In recent years, there have been a number of reviews into various aspects of the regulation of the financial services industry. The wholesale client eligibility rules is one area that is attracting increased attention as being in need of reform.
While the Hayne Royal Commission had nothing to say in relation to wholesale client eligibility, the review in relation to AFCA's jurisdiction and the ALRC's review of Chapter 7 of the Corporations Act both recommended changes. You can read about those proposals in this article here.
With the release of the Final Report of the Quality of Advice Review, we now have another recommendation for changes to the wholesale client eligibility rules. However, the restricted scope of the Terms of Reference in relation to wholesale clients would appear to have forced the Review to "pull its punches" when making its recommendations.
What was the Quality of Advice Review?
The purpose of the Quality of Advice Review was to ensure that Australians have access to "high quality, accessible and affordable" financial advice. The Review was conducted by Michelle Levy, a financial services lawyer, who was asked to consider how the regulatory framework could better enable the provision of high quality, accessible and affordable financial advice for consumers.
The Final report of the Review was provided to the Government in December 2022 and subsequently made public in 2023.
Why was the Review looking into wholesale client eligibility?
The Review was asked to consider whether the consent arrangements for sophisticated investors and wholesale clients were working effectively for the purposes of financial advice.
However, the actual definitions of retail client and wholesale client and the associated income and asset thresholds were outside of the Review's Terms of Reference.
Despite that, the Report did note that the assets and income thresholds for the Individual Wealth tests have not been reviewed or indexed since they were first introduced in 2001 and that "there does appear to be a need to consider whether they are appropriate".
Of the 5 eligibility tests, the Review only looked into the Individual Wealth tests and the sophisticated investor test. This was, presumably, because they are the tests that are most commonly applied to the consumers that were the focus of the rest of the Review.
What did the Review recommend?
The first point that the Report noted was that there were actually no consent arrangement in place for the Individual Wealth tests. Technically, a person does not even need to be told that they are being treated as a wholesale client under these tests, let alone the implications of being treated as a wholesale client. That said, the need for the client to obtain an accountant's certificate would, in practice, involve the client in the process to a large extent.
For sophisticated investors a consent requirement already exists in that the client has to first sign an acknowledgement as to the implications of being treated as a wholesale client.
It was also noted in the Report that a sophisticated investor must have a certain level of experience and understanding of using financial services or financial products whereas the Individual Wealth tests are based solely on whether the client's level of wealth exceeds one of the statutory thresholds.
Based on these observations, the Review recommended that the Individual Wealth tests include both disclosure and consent obligations as with the sophisticated investor test. This would involve the following eligibility requirements for the Individual Wealth tests:
- An accountant's certificate as at present.
- An explanation of the consequences of being a wholesale client.
- The client to sign a written acknowledgement.
However, the Review did not recommend that any assessment of the client's financial literacy is required for the Individual Wealth tests - on the somewhat curious ground that an adviser could not "form that view objectively". We consider whether a licensee might want to make such an assessment anyway under the existing laws in this article.
The written acknowledgement proposed by the Review would need to explain the important consequences of being treated as a wholesale client, namely that:
- an advice provider is not required to be a "relevant provider" and accordingly will not have to comply with the professional standards;
- an advice provider will not have a duty to give good advice or to act in the best interests of the client under the Corporations Act;
- an advice provider is not required to give the client a PDS or FSG; and
- the client will not be entitled to complain about the advice under the licensee's IDR procedures or to AFCA.
The Review also recommended that this form of acknowledgement should replace the existing form of acknowledgement provided by sophisticated investors.
What are the likely consequences of the Review's recommendations?
The recommendation that the Individual Wealth tests have a consent and disclosure requirement is unlikely to be controversial. Despite the increased paperwork required, we doubt that it will actually have much effect on the number of clients that are treated as wholesale under these tests.
The use of a common acknowledgement across both tests would be a definite improvement as the present acknowledgement required for the sophisticated investor test is not particularly well worded.
The lack of a recommendation for a financial literacy assessment for the Individual Wealth tests is interesting and probably (in our opinion at least) more a reflection of the limitations of the Review's Terms of Reference than a considered opinion that such assessments are unwarranted.
We are also inclined to query whether, if the Review was allowed to conduct a wider review of the actual definitions of wholesale client, then would it have recommended the removal of the Individual Wealth tests and their replacement with some form of sophisticated investor "licence" or "passport" - as the ALRC recommended in 2022?
If nothing else, it would appear that a significant increase in the thresholds for the Individual Wealth tests would have been recommended.
Will the distinction disappear if the Review's other recommendations are implemented?
If some of the other recommendations in the Report are accepted by the Government, then many of the disclosure and conduct rules that currently apply only to retail clients will be removed or become less onerous. This will provide less incentive for financial services providers to operate "wholesale only" business models.
It could be that these other recommendations will result in less clients being treated as wholesale than would be achieved by tinkering with the eligibility requirements themselves.
Practical measures to take now in relation to wholesale clients
If you presently have a wholesale client business model or are considering moving to one we recommend that you:
- Obtain legal advice on whether and how wholesale client eligibility presently apply to your products and services. The legislative provisions are complicated, not easy to find and involve many exclusions and exceptions.
- Be careful in how you assess and evidence wholesale client eligibility and make sure that you implement controls to ensure that it is maintained (for example, accountant's certificates need to be renewed every 2 years).
- Carefully consider whether it is appropriate to treat individual investors as wholesale clients based purely on their level of wealth. Some assessment of a client's level of financial literacy would also appear to be prudent.
- Keep an eye out for regulatory developments in relation to wholesale client eligibility.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.