The Productivity Commission’s final report into competition in the Australian financial system was publicly released on 3 August.  The findings relate to the state of competition, new entrants in banking, the role of vertical integration; consumers capacity to put competitive pressure on providers; mortgage brokers and home loan markets; general insurance; financial advice; the payments system and the role of the regulators.  A high level overview of the key findings and recommendations in the report is below.

Overall Findings

• Limited competition generally: The report found that overall, there is limited competition in the financial sector and the 'the larger financial institutions, particularly but not only in banking, have the ability to exercise market power over their competitors and consumers'.  This is attributed to: 'persistently opaque pricing; conflicted advice and remuneration arrangements; layers of public policy and regulatory requirements that support larger incumbents; and a lack of easily accessible information, inducing unaware customers to maintain loyalty to unsuitable products'.
• Limited ability for customers to apply competitive pressure on providers: 'Poor advice and complex information supports persistent attachment to high margin products that boost institutional profits, with product features that may well be of no benefit'.  This is attributed to the failure of 'channels for the provision of information and advice (including regulator information flow, adviser effort and broker activity)'.
• Competition issues are not 'clearly caused' by vertical integration and 'forced separation is not a panacea':  Findings 9.1-9.2 state that the PC found no clear causal link between competition issues in either mortgage or wealth management markets that are 'clearly associated with integration' and that 'forced structural separation is not likely to provide an effective regulatory response to competition concerns in the financial system, specifically not in either home loan or wealth management markets'.
• ACCC should act as a competition champion for the financial sector: Recommendation 19.1 states that ‘To address gaps in the regulatory architecture related to lack of effective consideration of competitive outcomes in financial markets, the ACCC should be given a mandate by the Australian Government to champion competition in the financial system, including in decisions taken by regulators that have or may have the outcome of restricting competition.

Key findings and recommendations

Banking sector

Among the findings in the report were the following.

• Price competition in the banking system is limited: 'Although institutions claim that they compete in loan markets by discounting, such behaviour is not indicative of a competitive market when price obfuscation is common and discounts are specific to groups of customers'.
  Lack of competition in home loan markets: 'The mortgage brokers who once revitalised price competition and revolutionised product delivery have become part of the banking establishment. Fees and trail commissions have no evident link to customer best interests. Conflicts of interest created by ownership are obvious but unaddressed'.
• The Four Pillars policy is 'redundant': 'The Four Pillars policy is unnecessary as a means of ensuring either competitive or prudential outcomes given the strong existing laws in place'.  The report adds that it 'potentially erodes competition. It also removes the potential threat of discipline by the market on the management of the four banks covered by it, undermining effective corporate governance.  At best, it is a redundant policy that does not achieve its stated objectives.'
• Trail commissions should be ‘banned’: 'There is little if any evidence to substantiate the claim that trail commissions are a payment for the ongoing provision of services to borrowers. In practice, trail commissions have the effect of aligning the broker’s interests with those of the lender, rather than those of the borrower'.

To address these (and other issues identified) the report makes a number of recommendations including the following.

• To encourage new entrants into the market, the report recommends that ASIC should expand the scope of products eligible for testing under ASIC’s regulatory sandbox beyond the proposed enhanced regulatory sandbox, take a 'more hands-on approach' to approving and supporting fintechs and consider requests from existing institutions to access the sandbox on a case by case basis.  In addition, an 'ongoing program of regulatory improvement in support of the sandbox' should be a 'standing item for the Commonwealth Treasury's legislative program' (recommendation 4.1).Mortgage broking reforms — reform of commission structures and increased reporting requirements: Recommendations 11.1-11.4 relate specifically to mortgage broking.  They include the proposed reform of mortgage broker commission structures via an ‘enforceable Code’ to be created and imposed by ASIC to ban the payment of trail commissions in mortgage broking for all loans originated after the end of 2018 as well as a ban on the payment of volume based commissions, campaign based commissions and volume based payments.  It’s also proposed that the ban on early exit fees be extended to explicitly prohibit commission clawbacks being passed on to borrowers.  The report recommends that ASIC’s powers should be expanded to allow it to enforce the ban.  In addition, it’s recommended that increased broker reporting that ‘accords with it being the dominant home loan distribution channel’ be imposed.
• Best interest obligation for credit licensees that facilitate home loans: Recommendation 11.4 proposes that the government should amend the National Consumer Credit Protection Act 2009 (Cth) to impose best interest obligations on licensees that provide credit or credit services in relation to home loans.  These obligations should comprise: ‘a duty to act in the best interest of the client; a requirement that any resulting recommendations must be appropriate to the client, having regard to the duty to act in the best interest of the client; a duty to prioritise the interests of the client, in the event of a conflict; a duty to ensure that certain information is disclosed to the client.’  The report adds that ‘Where the lenders have an ownership interest in firms that provide the credit assistance services, those lenders should also have a legal responsibility to ensure that the licensee discharges its best interest obligations’.
• Principal Integrity Officer: Recommendation 9.2 proposes that the government should legislate the appointment of a Principal Integrity Officer (PIO) in authorised deposit taking institutions (ADIs) initially, but ‘with potential extension to other Australian Credit licensees and Australian Financial Service Licensees’.
  • The PIO would have ‘independent status within the entity’ and a ‘direct reporting line to its board’.  More particularly, The PIO would have a ‘statutory duty to advise the entity’s board on performance related to remuneration and practices that may be inconsistent with serving a customer’s best interests, including breaches of commission or other remuneration benchmarks and regulations’.  
    - In addition, the PIO would ‘also review internal business practices as they develop over time that may be inconsistent with the entity’s obligation to act in the customer’s best interests’.
  • The PIO would be required to report independently to ASIC on unsatisfactory responses to its reports, ‘including persistent failure of its board to observe standards supporting consumer best interest obligations. 
  • The report recommends that the PIO should ‘be protected from adverse action by statute where they do so report’.  
  • The report recommends that consultation on the details of the PIO, related legislative changes and penalties should be determined through a consultation process commencing by the end of 2018.

  PIO concept 'convincing'? Commenting on this Treasurer Scott Morrison said that the recommendation ‘has potentially far greater application than recommended and can work in well with the BEAR regime.  These roles are effectively already being performed in banks reporting through to the Chair of Audit and Risk Committees. But as we have seen in the Laker Report into CBA, where the Board drops the ball, what happens then?  I do find the Chief Pilot analogy convincing. A statutory obligation to pick up the phone direct to the regulators to an assigned senior executive within the bank with these responsibilities, spelled out in the accountability map as part of the BEAR, is a very worthy idea’.  He added that ‘as with all the recommendations in the PC report we will look carefully at them, consult, and consider our response in concert with any further matters coming forward, in particular from the Royal Commission. And I note this report had already been shared with Royal Commission'.

• Interest rate transparency for home loans – ASIC online report: Recommendation 12.1 proposes that ASIC should collect data from mortgage lenders (ADIs only) on interest rates of new residential home loans and develop an ‘online calculator that reports, with an elapsed time of no more than 6 weeks, median interest rates for loans issued according to different combinations of loan and borrower characteristics. The underlying data should be published in a way that is accessible to third parties such as web application developers. At a minimum, data should be published in a machine readable format’.
• Borrowers should be offered more choice for lenders mortgage insurance: Recommendation 13.2 proposes that ASIC should require all lenders to provide borrowers that are levied with lenders mortgage insurance with the option of being levied once at the commencement of their home loan or being levied annually over the first six years of their loan with transparency around the comparison of these options.
• Data Access: The report recommends that the Open Banking System should be implemented 'in a manner that enables the full suite of rights for consumers to access and use digital data' (recommendation 5.1).
  

  Financial Advice

  In relation to financial advice, the report made a number of findings including the following.
• Enabling financial advisers to provide personal advice on home loans would increase competition: The report suggests that allowing financial advisers to compete with mortgage brokers in offering personal advice on home loans would expand the sources of competition in home loan distribution as well as provide more holistic personal financial advice services to consumers. But notes that ‘more work is required before this could become a reality'.
• The term ‘general advice’ is problematic: Commenting on 'General advice’ the report found that ‘some consumers unduly rely on general advice, and in particular, sales and marketing material'.
• More transparency is needed around use of approve product lists (APLs): The report found that 'Better information is needed on how financial advisers make product recommendations through the use of approved product lists. Australian Financial Service Licensees should disclose a range of data indicators to assist ASIC enforce the standard of conduct required of financial advisers. The Commission recommends annual public reporting of this information'.
  The report makes a number of recommendations to address these concerns.  These include the following.
• Creation of a new Australian Financial Services Licence: The report recommends that ASIC should assess the feasibility of financial advisers providing advice on home loans and other credit products, via a new Australian Financial Services Licence that would not require a separate Australian Credit Licence to be obtained.  This assessment should examine the costs and benefits of a new licence, the consequences of various remuneration models and the applicability of a Principal Integrity Officer (recommendation 10.1).
• ‘General advice’ should be renamed and a new term should be in effect by mid-2020: The report states that general advice, as defined in the Corporations Act 2001 (Cth), is a ‘misleading term and should be renamed’.  The report adds that ‘Any replacement must ensure that the term “advice” can only be used in association with “personal advice” — that is, advice that takes into consideration personal circumstances’.  The report recommends that consumer testing of alternative terminology should be undertaken to ‘ensure that misinterpretation and excessive reliance on this type of information is minimised’.  The report states that ‘Including time for consumer testing and a transition period to enable industry training and adjustment, a new term should be in effect by mid-2020’ (recommendation 10.2).
• ASIC to publish approved product lists and conduct audits: The report recommends that Australian Financial Service Licensees should disclose to ASIC (for each broad class of financial product): the number of products on their approved product list (APL); the proportion of in-house products on their APL; the proportion of products recommended that are in-house the proportion of products recommended that are off-APL and ASIC should publish this information annually.  ASIC should also conduct selected audits of the information received to facilitate assessment of the effectiveness of advisers in meeting clients’ best interests (recommendation 10.3). 

Regulators

The report found that the lack of an advocate for competition is a 'mistake' and APRA is 'not well placed to consider competition effects'. 
The report adds that: 'Given the size and importance of Australia’s financial system, and the increasing emphasis on stability since the global financial crisis, the lack of an advocate for competition when financial system regulatory interventions are being determined is a mistake that should now be corrected’.

Among the recommendations to address this and other concerns in the report are the following.

• ACCC should act as a competition champion for the financial sector: Recommendation 19.1 states that ‘To address gaps in the regulatory architecture related to lack of effective consideration of competitive outcomes in financial markets, the ACCC should be given a mandate by the Australian Government to champion competition in the financial system, including in decisions taken by regulators that have or may have the outcome of restricting competition. To minimise cost and disruption, this role should be implemented in substantial part through the Council of Financial Regulators (CFR) by making the ACCC a permanent member of the CFR’.  The report adds that ‘there should be no change under this recommendation to the current legislated responsibilities of the regulators. Rather, the Australian Government should include in its Statement of Expectations for each of the financial regulator members of the CFR that the ACCC should be given the opportunity as a member of the CFR to advise the Council on regulator actions that may have material effects on competition, before they are implemented’.
• Statements of expectations for regulators: Recommendation 18.1 proposes that statements of expectations for regulators should be published as a matter of priority and regulators should publish Statements of Intent within three months of receiving the Statements of Expectations.  In their annual reports, the financial regulators should provide information on the actions they have taken in line with their Statements of Intent and outcomes on performance measures.
• Transparency of regulatory decision making: Recommendation 19.2 states that the CFR should apply the ‘ACCC analysis in a discussion amongst members on interventions that may have a material impact on competition in a product market. The ACCC assessment of competition impacts should be published in a simple form and timely manner as part of a new commitment to publish Minutes of CFR meetings’.
• ACCC should regularly review the effect of vertical and horizontal integration: Though the report found no clear causal link between integration and competition issues in the mortgage or wealth management markets and does not recommend 'structural separation', the report does recommend that the 'ACCC should undertake 5-yearly market studies on the effect of vertical and horizontal integration on competition in the financial system. The first of these studies should commence in 2019 and include establishing a robust evidence base of integration activity in the financial system' (recommendation 9.1). 
• Publication of ASIC data: The report states that the financial regulators ‘already collect large amounts of data, which is a valuable public resource. Subject to privacy requirements, much more such data should be made publicly available. As a first step towards improving the availability of data, ASIC should publish a list of the datasets collected and used in its research projects and reports and release any non-sensitive datasets’ (recommendation 18.2). 
• APRA should conduct post-implementation evaluations of its material interventions: The report recommends that APRA should conduct and publish annually quantitative post-implementation evaluations of its material prudential interventions, including costs and benefits to market participants and the effects on competition (recommendation 19.3).  The report specifically recommends that APRA should conduct a post-implementation review on how the changes in Prudential Standard APS 120 have affected the costs of funds and competitiveness of non-authorised (smaller) deposit-taking institutions (recommendation 8.1).  In addition, the report recommends that instead of applying a single risk weight to all small and medium business lending not secured by a residence, APRA should provide for a broader schedule of risk weights in its Australian Prudential Standard (APS 112) (recommendation 16.1). 

General insurance

The report found that there was a lack of competition in general insurance/lack of transparent consumer information. The PC writes that 'General insurance markets are concentrated' and 'there is a proliferation of brands but far fewer actual insurers, poor quality information provided to consumers, and sharp practices adopted by some sellers of add-on insurance products.  A Treasury working group should examine the introduction of a deferred sales model to all sales of add-on insurance'.

To address this, the report makes a number of recommendations including the following.

• Clearer disclosure:
  • The report recommends that renewal notices for general insurance products should transparently include the previous year’s premium and the percentage change to the new premium. This policy should commence by the end of 2019 and be enforced by ASIC (recommendation 14.1).
  • In addition to specifying which insurer underwrites their products, each insurance brand should specify on their website any other brands that are underwritten by the same insurer, for that particular form of insurance. Insurers should provide an up-to-date list of the brands they underwrite to ASIC. ASIC should transparently publish this information as a list on its website (Recommendation 14.2).
• State and territory taxes and levies on general insurance should be phased out consistent with the Productivity Commission’s 2014 Natural Disaster Funding Inquiry (recommendation 14.3).
• ASIC should proceed as soon as possible with its proposal to mandate a deferred sales model for all sales of add on insurance by car dealerships.  The deferral period should be a minimum of 7 days from when the consumer applies for or purchases the primary product.  Following implementation, the Australian Government should establish a Treasury-led working group with the objective of comprehensively extending the deferred sales model to all other add on insurance products, with the model set in legislation and ASIC empowered to offer exceptions on a case-by-case basis (Recommendation 15.1).
• Removal of the NCCP exemption? The Treasury should complete its 2013 review into the current exemption of retailers from the National Consumer Credit Protection Act 2009 (Cth), with a view to removing or reforming the exemption. The report should be made publicly available on completion (recommendation 15.2).

Payments System

• The Payments System Board should introduce a ban on card payment interchange fees by the end of 2019. Any other fees should be made transparent and published. (Recommendation 17.1)
• Review of current interchange fee regulation: The ACCC, with input from the Payments System Board, should investigate: whether current or recommended interchange fee regulation favours three party card schemes.  This investigation should be completed by no later than mid-2019. (Recommendation 17.2)
• Choice of default network: The Payments System Board should set a regulatory standard that gives merchants the ability to choose the default network to route transactions for dual network cards.  The report adds that as the technology is readily available, this reform should be in force by 1 January 2019 at the latest. (Recommendation 17.3).
• ePayments Code made mandatory: The Australian Government should give ASIC the power, by end 2018, to make the ePayments Code mandatory for any organisation that sends or receives electronic payments (recommendation 17.6) ASIC should review the ePayments Code and update it to reflect changes in technology, innovative business models and developments in Open Banking. ASIC should more clearly define the liability provisions for unauthorised transactions when third parties are involved, including participation in financial dispute resolution schemes.  ASIC should update the ePayments Code by end 2019 and commit to 3 yearly reviews.
• Review of PPFs: The Council of Financial Regulators should review the current regulation of Purchased Payment Facilities (PPFs).  The review should develop an approach to simplify the regime, develop clear thresholds for regulatory responsibility and reduce barriers to growth in this sector. The review should consult on and design a tiered regulatory structure for PPFs, including one tier that does not attract prudential regulation.  The review should be completed by end 2018 at the latest and provide a path forward for regulators by mid-2019 (recommendation 17.5).
• Access regime for the new payments platform (NPP)/improved functionality of the NPP: Recommendations 17.7 and 17.8 relate to the new payments platform.  Recommendation 17.7 recommends that the platform should subject to an access regime imposed by the Payments System board.  Recommendation 17.8 recommends that the ACCC in consultation with the Payments System Board should investigate ways to improve the functionality of the NPP to promote competition within the NPP and across the payments system more broadly. The investigation should be completed by mid 2019, with a view to implementing additional functionality by end 2019.

[Sources: Productivity Commission media release 03/08/2018; Overview — Competition in the Australian Financial System; Competition in the Australian Financial System — Inquiry Report; [registration required] The SMH 03/08/2018; Treasurer Scott Morrison speech to the Australian British Chamber of Commerce: 'Consumer powered competition in our banking sector' 03/08/2018]