Australia: Release of the Financial System Inquiry Report

As you have probably noticed, the Government and ASIC have been busy of late amending regulations, disallowing regulations and using a "facilitative" approach.

With all this activity, it may be easy to have missed the release of the Financial System Inquiry (FSI) Final Report. Overall, this report supports the status quo rather than reforming the system as the previous Wallis Report did with FSR. However, it still recommends a number of significant changes which will require thorough consideration and consultation.

Not everyone enjoys 350 pages of regulatory recommendations as we do at Holley Nethercote. To save you the hassle, you can find a mindmap summarising the recommendations below. If absorbing 44 recommendations feels too tiresome, we have also created mindmaps focused on a couple of industry sectors, which only contain the recommendations which we think are relevant to that sectors.

The Government is welcoming comments on its recommendations and is currently holding a consultation period which will end on 31 March 2015.

So what do we think?

Our lawyers at Holley Nethercote have provided their thoughts for some of the significant recommendations.

Recommendation 8 – Prohibiting limited recourse borrowing arrangements for superannuation funds on a prospective basis.

Christopher Lim says: "This recommendation will be a game changer for many segments of the market. Industry opposition is expected, most obviously from financial advisory firms with a focus on recommending investments in direct property through superannuation. But also from the real estate industry and possibly from consumers who prefer investing in direct property."

Recommendation 24 – Upfront insurance commission should not be greater than ongoing commissions.

Tim Nethercote says: "This recommendation will almost certainly result in a reduction of commissions paid to life insurance advisers and may result in less advisers wanting to take the time and trouble to provide insurance advice at a time when it is widely recognised that there is a high level of underinsurance in Australia. More insurance advisers may consider providing advice under fee for service arrangements which is currently not common for life insurance. Advisers will argue against this recommendation on the basis that insurance is difficult to "sell" and consumers may be reluctant to pay a fee to the adviser for insurance advice."

Recommendation 40 – Rename 'general advice' and require advisers and mortgage brokers to disclose ownership structures.

Paul Derham says: "Hopefully, the requirement to more prominently disclose ownership structures will replace, and not be in addition to, the existing ownership disclosure rules which currently result in multiple paragraphs of complex wording.

With regard to general advice, after 10 years of FSR, the personal vs general advice distinction is still not widely understood. Renaming general advice is more likely to add to the confusion, unless the drafting and subsequent ASIC guidance is excellent."

Recommendation 37 – Requiring superannuation statements to include retirement projections.

Michelle Chasser says: "Requiring superannuation funds to provide retirement income projections on superannuation statements will assist consumers plan for their retirement and engage them in the savings process. In addition, many financial planners currently grapple with what assumptions to use and what assumptions should be considered in retirement income projections. Standardisation on how income projections should be calculated, although not binding on financial planners, would also provide guidance to financial planners who provide estimated retirement income projections for clients."

Recommendation 22 – Giving ASIC the power to intervene or impose amendments to marketing and disclosure materials; warnings to consumers, and labelling or terminology changes; distribution restrictions; and product banning.

Tim Nethercote says: "This recommendation has been being implemented in other jurisdictions. It will represent another regulatory dimension although the proactive aspect is intended to be a last resort. A key to possible implementation will be a thorough examination of how such power has been used overseas. It is highly dependent on ASIC being sufficiently resourced in terms of numbers and expertise. It also has the potential for greater criticism of the regulators in the case of failures – "why didn't ASIC stop this?".

Recommendation 11 - Requiring superannuation trustees to pre-select a comprehensive income product for a members' retirement (i.e. similar to an annuity paying a regular and stable amount of funds to a person for the duration of their life).

Christopher Lim says: "This recommendation represents an attempt to shift a degree of longevity risk from retirees to product providers. However, moving from an account based pension to an annuity also carries its own pros and cons. Products which offer longevity protection are much more complicated to understand and engineer. Much more time will need to be spent on explaining product structures and implications to clients. Furthermore, as annuities are usually in the domain of life insurers this recommendation will result in structural changes in the market."

Recommendation 21 – Imposing obligations on product issuers during the design, distribution and sale of financial products.

Andrew Ham says: "This recommendation would require product issuers to consider the "type" of consumer whose financial needs would be addressed by buying the product (i.e. their target market), taking the products risk/return profile (among other characteristics) into account. Distributors would be expected to agree with product issuers as to the channel best suited to the product's distribution, and to have controls in place (presumably to ensure) the product is distributed to its target markets in accordance with the expectations of the issuer. The issuer and its distributor(s) will be expected to periodically review whether the product meets the needs of the target market and whether its risk profile is consistent with its distribution.

Typologies will need to be carefully construed. Typologies will need to be comprehensive and accurate to ensure customers are not deprived of a product that would otherwise make them better off, whilst restrictive enough to ensure products are not sold to inappropriate customers. For many products, a "race to the bottom" with customer typologies imposing minimal limitations on the take up of a product is one possible outcome without regulatory intervention.

The key will be to work out how the existing disclosure-based elements of the regime will interact with these limitations on the availability of the product. The infinite creativity of the market in developing and adapting financial products to opportunities means that customer typologies must constantly evolve with them – this will be a challenge.

Discussions between issuers and distributors relating to the distribution of products need to be handled with great care in light of the restrictions on anti-competitive conduct under the Competition and Consumer Act 2010."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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