NEED TO KNOW The Committee led by David Murray which is undertaking the Financial System Inquiry has today released its Interim Report. Overall the Interim Report has concluded that the Australian financial system has performed reasonably well, which is reflected in the policy option of ‘no change’ as being part of the spectrum of options considered for the majority of the priority issues and observations identified. However the Committee also acknowledged that there are areas for improvement and the Interim Report has made a number of observations and includes a range of policy options for each priority issue. The table set out in this publication provides a summary of the observations and the key policy options being canvassed by the Committee. The Committee has stressed that the policy options are not draft recommendations, and seeks stakeholder input on the observations and policy options in the Interim Report. NO REAL SURPRISES There are no real surprises in the Interim Report and many of the areas flagged as needing to be changed have been debated before. For example, better disclosure in financial services, enhanced powers for regulators, encouraging the use of income streams in retirement, and the power of technology in financial services. In his speech to the National Press Club, David Murray specifically referred to the challenges associated with the disclosure rules in the financial system and argued it may be appropriate “to develop a viable alternative approach that is not simply more detailed rules.” The Interim Report acknowledges that this problem remains despite several efforts to improve the disclosure regime. In future publications, we will be analysing in more detail some of the challenging policy options canvassed in the Interim Report. NINE PRIORITY ISSUES – OBSERVATIONS AND POLICY OPTIONS
Competition and contestability
Observations Policy Options (a) The banking sector, dominated by the big 4 banks, is concentrated but remains competitive. (b) Large banks derive some of their cost advantage by using internal ratingsbased (IRB) risk weights, allowing them to assign lower risk weights for mortgage lending than smaller ADIs. Reduce the risk weight margin for mortgages through means such as increasing minimum IRB risk weights or allowing smaller ADIs to adopt IRB modelling for mortgages only.
Observations Policy Options (c) The cost of residential mortgagebacked securities (RMBS) funding has increased since the GFC. Provide government support for the RMBS market or change the class of the asset to a high-quality liquid asset for the purpose of the liquidity coverage ratio. (d) Differences in the structure of payment systems (e.g. credit cards, debit cards) have resulted in systems that perform similar functions being regulated differently, which may not be competitively neutral. A spectrum of policy options have been outlined, including: no change, lowering or removing interchange fee caps, capping merchant service fees and a broadened ban on ‘no surcharge’ rules.
Funding Australia’s economic activity
Observations Policy Options (a) Foreign funding has allowed Australia to sustain higher growth than would otherwise have been the case. Risks associated with foreign funding (such as integration with international capital markets) can be mitigated by having a prudent supervisory and regulatory regime and sound public sector finances. (b) Structural impediments for small and medium sized enterprises (SMEs) to access finance, including information asymmetries (i.e. lender will have limited information about a new borrower’s financial position), regulation and tax. Facilitate development of SME finance database to reduce information asymmetry. (c) A range of regulatory and tax factors have limited the development of, and participation in, Australia’s domestic bond market. Companies who want to issue bonds face impediments in making public offers to retail investors in particular. • Allow listed issuers to issue ‘vanilla’ bonds directly to retail investors (no prospectus). • Review the size and scale of corporate bond offerings limited to a value of $2 million. (d) Australia’s tax system distorts household savings towards housing, both for home ownership and investment, and encourages people to take on higher levels of debt. The increase in housing debt and banks’ more concentrated exposure to mortgages mean that housing has become a significant source of systemic risk.
Superannuation efficiency and policy settings
Observations Policy Options (a) Operating costs and fees in the superannuation sector appear high in comparison to other OECD countries. There is little evidence of fee-based competition. • No change and review effectiveness after impact of MySuper regime can be assessed. • Consider mechanisms to improve services for MySuper members e.g. auctions for default fund status. (b) Growth in direct leverage by superannuation funds (especially SMSFs) may create vulnerabilities for the superannuation and financial systems. Restore the prohibition on super funds borrowing money on a prospective basis. (c) Superannuation policy settings lack stability that will add cost and reduce long-term confidence in the sector.
Stability and the prudential framework
Observations Policy Options (a) Australia should reduce perceptions that some institutions are ‘too big to fail’. This would involve presenting options for the financial market that do not involve Government support or bail outs in times of economic stress. The options discussed consider increasing the risk burden on financial institutions (by increasing capital requirements) and creditors (by increasing the ability to impose losses on creditors of a financial institution in the event of its failure). The options also consider strengthening regulators’ resolution powers for financial institutions and ring-fencing critical bank functions, such as retail activities. (b) Other jurisdictions have enacted macroprudential toolkits to assist in managing systemic risks, though their effectiveness in Australia is uncertain. • Introduce specific macroprudential policy tools. • Establish a mechanism to adjust the prudential perimeter to apply heightened regulatory oversight to institutions or activities that pose significant risk to the stability of the financial system.
Observations Policy Options (c) Australian banks’ capital ratios are around the middle of the range relative to other countries, though differences (e.g. definition of capital) and national divergence from some baseline international standards limits international comparability, and potentially create real costs for industry. • Calibrate Australia’s prudential framework, in aggregate, to be more conservative than the global median. • Develop public reporting of regulator-endorsed internationally harmonised capital ratios with the aim of increasing transparency. (d) Regulatory focus has confused the delineation between the role of the board and that of management in corporate governance and managing risk appetite within financial institutions. • Review prudential requirements on boards to ensure they do not draw boards into operational matters. • Regulators continue to clarify their expectations on the role of boards.
Consumer outcomes and conduct regulation
Observations Policy Options (a) The current disclosure regime for financial products is complex, lengthy and expensive and often does not enhance consumer understanding of financial products and services, and impose significant costs on industry participants. Potential solutions to move towards producing more targeted disclosure documents include: • online competitor analysis and risk profile disclosure; • removal of ineffective disclosure requirements; and • additional powers to ASIC to increase oversight and intervention. (b) Comprehensive financial advice is expensive, and there is consumer demand for lower-cost scaled advice. The options considered are focused on: • increasing the minimum competency levels of financial advisers, particularly those providing personal advice (eg through raising competency benchmarks); and • increasing regulation and public awareness of poorly performing financial advisers (eg enhancing ASIC’s power to ban individuals from providing financial advice, and introducing a public register of financial advisers which includes a record of each adviser’s current status in the industry).
Observations Policy Options (c) Underinsurance may be occurring for a number of reasons, including affordability and lack of adequate information or advice on the level of insurance needed. Improved technology may lead to streamlined products and increased competition.
Observations Policy Options (a) Australia’s financial regulatory framework could be re-examined in a number of areas to ensure each can capture emerging risks. Suggested areas for reexamination include regulation of the superannuation industry (prudential versus conduct regulation), simplified and transparent regulation of retail payment systems and the introduction of market integrity rules to securities dealers. (b) Australia’s regulators are generally well-regarded but improvements could be made to increase operational and budgetary independence and accountability. Suggested improvements include moving ASIC and APRA to a more autonomous budget and funding process and clarifying the metrics for assessing regulatory performance. (c) During and after the GFC Australia’s regulatory coordination has been effective, and the Council of Financial Regulators (CFR) plays an important role in coordinating financial regulation and stability issues, though there is room for greater transparency. A few options are being considered to increase the role, transparency and external accountability of the CFR, including: • formalising in statute the role of the CFR; • adding the ACCC, ATO and the Australian Transaction Reports and Analysis Centre to join the CFR; and • increasing reporting by the CFR. (d) Regulators’ mandates and powers are generally well defined and clear, though they could place more emphasis on competition matters. In addition, ASIC has a broad mandate and the range of penalties available to it is low in relation to comparable peers internationally. • Strengthen competition considerations through mechanisms other than amending the regulators’ mandates. • Refine the scope and breadth of ASIC’s mandate. • Review the penalty regime in the Corporations Act.
Observations Policy Options (e) Regulators need to be able to attract and retain suitably skilled and experienced staff in order to perform their roles effectively in accordance with their legislative mandate. Review mechanisms to attract and retain staff, including terms and conditions. Observations Policy Options (a) The retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees. A number of policy options are aimed at encouraging retirees to use income streams with longevity protection in retirement, including: • providing policy incentives to retirees; • introducing a default option for taking retirement benefits; and • mandating the use of particular retirement income products. (b) There are regulatory barriers to setting up new superannuation products with risk management features that are in the interests of retirees. • A flexible, principle based approach to and streamlining administrative arrangements for assessing tax concession eligibility and Age Pension means-tests treatment. • L onger dated Government bonds could support the development of retirement income products. Observations Policy Options (a) Technological advances can drive efficiency and competition, but regulators and the government need to mitigate any potential risks whilst promoting flexibility and innovation. A range of policy options focus on promoting technological neutrality in financial services regulation, such as by removing provisions in relation to specific technologies. Other policy options focus on facilitating technological innovation. One of these options is to establish a new (potentially public-private sector) body to advise the government on technology and innovation.
Observations Policy Options (b) Growing amounts of consumer information can be used to improve efficiency and competition, but it also raises privacy and data security risks. The policy options considered are focused on protecting the privacy of consumer information, such as: • implementing mandatory data breach notifications to affected individuals; and • reviewing information storage and privacy requirements, in particular those that impact on cross-border information flows. (c) The financial system’s shift to an increasingly online environment heightens cyber security risks and the need to improve digital identity solutions. The Government has a role in facilitating industry coordination in this area and the options provide for government driven policies in consultation with the private sector, financial institutions and stakeholders. The options include: • reviewing and updating the 2009 Cyber Security Strategy to reflect changes in the online environment and progress public-private sector collaboration; and • developing a national strategy for promoting trusted digital identities.
Observations Policy Options (a) The Government should seek to enhance the integration of Australia’s financial system with those in Asia, to benefit from opportunities to access capital and be involved in financial services exports and imports. The integration of Australia’s financial system could be more effectively coordinated with growing Asian financial markets with the removal of impediments to international capital flow.
Observations Policy Options (b) Domestic regulatory processes could be improved to better consider international standards and foreign regulation. Domestic regulatory process could better consider international standards and foreign regulation (which since the GFC increasingly extend to activities occurring in Australia) by including processes for: • consultation about international standard implementation; and • mutual recognition and equivalence assessment processes. (c) Coordination of Australia’s international financial integration could be improved across the Government, regulators and industry. Amend the role of an existing coordination body to promote accountability and provide economy-wide advice to Government about Australia’s international financial integration.
NEXT STEPS The Committee sought first round submissions following the release of the terms of reference, which closed on 31 March 2014. The Committee is inviting submissions and feedback on the Interim Report from interested parties to gather further evidence, check the validity of observations and test potential policy options. Second round submissions can be lodged online. The closing date for submissions is Tuesday 26 August 2014. The Committee is travelling overseas to consult international stakeholders from 19 July 2014 to 1 August 2014. After this, public forums will be held in Sydney, Melbourne, Perth and Brisbane. The Final Report of the Committee is due in November 2014.