The Senate Economic Legislation Committee reviewed a tranche of bills as part of the Government's implementation of the recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Hayne Royal Commission). The main issue for consideration was the legislation establishing a Compensation Scheme of Last Resort (CLSR).
It is vital that we act to restore trust in the financial services sector while maintaining Australia's status as a competitive market economy.
These additional comments address two of the bills which were considered in the report; the Financial Services Compensation Scheme of Last Resort Levy Bill 2021 [Provisions]; and the Financial Services Compensation Scheme of Last Resort Levy (Collection) Bill 2021 [Provisions].
In providing these comments, it is important to stress the two competing interests which are accommodated in the design of the CSLR.
Hayne Royal Commission
The bills implement recommendation 7.1 of the Hayne Royal Commission. In the Final Report, it was noted that some financial services providers are required to pay compensation where certain specific losses occur.
As was highlighted in the Ramsay Review, not all providers were meeting these obligations, and thus losses were passed on to affected consumers. It was submitted that these losses were concentrated in the financial advice sector.
The Hayne Royal Commission reaffirmed the recommendations of the Ramsay Review, and made the following recommendations for the design of the scheme:
The CSLR should be limited to 'areas of the financial sector where there is clear evidence of recurrent problems with uncompensated losses'.
A CSLR should 'initially be restricted to financial advice failures'.
A CSLR should be subject to strict caps on the amount claimable, time limitations, and only accessible where specific procedural circumstances require it.
The guardrails which were proposed by the Hayne Report have been incorporated into the bills considered by this committee. These guardrails are intended to contain the risk of moral hazard created by the establishment of the CSLR. They should be protected and maintained in order to prevent members of the scheme, and ultimately consumers and businesses, from underwriting misconduct by irresponsible providers.
The CSLR is designed to provide a safety net for consumers where losses cannot otherwise be compensated for. It should not be designed or tinkered with beyond this purpose. To do so would shield financial service providers from their obligations to their customers. Moreover, as the committee report notes, it would also expose consumers to significant risks related to the overall stability of the financial sector.
The Risk of Moral Hazard
'Moral hazard' occurs where an actor can offload the costs of their decisions. Actors are subject to perverse incentives, which means that the decisions that they make are vastly costlier to the entire system than they otherwise would be. The level of systemic risk consequently increases.
Financial regulation should be carefully designed to prevent this circumstance from occurring. Moral hazard was singled out as a contributing factor in the 2008 Financial Crisis, as 'too big to fail' banks made decisions which maximised their own rewards while passing the consequences on to the wider economy.
The misconduct exposed in the Hayne Royal Commission could also be seen through this prism. Across the financial services sector, consumers incurred losses as a result of conduct by individuals who were shielded, in varying ways, from accountability for their actions. Implementing the recommendations of the Hayne Royal Commission should increase, rather than decrease, the accountability of actors for their obligations to consumers.
Where a licensed corporation has breached their obligations to their customers, and where those customers have, as a result, incurred losses, liability should, as a general principle, rest with the corporation or the relevant responsible persons. The community expects this, the law should reflect it, and the stability of the financial system requires it. Policymakers should not lose sight of this fundamental principle.
The Compensation Scheme as a Safety Net
There was broad support among submitters for establishing a CSLR as a safety net. As noted in the majority report, this support spanned a broad range of stakeholders. Voicing explicit support was Choice, CPA Australia, the SMSF Association, the Financial Services Council, the Business Council of Australia, and the Mortgage and Finance Association of Australia (MFAA).
The support for the scheme was predicated on the assumption that it would be a backstop within a wider system which holds responsible entities to account. It was described variously as 'an additional layer of protection', a 'missing link', and targeted squarely at 'addressing the plight of consumers who have been unable to secure compensation'.
It is therefore necessary and appropriate that two critical guardrails be maintained to ensure that the recommendations of the Hayne Commission are properly implemented by this legislation.
First, it is imperative that the CSLR scheme not extend to managed investment schemes (MIS's). Participation MIS's can, depending on the type, come with significant downside risks.
To push these risks onto the wider sector would extend the exposure to risk to the wider financial sector, while insulating the responsible parties from accountability. De-risking investment activity would have a distortionary effect on financial markets, undermining the integrity of the financial system as a whole.
Second, the $150,000 cap should be maintained to contain overall costs to the scheme.
This concept proposes to compensate Australians in certain prescribed circumstances, namely where an Australian Financial Complaints Authority (AFCA) determination has been made on credit or personal financial advice.
This remains a novel legal construct which poses risks to Australians and the economy at large. That it has been limited to these prescribed circumstances is critical and I believe it could be workable alongside professional indemnity insurance and the suite of new regulatory tools.
However, the risk of moral hazard is real, and we should not expand the CSLR. Certainly, we should be clear in all public communication that the scheme is extremely limited.
I also note the real personal cost of bad financial advice but further note that there have been enormous reforms of the sector during the last decade which have radically changed the sector.
Ultimately, the government cannot legislate away risk, nor should it.
Senator Andrew Bragg
Liberal Senator for New South Wales