10 December 2014

Financial Systems Inquiry Final Report

The Financial Systems Inquiry (aka Murray Inquiry) has released its final report on how "to best position Australia’s financial system to meet Australia’s evolving needs and support economic growth". The report claims to offer "a blueprint for an efficient and resilient financial system over the next 10 to 20 years, characterised by the fair treatment of users" and reflecting "public interest: the interests of individuals, businesses, the economy, taxpayers and Government".

The report features 44 recommendations, reflecting an assessment that
Australia’s financial system has performed well since the Wallis Inquiry and has many strong characteristics. It also has a number of weaknesses: taxation and regulatory settings distort the flow of funding to the real economy; it remains susceptible to financial shocks; superannuation is not delivering retirement incomes efficiently; unfair consumer outcomes remain prevalent; and policy settings do not focus on the benefits of competition and innovation. As a result, the system is prone to calls for more regulation. To put these issues in context, the Overview first deals with the characteristics of Australia’s economy. It then describes the characteristics of and prerequisites for a well-functioning financial system and the Inquiry’s philosophy of financial regulation.
The report accordingly  focuses on seven themes-
The Overview deals with the general themes of funding the Australian economy and competition. The Inquiry has also made recommendations on five specific themes, which comprise the next chapters of this report:
•Strengthen the economy by making the financial system more resilient.
•Lift the value of the superannuation system and retirement incomes.
•Drive economic growth and productivity through settings that promote innovation.
•Enhance confidence and trust by creating an environment in which financial firms treat customers fairly.
•Enhance regulator independence and accountability, and minimise the need for future regulation.
These recommendations seek to improve efficiency, resilience and fair treatment in the Australian financial system, allowing it to achieve its potential in supporting economic growth and enhancing standards of living for current and future generations.
Its assumption is that
The financial sector plays a vital role in supporting a vibrant, growing economy that improves the standard of living for all Australians. The system’s ultimate purpose is to facilitate sustainable growth in the economy by meeting the financial needs of its users.
The Inquiry believes the financial system will achieve this goal if it operates in a manner that is:
•Efficient: An efficient system allocates Australia’s scarce financial and other resources for the greatest possible benefit to our economy, supporting growth, productivity and prosperity.
•Resilient: The financial system should adjust to changing circumstances while continuing to provide its core economic functions, even during severe shocks. Institutions in distress should be resolvable with minimal costs to depositors, policy holders, taxpayers and the real economy.
•Fair: Fair treatment occurs where participants act with integrity, honesty, transparency and non-discrimination. A market economy operates more effectively where participants enter into transactions with confidence they will be treated fairly. Confidence and trust in the system are essential ingredients in building an efficient, resilient and fair financial system that facilitates economic growth and meets the financial needs of Australians. The Inquiry considers that all financial system participants have roles and responsibilities in engendering that confidence and trust. ....
Central to the Inquiry’s philosophy is the principle that the financial system should be subject and responsive to market forces, including competition. However, competitive markets need to operate within a strong and effective legal and policy framework provided by Government. This includes predictable rule of law with strong property rights; a freely convertible floating currency and free flow of trade, investment and capital across borders; a strong fiscal position; a sound and independent monetary policy framework; and an effective, accountable and transparent government.
The Inquiry’s approach to policy intervention is guided by the public interest. Given the inevitable trade-offs involved, deciding how and when policy makers should intervene in the financial system requires considerable judgement. Intervention should seek to balance efficiency, resilience and fairness in a way that builds participants’ confidence and trust. Intervention should only occur where its benefits to the economy as a whole outweigh its costs, and should always seek to be proportionate and cost sensitive.
The report summarises the Inquiry's recommendations as follows
Resilience (pages 33–88)
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 Direct 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 (pages 89–142)
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 (pages 143–192)
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 (pages 193–232)
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 (pages 233–260)
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.
Significant matters (pages 261–276)
32 Impact investment -- Explore ways to facilitate development of the impact investment market and encourage innovation in funding social service delivery. Provide guidance to superannuation trustees on the appropriateness of impact investment. Support law reform to classify a private ancillary fund as a ‘sophisticated’ or ‘professional’ investor, where the founder of the fund meets those definitions.
33 Retail corporate bond market -- Reduce disclosure requirements for large listed corporates issuing ‘simple’ bonds and encourage industry to develop standard terms for ‘simple’ bonds.
34 Unfair contract term provisions -- Support Government’s process to extend unfair contract term protections to small businesses. Encourage industry to develop standards on the use of non-monetary default covenants.
35 Finance companies --  Clearly differentiate the investment products that finance companies and similar entities offer retail consumers from authorised deposit-taking institution deposits.
36 Corporate administration and bankruptcy -- Consult on possible amendments to the external administration regime to provide additional flexibility for businesses in financial difficulty.
37 Superannuation member engagement -- Publish retirement income projections on member statements from defined contribution superannuation schemes using Australian Securities and Investments Commission (ASIC) regulatory guidance. Facilitate access to consolidated superannuation information from the Australian Taxation Office to use with ASIC’s and superannuation funds’ retirement income projection calculators.
38 Cyber security -- Update the 2009 Cyber Security Strategy to reflect changes in the threat environment, improve cohesion in policy implementation, and progress public–private sector and cross-industry collaboration. Establish a formal framework for cyber security information sharing and response to cyber threats.
39 Technology neutrality --  Identify, in consultation with the financial sector, and amend priority areas of regulation to be technology neutral. Embed consideration of the principle of technology neutrality into development processes for future regulation. Ensure regulation allows individuals to select alternative methods to access services to maintain fair treatment for all consumer segments.
40 Provision of financial advice and mortgage broking -- Rename ‘general advice’ and require advisers and mortgage brokers to disclose ownership structures.
41 Unclaimed monies --  Define bank accounts and life insurance policies as unclaimed monies only if they are inactive for seven years.
42 Managed investment scheme regulation -- Support Government’s review of the Corporations and Markets Advisory Committee’s recommendations on managed investment schemes, giving priority to matters relating to: •Consumer detriment, including illiquid schemes and freezing of funds. •Regulatory architecture impeding cross-border transactions and mutual recognition arrangements.
43 Legacy products --  Introduce a mechanism to facilitate the rationalisation of legacy products in the life insurance and managed investments sectors.
44 Corporations Act 2001 ownership restrictions -- Remove market ownership restrictions from the Corporations Act 2001 once the current reforms to cross-border regulation of financial market infrastructure are complete.