Sean Hughes says the Australian Financial System Inquiry has taken a refreshing stance and deserve credit for laying the groundwork for a mature conversation

By Sean Hughes*

Last Sunday, David Murray, the former CEO of Commonwealth Bank of Australia (ASB’s parent) and former chairman of the A$104 billion Future Fund, delivered his Financial System Inquiry’s 350 page report to the Treasurer.

The 44 recommendations (and the commentary which underpins them) have created an opportunity for a wide-ranging and diverse dialogue about the future of Australia’s financial system, its markets and the infrastructure underpinning them.

As Australia’s closest trading partner and host to its most significant Australian-domiciled financial institutions, it’s inevitable that New Zealand policy-makers at the Treasury and Ministry of Business, Innovation and Employment will turn some attention to what Mr Murray and his fellow panellists found in the course of their year-long review.

There is some sense that the Report has struck a fine balance between different interest groups and perspectives and from my reading on this side of the Tasman, no one sector appears to be either celebrating with great joy or grimacing in searing pain.

The recommendations are split into 5 broad categories, with a further 6th group of individual suggestions. These 5 topics are:

• Resilience
• Superannuation and Retirement Incomes
• Innovation
• Consumer Outcomes
• The Regulatory System

Some of the individual recommendations have already generated considerable debate, namely:

• Whether an estimated additional A$20 billion in recommended bank capital to make the country’s banking system more resilient to the inevitability of future crises is an over-reaction to the GFC, current heated domestic property markets in Sydney and Melbourne, and a capitulation to the regional and smaller banks’ submissions for a perceived level-playing field.

• Could a Chilean-style tender or auction process for default status for employees’ choice of superannuation funds, as well as mandating a majority of independent directors on corporate trustee boards of public offer superannuation funds, be seen to be a direct political attack on the trade union-affiliated industry fund sector, to the benefit of the for-profit retail fund sector.

• An end to direct borrowing for limited recourse borrowing arrangements by superannuation funds is unattractive to the self-managed superannuation fund and real estate sectors, as it could curb current high levels of property investment through negative gearing mechanisms.

Appealing opportunities

That said, there are some immediately appealing opportunities which policy-makers and market participants would do well to consider. These include:

• Moving away from an undue reliance on product disclosure as the regulator’s default (and sometimes only) tool to address the information imbalance between consumers and suppliers of financial products. Disclosure, the great panacea of the Wallis reforms 10 years ago, has had its day and its limitations are apparent.

The Inquiry recommends instead a new product design and distribution obligation, requiring issuers and distributors to consider both the needs of consumers and the appropriate distribution channel at 3 key moments in the product lifecycle: design, distribution and periodically post-sale.

• Providing the twin peaks regulators (ASIC and APRA) with more stable funding by adopting a 3-year funding model based on periodic funding and capability reviews. (On the sidelines of this, there is also a suggestion in the Report that the regulators should be overseen by a new accountability mechanism known as the Financial Regulator Assessment Board.

Whether politicians, market participants and the regulators themselves have the stomach for another public sector oversight body – when their performance is already subject to review by the Parliament and their decisions can be reviewed by an independent judiciary – remains to be seen.)

The Government has sought submissions on the Report and is open to consultation until 31 March 2015, after which time we will know which of the recommendations will be implemented and in what manner.

It’s too early to say what the Murray Inquiry will stand for. While its two predecessors (Campbell – market liberalisation and Wallis – regulatory architecture) adopted a SWOT analysis approach and sought to bridge the gap between then-current state and perceived nirvana, Murray has taken a refreshing stance of accepting the world as imperfect as it is and instead seeks to enhance the capability and capacity of the Australian financial system to respond to it.

The inevitability of product, distributor, market, consumer, global and technological innovation and challenge is accepted – and instead the recommendations aim to strike a balance between strengthened issuer and distributor accountability, enhancing meaningful competition in the sector, and keeping a tight lid on compliance costs and policy reform processes.

What might this mean for NZ?

What might all this mean for New Zealand – assuming any of it is adopted? Shareholders in the Australian banks are being warned to expect lower dividends as increased costs of capital are passed on to security-holders and customers alike. Borrowers (especially property investors relying on gearing to service interest-only mortgages) may well experience a tightening in the availability and terms of capital. The flip side should be an even greater resilience to shocks and enhanced stability.

Policy-makers and others in Wellington will no doubt look to the retirement income proposals, especially the focus on building a more attractive post-retirement income product suite, to reduce dependency on state-provided age pensions. That said, there are a host of capital, liquidity and tax issues which need to be addressed in the development of a market which is attractive to retirees.

Some of the other suggestions, especially around enhancing the regulators’ toolkits and regulatory funding/accountability mechanisms, may already be strategic topics for discussion between RBNZ and FMA at the NZ Council for Financial Regulators and trans-Tasman bank supervisors’ meetings.

Perhaps what characterises this report is that it hasn’t been produced off the back of a significant market failure or regulatory crisis – and this should minimise the risk of any ill-judged and hastily-formed policy solutions to respond to immediate political imperatives.

Mr Murray and his colleagues on the Inquiry deserve credit for proposing a suite of potential reform opportunities, which acknowledge the underlying strengths of the financial system, while recognising that change and improvement are a constant in a fast-evolving and competitive market-place.

Legislative tinkering and frequent policy switches are undesirable for all participants and consumers in areas such as banking, superannuation and wealth management, which rely on long-term planning and capability building. Whatever the political response to the recommendations, this report lays the groundwork for a mature conversation about the future of the financial markets over the next decade.

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*Sean Hughes is a senior executive at UniSuper, one of Australia’s largest superannuation funds with approximately A$42 billion under management. He was the inaugural CEO of New Zealand’s Financial Markets Authority, until his term ended in December 2013. The comments and views expressed in this note are his, and his alone.