By Senior Regulatory Counsel Michael Mathieson and Lawyer Rosie Thomas
Since the 1996 Wallis Inquiry, disclosure has been at the heart of the regulatory philosophy for the retail financial services sector in Australia. Under the Financial System Inquiry's terms of reference, the Inquiry 'will refresh the philosophy, principles and objectives underpinning the development of a well-functioning financial system' and it is likely this will include a rethink of the role of disclosure. With this in mind, we take a look at the current disclosure regime and consider its likely future.
The Wallis Inquiry recommended the establishment of 'a consistent and comprehensive disclosure regime for the whole financial system'. Since then, attempts to improve disclosure for different classes of financial product have resulted in a disclosure regime with complex layers of regulation.
Let's take the current product disclosure statements (PDS) requirements for superannuation products as an example. The 'shorter PDS regime' generally applies to these products. However, a superannuation product that is solely a defined benefit product, solely a pension product or a risk-only superannuation product is expressly excluded from the regime. There is also interim class order relief from the regime for 'superannuation platforms' until 1 July 2015. If a superannuation product is excluded or the relief applies, then you're left with the traditional PDS regime. If that's the case, the issuer may elect to give a 'short-form PDS', which (to keep us on our toes) is distinct from giving a PDS under the 'shorter PDS regime'. Had enough? That's just the form of the PDS. Let's turn to the content requirements.
The content requirements for PDSs for superannuation products were amended as part of the 'Stronger Super' reforms. These amendments are significant and the new fees and costs disclosure requirements in particular can be difficult to apply. For those working in the superannuation industry, the challenges with the definition of 'indirect costs' are well known. These new content requirements commenced on 1 July 2013, but there is a transition period (during which issuers may comply with either the old or new requirements), which was to end on 31 December 2013 but has been extended by class order to 1 July 2014.
In addition to navigating PDS-related disclosure issues, the superannuation industry has also been preparing for changes to periodic statements, the development of product dashboards, portfolio holdings disclosure and other mandated website disclosures. These disclosure obligations are also affected by section 29QC of the Superannuation Industry (Supervision) Act 1993 (Cth) and the Australian Prudential Regulation Authority reporting standards. Each of these disclosure reforms has their own unique challenges and start dates.
Clearly, for those working in the superannuation industry, understanding the current requirements and keeping track of the various relevant dates involves considerable time and resources. If the current approach to disclosure regulation is to continue, there may well be similar experiences across the rest of the financial services industry.
Financial System Inquiry Chair David Murray has raised two key issues in relation to disclosure in his speeches about the Inquiry: the effectiveness of the current disclosure regime and the influence of technology on disclosure practices. His comments include:
The effects of the crisis were also felt by many Australian retail investors who suffered substantial losses associated with the failures of financial firms or misselling of financial products. These consequences have called into question whether disclosure is effective. (14 February 2014)
Traditional product disclosures are falling behind technological innovation. Consumers now regularly compare products online. (1 May 2014)
Submissions to the Inquiry from a wide range of financial system participants have commented on the effectiveness of the current disclosure regime. The common theme throughout these submissions is that current disclosure requirements are costly to comply with, while the effectiveness of the disclosure is limited. Many of these submissions note that most investors are not like the fabled 'rational investor' that is assumed by the current approach to disclosure. ASIC's submission notes:
One of the fundamentals of behavioural economics is that consumers do not use information optimally in an economic sense. This means that disclosure of certain information does not improve market outcomes, and may simply represent a cost for providers.
With this general acceptance of the limitations of disclosure in its current form, it is likely the Inquiry will look for new and more effective ways to use disclosure to inform decision-making by retail investors.
The remainder of this article outlines some of the reforms to the disclosure regime that have been proposed in submissions to the Inquiry. In a later article in this edition of Unravelling, we also consider the beginnings of a trend towards product suitability regulation, given the shortcomings of disclosure.
ASIC has made various recommendations about how the effectiveness of disclosure can be enhanced in its submission to the Inquiry. These include proposals to combine disclosure with broader 'investor education' tools (such as investor self-assessment quizzes), using 'layers' of disclosure (with different levels of information being provided at each stage of the decision-making process) and encouraging the use of 'new media' to provide information in more engaging ways. Unsurprisingly, these recommendations and others (see below) hope to take advantage of opportunities presented by technology.
Many submissions to the Inquiry have acknowledged the need for the regulation of disclosure to keep pace with technological development. There are also concerns that excessive regulation will stifle innovation, particularly when it comes to disclosing information through 'new media'. ASIC acknowledges the role regulation plays in this regard in its submission, saying: 'There are opportunities to reduce costs to industry by removing ineffective regulation. It may also mean that when we do use disclosure it can be better designed and can take advantage of new technologies.'
Further, ASIC and consumer groups have noted developments in information disclosure in the United Kingdom and United States, where disclosure of data held by financial institutions and government authorities is being encouraged or mandated, and have called for similar initiatives to be implemented in Australia. This can include disclosing data specific to a consumer (eg their transaction or usage history) or generic aggregated data about a financial services provider or product (eg the number of complaints they have received or the time taken to process insurance claims). The objective is that disclosure of this information in machine-readable formats will encourage third parties to develop applications (often called 'choice engines') to assist investors or financial advisers in their decision making. Adoption of this type of 'smart disclosure' is sure to bring its own regulatory challenges (such as overcoming privacy and confidentiality concerns), commercial pressures (as internal information becomes public) and implementation issues (such as resourcing and system upgrades).
One thing is certain: disclosure requirements will be different in the future. The Financial System Inquiry is likely to provide a glimpse into what that future may hold. While some may be pleased by signals that the current disclosure requirements may be relaxed, it is likely that any removal of 'ineffective regulation' will be complemented by new requirements that will no doubt present their own unique challenges. Be careful what you wish for.