Allens' second-round submission to the FSI: the nature and quality of financial services regulation

In brief

Written by Partner Marc Kemp and Senior Regulatory Counsel Michael Mathieson

On 26 August, we lodged our submission in response to the Financial System Inquiry's (FSI) Interim Report.

Although the Interim Report addresses the 'regulatory burden' and the 'volume of regulation', it does not address the nature and quality of financial services regulation. We think that this is an important issue – any attempt to deal with the regulatory burden, without dealing with the sprawling nature and the poor quality of much of the regulation governing financial services, would be incomplete. Two examples of what we would describe as bad quality law are:

• the rules governing financial product disclosure (see Part 7.9 of the Corporations Act); and
• the Future of Financial Advice provisions (see Part 7.7A of the Corporations Act).

The Interim Report identifies 'a predictable rule of law' as a pre-requisite to a well-functioning financial system. The rule of law is undermined when regulation is unclear and inaccessible to those affected by it, as well as those who enforce it. The questionable value of some of the guidance material prepared by the regulators is indicative of the difficulty of understanding what the regulation means.
Our submission also addresses the idea of expanding the duties owed by directors of APRA-regulated entities, in particular bank directors. Michael Mathieson and Michelle Levy summarise our views on that idea separately in this edition of Unravelled.

Bad quality law I: financial product disclosure

The Corporations Act, the Corporations Regulations and ASIC class orders contain literally hundreds of provisions which establish separate disclosure regimes for myriad products, from superannuation products, through IDPS and IDPS-like schemes, to simple managed investment schemes, and many others besides. The preparation of a PDS for a MySuper product, for example, at times seems to open the door to a Kafkaesque world where every statement is unexpectedly modified by a class order or regulation which is itself modified in turn. Other products, such as unlisted property schemes, infrastructure funds and hedge funds, have the additional overlay of 'if not, why not' so-called 'enhanced' disclosure guidance from ASIC.

Given this, it seems a little unfair to criticise product issuers for complex and long documents, while leaving the legislation untouched.

The state of affairs represented by the disparate disclosure regimes is regrettable and unnecessary. More tinkering is only likely to compound the problem – to a large degree the disparate regimes are the result of previous attempts made over many years to improve disclosure. We think that there is no real alternative to abolishing the current disclosure regime and starting again. We are concerned that the FSI might recommend more tinkering.

Bad quality law II: Future of Financial Advice

Turning to the Future of Financial Advice provisions, they are some of the poorest quality legislative provisions we have ever seen. In many respects, they are very unclear. The limitations on the grandfathering of conflicted remuneration stand out as provisions that are very difficult to understand and apply and which produce outcomes that were clearly not intended.

We appreciate that there is unlikely to be any real appetite to revisit the FoFA provisions, at least in terms of the quality of the drafting, anytime soon. However, we do identify those provisions as an example of a problem – very poor quality law – which adds considerably to the regulatory burden for industry participants and regulators. The Senate Economic References Committee's report into the performance of ASIC recommended that ASIC be more willing to prosecute breaches of financial services regulation. This is very difficult when the law is so unclear.

Regulator guidance: how helpful?

Finally, we do not agree with the unqualified statement in the Interim Report that 'guidance material produced by Regulators…helps the regulated population comply with regulation'.

Not infrequently, regulators have no sound basis in the law for their views. In some cases, they are asked to try to remedy problems in regulation through guidance and class orders, or issue class – we are aware of recent examples where ASIC has been asked by Treasury and Government to modify legislation (that has only recently been enacted) by class order, and, in other cases, to attempt to do so by regulatory guidance. There is also at least one example of ASIC modifying legislation by class order to respond to with the consequences of a view it has expressed in its guidance (that the issue price of an interest in a managed investment scheme should be 'independently verifiable') – a curious case of guidance effectively becoming law.

While class orders may provide relief, they add to the difficulty in applying the law and sometimes in even knowing what the law is. This difficulty is added to when regulatory guidance reflects what the regulator thinks the law should say, not what it does say.

One example of this was illustrated recently. On 8 August 2014, ASIC announced that it would take no action where a self-managed superannuation fund trustee is treated as a wholesale client, notwithstanding that the trustee does not meet the $10 million net asset threshold, even though the financial service in question may relate to a superannuation product. It did so despite its view to the contrary published in 2004 (in QFS 150). In changing its mind on this issue, ASIC referred to the 'ongoing legal uncertainty about when a financial service relates to a superannuation product'. It said nothing of its own contribution to the uncertainty, made through QFS 150.

This is not intended to be a criticism of all regulatory guidance. FAQs issued by both ASIC and APRA can be an effective means of allowing the regulators to provide practical assistance to industry. Not only can they be timely and to the point, but they can readily be changed or updated if, on further reflection or with the benefit of industry feedback, the regulator changes its mind about the correct response.