I would like to thank Jeff Lucy and his fellow ASIC Commissioners for the invitation to speak to you this morning.
From the program, I can see that this year’s ASIC Summer School matches the high quality of previous years.
The 2005 Summer School focuses on two recent legislative reforms that have been introduced by the Howard Government: CLERP 9 and Financial Services Reform (FSR).
I understand that CLERP 9 was examined yesterday, and that today you are considering FSR.
I’m assuming that many of you are quite familiar with the acronym FSR. And for those of you who aren’t, I suspect that you most certainly will be by the end of the day!
My brief today is to talk about the FSR disclosure requirements and whether they’re meeting their intended objectives.
Background
Before I deal with the ‘nuts and bolts’ of the FSR reforms, I’d like to place them in the context of the Government’s overall economic policy.
Australia’s economic performance over the past decade has been among the best in the world. It has delivered high economic, productivity and employment growth, low unemployment and sustained rises in living standards.
Much of this success is due to the policies we have pursued – sound macroeconomic policies combined with ongoing micro economic reform. These have delivered a low inflation, low interest rate environment.
A key focus of microeconomic reform has been the regulatory framework governing Australian corporations and the Australian financial system.
Financial markets perform a fundamental economic function by facilitating the allocation of savings and resources to their most productive uses.
It is therefore important to ensure that the regulation of the financial system is consistent with the government’s broader economic objectives.
The quality of the regulatory framework also has important implications for Australian households. Participation in the financial services industry allows then to build wealth, save for retirement and manage risks through insurance.
In 1996, the incoming Howard Government commissioned a fundamental review of Australia’s financial system under the leadership of Stan Wallis.
The Wallis Report, which was completed in 1997, set out a detailed agenda to improve the regulation of Australia’s financial system.
It sought to ensure that Australia’s regulatory framework could meet the challenges of globalisation, convergence and technological change.
At the same time, the Government also announced the establishment of CLERP - the Corporate Law Economic Reform Program.
The objective of CLERP was to improve the framework of corporate regulation to facilitate investment, employment and wealth creation while protecting investors and maintaining confidence in the business environment.
FSR represented the third and final stage of the implementation of the Wallis Report as well as the sixth instalment of the CLERP process.
FSR – An Overview
The FSR legislation was developed over a four year period between 1997 and 2001. It commenced in 2002 and came into full effect in March 2004, nearly seven years after the release of the initial paper which mapped the outlines of the proposed reforms.
It is important to understand that FSR had a number of different objectives.
Firstly, it aimed to provide the financial services industry with a uniform and consistent regulatory framework in place of the different rules which previously applied to different industry sectors.
This was a response to developments identified in the Wallis Report – the emergence of conglomerates providing a full range of financial services and the blurring of distinctions between financial products.
Secondly, it aimed to provide industry participants with greater flexibility through the adoption of a more principles based approach to regulation across services and products.
It was intended that the legislation would spell out general principles, with greater use made of regulations and ASIC guidance to “fill in” the details.
Thirdly, the FSR was intended to enhance consumer protection by improving standards of conduct and disclosure across the financial services industry.
It was intended to facilitate confident consumer participation in the financial services industry.
Finally, the FSR was intended to encourage competition between financial institutions by enhancing the capacity of consumers to understand and compare different financial services and products.
The Role of Disclosure in the FSR Framework
The FSR framework created new disclosure requirements that apply to financial services providers and financial product issuers.
These disclosure requirements are intended to address a type of market failure known in technical terms as “information asymmetry”.
Information asymmetry exists because consumers do not have the same degree of information or knowledge about financial services and products as do the providers of these services and products.
Furthermore, in many cases consumers cannot obtain this information, or can only do so at considerable expense.
A key feature of financial products is that there are essentially promises. This makes them difficult for consumers to evaluate. The quality of many financial products may only become apparent years into the future, for example when a claim is made on an insurance policy or a person retires and seeks to access their superannuation.
In the absence of mandatory disclosure requirements, consumers are more likely to make poor choices and select inappropriate financial products.
This exposes consumers to considerable risks – for example a lack of insurance or inadequate income in retirement.
Unwillingness on the part of consumers to participate in the financial services industry by investing their savings would also reduce the supply of capital available to Australian companies, or cause this capital to be misdirected away from its most efficient uses.
Disclosure aims to promote confident consumer participation in the financial services industry by addressing “information asymmetries”.
It is intended to assist consumers to better understand services and products on offer and make better decisions.
It also promotes competition by making more transparent the key features of financial services and products, thereby allowing consumers to more easily make comparisons between them.
Of course, disclosure is only part of the answer in overcoming “information asymmetries” and empowering consumers.
We need to look at how Australian consumers actually go about making financial decisions.
One of the Government’s election policies was the establishment of a Consumer and Financial Literacy Foundation with a remit to improve the general level of community understanding about financial services and offer realistic expectations of what they can deliver.
This initiative is being headed by my colleague the Assistant Treasurer.
FSR Disclosure Requirements
As I have already noted, the FSR disclosure requirements apply to financial service providers and financial product issuers.
However they only apply in relation to retail clients. This is because wholesale clients are not considered to require the same degree of statutory protection to safeguard their interests.
All financial service providers are required to provide certain basic information when they first establish a relationship with a retail client. This includes the identity of the service providers, how services will be paid for, and the rights of redress available to the client.
Where personal advice is provided to a retail client, more detailed disclosure is required. Clients must generally be given a written copy of the advice as well as the basis on which it is provided.
They must also be given information about potential conflicts of interest. This ensures that they are able to properly evaluate the advice being provided.
Financial product issuers are subject to a different set of disclosure obligations in relation to retail clients.
They must provide consumers with information about the main characteristics of their products: including benefits, costs and risks associated with holding the product.
This information is only required to the extent that it is relevant to the product and the typical client’s needs. It is also required to be provided in a manner that is clear, concise and effective.
In addition to this “up front” disclosure obligation, issuers of investment type products are also generally required to provide ongoing performance information as well as details of transactions associated with the product.
These obligations are intended to ensure that investors can keep track of their money, and can switch investments if they are not satisfied with the returns they receive.
For completeness, I might add that certain special rules apply in relation to the disclosure of superannuation fees and charges.
As most of you would know, superannuation choice begins on 1 July this year. Given the importance of superannuation products, they are subject to some additional disclosure obligations.
Fees and charges must be disclosed using a consistent format and terminology.
Annual fees and changes must also be illustrated on the basis of common assumptions.
There is a boxed consumer advisory warning on the potential impact of fees and charges on investment returns over time.
Finally advisers are subject to additional disclosure obligations if they recommend that a person move from one superannuation fund to another.
Other Mechanisms of Consumer Protection
While the focus of my presentation this morning is on the disclosure requirements of the FSR, it is important for us to recognise that disclosure is not the sole, or even necessarily the most important, consumer protection mechanism in the FSR framework.
The FSR licensing regime requires financial service providers to meet certain minimum standards of competency and integrity.
It provides ASIC with a means to maintain basic quality standards and to weed out those that do not meet these standards.
The FSR framework also provides consumers with a range of remedies in the event that something goes wrong.
These include the requirement for licensees to provide internal and external dispute resolution mechanisms; cooling off rights for certain products and civil remedies where licensees breach their obligations.
Disclosure is only one element of an integrated consumer protection framework. To be really effective, the different elements must work in harmony with one another.
It is also important to note that different elements of the consumer protection framework may be more relevant to different services and products.
For example, in relation to some financial products, such as superannuation, disclosure is particularly important. However in other more straightforward products, it may be possible to place less reliance on up front disclosure and more on remedies such as cooling off and dispute resolution.
Are the objectives of the FSR disclosure regime being met?
The focus of my remarks this morning is the question of whether the FSR disclosure regime is currently achieving its intended objectives.
Firstly, is it providing consumers with the type of information that they can readily use to make better choices about financial services and financial products?
Secondly, is it promoting competition in the financial services industry, leading to better services and lower fees and charges?
Thirdly, do the benefits of the FSR disclosure regime for consumers justify the costs to industry participants of meeting their disclosure obligations under the new regime?
The issue of compliance costs is particularly important.
The benefits of disclosure must be weighed against its costs to industry, which in many cases are ultimately borne by consumers.
It is important to ensure that costs are not so high as to price some consumers out of the market for particular financial services.
It also important to ensure costs do not become a major barrier to market entry and hence to competition in the industry.
Since being appointed in October last year, I have met a met a large number of industry and consumer representatives.
These meetings have enabled me to obtain a large amount of high quality feedback on the effectiveness of the FSR disclosure regime – some of it good and some of it bad.
I have also consulted with Treasury and ASIC on the operation of the FSR legislation to gain the benefit of their respective insights.
I personally have also seen both good and bad examples of disclosure documents.
It appears to me that there is strong and unanimous support for the basic principles that underlie the FSR disclosure regime.
I have also been heartened by feedback from many industry participants that consumers are appreciative of the disclosure documents that are now being provided.
Some have claimed that the cost of complying with the FSR disclosure outweighs their potential benefits to consumers.
I’m aware of strongly held views in a few quarters that the requirements have resulted in such lengthy and complex documents that consumers are actually worse off than if they received no information at all.
Others have identified particular areas in which the current framework could be refined to improve outcomes for both consumers and industry participants.
The main areas that have been identified will come as no surprise to most of you in the audience.
These areas include, by way of example, the application of the regime to telephone transactions, whether it can be streamlined to reduce costs in relation to ongoing advisory relationships and the extent to which it should apply to particular financial products or in particular situations.
As some of you in the audience may be aware, the Financial Sector Advisory Council – FSAC – has also recently reviewed industry experience with the FSR framework.
FSAC is a high level advisory group that advises the Government on the impact of regulation on the operation of the financial industry and the broader economy.
The Council wrote to a wide range of industry bodies seeking their feedback on the initial operation of the FSR regime – both positive and negative.
It has provided the Government with a report that summarises this feedback and provides recommendations on how it might be possible to improve the operation of the current framework.
Given the importance of the regulatory framework for the operation of Australia’s financial services industry, and the importance of this industry to the economy as a whole, it is vital that we get the FSR disclosure regime right.
By this, I mean ensuring there is an appropriate balance between costs and benefits and that it serves the interests of consumers.
It is important to recognise that perceptions of “information overload” are not surprising.
As with any new regulatory framework, there will initially be a period where
everyone — regulators and regulated alike — is coming to terms with
the requirements.
And it’s only to be expected that many people will take a conservative
approach to applying the requirements during this time.
While this is understandable, it’s important to guard against an excessively cautious approach.
Disclosure is a tool for communication with consumers and should not merely be used as evidence of compliance with the legislation.
Unfortunately, I would say that some requirements of the FSR disclosure regime have been interpreted in an overly legalistic and restrictive way.
The end result has been that the disclosure documents themselves are designed more to manage the liability of the service provider, rather than to inform the consumer.
Having said that, I admit that it would be disingenuous of me to suggest that the responsibility for this outcome lies wholly with compliance professionals, legal advisers and the like.
There is evidence that the quality of disclosure documents has improved as industry has become more familiar with the FSR regime.
While initial disclosure documents may have had a greater compliance focus than would otherwise be desirable, many industry participants are now developing better disclosure documents that are more user friendly and may provide them with a competitive edge in the market place.
The challenge for me as Parliamentary Secretary is to determine the extent to which sub optimal outcomes are the result of flaws in the legislation and the extent to which they are the result of the way it is being administered by ASIC or interpreted by industry participants.
I suspect that we can each make an important contribution towards improving the operation of the regime.
I am committed to ensuring that the Government plays its part to improve the operation of the FSR disclosure regime by addressing any inadequacies that exist in the legislative framework.
To this end, I am working on a series of proposed refinements that I believe will improve the operation of the legislation.
These refinements will be based on the feedback I have received from industry and consumer representatives, as well as from Treasury, ASIC and FSAC.
I will then lead a process of consultation with industry and consumer representatives. I want to ensure that all industry players, both large and small, get the opportunity to air their views.
I cannot promise that the Government will agree to every suggestion that we receive. However I can assure you that we will give careful considerations to all suggestions.
It is particularly important to ensure that any proposed changes reduce compliance costs for industry rather than impose further burdens.
I am confident that with ongoing dialogue, we can ensure that the FSR disclosure requirements, and for that matter all aspects of the FSR framework – operate fully as intended to provide maximum benefit to all stakeholders.
Conclusion
In concluding, I would like to emphasise the following four points.
Firstly, efficient and flexible financial regulation is a key component of microeconomic reform and has an important bearing on economic performance.
Secondly, I place a very high priority on ensuring that the regulatory framework is operating as effectively as possible.
Thirdly, while I believe the FSR disclosure regime has benefited consumers by providing better information to make informed decisions, there is definite scope to improve its operation.
Most importantly, I believe there is room to lower costs to industry while improving outcomes for consumers.
Finally, I am committed to playing my part in this process by, where appropriate, refining the legislative framework in consultation with industry and consumer representatives.
It will then be a matter for the regulator and industry participants to work together to ensure the best outcomes for consumers and industry participants alike.
Thank you again for the invitation to speak to you today.
I trust you will enjoy the rest of the Summer School.