More than 6500 second round submissions have been made to the Financial System Inquiry (FSI). The submissions made by ASIC and APRA will be read with greater interest than most. The recommendations in these submissions are likely to be given greater weight by the FSI panel members, and could find their way into the final recommendations and ultimately as changes in regulation.
We have looked at the these submissions with a particular eye for recommendations and comments that would, if taken up by the FSI and ultimately adopted as Government policy, result in regulatory change for the wealth management sector.
The regulators are not proposing any significant industry-transforming changes. This is understandable perhaps given that, over the past several years, the industry has had to implement the major regulatory changes brought about by the Stronger Super and Future of Financial Advice (FOFA) reforms. The Federal Government's enthusiasm for significant new regulatory changes may also be limited, unless they are consistent with its current bent for reducing rather than increasing the regulatory burden on business.
However, there are still a number of recommendations and observations in the regulators' submissions which, if taken up, could result in change. This could both impose new burdens as well as open up opportunities for the financial services industry.
Both ASIC and APRA have supported renewed consideration of proposals to allow product rationalisation of legacy products in the wealth sector, in particular in insurance and managed investment schemes. The current regulatory regime makes rationalisation in these areas difficult.
The industry has been aware of the problem for many years and this has been the subject of Government consultation in the past. Unfortunately, progress has been stalled since 2010 because of lack of Government focus on this issue.
In its submission, ASIC has put forward the view that product issuers should not be required to obtain consent from customers in relation to rationalisation proposals, and that instead any proposal should provide for adequate disclosure to customers and appropriate safeguards of their interests.
APRA strongly supports this as it sees legacy products as an operational risk issue for product issuers in prudentially regulated industries, such as insurance. It also makes the point that legacy products contribute to higher costs, which are also to the detriment of consumers.
The industry would also be enthusiastic about the resumption of efforts to allow for greater product rationalisation.
Given that everyone seems to be on the same page about this issue, we would expect it to be reflected in the FSI's recommendations. Given also that it essentially entails 'cutting red tape', it should find support with the Government.
If product rationalisation is permitted to a greater extent, we expect product issuers with significant legacy books to look for opportunities to reduce costs by rationalising their products.
Regulation of general advice
ASIC has given some attention to the issues around financial product advice. There has been a lot of discussion about advice recently, not least because of the scandals which have affected the industry. Proposals in particular for the reform of the training of financial advisers are being discussed.
One area of focus in ASIC's submission to the FSI is the regulation of general advice. This is advice that is usually not provided by a financial adviser, but may be included in advertising or promotional material, or may be given by a teller or call centre operator who is not otherwise authorised to provide personal financial product advice. Providers of general advice are, however, still subject to licensing and disclosure obligations (subject to a number of exceptions).
ASIC recommends re-thinking the regulation of general advice, given the breadth of the current definition. It suggests providing for different regulatory regimes for different types of general advice (all of which are currently treated in the same way). For example, some kinds of general advice (possibly sales or information-based advice) could be excluded from the licensing regime and would, instead, be regulated by general conduct standards, the prohibition on misleading and deceptive conduct and the requirement to provide consumers with access to a dispute resolutions scheme.
If adopted, such a recommendation would involve more change to the regulatory regime around advice. The industry may not be enthusiastic about more change, given that the FOFA reforms are still being bedded down, but this proposal also opens up opportunities. While the reduction in regulatory burden for some types of advice may be welcome, it will be difficult to draw clear distinctions.
Leverage in superannuation
The interim report of the FSI questioned the appropriateness of the use of leverage in the superannuation system. It is currently available only in limited circumstances, in particular where recourse of the lender is limited to the assets acquired using the credit provided. The interim report noted that, while the use of leverage in SMSFs is still relatively small, its growth poses a significant structural risk for the sector.
APRA, in its submission, also expresses concern about the use of leverage in superannuation. It says that 'the risks associated with direct leverage are incompatible with the objectives of superannuation and cannot adequately be managed within the superannuation prudential framework'. ASIC is also concerned about the manner in which the use of leverage has been promoted to SMFSs 'without adequate explanation of the risk and without sufficient regard to the needs, objectives and risk appetite of the investors'.
It seems therefore, the days of borrowing through superannuation are numbered. How the restriction on leverage and any mandated unwinding of leverage in the industry is implemented will be key. This also has the potential to affect the broader industry, such as lenders and issuers of structured products.
While there has been an enormous amount of interest in relation to retirement incomes and possible regulatory changes that could follow the FSI, the regulators do not make any specific recommendations for regulatory change. While there seems to be a recognition that the policy framework needs to be directed towards benefits being taken as income streams rather than lump sums, APRA, in particular, recommends that 'there is holistic consideration of the policy settings in both the pre-retirement and post-retirement phases of the system so that a coherent, sustainable and therefore stable retirement income policy framework is able to be established and effectively implemented'. If such a recommendation is adopted and implemented by the Government, it will be a substantial achievement of the FSI indeed.
Superannuation fees and costs
There has also been a lot of discussion in the industry in relation to the observation in the FSI's interim report about the lack of fee-based competition in the sector. Interestingly, APRA is of the view that 'fees should not be considered in isolation; assessment of the efficiency of the superannuation sector must be framed in terms of the ultimate outcome that is achieved for members'. This would include the risk adjusted return, after fees, costs and taxes are taken into account. The fact that investment management, insurance and advice may all be provided through the superannuation system adds complexity and makes it difficult to compare costs and benefits accurately against foreign retirement savings systems. The changes made by MySuper are also relatively new and it is too early to assess whether they will reduce fees and costs.
ASIC on the other hand is concerned about the 'continued lack of fee-based competition in the superannuation sector'. It does, however, recognise that MySuper may have increased fee-based competition.
There does not appear to be support for radical changes to the regime in order to drive down fees and costs (such as the adoption of the Chilean model). However, the industry will be anxious to see whether the FSI picks up this issue in its final recommendations and makes suggestions for structural changes which might drive fees down further.
ASIC is also keen to be given new product intervention powers, and APRA is seeking enhanced powers in relation to superannuation to match its prudential powers over other sectors. Even if given, these may have little practical effect on the industry, especially given that the regulators make limited use of their existing powers of intervention in product design or prudential management.