Released in December 2014, the Financial System Inquiry (FSI) Final Report (Final Report) drew much attention from Australian financial services providers and the media alike. The report made a total of 44 recommendations to address perceived areas for improvement in Australia’s current financial system. We provided our initial views on these recommendations in December 2014.
Submissions to Treasury in relation to the Final Report were due on 31 March 2015. The consultation period was designed to give market participants the opportunity to express their views on the recommendations. From the announcement of the Inquiry, through to the latest consultation period, we have been canvassing the market and talking with clients, market users, industry bodies and lawmakers on what recommendations are likely to be introduced and what impact the recommendations will have on our financial system.
From this consultation, there is a general appreciation that culture in industries connected with the financial system will be a matter for change. This is consistent with the regulatory focus and philosophical approach being adopted in other markets in which we operate, including the United Kingdom, Hong Kong, South East Asia more broadly.
The message that we’ve received is that any evolutionary legislative and regulatory changes that are to come need to fit within the existing legal frameworks and that legal certainty is a primary concern.
Our submission to Treasury addresses a number of recommendations, including those regarding:
- additional powers for regulators;
- superannuation and retirement incomes;
- financial technology (Fintech) and consumer outcomes; and
- product suitability.
In this article, we have provided an overview of some of our key recommendations which correspond to some of the recommendations made in the Final Report. For more context and information, please view our full submission.
Recommendation 3 – Loss absorbing and recapitalisation capacity (commonly known as ‘bailing-in’ of senior debt)
The introduction of a regime bail-in of senior creditors is an example of an idea emanating from overseas regulation that needs careful consideration and refinement before it migrates to Australia.
A general bail-in of all senior debt (other than depositors) is likely to place the risk of the failure of an Australian bank largely on foreign investors, given Australia’s reliance on foreign capital markets and the preference accorded to Australian depositors under the Banking Act. It is unlikely to be fair, effective or economical.
It is our view, that it would be preferable to promote the creation of a new class of senior instruments, under which relevant creditors agree to be bailed-in after the holders of regulatory capital instruments.
Recommendation 5 – Crisis management toolkit
As part of the original consultation process by the Treasury on the Strengthening APRA's Crisis Management Powers: Consultation Paper issued in September 2012 (Crisis Management Powers Paper), we provided comments on a number of the proposals identified by that paper.
In the Final Report there is recognition of certain practical and legal issues raised in the 19 industry submissions (including our own) relating to the package of resolution powers proposed. There is also a recommendation that a view be taken as to whether additional proposals warrant inclusion and that all proposals should go through appropriate consultation, regulatory assessment and compliance cost assessment processes.
The package of proposals to be subject to the new consultation process should take account of the industry submissions made in connection with the original consultation process on the Crisis Management Powers Paper and this consultation process on the Final Report. In this way, the package of proposals will assume the benefit of work already done, and the issues previously identified can be narrowed or solutions proposed.
Recommendation 8 – Direct borrowing by superannuation funds
The Final Report observed that limited recourse borrowing magnifies the gains and losses from fluctuations in the prices of assets held in funds and that this increases the probability of large losses within a fund. This concern lies at the heart of the Final Report’s recommendation to remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.
By implication, the result of doing so would be to eliminate the opportunity for funds to experience the enhanced gains, as well as the enhanced losses, that can be achieved through the use of gearing. We consider that borrowing to invest is a legitimate investment strategy which should be available to superannuation fund members so long as it is subject to appropriate safeguards.
In our view, we recommend against removing the limited recourse borrowing exception to the general borrowing prohibition. However, we consider there to be scope to reframe the exception to remove unnecessary complexity and introduce improved safeguards.
Recommendation 9 – Objectives of the superannuation system
For many years, the superannuation system has been besieged by constant changes to the legislative framework (many introduced at or around budget time each year) resulting in legislative “confetti”, with different changes serving inconsistent policy aims. These constant changes have had a destabilising effect on those operating within the system and only serve to undermine public confidence in the system. Accordingly, we consider that steps need to be taken to bring policy stability. We see the introduction of objectives for superannuation as an important factor in this regard.
The objectives for superannuation cannot be determined in isolation. Both compulsory and voluntary superannuation are part of a broader retirement income framework. As such, we believe that the objectives should be determined after considering the wider framework, involving the age pension, superannuation and non-superannuation savings.
The Final Report suggested the approach of an overarching primary objective and a series of subsidiary objectives. While this cascaded approach comes at the cost of simplicity, high level objectives could be too general to address the different policy issues surrounding superannuation.
In our view, the objectives for superannuation should be enshrined within legislation, adopting the primary objective / subsidiary objectives model to ensure that they actually have a positive effect. We recommend that the primary objective be framed in terms of both the desired level of support provided by superannuation and by reference to a decreasing proportion of the population relying on the age pension.
Recommendation 11: The retirement phase of superannuation We endorse the Final Report’s proposal to provide for a comprehensive income product for members on retirement (CIPR).
There are two aspects to the Final Report’s recommendations in relation to a CIPR, being that the product is to be “pre-selected” and that the product’s features should allow for both flexibility and longevity.
We agree with the Final Report’s rejection of making a CIPR compulsory. Each member’s circumstances would vary dramatically and there would be many situations where a CIPR would not produce the best outcomes for a member (e.g. a member with a low account balance).
In our view, for CIPR products to achieve an appropriate level of scale and deliver value to members as a whole, it is appropriate for the product to be offered on a default basis – but with the ability of the participating member to opt-out. The cost benefits of a CIPR would be less likely to be achieved if a member was required to opt-in on retirement to receive the CIPR.
In practice, there should be sufficient opportunity for a member to opt-out, as trustees would need to obtain up-to-date information about the member for payment purposes, such as a member’s bank account details.
We recommend that the legislative requirements for the product features of a CIPR be entirely principles-based and outcomes-based. If the product features are too prescriptive, this will serve to limit the choices available to members.
Recommendations 14 and 18 – Collaboration to enable innovation; and Crowdfunding
The impact of digitalisation is a major opportunity and challenge for providers of financial services in Australia. We agree with the Final Report’s proposal to establish an Innovation Collaboration (IC), to facilitate innovation and enable timely and coordinated policy and regulatory responses. In addition, we suggest that an IC should be mandated to liaise with and support Fintech hubs that are evolving in each State and Territory.
With legislation often perceived to be out of step with market developments, it is important that there is timely regulatory change in this space. As such, we believe that there should be a more flexible power to make regulations and regulatory instruments should be considered.
We recommend that early initiatives should focus on:
- Smoothing regulatory tape, while balancing interests of consumer protection and transparency;
- Providing funding pathways with clear legal frameworks and consistent tax and accounting treatment; and
- Drawing on industry support to establish standard industry documentation to reduce costs for start-ups.
Among other recommendations, we also think it is important that ASIC should be given a clear mandate to use its modification powers under the Corporations Act to facilitate Fintech innovation and start-up funding (including crowdfunding).
Recommendations 21 and 22 – Introduce a targeted and principles-based product design and distribution obligation; and Introduce product intervention power
The Final Report’s suggestion in relation to product design and distribution obligations, or ‘suitability reforms’, will have far reaching consequences, many of which may be unintended. We believe that a broader consultation process must be undertaken before any decisions are made to introduce suitability reforms.
It is our view that ASIC should not be provided with an intervention power that extends its regulatory mandate into pre-emption. This would be very difficult to apply within the parameters set for its exercise and may create effects beyond what is intended.
The banning of financial products and intrusion into structuring has the potential to cause harm to the market, to innovation and to access to funding for Australian banks and businesses. This will mean that suitability reforms will not achieve their intended aim and may also prevent genuinely experienced or well-advised investors from accessing sophisticated products.
These initiatives may tend to lead the market towards simplistic offerings that will reduce opportunities for legitimate wealth creation and diversification for retail investors, but leave them exposed to the risks of products that appear simple but that can involve significant market risk (e.g. ordinary equity).
Recommendation 23 – Facilitate innovative disclosure
We strongly agree with the Final Report’s recommendation to remove regulatory impediments to innovate product disclosure and communication with consumers and to improve the way risk and fees are communicated to consumers.
Recommendation 31 – Compliance costs and policy processes
We strongly support the recommendation in relation to compliance costs and policy processes. The pace of regulatory reform and the administrative impact on the industry imposes cost burdens and drains resources that could otherwise be applied to product enhancement. Increasing the time available for industry to implement complex regulatory change would aid this, as would conducting post-implementation reviews of major regulatory changes.
Recommendation 37 – Superannuation member engagement
We support the recommendation to publish retirement income projections on members’ statements from defined contribution superannuation schemes using ASIC regulatory guidance, however, we consider the current ASIC Regulatory Guidance to be too narrow and inflexible.
Calculators and benefit projections are important tools to assist in engaging members in their superannuation arrangements. The prevalence of defined contribution arrangements in Australia, and the regulatory reporting surrounding them, means that member attention is on return on investment rather than adequacy of retirement savings. Benefit projections and calculators can assist in shifting the focus towards retirement income.
Recommendation 39 – Technology neutrality
We strongly believe that barriers to the use of technology to access financial services should be removed to allow improved engagement with investors.
We recommend that selected priority areas of regulation be technology neutral and that the consideration of the principle of technology neutrality be embedded into the process of the development of future regulation.
Recommendation 43 – Legacy products
We strongly support the introduction of a mechanism to allow for rationalisation of legacy products in the life insurance and managed investment sectors on a basis that is streamlined and cost efficient while protecting the interests of consumers.
The summary above provides a brief insight into some of our key recommendations following the Final Report.