Later this month just over 600 financial advisers will sit the industry’s new professional competence exam. They’re the first cohort to submit to an exam developed by the Financial Adviser Standards and Ethics Authority (FASEA) under legislation to lift the education, professional and ethical standards of advisers. 

Whether they’re guinea pigs or canaries in the coalmine remains to be seen, but whatever form of fauna is the appropriate analogy, they’d better hope they pass. Failing the exam could have severe consequences on their ability to continue giving advice to clients.

Licensees at the 2019 Professional Planner Licensee Summit on June 3 and 4 expressed strong reluctance to allow advisers who fail the exam to continue to give advice to clients, until and unless the adviser resits the exam and passes. 

They expressed reservations about having to face a royal commission-like inquiry sometime in the future to explain why they allowed an adviser to continue to advise clients, when they had an objective assessment that the adviser was not up to the standard required.

An adviser must wait a minimum of three months after failing the exam before they can sit it again, meaning an adviser failing the exam could be prevented from seeing clients, and from charging for advice, for at least a quarter of a year – and that assumes the best-case scenario that they pass the exam at the second time of asking. 

The existential risk of failure

In practice an adviser could fail multiple times and be knocked out of action for three months each time. Each failure will lead to three months of foregone revenue. Not many individuals or businesses could withstand that kind of impact, so failing the exam could be an existential issue for some advisers and their businesses.

The exam is just one element of new professional, education and ethical standards for financial advisers, but it’s the most clear and present danger. All existing advisers need to sit and pass the exam before January 1, 2021, and if they do not, they will be removed from the Australian Securities and Investments Commission’s financial adviser register (FAR).

But the exam could cause significant disruption well before then – perhaps as early as this week, if not all of the first 600 pass – as some advisers fail and are prevented from giving advice for a period of time in the run-up to that deadline.

FASEA has published practice questions and will publish more in the months ahead. It will test the content of its exam with experts and – according to the head of FASEA – with recently retired advisers, to test whether the questions are reasonable and fair. Some advisers are understandably sitting back to see more of these example questions, and what befalls the first 600 candidates, before they take the plunge. But they can’t afford to wait too long – if they do fail, they need time to regroup and resit the exam to meet the end-2020 deadline.

It’s those unintended consequences – again

Removing advice capacity from the market is an unintended consequence of a law designed to raise the quality of advice. Preventing clients from receiving advice from someone who the day before sitting the exam was deemed appropriate to give that advice can’t be something they thought could (or will) happen when they drafted the new rules.

But unintended consequences crop up regularly, and with the benefit of hindsight often appear inevitable. After the Titanic sank in the mid-Atlantic in 1912, with the consequent loss of more than 1500 lives, legislation was passed in 1915 requiring all passenger ships to have enough lifeboats for all passengers. (The Titanic had 20 lifeboats with a maximum capacity of 1178 people – there were around 2200 passengers on board when it sank.)

It might seem unbelievable to us now that it wasn’t already a requirement that ships should have enough lifeboat space for all passengers. Nevertheless, by July 1915 a ship called the SS Eastland had been duly retrofitted with the required lifeboats, but the only place they could be put was on the ship’s upper deck. 

It is now believed this caused the Eastland to become top-heavy, and while it was still in dock on the morning of July 24, it rolled over and sank in 20 metres of water, drowning an estimated 800 passengers. This consequence, in addition to being clearly unintended, was also deeply ironic.

One consequence that’s definitely intended

One crystal-clear and fully intended consequence of not passing the FASEA exam before the stated deadline is that an adviser will be removed from the FAR and will be banned from practicing as an adviser.

Any adviser who is not on the FAR and wants to re-enter the industry will fall out of the transitional arrangements that apply after January 1 this year and will have to come in as a new entrant. This means they will be required to hold an approved degree, complete a professional year – and pass the exam.

An estimated 27,000 advisers on the FAR will have to pass the exam between now and the end of 2020, or they’ll be removed from the industry. The first 600 of them are about to go through the process, and then we’ll start to see the consequences – intended or not – for any who may fail.

The exam covers the practical application of the law, know-your-client (KYC) issues and ethics. It’s designed to ensure that all advisers’ current knowledge is up to scratch. 

A risk and return trade-off for advisers themselves

FASEA isn’t in control of the timetable for new education, professional and ethical standards, it’s simply implementing a program already defined in legislation. The body is doing the best it can to ensure everything is done in enough time to allow everyone to prepare properly.

There will be fallout from the FASEA exam as advisers fail. And the first 600 candidates are to be congratulated for their courage in tackling it early. As for the other 26,000-odd advisers on the register, the issue they’re facing is whether also to go early, to give them time to remedy any shortfalls in knowledge identified in time to pass by the end of 2020. The return they’ll get from passing the exam is remaining on the FAR. The risk they face is a potential cost to their business and livelihood if they fail the exam. Financial advisers are used to talking to clients about risk and return. The timing of sitting the FASEA exam is one trade-off calculation that all advisers must make for themselves.