In December 2014 the final report of the inquiry into Australia’s financial systems, commissioned by the Government in 2013, was released. The report is the culmination of an inquiry which encompassed over 6,000 submissions and consultation with market participants, 50 financial institutions and regulators from Australia, the USA, the European Union, United Kingdom, Asia and New Zealand.
The report, which is open for public comment until 31 March 2015, makes a number of policy recommendations, together with other recommendations regarding "significant matters", which, are directed at:
- promoting "a competitive and stable financial system that contributes to Australia’s productivity growth";
- promoting "the efficient allocation of capital and cost efficient access and services for users";
- meeting "the needs of users with appropriate financial products and services"; and
- creating "an environment conducive to dynamic and innovative financial service providers".
The recommendations are wide ranging and include those which, if implemented, would see a fundamental change in the operation and regulation of the system. In addition to these broad policy changes, a number of the recommendations delve into the detail of particular industry conduct and practices.
For those already participating in the Australian financial system adoption of some or all of the recommendations is likely to require a significant review of current policies and procedures to ensure compliance with the law. For those looking to enter the Australian financial system the recommendations, especially those aimed at developing and enhancing competition, present new opportunities.
The state of Australia’s financial system
It is generally regarded that Australia’s financial system weathered the global financial crisis well. The strong characteristics of the system were acknowledged by the authors of the report but they also found a number of weaknesses which make the system "prone to calls for more regulation" Those weaknesses are:
- taxation and regulatory settings which "distort the flow of funding to the real economy";
- a susceptibility to financial shocks;
- a superannuation system which "is not delivering retirement incomes efficiently";
- a prevalence of "unfair consumer outcomes"; and
- policy settings which "do not focus on the benefits of competition and innovation".
The basis for the recommendations made in the report
Five specific themes underpin the recommendations in the report. They are the strengthening of the economy "by making the financial system more resilient", raising the value of the superannuation system and retirement incomes, driving economic growth and productivity "through settings that promote innovation", enhancing "confidence and trust by creating an environment in which financial firms treat customers fairly" and enhancing "regulator independence and accountability”, and minimising the “need for future regulation”.
The recommendations are said to be designed to ensure that the system operates efficiently, is able to adjust to changing circumstances, is one characterised by fairness, integrity, honesty, transparency and non-discrimination and in which there can be confidence and trust.
The report also stresses the importance of the system’s ability to respond to, and be subject to market forces, including competition, which brings with it a need for a “strong and effective legal and policy framework” covering “strong property rights; a freely convertible floating currency and free flow of trade, investment and capital across borders; a strong fiscal position; a sound and independent monetary policy framework; and an effective, accountable and transparent government”.
The role of competition
It is worth noting that competition was one of two areas (the other being funding) in which the report identified there was significant scope to improve. That scope for improvement arises from the high concentration in Australia’s banking system, increasing vertical integration in some parts of the system and the current barriers to international competition. A number of recommendations have been made to foster competition which, importantly, includes ensuring regulators are “more sensitive to the effects of their decisions on competition, international competitiveness and the free flow of capital”.
The recommendation that this be monitored over time (by way of reviews every three years) raises risks for incumbents and opportunities for potential new entrants into the Australian system.
The policy recommendations contained in the report are sweeping. Some of the more significant recommendations are:
- the setting of capital standards such that Australian authorised deposit-taking institution capital ratios are unquestionably strong;
- raising the average internal ratings-based (IRB) mortgage risk weight to narrow the difference between average mortgage risk weights for authorised deposit-taking institutions using IRB risk-weight models and those using standardised risk weights;
- implementing a framework for minimum loss absorbing and recapitalisation capacity in line with emerging international practice, sufficient to facilitate the orderly resolution of Australian authorised deposit-taking institutions and minimise taxpayer support;
- completing the existing processes for strengthening crisis management powers that have been on hold pending the outcome of the Inquiry;
- introducing a leverage ratio that acts as a backstop to authorised deposit-taking institutions’ risk-weighted capital positions;
- removal of the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds;
- establishing a permanent public–private sector collaborative committee, the ‘Innovation Collaboration’, to facilitate financial system innovation and enable timely and coordinated policy and regulatory responses;
- developing a national strategy for a federated-style model of trusted digital identities;
- enhancing graduation of retail payments regulation by clarifying thresholds for regulation by the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA);
- strengthening consumer protection by mandating the ePayments Code;
- improving interchange fee regulation by clarifying thresholds for when they apply, broadening the range of fees and payments they apply to, and lowering interchange fees;
- improving surcharging regulation by expanding its application and ensuring customers using lower-cost payment methods cannot be over-surcharged by allowing more prescriptive limits on surcharging;
- graduating fundraising regulation to facilitate crowdfunding for both debt and equity and, over time, other forms of financing;
- reviewing the costs and benefits of increasing access to and improving the use of data, taking into account community concerns about appropriate privacy protections;
- supporting industry efforts to expand credit data sharing under the new voluntary comprehensive credit reporting regime. If, over time, participation is inadequate, Government should consider legislating mandatory participation;
- removing regulatory impediments to innovative product disclosure and communication with consumers, and improving the way risk and fees are communicated to consumers;
- better aligning the interests of financial firms with those of consumers by raising industry standards, enhancing the power to ban individuals from management and ensuring remuneration structures in life insurance and stockbroking do not affect the quality of financial advice;
- raising the competency of financial advice providers and introducing an enhanced register of advisers;
- improving guidance (including tools and calculators) and disclosure for general insurance, especially in relation to home insurance;
- creating a new Financial Regulator Assessment Board to advise Government annually on how financial regulators have implemented their mandates;
- introducing an industry funding model for ASIC and providing ASIC with stronger regulatory tools;
- reviewing the state of competition in the sector every three years, improving reporting of how regulators balance competition against their core objectives, identify barriers to cross-border provision of financial services and include consideration of competition in the ASIC’s mandate; and
- conducting post-implementation reviews of major regulatory changes more frequently.
The recommendations in relation to significant matters include:
- reducing disclosure requirements for large listed corporates issuing ‘simple’ bonds and encouraging industry to develop standard terms for ‘simple’ bonds;
- supporting the Government’s process to extend unfair contract term protections to small businesses and encouraging industry to develop standards on the use of non-monetary default covenants;
- clearly differentiating the investment products that finance companies and similar entities offer retail consumers from authorised deposit-taking institution deposits;
- consulting on possible amendments to the external administration regime to provide additional flexibility for businesses in financial difficulty;
- updating the 2009 Cyber Security Strategy to reflect changes in the threat environment, improve cohesion in policy implementation, and progress public–private sector and cross-industry collaboration, and establishing a formal framework for cyber security information sharing and response to cyber threats;
- identifying, in consultation with the financial sector, and amending priority areas of regulation to be technology neutral and embedding consideration of the principle of technology neutrality into development processes for future regulation;
- renaming ‘general advice’ and requiring advisers and mortgage brokers to disclose ownership structures;
- supporting Government’s review of the Corporations and Markets Advisory Committee’s recommendations on managed investment schemes, giving priority to matters relating to consumer detriment, including illiquid schemes and freezing of funds;
- introducing a mechanism to facilitate the rationalisation of legacy products in the life insurance and managed investments sectors; and
- removing market ownership restrictions from the Corporations Act 2001 once the current reforms to cross-border regulation of financial market infrastructure are complete.
Where to from here for the Australian financial system?
It is difficult to predict which, if any of the proposed recommendations will be adopted by the present Government and, if so, what time frames will apply to that enactment.
There is little doubt that current concerns over the behaviours of some financial advisers and the financial institutions which employ them presents the Government with a timely justification to strengthen the regulation applying to that part of the industry. This feeds into calls for a comprehensive examination of how ASIC and other regulators have responded to issues which have highlighted flaws in the current regulatory system.
Similarly, concerns over the ability of the superannuation system to address the needs of Australia’s aging population may also operate as a powerful incentive to implement the recommendations designed to improve long-term net returns for members and better meet the needs of retirees.
Whether there is an appetite for reform based on any of the recommendations is yet to be seen. Whether that appetite will translate into actual reform is another matter. This is particularly the case given the current political climate which has seen many of the Government’s proposals for reforms in the financial sector stumble in a sometimes hostile upper house of Parliament. For those participating or seeking to participate in Australia’s financial system the only present certainty is “watch this space”.