- In this article we discuss potential reform of the way in which Australia's financial markets are regulated.
Oversight of the financial regulators in Australia is minimal but its importance is recognised. Broadly speaking, financial regulation is divided between four agencies, which have discrete responsibilities to achieve the regulatory objectives outlined below. They are:
- the Reserve Bank of Australia ("RBA"), charged with ensuring system stability;
- the Australian Prudential Regulation Authority ("APRA"), which develops and enforces prudential standards to reduce the risk of institutional failure in the banking and insurance sectors;
- the Australian Securities and Investments Commission ("ASIC"), which among other things, promotes disclosure, governance standards and consumer protection in relation to financial products; and
- the Australian Competition and Consumer Commission ("ACCC"), which promotes competition in the financial services sector (as part of its wider brief to regulate competition).
Senior representatives of the RBA, APRA, ASIC and the Federal Treasury also comprise the Council of Financial Regulators, whose charter is to "facilitate co-operation and collaboration" between the RBA, APRA, ASIC and Treasury to "contribute to the efficiency and effectiveness of regulation and to promote stability of the Australian financial system." The Council also has the aim of "harmonising regulatory and reporting requirements, paying close attention to the need to keep regulatory costs to a minimum." Although not a body which "regulates" those regulators, it provides a forum to help them work effectively.
All of the RBA, APRA, ASIC and the ACCC are independent, largely autonomous statutory authorities. As such, they are not overseen by a government department or another entity charged with their supervision. Both the RBA and APRA are managed by boards comprising ex-officio and independent non-executive directors or governors appointed by the Treasurer, while ASIC and the ACCC are governed by executive commissioners who also have day-to-day responsibility for its operations. The directors and commissioners have security of tenure, and senior personnel face regular scrutiny by parliamentary committees and are bound by statute to act properly. Nonetheless, there is little direct supervision of the regulators' activities.
Oversight, the Wallis Inquiry and the role of Treasury
The current structure of financial regulation in Australia is based on the recommendations of the federal government's Financial System Inquiry (known as the Wallis Inquiry after its chairman), which reported in 1997 and which were implemented through the late 1990s. Although it considered how regulators should be overseen in the context of advocating significant reform of the financial regulatory framework, the Wallis Inquiry recommended against specific measures to introduce greater supervision of those bodies. Instead, it recommended that regulatory agencies should improve their internal and external reporting processes and report annually to Parliament. Having noted that financial regulators were subject to oversight by:
- the Auditor General, who has wide powers to conduct periodic audits and investigations;
- the Parliament, particularly through standing committees and parliamentary inquiries;
- the Treasurer, who consults widely and has the advice of the Treasury; and
- independent analysts who periodically produce reports or commentary on the operation of regulatory agencies,
the Wallis Inquiry concluded that "current methods of external review will be enhanced through additional public reporting by the financial regulatory agencies… Against this background, the Inquiry considers it unnecessary to establish an additional standing body for the sake of external review of the efficiency of the financial regulatory agencies." It did, however, recommend the creation of a Financial Sector Advisory Council, comprising industry experts, to give policy advice to the Treasurer from an industry perspective in addition to the advice being provided by Treasury.
Regulatory failure and the collapse of HIH Insurance
One of the most far-reaching investigations into the conduct of a regulator in Australia was undertaken as part of the Royal Commission chaired by Justice Owen into the collapse of the HIH insurance group. HIH was one of the country's largest insurers and its failure was the largest collapse in Australian corporate history. Justice Owen, who reported in April 2003, inquired into the reasons for and the circumstances surrounding its collapse in March 2001. As well as identifying individuals and organisations which contributed to the failure, he was directed to enquire into the "adequacy and appropriateness of arrangements for the regulation and prudential supervision of general insurance," particularly in light of the reforms following the Wallis Inquiry.
Justice Owen found that
"There was no evidence that APRA contributed to, or could have acted to prevent, the collapse of HIH. However, APRA missed a number of warning signs that HIH was heading towards statutory and commercial insolvency."
As such, he investigated the appropriateness of APRA's supervision of HIH in light of those missed warning signs. He found systemic weaknesses in APRA's administration of the regulatory system, particularly as a result of a lack of resources and APRA's failure to address issues of staffing and loss of specialist knowledge following the restructuring brought about by the Wallis Inquiry. Crucially, Justice Owen found that APRA's board and executive management were not properly briefed on this lack of resources, nor on isolated concerns which had arisen regarding HIH's strength. Further, APRA took a narrow view of its own powers and functions, and a "light touch" approach to regulation which (incorrectly in the case of HIH) assumed that the entities it was regulating were prudently and professionally managed.
Importantly, his recommendations did not call for closer supervision of APRA itself. Generally, they related to resourcing and internal decision-making processes. However, he made two key recommendations which are particularly relevant to this paper. Firstly, he recommended that the non-executive board be replaced by a panel of executive commissioners to provide more clarity in lines of accountability and reduce the risk that information would not pass to the Authority's most senior levels. Secondly, he questioned whether APRA should continue to be subject to directions from the Treasurer and judicial and merits review of its decisions relating to prudential matters. Reference to the Treasurer or to independent review tribunals could, Justice Owen found, frustrate APRA's decision-making processes and reduce its capacity to take decisive action against a regulated entity, as it would allow protracted appeals. It is submitted that, in making this finding, he recognised the utility of less, rather than more, direct oversight of the regulators, particularly when combined with better internal processes. Although Justice Owen did not accept APRA's submission that being subject to external review promoted excessive caution on the part of decision-makers, that argument is consistent with his criticism that it took a reactive, rather than proactive approach to regulation. It is telling that, if anything, the most thorough review of corporate and regulatory failure since the Wallis Inquiry's reforms identified a need for less, rather than more, oversight of the principal regulator.
An alternative model - regulating outsourced regulators?
As noted above, the Wallis Inquiry rejected the idea of creating an additional supervisory body to oversee financial regulators. It also recommended against the establishment of a single financial "mega-regulator" which might become too powerful or unwieldy to perform its functions efficiently. The benefit of multiple regulators may also be manifested in the competitive tension between them. While ASIC, the RBA and APRA have separate roles which overlap only at the margin, their separation may help to promote innovation. It may one day be possible to take this a stage further, for example by requiring banks or insurers to register with, and be supervised by, a privatised prudential supervision agency. This would create a need for government oversight of those private agencies, but such oversight could take the form of a review, audit and policy-making function. This separation of day-to-day regulation from policy and review oversight could result in the creation of a dedicated regulator of regulators in a competitive, market-based regulatory system.
The auditing profession provides a possible model for such functions. Auditors are essential for ensuring confidence in the accounts of public companies; they operate under statute and enjoy a degree of statutory protection, and play a large part in upholding corporate governance standards. However, they are part of the private sector and operate in a competitive marketplace. While there have been high profile examples of auditing failures, the system generally functions efficiently. Indeed, it is arguable that prudential supervision is already outsourced to the private sector to some extent through the power of and reliance on private rating agencies. The rating assigned to a debt issuer by an agency such as Standard & Poor's is more precise and gives greater comfort to the market than the knowledge that the relevant issuer is supervised by APRA. In fact, Standard & Poor's placed HIH on credit downgrade long before APRA expressed concerns about its financial strength.
Outsourcing along these lines would require statutory support and some degree of government supervision. However, it has proved effective in areas such as auditing and regulation of securities exchanges, where the relevant exchange has the statutory power to develop and enforce its own listing rules, subject to the overall supervision of a corporate regulator. While the current regulatory structure in Australia appears sound, a future review of financial regulation should consider such a model.
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