The Federal Government has issued its response to the final report of the Financial System Inquiry led by David Murray, which was published in December 2014 (the Report).

The Government has accepted all but one of the Report’s recommendations and has created a timeline for the enforcement of key goals. The only recommendation rejected by the Government was the recommendation to prohibit limited recourse borrowing arrangements by superannuation funds.

In addition to agreeing to the majority of the Inquiry’s recommendations, the Government’s response sets out an agenda for improving the financial system to achieve its commitment to the recommendations.

Common features of its response and how to achieve change include:

  • an increase in legislation across various sectors of the industry to enhance confidence and resilience including introducing a professional standards regime for advisers;
  • revised mandates for regulators including expanding ASIC’s mandate to include competition in the financial sector; and
  • multiple projects for the Productivity Commission.

An increase in legislation, including the introduction of a professional standards framework for financial advisers will be beneficial to consumers but it will also increase the legal and compliance obligations of financial services entities.

Five key priorities for its agenda

The Government’s improvement agenda identifies five key priorities to achieve:

  • the resilience of the financial system;
  • the efficiency of the superannuation system;
  • innovation in the financial system;
  • fairness in the treatment of consumers of financial products; and
  • regulatory capabilities and accountability.

In the press conference to present the response, Prime Minister Malcolm Turnbull, Treasurer Scott Morrison and Assistant Treasurer Kelly O’Dwyer highlighted the changes to superannuation regulations and the crackdown on credit card fees as key Government priorities.

Resilience

Although the Government acknowledged that our current financial system is strong when compared to other similar economies, we cannot be complacent in light of certain features which are vulnerabilities. For example, the concentration of risk resulting from the large proportion of domestic lending that is made up of home mortgages.

The specific measures proposed by the Government to improve resilience in the financial system are:

  • the development of legislation to facilitate the participation of Australian entities in international derivative markets;
  • consultation on measures needed by regulators to manage a financial crisis; and
  • APRA taking additional steps to ensure that banks have strong capital ratios, total loss-absorbing capacity and leverage ratios in place.

The Government plans to begin developing legislation on these matters by the end of 2015. It has already announced a review of the Cyber Security Strategy which was one of the Report’s recommendations.

Improving confidence in superannuation

Superannuation is the second largest part of the financial sector in Australia, representing $2 trillion in assets, and as such it must be competitive, transparent and efficient.

The response criticises the current system, stating that it is “fragmented, costly, complex and suffers from a lack of member engagement”. There is ample room for improvement across the board to improve governance of the system to better enable people to understand and engage with the superannuation system.

The key proposals relating to superannuation are to:

  • develop legislation to improve governance and transparency;
  • progress the Retirement Income Streams Review;
  • task the Productivity Commission to develop and release criteria to assess the efficiency and competitiveness of the system and to develop alternative models for a formal competitive process for allocating default fund members to products;
  • enshrine the objectives of the superannuation system in legislation;
  • consult on legislation to facilitate the provision of pre-selected comprehensive income products for retirement;
  • create legislation to introduce director penalties;
  • consult on legislation to improve member engagement; and
  • monitor leverage and risk in the industry.

The development of improved governance and transparency legislation is projected to begin by the end of 2015. Other measures are to be implemented by 2016 “and beyond”.

Innovation: capitalising on technology is imperative

Technology and the increase in cross-border interaction have led to increased opportunities for innovation in the financial sector and the Government wants to capitalise on these trends. The Government aims to increase efficiency and clarity in areas such as credit card surcharges, and decrease regulatory burdens on companies through technology-neutral laws and regulations.

The measures aimed to promote innovation include:

  • consultation on legislation to support crowd-sourced equity funding and consult on crowd-sourced debt-financing;
  • tasking the Productivity Commission to review access to and use of data;
  • developing legislation to ban excessive card surcharges, to better protect consumers using electronic payment systems and to reduce disclosure requirements for issuers of ‘simple’ corporate bonds;
  • establishing the Innovation Collaboration Committee which will be linked with ASIC’s Digital Finance Advisory Committee;
  • giving legal effect to the Asian Region Funds Passport Initiative;
  • considering technology neutrality in financial sector regulation; and
  • facilitating the rationalisation of life insurance and managed investment scheme legacy products.

A Trusted Digital Identity Framework will also be developed to support the Government’s Digital Transformation Agenda. To date the Government has passed legislation to extend the period before unclaimed monies in the banking and insurance sector are captured from three to seven years, and plans to begin consultations on legislation to support crowd-sourced equity funding by the end of 2015.

Consumer outcomes: protection is key

The Government’s aim is to ensure that consumers are treated fairly. As there has been recent evidence of financial products and advice that are defective, the Government aims to lift the overall standard within the system to ensure that consumers are adequately protected.

The response identifies the commercial interests of advisers and distributors as a barrier to fairness and consumer protection, and extensive consultation will be carried out by the Government to develop a balance between these competing interests. The Government has raised the possibility of giving ASIC the power to amend or remove harmful products from the market if it is deemed necessary.

The actions proposed by the Government include:

  • developing measures to address the misalignment of incentives in life insurance;
  • developing legislation to provide a professional standards framework for financial advisers requiring them to hold a degree, pass an exam, undertake continuous professional development, subscribe to a code of ethics and undertake a professional year;
  • consulting on development of accountabilities for issuers and developers of financial products and ASIC product intervention powers;
  • giving ASIC the power to ban individuals from managing financial firms;
  • consulting on strengthening ASIC’s enforcement tools in relation to financial service and credit licencing schemes;
  • mandating ASIC review of remuneration arrangements in the mortgage broking industry and of stockbroking remuneration arrangements; and
  • consulting on legislation to enable innovative disclosure for financial products and to improve the regulation of managed investment schemes.

The Government plans to put the first of these actions into motion by the end of 2015 continuing throughout 2016.

Regulatory regime: needs to improve costly compliance

The Government has identified the growing compliance costs for businesses as they struggle to adjust to increased and complex regulatory changes in the industry.

In response, the Government has stated that it will work with APRA, ASIC and the Payments System Board to ensure that businesses have adequate time to adjust to changes.

A capability review of ASIC is currently being conducted and the Government will wait for the conclusion of this review before making any further recommendations regarding ASIC’s capability.

Other specific measures proposed are:

  • consulting on industry funding arrangements for regulatory activities undertaken by ASIC;
  • appointing new members and reviewing the Terms of Reference of the Financial Sector Advisory Council;
  • updating the Statement of Expectations for APRA, ASIC and the Payments System Board to give guidance regarding the Government’s expectations and to improve accountability;
  • considering the ASIC capability review and introduce changes as needed;
  • introducing competition into ASIC’s mandate;
  • reviewing ASIC’s enforcement regime; and
  • tasking the Productivity Commission to review the state of competition in the financial system.

The capability review of ASIC is set to be completed by the end of 2015 and the update of the Statement of Expectations for APRA, ASIC and the Payments System Board is to be completed by mid-2016 to allow competition to be introduced to ASIC’s mandate by the end of 2016.

Timing of changes

Generally, the Government aims to implement changes from 2015 (or what remains of it!) through 2016. Changes will also occur ‘beyond 2016’. In some cases the Government has already reacted to the recommendations in the Report by:

  • announcing a review of the Cyber Security Strategy;
  • passing legislation to extend the period before unclaimed monies in the banking and insurance sector are captured from three to seven years; and
  • APRA releasing an international capital comparison study.

What do these changes mean?

These changes are broadly in line with the shift towards competition, innovation and an efficient economic regulatory regime that have been the focus of the Federal Government under Prime Minister Turnbull.

The new Treasurer and Assistant Treasurer have a broad agenda to achieve change over the next two years and the wheels are in motion as steps have already been taken in furtherance of the Government’s resilience and innovation priorities.

There is a focus on increased accountability of all parties, from the financial advisers to the regulators, which aligns with the broad trend of regulation in this area following evidence of systematic issues with the financial advice being given by major banks.

The decision of the Government to increase capital ratios was not surprising, given the Murray Review was published over a year ago. Nevertheless, the speculation will increase on the extent to which this will lead to a burden on consumers.