Evolution not revolution

Carefully constructed evolution (not revolution) as an approach to regulatory reform has proven successful if the Government’s response to the FSI recommendations is any guide.

The Government has almost universally agreed with the FSI recommendations and importantly set out a roadmap for the way forward.

Design of the fabric as a whole

As with the financial system itself there is integral inter-connectedness between many of the FSI’s recommended reforms. The FSI will no doubt be particularly pleased therefore that, based on the Government’s support in its report, the overall picture they had designed for our financial system will remain complete.

The long lasting hangover from the pre-GFC excesses, the fast-paced development of digital financial services, the size of the superannuation savings pool, the ageing population and Australia’s unique position in the broader region are mega-factors which connect in many ways. It was important therefore that the FSI recommendations, which carefully took account of all these factors and which were each pieces of a complex puzzle, were adopted as a package.

While the timetable for implementation of recommendations such as innovative product disclosure (no earlier than 2017) are disappointing (particularly given the subject matter of that reform is already ahead of our legislation), we are quietly confident that, given the spirit of the Government’s announcement, the package, when looked at as a whole and with the right approach in implementation, will ultimately come together in a way which supports economic growth as the Government intends.

Clear timing commitments are refreshing

The fact that progress has been made already on some initiatives and a commitment has been made to a timetable for implementation is a strong sign that the Government means business when it comes to implementing the recommendations. Yes, some initiatives will be dependent on Productivity Commission reviews and some will be dependent on the Tax White Paper process outcome. But the strength of the language in the announcement gives business real clarity regarding the Government’s agenda. Whether any specific reform is good for a particular business or not, the need for certainty on the direction of reform is critically important to business in general.

While the published timetable appears conservative in some respects, given that 2015 is almost over we read any commitment to steps being taken by mid-2016 as a strong indication that the Government is serious about immediate reform (even if the language used is somewhat loose). Included in this category are the commitments to:

  • develop legislation:
    • to ban excessive card charges and better protect consumers using electronic payment systems
    • to reduce disclosure of “simple” corporate bonds
    • which provides a professional standards framework for financial advisors
  • establish the Innovation Collaboration Committee
  • consult on the development of accountabilities for issuers and distributors of financial products and ASIC product intervention powers
  • update the Statement of Expectations for APRA, ASIC and the Payment Systems Board, including providing for improvement of accountability.

Allowing time (among other business needs) for assessment and consultation on these developments would be wise.

The role of regulators

The Government's acceptance of nearly all the recommendations of the FSI also suggests it agrees with the principles underlying the recommendations and importantly some of the critiques made by the Committee on particular outcomes flowing from our current system. This may have implications for how the Government interacts with regulators and sets its expectations of them in future with flow on effects to the financial services sector.

The interpretation and application of the law by regulators is sometimes equally, if not more, important than the regulation itself. While we shouldn't over-analyse this, the acceptance by the Government of recommendations to introduce a new ASIC product intervention power and to make product issuers and distributors of financial products more accountable for their offerings, for example, suggests an environment of increasing conduct risk for financial firms operating in Australia, including as it relates to the application and interpretation of existing law and regulation.

Our regulatory conduct team has seen many different examples of these sorts of risks realised at an increasing rate in recent years and can use that experience to help you mitigate those risks going forward.

What about red tape reduction?

In some areas the recommendations add further regulation and in others regulation is proposed to be removed or made less intrusive. It will be important that the application of the recommendations for new regulation doesn't lead to over-reach or undue complexity, while a pragmatic and timely approach is adopted for recommendations proposing deregulation.

Global regulatory norms

The acceptance of the recommendations also demonstrates the globalisation of regulation is very real, and that it is increasingly difficult for countries like Australia to adopt approaches widely different from other relevant countries. This is particularly true given the continued importance of global wholesale debt markets and the growing push for mutual recognition in retail investment markets.

While many of the recommendations advocate greater regulation, in a number of instances these fall short of what has been adopted in Europe and elsewhere, and are less intrusive.

KWM's international network can be utilised to help your business to learn from how similar new regulations have been applied in other jurisdictions.

Be prepared and be smart about it

History tells us that one of the dangers of new regulation is that often industry fails to address adequately what is required under the new regime, sometimes because of poor legal interpretation and/or because of poor implementation or ineffective processes, even if these new processes have been implemented at very significant cost. Unfortunately, this has led to substantial losses some years later, sometimes involving significant brand damage.

In hindsight, it is probably fair to say that not enough independent testing was undertaken at the time of implementation. This is another area where KWM has considerable expertise to benefit your business.

Design thinking

While in some areas it will add to the cost of doing business, regulatory change nearly always creates new market opportunities for those that can move quickly to take advantage of it. KWM is well placed to support your business here given the genuine breadth and depth of our capability across all relevant areas (including regulatory capital, derivatives, capital markets, conduct, superannuation, life insurance, financial services regulation and tax).

It may be possible to apply concepts of design thinking to limit the cost of new regulation, to create new products and to comply with the regulation in a manner that improves the customer experience.

Consultation provides an opportunity to shape outcomes

In a number of important policy areas, the Government has flagged that it will consult extensively before finalising new legislation. This offers a further opportunity for the sector to influence final outcomes, and is an area KWM is very well placed to provide support. We have closely tracked the policy thinking since the outset of the root and branch review having made submissions to both stages of the FSI and to Treasury.

Two years on …

and after a large number of conversations, events and discussions with key clients and industry bodies, we are reaching the stage where rubber will start to hit the road. We are eager to continue to share our views on FSI outcomes as they unfold. Set out below is commentary from our experts on some key aspects of the response. Please contact us if you have any questions or would like to discuss any content in greater detail.

1. Derivatives market measures

Highlighted – Additional Government action

Australia’s derivatives market should welcome the Government’s statement of its intentions on international derivatives markets.

The legislation which is to be developed by the end of this year to clarify domestic regulation, to support the coordination of global policy efforts and to facilitate the ongoing participation of Australian entities in international capital markets will hopefully respond to the concerns which have been raised on these critical issues. These have included facilitating access to international clearing for superannuation entities and life companies, dealing with forthcoming international requirements for margining of uncleared derivatives and issues related to the interaction of Australia’s resolution regimes with international market processes and conventions.

Addressing these issues promptly is likely to be of great support to Australian market participants as they continue to compete in a global marketplace.

2. Resilience measures

Highlighted – Responses to Murray Report, Recommendations 3 & 5

There is nothing exceptionable or remarkable to report on the Government’s response to the FSI’s recommendations on resilience.

Bail-in and TLAC measures seem to remain on the table and we would expect them to develop consistent with international trends.

Matters of detailed prudential regulation, such as capital levels and their measurement, are referred to APRA for development in the next two years. Where the law needs development or overhaul, as in statutory powers to manage an institution in crisis, the Government will finish the consultation it began in 2012. It is the outcome of these further dialogues that will be most important to regulated financial institutions.

3. Superannuation measures

Highlighted – Responses to Murray Report, Recommendations 8, 9 & 11

The superannuation industry will welcome some of the Government’s positions, but others are more controversial. Confirmation of legislated superannuation objectives and of the Government’s commitment to a pre-selected CIPR are welcome positions. The most controversial aspects of the response involve the Government’s position on improvements to efficiency, both in relation to the aim to reduce member fees and to reform the Fair Work Commission model for selecting default funds. However, industry will have the opportunity to make further submissions as the Productivity Commission develops models for both of these aspects.

4. Innovation measures

Highlighted – Responses to Murray Report, Recommendations 14, 18 & 33

Collaboration to enable innovation

We are delighted to see that the Government will establish an Innovation Collaboration committee. Connectivity with the market and industry will be key to the success of this initiative, so we look forward to more detail on the terms of reference and composition of the committee.

The linkage with ASIC’s digital finance advisory committee makes sense. However, the impact on innovation of the proposed industry funding model for ASIC should not be overlooked. Regulatory frameworks often provide a major stumbling block for innovation, and a collaborative flexible approach by ASIC will be important in stimulating innovation.

With substantial fees proposed to be attached to any “novel” application to ASIC for varying its rules – the drivers do not yet seem to be aligned with innovative outcomes.


The Government’s statements on crowdfunding measures are a welcome response, but the success or failure of the reforms will depend on the significance of the changes proposed and the recognition that greater fundraising flexibility is needed in all relevant areas. Pure “retail” crowdsourcing models are not the whole solution to supporting start-ups, but streamlined regulatory frameworks for licensing and disclosure, across the board, could make a real difference.

Retail corporate bond market

We are supportive of the current legislative framework, but there is room for improvement. In particular, some flexibility needs to be included to adapt to particular issuers, so that the prescriptive disclosure framework drives productive and relevant disclosure and is not unduly rigid in all circumstances. A key part of the success of the new regime will depend upon an acceptance of the new model and ambition of the disclosure reforms, which differ from the past policy and practices of ASIC.

We remain supportive of further reforms to make greater use of cleansing notices for fundraising by listed companies. However, that also means looking more closely at Australia’s liability regime and whether the accountability “balance” for disclosure liability is sitting at the right level, and whether it is placing us at a competitive disadvantage to other markets.

5. Consumer outcome measures

Highlighted – Responses to Murray Report, Recommendations 21, 22 & 23

Strengthen product issuer and distributor accountability

The Government does not provide any detail as to the nature of the obligations that it will introduce, and we welcome the signal that there will be consultation.

These reforms have the potential to have a substantial impact on innovation in fundraising in the Australian market, and to drive the market towards simplistic offerings that may reduce the opportunity for wealth creation. This drive will also apply across other product types. The nature of the obligations, and the way that they are overseen by ASIC, will be of fundamental importance. Even if sought to be implemented initially in a light touch or scalable way, there is real concern about the likelihood that the principles will be interpreted in an increasingly demanding way, as has been the case with credit regulation around suitability.

We look forward to the consultation process, but suggest that this should be broad consultation. We also recommend that there be an extended period of Treasury oversight of the effect and implementation of the new obligations, with a review date set before the powers become “permanent”.

Introduce product intervention power

The potential for these powers to be used far beyond the circumstances in which the proposals intend remains a concern. The powers that ASIC already has would have been sufficient for ASIC to intervene in, and restrain, any of the market examples of products that have been promoted inappropriately. But the difficulty is knowing enough to be able to intervene in the exceptional cases, at the right time (and without broad banning orders that stifle markets) - that's a tough thing to address. We are not convinced that the additional powers will result in any improvement to consumer outcomes.

ASIC itself has noted that “[w]hat’s come from FSI is potentially very powerful for the future, and I think people don’t realise how powerful it is”. It is also concerning the extent to which ASIC appears to view this power as something which can be used to substitute its judgement in relation to product design for decisions in a market based context. ASIC has also noted that it that “[t]he attractiveness is it does allow us to dismantle disclosure and have something much more principle-based”.

Industry consultation, as a result, should include consultation on the nature of the threshold for action in respect of this power, on oversight and checks and balances on the use of this power by ASIC. This should include streamlined processes for urgent judicial review that extends to merits review, and a “sunset” date for Treasury to reconsider the use and effectiveness of the power, before it becomes a permanent part of our law. The impact on the growth and innovation in the Australian market needs to be considered.

ASIC should also be required to track the instances in which use of the power is “threatened” rather than used, for later review by Treasury and for the purposes of legal challenge.

Industry consultation should also test whether an Industry Panel (similar to the Takeovers Panel) would be a more appropriate forum than a court to test whether the power is being used, or threatened to be used, appropriately.

Facilitate innovative disclosure

The response to this recommendation is a little disappointing. ASIC’s initiatives around disclosure reform and streamlining have focussed on clarifying and expanding policy guidance, rather than true reforms. Whilst this is quite appropriate, it does not lead to significant innovation or development in disclosure.

Reform in this area should be driven by government, and industry consultation needs to be escalated sooner than 2017. Other markets are moving faster and more decisively than in Australia, and we risk being seen as adhering to dated, inflexible disclosure practices that are not adaptive to market developments in this region or globally.