Dealer groups are not required by law to have an approved product list (APL) in place, though with tens of thousands of products to choose from, it has become common practice for the majority of dealer groups to have one.
One of the big questions about APLs to arise since the global financial crisis (GFC) and the downfall of research-approved product providers, such as Basis Capital and Great Southern, is whether APLs will become more conservative in their future recommendations.
On top of that, while research houses and product manufacturers must abide by strict guidelines, dealer groups and advisers are still the only parties legally responsible for APLs and the recommendations given to clients.
This means even if a well-rated product goes south and it was an appropriate investment at the time for a client to make, it is the adviser and licensee that are at the coalface of client complaints.
While dealer groups and advisers do not deny responsibility, some still believe research houses and product manufacturers should have greater accountability for the roles they play.
If the guidelines for product manufacturers and research houses are not tightened, some say the due diligence process by dealer groups and advisers will need to become even more stringent, with the likelihood of APLs becoming more conservative in future.
Some worry this could limit choice and financial returns for clients, while others say it would mean greater safety and security for advisers and clients alike.
Grahame Evans, the managing director of Australia's largest dealer group, Professional Investment Services (PIS), says PIS has more than 500 products on its APL and the process behind approving products is a lengthy one.
"Quite often product providers come to us about adding products to our APL, however, there first needs to be a relevant amount of adviser demand for a product before we consider looking at it. Whether or not that product is then selected for our APL, we would still charge a product provider a non-refundable fee for consideration so as to ensure we only assess serious product providers and not time wasters," Evans says.
PIS then reviews research available from research houses van Eyk and Lonsec, as well as other research if it is available.
"We do this to ensure products have attained a certain rating because if they haven't, they're not up for consideration," Evans says.
Following that process, PIS then conducts its own due diligence.
"If there is adviser demand for a product, it has been researched and given the appropriate investment grade, we will then put it to our internal research team before our investment committee gives it final approval and the product is added to our APL," Evans says.
The dealer group's research team evaluates the product through a four-tier process, which looks at philosophy, people, process and performance.
Characteristics assessed include the philosophy of the manager, the quality and structure of the product development team, the investment selection process and product performance against benchmarks.
"Following that, recommendations are given to our investment committee, which is led by our head of research as well as three unnamed specialist PIS managers, who assess products against a range of criteria and risk measures," Evans says.
"If the product is then suitable to be added to our APL, the product becomes available for our advisers to utilise given that they conduct their own due diligence and believe the product to be an appropriate investment for the particular client."
He says in the past he has thought PIS has had too many products on its APL, but after talking with other dealer groups, he realises PIS does not have the largest or broadest APL in the market.
"When you take a moment to consider the range of product categories available, you realise there are a lot of options to choose from," he says.
"With that in mind, I think PIS's APL provides advisers with a good amount of choice, which is particularly important considering our network deals with a cross-section of industries in different locations and with clients who have individual needs." PIS reviews its overall APL once a year unless there is a change to a product or product provider, in which case those products are reviewed immediately, he says.
Smaller independent dealer group Premium Wealth Management is made up of only very mature practices and practice principals, chief executive Chris Saunders says.
"Premium has stringent parameters around the research houses we subscribe to, but the due diligence performed on products and the assessment of whether they are suitable for different clients is done by practices and not at the dealer group level," Saunders says.
"In other words, Premium does not have a defined APL per se. We approve products for our advisers by setting strict parameters and through using Lonsec and van Eyk ratings, whereby products need to have attained a highly recommended or recommended, AA or A rating."
He says as Premium practices are well established and led by experienced principals, the dealer group allows them to assess the research carefully, conduct their own due diligence, look at the client's individual risk profile and asset allocation, and make their own informed decisions.
With every investment considered, the same process applies. The reality is, that even with such a broad spectrum only a limited number of investments is ultimately used.
"For those who have been in the industry for a short amount of time, however, certainly tighter restrictions by their AFSL (Australian financial services licence) should apply," Saunders says.
"Because we provide advisers with greater choice than many other dealer groups, we rely on the research parameters we have set and also procure the services of analysts in different sectors as an overlay. We will also consider doing more of this going forward, particularly in light of recent events."
Premium assesses the products being used by its network every month through revising remuneration reports generated by head office, and also through updates from product manufacturers and by monitoring any research rating changes.
"As long as the products fit our AFSL guidelines, match the required research ratings and advisers have checked the appropriateness of that product against a client's particular circumstances, then they're in line with what Premium requires," Saunders says.
MLC general manager of advice solutions Greg Miller looks after National Australia Bank (NAB)-owned dealer groups Apogee Financial Planning and MLC/Garvan Financial Planning. He also oversees the team that does the research for both dealer groups as well as research for other NAB-owned dealer groups NAB Financial Planning and Godfrey Pembroke.
Miller says the research team looks at product research put together by Lonsec and will do an independent research overlay as well.
"Once research is conducted internally, our research team will make a submission to our APL committee, which is a subcommittee of our licensee board that works across all NAB dealer groups," he says.
The APL committee meets once a month and while its reviews are usually in accordance with Lonsec ratings, the group can make its own decisions throughout the year thanks to its internal research and assessment procedures.
Miller says the research team looks at factors including the coverage of products currently on the APL and what funds or products are needed to fulfil advisers' strategies for clients.
He says no minimum or maximum number of products applies to the APL, as long as advisers can fulfil the strategies put in place for clients.
"If an adviser wants to recommend a non-approved product they can go through a non-approved product list and still recommend it, but we will still check it. The main thing is the product and the advice adheres to a client's particular circumstances," he says.
"To minimise the risks we have rather strict investment guidelines for advisers to follow so that even if there was a more risky investment on our APL, advisers would not have put more than 5 per cent of the client's money into that investment.
"We monitor what advisers recommend to clients and whether they've stayed within the guidelines we've set out for them."
Association of Financial Advisers chief executive Richard Klipin says how often an AFSL checks the products on its APL, whether it is every one, three or 12 months, is really a strategic call dependent on the particular type of dealer group. "A well-constructed APL can provide a competitive advantage for advisers with their clients and equally if it is a poorly-constructed APL, all sort of issues can occur, such as what happened with Basis Capital, Great Southern, Westpoint and so on," Klipin says.
Evans says the major issue for dealer groups is that there are simply too many products for an AFSL to be able to meticulously research every single one.
"If an adviser has to thoroughly research every product on an APL, the whole industry would become very limited in what it offers clients as advisers would not have the capacity to review all products available," he says.
"There would need to be substantial consolidation of products or fewer products on APLs."
He says it isn't that the due diligence process conducted by dealer groups is wrong, but that the GFC has highlighted the need for dealer groups to be more risk averse, particularly as product manufacturers and research houses can also get it wrong.
"New rules must be implemented to reduce risks and while we don't want to reduce the products on our APL, it is certainly up for consideration now," he says.
"If we don't become more vigilant with the products that end up on our APLs and make extra time to research and assess these products, there could be serious problems."
Evans says despite the fact PIS might revisit its APL procedures, he does not blame the dealer group's exposure to Great Southern, Timbercorp and Westpoint on its APL process.
"The products aligned to these providers went through the necessary checks, with some segments of the market very keen to invest in tax-advantaged products," he says.
"The firms had the necessary ratings and met the required criteria, so one of the issues is still how well researchers are evaluating product providers."
Dealer groups are constantly reminded of their and their advisers' legal responsibility to perform due diligence on products and to ensure advice is appropriate for individual clients, he says.
"If product providers and research houses, however, are not in any way accountable for their part in the equation, the due diligence by dealer groups will no doubt need to become even more rigorous going forward," he says.
"I think if that happens we'll see a substantially lower amount of products placed on APLs and substantial consolidation in the industry to the detriment of consumers.
"Fewer products could lead to fewer choices and moving away from riskier products could also mean lower returns."
Saunders says Premium had a very limited exposure to Great Southern and other problematic products in the past 20 months and advisers had given clients advice appropriate for their individual circumstances.
"The main thing is that it was appropriate the client invest into that product and that the percentage of monies directed into the particular asset class was in line with the risk profile of the client and that appropriate due diligence was carried out by the adviser," he says.
"The priority is that the advice given by the adviser is appropriate for that particular client and that the product adheres to Premium's APL parameters."
He says that in his opinion APLs are certainly still relevant in today's market, with the major issue more around how APLs are put together and used by different licensees in the future.
"In a business like Premium, advisers want choice and not to be restricted," he says.
While the dealer group ultimately wears the risk, in every case the adviser must adhere to the dealer group's guidelines. "Our APL isn't probably that dissimilar from other dealer groups who use Lonsec or van Eyk, but we are happy with the amount of choice we currently have," Saunders says.
Due to the downfall of a number of product providers in recent times, it was likely dealer groups would become more vigilant in their compliance regime, including the checking of funds allocated to each asset class, the appropriateness of advice and the fee disclosure, he says. It is also likely they will become more stringent in ensuring transparency and in ensuring advisers have conducted their own due diligence and are continually monitoring the investments' progress and any additional risks associated with those investments.
"In terms of Premium specifically, our compliance regime is becoming far more robust in terms of continuously monitoring the advice that goes out through our network, which to date has been exemplary," Saunders says.
Miller says running an APL is a crucial responsibility for a licensee and that it is a major mechanism to give protection to both clients and advisers.
"We still see the APL as playing a very important role in determining what an adviser can and can't provide," he says.
"Considering the inquiries into financial services that are currently under way, there will no doubt be a range of changes that come into effect for AFSLs, including greater investment guidelines and standards.
"Product providers certainly have to be more diligent in how they construct products in all economic cycles going forward, but in saying that, licensees can't dismiss their responsibilities based on that either."
Miller says through the GFC the group made good decisions about the areas it avoided and it did not have exposure to Timbercorp, Westpoint, Great Southern or any other such firms.
He says a more diligent approach by dealer groups to products could lead to smaller APLs in future, however, that was more likely in terms of having fewer specialised niche investments.
"I don't think smaller APLs will necessarily limit consumer choice," he says.
"Smaller APLs will more likely ensure dealer groups are more prudent in their recommendations.
"They will put clients in a better position by ensuring there is a stronger link with the strategy and products recommended, and more security with products that have undergone changes.
"I think the GFC has certainly prompted licensees to be more diligent with the assessment of products and in acknowledging the repercussions of the GFC."
Klipin concurs and says considering the past 12 months, the organisations with more to lose will most likely be the ones that become more conservative in their APL selections.
"While some licensees could still potentially reduce the number of products on an APL due to a more robust research and review process, I don't think it would be that dramatic so as to reduce choice and returns for clients," he says.
Investment and Financial Services Association deputy chief executive John O'Shaughnessy says while APLs do not create a bulletproof system, they work well in minimising market failure and maximising consumer and adviser protection.
"They are no doubt still relevant in today's industry and in light of recent company collapses have meant there has been less fallout than what there would have been otherwise," O'Shaughnessy says.
"APLs clearly still have an important role to play in the industry, but in future there is a clear expectation that product providers, research houses, dealer groups and advisers, as a group, will pick up their game in terms of the roles each of them play."
While dealer groups seem committed to bolstering the research and due diligence processes behind APLs, there seems to still be a pending debate regarding accountability in the advice chain.
Evans says while advice is obviously the speciality of dealer groups and advisers, the fact product failure lies with them also is completely wrong. "When are fund managers going to stand up in relation to their products that fail?" he says.
"Likewise, if you put yourself out to a market to say your business is researching products, but the research is not thorough enough to detect issues, then you should accept responsibility.
"If a research house gives a product an investment grade and the actual advice provided by the adviser is appropriate but the product fails, it shouldn't necessarily rest all on the shoulders of advisers."
He says if there are not stricter guidelines for product manufacturers and research houses to abide by, dealer groups will have to spend considerably more time ensuring products do what they say they will.
"I think either way we'll see a significant change in the evaluation of products going forward and in what is and isn't acceptable," he says.
"In terms of fund managers and research houses being more accountable for their roles, I think this will only happen if dealer groups reduce their APLs enough to make an impact."
Klipin says effectively a product manufacturer needs a good rating to be included on an APL and the higher the rating, the greater ability it has to penetrate recommended lists.
"Therefore every part of the value chain, so the product manufacturer, the research house, the dealer group and adviser, has a responsibility," he says.
"The thing that is still yet to be determined, however, is whether a whole new process of research and review evolves from the recent collapses of a number of approved providers.
"People who invested in firms that achieved good ratings but that fell over during the GFC are questioning where they will turn now for good insight on investments."
The most important thing is that lessons from the GFC are not lost, he says.
"If we don't spend time implementing the lessons that were starkly obvious not even 12 months ago, it could be the case that history repeats itself," he says.
Lonsec general manager of research Grant Kennaway says in regards to accountability for APLs, research houses are licensed entities and do have obligations under ASIC.
Like dealer groups, research houses also have their own AFSL.
"Sometimes there is a misconception that research houses operate in an unregulated environment when we actually do," Kennaway says.
Like other financial services businesses, research houses must comply with the AFSL licensing regime, which includes capital adequacy requirements, disputes resolution, publication of a financial services guide outlining remuneration and management of potential conflicts of interest.
"It's also important people understand what a research rating means as there are sometimes misconceptions about what a rating suggests," Kennaway says.
The role of the research house includes identifying the risks associated with particular products and the types of investors the products would suit, he says.
"Some investors want conservative products but others want to take greater risks to generate greater returns and because of that, research houses will look at products at both ends of the spectrum," he says.
"Basically, you can't generate strong returns if you don't take some form of risk." Research articulates what the risks are, however, at the end of the day it is still the regulator's responsibility to determine to what extent research houses are accountable for their role in the advice chain, he says.
"Research houses must adhere to the guidelines the regulator sets out. We acknowledge that we are part of the advice process and that we need to operate honestly and with care and skill," he says.
It has certainly been a difficult period for financial markets, he says.
"When markets turn bad there are always products that will get caught up, which is just an unfortunate part of the cycle, but it's important to remember that a large number of highly-rated products did do well and did what they were meant to," he says.
"The researcher is certainly a strong chain in the process, but if accountability is to be more spread out, it is up to the regulator to decide how that works."
Vanguard principal and head of retail Robin Bowerman says product manufacturers need to ensure products do what they say they will.
"In some cases what you see isn't what you get with a product and in those situations advisers are quite rightly feeling disillusioned as products didn't perform as they were told they would," Bowerman says.
"There's an issue of trust there for the funds management industry generally as there has been a loss in confidence.
"Those good, actively-managed funds that stuck to their knitting and did what they said, however, shouldn't be criticised."
He says responsibilities must be shared across all parties in the advice chain, but at the end of the day the adviser still must be sure they understand the products they invest their clients' money in.
"What became clear last year is that a lot of advisers and product manufacturers didn't understand the risks they were taking. I think moving forward there will most likely be a move back to basics with a greater concentration on transparency at all levels," he says.
While accountability is obviously still a debatable issue when it comes to APLs, it appears evident the due diligence performed on products will certainly become more stringent.
APLs most likely will become more conservative and potentially smaller in size too.
Opinions as to whether the shift could limit choice as well as returns for clients as advisers turn away from riskier products, or whether choice and financial benefits could still exist in a more secure investment environment, are still mixed.
