Over the course of 2018, the Royal Commission into Financial Services has provided numerous examples of the conflicts of interest inherent to the vertically integrated model of financial advice. In this model, the financial adviser is often incentivised to direct their client's savings onto an investment platform and then invest in financial products, both of which are owned by the adviser's employer. Additionally, in the Royal Commission the regulators of financial services in Australia – APRA and ASIC have been criticised for being too soft and accommodating towards the companies that they supervise on behalf of Australian investors.
Whilst the share prices of vertically integrated financial services companies such as AMP and IOOF have been under pressure since March, in late 2018 many investors had been asking the question whether these stocks were undervalued as the outcomes from the Royal Commission might not be as bad as feared. On Friday morning this question was answered for many investors, after APRA (Australian Prudential Regulation Authority) announced that it was seeking to disqualify five directors from IOOF including the Chairman and CEO from acting as superannuation trustees for not being "fit and proper persons" to run a superannuation fund and impose additional licence conditions on IOOF.
This move by APRA puts a further nail in the coffin of the vertically integrated model of financial advice, as the consequences of breaches are moving beyond fines and enforceable undertakings to actually go after executives directly.
Furthermore, it signals that the regulators are looking to take a more proactive approach toward companies that are not acting in the best interest of their clients. This indicates that the costs of managing conflicts of interest have risen and suggests that it may be difficult in the medium term for both IOOF and AMP to maintain their financial supermarkets.
Just when I thought I was out...they pull me back in
Like Michael Corleone in The Godfather: Part III in trying to escape his mafia roots; the move by APRA could result in ANZ getting back into wealth management. Last October ANZ signed a deal to sell their OnePath pensions and investments business as well as ANZ financial advice business to IOOF for $975 million. APRA's announcement now puts this deal in doubt and may see ANZ refund the $800 million already received by IOOF and either look for another buyer.
Ironically given the 36% fall in IOOF's share price on Friday, returning the $500 million raised from shareholders last year would boost earnings per share in 2019. This occurs as IOOF would be buying back shares at less than half of the $10.60 per share that they raised equity at 12 months ago.
Pulling all of this together, the actions by APRA in taking action against IOOF indicates to us that the road ahead for AMP and IOOF is likely to be quite challenging. And whilst based on consensus analyst numbers these companies appear cheap, it is too early to invest in these companies as the costs and potential negative outcomes from the Royal Commission are hard to quantify.