalent to those already listed in the definition, or products that may not always be related to a basic banking product. [Schedule 1, item 14A, paragraph 961F(b)]

Application and transitional provisions

1.72 The amendments to the best interests obligation apply in relation to the provision of personal advice to a retail client on or after the commencement day. The amendments commence the day after the Royal Assent. [Schedule 1, item 43, sections 1531A and 1531B]

1.73 The current requirements continue to apply until the new law is in place or new regulations are made.