With changes in technology, consumers have increasing access to complex financial products. But these products can be difficult to understand, and they test the limits of Australia’s disclosure-based regulatory regime.
The Government’s foreshadowed introduction of a new product intervention power is significant. The proposed power would allow ASIC to ‘modify, or if necessary ban harmful financial products where there is a risk of significant consumer detriment’. In Australia’s highly concentrated vertically integrated financial sector a new product intervention power could help promote competition, market integrity and resilience as well as protect consumers.
Its introduction would be consistent with the Financial System’s Inquiry’s other recommendation that ASIC become a more proactive regulator.
Of course, to implement the new power, ASIC will need to be a better funded regulator. It will require additional personnel and resources for greater surveillance, earlier involvement of senior ASIC staff and greater authority for rapid decision-making.
Complex Financial Products and the Modern World
Research suggests that take up of complex products is particularly influenced by behavioural biases: people respond automatically and unconsciously to try to simplify the decision-making process, leading to poor financial decisions.
Too often, financial products with complicated structures and a high degree of risk are labelled, described and promoted in a way that suggests they have lower risk.
Even when accurately disclosed, a consumer may not correctly understand the risk/return trade-off or the central features of the financial product or strategy.
Current Regulatory Limits
Australia’s present disclosure-based regime limits ASIC’s ability to react quickly to market developments involving the release of new complex structured products. There is no pre-release approval process. ASIC can only take action to rectify consumer loss after a breach or suspected breach of the law.
Further, ASIC can only take enforcement action against conduct causing consumer detriment on a firm-by-firm basis, even where the problem is industry-wide.
This truncated regulator stance persists in the face of a recent history of increasing (although less complex) product failures, with patchy regulatory follow up. These include:
• frozen mortgage managed investment schemes;
• unlisted debenture investments (such as Banksia Securities) where many consumers erroneously thought the products they bought were like bank term deposits;
• leveraged investment strategies such as agribusiness schemes (such as Great Southern);
A Product Intervention Power
Recognising the systemic risk of unsuitable take up by consumers of complex financial products, the 2014 Final Report of the Financial System Inquiry recommended a significant addition to the regulatory tool-kit:
The Inquiry believes that targeted early intervention would be more effective in reducing harm to consumers than waiting until detriment has occurred. The regulator should be able to be proactive in its supervision and enforcement. Significant consumer detriment could be reduced if ASIC had the power to stop a product from being sold or, where the product had already been sold, to prevent the problem from affecting a larger group of consumers.
The proposed power is less extensive than is in place in other jurisdictions, the Inquiry believing the same outcome can still be achieved. In 2012, the United Kingdom introduced product intervention rules, and since then it has used them to restrict the distribution of contingent convertible instruments. Similar changes have been reflected in Europe through amendments to the Markets in Financial Instruments Directive, with a view to increasing consumer protection. The US Consumer Financial Protection Bureau has the power to declare certain practices unfair, deceptive or abusive.
Interestingly, the Inquiry flatly eschewed broad approaches which reduce the risk of consumer detriment by prohibiting the distribution of classes of non-mainstream investment products to retail consumers (a measure taken in the UK). The Inquiry did not recommend the adoption of this approach because they “remove choice across a range of products for consumers who may understand the risk involved“.
Of course, the confidence the Inquiry felt in the capacity of consumers to understand financial products tends to reflect more widespread assumptions as to sufficiency of financial literacy – a reality that may not yet be as prevalent in the Australian community as one may hope or think.
ASIC and accountability
Accountability will be an important part of the application of this new power, unsurprising against a background of heightened focus on ASIC’s performance. The Inquiry spelt out that ASIC would be expected to issue a general policy (after public consultation) describing:
• when the power may be used
• the process of engagement with affected parties
• consultation with other regulators before the use of the power
• transparency in its use, and
• public reporting of the review of each use of this power.
The Inquiry sensibly recognised that an affected product issuer or distributor, or class of affected firms, should be able to seek judicial review on the use of the power. This marked an awareness of a concern about the reputational cost if the new power is used.
Recognising the difficulty in balancing the economy’s interest in fostering product innovation, promoting consumer protection and ensuring regulatory integrity, the FSI expressed its expectation that the power would be used “infrequently and as a last resort or pre-emptive measure”. The Government response to the FSI also anticipated its use will be “exceptional”.
Whether that proves so in practice remains to be seen. The introduction and use of the product intervention power has the potential to be a potent and much needed addition to the regulatory tool-kit.
17 April 2016
Dominique Hogan-Doran SC is an Australian barrister specialising in complex commercial and financial disputes, regulatory actions and public inquiries.
Liability limited by a scheme approved under Professional Standards Legislation.