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Client Update: All but one: Federal Government issues response to FSI report

20 October 2015

In brief: The Federal Government today released its long-awaited response to the Financial System Inquiry. The Government says it has accepted all but one of the Inquiry's 44 recommendations released late last year. And this is broadly true, with the only substantial recommendation to be rejected being the recommendation to stop superannuation funds borrowing to invest.

We said at the time of the Inquiry's report that the recommendations were bold and sometimes radical. The decision by the Government to adopt them is similarly bold, although the Government's plans for implementation are perhaps less so. Many items are pushed out to 'beyond 2016' – this includes our favourite, ' facilitate rationalisation of life insurance and managed investment scheme legacy products' - and it appears we are in for a lot more consultation too. The Inquiry found that Australia has a well-functioning financial system, but the Government says its response 'will ensure it is the best in the world'. High ambition, or maybe hubris. As we have come to expect of Mr Turnbull, the word 'innovation' is everywhere - 'innovation champions' will get a 'direct voice' - but so are 'resilience', 'efficiency', and 'fairness'. Product manufacturers will be required to issue financial products that perform as they say they will and more will be done to address conflicted remuneration in life insurance and stockbroking.

The Government will enshrine the objective of the superannuation system in legislation. However, it is keeping its powder dry on what the objective might be. Whatever it is, achieving political consensus will be difficult. If the Government is successful, an objective that is well formulated would provide a guide for future reform that is less haphazard than it has been to date.

The big challenge now will be to see the reforms implemented. This will take years of work and commitment from Governments over several terms. If the desire is there, what is lacking at this stage is the detail. The Government's response provides general support for the recommendations. The real challenge will be in turning the proposals into detailed government policy and legislation. Proper consultation will be crucial. And the Productivity Commission has been handed a long list of jobs.

Resilience

The Government has acknowledged the risks of our highly concentrated lending market, and has accepted that the 'financial sector regulatory framework needs to be stronger than those of comparable economies' to be better able to withstand severe shocks.

A number of the Inquiry's recommendations in this area are in APRA's domain and are already being progressed. The Government says it will 'support and endorse' APRA as Australia's prudential regulator implementing the Inquiry's recommendations aimed at improving resilience of the banking sector, including to set capital standards such that Australian ADI capital ratios are 'unquestionably strong', and to increase the major banks' mortgage risk weights.

The Government proposes by mid-2016 to consult on additional tools the regulators want to manage financial crises. No mention is made of previous consultations on the very same issue.

Superannuation

The Government proposes to enshrine the objective of the superannuation system in legislation by the end of 2016, a long overdue reform coming more than 20 years after the compulsory system was set up. Whether defining the objective in a meaningful way is politically achievable is doubtful. Any objective that makes sense is likely to require other changes, such as in the taxation of superannuation.

The Government will ask the Productivity Commission to develop and release criteria to assess the efficiency and competitiveness of the superannuation system immediately, and develop alternative models for a formal competitive process for allocating default fund members to products. It sounds like the Government is seriously considering the possibility of an auction system for default superannuation. It also recognises that more needs to be done to reduce fees and improve after fee-returns. There is no detail at this stage about what measures will be proposed or adopted to achieve this, but the implication is that there will be some further screening of MySuper products. The Government will extend choice of fund to employees covered by certain enterprise agreements and workplace determinations (but again no detail).

On retirement incomes, the Government proposes by the end of 2016 to consult on legislation to facilitate trustees of superannuation funds providing 'pre-selected comprehensive income products for retirement', and will work to remove the impediments (real or perceived) to product development in this area.

Governance reforms are already in train, and the Government proposes to legislate further to introduce director penalties and criminal sanctions for breaches of the best interests duty.

While the Government has not adopted the recommendation to place limits on direct borrowing in the superannuation system, it wants to monitor leverage and risk through the Council of Financial Regulators and the ATO over the next three years.

Innovation

The Government says that its policy settings must facilitate the entry of 'disruptors' in the financial system, 'rather than acting as a blockage'.

The development of a crowd sourced equity funding market is a priority, and as already announced, the Government proposes to put through legislation by the end of 2015. Other proposals include the development of a 'Trusted Digital Identity Framework', giving legal effect to the Asia Region Funds Passport (by the end of 2016), and legislation to reduce disclosure requirements for issuers of 'simple' corporate bonds (by mid-2016).

The Government will also establish a public-private Innovation Collaboration Committee, which will consult on policy development to assist innovation. 'Technology neutral' regulation is an aim (which is easier said than done).

Efficiency and fairness in the payments system are also seen as priorities with the Government agreeing to a ban on excessive card surcharges, with legislation to be developed by mid-2016. A graduated regulatory regime gets support, with the regulators to conduct a review and develop guidance for industry. Key consumer protections in the ePayments Code may also be mandated.

The Government wants to improve access to and the use of data, which has the potential to improve efficiency in the system, and will ask the Productivity Commission to undertake a review.

Beyond 2016, the Government also proposes to look at measures to facilitate rationalisation of life insurance and managed investment scheme legacy products, although it recognises the challenges this poses, including for consumer protection and the taxation implications (to be explored in the Taxation White Paper).

Consumer outcomes

The Government's response notes the need for consumers to be treated fairly and that, in recent times, 'problems have arisen when commercial incentives have overridden consumer interests'.

A key reform be will to lift standards of financial advisers intended to 'professionalise' the industry, with legislation to be developed by mid-2016. It will require advisers 'to hold a degree, pass an exam, undertake continuous professional development, subscribe to a code of ethics and undertake a professional year'. A new industry funded body will set standards.

It also proposes to introduce a product design and distribution obligation to make issuers and distributors accountable for their offerings. In a deliciously ambiguous sentence, the Government says this obligation 'should be viewed as workable by the industry'. The Government is at particular pains to emphasise that any changes in this area will be made after extensive consultation, to occur by mid-2016. Depending upon the design of this obligation, it could have substantial implications for the financial services industry and its culture.

Consultation is expected by the end of 2016 on the proposed ASIC product intervention power, which could give ASIC power both to modify and remove products from the market.

Conflicted remuneration in life insurance, stockbroking and mortgage broking also comes in for scrutiny, with regulation and increased disclosure likely. On the life insurance measures, the Government supports the industry's proposal in response to the Trowbridge report (the 'Life Insurance Framework'), and will consider the extent to which legislation is required following a review in 2018, which could mandate a flat commission structure or extend FOFA.

'General advice' will be renamed, with the new name to be worked out in consultation with industry. Perhaps 'Financial product advice that is not personal advice' would be accurate but unhelpful.

Regulatory system

The Government supports the recommendation to increase regulator accountability and capabilities mainly through amending existing arrangements. It will not establish a separate Financial Regulator Assessment Board. The Government is already conducting a capability review and a review of the funding model for ASIC. It will review the Statement of Expectations for APRA, ASIC and the Payment System Board and increase the focus on performance assessment in the annual reporting by these regulators.

The Government will review ASIC's enforcement regime to ensure it provides a credible deterrent, although this has been pushed out to 'beyond 2016'. It will include competition in ASIC's mandate and ask the Productivity Commission to undertake reviews of competition in the sector.

The Government acknowledges the lack of time provided to business to implement recent regulatory reforms and says it will work with regulators to change this.

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