Introduce product intervention power
Introduce a proactive product intervention power that would enhance the regulatory toolkit available where there is risk of significant consumer detriment.
Government should amend the law to provide ASIC with a product intervention power. ASIC should be equipped to take a more proactive approach to reducing the risk of significant detriment to consumers with a new power to allow for more timely and targeted intervention. This power should be used as a last resort or pre-emptive measure where there is risk of significant detriment to a class of consumers. This power would enable intervention without a demonstrated or suspected breach of the law. Given the potential significant commercial impact of this power, the regulator should be held to a high level of accountability for its use.
This power would allow the regulator to intervene to require or impose:
- Amendments to marketing and disclosure materials.
- Warnings to consumers, and labelling or terminology changes.
- Distribution restrictions.
- Product banning.
This power is not intended to address problems with pricing of retail financial products, where consumers might be paying more than expected for a particular product or where a large number of consumers have incurred a small detriment.
The power would be limited to temporary intervention for 12 months. The temporary intervention could be extended by Government if more time was needed either by industry to change its relevant practices or for Government to implement permanent reform. The power could be used against an individual firm or class of firms in relation to a product or class of products. The power would be subject to a judicial review mechanism.
ASIC would be required to consult with the Australian Prudential Regulation Authority (APRA) prior to using this power when it may affect an APRA-regulated body. Government should review the use of this power after five years.
The Inquiry’s view is that providing ASIC with this new power complements the need for a proactive market-based regulator. The efficacy of this power depends on a strong, independent and accountable regulator. As part of its overall assessment of ASIC’s performance against its mandate, the proposed Financial Regulator Assessment Board should assess the use of this new power. (See Chapter 5: Regulatory system for a range of complementary recommendations.)
- Reduce significant detriment arising from consumers buying financial products they do not understand.
- Limit or avoid the future need for more prescriptive regulation.
- Build consumer confidence and trust in the financial system and, in turn, improve efficiency through increased consumer engagement and participation.
Problem the recommendation seeks to address
Currently, ASIC can only take action to rectify consumer detriment after a breach or suspected breach of the law by a firm. 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.
Australia has had cases of significant consumer detriment where ASIC had exhausted its current regulatory toolkit and where there was no clear basis to take enforcement action. These include:
- Mortgage managed investment schemes (MISs), where close to 100 were frozen in the market downturn during the global financial crisis. More than 4,000 consumers received hardship relief, indicating that many did not expect an investment of this type to be illiquid.22
- Unlisted debenture investments, such as Banksia Securities, where many consumers thought the products they bought were like bank term deposits. More than 1,500 consumers have lost more than $100 million after recoveries to date.23 Prior to the collapses, ASIC took action to stop a number of individual pieces of marketing, but that did not correct consumers’ overall impressions about the level of risk involved.
In both cases, ASIC responded to the emerging risk of significant consumer detriment by providing guidance on the nature of disclosure that should accompany these products. However, ASIC did not have power to impose such disclosure requirements, instead seeking to create an expectation on firms to provide clearer disclosure that outlined the risk and central features of the products.
There have also been cases where ASIC lacked a broad toolkit to respond effectively and in a timely way to an emerging risk of significant consumer detriment. For example, the following cases involving leveraged investment strategies that exacerbated the loss for many consumers:
- Agribusiness schemes, where the product did not perform in the way that consumers were led to believe, including schemes relying on ongoing sales to fund their operations. Many consumers did not understand the potential risk of borrowing to invest in these products. In total, more than 65,000 consumers invested and lost close to $3 billion.
- Financial collapses that involved poor distribution practices, such as Storm Financial and Opes Prime. More than 3,000 consumers lost more than $1.4 billion, of which around half was recovered.24
Although these cases have a number of contributing causes, a strong, independent and accountable ASIC, as recommended in Chapter 5: Regulatory system, in combination with early intervention using the proposed power, would likely reduce consumer losses in similar situations.
Changes in technology mean that consumers have increasing access to complex products, which can involve complicated structures and heightened risk. These products may be difficult for consumers to understand, testing the limits of the disclosure-based regulatory regime. For example, some structured products have a high degree of risk, but are labelled, described and promoted in a way that suggests they have lower risk.25 In such cases, consumers may still not understand the risk/return trade-off or the central features of the financial product or strategy, even where they are accurately disclosed.
Although complexity does not necessarily correlate to higher risk, complex features make it particularly difficult for consumers to assess the risk and appropriate pricing of higher-risk products. ASIC found that 71 per cent of survey respondents, including industry participants, consumers and financial literacy specialists, believe that Australian consumers do not understand the risk involved with complex products.26 Also, complex products are particularly influenced by behavioural biases: people respond automatically and unconsciously to try to simplify the decision-making process, leading to poor financial decisions.27
That said, the risk of consumer confusion about risk and features is not limited to complex products. Past case studies involving margin loans, mortgage schemes and debentures indicate consumers may also misunderstand less complex products and their core features and risk.28 Many consumers find information imbalances or behavioural biases hard to overcome. Some current product distribution strategies also hamper understanding. For example, investors in CFDs may rely disproportionately on issuer marketing materials, which may not provide a sufficient basis for making an informed decision.29 (See Recommendation 21: Strengthen product issuer and distributor accountability.)
This recommendation takes into account the Senate Economics References Committee’s report on ASIC’s performance. The Senate Committee suggested that urgent attention should be given to providing ASIC with the necessary toolkit to prevent consumer detriment through allowing ASIC to intervene and prohibit the issue of certain products in retail markets.30
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 Inquiry raised two options in its Interim Report to reduce consumer detriment:
- Recommended: Introduce a product intervention power.
- Introduce default products for a range of basic financial needs; for example, deposits, home and contents insurance and basic investments.
In response to the Interim Report, submissions also suggested the following additional option:
- Prohibit distribution of certain classes of non-mainstream products to retail consumers.
Option costs and benefits
Introduce product intervention power
Most consumer group submissions support a broad intervention power.31 The banking industry supports the ability to ban products temporarily where detriment to consumers is significantly likely, but not to prescribe terminology or restrict product features, due to the potential constraints on product innovation.32 However, many industry stakeholders do not support changes of this nature, citing concerns about misuse of the power obstructing legitimate business opportunities. Others believe such a power needs court or parliamentary oversight. They question whether ASIC’s cultural and skills mix is sufficient to carry out the responsibilities associated with such a power. On the other hand, some believe additional powers “… would allow ASIC to react quickly to market developments”.33
Some stakeholders believe the nature of the powers would create uncertainty, constrain innovation, detract from consumer accountability and introduce costs that may be borne by consumers. They are also concerned about the reputational cost if the new power is used. The Inquiry considers these concerns can be addressed by the design and implementation of the power. Specifically:
- If the power is used effectively, it should not significantly affect innovation. The power is expected to be used infrequently and as a last resort or pre-emptive measure. In addition, this power is not intended to be used for pre-approval of products as this is likely to result in moral hazard: the perception that no regulator intervention implies a low-risk product.
- This power is not intended to alleviate consumers from bearing responsibility for their financial decisions. This would be made clear when the power is implemented.
- Firms with robust product design and distribution practices should not face additional regulatory costs as the focus would be on products being distributed to consumers who do not understand the central features of the products, such as risk. ASIC engagement with potentially affected firms would allow these firms to change their practices before any use of the power, thereby limiting public reputational damage.
- The regulator would be accountable for the use of its power, and it would be subject to post-implementation review. ASIC would be expected to engage with potentially affected firms and to consult with Council of Financial Regulators colleagues before any use of the power, including consulting with APRA where prudentially regulated firms may be affected.
This recommendation would be consistent with policy responses in most peer jurisdictions, which have taken an increasingly proactive regulatory stance. In 2012, the United Kingdom introduced product intervention rules, and since then it has used them to restrict the distribution of contingent convertible instruments.34 Similar changes have been reflected in Europe through amendments to the Markets in Financial Instruments Directive, with a view to increasing consumer protection.35 The US Consumer Financial Protection Bureau has the power to declare certain practices unfair, deceptive or abusive.36 However, the Inquiry believes that the same outcome can be achieved in Australia with a less extensive power than is in place in these jurisdictions.
Many cases of financial firm failure include situations where consumers have failed to understand the risk/return trade-off involved in a product, even if disclosure and advice were compliant. Examples of cases discussed earlier have affected a significant number of Australians, and involved large uncompensated losses. Although it is hard to quantify the dollar value of the consumer detriment the power might prevent, the Inquiry believes that the benefits to consumers would be substantial.
In addition, as discussed in Recommendation 21: Strengthen product issuer and distributor accountability in this chapter, consumer confidence and trust in the financial system can be improved by shifting to a more proactive regulator.
Introduce default products
Introducing default products would involve significant new powers and require considerable resources and skilled personnel. Although some areas may need default products, such as superannuation, where consumers are compelled to participate, the Inquiry does not believe this rationale extends to other product types. Widening the pool of default products may risk significantly limiting innovation and reducing competition.
Prohibit distribution of products
Some international jurisdictions have prohibited the distribution of certain classes of product to retail consumers. For example, in the United Kingdom, non-mainstream investment products are prohibited from being distributed to retail consumers.37
Although such measures may reduce the risk of detriment, they take a broad approach and remove choice across a range of products for consumers who may understand the risk involved. For this reason, the Inquiry does not recommend them.
The Inquiry believes it is important to reduce consumer detriment and rebuild consumer confidence and trust in the financial system in the longer term. A more proactive approach to improving retail consumer outcomes underscores the importance of financial firms treating consumers fairly. This is a significant new power that is consistent with having a proactive regulator. The power should be used carefully, and ASIC should be accountable for its use as discussed in Chapter 5: Regulatory system.
Accountability would be an important part of the application of this new power. ASIC would be expected to issue 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. An affected product issuer or distributor, or class of affected firms, should be able to seek judicial review on the use of the power.
Given the significance of this new kind of power, Government should review its use after five years.
22 Parliamentary Joint Committee on Corporations and Financial Services 2011, Statutory oversight of the Australian Securities and Investments Commission, 28 February, Commonwealth of Australia, Canberra, page 10.
23 McGrathNicol 2012, Banksia Securities Limited Cherry Fund Limited (Receivers and Managers appointed to both companies): Receivers and Managers’ Report to debenture holders, Sydney, page 14; McGrathNicol 2014, Banksia Securities Limited (Receivers and Managers appointed): Circular to debenture holders, Sydney, page 1.
24 Australian Securities and Investments Commission (ASIC) 2014, First round submission to the Financial System Inquiry, page 191; ASIC 2013, Verdict in Opes Prime director trial, media release, 6 September.
25 Australian Securities and Investments Commission (ASIC) 2013, Report 340: ‘Capital protected’ and ‘capital guaranteed’ retail structured products, ASIC, Sydney, page 8.
26 Australian Securities and Investments Commission (ASIC) 2013, ASIC Stakeholder survey, ASIC, Sydney, page 28. Survey conducted by Susan Bell Research, covering 1,468 stakeholders.
27 Kahneman, D 2011, Thinking Fast and Slow, Penguin Books Ltd, London, page 224.
28 For example, Parliamentary Joint Committee on Corporations and Financial Services 2009, Inquiry into financial products and services in Australia, Canberra, Commonwealth of Australia, pages 28–30, 56–58; Australian Securities and Investments Commission (ASIC) 2012, Regulation impact statement: Mortgage schemes: Strengthening disclosure under RG 45, ASIC, Sydney, pages 12–13.
29 Australian Securities and Investments Commission (ASIC) 2010, Report 205: Contracts for difference and retail investors, ASIC, Sydney, page 8.
30 Senate Economics References Committee 2014, Performance of the Australian Securities and Investments Commission, Canberra, Commonwealth of Australia, pages 442–443.
31 For example, Superannuation Consumers’ Centre 2014, Second round submission to the Financial System Inquiry, pages 14–15.
32 Australian Bankers’ Association 2014, Second round submission to the Financial System Inquiry, page 51.
33 Deloitte Access Economics 2014, Second round submission to the Financial System Inquiry, page 58.
34 Financial Conduct Authority (FCA) 2014, Restrictions in relation to the retail distribution of contingent convertible instruments, FCA, London.
35 European Securities and Markets Authority (ESMA) 2014, Consultation Paper: MIFID/MiFIR, ESMA, Paris, page 166.
36 Dodd-Frank Wall Street Reform and Consumer Protection Act 2010, USA, s1031.
37 Financial Conduct Authority (FCA) 2013, PS13/3: Restrictions on the retail distribution of unregulated collective investment schemes and close substitutes, FCA, London.