Minter Ellison supports regular reviews of Australia’s financial system. The Wallis inquiry, the Henry review, and the Johnson report each provided the context for discussion and constructive change aimed at reshaping the financial services sector for the benefit of Australians while factoring in the interests of the global investment community.
We therefore welcome the Financial System Inquiry (FSI) and the opportunity to offer detailed insights and recommendations to the Inquiry via this written submission.
While we agree with the key themes of the FSI identified by the Chairman – funding the Australian economy, ensuring the financial system has the right balance between competition, stability and efficiency, and addressing the impact of and facilitating the opportunities arising from technology – we submit there are a number of other fundamental themes and key legal and regulatory issues that the Inquiry should consider.
Fundamental themes
1. Need for structural change to promote innovation, efficiency and competition
Australia's financial system has served us well and allowed us to came through the Global Financial Crisis (GFC) relatively unscathed. However, if Australia is to meet future challenges, structural reform of our regulatory system is needed, with a focus on promoting innovation, efficiency and competition. A new structure will require a fundamental rethinking of our existing regulatory approach.
2. Impact of the Asian century and Australia's changing position in the world
With Asia fast emerging as a global powerhouse, Australia and our financial system must be ready to the meet challenges emerging from this geopolitical change:
- Shift to the East: Asian countries represent more than 50% of the world's population and their impact as consumer economies will increase dramatically. Australia needs to ensure its financial system is able to take advantage of the growing opportunities in Asia.
- Reduced significance of US economy / financial system: While the US will continue to have a significant influence on the global financial system for years to come, its relative importance is declining. Australia needs to be ready to respond to the implications of this, including the reduced significance of the US dollar as a reserve currency.
- Changing composition of the G20: As emerging markets mature, Australia is likely to drop in world rankings and thus have reduced influence on global economic and financial institutions. The trend to being a regulation taker rather than setter will continue, with profound implications for our regulatory system. It is therefore essential we measure our regulatory system not only against Western economies but also against those of our Asian neighbours to ensure our financial system becomes and remains competitive with current and future regional centres such as Hong Kong, Singapore, Japan and China.
3. Demographic change in Australia
The doubling of our aged population over the next 40 years will put significant additional pressures on government expenditure on health, aged care and the Age Pension. The FSI should consider the implications of this for the financial system, in particular the changes required to our insurance and pension sectors to help Australia meet these challenges.
Key legal and regulatory issues
We believe that a fresh look needs to be taken to the ever-increasing and complex regulation of our financial system. We submit that the FSI's recommendations should be informed by a regional perspective and should help Australia achieve the goal of becoming the most innovative, efficient and competitive financial system in east and south Asia.
In this context, our submission sets out a number of recommendations in relation to key legal and regulatory issues:
1. Role of regulators
Regulation has a significant effect on businesses' productivity. Regulators should be encouraged to focus on their objectives of promoting innovation, efficiency and competition. Different ways of achieving this could include:
- requiring regulators with responsibilities in the financial sector to demonstrate how any regulation, policy or guideline promotes innovation, efficiency and competition in the sector.
- adopting a regulatory structure model based on a designated primary regulator to remove duplication between the roles of ASIC and APRA and reducing the number of regulators with responsibility for the financial sector.
2. Form of regulation
As the Johnson Report recommended, regulation should always be 'necessary, effective and imposes as small a compliance burden on industry as possible'. We are concerned that this is not currently being achieved by our regulatory system through:
- complex layers of regulation by legislation, regulation, regulator modifications and rules;
- regulatory guidance instruments as well as 'catch all' regulation that requires regulator involvement to provide necessary exemptions;
- a complex disclosure model that does not seem to be achieving effective disclosure of the information investors need to make an investment decision; and
- inconsistent and uncertain application of regulation to technology-based solutions, such as electronic disclosure.
- We believe that the FSI should consider how the regulatory burden of our current regime can be reduced.
3. Global regulation
As a net importer of capital, with substantial investment needed in the short/medium term to address infrastructure requirements, it is important that Australia is compliant with global requirements.
Australia must have a clear commitment to implement global regulations in a way that is sensitive to the efficient operation of the Australian financial markets but does not impede foreign investment. We strongly support:
- using intergovernmental agreements and appropriate safe harbours where appropriate to minimise the impact of inconsistent regulation and requirements between jurisdictions;
- better integration of our anti-money laundering and counter-terrorism financing regime with international regimes;
- broader but reciprocal recognition of overseas regulated entities – not only investment managers but also prudentially regulated institutions such as banks and insurance companies.
4. Corporate governance
Corporate governance standards are important for all participants in the Australian financial system. We submit the FSI should give particular consideration to:
- the role of independent directors;
- delegation arrangements;
- risk management standards for non-APRA regulated bodies;
- transparency of reporting; and
- addressing conflicts of duty.
5. Competition
The intersection of financial services and competition law is very important for the Inquiry. The Inquiry's competition analysis needs to take into account the concurrent 'Root & Branch' review of competition law in Australia.
Highlighting particular issues
A. Taxation
Tax reform is a critical element of renovation of Australia's financial system and our capacity to both attract foreign investment and export our capability offshore. As part of its review, we believe the FSI should consider such critical issues as:
- how global tax harmonisation can be implemented in a efficient manner for less cost;
- permitting a wider range of 'tax transparent' investment vehicles, including limited partnerships and companies; and
- implementing the other Johnson Report recommendations.
B. Banking, finance and capital markets
A critical focus of the FSI needs to be on the regulation of systemically important institutions, including how regular assessment can be made of institutions enjoying an implicit government guarantee, the implications and limits on the effective size of institutions, and the extent to which systemically important activities should be separated.
The FSI should also consider measures being implemented and proposed to address pro-cyclicality, including how behavioral issues can be managed – such as the competitive need to match market returns that may be based on pro-cyclical behavour.
There are also a number of regulatory issues affecting the sector, including:
- reform of the Personal Property Securities regime;
- different regulatory regimes applying to listed companies and listed trusts;
- inconsistent application of tracing and substantial shareholder regimes;
- a restrictive debenture regime; and
- the implications of electronic trading on financial markets.
C. Financial advice
While the Future of Financial Advice (FOFA) is not perfect, we believe that it should be allowed to settle in before it undergoes any substantive review. That said, the FSI should consider the inconsistent regulation of investment advice depending on the nature of the asset, with quite different regimes applying to financial products, real estate and other investments.
We also submit that improving financial literacy is important to the financial system because better educated consumers can play an important role in a more innovative, efficient and competitive system.
D. Insurance
Insurance plays a critical role in transferring and managing risk in a modern capitalist economy. Without it, many of the activities we take for granted would not be possible. There are challenges to the availability of insurance, however, which the FSI should consider, including:
- the impact of technology;
- the increasing incidence of natural disasters;
- increasing levels of disability claims particularly affecting insurance through superannuation; and
- longevity risk – a challenge both for health insurance and pension providers.
In addition to these key economic considerations, we submit there are some regulatory issues the FSI should look at, including whether there should be a single regulatory regime and regular for all insurance products.
E. Managed investments
A critical consideration for the FSI should be the steps that need to be taken to leverage our domestic wealth management capability internationally. Fully implementing the Johnson Report is a key element of this, in particular addressing limitations on the use of non-trust investment vehicles and passporting to recognise not only funds but also licensing regimes.
Encouraging innovation and efficiency is another key requirement for our funds management sector, through, among other things, a review of disclosure regimes and regulation of hedge funds, and critically the introduction of a workable product rationalisation regime.
F. Superannuation
The increasing size of our superannuation pool is a critical component of the success and resilience of our financial system. However, responsible investment of these assets is an equally important part of our system. Encouraging greater investment in longer-term investments and small-medium businesses is a worthy goal but must not interfere with the trustee's duty to invest member funds in a prudentially sound manner.
We believe that pension reform is a critical element to address the longevity risk Australia faces. Attention needs to be given to:
- removing unnecessary restrictive and inflexible rules;
- extending tax incentives to help promote innovative income stream products and to encourage retirees to take out pensions; and
- reducing the current over-emphasis on costs.
Our full submission is available on our website.