Regulatory theories and their application to ASIC
The previous chapter outlined ASIC's extensive functions. However, all regulators
face a multitude of challenges. They can be tasked with a long list of
responsibilities that involve an enormous regulated population and a staggering
amount of activity. The expectations about what the regulator is supposed to
achieve may not be clear or they may not match the community's expectations. They
may have a role as an arbitrator that works with entities to seek efficient
outcomes, while also being required to investigate and prosecute entities for
contraventions of the law. They can be criticised for being inflexible and burdening
business when times are good, and criticised for not having acted when a crisis
Regulators need to make decisions about how to use their limited
to address conflicting priorities. Many regulated entities will have
significantly greater resources at their disposal than those available to the
regulator. For many reasons a regulator may consider that it does not have all
the powers necessary for it to perform its role, or that its powers have not
kept pace with emerging developments. Many of the good outcomes they achieve
are not made public or are not newsworthy. They can be criticised for losing
cases while also being criticised for not pursuing certain matters.
Various theories of regulation consider the challenges that regulators in
general face and propose techniques that regulators can adopt to carry out their
functions. This chapter introduces and examines some of the sets of principles
on which regulation can be based, such as response regulation and risk-based
The theories discussed are not mutually exclusive options; elements of each may
be relied on by policymakers or by ASIC. Specific regulatory ideas that are
relevant to the financial services sector are outlined at the end of the
Fundamentals of regulation
Regulation is generally considered in response to a market failure. The
1997 review of the financial system chaired by Mr Stan Wallis (the Wallis
Inquiry) observed that regulation can be categorised into the following three
broad purposes. These purposes, in order of decreasing frequency, are to:
ensure that markets work efficiently and competitively—such
regulation would promote adequate disclosure and target fraud, unfair practices
and anti‑competitive behaviour;
prescribe particular standards or service quality, such as food
achieve social objectives, such as community service obligations.
The development and implementation of regulation that achieves its
stated aims is a difficult challenge and one that is not limited to corporate
or financial regulation. Professor Julia Black, a researcher at the London
School of Economics who has written extensively on regulatory regimes,
concluded that 'paradoxes abound' in regulation, with policymakers and
regulators often achieving the opposite outcome to that intended:
This is so regardless of the regulatory techniques adopted.
For example regulation to reduce risks can inadvertently lead to greater risks,
for example safety regulation can create moral hazard, increasing risk-taking
activity. Clean-ups can lead to greater environmental harm. Regulation to
enhance disclosure can inhibit it. Warnings or bans on activities can produce
the very conditions that they are designed to prevent: warnings about dangerous
sports can make them more attractive to risk‑seekers; conversely warnings
that a particular bank is likely to fail can create a run on the bank, so
precipitating its failure.
Policymakers and regulators also have to consider the likely response of
the regulated entities to any regulation imposed and the regulator that
In this regard, a 2007 consultation paper on sanctions for breaches of
corporate law identified two alternative views on the starting point of a
the 'deterrence' model and the 'accommodative' model. These models reflect the opposite
ways in which the behaviour of individuals and corporations can be considered. Proponents
of the deterrence model argue that individuals and corporations are motivated
entirely by profit-seeking and will comply with rules only when confronted with
suitably severe penalties. The accommodative model takes the view that the
entities are 'ordinarily inclined to comply with the law, partly because of
belief in the rule of law, and partly as a matter of long-term self-interest',
and that as a result regulatory compliance is more likely to be achieved
through persuasion and cooperation.
However, the consultation paper observed that a regulatory system based solely
on the deterrence or accommodative model 'is not desirable', as major
disadvantages arise if one model is adopted exclusively:
It has been shown that a predominantly punitive policy
fosters resistance to regulation and may produce a culture that facilitates the
sharing of knowledge about methods of legal resistance and counter attack. It
has been suggested that laws that promote a 'tick the box' approach to
compliance may have the effect of weakening the ethical sinews of society by
absolving participants of any responsibility for choosing to act in a manner
that is right. An unintended consequence of a regulatory system designed to
ensure that people cannot choose to do what is wrong is that they can no longer
choose to do what is right. They no longer choose at all, they merely comply.
Another concern is that if regulators adopt a purely punitive method of
regulating, whereby they assume that individuals are solely self‑interested
and motivated by financial gain, this may be perceived as unreasonable and will
dissipate the will of well-intentioned individuals to comply. In addition to
the negative psychological effect of an undue focus on deterrence, punishment
is often time consuming and expensive.
Adopting a purely accommodative model of regulation, which
assumes all individuals are honest, would be naïve. This regulatory style fails
to recognise that there are individuals who may not be honest and who will take
advantage of being presumed to be so. There are a number of recent examples of
conduct by corporate actors in Australia that confirm that some people will
intentionally breach rules to secure an economic benefit.
When considering regulation, it is clear that there is also a choice
about the type of rules to enact. For example, regulation can be drafted
starting from either
a rules‑based or a principles-based approach. Rules-based regulation is
generally characterised by specific provisions and detailed rules, whereas
principles-based regulation 'involves formulating rules which are broad,
general and purposive and which may or may not be elaborated in further rules
or guidance, for example, "you shall act with integrity" or
"firms shall act in the best interests of their clients"'.
In his evidence to the committee, Professor Justin O'Brien explained
that the United States of America (US) has predominately taken a rules-based
approach to financial regulation, while the United Kingdom (UK) has adopted a
principles-based style. However, the choice between rules-based and
principles-based regulation is generally not one at the expense of the other;
for example, Professor Black noted that despite the UK's financial services
regulations being designed using a principles-based approach, the rulebook of
its regulator still comprises several thousand pages.
Both rules-based and principles-based approaches also present challenges
to the regulator. A rules-based approach can result in the rules being
In addition, the managing director of the UK's Financial Conduct Authority has
observed that historically, systems based on whether particular sets of rules
were followed to the letter can create 'a cottage industry out of compliance'
but 'did not necessary lead to good outcomes'.
A principles-based approach also presents challenges:
The problems with the principles based approach is sometimes
they lack the granularity to be enforceable and as [Hector Sants at the
Financial Services Authority] put it very succinctly, he firmly believed in the
value of principles based regulation but it does not work with people with no
One regulatory theory that has contributed to corporate law in Australia
is 'responsive regulation' (also known as 'strategic regulation theory').
This approach to regulation influenced the introduction in 1993 of the civil penalty
regime for contraventions of the statutory duties of company directors and
other officers. The theory was articulated and expanded on by Ian Ayres and John Braithwaite.
Responsive regulation 'recognises that it is not possible for any regulatory
to detect and enforce every contravention of the law it administers and
provides insights into how regulatory compliance can be achieved effectively'.
It is essentially a convergence of the 'deterrence' and 'accommodative' models
of regulation; responsive regulation focuses not on 'whether to punish or
persuade, but when to punish and when to persuade'.
As Aakash Desai and Ian Ramsay note, to achieve maximum regulatory
compliance the theory promotes 'responsive' or 'strategic' supervision by
regulators. Methods for promoting voluntary compliance, such as persuasion and
education, are made more effective as a result of the credible sanctions of
escalating severity available to the regulator that it can threaten to utilise
or pursue. This structure of sanctions is generally referred to as the
'enforcement pyramid' or 'compliance pyramid'; the shape is intended to reflect
the theoretical less frequent use of the most severe sanctions, which form the
apex of the pyramid, compared to the persuasion-focused methods of resolution
that form the pyramid's base.
Responsiveness can also be defined as 'the ability of a regulator to
respond purposively and effectively to the particular context of regulation,
and persuade the regulated firm to do so too'.
To achieve this, the theory of responsive regulation requires that a combination
of punishment and persuasion exists that is premised on 'minimal sufficiency'
and the projection of 'regulatory invincibility'. Professor Dimity Kingsford
Smith explains these two principles and how they operate according to
responsive regulation theory:
[Minimal sufficiency] involves signalling to the organization
that the regulator will use the least intrusive strategy first (such as asking
for a defect to be fixed), and only escalate to more formal enforcement if
minimally sufficient strategies do not work. At the same time, in order to make
the threat of escalation credible, the regulator has to keep in the background
the threat of serious enforcement action: prosecution, civil penalty sanctions,
and license cancellation. Clearly it is easiest to convey an intention to
intervene minimally if the regulator has powers and resources to do so—inspection
is an ideal setting for this. Clearly too, it is easiest to project invincibility
and to keep the threat in the background if the regulator has powers and
resources for enforcement, and enjoys formal enforcement successes. It is in
signalling its intention to move between these poles that the regulator shapes
a responsive regulatory relationship.
The sanctions made available to ASIC in legislation, and the enforcement
policy developed and published by ASIC, reflect many aspects of responsive
ASIC's enforcement pyramid includes: punitive action (prison sentences,
criminal or civil monetary penalties), protective action (such as disqualifying
orders), preservative action (such as court injunctions), corrective action
(such as corrective advertising), compensation action and negotiated resolution
(such as an enforceable undertaking). ASIC can also issue infringement notices
for certain alleged contraventions, however, in the event that the recipient
elects not to pay, this would likely need to be followed by court proceedings
seeking a civil penalty. The application of the enforcement pyramid to ASIC is discussed in Chapter 17.
While the responsive regulation model highlights the need to resort to
severe punishments in some circumstances, in the context of Australia's
corporate law it has been argued that this 'must be balanced against the
potential for severe penalties to have a "freezing effect" on
responsible risk taking and commercial decision making'.
A regulatory structure based on strategic regulation theory may be
complemented by a 'risk‑based' regulatory approach. Recognising that not
all contraventions can be detected and addressed, risk-based regulation seeks
to inform the decisions that a regulator takes when determining its priorities
and allocating its resources. According to risk-based regulation, a regulator would
deploy its inspection and enforcement resources in accordance with an
assessment of the potential risk that particular regulated entities or
individuals pose to the regulator's aims.
Julia Black and Robert Baldwin explain that risk-based regulatory frameworks
'focus on risks not rules', as regulators 'are usually overburdened by rules' and
cannot enforce every rule at all times. A risk‑based framework acknowledges
the selections about enforcement that regulators have always implicitly made
and provides a framework of analysis for making those selections.
After examining various government regulators across jurisdictions,
including financial services regulators, Baldwin and Black consider that the
frameworks adopted have the following five core elements in common:
First, they require a determination by the organization of
its objectives—of the risks 'to what' that it is concerned to control.
Secondly, they require a determination of the regulator's own risk appetite—what
type of risks is it prepared to tolerate and at what level...Thirdly, risk-based
frameworks involve an assessment of the hazard or adverse event and the
likelihood of it occurring...Fourthly, regulators assign scores and/or ranks to
firms or activities on the basis of these assessments...Fifthly, risk-based
frameworks provide a means of linking the organization and supervisory,
inspection, and often enforcement resources to the risk scores assigned to
individual firms or system-wide issues.
However, Baldwin and Black have also identified that risk-based
approaches can present certain challenges, as they may result in an inclination
for regulators to:
focus on known risks, resulting in new or developing risks going
undetected (a related issue is that risk-based approaches 'tend to be backward
looking and "locked in" to an established analytic framework');
neglect areas determined to be of lower risk, which may
ultimately result in considerable damage; and
focus on individual firms rather than on how compliance across
regulated entities can be improved.
Formalising the role of non-state bodies: strategies of co‑regulation
The possible regulatory strategies available to policymakers and
regulators can be considered as a spectrum. At one end, representing the form
of regulation with the most involvement by the government, is command-and-control
regulation. At the other end of the spectrum is no regulation (or
self-regulation if no regulation was considered to be an unviable option).
Where the state and regulated entities start
to interact more closely is when strategies such as co-regulation are
considered. Under a co-regulation strategy, the regulated entities develop and
administer the regulatory arrangements, which are underpinned by legislation
set by the government.
Another theory of regulation that has some application to ASIC's work is
a strategy based on enrolment. This approach relies on others who are
to support the regulator. These entities are 'gatekeepers', described by Julia
Black as those who are 'not directly the subject of regulation, but who have a
strategic position over those who are'.
In Australia's financial system, directors, company officers, auditors and
insolvency practitioners are some examples of gatekeepers. These groups have
professional bodies that can promote better practices through standards,
education, training and advocacy. The standards or rules adopted by these other
bodies can also be enrolled by regulators or policymakers.
ASIC frequently highlights the important role that gatekeepers perform.
A strategy based on enrolment can encounter problems. Julia Black argued
that gatekeepers were not necessarily reliable and may not perform the role that
In its examination of the collapse of Trio Capital, the Parliamentary Joint
Committee on Corporations and Financial Services (PJCCFS) also highlighted expectations
gaps between the role of gatekeepers and investors' expectations of that role.
The PJCCFS formed the view that the current system of gatekeepers did not work
in relation to Trio Capital and that '[t]here is no reason to believe that this
system will be any more successful in detecting fraud in the future'.
Julia Black concluded that enrolment is a 'potentially useful' strategy of
...whether the strategy is successful depends on the
motivation, regulatory capacity, and most importantly, the broader market
context, culture and incentives of those being relied upon to act as gatekeepers.
Unless these are aligned with the goals of the regulatory regime, regulators
will find that their reliance is dangerously misplaced.
Effectiveness of the regulatory regime and ASIC's regulatory approach
Responsive regulation and risk-based approaches to regulation have
influenced the development of Australia's corporations law and the approach
taken by ASIC. The following paragraphs outline general observations about the
extent it is considered that these theories apply to ASIC. Issues considered by
regulatory theory have been contemplated when particular aspects of ASIC's work
were examined in detail, however, to avoid repetition the discussion of
regulatory theory is generally confined to this chapter.
ASIC's responsiveness and ability
to conduct surveillance
Professor Dimity Kingsford Smith has described ASIC's after‑the‑loss
approach to enforcement as: 'waiting for complaints, investigating a minute
proportion of them, and prosecuting even fewer'.
Dr Vicky Comino has suggested that 'ASIC has generally behaved in a reactive
rather than a proactive fashion' and that the 'discovery of corporate breaches
is often almost accidental'.
A former enforcement adviser at ASIC agreed that regulation cannot eliminate
all misconduct, but argued ASIC could still be more vigilant at after-the-loss
enforcement. Transnational crime was an issue he particularly highlighted:
Things happen, but that does not mean that you put hands in
the air and not chase people overseas. If people steal from mums and dads in
Australia, we should pursue those individuals to the end of the earth and tell
them, and the world, that if you come here you cannot steal from our mums and
dads, who have worked hard all their lives.
In September 2012, ASIC published figures on the number of staff
allocated to each of its stakeholder teams, the number of regulated entities
they oversee and, for the first time, the number of years it would
theoretically take to conduct surveillance on every entity. An updated set of
these figures is reproduced in Table 4.1.
Table 4.1: ASIC’s surveillance
coverage of regulated populations in 2012–13
Key industry statistics and ASIC's surveillance
AFS licensees authorised to provide personal advice:
- Top 20—0.8 years on average
- Next 30—1.8 years on average
- Remaining 3,344—primarily reactive surveillances
AFS licensees authorised to provide general advice—reactive surveillances
ASIC-approved external dispute resolution schemes—every year
investment banks—once a year
hedge fund investment managers/REs—11.3 years on average
retail OTC derivative providers—every year
credit rating agencies—every year
Investment managers and
483 active responsible
- Top 25—70% of funds under management—every two years
- Nine identified as most at risk of noncompliance—every
- 91 responsible entities in sectors where risks have
been identified or where ASIC has concerns—varies from year to year
- Remaining 358—primarily reactive surveillances
200 super fund trustees
- Five identified as most at risk of noncompliance—every
- Remaining 195—primarily reactive surveillances
20 major custodians—2.9 years
Deposit-takers, credit and
deposit-taking institutions (ADIs)
- Big four ADIs—every year
- Remaining 169—13 years on average
141 insurers—seven years
641 licensed non-cash
payment facility providers—primarily reactive surveillances
13 trustee companies—seven
years on average
5,688 non-ADI credit
licensees (lenders and intermediaries) with 28,201 credit representatives—37
years on average
emerging mining and resources companies)
21,690 public companies,
including 1,983 listed entities (excludes foreign companies)
- All control transactions for listed entities
- A significant proportion of prospectuses
- A small sample of entities in areas of emerging
- Remaining entities—reactive surveillances only
Financial reporting and audit
86 audit firms:
- the big four audit 95% of listed entities by market capitalisation—1.5 years
- the next eight audit 4% of listed entities by market
capitalisation—2.5 years on average
- the remaining 74 audit 1% of listed entities by market
capitalisation—10.3 years on average
Financial reports of
1,983 listed entities (excludes foreign companies) and 26,000 unlisted
- top 500 listed entities – three years on average
- remaining 1,500 listed entities (excludes foreign
companies)—12 years on average
- 300 unlisted entities with larger numbers of users—90
years on average supplemented by reactive surveillances
685 registered liquidators—3.6
years on average
Financial market infrastructure
18 authorised financial
Six licensed clearing and
settlement facilities—every year
Market and participant supervision
Monitoring of the ASX, Chi-X,
NSX and ASX24 markets—every day
136 market participants—3.3
years on average
800 securities dealers:
- 100 larger entities (clients and volumes)—four years
- 700 smaller entities—reactive surveillances and
targeted reviews of high risk entities
Source: ASIC, Annual
Report 2012–13, pp. 16–17.
Notes: The figures on ASIC's
surveillance coverage indicate the number of years it would theoretically take
to cover the entire regulated population through high intensity surveillances,
based on the number of surveillances ASIC conducted in the 2012–13 financial
year. ASIC noted that, in practice, its risk-based approach to surveillance
means that 'some portion of the population would be touched multiple times
while others would not be touched at all'. Figures on staff numbers are on a
full-time equivalent basis.
The figures on the number of years it would theoretically take ASIC
to conduct high intensity surveillance on the entire regulated population indicate
that relationships between the regulator and many regulated entities could be
underdeveloped. When its surveillance coverage figures were first released,
the chairman of ASIC, Mr Greg Medcraft, outlined how the level of surveillance
depends on ASIC's resources. In particular, with the resources it has, ASIC
undertakes a risk‑based approach to surveillance that relies on financial
I guess the warning we have to Australians is frankly what we
have is a system that is based on self-execution and relies on people to do the
right thing. It is so important—I will not emphasise this more—that it is up to
the gatekeepers to do the right thing. The amount of surveillance we do is
based on the resources we have. We try and do risk based surveillance, so we
target the largest licensees, and for those where we have complaints we go
reactive. But in terms of proactive surveillance with the resources we have,
...It is really important that this surveillance coverage that we have released
publicly for the first time is explaining to Australians that ASIC is not a
prudential regulator, not a conduct and surveillance regulator...We are not
resourced to be looking at everybody, and that is a very important message.
That is why education is really important. Australians are proactive in getting
educated and understanding what they should be doing.
In a 2011 journal article that responded to the 2009–10 surveillance statistics,
Professor Kingsford Smith observed that the figures reveal 'in very brutal
terms of resources and enforcement policy, there is at present no realistic
prospect of developing anything approaching a regular surveillance or
inspection program'. Although alternative responsive strategies could be
considered, 'as things stand it is difficult to see how there could be
sufficient contact between the financial services firms and the regulators for
responsive regulation to be a success at the low end of the regulatory
With the aim of suggesting ways that financial regulation could be encouraged
to be more relational which, in her view, would result in more effective
regulation, Professor Kingsford Smith questioned the current application of responsive
regulation theory to financial markets. She argued that responsive regulation
has been successful 'in regulatory contexts where physical inspection of
workplaces, mines, nursing homes, and so on is undertaken', but it has been
less successful in environments, such as the financial services sector, that
...large populations of regulatees and insufficient resources
for visits, inspections, or other regular checks, and where detection of
non-compliance is difficult. Here the regulatory circumstances do not provide
the bridge for contact between the regulator and the firm, which allows a
relationship to develop which can support responsive action.
Despite this, Professor Kingsford Smith maintained that inspections in
the financial sector could still be an effective regulatory technique as they
'remind the regulated entity that the regulator is paying attention to what
they do, or fail to do':
It provides a location for practical, responsive remedial
action. In a situation where inspection is not a possibility but where the
regulator has noticed a trend in a particular type of infringement, a letter to
all the regulated actors doing the same type of business, pointing out the
trend and asking for details of their compliance, alerts the regulated to the
fact the regulator is watching. It projects, even at the lower end, an
appearance of capacity in detection that may be greater than the reality.
Depending upon the responses received and reviewed, further action in the
regulatory relationship could be pursued: slating some firms for surveillance,
reviewing relevant firm disclosure documents, or checking the firm's complaints
ASIC's ability to change behaviour
An element of effective regulation is how the regulatory environment and
the regulator's actions and reputation influence the behaviour of regulated
The chief executive officer of CPA Australia, Mr Alex Malley, questioned whether
ASIC has exhibited the culture it needs to act in the public interest and
argued that ASIC had failed to show appropriate leadership.
According to Mr Malley:
Leadership can be benchmarked against principles of
proactivity, capacity to positively influence and ability to take stakeholders
and the community along a journey. Over a long period of observation, with many
considered public statements made by us, it is our informed view that ASIC has
failed to exhibit these characteristics. In fact it displays the opposite. It
is reactive, it is defensive, it is contradictory and it is insecure in its own
ability to provide solutions.
Some witnesses were asked whether ASIC should 'became an agency of fear',
where significant punishments would be promptly imposed when particular
contraventions occurred. In his response, Mr Malley expressed support for the
overall enforcement pyramid approach of escalating penalties and sanctions,
although he reiterated that there was greater scope for ASIC to show leadership
and influence behaviour within this framework:
...I think what people should understand is that there is a
process that allows them to perform within a marketplace and have the comfort
that the regulator is willing to work with them to improve the way things work.
I think it has to have a very, very severe punishment mechanism, but it also
should be not the starting point of the dialogue of the regulator of the
market. There should be a very clear message that, should one go past a point,
there is no doubt that there will be a significant punishment. So I believe in
that but, from all of my business experience, the only way to lead any
organisation, whether it be a regulator, a government or a business, is to lead
by positive influence and by seeking to have the very best outcomes and
Mr Lee White, the chief executive officer of the Institute of Chartered
Accountants Australia (ICAA), expressed a similar view. Mr White stated that:
...the best regulatory outcomes are achieved through effective
communication and the ability to persuade...The second elements is that we need
to be very careful around culture. If the culture gets too dominated by, 'We
have all these powers and can exercise them when rightfully so,' it is very
hard to turn off the mindset that I can now collaborate or work with the
people. It becomes such a dominant force in how people are approached.
Many academics recognise that the ethical culture and perception of risk
within corporations are key factors in regulatory compliance, with the effective
enforcement of corporate law beginning within the corporation itself.
Dr Comino points to HIH Insurance and the action taken by the Australian
Competition and Consumer Commission (ACCC) against Visy as examples where the
culture inside organisations can be unreceptive to compliance.
Professor Kingsford Smith has suggested that ASIC cannot act effectively as 'a
benign big gun' and, therefore,
it cannot simultaneously project power and use 'minimal sufficiency' techniques
as suggested by responsive regulation. To support her argument, Professor Kingsford
Smith noted that while ASIC's powers are great on paper 'it has a track
record of prosecuting small, rather than large, firms'.
Professor Kingsford Smith also argued that while the reputation of financial
services regulators generally, including ASIC, have suffered as a result of the
global financial crisis, ASIC has 'contributed to its own lowered regard':
...by using its enforcement powers in a series of high profile
cases which it has lost resoundingly, and at very great public expense. So in
implementation of its high-level enforcement powers, ASIC has had mixed
success, and this diminishes its ability to project itself as invincible.
CPA Australia also argued that perceptions about ASIC's effectiveness impact
its ability to regulate:
Being regular front-page news on questions of your
performance rather than your outcome leaves ASIC in a difficult position to
influence better behaviours of others. No-one wins in this circumstance.
Others consider there are wide-spread and established 'dysfunctional
elements in Australian business culture' that ASIC is unable to counter because
of its structure and culture:
ASIC, as with its institutional predecessors, was born with a
regulatory emphasis on enhancing disclosure and transparency in the financial
marketplace, and has acquired a dominant culture that underpins that emphasis.
ASIC has yet to acquire a culture commensurate with the cowboy frontier
environment that it is expected to regulate.
How regulated entities respond to enquiries from or action taken by the
regulator is also significant. The potential for ASIC to have an adversarial
relationship with regulated entities is readily apparent. For example, Baldwin
and Black, in describing the theory of 'really responsive risk‑based
provided the following observation about risk-based regulators relationship
with the entities they regulate:
[Risk-based] regulators need considerable information from
firms to sustain their oversight. They may, however, have to use formal
enforcement actions, such as fines, to change the behaviour of many firms. In
such circumstances, responding to noncompliance with a deterrence approach may
cut across the ability to detect that noncompliance in the first place. Firms
know that any information they give to the regulator may potentially be used
against them in an enforcement action, and this can have a chilling effect on
their cooperation with that regulator. A good, albeit anecdotal, example is the
contrast in enforcement approaches of the two Australian financial regulators,
APRA and [ASIC]...APRA has a model of intensive supervision for its
high-risk financial institutions, but this does not involve using formal
enforcement actions. ASIC, on the other hand, has moved to a much more
deterrence-based approach. The consequence for their respective monitoring
functions was noted recently by an Australian lawyer, who quipped, "When
APRA asks for information, firms give it to them; when ASIC asks, they call
their lawyers" (Note on file with author).
Reflection and self-assessment by
A further element of really responsive risk-based regulation is whether
the regulator assesses their successes and failures and then modifies their
It is considered that:
Really responsive risk-based regulators will be performance
sensitive: they will be capable of measuring whether the enforcement tools and
strategies in current use are proving successful in achieving desired
objectives. Such regulators will also operate systems that allow them to
justify their performance to the public and other interested parties. They will
also be able to adjust their strategies in order to improve on the levels of
performance that they have assessed.
ASIC's actions in response to the misconduct within CFPL, a key reason
for the referral of this inquiry, are examined in detail in Chapters 8 to 11.
at this point it is useful to note that during Senate Estimates in June 2013 ASIC
focused on the outcome achieved in the CFPL matter, which the deputy chairman
eagerly outlined. ASIC was less forthright when asked about the investigation
and the whistleblower.
ASIC's first submission to this inquiry was more reflective and acknowledged
inadequate aspects of how it handled the investigation.
ASIC also advised that it has considered all of the submissions received by the
committee 'in an effort to learn as much as we can from them and also to enable
ASIC to do a better job'.
ASIC's main submission also outlined the actions it has taken to improve how it
deals with whistleblowers.
The philosophy underpinning
Australia's financial services regulation regime
The final section of this chapter focuses on one specific and
high-profile aspect of ASIC's work: its role as a financial services regulator.
The bulk of submissions received by the committee relate to this function. This
section provides some background information on the principles that have guided
policymakers to date, such as those outlined by the 1997 Wallis Inquiry.
However, it should be noted that the latest review of the financial system that
is currently underway, the Financial System Inquiry chaired by Mr David Murray
AO, has been tasked with refreshing the philosophy that underpins Australia's
Efficient markets theory
The current approach to regulating Australia's financial services
industry largely stems from the 1981 report of the Committee of Inquiry into
the Australian Financial System (the Campbell Inquiry) and the Wallis Inquiry
of 1997. Both of these inquiries were guided by 'efficient markets theory',
that is, a belief that 'markets operate most efficiently when there is a
minimum of regulatory intervention'. The Wallis Inquiry maintained the fundamental view that investors have the
responsibility to make good decisions.
It also observed that 'all markets, financial and non‑financial, face
potential problems associated with the conduct of market participants,
anti-competitive behaviour and incomplete information'.
Nevertheless, the Wallis Inquiry concluded that although the objectives of
conduct and disclosure regulation in the financial system are similar to those
that apply to non‑financial markets, specialised regulation for the
financial services sector is necessary:
...to ensure that market participants act with integrity and
that consumers are protected. The financial system warrants specialised
regulation due to the complexity of financial products, the adverse
consequences of breaching financial promises and the need for low-cost means to
On consumer protection, the Wallis Inquiry observed that information
asymmetry can arise between consumers and providers of financial products as
'consumers lack (and cannot efficiently obtain) the knowledge, experience or
judgment required to make informed decisions...a situation where further
disclosure, no matter how high quality or comprehensive, cannot overcome market
Others have noted that there is 'also a view that consumers need protection
from themselves, due to their vulnerability to making poor financial decisions,
their susceptibility to certain sales messages when framed in a particular way,
and their underestimation of their own lack of financial understanding'.
The Wallis Inquiry also distinguished between investments and the
consumption of other goods and services. It argued that as investments are not
based on consumption but rather the sharing of risk (and the reward for bearing
that risk), there should be an appropriate balance between investor protection
and market efficiency.
Although the Wallis Inquiry envisaged a role for regulation in the financial
system beyond that applied to markets generally, as the financial system
fundamentally engages in risk it did not support the elimination of risk by
If regulation is pursued to the point of ensuring that
promises are kept under all circumstances, the burden of honour is effectively
shifted from the promisor to the regulator. All promisors would become equally
risky (or risk free) in the eyes of the investing public. Regulation at this
intensity removes the natural spectrum of risk that is fundamental to financial
markets. If it were extended widely, the community would be collectively
underwriting all financial risks through the tax system, and markets would
cease to work efficiently...Primary responsibility should remain with those who
make financial promises. It would be inequitable for the government to
underwrite some financial promises but not other promises made by participants
in the broader economy.
ASIC noted that this philosophy is not only reflected in Australia's
financial system, but applies to financial regulators in foreign jurisdictions
...the settings established by the parliament for our financial
system are such that no financial regulator can prevent all risk of losses from
occurring. Our system is designed this way because removing the risk of loss
would substantially reduce economic growth, individual choice and return to
investors. Preventing all risk of loss from poor products, misconduct or
criminal activity would involve highly expensive and intrusive regulatory
intervention. For financial regulators like us—[securities] regulators around
the world—the systems are similarly designed to ours. While the risk of loss
can never be entirely removed from the financial markets, we work hard to
enforce the law and to deal with misconduct that puts investors at risk. We
also work hard to help consumers and investors make appropriate choices in
their dealing with financial services providers.
Developments since the Wallis
Seventeen years have passed since the Wallis Inquiry finalised its
As this chapter has noted, a new Financial System Inquiry is currently underway
which has been tasked with refreshing the philosophy that underpins Australia's
financial system. However, in considering ASIC's performance, it is useful to
note some of the developments since 1997 that have led to some of the
assumptions that informed the Wallis Inquiry being questioned or departed from.
The growth in superannuation
Australians are increasingly becoming involved in the financial markets
a result of the superannuation system which, because of its compulsory nature,
is considered to be 'the most significant exception' to efficient markets
theory in Australia's financial system.
This exposure has been reinforced by the increase in the superannuation
guarantee over the past two decades and the significant increase in the number
of SMSFs. More recent government inquiries and reforms to superannuation have
diverged from certain principles expressed in the Wallis Inquiry report.
The global financial crisis
4.43 The global financial crisis that began in 2007 and intensified as a
result of numerous events in 2008 has, in particular, caused some of the
assumptions about how financial markets function to be questioned. For example,
in 2009 the then ASIC chairman Mr Tony D'Aloisio noted that efficient markets
theory emphasises the importance of disclosure. It also assumes that investors
(both retail and institutional) have 'the tools to understand what disclosure
means'. To illustrate how the global financial crisis revealed that this was
not always the case, Mr D'Aloisio noted that at the institutional level there
was widespread disclosure on credit default swaps and collateralised debt
obligations, however, 'that disclosure did not translate into an understanding
of the risks associated with those products'.
In her submission, Professor Kingsford Smith argued that there should be some
thought given to how the variety of different investors are treated. As an
example, she noted the complex products offered to local councils as sophisticated
investors, when in reality they were 'very unfamiliar with the products being
Various other informed observers have also commented on regulatory issues that
the crisis revealed.
In its main submission to this inquiry, ASIC noted that since the global
financial crisis, regulators internationally 'are looking for a broader toolkit
to address market problems, moving beyond traditional conduct and disclosure
to design regulatory interventions that address the types of problems investors
and financial consumers often experience in financial markets'. ASIC noted the
recent restructure of financial services regulators in the UK, and in
particular the new temporary product intervention powers given to the Financial
Implications of the current financial
services regulatory system for ASIC
The promotion of market integrity and consumer protection is generally
undertaken through conduct and disclosure regulation, although certain reforms
enacted in the past five years, such as the national credit regime (which will
be examined in the following chapters) have diverged from this approach.
This has clear implications for the role of ASIC. In its main submission, ASIC
presented the following argument:
Consistent with the underlying philosophy of the financial services
regulatory regime, ASIC's role is not to control the types of products that are
available in financial markets, to prevent investments from failing, or to
place checks on investors' investment decisions.
We understand that, where investors suffer losses, a natural
tendency is to question why this has happened, and ask why ASIC has not
prevented the losses from occurring. Nevertheless, ASIC's performance should be
assessed in terms of how we fulfil our role in the financial services
regulatory system, and not against the benchmark of whether we have been able
to prevent all losses suffered by investors
...ASIC can, and does, try to minimise the risk of losses
occurring. We try to help investors and financial consumers to use financial
markets successfully through our work on financial literacy. We set standards
for the conduct of industry participants by enforcing compliance with the law.
We focus on preventing losses arising out of bad advice, addressing conflicts
of interest that could lead to poor outcomes for investors, and detecting and
addressing instances of outright fraud and other misconduct.
The case studies on lending practices and financial advice contained in
the following chapters of this report highlight the real implications that the
regulatory framework can have for consumers. The committee uses these case
studies to start its examination of how ASIC has fulfilled its role in the
financial services regulatory system. The committee assesses ASIC's performance
against its own stated objectives: of trying to minimise the risk of loss
occurring; of helping consumers to use financial markets successfully through
improved financial literacy; and by setting and enforcing industry standards.
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