The Murray Report on Australia’s financial system has made a total of 44 recommendations which, if adopted, will significantly affect the banking, superannuation and payments sectors, other financial services participants and the capital markets.
The Inquiry has focused its Report on the present weaknesses it sees in Australia’s financial system – being distortions of funding flows to the real economy from tax and regulatory settings, a susceptibility to financial crises, inefficiency in the delivery of retirement incomes via superannuation, the prevalence of unfair consumer outcomes and a lack of policy or regulatory emphasis on the benefits of competition and innovation.
It recognises a series of material developments in the market since previous inquiries, including the GFC, technological innovation and that “the Australian financial system is part of a global economy increasingly influenced by Asia”.
In making its recommendations, the Inquiry has sought to promote a resilient, efficient and fair financial system.
Key recommendations that we think are ones to watch are set out below.
Capital levels, loss absorption and recapitalisation capacityThe recommendations around higher capital levels and higher risk-weighting for ADIs that use an internal ratings-based (IRB) approach confirm the speculation of recent weeks. It is welcome, but not surprising, that the suggestions for Volker or Vickers-style structural separation of categories of bank business have not found favour in the Report. What the Inquiry would conclude on proposals to bail-in senior debt was less certain. In adding proposals for the bail-in of senior debt (other than deposits) and enhanced crisis management powers on top of increased common equity capital levels, the Report is certainly placing a premium on the security of the system. If these measures are accepted as necessary, the Report’s approach to them is commendably cautious, as the issues they raise are complex. It is welcome to see the Report recognise that the best way to produce a workable bail-in regime is through contractual agreement by the creditors operating within a legislative framework that is improved to enhance the certainty of the outcome. The Report rejects the possible application of bail-in to deposits. In doing so, it appears to support retention of the existing depositor preference regime. Within such a framework, bail-in is likely to be confined to those bond investors who agree to supply capital on those terms.
Direct borrowing by superannuation fundsBanks and the superannuation sector will be affected by the proposed abolition of section 67A of the Superannuation Industry (Supervision) Act 1993 (Cth). Before outright abolition, consideration should at least be given to the original purpose of the section in facilitating investment warrants. Even if the section were to be repealed on a prospective basis, the manner and timing of any transition would need to be framed with considerable care.
Superannuation and retirement incomesThe Report delivers a miscellany of recommendations for superannuation, with no one theme driving those recommendations beyond the overriding principles for policy intervention of efficiency, resilience and fairness. There are two headline recommendations – one for the default superannuation market and one for retirement income products (each as described in more detail below) – and a number of single issue recommendations impacting general policy, governance and disclosure.
- Improving efficiency during accumulationThe first headline recommendation for the default superannuation market has advanced from the Interim Report discussion on driving down fees through an auction process. The Inquiry’s final position is that MySuper is unlikely to drive down fees and that a further “quality filter” is required. While recommending that a competitive process should be adopted, the Report provides few details on what this process would look like, preferring to leave it to the Productivity Commission to develop an appropriate process.
Key points arising from this recommendation are (1) the MySuper regime should be given 5 to 6 years to properly develop, leaving the final decision whether to implement a competitive process with a Productivity Commission review (separate to the one mentioned above) by 2020, (2) the competitive process would apply to both new entrants to the workforce and existing members, (3) large employer plans could be excluded from the competitive process, (4) there is no commentary from the Inquiry on how often the competitive process should be undertaken, but the Report does state that those funds which become uncompetitive would be removed, and (5) the Report posits that a quality filter is necessary, and the Inquiry has expressly rejected the removal of superannuation from modern awards as an interim measure.
- Retirement phase of superannuationThe headline recommendation for retirement incomes is to introduce a “comprehensive income product for retirement” (CIPR) which should combine the flexibility of an account based pension with the longevity protection of a deferred lifetime annuity (DLA) or group self-annuitisation (GSA). The Inquiry considers that this should be a pre-selected option – i.e., the default approach to the payment of retirement benefits.
Key points arising from this recommendation are (1) the Report recommends that the Government legislate product features for the CIPR such as providing a regular stable income stream, (2) individual superannuation funds could determine the appropriate portion of a member's account balance to allocate between the account based pension and the DLA or GSA, (3) the only answer the Inquiry offers to the problems of providing a default income product to low balance members is that members could opt-out through the use of a cooling-off mechanism, and (4) that it would appear to apply to both corporate superannuation and personal / platform products.
- Single issue recommendationsThe single issue recommendations in the Report include:
- the introduction of legislated superannuation objectives against which all future superannuation changes would need to be measured;
- a move to majority independent directors on boards of superannuation trustees for public offer funds;
- aligning the penalty regime for superannuation directors with the penalty regime for directors of responsible entities of managed investment schemes under the Corporations Act 2001 (Cth) (Corporations Act);
- the introduction of mandatory benefit projections; and
- the removal of tax concessions in superannuation – for example, by taxing pension assets at 15% – to be explored further in the Government’s tax white paper.
In the context of innovation, the Report is timely. Everyday we see more reports of innovation that may improve or disrupt existing services. Facilitating the benefits offered by innovation and managing the risks is key. Apart from recommending the creation of an “Innovation Collaboration” – a public-private collaborative committee to enable policy and regulatory responses – the Inquiry makes key recommendations in the following areas:
- Digital identity and verificationThe Report recommends implementing a federated digital identity strategy that would involve the Government setting up a framework under which private and public sectors compete to supply digital identities to consumers and businesses. This is needed because of increasing consumer preference to engage online, fraud concerns and efficiency (the cost of anti-money laundering and counter-terrorism financing (AML/CTF) compliance, in particular, is discussed). The framework approach is preferred because it will allow for ongoing competition and innovation in the provision of identity services. The Report notes that appropriate privacy protections and mechanisms would need to be considered to maintain consumer confidence and trust in the system. It will also be necessary to ensure that any approved framework accommodates the requirements of AML/CTF and similar legislation, or that appropriate amendments are made in conjunction with a new framework.
- Payment systemsThe recommendation for raising the threshold for exemption for non-cash payment facilities in Chapter 7 of the Corporations Act from systems that hold less than $10 million to systems that hold less than $100 million or $500 million (depending on the number of payee groups) is a significant development for non-banks (and, in particular, retailers) that want to issue or distribute third party non-cash payment facilities.
In addition, while little detail is provided in the Report, the recommended two-tiered approach to the prudential regulation of purchased payment facilities (PPFs) may have a significant impact on competition in this area. The prudential regulation of PPFs has been a substantial barrier to entry for both domestic and foreign entrants to the Australian market.
- Crowdfunding and P2P lendingIn the interests of facilitating alternative funding sources for the SME sector, the Inquiry recommends that the Government “graduate fundraising regulation to facilitate securities-based crowdfunding and consider more holistic regulatory settings to facilitate internet-based financing”. The practicalities of a ‘graduated approach' might be evident, for example, in the context of annual fundraising limits or investor funding caps but harder to conceptualise in other areas of regulation (such as licensing of P2P lenders). We hope that the Inquiry’s recommendations facilitate a clear direction to regulators for discretions to be exercised in favour of innovation which promotes efficiency while not introducing new sources of excessive risk.
- Enhanced data usageThe Report recommends a Productivity Commission inquiry into the costs and benefits of increasing access to and improving the use of data, subject to privacy considerations. The intent is to enhance consumer outcomes, better inform decision making, and facilitate greater efficiency and innovation in the economy. As well as increased access to public sector data (including de-identified data), other issues for consideration are standardising data collection and aggregation, issues relating to an individual’s access to their data and how to enhance individuals’ confidence and trust in the way data is used. In relation to individuals' access to data, issues that were considered include the type of information which can be accessed, whether this can effectively be done via third parties, and the requirements around how it is to be provided (for example, format).
- Comprehensive credit reportingThe Report recognises that the comprehensive credit reporting (CCR) regime for consumers will not be fully in effect until 2016 or 2017, given the issues involved in transition. While the Inquiry believes that CCR will lead to better credit decision-making, and notes that submissions favour extension to SMEs and expansion of data fields, it recommends that the Government should review industry’s participation in CCR in 2017 to determine whether there should be further incentives or support for mandatory CCR.
Rather than a formal product suitability test on the issue (as is the case in the credit space with responsible lending), the Inquiry recommends improving the accountability for design and distribution of financial products.
If implemented, the recommendation will result in product issuers and distributors being regulated in a way that they have not been regulated before.
The recommendation involves the issuer identifying target and non-target markets taking into account various product features. This may involve stress testing the product, and consumer testing on whether product features are clear and easy to understand. Distributors and issuers would then need to agree on how a product should be distributed, and the distributor may need controls in place to ensure that distribution meets the issuer’s expectations and requirements. For ongoing products, the issuer and distributors should periodically review whether the product still meets the target market. This is a deliberate principles-based obligation, and the Inquiry contemplates that it will be scalable depending on the nature and risk level of the product. It also envisages introducing a principles-based regulatory obligation that enables industry to develop standards of practice tailored to product classes.
Simplifying retail corporate bond offerings
The recommendations for even ‘simpler’ corporate bond offerings are a welcome development. In particular, the Report proposes that an offering of retail bonds by the top 150 ASX listed corporates should be able to be made using disclosure under a term sheet, a cleansing notice and industry-standard form terms and conditions. These measures would further reduce the costs of diligence and documentation for an eligible issuer. However, this costs benefit may be eroded to some degree by costs arising from other recommendations. For example, to what extent will the issuer of a simple corporate bond be subject to the proposed “product design and distribution obligations”?
Product intervention power and other enhanced powers for ASIC
The Report recommends providing ASIC with a new product intervention power to allow a proactive approach to reducing the risk of significant detriment to consumers. As stated in the Report, this power:
- should be used as a last resort or pre-emptive measure where there is risk of significant detriment to a class of consumers;
- would enable intervention without a demonstrated or suspected breach of the law;
- could be exercised in a range of ways, from requiring changes to advertising or disclosure document, to an outright ban;
- would be temporary (12 months is recommended); and
- would be subject to a judicial review mechanism and to prior consultation with APRA where it may affect an APRA-regulated body.
Although there is overseas precedent for this, it is not uncontroversial.
Consistent with our own submissions, many industry stakeholders expressly did not support a power of this kind in their submissions to the Inquiry and there are concerns that it could create uncertainty, constrain innovation, increase costs, detract from consumer accountability and increase reputational risk. However, the Inquiry did not accept these concerns. As stated above, the power is intended to be used “as a last resort”, and ASIC would be expected to engage with potentially affected firms and to consult with Council of Financial Regulators before any use of the power.
In addition, the Report recommends that ASIC’s regulatory tools are to be further enhanced to include the following:
- ASIC should be able to consider all relevant factors in determining whether or not an Australian financial services licence or Australian credit licence should be granted;
- ASIC approval should be required for material changes in the ownership or control of a financial services or credit licensee;
- ASIC should have more capacity to impose conditions requiring financial services and credit licensees to address concerns about serious or systemic non-compliance;
- the maximum civil and criminal penalties for contravening ASIC legislation be substantially increased; and
- ASIC should be able to seek disgorgement of profits earned as a result of contravening conduct.
These proposed powers would add to ASIC’s broad range of regulatory tools and will increase what is expected of ASIC at the same time as its budget is decreasing (an issue also subject to commentary in the Report). It will be interesting to see how often ASIC would use these powers.
While the Report concludes that there is no need for major changes to Australia’s regulatory framework, it has made a number of recommendations to improve the operation of our regulatory system. A new Financial Regulator Assessment Board, created to monitor Australia’s financial regulators and advise the Government annually, will provide a useful forum for assessment of financial regulator performance against their mandates.
Certainty of contract
The recommendation that unfair contract term protections be extended to small business seems contrary to the comments earlier in the Report sensibly promoting the fundamental importance of principles of legal predictability and the certainty of contracts. We question the need for any extension of the unfair terms regime in this manner. Policy initiatives promoting competition in the SME lending space (including on the terms of such lending) seem more consistent with the Inquiry’s stated objectives.
Insurers, as well as credit providers, may be interested in the Report's proposals to promote data sharing and its recommendations that insurers provide more guidance to policy holders on the replacement value of homes.
One noticeable omission from the Report was any recommendation for asset allocation policy settings, for example, to facilitate the use of the large pool of stable retirement savings to fund the nation's infrastructure needs or to provide funding to other sectors of the economy. The Inquiry seems deliberately to have avoided such recommendations stating that “to maximise the efficiency of the financial system policy makers should not set out to favour one particular funding destination over another”. In our free market economy and given the Report’s focus on the efficiency of Australia’s financial system, it is hard to argue against that position without examining a broader range of public policy considerations beyond the Inquiry’s terms of reference.
The Report notes that tax may have significant effects on funding and investment preferences but that these are matters for the Government’s tax white paper.
It will be the Federal Government’s reform agenda that will dictate the extent and timing of any changes. Although, the Federal Treasurer has also noted that consideration of the recommendations relating to bank capital and payment systems will also be given by APRA and the RBA, where those matters are within their respective prudential mandates.
As we have seen recently, politically sensitive areas are likely to be subject to challenges. We may see reform more quickly during the course of 2015 where political interests are aligned.
In the areas where the Inquiry has made its recommendations – be they revolutionary, evolutionary, obvious or more subtle – it will be useful for the market to examine the opportunities and challenges that arise, and to appreciate the knock-on effects in particular areas from changes made in another. The Federal Treasury has already opened a public consultation on the recommendations generally, with submissions due by the end of March 2015.