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Financial System Inquiry
8 December 2014
 
Treasurer Joe Hockey released the final Financial System Inquiry (FSI) report in Sydney yesterday, delivering on a pre-election commitment of the Abbott Coalition Government.  Led by David Murray AO, the Inquiry found that the financial system has performed well since the Wallis Inquiry of 1997, the last in-depth examination of the financial system, and offers 44 recommendations for the Government’s consideration as well as a blueprint for an efficient and resilient financial system for the next 20 years.  A third of these recommendations seek to improve competition in the financial sector, while several relating to taxation will be fed into the upcoming Tax White Paper.
 
The main recommendations of the report relate to banking capital and superannuation, noting that since 1996, output from the financial services sector has increased from $41 billion to $133 billion, and the superannuation system has grown from $300 billion of assets in 1997 to $1.8 trillion today. In particular, the Inquiry Panel suggests that banks hold more capital to remain ‘unquestionably strong’ or, as Murray expressed, hold a global position in the top 25 per cent on this measure.  In regard to superannuation, the Report advocates for more competition and changes to the governance of superannuation funds.
 
In the course of compiling the report, the Panel received over 6,800 submissions and hosted hundreds of stakeholder meetings across Australia and overseas.  This process will now continue in earnest for the Government, who will consult on the recommendations up until 31 March 2015, before responding to the final report.
 
The Report overview provides analysis of the general themes relating to funding the Australian economy and competition, while five specific themes comprise the distinct chapters.  GRACosway’s summary below offers an introduction to these specific themes and lists the majority of the Report’s recommendations.


SUMMARY

Resilience

The opening chapter acknowledges that while Australia has maintained a strong financial system which has been supported by effective stability settings, the Inquiry seeks to address particular aspects that open it up to risks, including dependence on importing capital.  Recommendations seek to make the country’s financial institutions less susceptible to shocks with the ability to continue their core economic functions during these times. Further, they aim to align Australia’s financial institutions with international regulatory norms to ensure they are not disadvantaged in raising funds in international markets.
 
1. Capital Levels
 
Set capital standards such that Australian authorised deposit-taking institution capital ratios are unquestionably strong.
 
2. Narrow mortgage risk weight differences
 
Raise 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.
 
3. Loss absorbing and recapitalisation capacity
 
Implement 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.
 
4. Transparent reporting
 
Develop a reporting template for Australian authorised deposit-taking institution capital ratios that is transparent against the minimum Basel capital framework.
 
5. Crisis management toolkit
 
Complete the existing processes for strengthening crisis management powers that have been on hold pending the outcome of the Inquiry.
 
6. Financial Claims Scheme
 
Maintain the ex post funding structure of the Financial Claims Scheme for authorised deposit-taking institutions.
 
7. Leverage ratio
 
Introduce a leverage ratio that acts as a backstop to authorised deposit-taking institutions’ risk-weighted capital positions.
 
8. Director borrowing by superannuation funds
 
Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.
 

Superannuation and Retirement Incomes

This chapter reflects on the strengths of Australia’s large superannuation system but finds that the system is not ‘operationally efficient due to a lack of strong price-based competition…’  Accordingly, the Panel recommends changes to legislation underpinning superannuation, MySuper products, tax concessions in the system and the governance arrangements of funds, among other recommendations.
 
9. Objectives of the superannuation system
 
Seek broad political agreement for, and enshrine in legislation, the objectives of the superannuation system and report publicly on how policy proposals are consistent with achieving these objectives over the long term.
 
10. Improving efficiency during accumulation
 
Introduce a formal competitive process to allocate new default fund members to MySuper products, unless a review by 2020 concludes that the Stronger Super reforms have been effective in significantly improving competition and efficiency in the superannuation system.
 
11. The retirement phase of superannuation
 
Require superannuation trustees to pre-select a comprehensive income product for members’ retirement. The product would commence on the member’s instruction, or the member may choose to take their benefits in another way. Impediments to product development should be removed.
 
12. Choice of fund
 
Provide all employees with the ability to choose the fund into which their Superannuation Guarantee contributions are paid.
 
13. Governance of superannuation funds
 
Mandate a majority of independent directors on the board of corporate trustees of public offer superannuation funds, including an independent chair; align the director penalty regime with managed investment schemes; and strengthen the conflict of interest requirements.


Innovation

This chapter focuses on harnessing new technologies to improve the efficiency of the financial system and generate better outcomes for consumers and businesses.  The Inquiry notes that while new business models and products can present risks to stakeholders, effective policy settings can help to maximise the benefits of innovation within the financial system.
 
14. Collaboration to enable innovation
 
Establish a permanent public–private sector collaborative committee, the ‘Innovation Collaboration’, to facilitate financial system innovation and enable timely and coordinated policy and regulatory responses.
 
15. Digital identity
 
Develop a national strategy for a federated-style model of trusted digital identities.
 
16. Clearer graduated payments regulation
 
Enhance graduation of retail payments regulation by clarifying thresholds for regulation by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority.
 
Strengthen consumer protection by mandating the ePayments Code. Introduce a separate prudential regime with two tiers for purchased payment facilities.
 
17. Interchange fees and customer surcharging
 
Improve interchange fee regulation by clarifying thresholds for when they apply, broadening the range of fees and payments they apply to, and lowering interchange fees. Improve 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.
 
18. Crowdfunding
 
Graduate fundraising regulation to facilitate crowdfunding for both debt and equity and, over time, other forms of financing.
 
19. Data access and use
 
Review the costs and benefits of increasing access to and improving the use of data, taking into account community concerns about appropriate privacy protections.
 
20. Comprehensive credit reporting
 
Support 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. 


Consumer Outcomes

This chapter notes that the current system fails to deliver sufficient consumer protections, especially in the area of disclosure and financial advice requirements.  It argues that while the current framework cannot prevent all consumer losses, there are a number of ways to ensure that consumer interests are at the core of the financial system.
 
21. Strengthen product issuer and distributor accountability
 
Introduce a targeted and principles-based product design and distribution obligation.
 
22. Introduce product intervention power
 
Introduce a proactive product intervention power that would enhance the regulatory toolkit available where there is risk of significant consumer detriment.
 
23. Facilitate innovative disclosure
 
Remove regulatory impediments to innovative product disclosure and communication with consumers, and improve the way risk and fees are communicated to consumers.
 
24. Align the interests of financial firms and consumers
 
Better align 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.
 
25. Raise the competency of advisers
 
Raise the competency of financial advice providers and introduce an enhanced register of advisers.
 
26. Improve guidance and disclosure in general insurance
 
Improve guidance (including tools and calculators) and disclosure for general insurance, especially in relation to home insurance. 


Regulatory System

This chapter deals with regulatory institutions, namely the Reserve Bank of Australia (RBA), the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC), and analyses their performance, oversight and governance.  The Inquiry does not see a strong case for change in the current institutional arrangements, however, it does conclude there are steps that can be taken to strengthen ASIC’s powers and the accountability of all regulators.
 
27. Regulator accountability
 
Create a new Financial Regulator Assessment Board to advise Government annually on how financial regulators have implemented their mandates.
 
Provide clearer guidance to regulators in Statements of Expectation and increase the use of performance indicators for regulator performance.
 
28. Execution of mandate
 
Provide regulators with more stable funding by adopting a three-year funding model based on periodic funding reviews, increase their capacity to pay competitive remuneration, boost flexibility in respect of staffing and funding, and require them to undertake periodic capability reviews.
 
29. Strengthening the Australian Securities and Investments Commission’s funding and powers
 
Introduce an industry funding model for the Australian Securities and Investments Commission (ASIC) and provide ASIC with stronger regulatory tools.
 
30. Strengthening the focus on competition in the financial system
 
Review the state of competition in the sector every three years, improve 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 Australian Securities and Investments Commission’s mandate.
 
31. Compliance costs and policy processes
 
Increase the time available for industry to implement complex regulatory change. Conduct post-implementation reviews of major regulatory changes more frequently.
 
The Report also details 13 recommendations in Appendix 1, see here.
 

FURTHER READING
 
FSI FINAL REPORT
 
FSI WEBSITE
 
TREASURER’S MEDIA RELEASE
 
TERMS OF REFERENCE
 
About GRACosway
GRACosway is Australia's leading public affairs and corporate and financial communications counsel. Our integrated suite of services provides public policy, communications, regulatory, issues management, and media relations advice to a range of domestic and international clients across all industry sectors. From offices in Sydney, Melbourne, Brisbane, Adelaide, Canberra, and Perth (through GRA Everingham), GRACosway's clients benefit from the combined experience, expertise, and strategic perspective of our team in addressing complex and commercially sensitive projects. For more information head to gracosway.com.au
 
GRACosway is a Member of the Clemenger Group
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