The role of research houses in the advice process

The reality is that Australian advisers are largely generalists, and the methodologies, culture and education of the advice profession all speak to this. The Australian Securities and Investments Commission’s (ASIC) recent rumblings are part of a broader global trend that the Australian advice profession needs to prepare for.

There are some important legal and ethical implications of the best interests duty in relation to Australian financial advice, and there are some useful guidelines and recommendations for advisers who use external research sources.

Given the best interest duty of a financial adviser, it is not sufficient to rely on an external investment research house or asset consultant and claim no responsibility for the advice given to clients. The adviser has a duty to understand the methodologies and outcomes of the research house or asset consultant, and to assess their strengths and weaknesses in relation to the client’s needs and objectives. The adviser also has a duty to measure and track the success of the advice, and to review and adjust it as necessary.

The best interests duty is a legal obligation for financial advisers under the Corporations Act 2001 (Cth), which requires them to act in the best interests of their clients when providing personal advice, and to prioritise the client’s interests over their own or any other party’s interests. The best interests duty also covers several steps that advisers must take to ensure that their advice is appropriate.

This includes identifying the client’s relevant circumstances, conducting a reasonable investigation into the financial products that might meet the client’s needs, and providing clear and concise information and explanations to the client. The best interests duty is enforced by the Australian Securities and Investments Commission, which has the power to impose penalties, sanctions, or bans on advisers who breach their obligations.

The use of external research sources, such as investment research houses or asset consultants, can be a valuable tool for financial advisers to obtain information and analysis on various financial products and markets. However, relying on external research sources does not absolve advisers from their best interests duty, nor does it transfer the responsibility for the advice to the research provider.

Advisers who use external research sources must still exercise their own professional judgement and critical thinking, and ensure that the research is relevant, reliable, and consistent with the client’s needs and objectives. Advisers must also disclose any conflicts of interest or limitations that may arise from using external research sources, such as fees, commissions, affiliations, or biases.

According to ASIC Regulatory Guide 175: Licensing: Financial product advisers—Conduct and disclosure (RG 175), advisers who use external research sources should:

• Understand the methodology, assumptions, limitations, and scope of the research.
• Evaluate the quality, objectivity, and independence of the research.
• Compare and contrast different research sources and opinions.
• Apply the research to the client’s specific circumstances and objectives.
• Monitor and review the research regularly and update the advice accordingly.

Some examples of how advisers can apply these principles in practice are:

• Reading the full research report, not just the summary or rating.
• Checking the credentials, qualifications, and experience of the research provider.
• Assessing how the research provider collects, verifies, and updates data.
• Considering how the research provider handles conflicts of interest or complaints.
• Seeking alternative or independent views on the same financial product or market.
• Testing the validity and robustness of the research findings and recommendations.
• Explaining to the client how the research supports or contradicts the advice.
• Documenting how the research was used in forming the advice.
• Reviewing the performance and suitability of the advice based on updated research.

By following these guidelines, advisers can ensure that they use external research sources in a way that enhances their advice quality.

International standards

As a means of international comparison, and in contrast to Australia’s best interests duty, which applies only to personal advice, the UK’s so-called Consumer Duty is a broader principle that applies to all aspects of a firm’s relationship with its customers. The Consumer Duty is a new rule introduced by the Financial Conduct Authority (FCA) in July 2022, which aims to raise standards of consumer protection across financial services. The Consumer Duty requires firms to put their customers’ needs first and deliver products and services that meet their needs and offer fair value. The Consumer Duty also covers areas such as communication, customer support, fees and charges, cancellation and switching rights, and vulnerable customers.

The Consumer Duty consists of three main elements:

• The Consumer Principle: firms must act in good faith towards their customers.
• The Cross-cutting Rules: firms must take all reasonable steps to avoid foreseeable harm to customers; enable customers to pursue their financial objectives; act in a way that enables customers to make informed decisions.
• The Four Outcomes: firms must ensure that products and services are fit for purpose; customer service meets customer needs; price represents fair value; information empowers customers.

The FCA expects firms to embed these elements into their culture, policies, processes, governance, systems, controls, training, monitoring, reporting, and remediation. The FCA will supervise firms’ compliance with the Consumer Duty using a range of tools, such as data analysis, thematic reviews, market studies, firm visits, and consumer research. The FCA will also enforce the Consumer Duty by imposing sanctions, such as fines, suspensions, or bans, on firms or individuals who breach the rules.

The significance of the Consumer Duty for Australian financial advisers who use external research sources is that it sets a higher and clearer benchmark for consumer protection that they may need to consider if they want to align their practices with international standards. The Consumer Duty may also have implications for the quality and reliability of the external research sources that advisers use, as the research providers may also be subject to the Consumer Duty if they wish to meet the one rigorous standard.

The Consumer Duty requires firms to act in good faith towards their customers, which goes beyond acting in their best interests.

The Consumer Duty specifies four outcomes that firms must deliver to their customers, which are more detailed and measurable than the Australian best interest duty.

The Consumer Duty includes a cross-cutting rule that requires firms to enable customers to pursue their financial objectives, which may involve providing more guidance and support to customers.

One of the challenges that Australian financial advisers may face when using external research sources is whether they have sufficient education to truly assess the research house methodologies.

Education is key

Australian adviser education requirements are designed to ensure that financial advisers have the necessary skills to provide personal advice on relevant financial products to retail clients. However, they may not be sufficient to enable financial advisers to critically evaluate the methodologies used by external research providers, especially if they are complex, technical, or based on different assumptions or models.

Therefore, financial advisers who use external research sources may need to undertake additional training or seek expert guidance on how to understand and assess the research house methodologies. This may involve:

• Enrolling in courses or workshops that cover topics such as statistics, econometrics, portfolio theory, asset allocation, valuation methods, etc.
• Consulting with academic experts or independent analysts who have specialised knowledge or experience in applying or reviewing different methodologies.
• Accessing online resources or publications that explain or critique the methodologies used by external research providers.
• Participating in peer networks or forums where financial advisers can share and discuss their views and experiences with using external research sources

By increasing their education and understanding of research house methodologies, financial advisers can improve their ability to use external research sources in a way that is consistent with their best interest duty and the needs and objectives of their clients. It is also a way of meeting future regulatory burdens. It is also a signal that the “generalist” era of financial advice is coming to an end.

Highly educated and specialised professionals are required to provide support to the generalist adviser cohort. This is to empower the generalist adviser to focus on relationship management which is the heart of the profitability of any advice business.

Benjamin Walsh is head of research at Padua.