CFA Institute: Investor protections improve in Asia Pacific as regulators focus on sales inducements

CFA Institute, the global association of investment management professionals, today announced in its latest report Sales Inducements in Asia Pacific that, following claims made by investors of widespread mis-selling of investment products during the 2008 global financial crisis, core markets in Asia Pacific have made material improvements to their regulatory frameworks.

Regulators have imposed tighter regulations with regards to sales and distribution of investment products in an attempt to prevent systemic mis-selling and improve investor outcomes. These regulations range from a ban on commissions, higher transparency on fees, mitigation on conflicts of interest, and an increase in individual accountability. Traditionally, a lion’s share of a distributor’s compensation has come from sales commissions, paid upfront or as trailer fees.

“Commissions and other inducements may generate incentives for financial advisers and other distributors to promote products that bring them the highest reward, rather than those that best meet clients’ needs,” said Mary Leung, CFA, Head, Advocacy, Asia Pacific, CFA Institute. “Cash or non-cash sales incentives built into employee compensation may also create conflicts of interest that lead to misconduct and mis-selling.”

An alternative business model is a pay-for-advice one in which clients are charged a percentage of assets under management on an annual basis.

“We strongly believe that a healthy and well-functioning market should have a high degree of investor protection with convenient access to affordable advice and quality products,” Leung said. “It should accommodate a range of different fee and commission-based business models, that can cater to clients’ individual needs.”

The report examines regulations and industry practices around sales inducements in a number of financial markets including Australia, Hong Kong SAR, India and Singapore. It notes that although the underlying issues in the four analyzed markets are similar, the approaches regulators have taken differ. Australia and India have banned some or all sales commissions, but both markets continue to experience problems arising from a sales-driven culture. Mis-selling practices continue as some intermediaries continue to be motivated solely by short-term profit.

Even though regulators in Hong Kong SAR and Singapore have not called for a ban on commissions, they have introduced stricter regulations such as suitability assessments and disclosure requirements for fees and conflicts, placing the onus on the customer to make informed decisions. Increased transparency has helped mitigate some conflicts of interests among financial advisers, intermediaries, and product distributors.

In the report, CFA Institute observes that commission bans will not prevent mis-selling unless they are backed by effective enforcement and a consistent, holistic regulatory approach, which would reduce conflicts of interest and prevent regulatory arbitrage across all types of products, all intermediaries, and all investor segments.

At the same time, new compensation structures that take into account a combination of financial and non-financial metrics, rather than focus purely on sales, further reduce mis-selling incentives. That, in turn, enhances the level of professionalism among client-facing staff and helps build trust in the profession.

There is also a renewed focus on organizational culture with regulatory initiatives focusing on individual accountability.

“An organization’s ability to promote good conduct and behavior is closely related to its culture,” Leung continued. “In short, culture drives behavior, which in turn drives how employees treat customers. We believe that markets in Asia Pacific can further improve consumer outcomes by promoting a culture of building long-term relationships and putting clients’ interests first.”

CFA Institute believes that a healthy market can accommodate a range of different fee- and commission-based business models. Such markets must ensure sound investor protection, access to affordable, quality advice and products, and fee transparency. Advisers must demonstrate a high degree of professionalism and a culture of accountability. Conflicts of interest must be eliminated, where possible, or mitigated, managed and disclosed, as appropriate.

To facilitate the development of such markets, CFA Institute recommends:

• Regulators minimize opportunities for regulatory arbitrage by adopting a holistic approach across all client segments and all investment products. It should cover such aspects as incentives, licensing of firms and individuals, disclosures, product authorization and duty of care in the selling process.
• Advisers be upfront and clear to investors as to the duty of care the investors are owed. This enables advisers to differentiate their offerings and better service investors with diverse needs.
• Regulators set a clear standard of disclosures to ensure that pertinent information is provided and that advisers explain such information to their clients. It is important to make the disclosures meaningful and clear.
• Financial literacy and investor education be promoted as essential for development of a healthy market for financial services.
• The compensation structures of advisers and senior executives be aligned with long-term interests of clients. The move in some markets towards a balanced scorecard approach in evaluating frontline performance is a welcome development and is conducive to achieving better investor outcomes.

This report was prepared based on literature reviews and interviews conducted by CFA Institute with industry participants, including regulators, intermediaries, distributors, financial advisers, private bankers, robo-advisers, investors, fund supermarkets and academics. The focus of the interviews was on the sale and distribution of mutual funds, but they also covered insurance and other complex alternative products. This is an updated version of the report issued by CFA Institute in 2013, entitled “Restricting Sales Inducements”.