You’ve likely noticed the spike in reports about shareholder class actions against major financial institutions recently, and it shouldn’t come as any surprise as to why this is occurring.
It isn’t just that the press is paying more attention to these cases due to the Royal Commission, though – this type of class action is both relatively new in Australia and definitely on the rise. A report from law firm Allens noted that the first shareholder class action was launched in 1999, and a further 50 had been commenced as at February 2017. There’s a clear upward track in the number of these actions, and although most don’t end up making it to trial, the costs involved in responding are tangible and substantial.
Obviously, not all of these actions involve financial services, but given the number of those that do appearing in headlines over the past few months, it’s worth considering how this trend will affect Australia’s financial advice industry.
A cost of doing business?
If you look at the annual reports of listed finance companies – including wealth businesses – they can often exclude non-recurring litigation expenses from pro forma financial statements, with a view to portraying a “truer” picture of a company’s valuation. If these class actions continue their steady rise, though, it may be fairer to describe such expenses as recurring.
Should that occur, litigation could come to be perceived as a “cost of doing business” in wealth management – this is compounded by the Government’s proposed expansion of ASIC’s powers and general adjustments to legislation which would open the doors to civil action against any financial advice entity that fails to comply with new disclosure and distribution rules.
Rising liabilities
If the wolves really are circling the caravan, so to speak, you can bank on one particular sector paying close attention: providers of advisers’ professional indemnity insurance. A recent research report from Aon noted that PI insurers’ loss ratios have been “hovering around 80%” in the three years to 2017. In order for PI insurers to make a profit, their loss ratios need to be under 70%.
“It is therefore understandable,” the research says, “why insurers are looking to push rate.”
The report notes that “insurers writing PI are generally also directors and officers (D&O) underwriters,” and that the “heightened securities class action environment in Australia has drawn focus from insurers’ global head offices.”
On top of this, back in 2017, both the Financial Planning Association and the Association of Financial Advisers submitted concerns to Treasury that proposals to increase monetary claims limits under the new Australian Financial Complaints Authority (AFCA) regime may drive PI insurance providers out of the financial planning sector, resulting in a more concentrated market and significantly increased premiums being charged to financial advice businesses.
Margin pressure
On a broader note, rising PI premiums and litigation expenses could put further pressure on the projected profit margins of many large Australian financial institutions. The effects of this would be twofold: first, it follows that this would reduce the overall valuation of the largest contributor to Australia’s economy.
Second, we’ve previously discussed that of the $1.6 trillion in superannuation money monitored in APRA’s quarterly super performance statistics, 23% was invested in Australian shares as at March 2018. For the roughly $700 billion invested in SMSFs, ATO data shows about 29% was invested in Australian shares at the same period.
If one breaks down the ASX All Ords, financials are by far the largest sector at the time of writing, occupying 29.9% – materials comes in second at 16.6%. It stands to reason, then, that a substantial proportion of Australia’s retirement funds are invested in companies exposed to the above concerns, which could potentially lead to pressure on super savings.
What’s there to be done about it?
All of the above issues are worth considering, but so too are the practical ways any wealth business can mitigate these risks, regardless of its size: first, one can review PI insurance arrangements.
After that, it’s critical to remain abreast of any further regulatory complexities that may give rise to potential civil action. In that regard, we’ll be there with you every step of the way.
The opinions expressed in this content are those of the author shown, and do not necessarily represent those of No More Practice Education Pty Ltd or its related entities. All content is intended for a professional financial adviser audience only and does not constitute financial advice. To view our full terms and conditions, click here.
