Fallout from the banking royal commission has prompted a further downgrade in Morningstar's fair value estimate for narrow-moat insurance giant AMP (ASX: AMP) to $3.40 per share from $3.60.

In a note published on Wednesday, Morningstar equity analyst Chanaka Gunasekera says the three key takeaways from the commission’s interim report are:

• more aggressive enforcement action by ASIC
• significant further investments in systems and processes, and
• increasing potential for major structural changes in the advice industry.

At 3.30pm, AMP was trading up 0.83 per cent at $3.06.

amp royal commission banking inquiry misconduct

ASIC has announced its officers will be embedded within AMP

Stricter enforcement won't just hit AMP with higher legal costs and compensation payments, it will also make it harder for the firm to attract both financial advisers and investors to its products. The Australian Securities & Investments Commission has already begun federal court action against AMP and announced the embedding of ASIC officers within AMP.

Advisers will also be more likely to leave should the commission's final report recommend that grandfathered commissions be abolished. This would also reduce fund inflows, increase AMP's margin pressures and potentially trigger "buyer of last resort" agreements (whereby AMP is committed to buy an AMP adviser’s practice). Grandfathered commissions are also linked to higher fee-generating legacy products.

Gunasekera says that while it's too early to know exactly what new systems changes may be required, Morningstar’s reading of the interim report indicates "these have the potential to be significant".

He believes they will "generally require stronger monitoring of financial advisers; and potentially expensive changes to platforms, software and processes."

Processes may also be required that allow clients to change platforms more easily, including providing in specie transfers.

Morningstar still believes the most likely outcome is that the government will not seek to completely abolish vertically integrated business models. However, given the interim report expresses concern about this model, Morningstar is less confident in this view.

This is because the report notes that the one-stop shop has an incentive to promote the product manufacturer’s product over others, even when this may not be in the best interests of clients. AMP’s vertically integrated model could also be negatively affected by the prospect of advisers being individually licensed and directly supervised by ASIC.

However, it's doubtful whether ASIC has the capacity to individually supervise the circa 25,000 financial advisers in Australia. There's also the potential for unintended consequences, such as individual advisers not having the funding to compensate clients should misconduct occur.

Given the next half-Senate election must be held before 18 May 2019, just months after the scheduled release of the commission’s final report by 1 February 2019, it’s likely the final report complete with recommendations will be released in either the lead-up to or during the next federal election.

Because it will be difficult for either major party not to accept the commission’s recommendations, Gunasekera says AMP will continue to be a high-risk in the near term.

 

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Roger Balch is a Morningstar contributor

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