Tag: FSI

Are Our Major Banks “Unquestionably Strong”?

New data suggests that our four major banks are less well capitalised than you might expect, so today we discuss the implications.

Back in 2014, ex-Commonwealth Bank of Australia chief David Murray lead a financial system inquiry which recommended that Australia’s banks should maintain “unquestionably strong” status from a capital perspective.  Specifically, to avoid issues in a crisis, the review recommended that they should be in the “top quartile” of banks globally relative to their international peers in terms of capital strength. All but one of his recommendations were accepted by the Government.

Murray told The Australian Financial Review on Tuesday the “unquestionably strong” target was introduced to deal with two issues. The first was to ensure that if the government did have to support the banks in a crisis they would eventually get their money back. The second issue was to allow the banks to retain the faith of foreign investors in a systemic downturn, given the reliance on international debt capital markets.

APRA, the prudential regulator was then given the task of defining the “unquestionably strong” target that sharemarket investors at the time feared would force the banks to conduct dilutive capital raisings.

The banks have indeed increased their capital since 2014, but it was only in July 2017 that APRA provided clear guidance, setting a common equity tier one ratio target of 10.5 per cent. The banks were given 2½ years to achieve the modest uplift, and at the time bank stocks rallied on the limited targets and extended timeframes.  APRA said the 10.5 per cent target also factored in expectations that global banks would increase their capital levels. Their subsequent papers did not change this fundamental target, even if the mix may change.

But despite being depicted by the government and the media as among the most secure in the world, the big four banks are no longer “unquestionably strong,” according to an S&P Global Ratings report released recently. The reason is their exposure to record levels of household debt and declining real estate values.

Based on a survey of 100 world banks compiled by S&P Global Ratings, Australian banks last year experienced among the “steepest declines” in their risk adjusted capital, or RAC, pushing them into the bottom half of global rankings. They would need to raise billions of dollars to return to the “unquestionably strong” top quarter of lenders.

This is because banks in other major economies bolstered their capital positions, while the economic risks posed by high levels of household debt and inflated property prices prompted S&P to penalise the Australian banks.

This result, reported on the front page of the Australian Financial Review last Wednesday, but virtually nowhere else, is another indicator of a potential property and financial crash that would have devastating economic consequences, for the economy and households.

The capital decline has placed the four major banks around the 40th to 50th percentile of surveyed banks when ranked by the RAC ratio, the credit rating agency’s preferred measure of financial strength.

That is well outside the much trumpeted “top quartile” target set by regulators as a result of the David Murray-led 2014 Financial System Inquiry.

The AFR says that the S&P RAC ratio is calculated by dividing a bank’s total capital by its risk-weighted assets. The risk-weighted assets figure is adjusted by the agency based on the prevailing economic risk score of the country in which the bank operates.

The RAC scores of the big four banks range between 8.9 per cent (National Australia Bank) and 9.4 per cent (Commonwealth Bank).

That is below the average 10 per cent ratio that APRA said would “would improve the likelihood of being perceived by financial market participants as having unquestionably strong capital ratios”.

The RAC ratios do, however, factor in the agency’s dimmer view on the economic risks in Australia that had resulted from a build-up in household debt.

S&P’s decision in May 2017 to downgrade the economic risk score in Australia sliced about 90 basis points off the RAC ratios of the Australian banks, APRA said.

The prudential regulator said it preferred to calculate the RAC using a higher “normalised” economic risk score, which put the banks in the 10 per cent range.

But the S&P commentary is yet another signal of potential trouble ahead.

Enhanced Financial Services Product Design Obligations Announced

The Treasury has released draft legislation for review  which focusses on the design and distribution obligations in relation to certain financial products. We think is is potentially a big deal, and will put more compliance pressure on Financial Services providers. It is a response to the FSI recommendations. Consultation is open until 9 February 2018. It includes investment products and well as credit products such as consumer leases, mortgages, and guarantees.

It sets out:

  • the new obligations;
  • the products in relation to which the obligations apply;
  • ASIC’s powers to enforce the obligations; and
  • the consequences of failing to comply with the obligations.

Here is a brief summary of the 57 page document.

The new design and distribution regime generally applies to a financial product if it requires disclosure in the form of a PDS. However, some financial products requiring a PDS are not subject to the new design and distribution regime: MySuper products and margin lending facilities. These products are currently subject to product-specific regulations that negate the need to apply the new regime.

The new design and distribution regime also applies to financial products that require disclosure to investors under Part 6D.2 of the Corporations Act. The section defines ‘securities’ for the purposes of Chapter 6D of the Corporations Act as meaning: a share in a body; a debenture of a body (except a simple corporate bond depository interest issued under a two-part simple corporate bonds prospectus); or a legal or equitable right or interest in such a share or debenture. Again, there are some exceptions.

The obligations require issuers of such products to:

  • determine what the appropriate target market for their product is
  • take reasonable steps to ensure that products are only marketed and distributed to people in the target market, and that appropriate records are kept to demonstrate this
  • and gives ASIC powers to “intervene” if a financial or credit product has resulted in or will, or is likely to, result in significant detriment to retail clients or consumers. There are two main limitations on the types of financial products that can be subject to the intervention power under the Corporations Act. First, the power generally only applies in an ‘issue situation’. Second, the power only applies where a product may be made available to ‘retail clients’.

Background

As part of the Government’s response to the Financial System Inquiry (FSI), Improving Australia’s Financial System 2015, the Government accepted the FSI’s recommendations to introduce:

  • design and distribution obligations for financial products to ensure that products are targeted at the right people (FSI recommendation 21); and
  • a temporary product intervention power for the Australian Securities and Investments Commission when there is a risk of significant consumer detriment (FSI recommendation 22).

This consultation seeks stakeholder views on the exposure draft of the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2018 which implements these measures.

 

 

Major Banks Second Report – Déjà Vu (All Over Again!)

The House Of Representatives Standing Committee on Economics released its Major Banks Second Report in April 2017. Right over the Easter break and just before the budget!

Its a pretty weak document, in that while the issues they raise are quite important they miss the core structural issues which beset the industry, from vertical integration, lack to real competition, price gouging and poor culture. In fact the FSI inquiry did a better job, and there are still open issues from that review.

We think the “review fest” needs to stop and the focus should shift to making real change. This is what the summary of report 2 says:

The Committee’s second round of hearings has confirmed that the Recommendations of the First Report should be implemented now in order to improve the Australian banking sector for the benefit of customers. The Committee reaffirms each Recommendation from the First Report. While the Committee is open to some modest variations to the Recommendations, it affirms the substance of each of them.

Recommendation 1 of the First Report proposed the establishment of a one-stopshop where consumers can access redress when they are wronged by a bank. The Committee retains its view that one dispute resolution body should be established to provide straightforward redress for consumers. It is highly preferable to have one body dealing with these matters rather than two or more. The Committee believes that the Ramsay review should determine the precise administrative structure of this body – the key point is that it should be a one-stop-shop.

Recommendation 2 of the First Report calls for a new public reporting regime to be put in place to hold senior bank executives much more accountable. This Recommendation is essential to achieving a change in bank culture. It will place relentless pressure on CEO-reporting executives to focus on the treatment of customers. While all of the banks except ANZ oppose this Recommendation, in the Committee’s view it will have a very substantial impact on the behaviour of banks, to the benefit of consumers. It should be implemented.

Recommendation 3 of the First Report proposed that a regulatory team be established to make recommendations on improving competition in the banking sector to the Treasurer every six months. The ANZ agreed with Recommendation noting that ‘analysis from a government agency would help demonstrate the nature and level of competition.’ The other banks oppose this Recommendation, for reasons that the Committee does not find persuasive. This team should be put in place to fill a substantial gap in Australia’s regulatory framework today: we do not currently have a permanent team focused on systemic competition issues in banking, and we should.

Recommendations 4 and 5 of the First Report seek to empower consumers. In particular, Recommendation 4 proposes that Deposit Product Providers be forced to provide open access to customer and small business data by July 2018. All four banks noted general support for data sharing. However, the banks are conflicted on this issue, as the process of opening up data means that an asset which is currently proprietary to the banks will be non-proprietary in the future. For this reason, it is critical that the banks are not allowed to control the process or set the rules by which consumer data is opened up. An independent body must lead the change and be responsible for implementation.

Recommendation 7 of the First Report proposes that there be an independent review of risk management frameworks aimed at improving how the banks identify and respond to misconduct. Each of the banks has responded claiming that APRA Prudential Standard CPS 220 performs this function. The Committee is not convinced that the CPS 220 risk management review process is sufficient in relation to misconduct. CPS 220 has a broad focus on the material risks to a bank. While these objectives are important for prudential reasons the Committee’s focus
in this Recommendation is the ongoing and serious nature of misconduct by the banks towards their customers. The Committee’s Recommendation will ensure that the banks give top priority to developing a risk  management framework that truly puts customers first. This risk management review should work in parallel to CPS 220.

As part of the hearings in March 2017, the Committee scrutinised the banks over their use of non-monetary default clauses in small business loans. This matter was examined by the Australian Small Business and Family Enterprise Ombudsman, Ms Kate Carnell, as part of her inquiry into small business loans. Ms Carnell recommended that for all loans below $5 million, where a small business has complied with loan payment requirements and has acted lawfully, the bank must not default a loan for any reason. The Committee commends Ms Carnell on her important work on this issue and has recommended that non-monetary default clauses be abolished for loans to small business.

 

Here is an excellent piece from King & Wood Mallasons which puts their finger nicely on the key issues.

The House Of Representatives Standing Committee on Economics released its Major Banks Second Report in April 2017. Its ten recommendations largely repeat those contained in its first report and the Committee’s Chairman has called for each of them to be implemented.

We have used the heading of “Here we go again” as that is the truth: the majority of the recommendations represent another attempt at addressing issues identified by the comprehensive and properly considered Financial System Inquiry, but do little to address the underlying issues and take a simplistic approach to a complex industry. At best they will add further process and cost for little incremental benefit; at worst they will create further confusion and overlap between other legislative change and regulations.

Given the strength of the convictions and apparent political will, we think it is highly likely that many of them will be implemented. Some of the recommendations could be positive if they are implemented in a meaningful way. Our concern is that political considerations and expediency will force the opposite result.

In an attempt to more actively engage and shape the implementation of these recommendations, we have put forward our predictions and what you need to be aware of on the following recommendations:

  • “One-stop-shop” EDR: Banking & Financial Sector Tribunal
  • Senior Executive / Manager Regime
  • A new focus on banking competition and making it easier for new banking entrants
  • Empower consumers (data sharing and use)
  • Independent review of risk management framework
  • Carnell Inquiry: Non-Monetary default

Now is the time to be conscious of these recommendations and understand the potential implications they may have.

“One-stop shop” EDR: the “Banking & Financial Sector Tribunal”

Recommendation: The Government amend or introduce legislation to establish a “one stop shop” Banking and Financial Sector Tribunal by 1 July 2017. This Tribunal should replace the Financial Ombudsman Service, the Credit and Investments Ombudsman and the Superannuation Complaints Tribunal.

Our prediction: This recommendation will be implemented, and with an increased monetary threshold for both claims and compensation. It is a practical solution to a key problem of the multiplicity of existing tribunals, and is inevitable given the government and industry positions in respect of them. However, it is still a work-in-progress, as the hard work of the design and detail of the one-stop shop has been delegated to the Ramsay review. The devil will be in the detail of what is suggested by that review.

What to watch for: Whether the recommendation solves the problem, and gets right the balance between pragmatism and legalism.

The interim report of the Ramsay review recommends that the claim and compensation limits under the existing EDR schemes be significantly increased for small business and consumer complaints. The Carnell report suggests a limit of $5 million. Ramsay currently recommends that the new EDR scheme be an industry ombudsman scheme, while the Committee recommends that it be a statutory banking tribunal. Consumer groups have also been strong advocates of a tribunal model. The difference is that a statutory banking tribunal is likely to have more comprehensive appeal rights, be more accountable and be more legalistic than an industry scheme.

In our opinion, an “all powerful” tribunal with higher limits and compensation thresholds will, by default, become more “legalistic” and some of the perceived benefits of the current EDR schemes, and their more informal and speedy processes and outcomes, will not be preserved. This could be an advantage for banks, as the appeal rights in relation to the existing EDR schemes are limited, and it is likely that more comprehensive appeal rights would be available for banks should a banking tribunal be established.

The consumer response to this change will need to be managed and positioned as a result of government policy which was supported by consumer groups, rather than as a result of a bank’s behaviour toward the tribunal.

Senior executive/manager regime

Recommendation: That, by 1 July 2017, the Australian Securities and Investments Commission (ASIC) require Australian Financial Services License holders to publicly report on any significant breaches of their licence obligations within five business days of reporting the incident to ASIC, or within five business days of ASIC or another regulatory body identifying the breach.

Our prediction: The problems to solve include culture and enforcement. These are inextricably linked. The proposed solution will not address either problem and could worsen them. It is simplistic, takes no account of the strong systems in banks, currently overseen by APRA, and will have at least two unintended consequences:

  • first, the time period for disclosure could result in a fast but wrong decision which in turn creates a culture of non-disclosure for fear of an arbitrary outcome or the prospect of being a “scapegoat”. Further, a “significant” breach will require investigation and often systems based responses which take time to investigate and develop – customers and shareholders will be prejudiced if a thorough review and response is compromised;
  • second, the statement in the recommendation that the CEO-level reports within a bank have the greatest capacity to change the culture shows a lack of understanding of the banking industry and the scale of each bank division’s operations, as a “CEO-level” report is basically the CEO of each of those divisions. The problem can only be fixed by changing the culture through the entire bank, with a focus on training, education, accountability and reporting systems. Senior management can set values and oversee systems and processes, but implementation errors will often not be obvious until the issue is spotted. Speedy escalation of the issue needs to be supported and not feared.

What to watch for: The balance between culture and enforcement.

In terms of culture, banks recognise that they need to address issues in their culture and rebuild trust with the public, and that one element of doing so is to ensure that breaches are identified, reported and acted upon and that bad behaviour has consequences, at all appropriate levels. There have been failures to do this in the past that cannot be repeated.

To do so, a culture of disclosure rather than a culture of fear needs to be created. People within banks at all levels need to feel safe to report a problem by having a supportive environment in which possible breaches can be reported, assessed and actioned, not an environment where they are afraid to do so because of arbitrary standards, a time frame which could result in the wrong decision being taken or where there is the risk of adverse publicity which is not warranted by the underlying circumstances.

In terms of enforcement, the solution of a senior manager regime will create a problem of duplication between this regime, ASIC’s current powers to penalise behaviour of senior office holders under the Corporations Act and APRA’s current powers under the fit and proper person regime. Which will have priority? How will competing claims between regulators and the courts be managed?

In our opinion, the better solution is to improve these existing laws and clarify and coordinate their enforcement – and actually use them – rather than creating a further set of laws that will not solve the problem and will likely cause further cost and complexity for the industry for little additional benefit, and distract banks from their priority of serving customers’ needs.

For this sort of regime to be workable and fair, there needs to be a tiered approach of notification, an appropriate time to investigate and then reporting of the proposed action to be taken and the involvement of management. Given the draconian consequences, our view is that these proposals will inevitably lead to a conservative view being taken of what is a “significant breach”, which will not be much different to the current regime. An approach which encourages and rewards the reporting of breaches, and building a strong relationship between the industry and the regulator, is more preferable and would go further towards solving the current problems.

A new focus on banking competition and making it easier for new banking entrants

Recommendation: that the Australian Competition and Consumer Commission, or the proposed Australian Council for Competition Policy, establish a small team to make recommendations to the Treasurer every six months to improve competition in the banking sector, and suggest any changes required to improve competition.

Our prediction: The recommendation is a triumph of process over substance that may not deliver any tangible results or achieve any significant change in levels of competition.

What to watch for: Political pressure driving further bad policy and another unwarranted inquiry into the banking industry.

“Competition” is a motherhood problem that always generates a motherhood statement: while everyone will always say that they want more competition, and will welcome more competition, the real questions to be asked and answered are:

  1. What is improved competition? Is it more banks, or increased competition between existing banks or both?
  2. How will improved competition be achieved? Will it involve legislative reform to lower barriers to entry and expansion, or to increase demand-side power or will the other reforms, including those directed at changing culture in the banking sector, achieve the underlying objective?
  3. How should the increased competition be measured? Should it be measured in increased productivity, or increased consumer welfare, or reduced profitability?

In the fuel sector, the ACCC claimed that “shining a light on petrol prices” improved competition. But, is there any enduring evidence to support this?

To solve the problem, we think that the government needs to take a holistic view of the future banking industry, not tinker with the current. That is:

  • first, reduce the barriers to entry by creating a more supportive environment for new entrants and start-ups (including a UK style “two stage” licensing system for new entrants) as well as reviewing the APRA process for licensing and prudential regulation to achieve a better balance between APRA’s obligations to promote stability and competition as well as different capital applications for different sized lenders (as the US is moving towards, and as the report contemplates);
  • second, reduce the height of those barriers in terms of access to customer data, portability of customers, prudential requirements and infrastructure costs; and
  • third, recognise that the new suppliers are less likely to be traditional financial institutions but rather technology companies which both have and need access to data (such as Amazon, Google, Alibaba, Apple) and that a regulatory environment that both encourages their entry into the Australian market while preserving the ability of the current suppliers to access capital and funding is the best way of ensuring better long term competition in the Australian market.

One thing is certain. Access to foreign debt capital is critical for the Australian Banking system and the cost of that capital directly affects the cost of mortgage loans to mums and dads. The Government needs to tread very carefully here.

Therefore, a comprehensive and well thought through, holistic solution to all of these related issues is required, not a further series of knee jerk reactions that will never be implemented or, if implemented, will not solve the problem of improved competition.

Empower Consumers (data sharing and use)

Recommendation: that Deposit Product Providers be forced to provide open access to customer and small business data by July 2018. ASIC should be required to develop a binding framework to facilitate this sharing of data, making use of Application Programming Interfaces (APIs) and ensuring that appropriate privacy safe guards are in place. Entities should also be required to publish the terms and conditions for each of their products in a standardised machine-readable format.

The Government should also amend the Corporations Act 2001 to introduce penalties for non-compliance.

Our prediction: While we are still waiting for the Federal Government’s response to the final recommendations of the Productivity Commission on data availability and use, our prediction is that a new regime of open data for consumers and small business is inevitable. This train has left the station. The only questions are what model will be implemented and how it will be implemented.

What to watch for: These recommendations bring the questions of data “front and centre”. Data is the current and future asset of value in the industry. However, there are two critical aspects to this:

  • first, the recommendations are in several ways inconsistent with (or critical of) the approach taken by the Productivity Commission in its draft report. We need one model that reflects the culture and values of the Australian industry and consumers; and
  • second, competition cannot be improved without a solution to the questions of: who owns the data; how will it be secured; who can access it; how is that access provided; how is privacy maintained; who is accountable and who bears the risk if the data security is lost?

A key challenge for the industry is that a customer-centric model of open data may not be fully consistent with the industry’s business model or needs, and that the industry’s role in developing that model will need to be carefully managed given the range of stakeholders’ interests in play.

Independent review of risk management framework

Recommendation: that the major banks be required to engage an independent third party to undertake a full review of their risk management frameworks and make recommendations aimed at improving how the banks identify and respond to misconduct. These reviews should be completed by July 2017 and reported to ASIC, with the major banks to have implemented their recommendations by 31 December 2017.

Our prediction: This will be implemented as it is a no-brainer for the government. At least it doesn’t require a “culture audit”. It provides a customer, not a prudential, framework for the risk management of conduct. However, the time-frame will need to be longer: all banks have existing detailed risk framework and processes which need to be taken into account.

What to watch for: Will it solve the problem? No, as a review alone will change nothing. It needs to be seen as part of the solution to the culture and enforcement problem (described above) and to assist a bank in reviewing and making wider changes to its organisation and behaviours that will help it to drive a different culture. Nothing is gained by simply reviewing the current systems, or just creating a new penalty or threat for employees.

A review of this nature needs to be undertaken by an independent party that genuinely understands the banking industry, its consumer products, its current legal framework and regulation and the current steps being taken by the banks to reform their systems of culture, incentives, accountability and enforcement. It needs to be part of the solution and assist a bank in making these wider changes to its business.

Carnell Inquiry: Non-monetary default

Recommendation: That non-monetary default clauses be abolished for loans to small business. If the banks do not voluntarily make this change by 1 July 2017 then the Government should act to give effect to this Recommendation.

Our prediction: The recommendation will solve the perceived problem of allowing a lender to enforce for a non-monetary default, and this is already being actioned by the industry. However, it will simply create a different problem for a customer: the term of a loan could be shorter (say, between 12 months and 3 years) and be charged at a higher interest rate, as the recommendation transfers more risk to the bank. So a customer could get less certain and more expensive credit as a result.

What to watch for: The problem is said to be one of unfairness, in that a lender should not be able to default a loan except if the borrower has not paid interest or principal on time. A non-monetary default gives too much power to the lender to take action even when a customer might be making those payments on time.

The reality is that there are too many non-monetary default provisions, and they can be simplified. They are also rarely, if ever, used. However, they underlie the relationship between the bank and the customer, and in some cases reflect prudential risk management requirements on the bank and give each of them a catalyst to discuss improvements to the customer’s business that may increase its ability to pay or the adequacy of the security given to the bank for the loan, rather than calling a default. Banks currently use non-monetary default provisions as “early warning signs” to enable banks to meet the risk requirements imposed by prudential regulation and work with customers with deteriorating businesses to turn them around before customers commit monetary defaults.

The balance between the term of the credit (more than 12 months to give certainty of funding to small business) and the terms of the credit (to allow banks to monitor and manage their exposures, and ultimately their capital) needs to be fair between them and put into the right balance.

What now?

The next few months are critical, as not only the Committee but many commentators are calling for implementation of these recommendations. A firm but fair approach by the banking industry, which recognises its issues to be addressed which is accompanied by meaningful suggestions, is required to all stakeholders.

Murray slams Medcraft for “political agenda”

From Australian Broker.

The head of the financial systems inquiry, David Murray, has publicly criticised chairman of the Australian Securities & Investments Commission (ASIC) Greg Medcraft for overreaching in what Murray phrased as bank bashing.

In an interview on Sky News Business, Murray responded to comments made by Medcraft welcoming tighter controls on banks to limit cross-selling.

These recommendations were “outside the intent” of the inquiry’s original product intervention power with Medcraft “well and truly” exceeding the mandate set for him, Murray said.

“By attacking vertical integration of the banks, he’s picking up a political agenda and running with it. For the regulators, that is the wrong thing to do.”

The topic of bank bashing was also raised after Medcraft’s comments of the Australian banking oligopoly were raised.

“I think we should put in context what the banks actually do,” Murray said. “Whilst the structure is oligopolistic, that’s not uncommon in Australia. We have two major airlines, we have a small number of [major] retail landlords, we have a small number of integrated transport companies, and on it goes.”

There is a need to “start building and stop bashing,” Murray said.

“You cannot have a large number of small, badly rated banks borrowing in foreign markets to intermediate the current account deficit. We need a small group of strong banks to do that.”

The act of bank bashing leads to systemic risk as this can lead to a fall in bank ratings, he said.

“If there’s a political agenda for a Royal Commission – that is a Royal Commission that you have to have when you don’t really need one – the Commission can go searching for solutions that we don’t really need either.”

The current environment had already put a number of “dark clouds” on the banks that need not be there, including the present housing issue, Murray added.

“If foreign investors in banks and foreign lenders to our banks believe that that’s an added layer of risk and their credit ratings could slide further than the Commonwealth government, we are then inducing a price spiral which will hurt the economy deeply.”

“This bank bashing is really helping people think that a Royal Commission is necessary. It’s not necessary.”

Banking reform report card: ‘could do better’

A new report from Deloitte Access Economics has highlighted significant work remains on implementing key recommendations of the Financial System Inquiry (FSI).

The Customer Owned Banking Association (COBA) commissioned the report on implementation of FSI recommendations 1, 2, 3 & 30 because it is now more than two years since the report was delivered to Government and more than one year since the Government announced its response.

The Customer Owned Banking Association (COBA) engaged Deloitte Access Economics to report on progress in implementing the following recommendations of the 2014 Financial System (Murray) Inquiry (FSI):

  • Recommendation 1: Set capital standards such that Australian authorised deposit-taking institution capital ratios are unquestionably strong.

  • Recommendation 2: Raise the average internal-ratings-based (IRB) mortgage risk weight to narrow the difference between average mortgage risk weights for authorised deposit-taking institutions using IRB risk-weight models and those using standardised risk weights.
  • Recommendation 3: Implement a framework for minimum loss absorbing and recapitalisation capacity in line with emerging international practices, sufficient to facilitate the orderly resolution of Australian authorised deposit-taking institutions (ADIs) and minimise taxpayer support.
  •  Recommendation 30: Review the state of competition in the sector every three years, improve reporting of how regulators balance competition against their core objectives, identify barriers to cross-border provision of financial services and include consideration of competition in the Australian Securities and Investments Commission’s (ASIC) mandate.

Deloitte Access Economics finds that delays to implementation of the recommendations would adversely affect the ability of the financial system to realise the benefits of these reforms. These benefits were identified by the FSI as helping to:

  • ensure the robustness of the financial system
  • aid competition in the banking sector
  • address the ‘too big to fail’ issue in the banking sector.

“The customer owned banking sector wants to see more urgency from government and regulators in implementing the key FSI reforms,” COBA CEO Mark Degotardi said.

“This report is timely because the House of Representatives Economics Committee has just found that Australia’s banking market is an oligopoly where the major banks have significant market power that they use to the detriment of consumers.

“The House Economics Committee found that a lack of competition in banking has significant adverse consequences for the economy and consumers.

“There is no time to waste, yet Deloitte Access Economics’ report card finds only limited progress on the key FSI recommendations.

“In relation to the Recommendation 30 requirement for regulators to explain how they balance competition with their other mandates, Deloitte Access Economics finds that there has been ‘little progress’.

“This is particularly disappointing because regulator decision-making can have a significant impact on competition. Deloitte Access Economics mentions two examples of this: APRA’s approach to regulatory capital instruments for customer owned banking institutions and APRA’s application of the cap on investor lending growth.

“Deloitte Access Economics’ report proposes a draft terms of reference for a Productivity Commission review of competition in the financial system, focusing on the banking sector.

“COBA welcomes Deloitte Access Economics’ suggestion the PC review should consider whether regulators’ rules and procedures are creating inappropriate barriers to competition and whether there is appropriate regard to other business models, including the customer owned model.”

Deloitte Access Economics has provided the following snapshot of the status of key FSI recommendations:

Table 1.1: Overall state of play

 

State of play
Recommendation 1

Capital levels

 Some progress, yet to be completed.

·         Steps already taken which have seen an increase in the capital ratios of the Australian major banks.

·         Current schedule suggests that implementation may be completed in 2018.
Recommendation 2

Narrow mortgage risk weight differences

 Some progress, yet to be completed.

·         Still in progress, although interim steps have been taken to narrow risk weights.

·         Current schedule suggests that implementation may be completed in 2018.
Recommendation 3

Loss absorbing and recapitalisation capacity

 Limited domestic progress; contingent on international developments.

·         No set timeframe, but progress is expected to “hasten slowly”.
Recommendation 30

Strengthening the focus on competition in the financial system

 Limited progress.

·         Current schedule suggests that implementation could be completed by end-2017.

Source: Deloitte Access Economics

More Messing With Super?

Yesterday the Treasury released, late in the day, a consultation on the “Development of the framework for Comprehensive Income Products for Retirement“. The framework appears to open the door to new products, which offer significant opportunities for industry players to invent yet more fees and charges. Just remember the biggest killer on superannuation in the accumulation phase is the level of fees and charges. We fear this exercise will open the door to more income flows to industry participants in the income draw-down phase of retirement, and raise more disclosure questions. This could be exacerbated if distributed via Robo-advice platforms.

Bear in mind also that superannuation savings is a relatively small proportion of total household assets – property being the largest element (thanks to the massive rise in value), according to the ABS.

The paper says the CIPRs framework is not intended to encourage annuities over other products; compel retirees to take up a certain retirement income product; or replace the need for financial advice. We shall see.

The Government agreed to support the development of more efficient retirement income products and to facilitate trustees offering these products to members, in response to the Financial System Inquiry.

These products were labelled by the Murray Inquiry (Financial System Inquiry) as ‘Comprehensive Income Products for Retirement’, or CIPRs; however the Government proposes to use ‘MyRetirement products’ as a more consumer‑friendly and meaningful label.

The MyRetirement framework is intended to increase individuals’ standard of living in retirement, increase the range of retirement income products available, and empower trustees to provide members with an easier transition into retirement. Through this framework, the Government is aiming to increase the efficiency of the superannuation system so it can better achieve the proposed objective of superannuation, which is to provide income in retirement to substitute or supplement the Age Pension.

The Government has released, for public consultation, a discussion paper that explores the key issues in developing the framework for Comprehensive Income Products for Retirement, or MyRetirement products. Views are sought from interested stakeholders, in particular on:

  • the structure and minimum requirements of these products;
  • the framework for regulating these products; and
  • the offering of these products.

The Government is committed to consulting extensively with stakeholders on this framework.

A public consultation process will run from 15 December 2016 to 28 April 2017.

The discussion paper covers a lot of ground, in this complex policy area.

WHAT IS A COMPREHENSIVE INCOME PRODUCT FOR RETIREMENT (CIPR)?

It is envisaged that a CIPR would be a mass-customised, composite retirement income product (for example, combining a pooled product with a product that provides flexibility), which trustees could choose to offer to their members at retirement.

The offering of a CIPR would provide an ‘anchor’ to help guide individuals in their retirement income decision-making. Importantly, an individual would have the freedom to choose whether to take up the CIPR or take their retirement income benefits in another way.

Under the CIPRs framework although different product providers (for example, life insurance companies) could administer the underlying component products, trustees would offer a single income stream to their members.

If a trustee designs a product that: meets the proposed minimum product requirements; is in the best interests of the majority of their members; and offers the product in line with the offering requirements, it is proposed that the trustee will receive a safe harbour. The safe harbour would protect the trustee from a claim on the basis that the CIPR was not in the best interest of an individual member. This is intended to provide legal certainty for trustees in undertaking the CIPR offering.

PROPOSED STRUCTURE AND MINIMUM PRODUCT REQUIREMENTS OF A CIPR

Ensuring all CIPRs meet minimum product requirements is a key way to achieve good outcomes for consumers and to increase comparability between products.

The paper seeks feedback on possible minimum product requirements of this composite product, such as requiring a CIPR to:

  • deliver a minimum level of income that would generally exceed an equivalent amount invested 1.in an account-based pension drawn down at minimum rates, with recognition of the benefit of a guaranteed level of income where relevant;
  • deliver a stream of broadly constant real income for life, in expectation (in particular, to manage 2.longevity risk); and
  • include a component to provide flexibility to access a lump sum (for example, via an 3.account-based pension) and/or leave a bequest.

PROPOSED REGULATION OF CIPRS AND TRUSTEES

The paper also seeks views on how to regulate both trustees and CIPRs, in addition to regulation of the proposed minimum product requirements outlined above.

Trustees could choose to design a single mass-customised CIPR that would be in the best interests of, and offered to, the majority of their members. However, trustees would not be required to design and/or offer a product that is in the best interests of any particular member. In designing the product, trustees would need to consider whether it is in the best interests of members to outsource the administration of underlying component product(s) where the trustee does not have the necessary skill set or scale to administer the underlying component product(s).

As is currently the case, trustees and other product providers such as life insurers could also create new retirement income products that are tailored to particular member segments or individuals, rather than to the majority of the membership. These products could be offered via personal financial advice (including through robo advice) where the adviser is required to consider the individual’s circumstances and needs. Individuals could also purchase these products via direct channels. If these products are certified to meet the proposed minimum product requirements of a CIPR, it may be appropriate to allow a label to be attached indicating that the product ‘meets the minimum product requirements of a CIPR’.

WHAT THE CIPRS FRAMEWORK IS NOT ABOUT

It is important to debunk some myths about the CIPRs framework. The CIPRs framework is not intended to:

  • encourage annuities over other products;
  • compel retirees to take up a certain retirement income product; or
  • replace the need for financial advice.

EXAMPLES

Below are three illustrative examples of possible CIPRs: ‘the cut’, ‘the stack’, and ‘the wrap’.

For ‘The cut’ CIPR, the deferred longevity product component could represent as little as 15 to 20 per cent of an individual’s total superannuation balance and still provide a higher and more stable

income than an account-pension drawn down at minimum rates. The large account-based pension component provides a high degree of ‘flexibility’, thereby efficiently managing the concern about dying early and forfeiting an individual’s superannuation savings.superannuation savings.

‘The stack’ CIPR would provide an individual with the flexibility to access ‘lumpy’ income throughout retirement from an account-based pension component drawn down at minimum rates. Compared to ‘The cut’, a larger proportion of the individual’s total superannuation balance would go towards a longevity product component.

‘The wrap’ CIPR represents a combination of ‘The cut’ and ‘The stack’ CIPRs and in doing so, delivers a balance of their benefits. ‘The wrap’ provides longevity risk management (through the deferred longevity product), higher income than an account-based pension drawn down at minimum rates, and provides a degree of flexibility to access ‘lumpy’ income throughout retirement.

FEES AND CHARGES

Increasing the fees charged on a CIPR, post-commencement
Currently, fees for annuities and defined benefit pensions are essentially ‘locked in’ at the time of purchase due to the guaranteed level of income these products provide. However, for an account-based pension component or a group self-annuitisation component of a CIPR, there is a risk that increases in administration fees would decrease income in retirement. Individuals would not easily be able to change CIPRs in response to an increase in fees.

One option may be to restrict administrative fees from increasing over the life of a CIPR, although there is a risk that if administrative costs increased substantially accumulation members may need to cross-subsidise members in the pension phase.

Another option may be to rely on the income efficiency concept. However, given that administration fees would have a small effect on efficiency as compared with bequests and capital costs, there would need to be a large increase in fees before income efficiency is affected.

An alternative option could be to allow trustees to increase fees so long as there is no differentiation between the fees paid by existing members and new members of the CIPR. This would ensure trustees continue to face competitive fee pressure.

Trustees could lose the right to offer a CIPR to new members if they increased their fees only for existing members.

This paper also seeks alternative ideas on how to protect individuals from significant increases in fees that would erode retirement incomes.

TIMETABLE

In due course, consultation will also be undertaken on exposure draft legislation and regulations to give effect to the CIPRs framework.

It is envisaged that the CIPRs framework would not commence until trustees and other product providers have had sufficient lead-time to develop appropriate products. Given a commencement date for alternative income stream product rules of 1 July 2017, and the Government is currently reviewing the social security means testing of retirement income streams, the CIPRs framework is not expected to commence any earlier than mid-2018.

The Government could, at a later date, and following an appropriate transition period, consider whether certain trustees should be obliged to offer CIPRs to any of their members. Given this, it will be important for the current proposed CIPRs framework to be sufficiently robust to accommodate a potential change in trustee obligations down the track.

 

ABA Welcomes Federal Government’s review into external dispute resolution

The Australian Bankers’ Association has today welcomed the release of the terms of reference of the Federal Government’s review into external dispute resolution.

Complaint-TTy

“The handling of customer complaints is a major factor in people’s trust in their financial institution,” the ABA’s Executive Director – Retail Policy, Diane Tate, said.

“Banks want to help customers work through any problems to avoid the need for external dispute resolution, however, in some instances it is necessary.

“It’s important to make sure that external dispute resolution works well. Customers need to know how and where to get a complaint or dispute resolved,” she said.

“The ABA supports broadening external dispute resolution schemes so more people have access to them if needed. This includes considering increasing the monetary limit on the claims that the Financial Ombudsman Service can assess and on the amount of compensation it can award.

“The ABA looks forward to working with the Government on this review to help ensure people have easier and greater access to get a problem resolved,” Ms Tate said.

“Banks are also taking steps to improve complaints handling processes. Banks will appoint dedicated customer advocates to offer support and give customers a greater voice when things go wrong.

“Banks are also making sure that if a dedicated program is needed to deal with a more difficult problem, these remediation programs operate effectively,” she said.

“This is part of a range of measures recently announced by the banking industry to enhance customer protections, increase transparency and accountability and build trust and confidence in banks.”

Terms of reference released for complaints system review

From Financial Standard.

The federal government has released the terms of reference for the independent review into the financial system’s external dispute resolution and complaints framework.

ComplainyThe independent expert panel consisting of Professor Ian Ramsay (chair), Julie Abramson and Alan Kirkland and will examine the Financial Ombudsman Service (FOS), the Superannuation Complaints Tribunal, and the Credit and Investments Ombudsman to ensure that they’re working effectively to meet the needs of consumers and industry.

The review will have regard to efficiency, equity, complexity, transparency, accountability, comparability of outcomes and regulatory costs.

“The terms of reference also allow for comprehensive consideration of the effectiveness of the existing framework, as well as consideration of different models in providing effective avenues for resolving disputes,” said Minister for Revenue and Financial Services, Kelly O’Dwyer.

“The Turnbull Government is committed to ensuring the three bodies are working effectively to meet the needs of users.”

The panel requested a three month extension and will now provide a report to the government by the end of March 2017.

“The additional time will allow for in-depth consultation with stakeholders, industry, the dispute resolution and complaints schemes, peak bodies, and regional and consumer representatives.

“This review builds on the government’s response to the Financial System Inquiry which sets out a suite of policies to improve Australia’s financial system,” O’Dwyer said.

The review will make recommendations on:

The role, powers, governance and funding arrangements of the dispute resolution and complaints framework in providing effective complaints handling processes for users, including linkages with internal dispute resolution

The extent of gaps and overlaps between each of the bodies (including consideration of legislative limits on the matters each body can consider) and their impacts on the effectiveness, utility and comparability of outcomes for users

The role of the bodies in working with government, regulators, consumers, industry and other stakeholders to improve the legal and regulatory framework to deliver better outcomes for users, and

The relative merits, and any issues that would need to be considered (including implementation considerations), of different models in providing effective avenues for resolving disputes

In making its recommendations the review can take into account best practice developments from international dispute resolution arrangements and other sectors and will consult with ASIC on the concurrent review of the FOS’s small business jurisdiction.

The review also has the ability to make observations, but not recommendations, on the establishment of a statutory compensation scheme of last resort.

The FOS has welcomed the release of formal terms of reference and has endorsed the work of the independent expert panel and key considerations guiding the review.

Chief ombudsman Shane Tregillis said: “FOS is committed to the principles of fair, open and simple resolution of financial disputes. Reducing complexity for consumers in accessing effective independent dispute resolution has the strong support of FOS.”

Tregillis further welcomed the ability of the panel to make observations on a compensation scheme of last resort.

“FOS has been a longstanding advocate of a compensation scheme over many years. It is essential for the effective operation of external dispute resolution that consumers who get an award of compensation by FOS can be confident that this compensation will be paid.” Tregillis

The Superannuation Maze Exposed

The Productivity Commission has released its draft report on the Superannuation Industry, which outlines a framework for a review over the next few years. The report says that information about funds are confusing and incomplete. As a result, even the most literate households in the community have difficulty in choosing between funds.  Many put off making decisions about super until close to retirement.

However, the review process as outlined in the report is long-winded, and as a result, little will change for several years.

Retirement-SignPost

This study is stage 1 of a 3 stage process, and stems from the Australian Government’s response to recommendations made in the 2014 Financial System Inquiry (FSI). Stage 1 involves developing criteria to assess the efficiency and competitiveness of the system.

Many recent reviews, including the FSI, have made observations relating to perceived shortcomings in the system. The criteria developed in this study will provide a useful and enduring framework for any future assessments (including by regulators) and reforms.

Currently, there is about $2 trillion in funds under management held by over 250 institutional funds and over 556 000 self-managed superannuation funds. The average account balance is just over $67 000. But averages can be misleading, given the distribution of account balances.

This study stems from the recommendations of the 2014 Financial Services Inquiry (FSI), which considered some of the issues in the superannuation system as part of a broader review of the performance of the Australian financial system. The FSI suggested a Productivity Commission inquiry into the efficiency and competitiveness of the superannuation system should occur by 2020.

In response, the Government tasked the Commission to develop and release criteria to assess the efficiency and competitiveness of the superannuation system (stage 1). These criteria will then be used to inform a review of the system following the full implementation of the MySuper reforms by mid-2017 (stage 3). While aspects of the Australian superannuation system have been reviewed in the past, stage 3 will be the first comprehensive review specifically assessing the efficiency and competitiveness of the entire system.

The Commission has also been tasked with examining alternative models for a formal competitive process for allocating default fund members to products (stage 2). The Commission will begin work on stage 2 in late September. Indicative timelines for the three stage process are outlined in figure 1.1.

PC-Review-Timeline

 

The super industry has evolved to the point where around 20% of household assets are in the sector, worth more than $2 trillion. The number of accounts peaked at about 32 million in 2009-10, and is now down to just under 30 million. The number of small funds has been driven by the increasing popularity of SMSFs. In 2001, there were about 210 000 SMSFs, but this had more than doubled to over 550 000 by June 2015.

PC-Review-MapThe level of funds under management and average account balances should continue to increase at substantial pace over the next few decades. Most projections forecast continued strong growth until the mid-2030s with between $5 trillion and $6.3 trillion under management, representing between 130 to 180 per cent of GDP, depending on the assumptions employed.  Despite the projected growth in absolute size, there is still some uncertainty about whether a mature system in the 2030s will actually provide adequate retirement incomes, although sometimes it can be difficult to distinguish substance from self interest in such claims.

They highlight that the super market is unique, as demand is driven by government policy around compulsory contributions and concessional tax treatment. Many participants though are constrained from making an active choice, the system uses a default model and there are “cognitive constraints and behavioural biases”. Moreover, there are more than 40,000 investment products offered by funds. However, as a defined contribution scheme, risks fall to the members.

The system is highly regulated, and principal-agent relationships abound.

They conclude “The design, size, diversity and complexity of the superannuation system distinguish it from typical markets. Therefore the assessment framework has a focus on incentives and drivers (inputs or processes) of particular outcomes, as well as the outcomes themselves. Importantly, no single criterion or indicator can be used to adequately assess its competitiveness and/or efficiency. In some cases, the assessment will focus on a particular element of the system and in other cases, the system as a whole. Finally, the assessment framework will need to be sufficiently flexible to accommodate the dynamic and segmented nature of the system and policy-induced constraints on the system’s competitiveness and efficiency.”

The report then describes the Commission’s approach to the assessment of the system.

PC-Review-FrameBeyond that, they also describe some of the mechanics within the system which will also be investigated though the review along with governance and regulation.

The deadline for making a written submission to the Productivity Commission on the framework in the report is Friday 9 September 2016.

Life Insurance Remuneration Reform Regulations

The Government has released draft regulations that will support the Government’s life insurance reform package to better align the interests of financial firms with consumers.

Remuneration relating to life insurance advice provided outside of superannuation was excluded from the ban on conflicted remuneration (remuneration likely to influence advice) introduced under the Future of Financial Advice (FOFA) laws.

A series of reports, including a review the Australian Securities and Investments Commission (ASIC), the industry-commissioned Trowbridge Report and the Financial System Inquiry (FSI), identified the need to better align the interests of providers of financial advice in the life insurance sector with consumer outcomes. As part of its response to the FSI, the Government announced that it would support a reform package put forward by industry.

The reform package introduced by the Life Act removes the exemption from the ban on conflicted remuneration, and introduces caps under which commissions will be permitted to be paid, as well as arrangements to ‘clawback’ commissions where policies lapse in the first two years. The reforms will commence on 1 July 2016.

The Regulation supports the reform package introduced by the Life Act by:

  1. allowing the temporary inclusion of stamp duty relating to death benefits to be included in commission calculations while industry update its information technology systems;
  2. prescribing circumstances where ‘clawback’ does not apply, such as in situations where a policy is cancelled automatically due to the age of the insured or where a premium rebate is offered to encourage customers to take up a policy; and
  3. ensuring that existing life insurance remuneration arrangements are grandfathered in a manner broadly consistent with FOFA by ensuring that remuneration arrangements not effectively grandfathered by the Life Act
    (i.e. employee-employer remuneration arrangements) are explicitly grandfathered in the Regulation. Grandfathering means that the existing rules continue to apply to existing arrangements, while new rules apply to new arrangements.

Closing date for submissions: Thursday, 28 April 2016